Bookkeepers Knowledge Base
A publication of the Australian BookkeepersNetwork Pty. Ltd. www.austbook.net
Edition # 9 / April 2002
Introduction
Welcome to the Bookkeepers Knowledge Base, a subscription based newsletter provided by the Australian Bookkeepers Network.
Bookkeepers Knowledge Base brings you topical and informative articles that will be beneficial to your business in a number of ways. The newsletter serves as a valuable reference source for your business, keeping you and your staff in front of topical issues.
The newsletter is centred on feature topics, which are comprehensively examined and complemented with practical advice regarding journal entries and the like.
By giving proper amounts of time to the newsletter each month, your knowledge and skills in crucial, topical areas of accounting and taxation will improve immeasurably. In short, you will be adding resources to your business, quality to your service, and value to your client.
We would also like to hear from our subscribers as to any particular topics you may like addressed in the newsletter and we will endeavour to address these if we see that common concerns are being raised.
We look forward to hearing from you, and welcome any feedback you may have on not only the newsletter, but any other product or service we may be able to assist your organisation in obtaining. You can contact us through our web site, www.austbook.net.
This Month’s Feature Topic:
Accounting for Shares
Australia ranks among the world leaders in terms of individual share
ownership per capita. Shares and other financial securities are featuring more and more in the day-to-day transactions that bookkeepers account for. In this edition of the Bookkeepers Knowledge Base, we commence by providing some taxation background on the difference between share trading and investing. We then examine the various income and expense items that relate to shares. Having identified these, we focus on the GST and BAS implications of these items. Ancillary issues relating to trading stock
valuation and non-commercial losses are dealt with. We then draw all of these issues together by providing a comprehensive case study.
There are, however, certain caveats which require stipulation. Firstly, this article is not designed to be an exhaustive examination of the capital gains tax (CGT) regime and its applicability to share transactions. By necessity, the taxation treatment of shares is discussed to a certain point as it dictates the appropriate accounting treatment for bookkeepers. However, specific capital gains tax issues are beyond the scope of service for many of our bookkeepers and it is for this reason that they will not be addressed within this article. Secondly, the taxation, GST and accounting treatments espoused in this article are not appropriate for self-managed superannuation funds (SMSFs). SMSFs have specific requirements which are beyond the scope of this article. Finally, some of the principles of this article may be indirectly applicable to managed funds, but should not be taken as being so. Managed funds carry with them taxation and accounting issues which are many and varied and will likely justify a dedicated Bookkeepers Knowledge Base article in due course.
Share Trading versus Investing
The correct method of accounting for share transactions can vary between individuals and/or entities. Essentially, the choice of treatment rests on whether the share transactions amount to share trading, or merely investing. In determining whether share transactions represent share trading, it is necessary to first determine whether the taxpayer's activities amount to the carrying on of a business. The term "business" is defined in s.995-1 of the Income Tax Assessment act (1997) and includes any profession, trade, employment, vocation or calling, excluding occupation as an employee. The notion of "carrying on a business" is, however, not defined in the legislation. Consequently, we must turn to case law to identify the principles used by the courts. Some of the relevant factors which have evolved are:
the degree of system and organisation used - the more systematic, organised and commercial the basis, the more likely the activities are to constitute a business;
scale of activities - the greater the scale, the more likely the activities are to constitute a business;
repetition of transactions - regular, repetitive transactions are more likely to be indicative of a business;
profit factor - a business operation is usually carried out in order to make a profit, which although may not be immediate, should at least be anticipated;
type of activity - where the underlying transaction involves goods or services which are unlikely to be for personal use, the more likely it is that a business is in existence;
time - the more time that a taxpayer spends on an activity, the more likely it may be of a business nature.
These factors should only be interpreted as guidelines. In terms of applying the above guidelines to share trading specifically, it is useful to refer to the Commissioner of Taxation's Interpretative Decision ATO ID 2001/746. This particular decision served to characterise the taxpayer in question as an investor for the following reasons:
the taxpayer predominantly relied on professional advice to make decisions about the investments;
limited time was spent on the activity; the method of operation was simple; the taxpayer did not have a trading plan;
the taxpayer did not have a contingency plan in place to absorb market downturns;
the taxpayer did not demonstrate that the necessary source of funding required for continuing the activity for an indefinite period could be maintained;
the taxpayer kept limited records; and
the extent of the activities is such that a home office was not maintained.
Again, no one factor is decisive and it is necessary to look at the facts as a whole. A determination is made on the general impression gained from various indicators of carrying on a business and the individual circumstances of the taxpayer and discussed by the Commissioner in Taxation Ruling TR 97/11.
Nonetheless, if we were to apply these generic principles to the subject of share transactions, we could begin to create a profile of a share trader as distinct from an investor, vis-à-vis:
a share trader is likely to employ a more systematic approach than an investor, operating to a plan, setting budgets and keeping detailed records;
a share trader is likely to engage in a greater number of share
transactions than that of an investor, and employ a greater capital. The complexity of transactions could also be greater;
a share trader is likely to buy and sell shares at more regular intervals than an investor, and is likely to hold the underlying security for a shorter period of time than an investor;
a share trader is more likely than an investor to be motivated by the prospect of short-tem profit, and that profit is more likely to arise from a discernible pattern of trading. An investor is more likely to have long-term timeframes in mind;
a share trader is likely to spend a greater amount of time on share transactions than an investor, in part due to the greater scale and repetition of the activities.
Once a decision has been reached as to whether a taxpayer is carrying on a business of share trading, the appropriate accounting treatment can be determined.
Accounting issues with shares
What, then, are the major accounting issues when dealing with share transactions.
Share Purchase. The purchase of a share should be recorded as either an asset (in the case of an investor) or as an expense in the trading account (in the case of a share trader).
Acquisition costs. Costs such as brokerage and stamp duty should be treated in the same way as the purchase of the share itself. Thus, a share trader would include these items as an expense in the trading account. An investor would capitalise such costs as they represent the second element of a cost base of a capital asset under section 110-25 of the Income Tax Assessment Act 1997.
Share Sale. The proceeds on sale of a share should be recorded as capital proceeds (in the case of an investor) or as income in the trading account (in the case of a share trader).
Disposal costs. Costs such as brokerage should be treated in the same way as the disposal of the share itself. Thus, a share trader would reduce the amount otherwise shown as income in the trading account. An investor would capitalise such costs as they represent the second element of a cost base of a capital asset under section 110-25 of the Income Tax Assessment Act 1997.
Closing stock.Shares that are "on hand" at the end of the financial year must be brought to account by a share trader as closing stock in the trading account. A closing stock asset, classified as a "current asset", for the same amount would be taken up in the balance sheet. Investors would also reflect shares that are "on hand" at the end of the financial year in their balance sheet, although these would likely be classified as "non-current" or
"investment" assets. A later section in this article discusses the valuation of closing stock.
Dividends.To share traders and investors alike, dividends represent income. A share trader would typically show such income prominently in their profit and loss statement, although not as part of a trading account. An investor would be more likely to disclose such income in the "Other Income" section of their profit & loss statement.
Imputation credits.Dividends paid to resident shareholders by Australian resident companies are taxed under a system known as imputation. It is called an imputation system because the payment of company tax may be imputed or attributed to the shareholders. The basis of the system is that if a company pays or credits you dividends which have been franked, you may be entitled to a franking tax offset for the tax the company has paid on its income. The franking tax offset will cover or partly cover the tax payable on the
dividends. A resident company may also pay or credit you a dividend that is called an unfranked dividend. There is no imputation credit attached to these
dividends. A dividend statement advises whether the dividends have been franked and to what extent.
Prior to 1 July 2000 your franking tax offset could not create a refund. If you had any remaining franking tax offset available after your tax liability had been reduced to nil, it was lost. However, under measures contained in the
New Business Tax System (Miscellaneous) Act 1999, from 1 July 2000 excess franking tax offset will be refunded after any income tax and Medicare levy liabilities have been met. This means that for share traders and investors alike, imputation credits serve to increase income but also serve to create a corresponding asset being a prepayment of income tax.
Tax File Number Credits.Where a tax file number has not been quoted to the share registrar responsible for administration of a company's dividend, tax file number credits may be deducted. For share traders and investors alike, these tax file number credits should be grossed-up against income but also serve to create a corresponding asset being a prepayment of income tax.
Foreign Tax Credits.If you were paid or credited a dividend from a non-resident company, it will not be called a franked or unfranked dividend, but is likely to be referred to simply as a dividend. Non-resident companies are not subject to the imputation system and you will not be entitled to claim a franking tax offset for any tax paid by the company. However you may find that foreign tax has been deducted from the dividend so that the amount paid or credited to you is reduced.
In most circumstances you will be liable to pay Australian income tax on the dividend. You must include on your tax return the full amount of the
dividend—that is, the amount you are paid or credited plus the amount of any foreign tax which has been deducted—and claim a credit for the foreign tax paid.
There are special rules which need to be satisfied for you to claim a foreign tax credit which are beyond the scope of this article. For share traders and investors alike, foreign tax credits should be grossed-up against income but also serve to create a corresponding asset being a prepayment of income tax. However, this prepayment of income tax may span several years, depending on the level of foreign income.
Deductions. There are a range of deductions in relation to dividend income. These are discussed in the next section. A share trader would typically show such expenses in the main body of their profit and loss statement, while an investor would be more likely to disclose such expenses in the "Other Expenses" section of their profit & loss statement.
Deductions in relation to dividend income
The Australian Taxation Office have posted information on their Tax Reform web site (detailed below) which outlines the deductions that can be claimed against dividend income. You will notice that the deductions are somewhat broad and it is foreseeable that some or all of these costs are not being brought to your attention by your clients as they may not be aware of the deductibility of such items.
Management fees. Where you pay ongoing management fees or retainers to investment advisers you will be able to claim the expenditure as an allowable deduction. Only a proportion of the fee is deductible if the advice covers non-investment matters or relates in part to non-investments that do not produce assessable income. You cannot claim a deduction for a fee paid for drawing up an initial investment plan.
Interest. If you borrowed money to buy shares you will be able to claim a deduction for the interest incurred on the loan, provided it is reasonable to expect that assessable dividends will be derived from your investment in the shares. Where a loan was obtained for more than one purpose, you will only be able to claim interest incurred on that part of the loan used to acquire the shares.
FID and other taxes. State governments charge Financial Institutions Duty (FID), government duty tax (GDT) and debits tax for operating certain types of accounts held with financial institutions such as banks, building societies and credit unions. You can claim a deduction for any FID charged on the deposit of assessable dividend income into your accounts. You can also claim a deduction for that part of any GDT or debits tax charged on debits from your account used to fund deductible expenses in relation to earning dividend income. If only a proportion of the debit was used to fund deductible
expenses, then only the same proportion of GDT or debits tax is deductible.
Travel expenses. You may be able to claim a deduction for travel expenses where you need to travel to service your investment portfolio—for example, to consult with a broker or to attend a stock exchange or company meeting. You can claim a deduction for the full amount of your expenses where the sole purpose of the travel relates to the share investment. Where the travel is predominantly of a private nature, only the expenses which relate directly to servicing your portfolio will be allowable.
Cost of newspapers and journals. You may be able to claim the cost of purchasing specialist investment journals and other publications which you use to manage your share portfolio.
Borrowing expenses. You may be able to claim expenses you incurred directly in taking out a loan for purchasing shares which can reasonably be expected to produce assessable dividend income. The expenses may include establishment fees, legal expenses and stamp duty on the loan. If you incurred deductible expenses of this kind totaling $100 or more they are apportioned over 5 years or the term of the loan, whichever is less. If your expenses are less than $100, they are fully deductible in the year you incur them.
Internet costs. You can claim a deduction for internet and share data access costs to the extent that these are incurred in relation to the income producing activity of share investing. The reference for this comes from an ATO Interpretative Decision ATO ID 2002/70.
Share trading software. Division 46 of the ITAA 1997 allows a deduction to be claimed for depreciation of software that has been used for income producing purposes. In accordance with subdivision 46B of the ITAA 1997, the deduction is to be calculated using the prime cost method with an effective life of 2.5 years (i.e. a rate of 40%). This rate and method is prescribed by the ITAA 1997 and is the only rate available for calculating
depreciation for software expenditure. The reference for this comes from an ATO Interpretative Decision ATO ID 2002/106.
Other deductions. Any other expenses that you incur which relate directly to maintaining your portfolio are also deductible. These could include
bookkeeping expenses and postage.
GST & BAS Implications on share transactions
GST is not applicable when you buy or sell shares because the provision, acquisition, or disposal of an interest in shares is a financial supply under item 10 of subregulation 40-5.09(3) of the GST regulations. The Treasurer has also excluded stamp duty from GST by a determination.
However, GST may apply to many of the costs associated with share transactions such as brokerage, management fees and software.
As to whether the input tax credits associated with such expenses can be claimed will rest initially on whether the taxpayer is a share trader or an investor.
Investor. If the taxpayer is an investor, they will not be entitled to input tax credits for GST paid on such expenses because they have not bought or sold shares in the course of furtherance of an enterprise. GST included in brokerage will merely add to the cost base of the affected shares. GST included in other expenses will merely add to the expense. All transactions would be non-reportable in the GST section of the BAS, and would be tax coded with N-T or an equivalent code.
Share Trader. If a taxpayer is registered for GST and buys and sells shares in the course of furtherance of an enterprise, then the taxpayer is considered to be making "financial supplies" and consequently, cannot claim input tax credits on most related expenses. The ATO have advised that the cost of the share and stamp duty are not reportable on the BAS and would thus be tax coded N-T or an equivalent. Where shares are sold for a price less than or equal to what was paid for the shares, the gross proceeds of sales would not be reported on the BAS and would be tax coded N-T or an equivalent. Where shares are sold for a price greater than what was paid for the shares, the net of gross proceeds less cost price should be treated as input taxed sales, tax coded as ITS (or tax coded N-T and added manually to the BAS), and included at label G1 on the BAS and label G4 on the GST calculation sheet. Note that reduced input tax credits can be claimed on brokerage as it is a Reduced Credit Acquisition under item 9 of subregulation 7-5.02(2) of the GST Regulations. The same concession applies, among other things, to funds management and trustee and custodial services that include GST.
The amount of the Reduced Input Tax Credit is 75% of the GST included. 75% of the GST-inclusive total of these expenses would be tax coded as GST and would be included at label G11 on the BAS. The remaining 25% of the GST-inclusive total of these expenses would be treated as purchases relating to input taxed sales, tax coded as ITP or an equivalent code, and would be included at label G11 on the BAS and label G13 on the GST calculation sheet.
Share Traders should, however, consider the applicability of the financial acquisitions threshold to their circumstances, which is now discussed.
Financial Acquisitions Threshold. If a share trader does not exceed the financial acquisitions threshold, they may be entitled to a full input tax credit on creditable acquisitions that they have made in relation to their share trading. The purpose of the financial acquisitions threshold is to allow entities that make a relatively small amount of financial supplies, as compared to their taxable supplies or GST free supplies, to claim full input tax credits relating to those financial acquisitions (e.g. share transactions). Sections 189-5 and 189-10 of the GST Act set out when an entity will exceed the financial acquisitions threshold . This will be if you make, or are likely to make, financial acquisitions where the input tax credits related to making those acquisitions would exceed the lesser of either:
$50,000; or such other amount specified in the regulations (1st limb test); or
10% of the total amount of input tax credits to which you would be entitled (2nd limb test).
You will determine whether you exceed the financial acquisitions threshold in a given month based on your acquisitions in:
that month and the previous 11 months; and that month and the next 11 months.
By way of example, a share trader who derives input tax credits of $2,000 from share transactions and $15,000 from business transactions would exceed the financial acquisitions threshold, as the $2,000 input tax credit relating to financial supplies (share transactions) exceeds 10% of the total input tax credit of $17,000. In this case, the share trader would not be entitled to a full input tax credit on the $2,000 although may be entitled to a Reduced Input Tax Credit on GST relating to expenses such as brokerage which are Reduced Credit Acquisitions.
Extending on the same example, had the input tax credits from the business transactions have been $25,000, the 10% test limb would not have been passed, nor would the first limb dealing with input tax credits from financial supplies being equal to or greater than $50,000. Thus, full input tax credits could be claimed in creditable acquisitions relating to share transactions.
PAYG Instalment. For instalment income purposes, share traders and investors alike must include dividend income but not imputation credits. Dividend income must be grossed-up by foreign tax credits and/or tax file number credits if applicable. In terms of share sales, share traders would need to disclose the gross proceeds of any sales. Investors would disregard sales where they fall under the CGT regime as capital gains do not figure in instalment income.
Valuation of closing stock on hand
As stated earlier, a share trader must bring to account as closing stock those shares which have not been sold by the end of the financial year. There are various schools of thought among bookkeepers and accountants alike as to how this should be done. Definitive guidance, however, is available by the Commissioner through his taxation ruling TR 96/4. The salient points from that ruling are discussed below. As is the case with any business attempting to quantify its closing stock, the initial task is to identify what is "on hand" and how much it cost.
If shares held by a taxpayer as trading stock on hand at the end of a year of income can be specifically identified and the taxpayer values the shares at cost price under subsection 31(1), the actual cost of the shares must be ascertained. Whereas specific identification of shares was made possible in years passed through the issue of certificates, this is no longer the case. The situation now exists where taxpayers, in most situations, will not be able to identify shares by individual numbers, nor, following implementation of the CHESS system, will they be able to identify parcels of shares traded through that system by means of a share certificate . Accordingly, it is necessary to consider whether, in circumstances where shares cannot be identified by reference to individual numbers, another method of identifying shares will be acceptable for purposes of subsection 25(1) or 51(1) (the sections applicable to share traders) and for CGT purposes in the case of investors.
For that purpose, it will be necessary for a taxpayer to maintain updated records that will account for the purchase and sale of shares on a trade by trade basis. Those records will be regarded as sufficient for the purpose of specifically identifying shares if they:
allocate a specific identity code to, or otherwise identify specifically, each buy or sell transaction;
identify the company in which a parcel of shares is acquired; identify the class of shares acquired;
identify the date on which shares are bought or sold;
record the price at which parcels of shares are purchased and sold; record the balance of shares acquired in a particular trade where a proportion of those shares are appropriated to a subsequent sale transaction; and
preserve the integrity of those codes and system through inbuilt system or other audit trails.
On the other hand, where a taxpayer has not maintained the above records and is unable to specifically identify what shares are actually on hand at the end of the year of income, the taxpayer will be required to use either the FIFO method (first-in, first-out) or the average cost method to determine the cost price of those shares for the purposes of subsection 31(1).
However, in relation to a share trader, FIFO does not necessarily provide a proper reflex of the taxpayer's income. Specific identification will typically be more appropriate than FIFO because the progressive acquisition and disposal of shares does not have a natural flow, unlike other kinds of trading stock. Shares are non-wasting revenue assets. Consequently, it cannot be assumed that a taxpayer who acquires such assets will intend necessarily to dispose of those assets that were acquired first.
Where a taxpayer has acquired shares, the reality of the situation in many cases is more likely to be that the taxpayer will seek to appropriate the highest cost shares to any sale. However, because the taxpayer is in the position of having acquired intangible assets that cannot be physically identified, the taxpayer must be able to provide evidence of the actual appropriation of those shares to a particular trade. Where a taxpayer can identify shares either individually or by reference to share certificates or maintains appropriate accounting records as outlined earlier, that will be regarded as sufficient to specifically identify shares for taxation purposes.
The following example was used by the Commissioner in TR 96/4 and clearly illustrates the impact on a share trader's income of using specific identification versus FIFO versus average costs when valuing closing stock. The merits of maintaining adequate records are brought to bear.
Example
Dealer Pty Ltd, which carries on a business of trading in shares, purchases 10,000 shares at $2 each in Megacom Ltd on 1 February 1990 and 20,000 shares in the same company at $3 each on 1 May 1990. The value of closing stock on hand at 30 June 1990 is $80,000. Share certificates were not issued to Dealer. On 1 December 1990 Dealer sold 15,000 of its Megacom shares at $4 each. For the sake of simplicity, there are no brokerage charges or other transfer costs in this example.
At 30 June 1991, Dealer still held 15,000 Megacom shares and it decided to value those shares at cost price for the purpose of subsection 31(1). The accounting records of the taxpayer demonstrate that the shares appropriated to the sale on 1 December 1990 were those acquired on 1 May 1990, with a residual holding of 5,000 shares acquired on that date. Under the specific identification method, the shares on hand at 30 June 1991 are the 10,000 acquired on 1 February 1990 at a cost price of $2 each and 5,000 of the shares acquired on 1 May 1990 at a cost price of $3 each. Accordingly, the value of trading stock on hand at the end of the year of income is $35,000. In this situation, Dealer returns the gross proceeds of $60,000 as assessable income and claims a deduction of $45,000 under subsection 28(3), being the excess of trading stock on hand at the beginning of the year of income over the value of trading stock on hand at the end of that year. The net result is a profit of $15,000. However, if Dealer does not maintain adequate accounting records, it is necessary to use either FIFO or the average cost method (where average cost is the most appropriate method) to value the shares.
Under the FIFO method, it is assumed that the 15,000 shares sold by Dealer consisted of the 10,000 shares purchased at $2 and 5,000 of the shares purchased at $3. Accordingly, the 15,000 shares on hand at 30 June 1991 have a cost price of $3 each. In this situation, Dealer returns the gross proceeds of $60,000 as assessable income and claims a deduction of $35,000 under subsection 28(3). The net result is a profit of $25,000.
Under the average cost method, the average cost of the Megacom shares is $2.6666 ($20,000 + $60,000/30,000 shares). As there were no subsequent purchases, the average cost per share at 30 June 1991 is also $2.6666. In this situation, Dealer returns the gross proceeds of $60,000 as assessable income and claims a deduction of $40,000 under subsection 28(3). The net result is a profit of $20,000.
Non-commercial loss provisions
Since 1 July 2000, non-commercial loss provisions have applied to prevent taxpayers from claiming losses on businesses unless they can meet one of four tests or satisfy the Commissioner's discretion. The measures do not disqualify losses altogether, they merely defer them until such time that the business becomes profitable. Deferred losses from the past can then be offset against such profits.
The four tests are applied in each financial year and one of which must be passed in order to offset a business loss against other income are:
1. the profits test - assessable income from the activity must be at least $20,000;
2. the income test - the business must have produced a profit in three out of the past five years;
3. the real property test - the business must use real property or an interest in real property worth at least $500,000 on a continuing basis;
4. the other assets test - the business must employ other assets besides real property which amount to more than $100,000 on a continuing basis. The Commissioner has confirmed that the above measures will apply to share traders. However, it is expected that taxpayers who are in the business of share trading will satisfy at least one of the tests. Most notably, the profits test will be passed if the share trader generates gross proceeds from sales of $20,000 for the financial year. Note that this does not refer to net profit on trades, but rather just gross proceeds of trades. Thus, if a share trader purchased a parcel of BHP shares for $22,000 and sold them a month later for $21,000 a net loss of $1,000 has been incurred, but gross proceeds amount to $21,000 and the profits test would have been passed for the financial year on the strength of this trade alone.
The more likely scenario where the non-commercial loss provisions might impact upon a share trader would be in broken income years (i.e. the share trader commences their business in June of a financial year or ceases their share trader business in July of a financial year).
Worked example
Facts of the case
Katrina decided to pursue her dream of trading in shares for a living, and on 30 June 2001 ceased her employment as a transport worker. On 1 July 2001, Katrina began to devote all of her days to this pursuit. She purchased multiple high-price investment books, subscribed to a share magazine and purchased a computer and charting software. Katrina prepared a trading plan and executed that trading plan in accordance with the predictions of her charting software. She adopts meticulous record keeping practices through her software and records her transactions using an already owned version of MYOB. Katrina adopts the periodic inventory system within MYOB, on the basis that her closing stock at any point in time can be ascertained by reference to her charting software. Katrina’s only source of income became her share trading.
During the month of July 2001, Katrina conducted the following transactions:
Share purchases:
Date Company # shares Price Sub-total S/Duty Brokerage Total
8/07/2001 Company A 1000 2.20 2,200.00 6.60 36.30 2,242.90 12/07/2001 Company B 500 3.56 1,780.00 5.34 29.37 1,814.71 25/07/2001 Company A 800 5.00 4,000.00 12.00 66.00 4,078.00
7,980.00 23.94 131.67 8,135.61
Share sales:
Date Company # shares Price Sub-total S/Duty Brokerage Banked
21/07/2001 Company B 300 3.90 1,170.00 - 19.31 1,150.70 29/07/2001 Company A 1000 4.00 4,000.00 - 66.00 3,934.00
5,170.00 85.31 5,084.70
Dividends:
Company B paid a dividend of 5 cents per share on 15/7/01. On 500 shares, this meant that Katrina received a dividend of $25. The imputation credits attached were $10.71. However, as Katrina did not remember to advise the share registrar of her Tax File Number, some $12.13 was deducted from her dividend. She banked only the net amount of $12.87, being $25 minus $12.13.
Borrowings:
Katrina obtained a $100,000 overdraft and funded her initial share purchases and other expenses through this facility. At 31 July 2001, her bank statement revealed interest expense of $53.33 and bank charges of $13.40.
Expenses:
Katrina incurred the following costs for the month:
2/7/01 Purchase of computer (100% business): $2,200 including GST 2/7/01 Accushare Charting Software: $1,500 including GST
5/7/01 Personal Investor Magazine Subscription: $55 including GST 31/7/01 Stationery account: $28.60 including GST
31/7/01 Internet Fees: $66 including GST Solution
Share Trader versus Investor. The initial decision to make in deciding on how to account for Katrina’s circumstances are to determine whether she is a share trader or an investor. Based on the tests outlined earlier in this article, the evidence would support the view that she is a share trader. The significant factors are her decision to abandon other income earning activities, the development of a trading plan, the purchase of specialist software, the acquisition of extended funding from the bank which would enable continuity of the activity over time, the presence of strong record keeping
practices, and a general intention on her part to make the activity a profitable livelihood.
Financial Acquisitions Threshold. As all of the input tax credits that Katrina would be entitled to relate to her share trading, she satisfies the second limb of the Financial Acquisitions Threshold test. As such, she will not be entitled to input tax credits on any of her acquisitions, except those qualifying as Reduced Credit Acquisitions.
Share Purchases. On the basis that she is a share trader, Katrina would record the following entry to deal with her share purchases for the month:
Account Tax Code Debit Credit
Purchases (Note 1) N-T 7 980.00
Purchases (Note 2) N-T 23.94
Purchases (Note 3) GST 89.77
GST paid (Note 3) N-T 8.98
Purchases (Note 3) ITP 32.92
Bank Overdraft N-T 8 135.61
(Where ITP=expenses relating to input taxed sales, GST=non-capital purchases attracting GST, N-T=outside the scope of the GST system)
Note 1: The purchases expense account includes the purchase price of the shares;
Note 2: The purchases expense account includes the stamp duty on purchase; Note 3: As brokerage is a reduced credit acquisition, 75% of the total cost becomes entitled to an input tax credit. The purchase expense account includes 75% of brokerage costs less the input tax credit, and remaining 25% of brokerage costs.
Share Sales. Katrina would record the following entry to deal with her share sales for the month:
Account Tax Code Debit Credit
Bank Overdraft N-T 5 084.70
Sales (Note 1) GST 58.17
GST paid (Note 1) N-T 5.82
Sales (Note 1) ITP 21.31
Sales (Note 2) N-T 5 170.00
(Where ITP=expenses relating to input taxed sales, GST=non-capital purchases attracting GST, N-T=outside the scope of the GST system)
Note 1: As brokerage was deducted from the sale proceeds and is a reduced credit acquisition, 75% of the total cost becomes entitled to an input tax credit. The sales account is reduced by 75% of brokerage costs less the input tax credit, and reduced further by the remaining 25% of brokerage costs for which no input credit can be claimed. Note that the brokerage is debited to sales as it is treated as an incidental cost of disposal rather than as an expense in its own right;
Note 2: The gross proceeds of the sale are treated as N-T, although as advised by the ATO, a manual addition will need to be made to the BAS to record sales where the sale price of the share exceeded the purchase price.
Dividend. Katrina would enter the following journal to account for her share dividend:
Account Tax Code Debit Credit
Bank Overdraft N-T 12.87
Provision for Income Tax (Note 1) N-T 12.13
Dividend Income N-T 25.00
Provision for Income Tax (Note 2) N-T 10.71
Income Tax Expense (Note 3) N-T 10.71
(Where N-T=outside the scope of the GST system)
Note 1: Provision for Income Tax is a liability account. This debit merely reflects the fact that the tax file number withholding is akin to a prepayment of the year-end liability.
Note 2: This debit to Provision for Income Tax reflects the fact that imputation credits can not only offset tax but also lead to a refund if necessary. Again, they serve as a prepayment of income tax.
Note 3: Because imputation credits are not received physically but rather serve as just a tax concept, it may be misleading to a profit and loss statement to credit them to a dividend income account. By crediting the income tax expense account, the profit and loss statement reflects only the cash amount of a dividend. When a journal is taken up at year-end (e.g. debit income tax expense, credit provision for income tax), the amount used in the journal should be the tax liability before offsetting any imputation credits. The income tax expense will then agree with the provision in the balance sheet. It is important to remember that when calculating income tax expense, taxable income must first be grossed-up by any imputation credit.
Other expenses. Katrina's various expenses are recorded as follows:
Account Tax Code Debit Credit
Plant & Equipment Asset (Note 1) ITC 2 200.00 Software Asset (Note 2) ITC 1 500.00 Subscriptions (Note 3) ITP 55.00 Printing & Stationery (Note 3) ITP 28.60 Internet Fees (Note 3) ITP 66.00
Bank Overdraft N-T 3 849.60
(Where ITC=capital expenses relating to input taxed capital sales; ITP=expenses relating to input taxed sales; NT=outside the scope of the GST system)
Note 1: The computer asset must be capitalised and, for income tax purposes, depreciated over time. If Katrina is not considered a non-small taxpayer for income tax purposes (e.g. her annual turnover does not exceed $1 million), then the rate of depreciation applicable to the computer will likely be 40% p.a. on a diminishing value basis. The depreciation charge, however, will not impact upon the BAS. The unique tax code of ITC is designed to quarantine
those items of an input taxed nature that are capital as capital acquisitions are disclosed separately on the BAS at label G10.
Note 2: The software must also be capitalised and written off over time. In accordance with division 46B of the ITAA 1997 (discussed earlier), the software will be written-off using the prime cost method at the rate of 40%. The depreciation charge, however, will not impact upon the BAS.
Note 3: Katrina's other expenses are all purchases relating to input taxed sales and thus there is no ability for her to claim GST on them. None of these items have been legislated as Reduced Credit Acquisitions.
Interest and bank charges. Both of these items represent purchases relating to input taxed sales, as they have funded her share trading operations.
PAYG Instalment Income. Katrina will not need to show PAYG instalment income until her September BAS. However, for illustration purposes, her instalment income for the month of July 2001 will include the $5,091.51 in share sales (the banked amount of $5,084.70 plus the input tax credit received on 75% of the brokerage of $5.81) and the $25 dividend income. Note imputation credits are not added.
Valuation of closing stock. Katrina’s charting software enables thorough record keeping. The software possesses each of the hallmarks alluded to in Taxation Ruling TR96/4, the result of which is that Katrina has the ability to indicate which of her shares have been sold and which remain. Katrina has 200 shares remaining of her only parcel of Company B shares. Of the 800 shares that she has remaining in Company A, she elects for these to be the legacy of her original parcel of 1000 shares purchased on 8/7/01 for $2.20, rather than being the 800 shares that she purchased on 25/7/01 for $5.00. The value assigned to Katrina’s 200 Company B shares is:
( 200 shares x $3.56 purchase price ) + (40%* x $32.71**) = $725.08 * 40% represents the proportion of the parcel sold
** $32.71 is the combined brokerage and stamp duty costs less 75% of the input tax credits
The value assigned to Katrina’s 800 Company A shares is:
( 800 shares x $2.20 purchase price ) + (80%* x $40.43**) = $1,792.34 * 80% represents the proportion of the parcel sold
** $40.43 is the combined brokerage and stamp duty costs less 75% of the input tax credits
Thus, Katrina’s closing stock on hand will be $725.08 + $1,792.34 = $2,517.42.
Account Tax Code Debit Credit
Closing stock – P&L N-T 2 517.42
Stock on Hand – Balance Sheet N-T 2 517.42
Profit & Loss Statement
Katrina’s Profit & Loss Statement (ignoring depreciation and income tax) for the month of July 2001 would appear as follows :
$ $
Sales 5,090.52
Less cost of goods sold:
Opening stock (1/7/01) 0.00 Purchases 8,126.63
Closing stock (31/7/01) (2,517.42) 5,609.21 Gross profit (loss) (518.69) Add dividend income 25.00 (493.69) Less expenses:
Bank charges 13.40 Interest expense 53.33 Internet fees 66.00 Printing & Stationery 28.60
Subscriptions 55.00 216.33
Net profit (loss) (710.02)
BAS.
A summary of Katrina’s tax codes are as follows :
ITP Tax Code Total = $270.56 being $32.92 (portion of brokerage on purchase) + $21.31 (portion of brokerage on sale) + $216.33 (subscriptions, stationery, internet fees, bank charges, interest)
ITC Tax Code Total = $3,700.00 being $2,200 (computer) + $1,500 (software)
GST (purchases) Tax Code Total = $162.74 being $98.75 (GST-inclusive portion of purchases brokerage) + $63.99 (GST-inclusive portion of sales brokerage)
ITS Tax Code Total = $462 calculated as:
Company B: 300 shares x 34c ($3.90 sale - $3.56 purchase) = $102 Company A: 200 shares x $1.80 ($4 sale - $2.20 purchase) = $360 (Note that the other 800 shares of company A which were sold were purchased for $5 per share and thus a loss created)
A summary of Katrina’s BAS disclosures (using the calculation sheet) follows:
G1: $462
G4: $462
G5: $462
G6: $0
G8: $0
G9: $0
1A: $0
G10: $3,700 (ITC)
G11: $162.74 (GST) + $270.56 (ITP) = $433.30
G12: $4,133.30
G13: $3,700 (ITC) + $270.56 (ITP) = $3,970.56
G16: $3,970.56
G17: $162.74
G19: $162.74
G20: $14.79
1B: $14.79*
*The input tax credits ultimately claimed, being $14.79, represent 75% of the input tax credits attributable to the brokerage on purchase and sale of shares.
Non-commercial losses. Katrina is unlikely to be affected by the non-commercial loss provisions at year-end. Her turnover is likely to exceed $20,000 and if it does, she will pass the so-called “income test”.
