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In January 2014 Fastwater Ltd, a manufacturer of speed boats, signed a 10-year contract with Neptune Ltd, a manufacturer of boat parts, according to which Neptune would provide engines and other boat parts for Fastwater. Neptune estimated that the contract represented 30% of their engine sales.
In 2016, due to a changing market and increasing competition, Fastwater decided to reduce costs and optimize their processes by manufacturing their own boat engines. As a result, between July and September 2016 Fastwater spent $1,500,000 developing a new range of fuel efficient engines – ‘Acquablast’ – which were fitted into their speed boats. Fastwater anticipated that the ‘Acquablast’ line would represent 40% of their sales.
As Neptune’s engines were no longer required for their production line, in October 2016 Fastwater cancelled the aforementioned contract without any prior notice. In December 2016 Neptune took Fastwater to Court. The Court’s final decision, issued 10 June 2017, ordered Fastwater to pay Neptune an amount of $800,000 in damages, which were calculated on the expected loss of profits for the next 6 months. This amount was to be paid in two installments, the first one due on 20 June 2017, and the second one due on 20 August 2017. By the 30 June 2017, Fastwater had also incurred $75,000 in legal fees defending the lawsuit.
(a) Advise Fastwater Ltd on the tax consequences in relation to the above expenses for the year ending 30 June 2017, applying legislation and case law to support and develop your arguments. (Suggested word limit: 1,200 words. Calculations are not required)
(b) Advise Neptune Ltd on the tax consequences in relation to the damages received from Fastwater Ltd for the year ending 30 June 2017, applying legislation and case law to support and develop your arguments. (Suggested word limit: 800 words. Calculations are not required