SE Machinery Pty Ltd [SEM] is a private resident Australian company incorporatedin 1981. The company develops and manufactures Teftoffel, a component used in themanufacture of small engines.The following financial information relates to SEM for the year ended 30 June 2012.[Disregard GST.]RevenueGross trading income $3,035,000Australian public company dividends received($600 imputation credits attached) 2,000Profit on sale of fixed assets - furniture 2,600 3,039,600ExpensesBad debt written off 8,000Cost of borrowing funds to finance working capital 300Depreciation (including Buildings) 175,000Education fees 22,000Entertainment expenses 15,000Fringe benefits tax 43,000Legal expenses 4,600Loss on sale of fixed assets - precision machinery 1,000Overseas travelling expenses 24,000Provision for long service leave 26,000Repairs & maintenance 64,500Research & development (carried out by CSIRO) 20,000Salaries & wages 948,650Superannuation contributions 76,000Other expenses (all tax deductible) 200,000 1,628,050Net profit before tax 1,411,550Other information

1. On 1 May 2011 SEM received a special order and payment for ten cartons ofTeftoffelex - a new product. The manufacture of Teftoffelex required somemodification the company's production system. The customer agreed tocontribute $500,000 to the cost of modifications. Under the terms of thecontract the amount was described as ‘capital contribution to establishmentand construction costs'.The contract provided for supply of Teftoffelex in August 2012 and theadvance payment of the agreed price as follows:Capital contribution to modifications $ 500,000100 cartons @ $7,000 $ 700,000$1,200,000The amount of $1,200,000 is included in gross profit.Required 1 [Approx 500 words](a) Advise the taxpayer whether the amount of $500,000 is assessable under s6-5.[Cite relevant authority.](b) Advise the taxpayer whether the Arthur Murray principle applies to some orall of the $1,200,000 amount.Other Information (continued)

2. The bad debt of $8000 was written-off after SEM entered into a scheme ofarrangement to accept 40 cents in the dollar from a bankrupt debtor.

3. On 1 February 2012 SEM borrowed $25,000 for 3 years @ 8% to financeworking capital. Borrowing expenses were $300.

4. Depreciation:Company policy is to use straight line [prime cost] depreciation and toadopt tax rates for accounting purposes except in respect of buildings.Building depreciation was $15,000. Apart from extensions [Note 6], allbuildings were constructed before 1982. Included in the expense isdepreciation on motor vehicles provided to staff (except new car forManaging Director - Note 5).

5. Fixed assets disposed of during the year were:? Furniture - cost $4,000- adjusted value 2,926- termination value 20/6/12 5,526? Precision machinery - cost 5,000- adjusted value 3,277- termination value 1/11/11 2,277

6. Additions to fixed assets during 2011/11:? Extensions to administration building - construction commenced1/10/11; occupied 1/4/12: $100,000? Motor vehicle for Managing Director - purchased 1/7/11; $65,466.

7. Education expenses:In accordance with a resolution of the directors, the company paid theschool fees of the directors' children. The reason given for the policywas to provide a standard of educational instruction appropriate to thepossible future directors of the company.

8. Entertainment expenses of $15,000 was spent on meals at restaurants. Recordsshow 60% related to employees and their associates and 40% related to clients.The company uses the actual basis for FBT meal entertainment valuationpurposes.

9. Legal expenses comprised:? Redrafting the company's Memorandum and Articles 2,000? Debt collection 2,100? Advice on dismissal of a senior staff member for misconduct 500

10. Overseas travel:In December 2011 one of the directors travelled to the USA to seek outnew agencies to handle the company's products; costs totalled $11,000.In February 2012 the Marketing Manager attended the InternationalEngine Exhibition in Singapore. His wife accompanied him. After theExhibition they travelled to China for a week's holidaying.- Singapore costs: 5,000- China costs 8,000 13,000(The company accepts FBT liability for the China trip.)

11. Long service leave paid in 2011/12: $20,395.12. The following amounts were debited to Repairs & Maintenance Expense:? Costs incurred in early November 2011 replacing the roof on a buildingpurchased for use as a warehouse in August 2011. The work wascompleted on 12 November: $7,000.? Costs of converting an old store into a lunch and change room foremployees; completed 31 October 2011; life 5 years:- showers and toilets 30,000- partitioning and panelling 10,000- furniture for lunch room 5,000Required 2:

1. Indicate with explanations, sections of the Acts and relevant caselaw how the Revenue and Expense items (together with the Notes)in the company's accounts are treated for tax purposes.

2. Calculate SEM Pty Ltd's taxable income for 2011/12.