Seminar 3: Taxation of Companies; Taxation of Partnerships

Company Questions

Question 1

A resident company, owned by two resident individuals, has an opening credit balance of
$7,000 in its franking account in this income year. It has the following transactions in the
year:

• on 18 July, it paid a PAYG instalment of $30,000;

Franking credit: $30,000 (s205-15)
Franking account balance: $7,000 + $30,000 = $37,000
• on 29 August, it paid a $35,000 cash dividend franked to 80%;
Franking credit: 35,000 × 0.80 × 30/70 = 12,000
Franking debit: $12,000 (s205-30)
Franking account balance: $37,000 - $12,000 = $25,000
• on 3 September, it received a $28,000 cash dividend franked to 90%;
Franking credit: 28,000 × 0.90 × 30/70 =10,800 (s205-15)
Franking account balance: $25,000 + $10,800 = $35,800
• on 21 September, it paid a $7,000 cash dividend with franking credits of $1,800
attached;
Franking debit: $1,800
Franking account balance: $35,800 - $1,800 = $34,000
Maximum franking credit: 3,000
“Benchmark franking percentage”: franking percentage of the first frankable distribution in
the franking period (s 203-30)  80% is the benchmark
Under-franked: 1800/3000 = 60%, but the benchmark is 80% (it must be 2,400)
 Franking differential is 20% - 20% x 30/70 x 7,000 = 600
Franking debit: 600
Franking account balance: 34,000 – 600 = 33,400
• on 5 October, salaries paid to one of its shareholders were deemed to be dividends
under Div 7A of ITAA36. The amount of deemed dividend was $21,000;
(unfrankable so no debit)
• on 2 February, it received an income tax refund of $18,000 from the ATO;
Franking credit: $18,000
Franking account balance: $25,000 + $18,000 = $43,000
• on 10 March, it paid a $20,000 cash dividend franked to 95%; and
Franking debit: 20,000 × 0.95 × 30/70 = 8,142.86
Franking account balance: $43,000 - $8,142.86 = $34,857.14
• it had a $90,000 PAYG instalment due on 21 April, but did not pay it until 3 July in
the following income year.
No immediate effect on the current year's franking account balance as it is paid in the next
year.

Franking account closing balance: $34,857.14

Required: Prepare the company's franking account for this income year.

Question 2

Green Planet Pty Ltd was incorporated to research and develop a new technology to produce
biodegradable plastic from seaweed. After making losses for several years, a venture capital
company purchased 60% of the shares in the company. The company then discovered that the
“seaweed to plastic” technology can also be used to make an organic fertiliser. This new
product contributed 40% of the turnover of the company, which turned around and made a
profit in the current income year.

Required: Advise whether the company can use the carry forward losses in this income
year.

The first issue is whether the company pass the CoT test under s165-12. Continuity of
Ownership Test (CoT) requires the company must maintain the same majority owners during
the "ownership test period," which means the same person holding more than 50% of the
voting power, dividend rights, and capital distribution rights of company. Ownership test
period start of the loss year to end of the current year: s 165-12(1). Since a venture capital
company now owns 60% of the shares Green Planet Pty Ltd due to the losses, which means
there was transfer of ownership and the Green Planet Pty Ltd hold only 40% maximum (in
case there is no company, except a venture capital company, purchased the shares).
Therefore, the continuity of ownership test may not be satisfied because the ownership has
significantly changed from the period when the losses were incurred.

If the company didn’t pass the CoT, the next issue is whether it passed the Business
Continuity Test (BCT) under s165-13. If Green Planet Pty Ltd fails the CoT, it must satisfy
the BCT, which involves either the Same Business Test (SaBT) under s165-210 ITAA97 or
the Similar Business Test (SiBT) under s165-211 ITAA97. Regarding the SiBT, the company
can pass this test if the business it is carrying on is similar to the business it was carrying on
before the change in ownership. Since the new product (organic fertiliser) is related to the
original research (biodegradable plastic from seaweed) and the firm use of assets in current
and former businesses that use the same technology, Green Planet Pty Ltd. is still following
the same concept of business is researching and developing new biodegradable products. The
company might satisfy the SiBT because they satisfy these criteria. Therefore, Green Planet
Pty Ltd is likely to utilise its carry-forward losses if it can demonstrate that the business
activities remain similar under the SiBT, despite failing the CoT due to the significant change
in ownership.

Include this one if have enough time/wordcount: Same Business Test (SaBT) requires the
company must carry on the same business it carried on immediately before the "test time”
and not derive any assessable income from a new kind of business or new kind of transaction
that it did not carry on or enter into before the “test time”. The “test time” here is generally
the time when the company fails CoT. According to the fact, we know that Green Planet Pty
Ltd has diversified its business activities significantly from its original business because the
firm generated assessable income from transactions of selling organic fertilisers, which it
didn’t enter before the “test time” . Before the “test time”, the company carried on
transactions of biodegradable plastic from seaweed only. Therefore, the firm might fail this
test.
 If not, just include the relevant test.

SaBT:
https://www.ato.gov.au/law/view/view.htm?docid=EV/1051771401434&PiT=999912312359
58#:~:text=Paragraph%2013%20of%20TR%201999,sense%20of%20the%20identical
%20business.

SiBT: https://www.ato.gov.au/law/view/document?DocID=TXR/TR20191/NAT/ATO/00001
 This Ruling applies to income years commencing both before and after its date of
issue. However, this Ruling will not apply to taxpayers to the extent that it conflicts
with the terms of a settlement of a dispute agreed to before the date of issue of this
Ruling (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10 Public Rulings).

Partnership Questions

Question 1

Peter and Jill are in a partnership as retailers of electrical goods. The partnership records,
exclusive of GST, for this income year disclose:

Receipts ($):
300,000 Gross receipts from trading
Payments ($):
100,000 Purchases of trading stocks
30,000 Partners' salaries (each)
2,000 Interest on cash advance made to the partnership by Peter
60,000 Salaries for employees and rent paid
2,000 Legal expenses in recovering bad debts

Other details:
• Peter and Jill share partnership profits equally
• Trading stock on hand 1 July: $10,000 • Trading stock on hand 30 June: $20,000
Difference in trading stock: 20,000 – 10,000 = 10,000
Since closing stock is higher than opening stock, therefore the amount will be included in
asessable income under s70-35 ITAA97
• Peter's personal records disclose:
• Gambling winnings: $2,000
• Net salary as a part-time instructor (excluding PAYG tax instalments of $2,000):
$5,000
• Subscription to professional journals: $500
• Peter is a member of a private health fund
Required: Calculate Peter's taxable income for the income year explaining your
treatment of each item in this question.

(1) Net income of partnership:

- Assessable income
Gross receipt from trading: s6-5 ITAA97 300,000
Excess of closing trading stock over opening stock: s70-35 10,000
- Deductions:
Purchases of trading stock: s8-1 ITAA97 100,000
Employee salaries & rent: s 8-1 ITAA97 60,000
Legal expenses in recovering bad debts: s8-1 ITAA 97 2,000
Net income of partnership 148,000

- The AAT held that partners cannot employ themselves and pay themselves a salary:
Scott’s case. Therefore, the amount of 30,00 each for Partners' salaries won’t be
deductible.
- Interest received by partner is included in their assessable income: FCT v Roberts and
Smith (1992) and TR 95/25. Therefore, the interest paid to Peter on the cash advance
is not regarded as an expense and is not deductible by the partnership.

(2) Peter’s taxable income:

- Gambling winnings of $2,000 won’t be included in Peter’s assessable income because
there is no regular and skill involved, but it’s just a matter of luck. Contrast with
Kelly’s case.
- Interest received by partner is included in their assessable income: FCT v Roberts and
Smith (1992) and TR 95/25, therefore the 2,000 amount will be included in Peter’s
assessable income.

- Assessable income
Share of partnership net income 74,000
($148,000 x 50%): s92 ITAA36
Partner’s salary 30,000
Interest on cash advance 2,000
Net salary as a part-time instructor 7,000
- Deductions:
Professional jounals suscriptions: s8-1 ITAA97 500
Taxable income 112,500

Question 2

Alasdair is a retired solicitor. His wife Tracy is a retired school teacher. Both wish to remain
active and they invest in a gift shop that is to be managed by their daughter Carol, who is
aged 35. They form a partnership of three called “Carol's Gift Shop”.

Alasdair and Tracy contributed $40,000 each to fund the purchase of the shop. The
partnership agreement provides:
 • Both Alasdair and Tracy are to receive interest at the rate of 10% pa on their capital
contribution of $40,000.
• Carol will receive a salary of $25,000 for the management of the shop, as well as
superannuation contributions of $6,000.
• A car will be leased by the business and provided to Carol.
• All profits and losses are to be shared equally between the three partners.

The accounts for this income year show the following:

Income ($)

Sales (excluding GST) 240,000

Expenses ($)

Cost of goods sold 130,000

Interest on capital paid to Alasdair and Tracy 8,000
Salary to Carol 25,000
Superannuation to Carol 6,000
Lease payments on car (excluding GST) 7,000
Other deductible operating expenses (excluding GST) 14,000

The leased car was used 80% of the time for business and 20% of the time for private
purposes.
Lease payments on car (80% business use): $7,000 * 80% = $5,600

Required: With reference to the facts above:

1 Calculate the net income of the partnership. Show the allocation of net income to
each of the three partners.
(1) Net income of partnership:
$
Assessable income:
- sales: s 6-5 ITAA97 240,000
Deductions:
- cost of goods sold: s 8-1 ITAA97 130,000
- car lease payments ($7,000 x 80%) 5,600
- other deductible expenses 14,000
Net income of partnership 90,400

Superannuation to Carol 6,000 not deductible because partners cannot employ themselves.
Take out the salary = $25,000
Take out the interest on capital = $8,000

90,400 - 33,000 = $57,400

Since there are 3 partners and the profit and loss are shared equally among the partners -
57,400/3 = $19,133.33

Distributions to partners
Alasdair
Interest (40,000 x 10%) 4,000
Share of net income of partnership (84,400/3) $23,133
Tracy
Interest (40,000 x 10%) 4,000
Share of net income of partnership (51,400/3) $23,133
Carol
Superannuation 6,000
Partner’s salary and super 25,000
Share of net income of partnership ($51,400 / 3) 30,133

2 Explain if the provision of the motor vehicle by the partnership to Carol imposes
any fringe benefits tax liability on the partnership.
The provision of the motor vehicle is not subject to FBT because Carol, as a partner of the
partnership, is not regarded as an employee of the partnership.

The car provided to Carol is used 20% for private purposes. This constitutes a fringe benefit.
FBT is payable on the private use portion of the car.

FBT Calculation:
Total lease payments: $7,000
Private use portion: 20% of $7,000 = $1,400
The partnership needs to account for FBT on $1,400.