Module 2 Principles of assessable income (CPA 105)

CPA 105 Taxation

Module 2 Principles of assessable income

Question 1
During the 2007/08 tax year, Alfred Allen sustained a serious injury in the course of his employment. As a result
of this injury, Allen received the following amounts:
$
■ Workers compensation for loss of wages 2400

■ Reimbursement from the employer’s accident and health plan for medical expenses 1800
paid by Allen

■ Damages for personal injuries 8000

How much of the above amounts should Allen include in his gross income for the 2007/08 tax year?

a. $1800.
b. $2400.
c. $4200.
d. $12 200.

Question 2
Dr Anne Berger, a physician, reports on the cash basis. The following items relate to Dr Berger’s medical
practice in 2007/08:
$
■ Cash received from patients in 2007/08 200 000

■ Cash received in 2007/08 from third-party reimbursers for services provided by Dr Berger 30 000
in 2006/07

■ Salaries paid to employees in 2007/08 20 000

■ Other expenses paid in 2007/08 24 000

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What is Dr Berger’s net income for 2007/08 from her medical practice?

a. $200 000.
b. $156 000.
c. $230 000.
d. $186 000.

Question 3
In preparing the taxation return for an Australian resident individual, which one of the following is
exempt income?

a. An amount received weekly for two months under an industrial accident insurance policy.
b. A salary from working in the United States for two months. Tax was paid in the USA on the salary.
c. A salary for part-time service in the Naval Reserve.
d. A dividend received from a company resident in the United Kingdom, on which withholding tax had
been paid in the United Kingdom.

Question 4
Which of the following statements are correct?

I. A cash dividend paid out of an asset revaluation reserve is not assessable income.
II. Where a royalty comes within the operation of s.15-20 it is assessable income if it is of a capital nature.
III. Foreign exchange gains made on the purchase of trading stock are assessable income under Division 775
of the Income Tax Assessment Act 1997 (Cwlth).
IV. Companies which are not incorporated in Australia cannot be resident in Australia for tax purposes.

a. I and II only.
b. I and III only.
c. II and III only.
d. III and IV only.

Question 5
At 30 June 2008, Snowball Ltd had the following stock on hand with the following values:

Market selling Replacement

Unit Cost value price
$ $ $
A 100 150 125
B 80 90 70
C 400 300 390
D 375 500 450

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If Snowball Ltd wishes to minimise its tax payable for the year, it should value its closing stock at:

a. $825.
b. $845.
c. $955.
d. $1140.

Question 6
Which of the following can be treated as trading stock for income tax purposes?

I. Videos held by a video lending library for hire to customers.

II. Pine trees growing in a pine forest.
III. Detergents used to clean manufacturing machinery.

a. I only.
b. I and II only.
c. II and III only.
d. None of the items I, II and III.

Question 7
Which of the following is not a factor useful in determining whether a taxpayer is carrying on a business?

a. The taxpayer’s intention with respect to receipts exceeding outgoings.

b. The existence of repetitive transactions.
c. The legality of the taxpayer’s operations.
d. The extent to which the taxpayer is prepared to trade with the public at large.

Question 8
Joel recently died having operated a small sales business as a sole trader for many years. On Joel’s passing,
his business ceased operating. From Joel’s records, the following information regarding stock on hand at the
date of death has been obtained:

Market Replacement
Cost selling value value
Product A $100 $475 $230
Product B $200 $190 $200

What is the amount to be included in the ‘date of death’ return in respect of trading stock?

a. $290.
b. $300.
c. $430.
d. $665.

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Question 9
Which of the following items constitute trading stock ‘on hand’?

I. Goods held for sale on consignment by an agent.

II. Demonstration motor vehicles owned by a car dealership which will be sold once they have travelled
1500km in their demonstrator role.
III. Trout in a natural mountain stream (which runs through a trout farm) which will be caught and sold.
IV. Trout in a trout farm breeding pond which will be caught and sold.

a. I and II only.
b. I, and IV only.
c. I, II and III only.
d. II and IV only.

Question 10
Baileys Ltd frequently ordered trading stock from United States’ wholesalers. On 1 January 2008, they ordered
stock which was delivered on 15 January 2008 on credit. The cost of the trading stock delivered on 15 January
2008 was $US525 which was equivalent to $A1000. On 15 February 2008, when Baileys Ltd paid the US account,
they raised a cheque for $A950 being equivalent to $US525 at the time as the value of the Australian dollar had
increased against the US dollar.

In respect of this transaction, which of the following is most accurate?

a. Baileys Ltd will receive a deduction for trading stock purchased of $950.
b. Baileys Ltd will receive a deduction for trading stock purchased of $1000.
c. Baileys Ltd will receive a deduction for trading stock of $1000 and an assessable foreign exchange
gain of $50 will arise.
d. Baileys Ltd will receive a deduction for trading stock of $1000 and a non-assessable foreign exchange
gain of $50 will arise.

Question 11
Which of the following are exempt income?

I. Child maintenance payments received by an individual from a previous spouse as the result of a
marriage breakdown.
II. Unemployment benefits received from the Commonwealth Government.
III. Youth allowance received by a student in full-time study.
IV. Fees received by a public university from full-fee-paying students.

a. I only.
b. I and IV only.
c. II and III only.
d. None of the above.

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Question 12
Jansen is an Australian resident. During the year ending 30 June 2008, Jansen worked under contract as a marine
engineer on a sea-going dredge registered in Holland.

The dredge was leased to a Turkish-based company for use in carrying out work in Greece. Jansen worked on
the dredge in Greece and was paid from the Turkish company’s subsidiary in Egypt.

The source of the income derived by Jansen is:

a. Holland.
b. Turkey.
c. Greece.
d. Egypt.

Question 13
Marco, an Australian resident, is a magician known the world over. Recently, he signed a contract with a
Singapore resident organisation called Life Through Laughter (Singapore) Pty Ltd. This company hires
entertainers from all over the world and sends them to international ‘trouble spots’. Marco’s contract with
Life Through Laughter was signed in London and provided for payment for his services in UK pounds into a
Swiss bank account. The contract stipulated that Marco needed to perform his magic in a small South American
country presently suffering from a harsh military dictatorship.

For Australian tax purposes, the source of Marco’s income as a result of his work for Life Through Laughter
would be:

a. Australia.
b. London.
c. Singapore.
d. The South American country.

Question 14
PeeKay is a professional sportsman and has supplied you with the following information relating to the year
ended 30 June 2008.

Receipts $
Appearance fees 75 000
Winnings 190 000
Interest income 1 500
Endorsement income 50 000

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Outgoings
Travel expenses—attending various sports events 39 000
Manager’s fees 25 000
Physiotherapist’s costs to overcome a sports injury 9 000

What is PeeKay’s assessable income for the year ended 30 June 2008?

a. $53 500.
b. $126 500.
c. $243 500.
d. $316 500.

Question 15
In August 2007 Techno Manufacturing Ltd imported some capital equipment from the United States at a cost of
US$120 000. At the time the equipment was ordered the exchange rate was A$1 = US0.55¢. However, when the
account was paid in June 2008 the exchange rate was A$1 = US0.58¢.

In order to finance an expansion of its manufacturing plant Techno Manufacturing Ltd borrowed US$500 000 in
August 2007 when the exchange rate was A$1 = US0.55¢. When it was repaid on 30 May 2008 the exchange rate
was A$1 = US0.57¢.

The amount of assessable income or allowable deduction arising from the above transaction is as follows:

a. Nil.
b. $11 285.
c. $31 898.
d. $43 183.

Question 16
Which of the following statements is incorrect?

I. Ordinary income under s.6-5 is based on common law concepts.

II. Statutory income can only be included as income by statutory provisions.
III. Exempt income under s.6-5 is both a statutory and common law concept.
IV. Where there is a conflict in determining what is included in ordinary income and statutory income the
provisions of s.6-5 have priority over s.6-10.

a. I and II only.
b. II and III only.
c. I and IV only.
d. III and IV only.

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Question 17
In July 2007, Joe May commenced work as an architect on a consulting basis. During the year he received
$50 000 in fees. However, at year ending 30 June 2008 he was owed $20 000 in outstanding fees. Because of the
work which he completed with one client, ‘IDAPS’, he received $1000 by way of a bonus.

As part of Christmas festivities he received a box of wine valued at $250 from one client. He also received an
invitation to ‘IDAPS’ Christmas party, which he attended at the Hilton and which had a value of $100.

The assessable income of May for the year ending 30 June 2008 is:

a. $51 000.
b. $50 250.
c. $50 350.
d. $51 250.

Question 18
Shanghai Imports Ltd is a Hong Kong registered company, which distributes computer software in Australia
through a local distributor, ‘Microtel’.

For the year ending 30 June 2008 it distributed $250 000 of parts in Australia through its local distributor,
which imported them from Hong Kong and made other world-wide sales of $750 000. The company also received
franchise fees of $100 000 from its Australian distributor.

Sixty per cent of the company is owned by residents of Hong Kong and 40 per cent by Australian residents.
The board of directors, which directs its operations, meets in Hong Kong.

For the year ending 30 June 2008 the assessable income of Shanghai Imports Ltd is:

a. $100 000.
b. $350 000.
c. $1 000 000.
d. $1 100 000.

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Solutions

Question 1
Correct Answer: b

Workers compensation payments for loss of wages are fully assessable under s.6-5.

Neither reimbursement from the employer’s accident and health plan for medical expenses paid by Allen nor
damages for personal injuries are assessable. The latter receipt is excluded from capital gains tax by virtue of
s.118-37(1)(a).

Question 2
Correct Answer: d
$ $
Cash from patients 200 000
Cash from third-party reimbursers 30 000 230 000

Less Salaries paid 20 000

Expenses paid 24 000 44 000
186 000

Question 3
Correct Answer: c

The salary for part-time service in the Naval Reserve is exempt income pursuant to s.51-5 item 1.4. Income from
employment overseas can only be considered for exemption under s.23AG where the period of foreign service
is at least 91 days of continuous employment in a foreign country.

The insurance may be taxable as ordinary income under s.6-5 or under s.15-30 if it represents the loss of
something that would otherwise be included in assessable income.

Foreign dividends are not exempt from tax in Australia, although a credit for the withholding tax may
be available.

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Question 4
Correct Answer: c

Statement I is incorrect. The dividend is assessable under s.44(1) and is not excluded as a dividend under
the definition of dividend in s.995-1(1).

Statement II is correct as s.15-20 brings royalties, within its ordinary meaning, to account if it is of a
capital nature.

Statement III is correct. Division 775 operates to bring to account as income, gains on the purchase of
trading stock.

Statement IV is incorrect. Companies may be resident in Australia if they carry on business in Australia and
either the central management and control is in Australia or the voting power is controlled by Australian
resident shareholders.

Question 5
Correct Answer: b

Section 70-45 provides that each item of trading stock shall be valued at the taxpayer’s option from one of three
bases: cost, market selling value or replacement price.

To minimise tax payable, Snowball Ltd would select the lowest closing stock value for each unit.

$
Unit A 100
B 70
C 300
D 375
845

Question 6
Correct Answer: d

Trading stock is defined in s.70-10 to ‘include anything produced, manufactured or acquired that is held for
purposes of manufacture, sale or exchange in the ordinary course of a business’, and includes live stock.
None of the listed items fit into this definition. The videos are goods acquired for hire to customers—the
detergents used to clean manufacturing machinery do not form part of manufacture, and growing trees are not
trading stock until severed from the land.

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Question 7
Correct Answer: c

There is no hard and fast rule which states whether a business is being carried on or not. However, a number of
such indicators have become apparent as a result of judicial decisions. These include the nature of the activity
being carried on, the existence of a profit motive, the size and scale of activities, the commercial character of the
activities, the level of organisation of the activities and the existence of repetitive transactions.

Accordingly, all of the options are useful in determining whether a business is being carried on with the
exception of the legality of the operations.

Question 8
Correct Answer: d

ITAA97 s.70-105 requires that trading stock on hand at the date of death be brought to account at its market
value. Accordingly, $665 will be included in the assessable income of Joel’s final return. Alternative values may
only be used if the business continues after Joel’s death.

The other options are calculated as follows:

a Lower of cost and MSV.

b Total cost price of all stock.
c Total replacement value of all stock.

Question 9
Correct Answer: d

In IT2472, the Commissioner stated that goods held on consignment are trading stock on hand of the consignor
(i.e. the owner) and not the consignee (i.e. the agent selling the goods). The exception to this rule is where the
transaction involves a sale of the goods from the consignor to the consignee.

The Commissioner accepts that demonstration vehicles held for short periods before sale by a car dealer are
trading stock on hand (see IT2648).

The definition of trading stock (see ITAA97 s.995-1 and s.70-10) includes livestock. As the trout farm would be a
primary production business, the trout in the breeding ponds would be considered trading stock on hand.
In such a situation, the fish breeder would be likely to know the approximate number of fish in his ponds and
their value. However, the fish swimming freely in the mountain stream would be unlikely to be trading stock on
hand. It could not be said that the fish breeder had the power of disposition over those fish at any one time and
therefore one of the key tests for trading stock being on hand is not satisfied.

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Question 10
Correct Answer: c

The deduction for the trading stock available under ITAA97 s.8-1 is the amount of $1000. For the purposes of
determining the deduction available, the movement in the exchange rate is not relevant. This is so as the loss or
outgoing was incurred on 15 January 2008 and at this time the amount of the loss or outgoing was $1000
Australian.

The movement in the currencies has given rise to a foreign exchange gain. It will be assessable under ITAA97
Division 775-15.

Question 11
Correct Answer: b

ITAA97 s.51-50 exempts from assessable income child maintenance allowances paid by a previous spouse.

The income of a public university is exempt under Item 1.4 of s.50-5 subject to the conditions contained in
s.50-55.

Unemployment benefits are ordinary income under s.6-5 and they are not exempt income. Similarly,
Youth Allowance payments are ordinary income and not exempt under the Act.

Division 11 of ITAA97 provides a good summary of income and entities that are exempt.

Question 12
Correct Answer: c

In Jansen’s case, the source of income is the place where he performed the work, that is Greece.

Question 13
Correct Answer: d

In the case of income in respect of personal services, the place where the services are rendered will generally be
the source of the income. Therefore, the source of Marco’s income from Life Through Laughter will be the
South American country as this is where he performs his magic.

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Question 14
Correct Answer: d

All of the receipts are assessable and all of the outgoings are deductible. However, the question asks for the
assessable income (not the taxable income), and so the answer is D, $316 500.

Option A is incorrect as it is the taxable income excluding the prize winnings.

Option B is incorrect as it excludes the prize winnings from assessable income.

Option C is incorrect as it is the taxable income (i.e. assessable income less allowable deductions).

Question 15
Correct Answer: c

Gain on capital equipment purchase is capital and not assessable. The gain will form part of the cost base of
the equipment.

The gain on borrowing is assessable under Division 775 of ITAA97, that is ($909 090 – $877 192) = $31 898.

Question 16
Correct Answer: d

Exempt income is only determined by statutory provisions (s.6-20).

Where there is conflict the specific provisions apply (s.6-25).

Question 17
Correct Answer: a

■ Section 6-5 consulting fees $50 000.

■ Outstanding fee—a cash basis of income recognition, therefore not assessable.
■ Bonus is income $1000—s.6-5.
■ Box of wine—assessable under s.21A but exempt on $<300 benefit.
■ Christmas party not assessable under s.21A, as not deductible to the provider.

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Question 18
Correct Answer: a

As the company is a non-resident company (it is not carrying on business in Australia):

■ it is only taxable on Australian sourced income; and

■ the only Australian income is from the franchise.

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