LAWS5144 – Introduction to Taxation Law
Final Exam Notes
Semester 1, 2009
Alexander Psaltis
40987910
Dated: 12 June 2009
Table of contents
Taxation law overview ................................................................................................................. 13
1
General introduction .......................................................................................................... 13
Aspects of tax ...................................................................................................................... 13
Introduction...................................................................................................................... 13
Tax policy ......................................................................................................................... 14
The nature of taxation .......................................................................................................... 14
Defining tax ...................................................................................................................... 14
Complications ................................................................................................................... 14
Types of taxation within Australia .......................................................................................... 14
Direct taxes ...................................................................................................................... 14
Indirect taxes ................................................................................................................... 15
Tax as a social process ......................................................................................................... 16
2
How a tax system works? .................................................................................................. 16
Incidence of Taxation ........................................................................................................... 16
Types of tax systems......................................................................................................... 16
How this works in Australia ................................................................................................ 16
Functions and objects of taxation .......................................................................................... 17
Criteria for evaluating a tax system ....................................................................................... 17
3
Australia’s tax system ........................................................................................................ 18
Federal power to make taxation laws..................................................................................... 18
The power to tax .............................................................................................................. 18
Limitations on the Commonwealth power ........................................................................... 18
Sources of Australian Taxation law ........................................................................................ 19
Statute law ....................................................................................................................... 19
Common law .................................................................................................................... 19
The Australian Tax Office .................................................................................................. 19
History of Australian taxation law .......................................................................................... 19
4
General overview of tax ..................................................................................................... 20
Income tax basics ................................................................................................................ 20
The tax formula ................................................................................................................ 20
The core provisions ........................................................................................................... 21
The core provisions explained ............................................................................................... 21
Ordinary income ............................................................................................................... 21
Statutory and non-assessable income ................................................................................. 21
Income tax accounting ...................................................................................................... 21
Capital gains tax ............................................................................................................... 22
General deductions ........................................................................................................... 22
Specific deductions ........................................................................................................... 22
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Capital allowances and car expenses .................................................................................. 22
Tax offsets ....................................................................................................................... 22
Tax payable ...................................................................................................................... 22
Residence and source.................................................................................................................. 24
1
Introductory principles for calculating ‘taxable income’ ........................................................ 24
Introduction...................................................................................................................... 24
Section 4-10(3) ................................................................................................................. 24
Section 4-15(1) ................................................................................................................. 24
The nature of income ........................................................................................................ 24
Defining assessable income ............................................................................................... 25
2
Types of income ............................................................................................................... 25
Ordinary income – s 6-5 ....................................................................................................... 25
The provision .................................................................................................................... 25
Commentary ..................................................................................................................... 26
Statutory income – s 6-10 ITAA97 ......................................................................................... 26
The provision .................................................................................................................... 26
What is not assessable income – s 6-15 ITAA97 ..................................................................... 26
The provision .................................................................................................................... 26
Commentary ..................................................................................................................... 27
Exempt income – s 6-20 ....................................................................................................... 27
The provision .................................................................................................................... 27
Commentary ..................................................................................................................... 27
Non-assessable non-exempt income – s 6-23 ......................................................................... 27
The provision .................................................................................................................... 27
Commentary ..................................................................................................................... 27
Relationships amongst various rules about ordinary income – s 6-25 ....................................... 28
The provision .................................................................................................................... 28
Commentary ..................................................................................................................... 28
Tying this into residence and source .................................................................................. 29
3
Residence ......................................................................................................................... 29
Residence requirements generally ......................................................................................... 29
Introduction...................................................................................................................... 29
Foreign residents .............................................................................................................. 29
Temporary Resident (from 01 July 2006) ............................................................................ 30
Introductory matters to residence ...................................................................................... 30
Residence of individuals ........................................................................................................ 30
Residence defined – s 6(1) ITAA36 .................................................................................... 30
The ordinary concepts test ................................................................................................ 31
The domicile test – s 6(1) ITAA36 ...................................................................................... 33
The 183 day test ............................................................................................................... 36
The superannuation test .................................................................................................... 36
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Residence of companies ....................................................................................................... 37
Introduction...................................................................................................................... 37
Incorporated in Australia ................................................................................................... 37
Carries on business in Australia with central management and control in Australia ................ 37
Carries on business in Australia with voting power controlled by Australian residents ............ 38
4
Source ............................................................................................................................. 39
Introduction ......................................................................................................................... 39
General principles ............................................................................................................. 39
Where these rules come from ............................................................................................ 39
Specific sources.................................................................................................................... 39
Sale of goods .................................................................................................................... 39
Source of services ............................................................................................................. 40
Source of interest ............................................................................................................. 40
Source of dividends ........................................................................................................... 41
Source of royalties ............................................................................................................ 42
Income....................................................................................................................................... 43
5
Income according to ordinary concepts .............................................................................. 43
Introduction...................................................................................................................... 43
General principles ............................................................................................................. 43
Characteristics of income ................................................................................................... 43
Specific instances of income according to ordinary concepts ................................................... 44
Income as a Flow .............................................................................................................. 44
Income must be a product of labour and/or property .......................................................... 44
Reward for services rendered ............................................................................................ 45
Gains (in the Eisen sense) must be realised ........................................................................ 45
Income must “come in” to the taxpayer ............................................................................. 46
There must be a gain ........................................................................................................ 47
Cash or convertible to cash – NB this has been modified by s 21A (see below) ..................... 47
Periodical gains have the character of income ..................................................................... 48
Disposal of capital asset versus an income stream .............................................................. 48
Gratuitous payments ......................................................................................................... 48
Receipts from Illegal Activities ........................................................................................... 49
Income from personal services .............................................................................................. 49
Introduction...................................................................................................................... 49
Receipts related directly to employment or services (Deane) ............................................... 50
Receipts unrelated to employment or services .................................................................... 50
Reward schemes ............................................................................................................... 51
Reward for services or capital? .......................................................................................... 51
Prizes ............................................................................................................................... 51
Categories of income from labour ...................................................................................... 52
6
Business income ............................................................................................................... 52
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Introduction ......................................................................................................................... 52
Common law .................................................................................................................... 52
Statutory expansion – 3 fold .............................................................................................. 52
Identifying a business ........................................................................................................... 53
How is a business identified? ............................................................................................. 53
Has the business commenced? .......................................................................................... 53
Indicators of a business ........................................................................................................ 54
Introduction...................................................................................................................... 54
System and organisation ................................................................................................... 55
Scale of activities .............................................................................................................. 55
Sustained, regular and frequent transactions ...................................................................... 56
Profit motive – see TR 97/11 ............................................................................................. 56
Commercial character of transactions ................................................................................. 57
Characteristics or quantities of property dealt in ................................................................. 58
Other factors .................................................................................................................... 58
Example – Farming business/passive investment ................................................................ 58
Turning talent to account for profit .................................................................................... 59
Taxation of income from business ......................................................................................... 61
Introduction...................................................................................................................... 61
Receipts received in the ordinary course of business ........................................................... 62
Business income from certain transactions ............................................................................. 63
Business income from ‘isolated’ transactions ....................................................................... 63
Business income from ‘extraordinary’ transactions ............................................................... 64
Lease incentives – application of the Myer principle............................................................. 65
7
Statutory income .............................................................................................................. 66
Allowances in relation to employment and services – s 15-2 ITAA97 ........................................ 66
Introduction...................................................................................................................... 66
s 15-2 – conditions............................................................................................................ 66
There must be a benefit etc ............................................................................................... 67
Provided to the Taxpayer .................................................................................................. 68
Nexus with employment or services rendered ..................................................................... 68
s 15-2 examples ............................................................................................................... 68
Non-cash business benefits – s 21A ITAA36 ........................................................................... 69
Introduction...................................................................................................................... 69
Application ....................................................................................................................... 70
8
Other types of income ....................................................................................................... 71
Compensation payments ....................................................................................................... 71
General principles ............................................................................................................. 71
Distinguishing income from capital ..................................................................................... 71
Compensation categories ................................................................................................... 72
Statutory provisions .......................................................................................................... 74
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Application of CGT on compensation payments generally .................................................... 74
Interest as Income ............................................................................................................... 74
Discounted securities and Div 16E securities .......................................................................... 75
Introduction...................................................................................................................... 75
Reason for the introduction of Div 16E ............................................................................... 76
Income from real property .................................................................................................... 76
Introduction...................................................................................................................... 76
Negative gearing ............................................................................................................... 76
Dividend imputation ............................................................................................................. 77
The classical system .......................................................................................................... 77
Statutory dividend imputation system – s 207-20 ITAA97 .................................................... 77
Franking credits in practice ................................................................................................ 79
Franking Credit Formula .................................................................................................... 79
Shareholder level (shareholder in 45% bracket) .................................................................. 79
Shareholder level (shareholder in 30% bracket) .................................................................. 79
Shareholder level (shareholder in 15% bracket) .................................................................. 80
Dividend advices ............................................................................................................... 80
Non-assessable income ......................................................................................................... 80
Non-assessable income generally – s 6-15 ITAA97 .............................................................. 80
Exempt income ................................................................................................................. 80
Category One – Exempt entities – Div 50 ITAA97 ................................................................ 81
Category Two – Exempt income – Div 51 ITAA97 ............................................................... 81
Category three – see the legislation ................................................................................... 82
Interest on judgment debt .................................................................................................... 82
Introduction...................................................................................................................... 82
Structured settlement payments ........................................................................................ 82
Consequences of an amount being exempt income ................................................................ 82
Non assessable non exempt income ...................................................................................... 83
General principle ............................................................................................................... 83
Examples.......................................................................................................................... 83
Capital gains tax (CGT) ............................................................................................................... 84
1
CGT as a process .............................................................................................................. 84
The 3 steps of CGT............................................................................................................... 84
2
Step 1 – have you made a capital gain or loss? ................................................................... 84
Introduction ......................................................................................................................... 84
Step 1 can be broken up into 4 questions ........................................................................... 84
Question 1 – What attracts CGT? .......................................................................................... 84
Introduction...................................................................................................................... 84
12 categories of CGT events .............................................................................................. 84
Event A1 – Disposal of a CGT asset .................................................................................... 85
Event B1 – Use and enjoyment before title passes .............................................................. 86
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Event C1 – the end (loss or destruction) of a CGT asset ...................................................... 87
Event C2 – the end (cancellation, surrender or similar) of an intangible asset ....................... 87
Event C3 – the end of an option to acquire shares .............................................................. 88
Event D1 – the bringing into existence of a contractual (or other) right in another entity....... 89
Event D2 – the granting of an option ................................................................................. 90
Events D3 and D4 – specific events .................................................................................... 90
Events E1 – E9 – events relating to trusts........................................................................... 90
Events F1 – F5 – events dealing with leases ....................................................................... 91
Event F4 – lessee receives payment for changing a lease .................................................... 91
Event F5 – lessor receives payment for changing lease ....................................................... 92
Events G1 – G3 – events dealing with shares ...................................................................... 92
Event G3 – liquidator declares shares worthless .................................................................. 92
Events H1 – H2 – special capital receipts ............................................................................ 93
Events I1 – I2 – ending of Australian residency .................................................................. 93
Events J1 – J4 – reversal of rollovers.................................................................................. 93
Events K1 – K2 – other CGT events .................................................................................... 94
Events L1 – L8 – consolidated groups................................................................................. 94
Question 2 – What is a CGT asset?..................................................................................... 95
Introduction...................................................................................................................... 95
General principles ............................................................................................................. 95
Collectables ...................................................................................................................... 96
Personal use assets ........................................................................................................... 97
Separate CGT assets ......................................................................................................... 97
Timing of acquisition of the assets ..................................................................................... 99
Question 3 – does an exception (Div 104) or exemption apply (Div 118)? ................................ 99
General principles ............................................................................................................. 99
Exempt assets ................................................................................................................ 100
Exempt or loss denying transactions ................................................................................ 100
Anti-overlap provisions .................................................................................................... 101
Small business relief ........................................................................................................ 101
Main residence exemption ............................................................................................... 104
Question 4 – Can there be a roll-over? ............................................................................. 108
3
Step 2 – work out the amount of the capital gain or loss ................................................... 109
Introduction ....................................................................................................................... 109
Step 2 can be broken down into 3 questions ..................................................................... 109
Question 1 – what is a capital gain or loss? .......................................................................... 109
Question 2 – what factors come into calculating a capital gain or loss? .................................. 109
Question 3 – how to calculate the gain or loss for most CGT events?..................................... 109
Introduction.................................................................................................................... 109
Calculation 1 – capital proceeds ....................................................................................... 110
Calculation 2 – cost base ................................................................................................. 112
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Calculation 5 – reduced cost base .................................................................................... 115
4
Step 3 – work out your net capital gain or loss for the year ............................................... 115
Introduction ....................................................................................................................... 115
Step 3 can be broken down into 2 questions ..................................................................... 115
Question 1 – How do you work out your net capital gain or loss? .......................................... 116
Introduction.................................................................................................................... 116
Calculation 1 – gains and losses for the income year ......................................................... 116
Calculation 2 – use previous years capital losses ............................................................... 116
Calculation 3 – discount percentage ................................................................................. 117
Calculation 4 – small business concessions ....................................................................... 118
Calculation 5 – determining the capital gains .................................................................... 118
3 step process for net capital losses – see s 102-10 .......................................................... 118
Question 2 – How do you comply with CGT? ........................................................................ 118
Deductions ............................................................................................................................... 119
1
Introduction.................................................................................................................... 119
General principles ........................................................................................................... 119
Key points ...................................................................................................................... 119
The nature of deductions................................................................................................. 120
Substantiation: Div 900 ................................................................................................... 120
2
General deductions ......................................................................................................... 120
Introduction ....................................................................................................................... 120
Limbs ............................................................................................................................. 120
Positive limbs ..................................................................................................................... 121
Introduction.................................................................................................................... 121
Common elements .......................................................................................................... 121
Gaining or producing your assessable income ................................................................... 122
Nexus test ...................................................................................................................... 122
Necessarily incurred in carrying on a business .................................................................. 123
Involuntary Expenses ...................................................................................................... 123
Connection with income earning activities......................................................................... 123
Temporal connection ....................................................................................................... 124
Characterising losses and outgoings ................................................................................. 125
Grossly excessive expenditure (TR 2006/3)....................................................................... 126
Negative limbs ................................................................................................................... 127
Introduction.................................................................................................................... 127
Loss or outgoing of capital, or capital in nature ................................................................. 127
Private or domestic in nature ........................................................................................... 129
Incurred in relation to gaining or producing exempt income .............................................. 130
Where another provision in the ITAA prevents the TP from a deduction ............................. 130
Apportionment: ‘To the extent that…’ .................................................................................. 132
Common general deduction types ....................................................................................... 132
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Introduction.................................................................................................................... 132
Expenses incurred in gaining employment ........................................................................ 133
Relocation Expenses........................................................................................................ 133
Child care expenses ........................................................................................................ 133
Travel Expenses .............................................................................................................. 133
Self-education expenses .................................................................................................. 134
Home office expenses ..................................................................................................... 135
Clothing Expenses ........................................................................................................... 137
Interest expense ............................................................................................................. 137
Legal Expenses .................................................................................................................. 138
General principles ........................................................................................................... 138
3
Specific Deductions ......................................................................................................... 139
Introduction ....................................................................................................................... 139
Tax related expenses .......................................................................................................... 140
Repairs .............................................................................................................................. 140
Introduction.................................................................................................................... 140
What is a repair?............................................................................................................. 140
Essential attributes .......................................................................................................... 141
Notional repairs .............................................................................................................. 142
Non-deductible repairs .................................................................................................... 143
Additions ........................................................................................................................ 143
Improvements ................................................................................................................ 143
Example ......................................................................................................................... 144
Example ......................................................................................................................... 144
Example ......................................................................................................................... 144
Initial Repairs ................................................................................................................. 145
Example ......................................................................................................................... 145
Combination of repairs and non-deductible renovations ..................................................... 145
Payment for lease obligation to repair .............................................................................. 146
Repairs to assets used only partly for income-producing purposes ..................................... 146
Bad debts .......................................................................................................................... 147
Requirements ................................................................................................................. 148
Payments to Associations .................................................................................................... 149
Travel between work places ................................................................................................ 149
Borrowing expenses ........................................................................................................... 150
Losses by theft ................................................................................................................... 150
Car expenses ..................................................................................................................... 151
Introduction.................................................................................................................... 151
Available methods ........................................................................................................... 151
Cents per kilometre - Div 28-C ......................................................................................... 152
12% of original value - Div 28-D ...................................................................................... 152
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1/3 of actual expenses - Div 28-E .................................................................................... 152
Log book method - Div 28-G ............................................................................................ 152
Substantiation rules for car expenses ............................................................................... 152
Extent of substantiation required ..................................................................................... 153
Gifts .................................................................................................................................. 154
Prior year losses ................................................................................................................. 154
Principles ........................................................................................................................ 155
Example ......................................................................................................................... 155
4
Capital Allowances .......................................................................................................... 155
Key Points.......................................................................................................................... 155
Introduction.................................................................................................................... 155
Expenditure on depreciating assets ..................................................................................... 156
Deductions for depreciating assets ................................................................................... 156
Deducting amounts for depreciating assets ....................................................................... 156
‘taxable purpose’ ............................................................................................................. 156
Circumstances in which Div 40 has no application ............................................................. 156
What is a depreciating asset? .......................................................................................... 156
Holding a depreciating asset ............................................................................................ 158
Deduction for decline in value .......................................................................................... 158
Diminishing value method – where asset is first held on or after 10 May 2006 .................... 159
Diminishing value method – where asset is first held pre-10 May 2006 ............................... 159
Prime cost ...................................................................................................................... 159
Base value ...................................................................................................................... 159
Asset’s cost .................................................................................................................... 159
Effective Life ................................................................................................................... 160
Exceptions ......................................................................................................................... 161
Immediate deduction for low-cost assets .......................................................................... 161
Low value pools .............................................................................................................. 161
Decline in value of a low-value pool ................................................................................. 162
Car Depreciation Limit ..................................................................................................... 162
Balancing Adjustments ....................................................................................................... 162
General principles ........................................................................................................... 162
Amount of Balancing Adjustment ..................................................................................... 163
Black hole expenditure........................................................................................................ 164
Capital works ..................................................................................................................... 165
Tax accounting and trading stock ............................................................................................... 166
5
Introduction.................................................................................................................... 166
6
Period and timing issues .................................................................................................. 166
The tax period ................................................................................................................... 166
Timing of income ............................................................................................................... 167
Introduction.................................................................................................................... 167
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Salary and wages, interest, and rent ................................................................................ 168
Income from professional practices .................................................................................. 168
Income from business ..................................................................................................... 170
Pre-paid income .............................................................................................................. 171
Deemed derivation .......................................................................................................... 171
Examples........................................................................................................................ 172
Timing of deductions .......................................................................................................... 172
Introduction.................................................................................................................... 172
TR 97/7 - Summary......................................................................................................... 173
Prepaid Expenses ............................................................................................................ 174
7
Trading stock – Division 70 .............................................................................................. 175
General principles ............................................................................................................... 175
What this division is about? ............................................................................................. 175
3 key features of tax accounting for trading stock ............................................................. 175
What is “trading stock”? .................................................................................................. 176
The taxpayer’s purpose ................................................................................................... 176
Division 70 & tax accounting ............................................................................................ 177
When is a deduction available? ........................................................................................ 178
Valuation of trading stock ................................................................................................ 179
Transactions outside the ordinary course of business ........................................................... 180
Extraordinary disposals.................................................................................................... 180
Starting to hold as trading stock an item already owned .................................................... 180
Ceasing to hold an item as trading stock .......................................................................... 181
Private use example ........................................................................................................ 181
Gift example ................................................................................................................... 181
Tax offsets, tax payable and tax administration .......................................................................... 183
1
Tax payable .................................................................................................................... 183
General principles ............................................................................................................... 183
The formula .................................................................................................................... 183
Tax payable .................................................................................................................... 183
Tax rates ........................................................................................................................ 183
PAYG – pay as you go ..................................................................................................... 184
Help debt ....................................................................................................................... 184
Medicare levy ..................................................................................................................... 184
General principles ........................................................................................................... 184
Example of the base case ................................................................................................ 185
Relief for Low Income Earners ......................................................................................... 185
High income earners – Medicare levy surcharge ................................................................ 185
2
Tax offsets ..................................................................................................................... 185
General principles ............................................................................................................... 185
What is a tax offset? ....................................................................................................... 185
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3 Types of Offsets ........................................................................................................... 186
General principles for offsets ........................................................................................... 186
Common offsets ................................................................................................................. 187
Introduction.................................................................................................................... 187
Dependant rebates.......................................................................................................... 187
Entrepreneurs’ tax offset ................................................................................................. 189
Low income earners rebate.............................................................................................. 190
Medical expenses rebate ................................................................................................. 190
Private health insurance tax offset ................................................................................... 190
Zone Rebate ................................................................................................................... 191
Overseas Defence Force Rebate....................................................................................... 191
Dividend imputation ........................................................................................................... 192
The classical system ........................................................................................................ 192
Statutory dividend imputation system – s 207-20 ITAA97 .................................................. 192
Franking credits in practice .............................................................................................. 193
Franking Credit Formula .................................................................................................. 194
Shareholder level (shareholder in 45% bracket) ................................................................ 194
Shareholder level (shareholder in 30% bracket) ................................................................ 194
Shareholder level (shareholder in 15% bracket) ................................................................ 194
Dividend advices ............................................................................................................. 195
3
Self-assessment .............................................................................................................. 195
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Topic 1
Taxation law overview
1
General introduction
Aspects of tax
Introduction
1.1
This course is not about tax in terms of employees, it is generally about business taxation
(e.g. small business taxation) – once these concepts are understood, the taxation of
partnerships, companies and trusts are readily understandable.
1.2
Tax is not all about number crunching, the way we think about tax can be divided into 3
categories – which involve economists, lawyers (of all sorts), financiers, accountants etc who
all deal with tax:
(a)
Tax Policy – what is the policy behind a particular tax rule?
(i)
(b)
(A)
e.g. whether or not to tax
(B)
under the ATO ruling they are treated as sole traders,
(ii)
This is up to Treasury not the ATO – i.e. the tax law is made by treasury (full
of lawyers and economists, writing tax policy);
(iii)
ATO is an administering body, they do not make the tax laws;
(iv)
This is how you make tax make sense, by going to the fundamental
rule/policy behind the provisions.
Tax Technical – taxed on income earned and then allowed a deduction on work
related expenses
(i)
(c)
1.3
Kerrie uses the example of the ATO fact sheet for “People in the Adult
Industry”:
e.g. with the adult industry, could get deduction for pole dancing lessons but
not gym membership
Tax Compliance – the need to have an ABN, file tax returns etc.
(i)
e.g. in the adult industry, you are required to have an ABN and if earn over a
certain amount must register and charge for GST and must keep records and
file tax returns etc
(ii)
this part of tax is not a comment on how many will apply, rather what should
happen.
Cases have application to tax when you least expect it – e.g. Whittaker – final award of
damages (with interest), ATO wanted their share (of her damages), she argued her interest
was not assessable.
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Tax policy
1.4
How much tax should be collected?
1.5
Who pays tax?
1.6
TB: table as to who pays (i.e. super funds, companies, individuals, trustees, partnership,
mutual insurance association, etc). See 9-1 ITAA 97
The nature of taxation
Defining tax
1.7
Definitions – suggest it is about revenue raising (and that is exactly what it should be):
(a)
“Tax” is a “contribution levied on persons, property or business in the support of
government”;
(b)
“a compulsory exaction of money by a public authority for public purposes
enforceable by law”; and
(c)
The process of “raising money for the purposes of government by means of
contributions from individual persons.
These definitions suggest that tax is about revenue raising – which is what it should be.
Complications
1.8
1.9
However, the system (in Australia) is a lot more complicated than just revenue raising, divide
into 2 parts:
(a)
Revenue raising – i.e. amount earned and tax on that etc; and
(b)
Policy reasons – social policy and economic policy:
(i)
e.g. currently complying super funds get a concessionary tax rate (15%) c.f.
normal rate (30%) – this has nothing to with revenue raising, it is rather, a
social and economic policy to encourage saving in super for retirement;
(ii)
e.g. similarly, co’s who invest in R&D and venture capital get larger
concessions and deductions.
Therefore, think about why a provision is there and examine what its function is – e.g.
deductions on donations to charities to encourage us to do that v higher taxes on cigarettes
etc.
Types of taxation within Australia
Direct taxes
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Examples of direct taxes
•
Income Taxes: personal income tax (sliding scale above), company tax (30%), poll taxes
(Aus doesn’t have), CGT (but somewhat of a misnomer as capital gains are included under
assessable income and is therefore not really a separate tax), gift duty (Aus doesn’t have),
inheritance taxes (Aus doesn’t have)
•
Property Taxes: death duty (Aus doesn’t have), wealth tax (Aus doesn’t have)
•
FBT is in separate legislation
1.10
CGT – is not actually a separate tax (and is actually included in the ITAA) – our net capital
gain gets included in our income:
(a)
it should not be put in with GST or FBT (paid by the employer not the employee);
(b)
i.e. these are separate taxes, contained in separate pieces of legislation.
Indirect taxes
Examples of indirect taxes
•
Sales Taxes: sales tax (Aus removed when GST introduced in 2000), GST (aka VAT) (10%),
turnover tax (Aus doesn’t have), purchase tax (GST), expenditure tax (GST), stamp duties
(some have been abolished e.g. shares, and all were meant to be as part of GST), customs &
excise, profits from Government industries
•
Factor Taxes: pay-roll tax, land tax (a change from unimproved value to improved value for
basis of investment recently as a result of a Court decision – will probably discourage
investment in Qld land), real estate tax
1.11
Stamp duties were supposed to be abolished with the introduction of GST, but these are still
there.
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Tax as a social process
1.12
2
What affects the tax system?
(a)
political changes – clear when a change of govt there will be tax changes – e.g.
Henry Review – root and branch review (probably will change company tax (30% rate
– and imputation credits);
(b)
economic changes – a recession will obviously create changes – Kerrie thinks it will
be interesting to see what will happen in the May Budget – there may be changes
there (e.g. more stimulus packages);
(c)
social factors – this includes views such as encouraging certain behaviours over
others – e.g. super encouragement, alcopops tax (did it honestly have anything to do
with revenue raising?) – there are over 300 socially motivated taxes.
How a tax system works?
Incidence of Taxation
Types of tax systems
2.1
This is – how does it work in terms of collecting money from us? – i.e. what makes the
system works?
2.2
Tax may be either:
(a)
Regressive – i.e. takes a decreasing proportion of income as income arises (e.g.
takes $1 from everyone – therefore it takes less of income as you earn more ($1/$10
is 10%, $1/$100 is 1% etc);
(b)
Proportional – i.e. takes the same portion no matter what we earn (i.e. 10%
applied across the board, etc but a higher earner will have a higher amount in their
pocket); and
(c)
Progressive – i.e. an increasing proportion of tax is paid as your income increases –
this is our system with tax brackets etc (e.g. $180,000 = 45% tax (on amounts over
$180,000 etc).
How this works in Australia
2.3
In Australia we have a progressive system; therefore, we have Marginal rates of tax and
average rates of tax:
(a)
Marginal rate of tax – is the bracket in which you fit into (e.g. over $180,000 you
pay 45c in every dollar you earn;
(b)
Average rate of tax – tax liability as a % of your taxable income – this will always
be lower than your marginal tax – i.e. it changes after $180,000 for the top bracket –
always get the benefit of the lower marginal rate on the first part of you income:
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(i)
you will only be paying 45% for amounts over $180,000;
(ii)
you will pay nothing on your first $6,000; and
(iii)
you will then pay increasing percentages above that until you hit $180,000.
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2.4
Medicare levy = 1.5% but exemption for low-income earners (+ Medicare Levy Surcharge).
See Div 785 ITAA 97
2.5
Financial impact of a tax i.e. who actually bears the burden of paying the tax:
(a)
Formal (nominal) incidence: X is nominated as the taxpayer;
(b)
Effective (actual) incidence: X shifts the impact of the tax forwards or backwards
to Y, the effective incidence falls with Y;
(c)
E.g. manufacturer may be the nominal taxpayer but may be able to shift the effective
incidence of the tax forward on to consumers OR employees shifting an income tax
backward on to employers by demanding higher wages
Functions and objects of taxation
2.6
Tax was originally to generate revenue for State based projects (i.e. to allow the government
to govern; now this is broader):
(a)
Enables the government to provide:
(i)
social goods – i.e. joint/non rival consumption, e.g. street lighting –
something we can all enjoy; and
(ii)
merit goods – i.e. deemed beneficial to the user and must meet criteria, e.g.
schools (7 year olds entitled to free education but 4 year olds not) and
health-system (you have to be sick to actually use it),
(b)
Supports those for whom a free market would not otherwise provide – social security,
unemployment benefits, pensions, low-cost housing, the $900 handout from KRudd
etc (these are examples of our taxpayer money going to this); and
(c)
Corrects other free market imperfections – subsidies, e.g. farming subsidies, flood
effected subsidies etc.
Criteria for evaluating a tax system
2.7
There are various criteria for evaluating a tax system – and these date back to Adam Smith
who came up with the first criteria, and they alter over time. The Ralph Committee talked
about: Equity, Simplicity and Certainty.
2.8
Fairness or equity:
Horizontal – taxpayers earning the same amount, pay the same amount of tax (in an
(a)
ideal system, but does not happen due to concessions etc); and
Vertical – in our system, the more you earn, the more you should pay, but it is a
question of how much more and what is appropriate (c.f. a regressive system or a
proportional system – see above).
(b)
2.9
Simplicity – we all want it to be simple – i.e. in order to reduce compliance costs etc, we
have tried to make it simpler:
(a)
e.g. E-Tax which automatically uploads information;
(b)
also want simplicity in the legislation itself – this has not been achieved in Australia
(ITAA 1936 and ITAA 1997 – 1936 was meant to be re-written and replaced with
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1997, but then, this stoped and we now have 2 acts – in looking for a section 1997
has ‘–’ in between sections e.g. 7-5.
2.10
2.11
Certainty – we want certainty of:
(a)
incidents (who has to actually pay);
(b)
liability (easy to work out and how much to pay);
(c)
avoidance (how much is being avoided, and govt trying to overcome this; and
(d)
fiscal marksmanship or budgeting (how much is the govt getting so they can budget
accordingly).
Efficiency or neutrality – any decisions (business, consumption etc) should be tax neutral:
(a)
Therefore, should make decisions without having to consider how much tax will be
paid as a result of the decision;
(b)
but this is not the case (there will always be examples where this doesn’t occur).
2.12
Flexibility – i.e. ability to adapt to current circumstances (e.g. hardship provisions – victims
of the Victorian Bushfires – where there is a link built into the ATO website to discuss
exemptions etc).
3
Australia’s tax system
Federal power to make taxation laws
The power to tax
3.1
s 51(ii) of the Constitution - “The Commonwealth Parliament shall have power to make laws
with respect to taxation, but not so as to discriminate between States or parts of States”:
(a)
this is a concurrent power, but States cannot charge an income tax – as this power
has been ceded to the Commonwealth;
(b)
the GST was going to be a problem for States, as such, they now get certain
percentages (but that caused problems w/ NSW complaining)
Limitations on the Commonwealth power
3.2
s 55 of the Constitution: taxation laws shall deal only with the imposition of taxation: i.e.
cannot tie tax laws to other laws;
3.3
s 99 of the Constitution: the Commonwealth may not give preference to any one state – i.e.
can’t discriminate between States and parts of States;
3.4
s 114 of the Constitution: the Commonwealth cannot impose tax on property belonging to a
state; and
3.5
s 53 of the Constitution: proposed laws imposing taxation shall not originate in the Senate
(must originate in House of Representatives) and the Senate cannot amend tax laws, only
suggest amendments which the House of Representatives must actually amend.
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Sources of Australian Taxation law
Statute law
3.6
There are the two key acts, but this also includes attached regulations:
(a)
Income Tax Assessment Act 1936;
(b)
Income Tax Assessment Act 1997;
(i)
Both contain definition provisions – e.g. 995-1; and
(ii)
See section 1-3 ITAA97: where different words are used
Common law
3.7
The common law has been quite prolific in terms of tax law.
(a)
Creation of law to fill a legislative vacuum – i.e. where policy is lacking; and
(b)
Statutory interpretation – this is where tax decisions usually fall (e.g. s 6-5 ITAA97
says you are assessed on ‘income according to ordinary concepts’ – courts have
interpreted this, because it is not defined in the ITAA97).
The Australian Tax Office
3.8
The practice of the ATO can make tax determinations etc.
3.9
It is not entirely accurate to say the ATO makes law, as the ATO does not make the law, but
they put out various quasi-legal documents:
(a)
Rulings (TR) – these are the ATO’s views on how the law applies:
(b)
(i)
usually based on cases – e.g. gives the ATO explanation of cases;
(ii)
are binding on the ATO to the extent that if a tax-payers situation fits within
the ruling and the tax-payer relies on the ruling the ATO must follow the
ruling;
(iii)
but are not binding on the tax-payer – obviously though, ATO may take you
to court over it – these may sometimes be wrong (e.g. their interpretation of
a case);
(iv)
They are a pretty good source of information and give useful examples,
There are also determinations, etc.
History of Australian taxation law
3.10
3.11
Pre-World War II
(a)
Customs and Excise duties
(b)
1915 Commonwealth Income Tax
The 1960’s
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3.12
3.13
3.14
(a)
Need for reform; and
(b)
System was in dire-straits.
1970’s-1980’s
(a)
The era of tax avoidance – greed is good;
(b)
Everyone did everything they could do avoid tax – the Bottom of the Harbour
Schemes.
Labor Government reforms (Hawke and Keating)
(a)
CGT (1985) – remember this is really not a separate ‘tax’; and
(b)
FBT (1986).
Liberal Government reforms (Howard and Costello)
(a)
GST (2000); and
(b)
the Ralph Business reforms (partially dealt with selling the GST)
3.15
Rudd Labor Government – 2008 Henry Review, it will be interesting to see where this will
lead.
4
General overview of tax
Income tax basics
The tax formula
4.1
The tax formula – s 4-1 ITAA97 (starting point) – remember this formula:
Income tax Payable
=
Taxable Income x Tax rate – Tax offsets
Where
Taxable Income = Assessable income – deductions
4.2
Attempts to get to an income tax payable:
(a)
Accessible income – 5-6 weeks of the course – CGT comes in here;
(b)
When you get lost in the course, come back to the formula and work out which part
we’re looking at;
(c)
This formula will help make the course make sense;
(d)
s 4-1 ITAA97 is the starting point for the calculation of tax; and
(e)
See also the pyramid which Kerrie does not think is particularly useful – s 2-5 ITAA97
contains the pyramid (and this was put in to show how the act should work).
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The core provisions
4.3
See below for an illustration of how the core provisions operate.
The Tax Pyramid
NB – the international aspects of income taxation – will not be dealt with in this course, we are
concerned with the core provisions.
The core provisions explained
Ordinary income
4.4
This is always the starting
tarting point in our analysis of income tax.
4.5
We will identify the amount of income (c.f. capital) which are assessable – s 6-5..
4.6
Div 6 of the ITAA97 deals with income and is divided into various categories (e.g. statutory
and non-assessable
assessable income as well).
well)
4.7
The first step in the taxation process is to examine a flow of money inwards and determine
whether that flow of money represents income.
inc
4.8
Since most income we will consider in this subject is assessable, it is important to identify it
(as distinct from capital) and determine the amount of it (for the purposes of calculating
income tax payable).
Statutory and non-assessable
assessable income
4.9
The next step is to look at specific types of income and see how they are treated for taxation
purposes. This includes examining exempt income and statutory income as well as income
from property.
Income tax accounting
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4.10
Third, in the income component is the accounting treatment. This is because the law varies
from accounting principles.
4.11
For example, trading stock is treated differently in determining the taxation burden from the
accounting for stock that we have covered in our introductory studies.
Capital gains tax
4.12
Capital as distinct from income flows is then considered, particularly the taxation of capital
gains realised on the sale of capital items (as distinct from trading stock).
4.13
Even though we imply that it is a separate tax, there is no such thing – it is just included in
our assessable income.
General deductions
4.14
See s 8-1 ITAA97 – when all of the possible sources of income have been considered and
their eligibility for taxation purposes considered, those items which constitute assessable
income will be added together, from which amount will be deducted items the taxation
regime allows.
4.15
NB – deductions are not offsets and are not as valuable as offsets – which come off the final
figure (see formula).
Specific deductions
4.16
Also s 8-5 ITAA97 – examples will be considered (Div 25 ITAA97 has a lot of specific
deduction provisions).
4.17
NB – deductions are not offsets and are not as valuable as offsets – which come off the final
figure (see formula).
Capital allowances and car expenses
4.18
We are allowed deductions for expenditure where the item purchased lasts for more than one
year
Tax offsets
4.19
A generic term in the ITAA97 to refer to credits and rebates – have nothing to do with
revenue raising (usually social policy) – e.g. childcare rebate.
4.20
Once the income and deductions from income have been determined, a net amount of
assessable income is then calculated, from which a preliminary amount of tax payable may be
calculated. This amount of taxation payable is called basic tax payable. Basic tax payable
may then be adjusted for amounts we will generally refer to as offsets.
4.21
These can throw out the idea of horizontal equity – but are different to deductions – they are
not taken off assessable income, rather they are offset at the end and are much more
valuable.
Tax payable
4.22
From the previous process, we are able to account for other amounts to arrive at a sum of
money which amounts to the individual taxpayer’s share of the taxation burden or a refund of
money owed to the taxpayer.
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4.23
Kerrie wants us to look at the tax rates, from 15% up to 45% - they are in the learning unit
and see if you can have a fiddle and work out how to calculate them!
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Topic 2
Residence and source
1
Introductory principles for calculating ‘taxable income’
Introduction
1.1
The following provisions are general provisions relating to calculating income for tax purposes
– i.e. your assessable income.
1.2
This does not necessarily follow ordinary meanings of income and there are process which
must be applied to work out what is assessable income.
1.3
These provisions are found in Div 4 – a core division of the ITAA97 – and it explains the
whole process of working out income tax payable.
1.4
The provisions below apply equally to assessing what is assessable income as to whether
someone is an Australian resident or not for tax purposes.
Section 4-10(3)
1.5
This is the tax formula and it is used to work out your income tax for the financial year:
Income Tax
=
(taxable income x rate) – offsets
1.6
This is about plugging various amounts calculated in accordance with the CL and ITAAs to
work out how much tax should be paid legally.
Section 4-15(1)
1.7
This is the harder part of the formula which allows you to work out your taxable income for
this income year:
taxable income
=
assessable income - deductions
where:
assessable income
=
(ordinary income + statutory income) - exempt income
1.8
This will provide the bulk of the course – go back to this if you get stuck.
The nature of income
1.9
Ordinary income – income according to ordinary concepts or judicial notion of income
developed by the courts – it was fairly narrow in its development (i.e. a flow of money
coming in, rather than a gain or increase in wealth).
1.10
Statutory income – this was developed by the legislation due to the narrow scope of
ordinary income – it allows for amounts that are included in assessable income by specific
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statutory provisions – e.g. capital gains tax – included because it is a statutory income – it is
therefore not ordinary income – also bonuses, premiums etc – covered in the ITAAs.
Defining assessable income
1.11
s 995-1 – assessable income has the meaning given by sections 6-5, 6-10 and 6-15:
(a)
s 6-5 – income according to ordinary concepts (ordinary income) – there is no
further definition in the legislation, cases have further considered this (see below)
(b)
s 6-10 – other assessable income (statutory income)
(c)
s 6-15 – what is not assessable income?
1.12
s 995-1 is the starting point in terms of defining things in the tax act – in this case, it does
not refer us to the old act, but rather to Div 6 (i.e. the above sections).
1.13
The following headings deal with the various definitions of income.
Diagram showing relationships amongst concepts in Div 6
2
•
There are many differences here which need to be acknowledged.
•
To fall within assessable income an amount must be ordinary or statutory income – but, not
everything that falls within those categories is assessable income.
Types of income
Ordinary income – s 6-5
The provision
2.1
s 6-5(1) [ordinary income] – your assessable income includes income according to
ordinary concepts, which is called ordinary income.
2.2
s 6-5(2) [Australian residents] – if you are an Australian resident, your assessable
income includes the *ordinary income you *derived directly or indirectly from all sources,
whether in or out of Australia, during the income year.
2.3
s 6-5(3) [non-residents] – if you are a foreign resident, your assessable income includes:
(a)
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the *ordinary income you *derived directly or indirectly from all *Australian sources
during the income year; and
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(b)
2.4
other *ordinary income that a provision includes in your assessable income for the
income year on some basis other than having an *Australian source.
s 6-5(4) [doctrine of constructive receipt] – in working out whether you have derived
an amount of *ordinary income, and (if so) when you derived it, you are taken to have
received the amount as soon as it is applied or dealt with in any way on your behalf or as you
direct.
Commentary
2.5
The provision consists of the following parts:
(a)
s 6-5(2) deals with Australian residents
(b)
s 6-5(3) deals with non-residents
(c)
s 6-5(4) is an anti-avoidance provision (e.g. prevents Kerrie saying to the UQ to pay
her salary to someone else to pay her bills) – i.e. she is deemed to have received the
amount, despite the fact that it was in effect paid to someone else.
Statutory income – s 6-10 ITAA97
The provision
2.6
s 6-10(1) [not ordinary income] – your assessable income also includes some amounts
that are not *ordinary income.
2.7
s 6-10(2) [definition] – amounts that are not *ordinary income, but are included in your
assessable income by provisions about assessable income, are called statutory income.
2.8
s 6-10(3) [doctrine of constructive receipt] If an amount would be *statutory income
apart from the fact that you have not received it, it becomes statutory income as soon as it is
applied or dealt with in any way on your behalf or as you direct.
2.9
s 6-10(4) [Australian resident] If you are an Australian resident, your assessable income
includes your *statutory income from all sources, whether in or out of Australia.
2.10
s 6-10(5) [non-resident] If you are a foreign resident, your assessable income includes:
(a)
your *statutory income from all *Australian sources; and
(b)
other *statutory income that a provision includes in your assessable income on some
basis other than having an *Australian source.
What is not assessable income – s 6-15 ITAA97
The provision
2.11
2.12
s 6-15(1) [not ordinary or statutory income] If an amount is not *ordinary income, and
is not *statutory income, it is not assessable income (so you do not have to pay income
tax on it).
s 6-15(2) [exempt income] If an amount is *exempt income, it is not assessable
income.
2.13
s 6-15(3) [non-assessable non-exempt income] If an amount is *non-assessable nonexempt income, it is not assessable income.
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Commentary
2.14
There are 3 situations where amounts are not assessable income:
(a)
not ordinary or statutory income;
(b)
exempt income; and
(c)
non-assessable, non-exempt income.
2.15
Therefore, you do not have to pay tax on it (e.g. $10 grandma sends on a birthday – it is a
gift, therefore not assessable. $10 given for baking a couple of cakes – if it is just a hobby;
2.16
If an amount is exempt income it is not assessable income; similarly if it is non-assessable
non-exempt income.
Exempt income – s 6-20
The provision
2.17
s 6-20(1) [made exempt] An amount of *ordinary income or *statutory income is
exempt income if it is made exempt from income tax by a provision of this Act or another
*Commonwealth law.
2.18
s 6-20(2) [ordinary income excluded] *Ordinary income is also exempt income to the
extent that this Act excludes it (expressly or by implication) from being assessable income.
2.19
s 6-20(3) [statutory income exempted] By contrast, an amount of *statutory income is
exempt income only if it is made exempt from income tax by a provision of this Act outside
this Division or another *Commonwealth law.
2.20
s 6-20(4) [non-assessable non-exempt income] If an amount of *ordinary income or
*statutory income is *non-assessable non-exempt income, it is not exempt income.
Commentary
2.21
An example of exempt income is income derived internationally by non-Australian residents.
Non-assessable non-exempt income – s 6-23
The provision
2.22
s 6-23 [non-assessable non-exempt income] An amount of *ordinary income or
*statutory income is non-assessable non-exempt income if a provision of this Act or of
another *Commonwealth law states that it is not assessable income and is not *exempt
income.
Commentary
2.23
C.f. with exempt income –here, the Act must say that it is non-assessable non-exempt
income:
(a)
e.g. when you had to hand back your guns, you got compo, that was labelled thus;
(b)
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2.24
2.25
But, what is the difference – if the legislation just labels them differently? Difference is how
they are treated for tax purposes:
(a)
non-assessable non-exempt income is not taken into account at all for tax
purposes;
(b)
exempt income is taken into account:
(i)
e.g. you may have to offset losses on the exempt income before you can
carry forward those losses to a future year;
(ii)
reduce the amount of loss you can actually use.
Subdiv 11B ITAA97 contains examples of non-assessable non-exempt income:
(a)
GST payable on a taxable supply – s 17-5 ITAA97;
(b)
Fringe benefits – s 23L(1) ITAA36; and
(c)
Amounts received from related entities, to the extent that the entity’s deduction is
reduced – s 26-35 ITAA97.
Relationships amongst various rules about ordinary income – s 6-25
The provision
2.26
s 6-25(1) [doubling to be included once] Sometimes more than one rule includes an
amount in your assessable income:
(a)
the same amount may be *ordinary income and may also be included in your
assessable income by one or more provisions about assessable income; or
(b)
the same amount may be included in your assessable income by more than one
provision about assessable income.
However, the amount is included only once in your assessable income for an income year,
and is then not included in your assessable income for any other income year.
2.27
s 6-25(2) [statutory income will prevail] Unless the contrary intention appears, the
provisions of this Act (outside this Part) prevail over the rules about *ordinary income.
Commentary
2.28
This provision tries to avoid the double taxation of income it is the counterpart of s 8-10
which prevents double deductions.
2.29
i.e. we may end up with doubling up of income because of two different statutory provisions
– what do we do?
2.30
(a)
this section allows it to only be included once in assessable income in that tax year;
and
(b)
it cannot be included again in another tax year.
The rule is that the statute will prevail, however:
(a)
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(b)
2.31
therefore, stick to normal rules of statutory construction.
Example – s 118-20: where the disposal of an asset gives rise to ordinary income and a
Capital Gain, the capital gain is reduced by the amount of ordinary income included in
assessable income in the absence of such a provision CGT would have prevailed:
(a)
therefore an assessable income provision prevails over CGT;
(b)
i.e. if the Act includes the gain as income (say for sale of land), then your CGT
liability is reduced.
Tying this into residence and source
2.32
The overall rationale is:
(a)
Australian resident – should be taxed on all sources of income (i.e. should not be
taxed on their foreign sources elsewhere);
(b)
Non-Australian resident – should be taxed only on Australian income sources (i.e.
will be taxed on their foreign sources elsewhere).
2.33
This provision is why residence and source is so important.
3
Residence
Residence requirements generally
Introduction
3.1
From the provisions above in Division 6, it shows that:
(a)
an Australian resident is taxed on income from all sources; and
(b)
a foreign resident is taxed on income sourced in Australia.
Foreign residents
3.2
A non-Australian resident is taxed on:
(a)
income sourced in Australia (ordinary (s 6-5(3)(a) and statutory income (s 610(5)(a));
(b)
ordinary or statutory income that a provision includes in assessable income on some
basis other than having an Australian source (s 6-5(3)(b) and s 6-10(5)(b))
(i)
e.g. CGT provisions bring to account capital gains and losses of a foreign
resident that arise where CGT events happen to CGT assets that constitute
taxable Australian property (s 855-10(1))
(c)
An entity is entitled to deduct any loss or outgoing to the extent that it is incurred in
gaining or producing assessable income or in carrying on a business for the purpose
of gaining or producing assessable income (s 8-1(1))
(d)
No deductions for exempt income (s 8-1(2)(c))
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Temporary Resident (from 01 July 2006)
3.3
A ‘temporary resident’ is defined in s 995-1 as:
(a)
a person holding a temporary visa under the Migration Act 1958; and
(b)
are not an Australian resident under the Social Security Act 1991; and
(c)
your spouse is not an Australian resident within the meaning of the Social Security
Act 1991.
3.4
However, you are not a temporary resident if you have been an Australian resident at any
time after the commencement of this provision.
3.5
All ordinary and statutory income derived from a foreign source is non-assessable nonexempt income: s 768-910(1).
3.6
Foreign source investment income (i.e. net capital gains made on assets other than
those which represent “taxable Australian property” and interest withholding tax obligations
associated with amounts owing to foreign lenders) is also non-assessable non-exempt
income.
3.7
All Australian source income is assessable under s 6-5(3) – ordinary income and s 610(5) – statutory income.
Introductory matters to residence
3.8
Controlled Foreign Company (CFC), Transferor Trust and Foreign Investment Fund (FIF)
rules were introduced to prevent residents from manipulating income to be deemed to be
foreign source income derived by a foreign resident (was therefore not taxable).
3.9
Double tax agreements (DTA): agreements which govern the way in which income derived
by residents of those countries are taxed to prevent double taxation and fiscal evasion (s 4
International Tax Agreements Act 1953 (Cth) together with ITAA36 and ITAA97).
3.10
N.B. ‘foreign resident’ (ITAA97 term) means the same as a ‘non-resident’ (ITAA36 term)
3.11
The status of a person in migration law is not conclusive for tax purposes (can be completely
different i.e. a resident for tax purposes but a non-resident for migration purposes. Often this
has obscure consequences – may have to pay the Medicare levy, but not be entitled to public
health services)
3.12
There is no test for foreign residency. You test for Australian residency, and if they
fail, they are a foreign resident
3.13
Residency is determined on a year by year basis (financial year), and can change.
Residence of individuals
Residence defined – s 6(1) ITAA36
3.14
s 6(1) ITAA36 sets out four tests (the first is from the common law):
(a)
residence according to ordinary concepts – common law test;
(b)
domicile test;
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(c)
183-day rule;
(d)
superannuation test.
3.15
These tests determine whether a person is an Australian resident – if they do not meet at
least one test they are a foreign resident.
3.16
If so, foreign residents are taxed at a different rate and do not pay the Medicare levy.
3.17
Three main contexts in which the question of residence arises:
3.18
(a)
A taxpayer is posted overseas and is arguing that they are now a foreign resident
deriving foreign source income, and is therefore outside Australia’s tax jurisdiction;
(b)
A taxpayer is posted overseas but still derives mainly Australian source income and is
therefore arguing they are still a resident so as to avoid foreign resident tax rates;
and
(c)
A foreign resident is posted to Australia for a limited or indefinite period and is
arguing that they are not a resident of Australia and therefore should be taxed only
on Australian source income.
We do not decide residency status in terms of a foreign jurisdiction, only that a person is a
foreign resident – it does not matter where it is that they are.
The ordinary concepts test
3.19
The following factors are considered:
(a)
physical presence in Australia:
(b)
pro-rated for financial year/arrival in Australia;
(ii)
generally some physical presence in Australia is necessary (Case 28) unless
the person has no place of abode elsewhere during the year of income
frequency, regularity and duration of visits:
(c)
(i)
if previously a resident: frequency and duration need not be substantial.
Generally the purpose is not an important factor and in particular, it is not
relevant that the visits were involuntary but necessitated by business or some
other reason (see Lysaght);
(ii)
if not previously a resident: short and temporary visits are not likely to result
in residency, the “quality and character” of an individual’s behaviour is to be
assessed if behaviour over the period of physical presence reflected a
degree of “continuity, routine or habit that is consistent with residing” then
usually regarded as a resident;
maintenance of place of abode in Australia during absences:
(d)
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(i)
(i)
house or hotel?:
(ii)
particularly important where the person has no place of abode outside
Australia during absences;
family and business ties:
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(e)
(i)
greater weight (particularly family ties) is likely to be given to this factor in
determining whether a person who was previously a resident has ceased to
be a resident (see Levine);
(ii)
however, business ties were not seen as an important factor in Lysaght;
present habits and mode of life:
(f)
(i)
if the taxpayer’s mode of life is similar before and after the alleged change in
residence, then this may indicate that there has been no change;
(ii)
the courts may be looking for a break in habits: Levine
nationality – normally in borderline cases only and normally will not play a role.
3.20
There is a long line of cases dating back to 1920s HOL cases in which the courts came up
with the factors (above).
3.21
Under the ordinary concepts test you can be a part-year resident:
(a)
e.g. applying the factors to a person arriving during the year) they will only be
considered a resident for the part of the year that they are in Australia;
(b)
the rest of the time, they would be a foreign resident;
(c)
N.B. see the difference in the tests below.
Levine’s Case
Facts
•
Taxpayer was retired and sold house in UK.
•
For two years, lived in hotels in England.
•
For the next 5 years, lived in hotels in England and abroad, spending less than ½ his time
in UK.
•
After this time, he bought a house in France.
Held - HL
•
Held, once he bought a house in France, he was a French resident.
•
The two years he was living in hotels in England was an Eng resident.
•
The real question was the 5 years where he predominantly lived abroad.
•
He had spent 4/5 months per year in the UK to obtain medical advice, visit relatives and
attend religious ceremonies.
•
HL: said was a resident maintained some physical presence.
•
Treated England as home (considering medical treatment).
•
There was no real break in habit until he bought the home in France.
Lysaght
Facts
•
UK taxpayer spent considerable time abroad
•
Partially retired with inherited estate in Ireland
•
Sold home in England but remained a non-exec director of the family co
•
Went back to England for 1 week each month to attend board meetings
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Lysaght
Held - HL
•
Held: also a resident according to ordinary concepts – i.e. followed Levine.
Example 1 – TR 98/17
Facts
•
Michael Desmond is a South African diamond corporation executive.
•
He takes the opportunity to participate in an intensive eight month advanced management
development program at an Australian university.
•
Michael's wife and children do not accompany him to Australia and while here he stays in
basic accommodation on campus.
•
He spends his time studying or writing reports for his company.
•
He is in Australia solely to do the course and at the end of eight months he returns home.
Decision
•
Michael does not exhibit behaviour that is consistent with residing here.
•
All of the facts lead to a conclusion that he is a non-resident (a foreign resident).
Example 2 – TR 98/17
Facts
•
Jane Cierpinski is single and is a Professor of Biology at the University of Warsaw.
•
She comes to Australia to work on a research project.
•
She is contracted to do the research in Australia for five months.
•
A six month lease of a small furnished unit near her work is such an attractive proposition
that she enters into the lease despite intending to leave after five months.
•
She also buys an old car.
•
She relaxes at the end of her long days by going to the movies, occasionally attending
dinner parties hosted by her colleagues, reading novels or writing letters to her friends and
parents.
•
Jane intends to return to Warsaw at the end of the project that actually lasts for seven
months.
•
She negotiates an extra month on the lease of her unit.
•
Apart from depositing her salary into an Australian bank account to cover normal living
expenses, Jane retains all assets and investments in Poland, her country of domicile.
Decision
•
Jane’s behaviour over the seven months in Australia is consistent with residing here.
•
She is regarded as a resident from her arrival.
The domicile test – s 6(1) ITAA36
3.22
A person whose domicile is Australia is a resident of Australia, unless the Commissioner is
satisfied that the person has a permanent place of abode outside Australia.
3.23
Domicile is a legal relationship between a person and a state by which the person invokes the
state’s legal system as his/her personal law
(a)
Domicile of origin: attributed at birth; and
(b)
Domicile of choice: acquired by demonstrating an intention to fix a permanent
residence in a new country (a choice).
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3.24
N.B. can only ever have one at a time (c.f. an abode)
3.25
Usually involves a person who is domiciled in Australia being posted overseas – issue is
whether the person has a “permanent place of abode outside Australia”
3.26
A person whose domicile is Australia is a resident of Australia, unless the Commissioner
is satisfied that the person has a permanent place of abode outside Australia:
3.27
3.28
(a)
FCT v Applegate
(b)
FCT v Jenkins
Application of the domicile test:
(a)
Generally applies to outgoing (overseas posting);
(b)
Domicile Act 1982 (Cth): usually the place of the father’s home by default;
(c)
Domicile of origin or domicile of choice; and
(d)
Residency not affected by citizenship.
Domicile of Australia = sufficient unless “permanent place of abode” outside Australia:
Permanent: something less than everlasting, not lasting forever but contrasted with
(a)
temporary or transitory
(b)
Everlasting would be another domicile.
FCT v Applegate
Facts
•
Aus taxpayer transferred to Vanuatu to open a branch of law firm
•
Always intended that the taxpayer would return to Australia, despite being transferred for an
indefinite period
•
Severed most links with Australia – left no assets and surrendered lease of house, wife moved
with him, but retained membership of an Australian health fund and wife returned to give
birth to child
•
Obtained house and residency status and admitted to practise in Vanuatu
•
Nov 1971 moved to Vanuatu June 1973 – came back for medical treatment Sep 1973 –
returned permanently and branch closed down
Issue
•
Whether the taxpayer had a permanent place of abode outside Australia
•
Permanent in this context had to mean something less than everlasting otherwise the person
would have lost their Australian domicile
•
Taxpayer argued he permanent place of abode outside Australia
Held – FCFCA
•
The taxpayer had a permanent place of abode outside Australia.
FCT v Jenkins
Facts
•
Aus taxpayer was bank employee transferred to Vila for 3 years with possibility to extend
•
Tried to sell home in Aus, but was unsuccessful and instead leased it to his employer
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FCT v Jenkins
•
Maintained a bank account in Australia, but cancelled his health insurance
•
Useless at job (“inability to perform services”) repatriated back at end of 18 months
Held – QSC
•
The taxpayer had a permanent place of abode outside Australia.
•
Applegate was applied.
•
The decisive factor was that he had not formed a definite intention to return to Australia in
the year of income, notwithstanding the bank account and house.
•
See also – IT 2650 (Old TR)
3.29
Taxation Ruling IT 2650: Factors to consider in determining whether the taxpayer has a
permanent place of abode outside Australia:
(a)
the intended and actual length of stay in the foreign country (<2 years is likely to
mean you are still an Australian resident);
(b)
establishment of a home outside Australia (i.e. more than temporary
accommodation); and
(c)
the durability of association with Australia (in particular: bank accounts and the
education of children)
The ruling enlivens a presumption, which can be rebutted in circumstances such as Jenkins.
Example 3 – IT 2650
Facts
•
A person who had just completed tertiary studies decided to leave Australia for an unspecified
period of time to work in one overseas country to gain work experience.
•
Before leaving she closed all bank accounts except for a 5-year interest bearing deposit.
•
She had no established home in Australia and no spouse or children in Australia.
•
She was forced to return to Australia after 18 months because of illness.
Decision
•
ATO believes she is a non-resident – she was forced to return to Australia, but her original
intention was to remain outside Aust for an unspecified period of time.
Example 4 – IT 2650
Facts
•
What if she had intended to (and did) spend one year each in 2 countries and then had
travelled for a further period of one year, making do in temporary or transitory
accommodation in each country as she went?
Decision
•
In this case, she would not be able to show that she has a permanent place of abode in any
overseas country and as such, she would continue to be a resident during the three years she
is overseas.
•
Don’t automatically assume that there will be double taxing – there is provision to get a
foreign tax off-set – so, if she earned money overseas – she would not pay tax twice, she
would get an off-set.
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The 183 day test
3.30
3.31
3.32
A person who is actually in Australia, continuously or intermittently, during more than half of
the year of income is a resident of Australia unless the Commissioner is satisfied that:
(a)
the person usual place of abode is outside Australia; and
(b)
the person does not intend to take up residence in Australia.
This is a purely mathematical test and is a half-a-year test:
(a)
such a person is deemed to be a resident (applied to inbound individuals);
(b)
the wording of this is ‘usual place of abode’ not ‘permanent place of abode’ and
therefore, is not as stringent.
It is pretty straightforward but there is confusion about the interaction between the tests – in
the other tests, you are a resident for a certain period of time – but here, you are a
resident for the whole of the income tax year.
Example 5 – How the tests interact
Facts
•
Bill is an intending migrant who comes to Australia with a view to settling here, but
subsequently changes his intention.
•
Bill arrives in Australia, having broken all connections with his former country of residence on
1 July 1992, and leaves after seven months.
•
After leaving, Bill travels the world (for the final five months of the year) without establishing
any further place of residence.
Decision
•
•
Bill is a resident under the ordinary concepts test only in respect of the seven-month period
spent in Australia and, therefore, the 183 day test needs to be considered in respect of the
other part of the year (i.e. the final five month period).
The precondition for the test is satisfied (i.e. being in Australia for more than one half of the
year).
•
Although Bill does not have an intention during the five-month period of residing in Australia,
he does not have a usual place of abode outside Australia during the period and,
consequently, he has not met both the conditions required to satisfy the specified exception
to the 183 day test.
•
Accordingly, the 183 day test will deem Bill to be a resident for the whole year and not only
the original 7 month period (slide said: final 5 month period).
The superannuation test
3.33
A person who is a member of a superannuation scheme established by deed under the
Superannuation Act 1990, an eligible employee for the purposes of the Superannuation Act
1976, or a spouse or child of such person is a resident of Australia.
3.34
This test is much more limited than what it appears – it deals with Commonwealth Public
Servants and Diplomats
(a)
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(b)
until recently Kerrie had not come across anyone who had been caught under this
test - a man who was working in NZ was covered by this and was therefore an
Australian resident for tax purposes.
Residence of companies
Introduction
3.35
A company is a resident of Australia if it:
(a)
is incorporated in Australia;
(b)
carries on business in Australia and has its central management and control in
Australia; or
(c)
carries on business in Australia and has its voting power controlled by Australian
residents.
Incorporated in Australia
3.36
The incorporation is a reference to the Corporations Act.
3.37
Incorporation is sufficient regardless of where central management and control is located.
Carries on business in Australia with central management and control in Australia
3.38
3.39
This has two requirements:
(a)
carrying on a business in Australia; and
(b)
central management and control in Australia, where control ≥ 50%.
The following cases are useful to prove this test.
Malayan Shipping Co. Ltd v FCT
Facts
•
Now limited to its facts
•
Often misquoted as if central management is Australia is the same as carrying on a business
in Australia (i.e. treats the test as one-limbed, not two-limbed)
•
Co was incorporated in Singapore, so couldn’t satisfy the first test
•
Central management was located in Australia
•
There were lots of contracts drawn up in Australia by Mr Sleigh, who was the Managing
Director of the Company
•
All were sent to Singapore for execution, where the contracts were to be carried out
Held – HCA
•
Held, by HCA that the Co was doing business in Australia because its central management
and control were located in Australia
•
Heavily criticised – it is a two-stage test – whilst the company had its central management in
Australia, Singapore was exercising control over the company.
•
This however does not mean that just because you have management and control in Australia
that your business will be carried on in Australia.
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TR 04/15
ATO’s position
•
Argued that the requirement of “carrying on a business in Australia” does not always simply
arise from a company’s central management and control being in Australia.
•
Some higher degree of presence in Australia is required and is a separate requirement that
needs to be satisfied.
Koitaki Para Rubber Estates Ltd v FCT
Facts
•
Incorporated in Australia, and operated a plant in PNG
•
Claimed a tax exemption in Australia, which required them to show residence in PNG
•
Central management was located in Sydney, but the plant’s manager enjoyed a great deal of
autonomy
•
The TP argued you could be a resident in two jurisdictions
Held – HCA
•
Per Dixon J: you can be a resident in two jurisdictions.
•
However, here, not a resident in PNG, because the plant manager could not exercise control
over the general and financial affairs of the company in PNG.
•
Central management and control will be where the “superior or directing authority” of the
company is located if there is more than one place of management (as opposed to the place
of management of the company’s day-to-day operations).
Example 6 – TR 04/15
Facts
•
Watch Co is a company that is not incorporated in Australia. Watch Co distributes watches in
the Australian market and warehouses its goods in Australia for distribution in the South East
Asian market.
•
Half of the board of directors of Watch Co reside in the country in which Watch Co is
incorporated and the remaining board members reside in Australia and also participate in the
process in Australia leading up to the making of high level decisions.
•
The board holds the majority of its meetings in Australia where it makes high level decisions
regarding the company's major contracts, finance and general policies and strategic directions
in respect of its business operations.
Decision
•
The majority of board meetings occur in Aust and therefore Control etc will be in Australia.
•
It also carries on business in Australia (e.g. warehousing business).
Carries on business in Australia with voting power controlled by Australian
residents
3.40
3.41
2 requirements:
(a)
the taxpayer must be carrying on business in Australia; and
(b)
its voting power must be controlled by shareholders who are residents of Australia.
As there is not necessarily a natural relationship between the shareholders and the carrying
on of a business, there has never been any suggestion that the Malayan Shipping reasoning
applies to this test consequently, both requirements must be satisfied.
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4
(a)
carrying on business by reference to the day-to-day operations of the company (if
reference to management powers, then the CM&C test would be satisfied)
(b)
looks to the residence of controlling shareholders, however, this is easily
avoided by interposing a foreign resident nominee as shareholder (this test does not
look through to the residence of the ultimate beneficial owner of the shares).
Source
Introduction
General principles
4.1
The source of income is what a practical man would regard as a real source of income – see
Nathan v FCT:
Nathan v FCT
Facts
•
The question was to decide whether dividends earned by the tax-payer derived from UK
companies were sourced in Australia.
•
There were operations undertaken by the Co’s in Australia.
Held – HCA (1918)
•
Court decided there was an Australian source for these dividends.
•
But, more importantly, the principle that ascertainment of the actual source of income is a
matter of fact – therefore, the court suggested that source is based, not on a legal doctrine
but rather, cases are determined on their own facts.
•
This really says nothing and all people seem to rely on Nathan to push their own case.
•
Courts were suggesting a subject over form argument.
Where these rules come from
4.2
Generally judge made law, however:
(a)
there are limited specific rules in the ITAA; and
(b)
a Double Tax Agreement (DTA) may be relevant – this is not really discussed.
Specific sources
Sale of goods
4.3
4.4
Trading stock: depends on the taxpayer’s activities:
(a)
essence of business is contracting – source = place of contract; and
(b)
essence of business is a large range of activities – source = apportionment (e.g.
buying products from overseas and assembling them in Australia).
Sale of Property other than trading stock – e.g. shares, IP:
(a)
usually place of contract; however
(b)
there are exceptions.
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(i)
e.g. real property – source is the location of the property;
(ii)
wouldn’t make sense to have source as an overseas location just because the
contract was signed overseas.
Source of services
4.5
The source of services income will generally be the place of performance of the services – see
FCT v French.
FCT v French
Facts
•
Involved taxpayer who was a resident of Aust and worked for an Aust Co – but went to NZ to
carry out work.
•
Then, there was a section in the act which is now repealed s 23Q – which used to exempt
foreign source income of this type.
•
Question was whether or not this income was sourced in NZ.
Held – HCA
•
The source was NZ where the services were carried out (i.e. place of performance).
•
Today however, under the double tax agreement with NZ he would pay tax in both places,
but get a foreign tax offset in Aust for the tax he paid in NZ.
Efstathakis
Facts
•
Paid by Greek bank account, working in Australia for a Greek Co into Aus a/c
Held
•
4.6
Source was Australia, because this was where the work was performed.
Other factors may determine the source, for example, the place of contract or the place of
payment – see FCT v Mitchum:
Mitchum v FCT
Facts
•
Case involved the actor Robert Mitchum.
•
He signed to star in the movie, produce it and be an advisor by a Swiss Co for a movie to be
filmed in Australia.
•
FCT tried to assess his income.
Held – HCA
•
You could look at place of k or place of payment for the services as well as where the services
were performed.
•
If the contract can be performed anywhere, look at the place the contract is made, and to
other factors (including payment).
It is not a requirement that a contract for services be assessed where performance takes
place.
•
Source of interest
4.7
The source of the interest income is the place where the credit is provided, normally – see
FCT v Spotless Services:
(a)
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(b)
4.8
the place where funds are advanced.
The question here is where is the economic activity giving rise to the interest?
FCT v Spotless Services
Facts
•
•
•
•
•
This case was not about source, but part 4A anti-avoidance provisions – still, can be relevant
as a rule.
Invested money in a bank account in Cook Islands.
Accepted a 4% lower interest rate.
However, because such a low tax regime, came out ahead – the amount was subject to low
withholding tax, which meant it was exempt as income within Australia.
FCT argued 4A – the dominant purpose was to avoid paying tax
Held – HCA
•
4.9
Was trying to avoid – took a 4% lower interest rate, and the only justification for this could
be avoiding tax.
Withholding tax – looks at what goes out (e.g. dividends and royalties) and taxes it – a
gross tax on final amount:
(a)
it is withheld by the payer;
(b)
so, it is not a source rule per se, but a practical way of enforcing payment
Source of dividends
4.10
s 44(1) ITAA36 – the source of dividend income is the determined by the source of the
profits out of which the dividend has been paid – see also Esquire Nominees v FCT.
4.11
This provision incorporates FCT v Nathan (see above) into statute – it is not an issue
nowadays because we have dividend imputation which tends to ensure that things even out a
little more – see further on.
Esquire Nominees v FCT
Facts
•
Taxpayer was incorporated in Norfolk Island, directors were all residents of NI and directors’
meetings were held in NI.
•
An Australian accounting firm, acting on behalf of the beneficial owners of the taxpayer,
prepared agendas for the meetings.
•
Dividends paid out of another Co’s dividends (which was elsewhere)
•
The question was, do you trace the source back.
Held – HCA
•
HCA: although the directors invariably did what they were told, this didn’t mean the
accountants managed and controlled the company.
•
The accountants simply exerted a strong influence (form over substance).
•
In terms of source, the court said no – you only go to the immediate source.
NB, if you choose to reinvest interest or dividends, you have still derived this amount, but have just
chosen to have it dealt with on your behalf. i.e. the doctrine of constructive receipt. Hence, you are
taxed on it.
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Source of royalties
4.12
s 6C ITAA36 – where the royalty is an outgoing incurred in an Australian business it will have
an Australian source
4.13
See also – United Aircraft – involved know-how rather than true patented type thing – but
was phrased in terms of royalties.
4.14
The withholding rules again make s 6C of little practical use.
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Topic 3
Income
5
Income according to ordinary concepts
Introduction
General principles
5.1
The principles relating to income from Divs 4 and 6 ITAA97 are equally relevant to Topic
3.
5.2
Receipts which ought to be treated as income must be determined in accordance with the
ordinary usages of mankind, except in so far as a statute dictates otherwise (i.e. common
law, unless the statute provides otherwise):
(a)
whether the payment received is income depends on a close examination of all
relevant circumstances; and
(b)
it is an objective test.
Scott v Commissioner of Taxation (NSW)
Held – (Jordan CJ)
•
5.3
“The word income is not a term of art, and what forms of receipts are comprehended within
it, and what principles are to be applied to ascertain how much of those receipts ought to be
treated as income, must be determined in accordance with the ordinary concepts and usages
of mankind, except in so far as the statute states an intention to the contrary…”
However – this is not a fixed concept, it is a dynamic concept and it will change:
(a)
e.g. an EBay business, people in 1950 would have not known what that was income;
(b)
now, it would be taken to be ordinary (assessable) income;
(c)
but what if you’re a one off user of EBay? – you probably wouldn’t be attracting
assessable income.
Characteristics of income
Prof Parsons 15 characteristics of income (Thompson Fundamental Legislation (pg x))
Principles
1. An item of an income character is derived when it has come home to the taxpayer
2. An item of income character that has been derived will be income in the amount of its
realisable value
3. The character of an item as income must be judged in the circumstances of its derivation by
the taxpayer
4. To have the character of income an item must be a gain by the taxpayer who derived it
5. There is no gain unless an item is derived by the taxpayer beneficially
6. There is no gain if an item is derived by a taxpayer from himself or herself (known as the
principle of mutuality)
Prof Parsons 15 characteristics of income (Thompson Fundamental Legislation (pg x))
7.
8.
9.
10.
11.
12.
13.
14.
There is no gain if an item is derived by the taxpayer as a contribution to capital
A gain which is a mere gift does not have the character of income
A mere windfall gain does not have the character of income
A capital gain does not have the character of income
A gain which is one of a number derived periodically has the character of income
A gain derived from property has the character of income
A gain which is a reward for services rendered or to be rendered has the character of income
A gain which arises from carrying on a business or from carrying out an isolated business
venture has the character of income
15. A gain which is compensation for an item that would have the character of income had it
been derived or for an item that has the character of a cost of deriving income has itself the
character of income
Commentary
• Propositions 5-10 inclusive are essentially negative propositions
• Propositions 11-15 are positive propositions
• Propositions 12-14 identity the three usual types of ordinary income (i.e. income from
property, income from services and income from business)
Specific instances of income according to ordinary concepts
Income as a Flow
5.4
Eisen v Macomber – the fruit and tree principle (USA):
The fundamental relation of ‘capital’ to ‘income’ has been much discussed by economists, the
former being likened to the tree or the land, the latter to the fruit or the crop; the former
depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured
by its flow during a period of time…. income may be defined as the gain derived from capital,
from labour, or from both combined, provided it is to be understood to include a profit gained
through a sale or conversion of capital assets…[Income is] not a gain accruing to, not a
growth or increment of value in the investment; but a gain, a profit, something of
exchangeable value proceeding from the property, severed from the capital, however
invested or employed, and coming in, being ‘derived’, that is, received or drawn by the
recipient (the taxpayer) for his separate use, benefit, and disposal; that is income derived
from property. Nothing else answers the description.
5.5
This is referring to ordinary income – however, a gain is now known as statutory income –
this is also relevant when we come to deductions
Income must be a product of labour and/or property
5.6
5.7
The income must in some sense be caused by the labour or property or labour and property
of the taxpayer.
(a)
i.e. income must be the product of employment or services, property or the proceeds
of a business, which generally involves a combination of labour and capital;
(b)
there must be a nexus.
Traditionally, income has been divided up into various categories:
(a)
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(b)
Business; and
(c)
Property,
5.8
However, there is no need to do that – in Australia, there is no difference, but that is how it is
taught.
5.9
The Common Law requires a nexus/connection between the receipt and labour or property
– and that is why a $10 gift (in a birthday card) is not income as it does not have the nexus.
Reward for services rendered
5.10
A reward for services rendered will always be income, even in the absence of repetition:
(a)
e.g. – Lecturer gets paid by university for services rendered, and that is income.
(b)
e.g. – what about where it is a one off payment and/or it is for services rendered or
the provision of a capital asset? – this was the question in Brent.
Brent v FCT (1971)
Facts
•
B was wife of well known train robber who escaped a fled to Rio.
•
She decided to cash in on the notoriety and sold her story to the press for $62,000.
•
It was a one off sale and she wasn’t in the business of writing.
Held – HCA (Gibbs CJ)
•
FCT successfully assessed her on that income – wife argued that she was selling the
copyright (which is an asset) – she had actually used ghost writers;
•
Therefore Gibbs CJ held that she did not own the copyright, because she didn’t actually write
it;
•
Then, she argued she was selling an asset, being information – which also failed, in that
information is not property – i.e. she still had the information;
•
What she had actually done was supply a service under a k – this was assessable income.
Gains (in the Eisen sense) must be realised
5.11
This means, there must be an alienation – i.e. the fruit must have actually been picked from
the tree – then they can become stock which can be sold, and when that happens, there is
income.
5.12
Unrealised gains are not income under ordinary concepts. Thus, the gain must be severed or
realised.
5.13
In the case of income from property, this has come to involve sale, alienation or other
transactions resulting in a payment or right to payment.
5.14
In the case of services, a stage must be reached where the taxpayer has a right to be paid.
5.15
Work in progress is not income – it will only be income when you become entitled to
charge for the services – see Henderson v FCT (1970) 1 ATR 596 – this comes up with
difference b/w cash and accruals.
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Income must “come in” to the taxpayer
5.16
5.17
5.18
Principle of mutuality – Income must “come in” and be derived from an external source –
i.e. you cannot be the source of your own income – see example of clubs:
(a)
This applies in clubs – members pay to be members;
(b)
Therefore, they are themselves the association;
(c)
As such, membership fees are not income – they can’t pay themselves income;
(d)
This is the same in partnerships – i.e. the partners pay the tax;
(e)
Companies are different b/c they are a separate legal entity.
If an amount does not come into the taxpayer, it will not be ordinary income
(a)
Only when a receipt is derived is it realised (“derived” in s 6-5 and s 6-10 – see
doctrine of constructive receipt);
(b)
If the receipt merely saves the taxpayer from incurring expenditure, this does not
necessarily make the receipt ordinary income;
(c)
A reduction in the amount of a liability can give rise to a gain that is ordinary income
– Unilever Australia Securities Ltd;
(d)
An amount may be derived by the recipient even though it is subject to a contingency
under which the recipient might be obliged to repay the amount in certain
circumstances – Case R107 – footballer may have had to repay an advance payment
if unable to play for the club); and
(e)
Unrealised money isn’t income.
The following cases are relevant here to determine whether the income has ‘come in’ to the
taxpayer, they are also relevant below under s 15-2 ITAA97.
Tennant v Smith
Facts
•
Ordinary income is ‘what comes into the pocket’
•
Bank employee was provided with free accommodation
•
He used it after hours for the bank, but was entitled to live there
•
Smith (the surveyor of taxes) included 50pds savings on rent as ordinary income
Held – HL
•
HL held, this was not income, as nothing had ‘come in’ to him
•
Income is not something that is being “saved”
•
As a result, s 26(e) was enacted, and when this failed, s 15-2, which was also unsuccessful
•
Now that we have FBT, the employer would pay tax on it – i.e. it is a fringe benefit.
5.19
Further, a saved outgoing cannot be income according to ordinary concepts –see FCT v
Cooke and Sherden.
FCT v Cooke and Sherden
Facts
•
Taxpayers were sellers of soft drink who were awarded a free holiday.
•
If a seller sold a certain amount, they could get a free holiday from the manufacturer of the
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FCT v Cooke and Sherden
soft drink.
•
The question was whether the award of the holiday was in fact income?
Held
•
It was not – it was a saved outgoing – i.e. an amount that saves a taxpayer from incurring
expenditure is not income – rather, income is what comes in, not what is saved from going
out.
•
Failed on both grounds – nothing had come in, and holiday couldn’t be converted to money
(holiday couldn’t be on-sold / transferred)
For s 26(e), it talks about services being provided, but here, he was a retailer of purchased
stock
So, s 21A put into Act, and still applies
Today, this would be assessable under s21A, at the rate of the benefit derived by the
taxpayer (so very subjective)
•
•
•
5.20
See also discussions relating to s 15-2 ITAA97 and Payne v FCT (below).
There must be a gain
5.21
Although the “flow” concept is deeply embedded in the notion of assessable income, a gain is
also required – i.e. some kind of profit.
5.22
This is emphasised in some of the cases which show that even a net gain can be assessable
income:
(a)
FCT v Whitfords Beach Pty Ltd;
(b)
FCT v Myer Emporium Ltd – (see facts below), but the amount paid was income,
though not in the ordinary course of Myer’s business it was a commercial transaction
entered into with a profit making intention.
These cases will be discussed in reference to businesses – but they essentially dealt with
capital v income.
Cash or convertible to cash – NB this has been modified by s 21A (see below)
5.23
Income must be cash or must be convertible to cash: FCT v Cooke and Sherden – i.e. the
holidays could not be converted into cash.
5.24
In this regard the Full Federal Court (in Cooke and Sherden) applied the House of Lords in
Tennant v Smith:
however, Tennant would now be a fringe benefit – but Cooke would not be a fringe
(a)
benefit;
Cooke was not, because it was a k’ual relationship for provision of services, but not
(b)
an employer/employee relationship;
now s 21A ITAA36 – introduced in response to Cooke – See Rick Kreber – sets out
cases and has a neat section called, what if it happened today – it would discuss s
21A.
(c)
5.25
It must be money or something capable of being turned into money:
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(a)
the “money value” is deemed to have been given in where non-cash consideration is
provided for a transaction – s 21 ITAA36);
(b)
In certain circumstances where a benefit is not convertible into cash, this is ignored
when determining the assessability of the benefit – s 21A ITAA36;
(c)
Payne: reward tickets were held to not be ordinary income because they were not
transferable and subject to cancellation if sold – see also Sherden;
(d)
FBT legislation was introduced to catch benefits that were provided but that couldn’t
be converted into money;
(e)
Fringe Benefits would usually be non-assessable income under s 23L ITAA36;
(f)
Barter: the market value of the goods exchanged is included in assessable income
(Taxation Ruling IT 2668).
Periodical gains have the character of income
5.26
One of the most common characteristics of income is periodicity and frequency – see FCT v
Dixon; FCT v Blake:
FCT v Dixon
Facts
•
Weekly payments to soldier from previous employer to make up the difference between his
civil and military pay
•
Commissioner assessed this as ordinary income
•
Argued that there was no nexus between the pay and his employment
Held – HCA (Dixon and Williams JJ)
•
5.27
Held, per Dixon and Williams JJ: it was ordinary income, not on the basis of the nexus (there
wasn’t one), but because there was an expectation, it was periodic and the taxpayer used it
for survival (the fact the payments were voluntary and he had already been remunerated
were not relevant).
Although, this characteristic is not always essential but absence doesn’t mean the amounts
are not ordinary income Myer Emporium.
Disposal of capital asset versus an income stream
5.28
The consideration for sale of a capital or structural asset will normally be on capital account
even if the payment is in instalments.
5.29
For example, if a taxpayer sells a house for $1 million payable in 10 annual instalments of
$100,000, each instalment will be on capital account.
Gratuitous payments
5.30
Determining the assessability of a gratuitous payment is a question of whether the payment
is a result of the provision of services or the carrying on of a business.
5.31
Where a payment is caused by the taxpayer’s provision of the service or the carrying on of
the business, it will be income, even if paid by a third party.
5.32
However, where the payment is received from a third party, it is less likely to be a product of
services.
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5.33
Example – a tip is a gratuitous payment – tips are ordinary income, provided by a 3rd party,
and are gratuitous, but, it is for services rendered, therefore, tax should be paid on tips (see
further below).
Receipts from Illegal Activities
5.34
Whether an amount is received illegally or immorally is irrelevant to the determination of
whether it is assessable income – Partridge v Mallandaine.
FCT v La Rosa (2003)
Facts
•
Taxpayer caught for drug dealing.
•
He hadn’t filed tax returns for 7 years.
•
Commissioner assessed him on drug payments for 7 years.
•
He argued that if this was to be done, then should be allowed to claim $200,000 of stolen
moneys as a deduction.
•
Based on Charles Moore: said stolen monies are deductable.
Held – FCFCA
•
The Court allowed the deductions.
•
Kerrie says the decisions is right – if assessing income, should also allow deductions.
•
However, there was public outcry, and now s 26-54 states that deductions cannot be
claimed for the proceeds of indictable offences.
Notes
•
5.35
5.36
La Rosa was apparently murdered earlier this year.
If you’re conducting a lawful and an unlawful business, you will still get a deduction for the
lawful business. The following are examples of illegal activities giving rise to assessable
income:
(a)
Partridge v Mallandaine (“business” of burglary)
(b)
Minister of Finance (Canada) v Smith (illegal bookmaker)
(c)
Lindsay v IR Commrs (whisky smuggler)
(d)
No 275 v MNR (prostitution)
(e)
England v Webb (ultra vires activities of company)
NB – not taxing such activities would in effect be encouraging crime and immorality but the
flipside is that losses may be deductible (s26-54 ITAA97 has been enacted to prevent such
deductions in some cases)
Income from personal services
Introduction
5.37
A receipt will be assessable where it is a: “… product or incident of employment or reward for
services rendered” Hayes v FCT (1956) (gift of shares where relationship had already ended)
5.38
Can be direct, incidental, or unrelated.
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Receipts related directly to employment or services (Deane)
5.39
Must have a nexus to the employment.
5.40
The earning activity may be either labour, investment, or labour and investment combined in
the carrying on of a business
5.41
Generally, an amount that does not have a sufficient nexus with an earning activity will not
be ordinary income
5.42
Salary, wages, tips and commissions will be considered income.
5.43
A retention payment or sign-on fee is income: Dean v FCT [1997] ATC 4762
5.44
(a)
To ensure employee remained in employment for a further 12 months, made a
retention payment; and
(b)
Was to be paid back on a pro-rated basis if the employee left.
(c)
Held to be income
A receipt will be assessable where it is a “… product or incident of employment or reward for
services rendered”.
Hayes v FCT
Facts
•
Tax payer was employed by Richardson as an accountant and adviser (full time);
•
R and H had shares in the business but H was really bad at his job;
•
The Company fell into difficulties and H sold shares to R;
•
R was ok at his job and got the company back to financial health;
•
R then made a gift of shares back to H;
•
Question was whether value of those shares was assessable income?
Held
•
The shares were not ordinary income, because he had already been adequately
remunerated for services.
•
They were not assessable, the shares were a gift because of friendship, not services
rendered, he had been adequately remunerated for services rendered.
•
Also held that Hayes’s informal advice wasn’t an income-producing activity – he had no
expectation that he would be remunerated for it
•
Also, s 26(e) failed to catch the gift because it was not ordinary concepts income.
Receipts unrelated to employment or services
5.45
Generally not income
(a)
Hayes v FCT – substantial gifts by a former employer
(b)
FCT v Harris
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(i)
Former bank officer received a gift of $450;
(ii)
The bank employees received the gift b/c they were seen to have not
received an adequate pension;
(iii)
This was held to be non-assessable as a gift.
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5.46
However – FCT v Blake - (1984) 15 ATR 1006, where a regular pension top-up payment was
held to be ordinary income.
Reward schemes
Payne v FCT
Facts
•
Mrs Payne joined the consumer loyalty program without her employer’s knowledge.
•
Mrs Payne was unable to cash in the flight reward (airline tickets) or transfer it to anyone
else, but she was able to have the flight reward made out in the name of family members.
•
The reward points Mrs Payne accrued from employer-paid travel (and some privately-paid
travel) were used to acquire airline tickets in the name of her parents who travelled from
England to visit her.
•
The Commissioner assessed Mrs Payne on the value of the airline tickets that accrued from
employer-paid travel.
•
The tickets were not convertible to cash.
Held
•
•
The commissioner failed on 2 grounds:
o
Benefit was not allowed, given or granted iro employment;
o
Employment relationship lacked the necessary connection to the rewards.
Now see TR 99/6.
TR 99/6
•
Flight rewards that are received by an individual who renders a service or has received the
flight reward as a result of business expenditure are, with the following provisos, not
assessable as the flight rewards arise as a result of a personal (i.e. non-service/non-business)
contractual relationship. The provisos are:
o
where the person renders a service on the basis that an entitlement to a flight reward
will arise; or
o
in a business context, where the activities associated with the obtaining of the
benefits amount in themselves to a business activity.
Reward for services or capital?
5.47
Disposal of a capital asset with incidental services.
5.48
Provision of services with the sale of an asset being incidental
5.49
See Brent v FCT – there was a restrictive covenant (i.e. not talk to anyone else) – but this
was a capital asset which was incidental to the services rendered.
Prizes
5.50
Regard must be had to the facts of the case and the relevant factors already discussed.
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Kelly v FCT
Facts
•
A professional footballer received $20,000 for a best and fairest medal.
•
Received money from channel 7.
•
Skills he had shown to the win the medal should be taken into account.
Held
•
There was no obligation to make the payment – that the gift was significantly independent as
to make it assessable.
•
The money was open to all players and incidental to his employment.
•
This will start down the So You Think You Can Dance track.
TR 99/17
•
•
A payment or other benefit received by a sportsperson is assessable income if it is:
o
income in the ordinary sense of the word (ordinary income); or
o
an amount or benefit that through the operation of the provisions of the tax law is
included in assessable income (statutory income). Statutory income includes noncash benefits that may not be ordinary income.
The following are assessable income:
o
payments received from, in respect of, or in connection with employment;
o
payments or other benefits received for, in respect of, or in connection with services
provided; and
o
amounts of a revenue nature or other benefits received, including prizes and awards,
from carrying on a business of participating in sport. This includes the exploitation of
personal skills in a commercial way for the purpose of gaining reward.
•
Money and other benefits received from the pursuit of a pastime or hobby are not assessable
income.
•
Note – a grant will be assessable if it is periodic, regular or recurrent and with one or more of
the following:
o
made under an agreement/arrangement to provide financial support;
o
received in circs where the person has an expectation of receiving the payment and is
able to rely on the payment for regular expenditure;
o
is made in substitution of income.
Categories of income from labour
5.51
Holmes v FCT – assessable income on sailor of salvage ship – he volunteered – there was no
guarantee he would get paid – if the operation had not been successful he would not have
been paid – however, despite that, the money was assessable.
6
Business income
Introduction
Common law
6.1
The normal proceeds of business are income: expanded by Whitfords Beach and Myer (see
below).
Statutory expansion – 3 fold
6.2
Non-cash business benefits – s 21A ITAA36 – put into act b/c of Cook (Soft drink sellers).
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6.3
Profit from sale of property purchased for resale at profit – s 25A ITAA36 – applies to pre
1985 purchases (i.e. when CGT was introduced).
6.4
Profit from profit-making undertaking or plan – s 15-15 ITAA97.
Identifying a business
How is a business identified?
6.5
This applies to deductions more than receipts.
6.6
It is a question of whether or not you have a business and also the scope of the business:
6.7
(a)
b/c the normal proceeds of the business are taxable;
(b)
but we need to know what the business actually does.
Therefore, we need to work out what a business activity is as opposed to a hobby:
6.8
(a)
i.e. any receipts in the course of ordinary business activity will be ordinary income;
(b)
but not if it is in pursuit of a hobby.
Usually you would think it is the ATO arguing for a business (to increase receipts) and the
business arguing a hobby – but, usually, because these businesses are running at a loss – the
taxpayer will want to argue that they are a business, so that they can claim their losses as
deductions.
Has the business commenced?
6.9
There can be no deductible working expenses of a business unless the business has actually
begun – therefore it is important to work out when the business has commenced – see
Softwood Pulp and Paper Ltd v FCT:
Softwood Pulp and Paper Ltd v FCT
Facts
•
Company was going to set up paper mill and ran feasibility studies etc.
•
However, then decided they would not proceed, but tried to claim a deduction for the losses
as a result of the business venture.
Held
•
Court found they had not actually begun to carry on a business – b/c of common law
principles – the expenses were ‘black hole’ expenditure.
•
i.e. they were not personal expenses but weren’t deductible.
•
see now s 40-880 which allows you to write off such expenses over a five year period.
Example 1
Facts
•
The XY Chemical Co Ltd makes cosmetics. It has 25 different colours of lipstick on the market
and a research scientist is trying to develop a 26th colour.
•
Given the scope of the business, the development of a new colour lipstick is part of the
general trading activities of the business.
•
If that research scientist had been working on developing a new kind of colour television,
then the business of manufacturing colour televisions would not have commenced and
expenses would accordingly not be deductible.
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Example 1
•
Now, under s 40-880 you would be able to deduct over five years, but you would not get an
immediate deduction.
Decision
•
Here, we have a company with potentially 2 different types of businesses – therefore, just
because you are a company does not mean that you will be able to deduct everything.
Indicators of a business
Introduction
6.10
s 995-1: “any profession, trade, employment, vocation or calling, but…not…occupation as an
employee”
(a)
However, this definition is not very helpful;
(b)
Therefore we go to the common law:
(i)
see Bivona – the use of the word business has a long and flexible meaning –
Oxford dictionary doesn’t really help either;
(ii)
but it comes down to a question of fact and degree.
Evans v FCT
Facts
•
Involved a tax payer who the FCT argued was in the business of gambling.
•
The tax payer was subject to an audit and had a sudden increase in wealth which he claimed
was due to gambling.
•
Was he involved in the business of gambling?
Held – FCA (Hill J)
•
Agreed that they were windfall gains and the taxpayer was not in the business of gambling –
but he looked at the various facts (such as – betting at the TAB rather than bookmakers, he
would often bet in exotic ways – i.e. quinellas and trifectas – evidence showed he gambled
for simply personal pleasure.
•
“The question of whether a particular activity constitutes a business is often a difficult one
involving as it does questions of fact and degree;
•
Although both parties referred me to comments made in decided cases, each of the cases
depends upon its own facts and in the ultimate is unhelpful in the resolution of some other
and different fact situation;
•
There is no one factor that is decisive of whether a particular activity constitutes a business.”
6.11
Therefore, we come up with a set of indicators that may suggest a business is in effect –
however, no objective test is actually going to be sufficient – i.e. will turn on the facts.
6.12
The following are helpful factors to consider:
(a)
system and organisation;
(b)
scale of activities;
(c)
sustained, regular and frequent transactions;
(d)
profit motive;
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(e)
commercial character of transactions;
(f)
characteristics or quantities of property dealt in; and
(g)
other factors.
System and organisation
6.13
To carry on a business means to “conduct some form of commercial enterprise systematically
and regularly ... and implicit in this idea are the features of continuity and system” –
Ferguson v FCT.
Ferguson v FCT
Facts
•
Taxpayer was naval officer, due for retirement and wanted to go into cattle farming.
•
He leased five cows for four years and used a management company to breed these cows
with artificial insemination.
•
He wanted to build he herd up to 200 cattle – here, the court held he was in the preliminary
business of primary production.
•
He wanted to argue he was carrying on a business was because he had losses which he could
offset against his naval salary.
Held – FCA
•
Held to be in the business of primary production, because venture had a ‘commercial flavour’.
•
Held that you can have a business of a limited nature in anticipation of a larger business in
the future.
•
The appointment of a management company was an important consideration.
•
Nowadays he couldn’t do that – b/c of Div 35 ITAA97 – which deals with personal losses –
unless you meet certain criteria.
Walker v FCT
Facts
•
Taxpayer was held to be in the business of goat breeding.
•
This was so, even though he only had one goat.
Held
•
They were actually implanting live embryos using high tech devices to get the goat to breed;
•
Therefore they were successful in proving that there was a business of goat breeding going
on.
•
Because they were systematic and organised, they were in business – had obtained expert
advice (c.f. a hobby)
•
They were able to show that a profit could be made after the first three years
Scale of activities
6.14
A man may carry on a business even though he does so in a small way, although the Courts
will be influenced by the size and scale of a taxpayer’s activities.
6.15
The smaller the scale the less likely it is to be a business:
(a)
Kerrie’s 2 chickens would be unlikely to give rise to a business of egg production;
(b)
but if she had 1,000 chickens and a business plan etc; and
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(c)
she would be much more likely to be found to be in the business.
Sustained, regular and frequent transactions
6.16
In most businesses the aim is to maximise the turnover through frequent and regular
transactions over a lengthy period.
6.17
See Livingstone – refitting of a cargo steamer was a one off transaction – but was held to
constitute a business because of the other factors – it is highly unlikely that this would be a
hobby.
Profit motive – see TR 97/11
6.18
Commercial reality is that a business is ordinarily carried on for the purpose of making profits,
so that the presence of a profit motive is a common feature of business activities
6.19
TR 97/11, [17] – subject to all the circumstances of a case, where an overall profit motive
appears absent and the activity does not look like it will ever produce a profit, it is unlikely
that the activity will amount to a business:
6.20
(a)
This is especially so with primary production
(b)
NB, look objectively at the viability, and the subjective belief –if a person genuinely
believes their business can make a profit, even if it will not in an objective sense, this
may constitute a business.
TR 97/11, [26] – relevant indicators of whether a primary production business is being
carried on:
(a)
Does the activity have a significant commercial purpose or character?
(b)
Does the taxpayer have more than a mere intention to engage in business?
(c)
Is there an intention to make a profit or a genuine belief that a profit will be made?
Will the activity be profitable?
(d)
Is there repetition and regularity in the activity? i.e., how often is the activity
engaged in? How much time does the taxpayer spend on the activity?
(e)
Is the activity of the same kind and carried on in a similar way to that of the ordinary
trade?
(f)
Is the activity organised in a businesslike manner?
(g)
What is the size or scale of the activity?
(h)
Is the activity better described as a hobby, a form of recreation or a sporting activity?
6.21
TR 97/11, [48] – We believe it is important that the taxpayer is able to show how the
activity can make a profit.
6.22
When you look at the business subjectively, did the taxpayer think they were going to make a
profit (even if it was a hair brain scheme).
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Example 1 – TR 97/11, [31]
Facts
•
Mark, a barrister, and his wife Tina, a medical researcher, bought 8 hectares of land on which
they built a home.
•
They realised that the land was fertile and capable of producing fruit.
•
Mark spent a year seeking advice from the Department of Primary Industries and local
farmers.
•
He collected technical literature on citrus farming and obtained soil and water analyses of the
land which showed the land was fertile and suitable for the intended activity.
•
He drew up a business plan and a budget of capital and recurrent costs.
•
After clearing the land he and Tina planted 700 mandarin trees, 700 orange trees and 700
lemon trees.
•
They did not expect to make a profit for eight years.
•
Mark also installed an irrigation system.
•
Mark and Tina spent many months investigating the market for citrus fruit and established
that there would be no problems in selling their product to wholesalers if it was of good
quality.
•
They complied with all registration and licensing requirements.
•
The trees grew well. Mark and Tina devoted a substantial part of their weekends to looking
after the trees.
•
They employed casual labour to spray for weeds and pests and to prune the trees.
•
But, before they received any income from the sale of fruit, the trees were destroyed by fire.
•
Were Mark and Tina carrying on a business of citrus fruit farming?
Decision
•
Yes — despite no income being gained — because:
o
the scale of their activity was far in excess of their personal needs, and large enough
to ensure the venture would be profitable;
o
there was a clear intention to make a profit, even though this would take some time
to occur;
o
the intention to make a profit was based on reasonable grounds and backed up by
appropriate research;
o
there were likely to be buyers for their produce for some time ahead;
o
the trees were looked after in a manner consistent with business operations;
o
they established and conducted the activity in a businesslike manner;
o
they asked for and followed advice from professionals; and
o
there was an overall permanence about their activity, and the trees would have
yielded fruit for a number of years.
Alternate scenario
•
What if Mark and Tina had not done the above research and analysis, had only planted a
small number of different types of trees to test which would grow best, and were still
investigating the likelihood of potential buyers?
•
This would suggest that their activity was only of a ‘preliminary or preparatory’ nature and did
not amount to the carrying on of a business.
Commercial character of transactions
6.23
A person in business is usually prepared to trade on the open market on the normal terms
and conditions applying in that sort of business.
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Characteristics or quantities of property dealt in
6.24
Property which does not provide income or personal enjoyment by ownership itself is more
likely to be accepted as being acquired for the purpose of business dealings – see Livingstone
– can the products be used for personal reasons, if not, then it will be a business.
6.25
However, sometimes goods are used for personal purposes – but the quantities are so large
that it is unrealistic for that to be the case – Rutledge v TRC (Eng):
Rutledge v TRC
Facts
•
Taxpayer bought 1 million rolls of toilet paper.
•
Stuck them in a warehouse and on-sold them.
•
Attempted to argue that he purchased the toilet paper for personal use.
Held – UK
•
He was found to be carrying on a business – despite toilet paper being something one can
use for personal consumption;
•
What can be a business purchase in the hands of one person, can be a domestic purchase in
the hands of another person.
6.26
Property which does not provide income or personal enjoyment by ownership itself is more
likely to be accepted as being acquired for the purpose of business dealings.
Other factors
6.27
Illegality doesn’t matter – need to show that there is a business, and that it is illegal – c.f.
US, Al Capone in 1931 – imprisoned for tax evasion – here it doesn’t matter b/c of the
business requirement.
6.28
Other employment doesn’t matter – e.g. Ferguson who was in preliminary business of
primary production despite being in the navy.
6.29
Can employ a manager – see Walker with the one goat; also Ferguson.
6.30
Failure is ok – see Walker where the goat did not bread for years.
6.31
Intention may be relevant – i.e. it may not work, but the intention.
6.32
Length of time may be relevant – turnover – businesses have quick turnover of stock – e.g.
buy something and sell it years later, less likely to be a business.
Example – Farming business/passive investment
6.33
Note Ferguson above, where a business was found to be conducted – c.f. the passive
investor situation in FCT v Vincent.
FCT v Vincent
Facts
•
The taxpayer invested money in a cattle breeding scheme and thereafter took no interest in
the venture.
Held
•
She was held to be a passive investor, the cattle were not trading stock and so the losses
were on capital account and could not be deducted against her salary as a schoolteacher.
•
This case is actually an anti-avoidance case (Part 4A).
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FCT v Vincent
•
Came down to the fact that she was just a school teacher, handing over money.
Turning talent to account for profit
6.34
This mainly involves athletes, property developers and primary producers – see Stone v FCT
(HCA).
Stone v FCT
Facts
•
Was the ‘existence of a business’ threshold lowered by the High Court? – Kerrie doesn’t think
so.
•
Javelin thrower for Qld – went to Olympics and world cup.
•
She was also a constable in Qld Police full-time.
•
For 1999, earned $136 000 from the sport, from prize money ($93 000), govt grants ($28
000), sponsorship ($12 000) and appearances ($2700).
•
Commissioner assessed her on this , and she claimed it was a hobby and only declared her
$39 000 from the police force.
Held – FCA (Hill J)
•
Hill J at first instance said she was carrying on a business.
Held – FCFCA
•
The FFC said that the prize money and grants not assessable – only the sponsorship and
appearance were.
Held – HCA
•
HC said it was a business and all was assessable.
•
The key was the sponsorship, as it required her to undertake activities and obligations.
•
Said if the sponsorship funds were assessable, then everything was – she couldn’t get the
sponsorship without everything else.
•
Couldn’t put some into a category of business and some into a category of hobby.
•
She had turned her talent to account for money – appearance fees.
•
Also, the amounts were more than trivial, and the money was paid in exchange for her
undertaking obligations.
•
Nb, would assume she then claimed deductions for airfares, accommodation, training, etc.
•
Once this is found to be assessable income – you are showing the taxpayer was using her
ability to derive money – therefore, she was carrying on a business and all of her receipts
became assessable (full $136,000);
•
Therefore, as she had turned her ability into a profit making venture, she was conducting a
business.
6.35
Nowadays – if you looked at Stone and thought it would apply to you as a sports person –
you would be able to deduct your expenses (e.g. training costs, flights, physio etc).
6.36
See also TR 05/01 – carrying on a business as a professional artist – whether a
business is being carried on is based on the overall impression gained after looking at the
activity as a whole and the intention of the taxpayer undertaking it, consider:
(a)
a professional artist directs artistic prowess to commercial ends. However, the fact
that an artist also pursues non-commercial goals will not necessarily deprive the
activity as a whole of a commercial character;
(b)
an intention to carry on business as a professional artist, and to profit from that
business, should be reflected in the overt and planned activities of the artist;
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(c)
professional artists are usually sole traders, so the scale of operations will be small;
(d)
while a professional artist is not required to work constantly to be carrying on a
business, artistic skills should be applied regularly and repeatedly to the work;
(e)
the relevant industry, for the purposes of determining whether the artist carries out
activities characteristic of the industry, is the particular type of art practiced by the
artist;
(f)
there may be perceived periods of inactivity during which the professional artist
engages in research or skill development;
(g)
an artist may engage in a number of arts-related activities, each of which is
insufficient to amount to a business, but which viewed collectively are of sufficient
scale to amount to a business;
(h)
engaging in non-arts related work to supplement income does not necessarily detract
from characterisation as an arts business.
Example 1 – TR 05/01
Facts
•
For the past ten years Serge has worked full-time in his chosen field as a writer.
•
Initially Serge published his work himself but he now has a contract with a major publishing
firm.
•
He spends his time researching, writing and promoting his work.
•
Research and promotion often involve interstate and international travel to literary festivals,
readings and public appearances.
•
Serge generates income from sales, royalties, appearance fees, commissions and grants.
•
Serge's annual income from these sources has varied from $8,000 to $45,000 over the past
five years but has averaged out at approximately $25,000 a year.
•
His expenses are generally around $15,000 a year.
•
Two years ago Serge was appointed to an academic position, with a salary of $65,000 a year.
•
Serge was selected for this position on the basis of his profile and performance in the literary
field.
•
His employer requires him to maintain his practice as a writer, and has indicated that Serge is
expected to spend half of his time teaching and half of his time on his practice as a writer.
Decision
•
Serge is carrying on a business for the following reasons:
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o
Serge's main source of income is now as an academic. However, he is continuing to
carry on a business of being a writer. Indeed, Serge is required to maintain his
practice as a writer as a condition of his present employment;
o
he has relevant knowledge and expertise in his field;
o
he has peer and public recognition as a writer;
o
he regularly practises his writing activity (noting again that this is indeed a
requirement of his current employment);
o
there is evidence of an intention to make a profit (notwithstanding some years do not
produce a profit);
o
his practice is conducted in a manner consistent with the norms for that particular
sector of the arts industry; and
o
he devotes a significant amount of time to his artistic activities.
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Example 2 – TR 05/01
Facts
•
Jennifer has been painting for several years. She is employed as a public servant, but works
on her art in her spare time — on average 12 to 15 hours a week outside normal work hours.
•
She uses a spare room in her home as a painting studio and to store materials.
•
Jennifer is a member of a local landscape painting club which regularly arranges painting trips
to sites in the area and once a year to the Northern Territory.
•
Jennifer attends club meetings once a month and shows her work at club meetings to gain
feedback from the other club members.
•
She engages in this art activity with a great deal of enthusiasm and commitment.
•
Jennifer does not make any concerted efforts to sell her art works.
•
Such sales as she has made have been to family and friends, and then only at prices that just
cover the cost of the materials used.
•
In 2001 Jennifer sold two of her art works to friends for a total of $760 and she spent $4,800
to create several other works of art. Jennifer does not keep receipts for all her expenses.
•
Every year Jennifer enters her work into the Royal Easter Show exhibition and in 2002
Jennifer won some prize money.
•
The cost of creating the art work she submitted for the Royal Easter Show exhibition
exceeded the prize money she was awarded.
•
Jennifer is only interested in occasionally entering individual art works in local community
festival exhibitions and competitions, rather than regularly exhibiting a body of work to the
general public for sale.
Decision
•
Jennifer is not carrying on a business for the following reasons:
o
she continually produces art works and spends a considerable amount of time in the
activity, but she does so for personal pleasure rather than having any developed
plans to display a body of her work to the public for sale or to create a market for her
work;
o
while Jennifer does enter her work in local competitions and festivals, she does not
have any aspirations to build a reputation as a professional artist;
o
her art work is generally sold to family and friends rather than the general public;
o
her record keeping is inadequate for a person carrying on a business, in that she
does not keep all her receipts for expenses;
o
it is unlikely the activity will make a profit due to the minimal efforts to sell her work,
build her reputation as an artist or create a market for her work; and
o
although she has made some efforts to achieve high quality in her art work, this has
not been for the purpose of commercially exploiting her artistic talent. Rather it has
been solely for the purpose of enhancing her reputation in the local community and
amongst her friends and fellow enthusiasts in the painting club.]
Taxation of income from business
Introduction
6.37
Not every amount received will constitute “ordinary income”.
6.38
The question is what constitutes income for a business?
(a)
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(b)
6.39
but would be considered disposal of a capital asset (and subject to depreciation
provisions) for a courier business.
In order to determine whether a receipt is the normal product of a business, it is necessary to
determine:
(a)
the precise nature and scope of the business:
(i)
Australian courts have tended to take a fairly broad view of the scope of a
business, and to be receptive to arguments that a new type of activity often
represents merely a new aspect or diversification of an existing business,
rather than an activity wholly outside the normal conduct of that business;
(ii)
Kosciusko Thredbo v FCT: premiums received for sub-letting apartments was
a “different method of exploitation of the resort facilities or a new found way
of conducting the business” and therefore assessable under the Californian
Copper principle;
(b)
(iii)
Jennings Industries v FCT: taking up shares in a joint venture company which
erected a building rather than direct construction itself was held to be
diversification;
(iv)
FCT v Merv Brown: company sold clothing by wholesale, some of which was
imported under import quotas. Due to a change in government policy, the
company decided to focus on more profitable lines and thus sold quotas for
its less profitable lines. FFC: proceeds from sale of quotas were capital in
nature and not assessable as sales were as a result of reorganising the basic
structure of the business; and
the relationship between that business and the receipt – i.e. not every single
receipt is assessable – nexus test:
(i)
Necessary to determine whether the receipt is produced by or is an incident
of the business;
(ii)
Usually straightforward but can be difficult in cases of “one-off” and
“extraordinary” transactions (see below);
(iii)
FCT v GKN Kwikform Services: scaffolding business charged customers the
retail list price if scaffolding was not returned. FFC held amounts for not
returning scaffolding were income, being a regular and ordinary incident of
the business; and
(iv)
6.40
Difficulties arise where the taxpayer is a member of a group of companies
which operates as one unit subsidiary’s activities were held to be an
integral part of the parent company’s business (GRE Insurance v FCT) in
comparison to where the subsidiary’s activities were held not to be an integral
part of the parent company’s insurance business (AGC (Investments) v FCT).
In the cosmetic example before – would the receipt from the sale of the warehouse be
assessable, you would think not, because the business is the cosmetics – this gets us back to
the nexus test – i.e. the amount must be produced by the business activities.
Receipts received in the ordinary course of business
6.41
Gains that directly relate to the business activity will be income.
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6.42
The Californian Copper principle (mere realisation principle):
(a)
Receipts will be assessable income under common law principles, and therefore
ordinary income under s 6-5 where:
(i)
“what is done is not merely a realisation or change of investment, but an act
done in what is truly the carrying on, or carrying out, of a business;”
(ii)
i.e. difference b/w carrying on a business and the mere realisation or change
of investment (e.g. sale of factory is a mere realisation);
(b)
The taxpayer carried out a range of profit making activities;
(c)
The sale of land was still held to be within the scope of the business (although the
company argued it wasn’t) despite being in the business of copper mining;
(d)
The court held land was bought for the purposes of making a profit and not just
mining.
Business income from certain transactions
Business income from ‘isolated’ transactions
6.43
Traditionally, case law supports the view that the mere realisation of an asset is not income –
see Scottish Australian Mining Co Ltd.
6.44
The cases often involved land, whether or not for income or whether or not for capital
purposes.
Scottish Australian Mining Co Ltd
Facts
•
Taxpayer purchased land for coal mining and used the land of over 50 years.
•
They ripped all the coal out and decided to sell the land.
•
They decided, when selling to subdivide the land, build roads, set aside land for parks and
train stations etc.
•
FCT assessed taxpayer on the basis that it was either ordinary income or the then equivalent
of s 15-15 (s 26AA).
Held – HCA
•
HCA – taxpayer not engaged in the business of dealing in land, it was only realising the value
of a capital asset.
•
Emphasised that the land had been purchased to be mined and not being sold at a profit.
•
It is highly unlikely that this conclusion would be reached today.
6.45
The scope of this mere realisation doctrine was severely limited in Whitfords.
FCT v Whitfords Beach
Facts
•
WB is in WA, south of Perth.
•
In 1954 3 fishermen who wanted access to the beach and formed a company to purchase
some land for their fishing shacks.
•
In 1967 3 other investors came along and purchased the shares from the fishermen – the
land did not change hands, rather, just the shares in the company (and as a result control
over the land).
•
The new shareholders changed the constitution of the company to allow for the development
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FCT v Whitfords Beach
of the land.
•
They did a similar thing to SAM.
•
FCT attempted to assess them on the profits they made out of the sale of the land.
•
Taxpayers tried to argue they were simply selling the land at its best advantage – realising
the value of a capital asset.
Held – HCA
•
HCA – came to a different conclusion – the activities amounted to the carrying on of a
business of land development and the profits derived were ordinary income.
•
When the new shareholder came in, the intention of the taxpayer changed.
•
From 10 December 1967 changed from not carrying on a business to carrying on a business
(this was the day the shares were transferred and the new articles introduced).
•
If not, they would have been statutory income under s 15-15.
•
More than just being a case about land transactions – also stands for principle that taxpayer
can change its intention for which it holds an asset.
6.46
The question of how to calculate the “profit” (i.e. the amount to be included in the taxpayer’s
assessable income) then arises:
(a)
gross proceeds of sale less the value of the relevant land at the date upon
which it was “ventured in” the taxpayer’s land development business;
(b)
“ventured in”: held to have occurred in December 1967 when the business began.
Business income from ‘extraordinary’ transactions
6.47
See FCT v Myer Emporium.
FCT v Myer Emporium
Facts
•
•
•
•
Myer Emporium lent $ to Myer Finance.
Finance paid interest (of $72m) at a commercial interest rate.
Instead of paying $72m to Emporium, Finance paid initial interest of $82,000 and Emporium
assigned the right to the remaining interest to Citicorp.
In return, Citicorp paid a one-off upfront fee of $45.37m.
Issue
•
•
Was the $45.37m paid to Myer by Citicorp income?
Taxpayer argued the ordinary course of business was retail trading and therefore this
payment fell outside the scope.
Held – HCA
•
•
The $45.37m was income under s25(1) ITAA36 / 6-5 ITAA97:
o Although not in the ordinary course of Myer’s business it was a commercial
transaction entered into with a profit making intention.
o And therefore in the course of Myer’s business (even if not in the ordinary course).
2 strands of the High Court decision:
o Even extraordinary transactions can generate assessable income:
If the taxpayer’s intention or purpose in entering into the
transaction was to make a profit or gain, the profit or gain will be
income, notwithstanding that the transaction was extraordinary
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FCT v Myer Emporium
(relevant principle from Myer).
Taxation Ruling TR 92/3: not the view of the Commissioner that all receipts
of a business are income.
FCT v Cainero: Myer was not reversing the established principle that the
mere realisation of a capital asset does not produce assessable income, nor
was it introducing some new concept of income.
Traknew Holdings v FCT: once it is established that the assets not derived
in the ordinary course of business were not acquired for the purpose of
resale at a profit, amounts will not be ordinary income unless the taxpayer
does “something more than merely realising the profit inherent in the
capital asset” (illustrated in Westfield).
The conversion of a lump sum takes on the character of the income stream it
replaces
Exceptions:
• The principle does not apply to annuities because an annuity is “the
produce of the very agreement which produces it... It will normally
be capital in the hands of the vendor as the price received for the
sale of a capital asset” (Harry Jones (IXL) v FCT).
• Where an income stream (not being an annuity) is sourced solely in
contact and there is no underlying property.
• Taxation Ruling TR 92/3: does not apply where the right to income
transferred is unrelated to any other property or where the taxpayer
transferring the right to income has never owned the underlying
property.
o
6.48
Note that now: TR 92/03 – provides guidance as to whether profits from isolated
transactions are assessable (transactions with a profit-making purpose).
Lease incentives – application of the Myer principle
FCT v Cooling
Facts
•
Taxpayer was partner in firm of lawyers – landlord said to lawyers, if they entered into a
lease of certain premises then the company would get $162,000.
•
Question was whether the partners’ share of that money was assessable?
Held – FCA (Hill J)
•
The amount was a payment in the course of the taxpayers business and was assessable.
•
He also found that there was a profit making scheme – which can be there, even if it is not
the dominant purpose of the transaction.
•
A lump sum payment was income.
FCT v Montgomery
Facts
•
Involved a partner in Freehills Melbourne – where firm had to move due to a building being
full of asbestos.
•
They moved into 101 Collins Street – the landlord contributed to the fit-out of the building.
Held – HCA
•
This was assessable as proceeds of a profit-making scheme – despite being an incentive
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FCT v Montgomery
payment.
•
6.49
7
The HCA upheld Cooling and applied the first strand of Myer Emporium.
Lease surrender and lease variation:
(a)
TR 05/06: a payment made to a lessee in return for surrender of a lease is
assessable as ordinary income if received in the ordinary course of a business of
trading in leases, as an ordinary incident of business activity or from a profit-making
business operation or commercial transaction.
(b)
IT 2631: an amount paid to a business lessee to vary a lease is also assessable.
Statutory income
Allowances in relation to employment and services – s 15-2 ITAA97
Introduction
7.1
s 15-2 ITAA97 (previously s 26(e) ITAA36) applies to employment and independent
services relationships and includes in assessable income amounts which are given as a
benefit.
7.2
Mentioned in relation to Cooke and Sherden – not a service relationship (i.e. not
employer/employee) but rather a business relationship
7.3
It is a statutory extension on the CL – it was only introduced in Sept 06 – it is very new, but it
does pretty much correspond with s 26(e) – therefore, rely on the cases which talk about
26(e).
ITAA 97, s 15-2
15-2(1) [3 conditions] Your assessable income includes the value to you of all allowances,
gratuities, compensation, benefits, bonuses and premiums *provided to you in respect of, or for or in
relation directly or indirectly to, any employment of or services rendered by you (including any service
as a member of the Defence Force).
15-2(2) [form] This is so whether the things were *provided in money or in any other form.
15-2(3) [exclusions] However, the value of the following are not included in your assessable
income under this section:
(a)
a * superannuation lump sum or an * employment termination payment;
(b)
an * unused annual leave payment or an * unused long service leave payment;
(c)
a * dividend or * non-share dividend;
(d)
an amount that is assessable as * ordinary income under section 6-5.
s 15-2 – conditions
7.4
There must be an:
(a)
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(b)
Gratuity;
(c)
Compensation;
(d)
Benefit;
(e)
Bonus; or
(f)
Premium.
7.5
The benefit must be provided (previously: allowed, given or granted) to the taxpayer.
7.6
The benefit must be in respect of, or for, or in relation directly or indirectly to, any
employment of or services rendered by the taxpayer.
There must be a benefit etc
7.7
Allowance – TR 92/15 = a predetermined estimate – a payment is an allowance when a
person is paid a definite predetermined amount to cover an estimated expense. It is paid
regardless of whether the recipient incurs the expected expense.
7.8
Compensation – TR 92/15 – a payment is a reimbursement when the recipient is
compensated exactly for an expense already incurred although not necessarily disbursed.
7.9
(a)
In general, the provider considers the expense to be its own and the recipient initially
incurs the expenditure on behalf of the provider.
(b)
A requirement that a recipient vouch expenses lends weight to a presumption that a
payment is a reimbursement rather than an allowance.
(c)
A payment made in advance of expenditure but which has the characteristics outlined
above will also be treated as a reimbursement.
(d)
Discretionary payments which upon receipt have the effect of enhancing the
employee’s remuneration;
Benefit – ‘advantage, profit or good’.
Example 1 – TR 92/15
Facts
•
Danielle and Thomas are both employees of Faraway Investments Pty. Ltd.
•
Apart from her usual salary, Danielle, an investment consultant, is paid $500 per month to
cover expenses she is expected to incur while entertaining clients.
•
Under an industrial award, Danielle also receives $50 per fortnight to cover medical insurance
premiums for herself and her family.
•
To be entitled to the $50 per fortnight, Danielle is required to produce a letter from the health
fund certifying that she is a member.
•
Apart from that, she is not required to vouch any of the expenses incurred in relation to both
payments.
Decision
•
The payments made to Danielle for entertaining clients and for medical insurance are
allowances.
•
Danielle is paid regardless of whether she spends the $500 on clients and whether she
spends the whole $50 on medical insurance.
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Example 2 – TR 92/15
Facts
•
Thomas, a bookkeeper, is entitled to payment for medical insurance premiums for himself
and his family up to a limit of $300 per year.
•
To claim the amount from his employer, he is required to produce his insurance premium
statements to his employer verifying the amount incurred by him in relation to those
premiums.
Decision
•
The payments made to Thomas are reimbursements.
•
He is compensated exactly for his medical insurance and would not be entitled to payment if
he is unable to vouch his claim.
•
The upper limit of $300 per year does not alter the character of the payment.
•
The payment is based on the precise accounting of actual expenditure.
Provided to the Taxpayer
7.10
7.11
Benefit may go to a third party, question of whether savings could be taken into account
because can’t use doctrine of constructive receipts (s 6-10) “provided”:
(a)
must be derived
(b)
see for example: Payne v FCT
“to the taxpayer”
(a)
Can’t use doctrine of constructive receipt;
(b)
However, we can consider savings under ITAA97;
(c)
Now – ITAA97 specifically deals with this issue, the statutory construction of the
doctrine applies – s 6-10(3);
(i)
e.g. – money earned then directed somewhere else will be caught by s 610(3);
(ii)
but the relationship of employer/independent contractor would be deemed as
a saving for the independent contractor under this provision.
Nexus with employment or services rendered
7.12
FCT v Cooke & Sherden – here, there was no rendering of services (i.e. not
employer/employee relationship) – it was also not an independent services relationship.
7.13
Payne v FCT (1996) – dealt with the issue of frequent flyer tickets – where it was exactly the
same as there was a contractual relationship (like in Cooke) and not an employment
relationship.
s 15-2 examples
7.14
Mostly from the AAT so case name is not important and they all deal with cash amounts, so
not covered by FBT.
7.15
The section originally covered non-cash, but valuation issues were problematic, so now FBT
deals with them (except for non-employer/employee relations). Brought in pre-FBT but failed
so FBT legislation will cover where contract for services
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7.16
The examples:
(a)
cash allowances such as overtime payments, travel allowances;
(b)
payments as compensation for accelerated depreciation of personal and/or household
effects as a result of relocation in employment;
(c)
an amount paid by an employer as an estimate of an employee's removal and storage
expenses where the employer does not require vouching of the actual expenditure or,
if vouching is required, the employee is allowed to retain any excess over actual
expenditure;
(d)
a housing allowance subsidy paid in respect of an employee's principal residence;
(e)
a location allowance paid to attract employees to live and work in remote areas;
(f)
an allowance for the cost of travel to and from work and vacation travel subsidies;
(g)
compensation for the loss of a rostered day off;
(h)
a cash prize awarded under an employer's suggestion award scheme;
(i)
a study incentive payment paid on successful completion of the studies – e.g. Smith v
FCT (1987) 19 ATR 274 – employee of a bank, he received a gift because of his
employment relationship – this dealt with s 26(e);
(j)
categories of income from labour:
(i)
salaries and commissions;
(ii)
gratuitous payments;
(iii)
unrequested services;
(iv)
reward schemes; and
(v)
reward for services versus the sale of a capital asset.
Non-cash business benefits – s 21A ITAA36
Introduction
7.17
The principle that a benefit is not assessable as income if it is not convertible into money has
been substantially altered by special statutory rules (see above) – this is as a result of the
decision in Cooke and Sherden.
7.18
s 21A ITAA36: a non-cash business benefit may be treated as income according to ordinary
concepts even if it is not convertible into cash, provided it is otherwise of an income nature:
(a)
this is a statutory provision which actually affects ordinary income;
(b)
i.e. it deems non-cash business benefits to be ordinary income (e.g. convertible to
cash);
(c)
enacted as a result of Cook and Sherden to cover non-service relationship.
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Application
7.19
For s 21A to apply:
(a)
There must be a “non-cash business benefit” (defined at s 21A(5) as property or
services provided after 31 August 1988 wholly or partly in respect of a business
relationship) (i.e. not an employment relationship);
(b)
The benefit must constitute income derived by the taxpayer from the carrying on
of a business for the purpose of gaining assessable income;
(c)
The total assessable value of all non-cash benefits during the year must exceed
$300 (s 23L(2) ITAA36);
(d)
The cost of the benefit must not be non-deductible entertainment
expenditure to the provider (i.e. expenditure to which s 32-5 ITAA97 applies and
that would otherwise be deductible under s 8-1 ITAA97);
(e)
The income can also be reduced by virtue of s 21A(3) in that if the taxpayer had
incurred the expenditure to provide the benefit for themselves, the taxpayer would
have been entitled to a “once-only” deduction for the expenditure incurred in
obtaining the benefit; and
(f)
A deduction which is allowable over more than one year (eg: depreciation, substantial
borrowing expenses on a loan > 1 yr) would not be a once-only tax deduction and
therefore would not reduce the amount taxed under s21A.
Example of s 21
Facts
•
Publisher of a magazine for builders wins a prize at a Builders Fair. Prize consists of: holiday
package and a mobile phone ($900 value) and free calls for one year. The benefits are not
transferable or convertible into cash:
o
Holiday: would otherwise be non-deductible entertainment expenditure and not
assessable (s 21A(4))
o
Phone: Would be depreciable and thus the publisher is not entitled to a “once-off”
deduction. The arm’s length value of the mobile phone would be included in
assessable income.
o
Phone calls: not assessable if they otherwise would have been incurred by the
publisher for business purposes and thus deductible (s21A(3))
7.20
s 21(A) does not apply to frequent flyer programmes because the relationship is contractual
between the recipient and the provider and not the requisite business relationship.
7.21
Also note s 51AK: A deduction allowable to a business taxpayer may be reduced where
non-cash business benefits are provided to induce the taxpayer to purchase particular items
of plant or equipment or to receive particular services.
Example of s 51 AK
Facts
•
A taxpayer purchases a computer for business purposes for a total expenditure of $10,000
and also receives from the supplier a watch worth $500 for the private use of the taxpayer.
•
By operation of sec 51AK, the amount of $500 will be taken to be expenditure incurred in
respect of the watch.
•
For the purposes of the depreciation provisions of the Act, the cost of the computer would in
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Example of s 51 AK
these circumstances be $9,500.
Decision
•
The expenditure relating to the watch ($500) would not be deductible under sec 8-1 because
it would not be expenditure incurred for the purposes stated in that provision.
•
Nor would it be available for depreciation, because the watch is not a business asset.
•
Would be different if given printer and ink that was used in the business only when for
personal / private use.
8
Other types of income
Compensation payments
General principles
8.1
It is important as a lawyer to understand the concepts of compensation payments. Look at
library of Principles of Taxation Law – for useful information regarding this area.
8.2
Common Law
(a)
a compensation receipt generally takes the character of the item it replaces:
(b)
8.3
(i)
if it is replacing lost capital it will be treated as capital;
(ii)
if it is replacing income it will be regarded as income etc,
where a person receives a payment by way of insurance, indemnity or other
recoupment of a deductible expense which is not otherwise assessable income, the
amount will be assessable as a “recoupment”.
Statutory provisions:
(a)
8.4
Where the replaced amount would have been assessable as statutory income, the
amount will be assessable under s 6-10 and s 15-30 (this allows for the same thing
as the common law).
NB - Personal injury compensation received as a lifelong series of periodic payments are
exempt income if Div 54 ITAA97 criteria are met
Distinguishing income from capital
Sommer v FCT
Facts
•
An amount paid in settlement of the taxpayer’s right to income under a Professional Income
Replacement Policy, in satisfaction of an entitlement to income, was itself income.
•
Because it was replacing an entitlement to income, that in itself was also income – i.e. one
step more removed.
•
Taxpayer was medical practitioner practicing in stress management – he fell victim to stress
and was unable to work;
•
The victim replacement policy provided him with monthly payments - $4k per month during
period of disability;
•
He claimed for a certain period of time and eventually the insurer settled;
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Sommer v FCT
•
He sort a private ruling as to the assessable of the money he received on settlement;
•
FCT said it was assessable on the basis that it was paid in settlement of the taxpayer’s right
to income, and being in satisfaction of an entitlement to income, was itself income
•
The taxpayer appealed to the AAT and the FCA;
Held – AAT and FCA
•
AAT agreed with Commissioner (held to be income)
•
Taxpayer appealed to FC
•
FC: dismissed the appeal
•
Fact that payment was a lump sum did not change its character
Compensation categories
8.5
Cancellation of business contracts – income in the hands of the recipient:
(a)
Short Bros v IRC: compensation for cancellation of contract for the construction of
two ships was assessable;
(b)
Heavy Minerals v FCT: compensation paid to a supplier of rutile for the negotiated
cancellation of contract by the purchaser was held to be assessable
8.6
Loss of trading stock – income in the hands of the recipient:
(a)
Trading stock being a revenue asset – FCT v Wade;
(b)
The disposal of trading stock is disregarded for CGT purposes (s118-25 ITAA97);
(c)
8.7
Temporary disablement of income producing assets – true ‘temporary’ disablement will
be assessable as ordinary income:
(a)
The more serious the damage to the asset and the longer it is unable to be used for
income-producing purposes, the less likely the compensation will be assessable
(b)
Ensign Shipping Co v IRC: compensation paid for compulsory detention by the
government of ships was assessable (temporary = < 3 weeks)
London and Thames Haven Oil Wharves v Attwooll: compensation for damage to a
(c)
jetty was held to be assessable (temporary = 1 year)
(d)
8.8
What is a “temporary” loss is a matter of fact and degree.
Cancellation of a ‘structural’ agreement, or permanent loss of a fixed asset - capital in
nature:
Fundamental structure principle – Van den Berghs v Clark:
(a)
Van den Berghs v Clark
Facts
•
Two margarine companies worked in “friendly allegiance” in relation to share profits and
losses, allocate territories and deal with various ancillary matters. The parties fell out, and
Van den Berghs was paid £450,000 in consideration of its release from the agreement.
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Van den Berghs v Clark
Held – HL (Lord MacMillan)
•
The compensation payment was characterised as capital for the following reasons per Lord
MacMillan:
o
By accepting the payment, Van den Berghs gave up their rights under the agreement
o
The agreements were not ordinary commercial contracts but related to the basic
structure of the company and affected the whole conduct of the business
o
The agreements formed the fixed framework in which the company’s capital
circulated. The agreements provided a means of making profits but did not
themselves yield profits (margarine manufacture yielded profits)]
Permanent loss of fixed asset – Glenboig Union Fireclay v IRC:
8.9
Glenboig Union Fireclay v IRC
Facts
•
Taxpayer carried on a business of mining and selling raw fireclay.
•
The company held leases over land containing deposits of fireclay, with railway lines running
over part of the land.
•
The railway company exercised its statutory right to require the fireclay to be left unworked
(for the stability of the railway lines) and paid an amount to the taxpayer as compensation.
Held
•
The payment was held to be capital because the taxpayer was permanently deprived of the
opportunity to carry on its business in relation to the fixed asset (fireclay).
•
The payment took the same character as the asset which it replaced.
8.10
Termination of agency and management contracts – depends on whether there is a
loss of an enduring asset
(a)
e.g. if you lose one and you have many others, then it is likely to be income, but if it
is the only one you have, that is a loss of capital – see next week’s tute for more
details;
(b)
Where the cancellation of an agency contract results directly in termination of the
taxpayer’s business, the payment will be capital – California Oil Products – agency
was a taxpayers only business – the taxpayer agreed to cancel the contract and the
business ceased – the compensation paid was characterised as capital;
(c)
Where there is compensation for cancellation of one among several agency contracts
it becomes a question of degree and impression – IRC v Fleming & Co:
(d)
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(i)
if the rights and advantages surrendered on cancellation are such as to
destroy or materially cripple the whole structure of the business then the
compensation will usually represent the price paid for loss or sterilisation of a
capital asset and therefore be a capital receipt;
(ii)
if it does not represent the loss of an enduring asset, the compensation will
be revenue in character (this was the situation in Fleming).
The distinction is made between ordinary trading contracts (ordinary income) and
contracts going to the fundamental structure of the business (capital).
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Statutory provisions
8.11
s 15-30 ITAA97 – your assessable income includes an amount you receive by way of
insurance or indemnity for the loss of an amount (the lost amount), if:
(a)
the lost amount would have been included in your assessable income; and
(b)
the amount you receive is not assessable as ordinary income under s 6-5.
8.12
This can only apply where the compensation is received iro the loss of trading stock or
assessable income.
8.13
Workers compensation payments received (e.g. under state workers comp legislation) are
assessable as ordinary income (on the basis that compensation takes the character of the
amount it replaces.
Application of CGT on compensation payments generally
8.14
Where a business agreement is breached or varied and as a result a right to receive
compensation arises, this right will constitute a chose in action.
8.15
Under the CGT provisions, this right may constitute a CGT asset under s 108-5 (see below).
8.16
Settlement of this right will constitute a disposal of the asset under s 104-35(1) (see
below).
8.17
Causes of action must arise on or after 20 September 1985 for CGT to apply.
8.18
There is scope for claiming an exemption in certain circumstances under s 118-37:
(a)
compensation for wrong or injury suffered in the taxpayer’s occupations (e.g. damage
to reputation);
(b)
compensation received for wrong or injury or illness suffered by the taxpayer or
taxpayer’s relative.
Interest as Income
8.19
We have tended to always classify income as being either:
(a)
business;
(b)
personal services; or
(c)
property – this is all about income from passive investment,
because we have differing tax rates for these types of taxation.
8.20
Income from property generally involves a capital asset and then the flow of income:
(a)
this goes back to Eiser fruit and tree metaphor;
(b)
i.e. the tree is the capital and the fruit is the flow of income;
(c)
however, this does not mean that there are no tax consequences for those trees and
fruits – they are just CGT consequences – which is actually statutory income (see
next week).
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8.21
Interest is the most common and likely sort of income from property:
(a)
the property is the investment, the bank deposit, security etc;
(b)
it is the flow from property which is the interest – i.e. $10,000 in bank account –
$500 earned as interest is assessable income under s 6-5 as assessable income.
8.22
Generally, interest is assessable income as ordinary income pursuant to s 6-5 ITAA 97;
however, this leads to many complicated arrangements – which will be discussed under CGT.
8.23
In terms of financial products, a simple investment in a term deposit is unlikely to happen,
they are usually much more complex than this and the most common is dealing with
securities or bonds.
Discounted securities and Div 16E securities
Introduction
8.24
Discounted securities and Div 16E securities are those where the interest is paid on maturity
as a lump sum together with the principal amount:
(a)
therefore, the discount is income and is regarded as the return on the investment;
(b)
NB it not regarded as part of the capital;
(c)
e.g. $900 return on capital and $100 as interest income (i.e. the return on
investment);
(d)
this is because, you pay $900 and get $1000 back at the end of the investment.
8.25
As a result of interest being paid on maturity, the income is deferred in the hands of the
investor.
8.26
What happens if they are redeemable in 5 years, 10 years, 20 years etc? – this is where Div
16E of the ITAA 36 kicks in:
(a)
The $5,000 earned over the period of the investment will be income and assessable
on an accruals basis (i.e. when you have the right to receive the money), c.f. a cash
basis (which is when you receive the money);
(b)
Div 16E only applies to “qualifying securities” that have an “eligible return”;
(c)
This provides that $5,000 earned over a period of years is income and is assessable
on an accruals basis (as opposed to a cash basis, which is when you actually receive
the money);
(d)
This is so, despite the fact that the interest is paid on maturity as a lump sum – the
aim Div 16 E is to defer the income in the hands of the investor.
8.27
Therefore, you will have to include in your tax return $500 for every tax year.
8.28
The issuer would get a deduction of $500 for what they would have to pay out to the investor
(i.e. every year for 5 years):
(a)
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but the common law said that the investor did not have to pay tax – i.e. not pay tax
every year, despite the deduction; and
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so they introduced Div 16E after 1984 case of FCT v AGC – see below.
(b)
Reason for the introduction of Div 16E
FCT v AGC
Facts
•
AGC offered a debenture to the public that matured after 20 years but with the investor being
able to redeem it at the end of five years with interest paid at that time.
•
AGC claimed a deduction for the interest expense each year and the investor did not include
any interest as assessable income until redemption at the end of five years.
•
There was clearly a timing advantage for the investor.
•
However, there was a mismatch (between the issuer and the investor) of income and
deduction.
Held – FCA
•
The Federal Court held that the interest expense was deductible each year, even though it
was not paid and the investor was only assessed on the interest when paid.
•
As a result of this decision, the Government introduced Div 16E into ITAA 1936 to prevent
this type of arrangement being used in this way.
•
The Division contains the basis on which these securities will be taxed and provides a
definition of the type of security that may be caught by the provisions.]
Income from real property
Introduction
8.29
8.30
The most common form of income derived from real property is rental income:
(a)
rental income is ordinary income and assessable pursuant to s 6-5 ITAA97;
(b)
this is the area where negative gearing always comes up – and everyone pretends
they know what it is, but most people have no idea – it is thought to be a good and
legal way of avoiding tax, but it means expenses are greater than income.
Rent is ordinary income from property – which is therefore assessable as ordinary income
(see Raja’s Commercial College v Gian Singh (1976) 2 All ER 801)
Negative gearing
8.31
8.32
A rental property is negatively geared if it is purchased with the assistance of borrowed funds
and the net rental income, after deducting other expenses, is less than the interest on the
borrowings:
(a)
i.e. less income from the property than what you paid (and other expenses);
(b)
therefore you can offset this against e.g. salary and wages – so it ends up being
beneficial;
(c)
then hoping you get a capital gain which makes up for the fact that you are
negatively gearing the property.
The overall taxation result of a negatively geared property is that a net rental loss arises:
(a)
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in this case, you may be able to claim a deduction for the full amount of rental
expenses against your rental and other income;
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(b)
such as salary, wages or business income;
(c)
when you complete your tax return for the relevant income year; and
(d)
where the other income is not sufficient to absorb the loss it is carried forward to the
next tax year.
8.33
Property can be positively geared – where rental income is greater than the expenses for the
property.
8.34
With business income – Div 35 ITAA97 – this applies only to active investment, not
passive investment and allows business losses to be offset against salaries and wages – but
only apply to passive investment.
8.35
In the mid-1980s there was a quarantining on negative gearing – it only lasted 2 years.
Dividend imputation
The classical system
8.36
This is all about the income that you get from shares – i.e. the shares are the tree (increasing
in value as a capital gain), but the income is the dividend.
8.37
Companies pay tax in their own right, but trusts are treated like a conduit where the income
flows through to the beneficiaries.
8.38
The following is the classical system of dividend taxation:
(a)
Companies pay tax at 30% - this is because they are a separate legal entity;
(b)
then pay a dividend of say $70;
(c)
that is income in the hands of the shareholder, who will have to pay tax on it;
(d)
if the shareholder is in the 30% tax-bracket, they will have to pay $21 tax on the $70
dividend they receive;
(e)
therefore, $49 is going to the shareholder and $51 is going to the ATO;
(f)
this is an example of a classical system where the company and the shareholder are
both taxed – i.e. the same income is taxed twice.
Statutory dividend imputation system – s 207-20 ITAA97
8.39
We now have a dividend imputation system:
(a)
this passes on the tax paid by the company to the shareholder (i.e. as a benefit);
(b)
this is done by a grossing-up and credit mechanism:
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(i)
it grosses the dividend up to pre-taxed profits;
(ii)
taxes the shareholder on that amount; and
(iii)
provides a credit for the tax already paid by the company (to the
shareholder).
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77
8.40
Under the imputation system, where a franked dividend (i.e. a taxed dividend), the
dividend is taxed already in the hands of the company.
8.41
Dividends are taxed as statutory income under s 44(1) ITAA36, but the imputation regime
is in s 207-20 ITAA97.
(a)
Where a dividend is paid by a resident company to a resident shareholder, the
assessable income of the shareholder includes, in addition to the amount of the
dividend, the franking credit attached to the dividend;
(b)
but the shareholder is entitled to a tax offset equal to the franking credit included in
assessable income.
s 44(1) ITAA36 – Dividends
44(1) [Shareholder assessable income]
The assessable income of a shareholder in a company (whether the company is a resident or a nonresident) includes:
(a)
if the shareholder is a resident:
(b)
(i)
dividends (other than non- share dividends) that are paid to the shareholder
by the company out of profits derived by it from any source; and
(ii)
all non- share dividends paid to the shareholder by the company; and
if the shareholder is a non-resident:
(c)
(i)
dividends (other than non- share dividends) paid to the shareholder by the
company to the extent to which they are paid out of profits derived by it from
sources in Australia; and
(ii)
non- share dividends paid to the shareholder by the company to the extent to
which they are derived from sources in Australia; and
if the shareholder is a non-resident carrying on business in Australia at or through a
permanent establishment of the shareholder in Australia, and the company is a
resident:
(i)
dividends (other than non- share dividends) that are paid to the shareholder
by the company and are attributable to the permanent establishment, to the
extent to which they are paid out of profits derived by the company from
sources outside Australia; and
(ii)
non- share dividends that are paid to the shareholder by the company and
are attributable to the permanent establishment, to the extent to which they
are derived from sources outside Australia.
This subsection does not apply to a dividend (or non-share dividend) to the extent to which another
provision of this Act that expressly deals with dividends includes some or all of the dividend (or nonshare dividend) in, or excludes some or all of the dividend (or non-share dividend) from, the
shareholder's assessable income.
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s 207-20 ITAA97 – General rule – gross-up and tax offsets
207-20(1) [Rule]
If an entity makes a * franked distribution to another entity, the assessable income of the receiving
entity, for the income year in which the distribution is made, includes the amount of the * franking
credit on the distribution. This is in addition to any other amount included in the receiving entity's
assessable income in relation to the distribution under any other provision of this Act.
207-20(2) [Application to the taxpayer]
The receiving entity is entitled to a * tax offset for the income year in which the distribution is made.
The tax offset is equal to the *franking credit on the distribution.
Franking credits in practice
8.42
Section 207-20 contains the imputation provisions:
(a)
imputation taxes profits already taxed in the hands of the company at the
shareholder’s marginal rate
(b)
this is achieved by a gross up and credit mechanism
Franking Credit Formula
8.43
Gross up dividend by – s 207-20(2) – the gross-up amount:
company tax rate
1 – company tax rate
8.44
An example, where a company pays the company tax rate of 30%.
8.45
Taxable income
8.46
tax (30%)
8.47
After tax profits
70
8.48
Dividend paid
70
100
30
Shareholder level (shareholder in 45% bracket)
8.49
Dividends (s44(1))
70
8.50
Gross up amount (s207-20(1))
30
8.51
Taxable income
100
8.52
Tax at highest rate (45%)
45
8.53
Franking Rebate (s207-20(2))
30
8.54
Net Tax Payable
$15 (i.e. they pay the extra $15)
Shareholder level (shareholder in 30% bracket)
8.55
Dividends (s44(1))
70
8.56
Gross up amount (s207-20(1))
30
8.57
Taxable income
100
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8.58
Tax at 30% bracket (30%)
30
8.59
Franking Rebate (s207-20(2))
30
8.60
Net Tax Payable
$ 0 (i.e. they don’t have to pay tax)
Shareholder level (shareholder in 15% bracket)
8.61
Dividends (s44(1))
70
8.62
Gross up amount (s207-20(1))
30
8.63
Taxable income
100
8.64
Tax at 15% bracket (15%)
15
8.65
Franking Rebate (s207-20(2))
30
8.66
Net Tax Payable
- $15 (i.e. they get money back).
8.67
i.e. the taxpayer receives a refund – i.e. can get an amount back, when your highest marginal
rate is less than the company tax rate.
8.68
Don’t forget to check whether the dividends are fully franked, or only partly franked – this will
effect how much you get back as franking rebate.
8.69
There could be changes to this system as a result of the Henry Review – be careful that
these changes do/don’t come about – he is taking into account the current cycle and taking a
medium to long-term view.
Dividend advices
8.70
Unfranked dividends – no imputation credit
8.71
Partially franked dividend – franked and unfranked component – i.e. franked to 60% - 30/70
x 60% to work out imputation credit
Non-assessable income
Non-assessable income generally – s 6-15 ITAA97
8.72
3 ways non-assessable income arise:
(a)
s 6-15(1) [not ordinary income] – an amount is not ordinary income or statutory
income – i.e. lottery winnings, $10 in the birthday card etc – they just don’t satisfy
any test;
(b)
s 6-15(2) [exempt income] – an amount that is ordinary or statutory income that
is made exempt by a section of the Act – i.e. the statute pulls it back out.
(c)
s 6-15(3) [non-assessable non-exempt income] – an amount that is ordinary
or statutory income that is non-assessable non-exempt income under the Act.
Exempt income
8.73
s 6-15(2) – Categories of exempt income – see Div 11 (core division dealing with exempt
income) it divides exempt income into 3 categories:
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(a)
entities which are exempt on all their income, no matter what type of income it is
(s 11-5 ITAA97 – refers you to Div 50 (and other divisions) – lists exempt entities);
(b)
income which is exempt, no matter whose it is (s 11-10 ITAA97) – example
which is relevant – judgement debts for personal injuries – s 51-57; and
(c)
income which is exempt only if derived by certain entities (s 11-15 ITAA97 –
refers you to other entities – this goes on for 4 pages).
Category One – Exempt entities – Div 50 ITAA97
8.74
s 50-5: Charity, education, science and religion – note that certain conditions must be
satisfied to qualify as a charity – i.e. the Statute of Elizabeth objects.
8.75
s 50-10: Community service – this excludes political and lobbying purposes.
8.76
s 50-15: Trade unions and employer associations – association must be registered under
Workplace Relations Act or Australian law relating to dispute resolution.
8.77
s 50-20: Friendly societies.
8.78
s 50-25: Government – local government bodies, public authorities etc.
8.79
s 50-30: Health – public hospitals etc, carried on by a society or association as do private
health insurers.
8.80
s 50-40: Primary and secondary resources, and tourism – associations for aviation, tourism
etc – not for purpose of profit or gain of individual members.
8.81
s 50-45: Sports, culture, film and recreation – can’t be carried on for profit or gain of
individual members.
Category Two – Exempt income – Div 51 ITAA97
8.82
s 51-5: Defence – members of the reserves are exempted from tax on their pay as a
member.
8.83
s 51-10: Education and training – various scholarships are exempt.
8.84
s 51-30: Welfare – certain payments only.
8.85
s 51-32: Compensation payments for loss of tax exempt payments – principle is replacing
one item with another item.
8.86
s 51-33: Compensation payments for loss of pay and/or allowances as a Defence reservist –
compensation is exempt just like payment.
8.87
s 51-35: Payments to a full-time student at a school, college or university.
8.88
s 51-40: Payments to a secondary student.
8.89
s 51-43: Income collected or derived by a copyright collecting society.
8.90
s 51-50: Maintenance payments to a spouse or child.
8.91
s 51-54: Gain or profit from disposal of eligible venture capital investments (equities).
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8.92
8.93
s 51-55: Gain or profit from disposal of venture capital equity.
s 51-57: Interest on judgment debt relating to personal injury (introduced as a result of
Whitaker).
8.94
s 51-65: Government co-contribution towards low income earner's superannuation.
Category three – see the legislation
Interest on judgment debt
Introduction
Whitaker v FCT
Facts
•
She didn’t know that there was a risk that she could go blind – eventually she was successful
and won herself heaps of money.
•
FCT wanted to tax her on the pre-judgement and post-judgement interest – note the fruit
and tree – the interest is different (the fruit).
•
Court said pre-judgement interest was non-assessable, though the post-judgement interest
was in the year it was received.]
Held – HCA
•
8.95
Held: Although pre-judgment interest is not assessable, post judgment interest is income
according to ordinary concepts and is assessable in the year in which it is received.
However: s 51-57 and s 23G: post-judgement interest will now also be exempt, along with
the actual payment itself and the pre-judgement interest.
Structured settlement payments
8.96
These relate to personal injury cases and represent a payment which replaces lost income –
usually, these will be assessable as income (because they replace income).
8.97
If you turn this into an annuity (i.e. paid on a fortnightly basis, paid for a lifetime) – if you
meet certain criteria that can be exempt:
(a)
annuities and certain deferred lump sums paid under structured settlements to
seriously injured persons may be exempt if certain eligibility criteria are met.
(b)
the bottom line is, these payments are a complete failure – but be aware (in personal
injuries law) – that you can do this.
Consequences of an amount being exempt income
8.98
8.99
The amount is tax-free:
(a)
a loss or outgoing incurred in deriving exempt income is not an allowable deduction;
(b)
exempt income may decrease a deduction for a tax loss;
(c)
The disposal of an asset used only to generate exempt income does not produce a
capital gain – i.e. a charity sells a property to produce income – tax is not paid on
that;
However, exempt income may be taken into account:
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8.100
(a)
in determining tax payable on foreign sourced income;
(b)
in determining Separate Net Income (SNI) of a dependant:
(i)
certain rebates apply if one partner is supporting the other, but if one is
earning exempt income, can only earn a certain amount before the benefit is
lost;
(ii)
wife working – husband with exempt income (not the same as taxable
income).
This is different to non-assessable, non-exempt income (see below)
Non assessable non exempt income
General principle
8.101
s 6-23: income is non assessable non exempt if the Act states so.
Examples
8.102
Div 17 – GST
(a)
You own a hardware store and a customer buys a lawnmower;
(b)
It may be sold for $550 - $50 of that will be GST and that is remitted to the ATO;
(c)
That is not income to the hardware store – which they would have paid $30 GST on
when buying from supplier for $330;
(d)
Therefore as they have paid $30 and collected $50 they net it off and they only remit
$20 to the ATO (i.e. the net amount from the sale of the lawnmower).
8.103
Temporary residents – i.e. amount is not included in income.
8.104
NB – Subdiv 11B ITAA97 and Div 59 ITAA 97 outline specific categories of nonassessable non-exempt income.
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Topic 4
Capital gains tax (CGT)
1
CGT as a process
The 3 steps of CGT
1.1
Step 1 – have you made a capital gain/loss?
1.2
Step 2 – Work out the amount of the capital gain/loss?
1.3
Step 3 – Work out the net capital gain/loss for the income year?
2
Step 1 – have you made a capital gain or loss?
Introduction
Step 1 can be broken up into 4 questions
2.1
Question 1 – What events attract CGT? – see s 100-20 and Div 104
2.2
Question 2 – What is a CGT asset? – see s 100-25 and Div 108
2.3
Question 3 – Does an exception or exemption apply? – see s 100-30 and Div 118; 152
2.4
Question 4 – Can there be a roll-over? – see s 100-33.
Question 1 – What attracts CGT?
Introduction
2.5
[events attracting CGT] s 100-20 – this is the first question to ask in terms of CGT –
basically, for a capital gain or a capital loss to occur there must be a CGT event. Thus,
CGT events will attract CGT.
2.6
[summary of Div 104] s 104-1 – this Division:
(a)
Sets out all the CGT events for which you can make a capital gain or loss;
(b)
Tells you how to work out if you have made a gain or loss from each event and the
time of each event; and
(c)
Contains exceptions for gains and losses for many events (such as the exception for
CGT assets acquired before 20 September 1985) and some cost base adjustment
rules.
12 categories of CGT events
2.7
[summary of CGT events] s 104-5 – this section summarises the CGT events:
(a)
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(b)
B Events – use and enjoyment of a CGT asset before title passes – see Subdivision
104-B.
(c)
C Events – end of a CGT asset – see Subdivision 104-C.
(d)
D Events – bringing into existence a CGT asset – see Subdivision 104-D.
(e)
E Events – trusts – see Subdivision 104-E.
(f)
F Events – leases – see Subdivision 104-F.
(g)
G Events – shares – see Subdivision 104-G.
(h)
H Events – special capital receipts – see Subdivision 104-H.
(i)
I Events – Australian residency ends – see Subdivision 104-I.
(j)
J Events – reversal of roll-overs – see Subdivision 104-J.
(k)
K Events – other CGT events – see Subdivision 104-K.
(l)
L Events – consolidated groups and MEC groups – see Subdivision 104-L.
2.8
For further information on the CGT Events above, see below and s 104-5 ITAA97.
2.9
Note that, where more than 1 CGT event happens:
(a)
[specific prevails] s 102-25 – the one that applies is the more specific one to the
taxpayer’s situation.
(b)
There are exceptions, which will present themselves later – e.g. CGT Events D1 and
H2 can only apply if no other CGT event happens in the circumstances – i.e. they will
never take priority over another CGT event.
Event A1 – Disposal of a CGT asset
2.10
This is the most likely CGT event (90% of cases) and it doesn’t need to be through sale –
rather, just any change of ownership.
2.11
[CGT event A1] s104-10(1) – CGT event A1 happens if you *dispose of a *CGT asset.
2.12
[disposal] s 104-10(2) – you dispose of a *CGT asset if a change of ownership occurs
from you to another entity, whether because of some act or event or by operation of law.
However, a change of ownership does not occur:
2.13
2.14
(a)
if you stop being the legal owner of the asset but continue to be its beneficial owner;
or
(b)
merely because of a change of trustee.
[time of disposal] s 104-10(3) – the time of the event is:
(a)
when you enter into the contract for the *disposal; or
(b)
if there is no contract – when the change of ownership occurs.
Example:
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2.15
(a)
In June 1999 you enter into a contract to sell land.
(b)
The contract is settled in October 1999. You make a capital gain of $50,000.
(c)
The gain is made in the 1998-99 income year (the year you entered into the contract)
and not the 1999-2000 income year (the year that settlement takes place).
(d)
NB the Commissioner doesn’t impose penalties if you have to go back and amend
your tax return. This would be an amendment, not an adjustment on your next tax
return, because you have to look at tax year-by-year.
[commentary] It therefore does not matter when you actually receive the money:
(a)
i.e. you may enter into k to sell in year 1 and then not actually receive the money
until year 10;
(b)
see – McDonald v FCT, the question of when ownership changes hand was held to be
a question of fact – it must be considered in light of the circumstances.
2.16
[gain or loss?] s 104-10(4) – you make a capital gain if the *capital proceeds from the
disposal are more than the asset's *cost base. You make a capital loss if those *capital
proceeds are less than the asset's *reduced cost base.
2.17
[exceptions] s 104-10(5) – a *capital gain or *capital loss you make is disregarded if:
(a)
you *acquired the asset before 20 September 1985; or
(b)
for a lease:
(i)
it was granted before that day; or
(ii)
if it has been renewed or extended - the start of the last renewal or extension
occurred before that day.
Event B1 – Use and enjoyment before title passes
2.18
This event happens where the right to use and enjoyment of a CGT asset you own
passes to the other entity before title actually passes – i.e. title will or may pass to the
other entity at or before the end of the agreement for use and enjoyment.
2.19
[agreement for use and enjoyment] s 104-15(1) – if you enter into an agreement with
another entity under which:
(a)
The right to the use and enjoyment of a CGT asset you own passes to the other
entity; and
(b)
Title in the asset will or may pass to the other entity at or before the end of the
agreement.
2.20
[time of event] s 104-15(2) – the time of the event is when the other entity first obtains
the use and enjoyment of the asset – i.e. a taxpayer should declare it on their tax return in
year 1 and if the person didn’t end up buying the property, they should go back and amend
their return.
2.21
[gain or loss?] s 104-15(3) – you make a capital gain if the *capital proceeds from the
agreement are more than the asset's *cost base. You make a capital loss if those *capital
proceeds are less than the asset's *reduced cost base.
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2.22
[exceptions] s 103-15(4) – a capital gain or capital loss you make is disregarded if:
(a)
Title in the asset does not pass to the other entity at or before the end of the
agreement; or
(b)
You acquired the asset before 20 September 1985.
Example of Event B1
•
On 1 August 2007, Graham Smith entered into a contract with Stephanie Miles which gave
him the use and enjoyment of her holiday house in Port Stephens, for a period of nine
months in order for him to decide if he wanted to buy the holiday house. Thereafter, on 30
April 2008, a contract was entered into for Graham to buy the holiday house from Stephanie
for $500,000.
•
In this example, CGT event B1 would happen on 1 August 2007 as Graham had use and
enjoyment of the holiday house before title to the property passed, rather than CGT event
A1, which does not take place until 30 April 2008 when Graham signed the contract to
actually buy the house from Stephanie.
•
Therefore, the significant question is: when does use and enjoyment pass – this is the CGT
event.
Event C1 – the end (loss or destruction) of a CGT asset
2.23
[loss or destruction] s 104-20(1) – CGT event C1 happens if a *CGT asset you own is
lost or destroyed.
2.24
[time of event] s 104-20(2) – the time of the event is:
(a)
When you first receive compensation for the loss or destruction; or
(b)
If you receive no compensation – when the loss is discovered or the destruction
occurred.
2.25
[capital gain or loss?] s 104-20(3) – see similar provisions above.
2.26
[exception] s 104-20(4) – disregard if acquired before 20 September 1985.
Example of Event C1
•
Erin owns a factory that burns down. She has insurance which compensates her for the loss.
•
CGT event C1 happens when the factory is destroyed and the time of the event is when she
receives the insurance payment.
Event C2 – the end (cancellation, surrender or similar) of an intangible asset
2.27
[end of an intangible asset] s 104-25(1) – CGT event C2 happens if your ownership of
an intangible *CGT asset ends by the asset:
(a)
being redeemed or cancelled; or
(b)
being released, discharged or satisfied; or
(c)
expiring;
(d)
being abandoned, surrendered or forfeited;
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if the asset is a convertible interest – being converted.
2.28
[time of event] s 104-25(2) – the time of the event is:
(a)
When you enter into the contract; or
(b)
If there is no contract, when the asset ends.
2.29
[capital gain or loss?] s 104-25(3) – see similar sections above.
2.30
[exceptions] s 104-25(4) – a capital loss/gain will be disregarded where:
(a)
You acquired the asset before 20 September 1985; or
(b)
For a lease where:
(i)
It was granted before 20 September 1985; or
(ii)
If it has been renewed or extended – the start of the last renewal or
extension occurred before 20 September 1985.
Example of Event C2
•
Tim has a contract with Acme Co to be the exclusive supplier of their widgets for the next 10
years. Acme Co terminates the agreement with Tim after five years. Tim is paid $5000 as
compensation for the early termination of the contract.
•
CGT event C2 happens as Tim’s intangible asset, i.e. the right to enforce the agreement, has
come to an end. The capital proceeds will be the $5000 less any costs associated with the
event (e.g. legal fees).
Event C3 – the end of an option to acquire shares
2.31
This deals with the company side of things – i.e. the Company making a gain from the end of
the option.
2.32
[end of option to acquire shares] s 104-30(1) – if an option a company or a trustee of
a unit trust granted to an entity to acquire a CGT asset that is:
(a)
shares in the company or units in the unit trust; or
(b)
debentures of the company or unit trust,
ends in one of these ways:
(c)
it is not exercised (by the latest time for its exercise);
(d)
it is cancelled; or
(e)
it is released or abandoned.
2.33
[time of event] s 104-30(2) – the time of the event is when the option ends.
2.34
[capital gain or loss?] s 104-30(3) – a capital gain is where the capital proceeds form the
grant of the option are more than the expenditure incurred in granting it and a capital loss is
where the capital proceeds from the option are less.
2.35
[exception] s 104-30(5) – if the option was acquired prior to 20 September 1985.
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Example of Event C3
•
On 1 January 2008 Gina pays Acme Co $100 for the right to acquire 10,000 shares in the
company for $1 per share. The option to acquire shares must be exercised within 12 months
of entering into the option.
•
Gina decides not to exercise the option. As a result, the option expires and CGT event C3
happens on 1 January 2009. Acme Co makes a capital gain of $100 (less any associated
expenses).
Event D1 – the bringing into existence of a contractual (or other) right in another
entity
2.36
[creating contractual or other rights] s 104-35(1) – CGT event D1 happens if you
create a contractual right or other legal or equitable right in another entity.
2.37
[time of event] s 104-35(2) – the time of the event is when you enter into the contract or
create the other right.
2.38
[capital gain or loss?] s 104-35(3) – you make a capital gain if the capital proceeds
from creating the right are more than the incidental costs you incurred that relate to the
event – you make a capital loss if those proceeds are less:
2.39
2.40
(a)
Costs include giving property;
(b)
However they do not include an amount received as recoupment of them that is not
included in your assessable income.
[exceptions] s 104-35(5) – this event does not happen if:
(a)
you created the right by borrowing money or obtaining credit from another entity;
(b)
the right requires you to do something that is another CGT event that happens to
you;
(c)
a company issues or allots equit interests or non-equity shares in the company;
(d)
the trustee of a unit trust issues units in the trust;
(e)
a company grants an option to acquire equity interests, non-equity shares or
debentures in the company; or
(f)
the trustee of a unit trust grants an option to acquire units or debentures in the trust.
Therefore, this event may happen if- see Master Tax Guide:
(a)
A person agrees not to compete with another person for a specified period within a
specified area;
(b)
A property owner grants management rights over the property;
(c)
A person agrees to endorse the use of particular goods and services;
(d)
There is a grant of a right to use a trademark; and
(e)
The granting of an easement, profit a prendre – see IT 2561, TD 93/235 and TR
95/6.
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2.41
Note that a lot of these events are related and the bringing into existence of an asset which
triggers a D1 often leads to an event C2 – when the asset comes to an end.
Example of Event D1
•
Bart sells his business to Lucy. As part of the agreement, Bart agrees not to operate a similar
business within a 5 km radius for the next two years. Lucy pays $10,000 for Bart to agree to
this. A contractual right in favour of Lucy has been created. If Bart breaches the contract,
Lucy can enforce that right.
•
CGT event D1 happens when the contract is entered into and Bart will have a capital gain (of
$10,000). At the end of the two-year period CGT event C2 will happen and Lucy will have a
capital loss (i.e. of $10,000).
Event D2 – the granting of an option
2.42
[granting of an option] s 104-40(1) – CGT event D2 happens if you grant an option to
an entity, or renew or extend an option you had granted.
2.43
[time of granting] s 104-40(2) – the time of the event is when you grant, renew or
extend the option.
2.44
[capital gain or loss?] s 104-40(3) – there will be a capital gain if the proceeds from
the granting of the option are more than the expenditure you incurred to grant and vice versa
for a capital loss.
2.45
[exceptions] s 104-40(6) - event D2 does not apply to an option granted by a company or
the trustee of a unit trust to acquire an asset that is:
2.46
(a)
shares in the company or units in the unit trust (see Event C3); and
(b)
debentures in the company or unity trust (see Event C3).
NB – remember to always apply the most specific CGT event – i.e. this is an option in
general, but C3 applies only to companies in the granting of options in shares – this is about
the timing.
Example of Event D2
•
Ben pays Sara $5000 for an option to purchase her business. The one-month option is
granted on 1 January 2009. Ben decides not to exercise the option.
•
CGT Event D2 happens on 1 January 2009 and Sara has a capital gain of $5000 less any
associated expenses (e.g. legal expenses). If Ben exercises the option, CGT event D2 is
ignored and CGT event A1 happens.
Events D3 and D4 – specific events
2.47
2.48
These events are very specific and will not be dealt with:
(a)
Event D3 – mining entitlement grants – see s 104-45; and
(b)
Event D4 – conservation covenants of rights over land – see s 104-47.
For further information see pages 648-650 Master Tax Guide.
Events E1 – E9 – events relating to trusts
2.49
The following are events relating to trusts:
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2.50
(a)
E1 – Creating a trust over a CGT asset – see s 104-55.
(b)
E2 – Transferring a CGT asset to a trust – see s 104-60.
(c)
E3 – Converting a trust to a unit trust – see s 104-65.
(d)
E4 – Capital payment for trust interest – see s 104-70.
(e)
E5 – Beneficiary becoming entitled to a trust asset – see s 104-75.
(f)
E6 – Disposal to beneficiary to end income right – see s 104-80.
(g)
E7 – Disposal to beneficiary to end capital interest – see s 104-85.
(h)
E8 – Disposal by beneficiary of capital interest – see s 104-90.
(i)
E9 – Creating a trust over future property – see s 104-105.
For further information see pages 650-656 Master Tax Guide.
Events F1 – F5 – events dealing with leases
2.51
2.52
The following are events relating to leases:
(a)
F1 – Granting a lease – see s 104-110.
(b)
F2 – Granting a long-term lease – see s 104-115.
(c)
F3 – Lessor pays lessee to get lease changed – see s 104-120.
(d)
F4 – Lessee receives payment for changing lease – see s 104-125.
(e)
F5 – Lessor receives payment for changing lease – see s 104-130.
For further information see pages 656-658 Master Tax Guide.
Event F4 – lessee receives payment for changing a lease
2.53
[payment for changing lease] s 104-125(1) – CGT event F4 happens if a lessee receives
a payment from the lessor for agreeing to vary or waive a term of the lease – (it can include
giving property).
2.54
[time of event] s 104-125(2) – the time of the event is when the term is varied or
waived.
2.55
[capital gain?] s 104-125(3) – the lessee makes a capital gain if the capital proceeds
from the event are more than the lease’s cost base (at the time of the event). If the lessee
makes a capital gain, the lease’s cost base is also reduced to nil.
2.56
[capital loss?] s 104-125(4) – if the lessee’s proceeds are less, the lease’s cost base is
reduced by that amount at the time of the event.
2.57
[exceptions] s 104-125(5) – a capital gain the lessee makes is disregarded if:
(a)
The lease was granted before 20 September 1985; or
(b)
For a lease that has been renewed or extended prior to 20 September 1985.
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2.58
This event reduces the lessees cost base – i.e. it defers payment.
Example of Event F4
•
On 1 January 2009 Jake (the lessee) enters a lease. On 1 May 2009 Jake agrees to waive a
term. Eastfield (the lessor) pays Jake $1000 for this. If Jake’s cost base at the time of the
waiver is $2500, it is reduced from $2500 to $1500.
•
On 1 September 2009 Jake agrees to waive another term. Eastfield pays Jake $2000 for this.
•
If Jake’s cost base at the time of the waiver is $1500, Jake makes a capital gain of $500 and
the cost base is reduced to nil.
Event F5 – lessor receives payment for changing lease
2.59
[payment for changing lease] s 104-130(1) – CGT event F5 happens if a lessor receives
a payment from the lessee for agreeing to vary or waive a term of the lease.
2.60
[time of event] s 104-130(2) – the time of the event is when the term is varied or
waived.
2.61
[capital gain or loss?] s 104-130(3) – the lessor makes a capital gain if the capital
proceeds from the event are more than the expenditure the lessor incurs in relation to the
variation or waiver. The lessor makes a capital loss if those proceeds are less.
2.62
[exceptions] s 104-130(5) – a capital gain or a capital loss to the lessor is disregard for
the usual 20 September 1985 reasons.
Example of Event F5
•
Eastfield owns a shopping centre.
•
Con (the lessee of a shop in the centre) pays Eastfield $10,000 for agreeing to change the
terms of its lease.
•
Eastfield incurs expenses of $1,000 for a solicitor and $500 for a valuer.
•
Eastfield makes a capital gain of $8,500.
Events G1 – G3 – events dealing with shares
2.63
2.64
The following are events relating to shares:
(a)
G1 – Capital payment for shares – see s 104-135.
(b)
G2 – (former) Shifts in share values – NB this section was replaced by the Direct
Value Shifting Rules – see s Divisions 723, 725 and 727.
(c)
G3 – Liquidator declares shares worthless – see s 104-145.
For further information see pages 658-660 Master Tax Guide.
Event G3 – liquidator declares shares worthless
2.65
[shares declared worthless] s 104-145(1) – CGT event G3 happens if a taxpayer owns
shares in a company and the company’s liquidator declares (in writing) that he/she believes
there to be no likelihood of shareholders receiving further distributions in the course of
winding up the company.
2.66
[time of event] s 104-145(2) – the time of the event is when the liquidator makes the
declaration that no further distributions are likely.
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2.67
[capital loss?] s 104-145(4) – a taxpayer can choose to make a capital loss equal to the
reduced cost base of the taxpayer’s shares at the time of the liquidator’s declaration. You
cannot make a capital gain.
2.68
[reduction to nil] s 104-145(5) – if you make the choice, the cost base and reduced cost
base of the shares are reduced to nil just after the declaration was made.
2.69
[exception] s 104-145(6) – a taxpayer cannot choose to make a capital loss from shares
acquired before 20 September 1985.
Example of Event G3 – see TD 02/3
•
In 1999 Jenny purchased shares in HIH Insurance Ltd.
•
On 10 October 2001 the liquidators declared that they believed there was no likelihood the
shareholders would receive any distribution on a winding up.
•
Jenny opted to make a capital loss equal to the reduced cost base of her shares as at 10
October 2001.
•
This reduced the cost base and reduced cost base of her shares to nil.
This might have interesting applications to the Kleenmaid winding –up – amongst others.
Events H1 – H2 – special capital receipts
2.70
2.71
The following events relate to special capital receipts:
(a)
H1 – Forfeiture of a deposit – see s 104-150.
(b)
H2 – Receipt for event relating to a CGT asset – these are like voluntary payments
(e.g. thanks you started work early on a building, have an extra $10,000) – see s
104-155.
For further information see pages 660-661 Master Tax Guide.
Events I1 – I2 – ending of Australian residency
2.72
The following events relate to the ending of Australian residency:
(a)
I1 – Individual or company stops being a resident – see s 104-160.
(b)
I2 – Trust stops being a resident trust – see s 104-170.
2.73
The rationale for Events I1 and I2 are to make sure that if the resident leaves the country we
capture any capital gain.
2.74
For further information see page 662 Master Tax Guide.
Events J1 – J4 – reversal of rollovers
2.75
The following events relate to the reversal of rollovers:
(a)
J1 – Company stops being member of wholly-owned group after roll-over – see s
104-175.
(b)
J2 – Change in status of small business roll-over replacement asset – see s 104185.
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2.76
(c)
J3 – Change in circumstances where share or interest was a small business roll-over
replacement asset – see s 104-
(d)
J4 – Trust fails to cease to exist after a roll-over under Subdiv 124-N – see s 104195.
(e)
J5 – Failure to acquire replacement asset and to incur fourth element expenditure
after a roll-over under Subdiv 152-E – see s 104-197.
(f)
J6 – Cost of acquisition of replacement asset or amount of fourth element
expenditure, or both – see s 104-198.
For further information see pages 663-666 Master Tax Guide.
Events K1 – K2 – other CGT events
2.77
2.78
The following events relate to other CGT events (i.e. it is the catch-all provision and consists
of some bizarre provisions):
(a)
K1 – (former) Partial realisation of intellectual property right – see rules relating to IP
rights.
(b)
K2 – Bankrupt pays amount in relation to debt – see s 104-210.
(c)
K3 – Asset passing to tax-advantaged entity – see s 104-215.
(d)
K4 – CGT asset starts being trading stock – see s 104-220.
(e)
K5 – Special capital loss from collectable that has fallen in market value – see s 104225.
(f)
K6 – Pre-CGT shares or trust interest – see s 104-230.
(g)
K7 – Balancing adjustment occurs for a depreciating asset used for purposes other
than taxable purposes – see s 104-235 – s 104-245.
(h)
K8 – Direct value shifts affecting your equity or loan interests in a company or trust –
see s 104-250.
(i)
K9 – Entitlement to receive payment of a carried interest – see s 104-255.
(j)
K10 – Forex realisation gain covered by item 1 of the table in s 775-70(1) – see s
104-260.
(k)
K11 – Forex realisation loss covered by item 1 of the table in s 775-75(1) – see s
104-265.
(l)
K12 – Foreign hybrid loss exposure adjustment– see s 104-270.
For further information see pages 666-671 Master Tax Guide.
Events L1 – L8 – consolidated groups
2.79
The following events relate to companies with wholly owned subsidiaries and allow them to
consolidate their taxation – these allow for capturing of capital gains/losses by the group:
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2.80
(a)
L1 – Reduction under s 705-57 in tax cost setting amount of assets of entity
becoming subsidiary member of consolidated group – see s 104-500.
(b)
L2 – Amount remaining after step 3A, etc, of joining allocable cost amount is
negative – see s 104-505.
(c)
L3 – Tax cost setting amounts for retained cost base assets exceed joining allocable
cost amount – see s 104-510.
(d)
L4 – No reset cost base assets against which to apply excess of net allocable cost
amount on joining – see s 104-515.
(e)
L5 – Amount remaining after step 4 of leaving allocable cost amount is negative (s
104-520)when entity ceases to be – see s 104-520.
(f)
L6 – Error in calculation of tax cost setting amount for joining entity's assets – see s
104-525.
(g)
L7 – Discharged amount of liability differs from amount for allocable cost amount
purposes – see s 104-530.
(h)
L8 – Reduction in tax cost setting amount for reset cost base assets on joining
cannot be allocated – see s 104-535.
For further information see pages 671-673 Master Tax Guide.
Question 2 – What is a CGT asset?
Introduction
2.81
Most events (see above) involve a CGT Asset. However, before looking at how much CGT
is payable – you must determine whether there is a CGT Asset. Division 108 deals with
CGT Assets.
2.82
CGT Assets are divided into the following:
(a)
Collectibles – see Division 108B;
(b)
Personal use assets – see Division 108C; and
(c)
Other assets – see Division 108D.
General principles
2.83
2.84
[definition of a CGT asset] s 108-5(1) – a CGT asset is:
(a)
any kind of property; or
(b)
a legal or equitable right that is not property.
[examples of CGT assets] s 108-5(2) – to avoid doubt, these are CGT assets:
(a)
part of, or an interest in, an asset referred to in subsection (1);
(b)
goodwill or an interest in it;
(c)
an interest in an asset of a partnership;
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(d)
an interest in a partnership that is not covered by paragraph (c).
Collectables
2.85
[definition of collectables] s108-10(2) – a collectable is:
(a)
*artwork, jewellery, an antique, or a coin or medallion; or
(b)
a rare folio, manuscript or book; or
(c)
a postage stamp or first day cover;
2.86
that is used or kept mainly for your (or your *associate's) personal use or enjoyment.
2.87
Therefore you must ask the following questions:
2.88
(a)
Firstly – is it a collectable; and
(b)
Secondly – is it used or kept mainly for personal use or enjoyment (e.g. artwork in a
home).
Where an item is defined as a collectable, there are four specific rules which apply:
(a)
Collectables acquired for $500 or less are exempt from capital gains tax – see s 11810(1):
(i)
N.B. the exemption applies to the acquisition cost;
(ii)
e.g. you go and pick up a Piccaso for $50 and then you go and sell it for
$100,000 later – it is not subject to CGT, because you acquired it for $50.
(b)
When working out the cost base of a collectable, disregard the third element (noncapital costs of ownership) – see s 108-17.
(c)
Capital losses from collectables can only be used to reduce capital gains from
collectables. This is known as a quarantining rule. Any losses not used in the
current tax year can be carried forward to be offset against gains from collectables in
future years – see s 108-10(1).
(d)
If you own collectables that are part of a set, then that set of collectables is treated
as a single collectable (an anti-avoidance rule to stop you splitting up items to get
them under the $500 threshold) – see s 108-15.
Example of losses from collectables
•
Bridgette has a capital gain from collectables of $200 and capital losses from collectables of
$400. She has other capital gains of $500. She has a net capital gain of $500 and a net
capital loss of $200.
•
The $200 loss can be carried forward to be offset against any capital gain from collectables
she has in future tax years. However, it cannot be used to reduce the $500 capital gain.
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Example of sets of collectables
•
Lily buys a set of three books for $900. If the books are of equal value, she has acquired the
books for $300 each. However, the books are taken to be a single collectable.
•
Lily will not get the exemption in s118-10 because she acquired the set for more than $500.
Personal use assets
2.89
2.90
[definition of a personal use asset] s 108-20(2) – a personal use asset is:
(a)
a *CGT asset (except a *collectable) that is used or kept mainly for your (or your
*associate's) personal use or enjoyment; or
(b)
an option or right to *acquire a *CGT asset of that kind; or
(c)
a debt arising from a *CGT event in which the *CGT asset the subject of the event
was one covered by paragraph (a); or
(d)
a debt arising other than:
(i)
in the course of gaining or producing your assessable income; or
(ii)
from your carrying on a *business.
Where an item is defined as a personal use asset, there are four specific rules which apply:
(a)
Personal use assets acquired for $10,000 or less are exempt from capital gains tax –
see s 118-10(3).
(b)
When working out the cost base of a personal use asset, disregard the third element
(non-capital costs of ownership) – see s 108-30.
(c)
A capital loss made from a personal use asset is disregarded see s 108-20(1).
(d)
If you own personal use assets that are part of a set, then that set of personal use
assets is treated as a single collectable personal use asset – see s 108-25.
Separate CGT assets
2.91
When an accessory becomes annexed to a principal asset, such as land, the accessory
becomes part of that principal asset – the common law principal.
2.92
For pre-CGT land building also would be taken as pre-CGT (even if built after), as annexed to
land.
2.93
[modifying the common law principle] s108-50 – for CGT purposes, there are:
2.94
(a)
exceptions to the common law principle that what is attached to the land is part of
the land; and
(b)
special rules about buildings and adjacent land; and
(c)
rules about when a capital improvement to a CGT asset is treated as a separate CGT
asset.
[land acquired after 20 September 1985] s 108-55(1) – if land is acquired on or after
20 September 1985, a building or structure on the land is taken to be a separate asset if the
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depreciating asset or research and development balancing adjustment provisions apply – see
s 108-55(1)). You are getting a write down, because of the building and adjustments need
to take place under other provisions.
Example involving land acquired after 20 September 1985
•
Mills Pty Ltd constructs a timber mill on land it already owns. The building is subject to a
balancing adjustment on disposal, loss or destruction. The timber mill is considered a
separate CGT asset – see s 108-55.
•
A deduction for building – often 2.5% or 4% capital allowance. But need to adjust at sale
2.95
[land acquired before 20 September 1985] s 108-55(2) – if land was acquired before
20 September 1985, a building or structure constructed on the land is taken to be a separate
CGT asset if the contract for construction was entered into on or after that day or, if there is
no contract, the construction started on or after that day.
Example involving land acquired before 20 September 1985
•
Acme Co purchases a block of land with a building on it on 1 January 1980. On 1 January
1990 Acme Co enters a contract to have another building erected on the land.
•
The second building is taken to be a separate CGT asset – see s 108-55.
2.96
[depreciating asset] s 108-60 – a depreciating asset that is part of a building is a
separate CGT asset.
Example involving a depreciating asset
•
Acme Co carries on a business of producing widgets from its factory. It installs new
bathrooms for the employees.
•
The plumbing fixtures and fittings are depreciable assets.
•
They are separate CGT assets to the factory – see s 108-60.
2.97
[adjacent land] s 108-65 – land acquired on or after 20 September 1985 that is adjacent
to land already owned is taken to be a separate CGT asset if the two parcels of land are
combined into the one title.
Example involving adjacent land
•
In 1980 David purchased a block of land. In 1990 David purchased the adjacent bock of land
and amalgamated the two titles into one.
•
The second block is a separate CGT asset.
•
A capital gain will be made on the second block when the land is disposed of – see s 108-65.
2.98
[major capital improvement] s 108-70 – A capital improvement is a separate CGT asset
to the land if:
(a)
a balancing adjustment provision applies to the land;
(b)
the cost base of the capital improvement to an asset acquired before 20 September
1985 is more than the improvement threshold for the relevant income year and more
than 5% of the capital proceeds from the event; or
(c)
the total cost base of related capital improvements to an asset acquired before 20
September 1985 is more than the improvement threshold for the relevant income
year and more than 5% of the capital proceeds from the event.
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2.99
[improvement threshold] s 108-85 – The improvement threshold for the 2007-08 income
year is $116,337:
(a)
the 08-09 threshold isn’t out yet (the figures take into account actual inflation);
(b)
the 06-07 threshold was $112,512.
Example involving the improvement threshold
•
In 1980 William purchased a boat. In 1990 he installed a new mast for $30,000. He sold the
boat a few years later for $150,000.
•
Assuming the cost base of the improvement in the year of sale is $41,000 and the
improvement threshold is $ 116,337, the improvement will not be considered a separate CGT
asset.
Timing of acquisition of the assets
2.100
Timing is important because:
(a)
CGT provisions normally won’t apply to assets acquired before 20 September 1985;
(b)
the CGT discount only applies to assets held for at least 12 months;
(c)
indexation applies only after an asset has been held for 12 months or more;
(d)
the indexation factor is determined every quarter.
(e)
time of acquisition is important where it is necessary to determine the asset’s market
value at date of acquisition.
2.101
[general rule] s 109-5(1) – taxpayer acquires a CGT asset when he/she becomes the
asset’s owner – there is a table in the section which contains a full list.
2.102
NB – if you inherit a pre-CGT asset in a will, you will hold it as a CGT asset.
Question 3 – does an exception (Div 104) or exemption apply (Div
118)?
General principles
2.103
Once you have identified whether a CGT event applies, you need to know whether there is an
exemption or exception:
(a)
If there is an exemption that is the end of the matter – there is no CGT
consequence; but
(b)
If there is an reduction (e.g. the 50% reductions in small business relief) this is
identified, but not applied until Step 3.
2.104
[exception] Div 104 – throughout Div 104 the mail exception which occurred was for
assets acquired before 20 September 1985 – these are contained in the CGT Events
themselves.
2.105
There are 4 categories of exemptions – these are not contained in the event themselves,
but rather, go to Div 118:
(a)
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Exempt assets (e.g. cars etc, NB is an antique car exempt?) – see Div 118-A;
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2.106
(b)
Exempt or loss-denying transactions – see Div 118-A;
(c)
Anti-overlap provisions – see Div 118-A;
(d)
Main residence relief – see Div 108-B and
(e)
Small business relief – see Div 152.
Note that, different provisions exempt assets in different ways:
(a)
e.g. motor vehicles and collectibles provisions exempt the asset from being a CGT
asset;
(b)
whereas only the gain or loss is excluded in relation to plant and main residence, so
these assets remain assets and records are required
Exempt assets
2.107
Thanks to Div 118-A – capital gains/losses may be disregarded for the following:
(a)
Motor vehicles, motorcycles etc designed to carry less than one tonne or fewer than 9
passengers – see s 118-5(a):
(i)
these are defined in s 995-1;
(ii)
e.g. vintage car, would it be a car, or a collectible?
(b)
Valour and brave conduct decorations – see s 118-5(b).
(c)
Collectables costing $500 or less – see s 118-10(1) and s 118-10(2).
(d)
Personal use assets costing $10,000 or less – see s 118-10(3).
(e)
Assets used to produce exempt income – i.e. the assets themselves are also exempt
(apples and trees are both exempt) – see s 118-12.
(f)
Depreciating assets – capital expenditure which the act give us deductions for, if you
sell these, you don’t take into account CGT consequences, you do a balancing
adjustment, to take into account expense and what the asset ended up costing you.
Exempt or loss denying transactions
2.108
2.109
[compensation] s 118-37(1)(a)-(b) – A capital gain or capital loss is disregarded if it is
made from a CGT event that relates directly to compensation or damages received:
(a)
for any wrong or injury suffered in an occupation; or
(b)
for any wrong, injury or illness that a taxpayer or a relative suffers personally.
[gambling and competitions with prizes] s 118-37(1)(c) – A capital gain or capital loss
made from a CGT event relating to gambling, a game or a competition with prizes is
disregarded:
(a)
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However, the exemption will not apply to capital gains or losses where the taxpayer is
considered to be in the business of gambling under the ordinary income provisions;
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(b)
2.110
NB – if your bank/financial institution offers some kind of prize that $5,000 will
actually be assessable.
The following are also exempt/loss denying transactions:
(a)
Expiry of a lease – see s 118-40.
(b)
Later distributions of personal services income – see s 118-65.
(c)
Transactions by exempt entitles – see s 118-70.
Anti-overlap provisions
2.111
[income or exempt income elsewhere] s 118-20(1) – any capital gain made from a
CGT event is reduced if, because of the event, a provision of the Act includes an amount in
the taxpayer’s assessable income or exempt income - (i.e. reduces by the amount already
included by virtue of another provision).
2.112
Thus if an amount is considered ordinary or statutory income under another provision of the
ITAA97 or ITAA36 that amount will not be included for CGT. Therefore, you treat CGT as a
regime of last resort – everything else applies first.
2.113
Examples of the application of anti-overlap rules:
(a)
Superannuation lump sums and employment termination payments – see s 118-22.
(b)
Depreciating assets and s 73BA depreciating assets – see s 118-24.
(c)
Trading stock, film copyright and R&D – these are dealt with elsewhere and will not
be caught – see s 118-25.
Small business relief
2.114
Div 152 outlines the small business relief, which is very useful in terms of saving money
in tax. This is one of two main exceptions (the other being main residence relief). This relief
was introduced with the GST to act as a sweetener for all the extra paper work brought about
as a result of GST.
2.115
There are four CGT concessions specifically for small business which apply to CGT events
happening after 11.45 am EST on 21 September 1999:
(a)
The 15-year asset exemption – see Div 152-B.
(b)
The 50% active asset reduction – see Div 152-C.
(c)
The retirement exemption – see Div 152-D.
(d)
The roll-over exemption – see Div 152-E.
2.116
This relief is predicated on the basis that small businesses don’t put money into
superannuation, but rather, everything into the business – therefore they should have
concessions for their CGT.
2.117
The 3 basic conditions for relief – Div 152-A
(a)
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[the entity] s 152-10(1)(c) – the entity is or does one of the following:
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(b)
the entity must be a small business entity; or
(ii)
a partner in a partnership that is a small business entity; and
(iii)
the net value of assets that the entity and related entities own must not
exceed $6 million.
[the asset] s 152-10(1)(d) – the CGT asset must be an active asset:
(c)
2.118
(i)
(i)
An active asset may be a tangible asset or an intangible asset – e.g. goodwill
in the business.
(ii)
Things that are inherently connected with the business will be active assets.
[share in a trust] s 152-10(2) – if the asset is a share or interest in a trust, there
must be a CGT concession stakeholder just before the CGT event, and the entity
claiming the concession must be a CGT concession stakeholders in the company or
trust, or CGT concession stakeholders in the company or trust must have a small
business participation percentage in the entity of at least 90%.
[15 year asset exemption] s 152-100 – first you must satisfy the basic conditions (see
Div 152-A):
(a)
[continuous ownership] s 152-105(1)(b) and s 152-110(1)(b) – the entity
continuously owned the asset for the 15 year period leading up to the CGT event.
(b)
[individual retires] s 152-105(1)(d) – where the entity is an individual, the
individual retires (and is over 55) or is permanently incapacitated.
(c)
[company or trust] s 152-110(1)(d) and (e) – if the entity is a company or
trust, the entity had a significant individual for a total of at least 15 years during
which the entity owned the asset and the individual who was the significant individual
just before the CGT event retires (and is over 55) or is permanently incapacitated.
(d)
[significant individual] s 152-55 - 152-55 – an individual is a significant
individual in a company or a trust at a time if, at that time, the individual has a *
small business participation percentage in the company or trust of at least 20%.
Example of 15-year small business exemption
•
Jo is 60 years old. He has owned the local newsagency which he purchased in 1986 for
$50,000. Jo decides to retire as he wants to travel the world. In March 2009 Jo sells the
business for $250,000.
•
Assuming Jo meets the three basic conditions to qualify for the small business exemptions, he
will qualify for the 15 year exemption as he is over 55 and has owned the business for more
than 15 years.
•
If a taxpayer does not satisfy this exemption, then you can look at the other exemptions.
•
Effectively, for small businesses, the assets of the business become the owner’s
superannuation
2.119
[50% active asset reduction] s 152-200 – this allows the tax payer to reduce the CGT
by 50% - which can work in conjunction with the 50% discount mentioned above:
(a)
[basic conditions] s 152-205 – the basic conditions in Div 152-A must be
satisfied first.
(b)
The section then allows that:
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(i)
Individuals get benefit of 50% discount;
(ii)
If they hold an asset for more than 12 months.
(c)
[other exemptions] s 152-210 – This exemption may be used in conjunction with
the retirement and roll-over exemptions. However, the 15 year exemption
takes priority see s 152-215.
(d)
Note that this exemption is not actually applied until Step 3.
Example of 50% asset reduction
•
2.120
Lana operates a small manufacturing business and disposes of a CGT asset that she has
owned for three years and has used as an active asset of the business.
o
She makes a capital gain of $17,000 from the CGT event and qualifies for the CGT
discount and for the small business 50% reduction.
o
Lana also has a capital loss in the income year of $3000 from the sale of another
asset.
o
She calculates her net capital gain for the year as follows:
$17,000 – $3000 = $14,000
$14,000 – (50% x $14,000) = $7000
$7,000 – (50% x $7,000) = $3500
o
Her net capital gain for the year is $3500 (assuming the small business retirement
exemption and the small business rollover do not apply).
o
If Lana chooses the rollover or the retirement exemption, some or all of the
remaining capital gain would be disregarded (see below).
[small business retirement exemption] s 152-300 – this applies in the following
circumstances:
(a)
[basic conditions] s 152-305(1) – the basic conditions in Div 152-A must be
satisified.
(b)
[15 year rule has priority] s 152-330 – therefore, the asset the subject of the
CGT event must not have been held for more than 15 years;
(c)
[proceeds used in conjunction with retirement] s 152-300 – the taxpayer
must be retiring and the amount is being used for their retirement.
(d)
[where taxpayer under 55] s 152-305(1)(b) –if the taxpayer is under 55 the
taxpayer must pay the funds into an approved Superannuation Fund.
(e)
[lifetime limit] s 152-320 – there is a lifetime limit of $500,000 – but it is your
net-gain which goes in – therefore, above it will only be the value of the CGT saved,
rather than the full value of the asset.
Example of retirement exemption
•
In December 2008 Harry retires from farming and transfers the farm (which he acquired in
1996) to his son for no consideration:
o the market value of the farm was $1 million so the market value substitution rule
applies to deem the capital proceeds to equal the market value of the farm;
o as the cost base of the farm was $600,000, Harry made a capital gain of $400,000
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Example of retirement exemption
o
o
o
2.121
(assuming the other retirement exemption conditions are satisfied);
harry reduces his capital gain by the 50% CGT discount to $200,000 and then further
by the 50% active asset reduction to $100,000;
notwithstanding that he did not receive any capital proceeds, Harry may choose the
retirement exemption for the full amount of the remaining $100,000 capital gain
(assuming the other retirement exemption conditions are satisfied);
therefore he would still have $400,000 of the lifetime limit left.
[small business asset rollover exemption] s 152-400 – this will kick in where you are
purchasing another business (i.e. sell one and purchase another).
(a)
Rather than ripping the money off you – you may fund the new business with all of
the proceeds of the previous business.
(b)
This defers the CGT to sometime in the future (i.e. where the second business in
sold). Go through all the tests and then roll-over the amount remaining.
(c)
[basic conditions] s 152-410 – you need to satisfy the basic conditions of Div
152-A first.
Example of the asset rollover exemption
•
The original capital gain was $100,000:
o
It has been reduced to $25,000 under the CGT discount and 50% active asset
reduction;
o
If the total of the first and second elements of the cost base of the replacement asset
is $20,000, $20,000 can be disregarded under the roll-over, leaving a final capital
gain of $5000;
o
Therefore when the second asset is sold, the fain will be $30,000 due to the roll-over.
Example of all small business exemptions
Maria Cavella operated a delicatessen for seven years as a sole trader. On 2 May 2009, she
sold the business for $400,000 and made a capital gain of $100,000. Maria had prior year
capital losses totaling $20,000.
• All the conditions of ITAA97 Subdiv 152-A are met, and Cavella chooses the CGT discount
method for determining her capital gain.
$
Capital gain
100,000
Less: prior years' losses
(20,000)
----------80,000
Less: 50% CGT discount
(40,000)
----------40,000
Less: 50% small business concession
(20,000)
-----------Assessable capital gain
$20,000
=======
•
Main residence exemption
2.122
Policy reasons behind exempting main residence: home ownership valued & encouraged,
affect mobility of workforce, cost-base calculations impossible, illusory gains (used usually to
buy another home, which will also have significantly increased in value since the original
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purchase of the home that was just sold). The exemption was originally called the ‘principal
place of residence’ exemption.
2.123
This does not involve ignoring the asset – rather just ignoring any gain or loss.
2.124
There may be a suggestion put to the Henry Review – that high value homes will be taxed,
but more about this as it comes to light.
s 118-105 – Map of the Residence Exemption
2.125
[basic case] s 118-110 – you can ignore a capital gain or capital loss you make from a
CGT event that happens to a dwelling that is your main residence, basically, it is a full
exemption.
(a)
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[primary exceptions] s 118-100 – however, this exemption may not apply in full
if:
|
(i)
it was your main residence during part only of your ownership period; or
(ii)
it was used for the purpose of producing assessable income – i.e. rental.
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105
(b)
2.126
there are special rules for dwellings passed from, or owned by a trustee of, a
deceased estate – these will not be discussed.
[defining a ‘main residence’] s 118-115 - “Dwelling”: unit of residential accommodation
that is a:
(a)
Building;
(b)
Caravan;
(c)
Houseboat; or
(d)
other mobile home,
and any land immediately under the accommodation – s 118-115
2.127
[exemption extends to adjacent land] s 118-120 – the exemption also covers up to 2
hectares of adjacent land to the extent that the taxpayer has used this land primarily for
private or domestic purposes in association with the dwelling.
2.128
Note that - if the land exceeds 2 hectares, the taxpayer can select which two hectares the
main residence exemption applies to – see TD 99/67.
2.129
Rules which extend the exemption – the following rules provide for extensions to the
exemption:
(a)
[practicable to move] s 118-135 – a dwelling may be a main residence from the
time of acquisition to the time when it is first practicable for the taxpayer to move
into the dwelling, e.g.:
(b)
(i)
if you buy a property and tenants are in it;
(ii)
once you kick the tenants out, then you move in – you will still get the
exemption from the time of purchase.
[intended main residence] s 118-140 – a taxpayer who acquires a new dwelling
which is intended to be a main residence, but still holds an existing main residence,
may treat both dwellings as a main residence, for whichever is the shorter of:
(i)
six months;
(ii)
or the overlap period,
(c)
this only applies where – see s 118-140(2) – original main residence must have
been the main residence for at least 3/12 months prior to disposal and was not used
to produce income in any of the 12 months prior to disposal.
(d)
[period of absence] s 118-145 A taxpayer may be entitled to treat a dwelling as
his or her main residence during a period of absence:
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|
(i)
This can apply even if they are earning income out of the residence, but only
applies up to a period of 6 years;
(ii)
If they are not earning income from the property, it can remain their main
residence indefinitely;
Combined notes
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(iii)
(e)
E.g. Kerrie owns a unit, lives for 3 years, moves to Canada and rents it out
(but she was renting in Canada), during the 7 months she was away, that
unit/apartment was her main residence.
[while renovating] s 118-150 – where a taxpayer builds, repairs or renovates a
dwelling, provided no other dwelling is treated as a main residence, a taxpayer may
choose to treat the dwelling as his or her main residence:
(i)
Predicated on the fact that there is no other main residence;
(ii)
Even though not actually living there,
NB – this can only be done for 4 years (inc. if you buy land and build a house), but
must be renting elsewhere.
2.130
(f)
[death of owner] s 118-155 – if the owner of a Main Residence dies while the
work done in accordance with s 118-150 – and this dwelling was considered to be the
deceased main residence, the exemption can apply accordingly.
(g)
[destruction of land] s 118-160 – where a dwelling that is a taxpayer’s main
residence is accidentally destroyed and a CGT event happens in relation to the land,
provided there is no other man residence, the taxpayer may choose to apply the
exemption to the period after destruction until the land is sold, for example:
(i)
House is destroyed by fire;
(ii)
Go to sell the land;
(iii)
This will not give rise to CGT.
Rules which limit the exemption – the following rules limit the exemption:
(a)
[separate event for adjacent CGT event] s 118-165 – the main residence
exemption does not apply to a CGT event that happens in relation to land, or a
garage, storeroom or other structure, to which the exemption can extend if the event
does not also happen in relation to the dwelling.
(b)
[spouse having different main residence] s 118-170 – a taxpayer and his or
her spouse will generally have the same main residence – where they have different
main residences, they have to choose, or they can nominate both, but only get a
partial exemption – e.g. it will be split in proportion between the two.
(c)
[separation roll-overs] s 118-178 – the main residence exemption will be limited
where the dwelling is acquired by a taxpayer under the marriage breakdown roll-over
provisions. In these circumstances the taxpayer’s exemption will be apportioned
according to how the dwelling was used both before and after the roll-over:
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(i)
Husband and wife, divorcing;
(ii)
Wife ends up with the family home;
(iii)
Husband ends up with rental property and kicks tenants out to claim as main
residence;
(iv)
He cannot get the exemption for the whole of the ownership period, only
based on apportionment.
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(d)
[partial exemption] s 118-185 – property being main residence during part only
of the period – you will only get the exemption for the part of the period that it is the
main residence. It is calculated using the following formula:
CG or CL amount x
non-main residence days
Days in your ownership period
Example of the partial exemption
•
Rebecca bought a house in July 1990 and moved in immediately:
o In July 1993 she moved out and began to rent it out;
o She sold it in July 2000, making a capital gain of $10,000. Rebecca chooses to
continue to treat the dwelling as her main residence under s 118-145 (about
absences) for the first six of the seven years during which she rented the house out.
Rebecca will be taken to have made a capital gain of:
$10,000 x 365 = $1000
3650
(e)
[use of dwelling for producing assessable income] s 118 -190 – where
property used to produce assessable income you will only get an exemption in
proportion to how much of the house was used as a main residence.
Example of the assessable income situation
•
Ruth bought her home under a contract that was settled on 1 January 1999:
o She sold it under a contract that was entered into on 1 November 2002 and settled
on 31 December 2002;
o It was her main residence for the entire four years;
o From the time she bought it until 31 December 2001 (3 years), Ruth used part of the
home to operate her photographic business.
o The rooms were modified for that purpose and were no longer suitable for private
and domestic use. They represented 25% of the total floor area of the home.
o When she sold the home, Ruth made a capital gain of $8000. The following
proportion of the gain is taxable.
o Capital gain X % of floor area not used as main residence X % of period of
ownership that that part of the home was not used as main residence = taxable
portion:
$8,000 x 25% x 75% = $1500
Question 4 – Can there be a roll-over?
2.131
2.132
NB – a roll-over, simply defers the tax, i.e. a new asset or a new taxpayer:
(a)
Transfer of assets to a wholly owned company;
(b)
Replacement asset rollovers – e.g. where an asset is destroyed it can move the
capital gain to the new asset and pay it when the new asset is disposed of – done by
adjusting the cost base of the new asset – it is reduced by how much the new gain
is;
(c)
Same asset rollover relief – see the marriage breakdown above – the capital gain
follows the asset and is paid upon disposal; and
(d)
Death.
Some examples of roll-overs:
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3
(a)
transfer of a CGT asset from one spouse to another because of a marriage
breakdown;
(b)
transfer of a CGT asset to a wholly owned company; and
(c)
transfer of an asset between related companies.
Step 2 – work out the amount of the capital gain or loss
Introduction
Step 2 can be broken down into 3 questions
3.1
Question 1 – what is a capital gain or loss? – see s 100-35.
3.2
Question 2 – what factors come into calculating a capital gain or loss? – see s 100-40.
3.3
Question 3 – how to calculate the capital gain or loss from most CGT events? – see s 10045.
Question 1 – what is a capital gain or loss?
3.4
[capital gain] s 100-35 – you make a capital gain if you receive capital amounts from the CGT
event which exceed your total costs associate with that event;
3.5
[capital loss] s 100-35 – a capital loss if your total costs associated with the CGT event
exceed the capital amounts you receive from the event.
Question 2 – what factors come into calculating a capital gain or
loss?
3.6
[calculating a capital gain] s 100-40:
3.7
capital gain = capital proceeds (Div 116) – cost base (Div 110)
3.8
[calculating a capital loss] s 100-40:
3.9
capital loss = reduced cost base (Div 110-B) – capital proceeds (Div 116)
Question 3 – how to calculate the gain or loss for most CGT events?
Introduction
3.10
[calculating capital gains and losses] s 100-45 – capital gains and losses should be
calculated in accordance with the following:
(a)
Calculation 1 – work out your capital proceeds from the CGT event – see Div
116.
(b)
Calculation 2 – work out the cost base for the CGT asset – see Div 110.
(c)
Calculation 3 – subtract the cost base from the capital proceeds.
(d)
Calculation 4 – if the proceeds exceed the cost base, the difference is your
capital gain.
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(e)
Calculation 5 – if not, work out the reduced cost base for the asset – see Div
110-B.
(f)
Calculation 6 – if the reduced cost base exceeds the capital proceeds, the
difference is your capital loss.
(g)
Calculation 7 – if the capital proceeds are less than the cost base, but more than
the reduced cost base, you have neither a capital gain or a capital loss.
Calculation 1 – capital proceeds
3.11
[general rule] s 116-20 – the capital proceeds from a *CGT event are the total of:
(a)
the money you have received, or are entitled to receive, in respect of the event
happening; and
(b)
the market value of any other property you have received, or are entitled to receive,
in respect of the event happening (worked out as at the time of the event).
Note – the legislation provides a useful table for how this works in relation to each CGT
event.
3.12
3.13
[five modifications] s 116-25 – there are 6 modifications to the general rules that may be
relevant to a *CGT event:
(a)
market value substitution rule;
(b)
apportionment rule;
(c)
non-receipt rule;
(d)
repaid rule;
(e)
assumption of liability rule; and
(f)
misappropriation rule
[market value substitution rule] s 116-30 – where there are no capital proceeds of the
CGT event:
(a)
You are taken to receive market value; or
(b)
The capital proceeds from a CGT event are replaced with the market value of the CGT
asset:
(i)
Some or all of those proceeds cannot be valued;
(ii)
those capital proceeds are more or less than the market value of the asset
and:
(A)
the parties to the CGT event are not dealing with each other at arm's
length; or
(B)
the CGT event is C2,
Example of market value substitution rule
•
You give a block of land, with a value of $300,000, to your daughter. The capital proceeds
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Example of market value substitution rule
are deemed to be $300,000.
3.14
[apportionment rule] s 116-40 – if payments are received in connection with a
transaction that relates to more than one CGT event or to a CGT event and something else,
the capital proceeds for the respective CGT events are so much of the payments as are
reasonably attributable to each CGT event.
Example of apportionment rule
•
•
•
•
•
•
3.15
You sell a block of land and a boat for a total of $100,000.
This transaction involves two CGT events.
The $100,000 must be divided among the two events.
The capital proceeds from the disposal of the land are so much of the $100,000 as is
reasonably attributable to it.
The rest relates to the boat.
i.e. ask what can reasonably be attributed to each of the assets.
[non-receipt rule] s 116-45 – this rule applies where:
(a)
the capital proceeds from a CGT event are reduced if it is unlikely that the taxpayer
will receive some or all of those proceeds – i.e. not going to pay tax on something we
didn’t get;
(b)
however, this rule only applies if the non-receipt did not arise because of anything
the taxpayer did or did not do and all reasonable steps were taken to enforce
payment of the unpaid amount;
(c)
NB – this occurs in a different tax year, you must go back and amend your
assessment.
Example of Non-receipt rule
•
•
•
•
•
3.16
You sell a painting to another entity for $5,000 (the capital proceeds).
You agree to accept monthly instalments of $100.
You receive $2,000 but then the other entity stops making payments.
It becomes clear that you are not likely to receive the remaining $3,000.
The capital proceeds are reduced to $2,000.
[repaid rule] s 116-50 – the capital proceeds from a CGT event are reduced by any part of
them that is repaid by the taxpayer and by any compensation paid by the taxpayer that can
reasonably be regarded as a repayment of part of them:
(a)
However, the capital proceeds are not reduced by any part of the payment that is
deductible.
(b)
The payment can include giving property – i.e. where the purchaser later sues the
seller.
Example of the repaid rule
•
•
•
•
You sell a block of land for $50,000 (the capital proceeds).
The purchaser later finds out that you misrepresented a term in the contract.
The purchaser sues you and the court orders you to pay $10,000 in damages to the
purchaser.
The capital proceeds are reduced by $10,000.
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3.17
[assumption of liability rule] s 116-55 – this increases capital proceeds – the capital
proceeds from a CGT event are increased if the entity acquiring the relevant CGT asset
acquires it subject to a liability by way of security over the asset:
(a)
In such a case, the capital proceeds are increased by the amount of the liability that
the acquiring entity assumes.
(b)
e.g. purchaser has taken on an asset with added liability attached.
Example of assumption of liability rule
•
•
•
3.18
Chan sells land for $180,000.
She receives $80,000 in cash and the buyer becomes responsible for a $100,000 liability
under Chan’s outstanding mortgage.
The capital proceeds are increased by $100,000 to $180,000.
[misappropriation rule] s 116-60 – the capital proceeds from a CGT event are reduced if
your employee or agent misappropriates (whether by theft, embezzlement or otherwise) all or
part of those proceeds. However, if you recoup the loss (all or part) the capital proceeds are
increased by the amount received.
Calculation 2 – cost base
3.19
3.20
[definition of cost base] s 110-25(1) – defines “cost base” as consisting of five elements:
(a)
The cost of the asset – see s 110-25(2);
(b)
Incidental costs of acquisition and disposal – see s 110-25(3);
(c)
Non-capital holding costs – see s 110-25(4);
(d)
Enhancement expenditure – see s 110-25(5); and
(e)
Expenditure to establish, preserve or defend title to or rights over the asset – see s
110-25(6).
Element 1 - [acquisition cost] s 110-25(2) – this is the total of:
(a)
the money paid, or required to be paid, in respect of acquiring the CGT asset; and
(b)
the market value of any other property given, or required to be given, in respect of
acquiring the CGT asset.
But – it does not have to be given to the seller.
Example – TD 2003/1
•
•
•
3.21
Bill sells an asset to James for $100,000:
The terms of the sale are that James must pay the $100,000 to an entity nominated by Bill.
Even though James does not pay the money to Bill (the person who disposed of the asset)
James pays it ‘in respect of acquiring’ the asset and he can include it in the first element of
the asset's cost base.
Element 2 - [incidental costs] s 110-25(3) this specifies that any incidental costs
incurred form part of the cost base – there are 9 of incidental costs outlined in s 110-35:
(a)
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(b)
cost of transfer;
(c)
stamp duty;
(d)
cost of advertising or marketing to find a buyer or seller;
(e)
costs for any valuation or apportionment;
(f)
search fees relating to a CGT asset;
(g)
cost of a conveyancing kit;
(h)
borrowing expenses; and
(i)
expenditure incurred by the head company of a consolidated group to an entity that
is not a member of a group and the cost reasonably relates to a CGT asset held by
the head company and is incurred because of a transaction between members of the
group – this does not necessarily relate to the acquisition of an asset or a CGT event.
Example of incidental costs
•
•
•
•
•
3.22
Land is transferred by one company to another company.
The companies are members of a consolidated group.
Stamp duty is payable as a result of the transaction.
The transaction has no taxation consequences because of its intra-group nature.
The stamp duty is included in the cost base and reduced cost base of the land.
Element 3 - [non-capital costs of ownership] s 110-25(4) – the expenses that you
incur, that would be deductible if the asset was earning income (e.g. a rental property):
(a)
However, you can only get a deduction where expenditure was incurred in gaining or
producing assessable income.
(b)
If you can’t get a deduction you can include it as non-capital costs of ownership,
including:
(c)
3.23
(i)
Rates;
(ii)
Interests on a mortgage;
(iii)
Land taxes; and
(iv)
Repairs and maintenance.
Basically, if it was an income producing asset, you’d get a deduction on it, but if
you’re not earning income on it, you can include the costs here as part of your cost
base.
Element 4 - [enhancement costs] s 110-25(5) – this is capital expenditure incurred:
(a)
With the expected effect being to increase the value of the CGT asset; or
(b)
That relates to installing or moving the asset; and
(c)
Can include giving property.
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However, the expenditure must be reflected in the state or nature of the asset at the time of
the CGT event. The cost of non-deductible initial repairs incurred after the acquisition of an
asset may be included in the fourth element of the cost base of an asset – see TD 98/19.
3.24
Element 5 - [title costs] s 110-25(6) – Capital expenditure incurred to establish, preserve
or defend the taxpayer’s title to the asset will form part of the cost base – see e.g. litigation
costs to defend ownership.
3.25
[not part of the cost base] s 110-37 – the following do not form part of the cost base
(essentially there is no double dipping):
(a)
expenditure that does not form part of the second or third element of the cost base
to the extent that you have deducted or can deduct it;
(b)
expenditure that does not form part of any element of the cost base to the extent
that it has been recouped unless the amount is included in assessable income;
(c)
expenditure that is prevented from being a deduction under s 26-54 (certain
offences) or s 26-5 (penalties) – see ss 110-38(1) and 110-38(4);
(d)
expenditure to the extent that it is a bribe to a public official – see s 110-38(2); and
(e)
expenditure to the extent that it is in respect of providing entertainment – see s 11038(3),
there’s a great provision in Div 26 which talks about bribes to public officials not being
deductible and says, to foreign countries (e.g. Greece) it is deductible, because it is normal in
certain jurisdictions to pay this money.
3.26
3.27
[cost base modification rules] Div 112-A – the following modify this calculation:
(a)
The market value substitution rule – see above for contract proceeds – see s 112-20
– i.e. where you did not incur expenditure to acquire the asset, your cost base will
include the market value of the asset;
(b)
Split, changed or merged assets – e.g. subdivision, apportion in a reasonable way
each element to each new asset – see s 112-25;
(c)
Apportionment of expenditure – see s 112-30; and
(d)
assumption of liability rule – see s 112-35 – cost base includes the amount of
liability you assume upon acquisition of an asset with attached liability.
[indexation of cost base] s 114-1 – prior to 1999 certain elements could be indexed, in
the cost base (not element 3):
(a)
You worked out when the expenditure was incurred, and when it was sold and
worked out the indexation factor, to increase your cost base.
(b)
It is still around, for assets acquired pre 21 Sep 1999, but it is frozen as at the Sep
Quarter 1999.
(c)
At that date, the 50% discount was introduced, as such, you can do an either or, but
you can’t combine them.
(d)
It is usually better to use the discount. Apply indexation as follows:
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(i)
in working out the *cost base of a *CGT asset, index expenditure in each
element;
(ii)
s 960-270(1) – expenditure of element x indexation factor = indexed
element;
(iii)
indexation factor = index number for CGT event quarter (or 30 Sept 1999,
whichever is earlier) / index number for quarter when expenditure was
incurred, calculated to 3 decimal places – see s 960-275;
(iv)
no indexation if factor is 1 or less – see s 960-270(2);
(v)
cannot however index the third element – see s 960-275(4); and
(vi)
index in accordance with s 960-275.
Example of indexation of cost base
•
•
•
•
•
•
Peter purchases a building as an investment on 1 January 1994 for $250,000. This amount
forms the first element of his cost base.
He sold the building on 1 February 1996.
The index number for the quarter in which he sold the building (the March quarter 1996) is
119.0.
The index number for the quarter in which he purchased the building (the March quarter
1994) is 110.4.
Applying section 960-275, work out the indexation factor:
119.0 = 1.078 x $250,000 = 269,500
110.4
So $500 CG for index, $10,000 for 50% reduction.
Calculation 5 – reduced cost base
3.28
The main difference between a cost base and a reduced cost base is that element 3 – noncapital costs of ownership is missing.
3.29
The reduced cost base of a CGT asset is often relevant in finding out if a capital loss has
been made from a CGT event which happens in relation to that asset.
3.30
All of the elements of the reduced cost base of a CGT asset are the same as those for the
cost base, except the third one.
3.31
The third element is instead any amount that is assessable because of a balancing
adjustment for the asset, or would be assessable if certain balancing adjustment relief
was not available.
3.32
Note – you can never index a reduced cost base.
4
Step 3 – work out your net capital gain or loss for the year
Introduction
Step 3 can be broken down into 2 questions
4.1
Question 1 – How do you work out your net capital gain or loss? – see s 100-50.
4.2
Question 2 – How do you comply with CGT? – see s 100-55.
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Question 1 – How do you work out your net capital gain or loss?
Introduction
4.3
This step reconciles gains/losses made from individual events. You must look at them
separately first, otherwise it would be a nightmare and then, when you get to this step, you
combine them.
4.4
[calculating net capital gains] s 100-50 and s 102-5:
(a)
Calculation 1 – reduce the capital gains for the income year, in the order you
choose, by your capital losses for the income year from your assessable income.
(b)
Calculation 2 – reduce any remaining capital gains, in the order you choose, by any
unapplied net capital losses for previous income years.
(c)
Calculation 3 – reduce any remaining discount capital gains by the direct
percentage – i.e. the 50% rule – see Div 115.
(d)
Calculation 4 – if you carry on a small business, apply the small business
concessions in further reduction of your capital gains (whether or not the gains are
discount capital gains) – see Div 152.
(e)
Calculation 5 – add up your capital gains – see Div 102:
(i)
any remaining capital gains that are not discount capital gains; and
(ii)
any remaining discount capital gains – see s 100-50.
Calculation 1 – gains and losses for the income year
4.5
[application of losses against gains] s 102-5(1) – able to apply losses against gains in
the order which maximises gains:
(a)
First, against capital gains that do not attract either the CGT discount or indexation;
(b)
Second, against capital gains that attract indexation; and
(c)
Third, against capital gains that attract the CGT discount.
Example of calculation 1
•
•
•
•
Assume a taxpayer has made a capital gain of $1,000 and the CGT discount is available to
reduce that capital gain to $500:
Further assume that the taxpayer has a capital loss of $750 in the same year;
The taxpayer cannot reduce the gain to $500 by using the 50% exemption method and then
applying $500 worth of the capital loss to reduce the gain to zero (with a $250 loss to carry
forward).
The loss must be applied to the capital gain before the CGT discount. Hence, the capital gain
is reduced to $250, and the 50% discount is then applied, leaving $125 as the net capital
gain for the year.
Calculation 2 – use previous years capital losses
4.6
[apply previous years losses] s 102-5(1) – if there is still a positive figure, you need to
apply capital losses brought forward from earlier years to reduce the capital gains.
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Example of calculation 2
•
•
•
•
•
You have capital gains for the income year of $1,000, and capital losses for the income year
of $600:
You capital losses are subtracted from your capital gains to leave a balance of $400.
You have available net capital losses of $300 (for last year) and $200 (for the year before
that);
The $400 is reduced to zero by applying the available net capital losses in the order in which
you made them;
This leaves $100 of the $300 to be carried forward and extinguishes the $200.
Calculation 3 – discount percentage
4.7
[conditions for the discount percentage] Div 115 – the following basic rules apply
under to the discount percentage:
(a)
[does not apply to companies] s 115-10 – the general discount does not apply
to companies (there are also proposals to exclude some trusts).
(b)
[21 September 1999] s 115-15 – the general discount only applies to CGT events
after 21 September 1999.
(c)
Assets acquired before 21 September 1999 may be indexed or the discount may be
applied but not both. However, indexation ceased at the end of the September
Quarter 1999.
(d)
[quantum of discount] s 115-25 – the following discounts apply:
(i)
superannuation trusts and life insurance get a 1/3 discount;
(ii)
individuals and trusts get a 50% discount.
(e)
[ownership period] s 115-25 – the asset must be held for at least 12 months to
be eligible for the discount.
(f)
The 50% discount does not apply to CGT events:
(i)
D1, D2, D3;
(ii)
E9;
(iii)
F1, F2, F5;
(iv)
H2;
(v)
J2, J3; and
(vi)
K1,
These are specifically stated in the legislation – but from a practical point of view,
they cannot apply.
Example of calculation 3
•
•
Holly acquired shares in a listed public company in 1994 for $20 each and sold the shares in
May 2004 for $38 each.
At the date of sale, the indexed cost base would be $22, based on indexation frozen at 30
September 1999.
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Example of calculation 3
•
•
•
•
Holly can choose to calculate the capital gain for each share in either of the following ways:
o the excess of disposal proceeds ($38) over indexed cost base ($22), giving a capital
gain of $16, or
o half of the realised nominal gain, being the excess of the capital proceeds ($38) over
the cost base without any indexation ($20), the nominal gain being $18 and half of
that gain being $9.
Given this outcome, Holly can choose to claim the CGT discount.
If Holly had capital losses (or net capital losses), indexation could produce a better result, e.g.
if Holly had capital losses of $16, then indexation would give a net capital gain of nil while
applying the discount would give a net capital gain of $1.
Therefore, it would be better to use the indexation approach.
Calculation 4 – small business concessions
4.8
These are outlined above – see Div 152, but recall:
(a)
The 15-year asset exemption;
(b)
The 50% active asset reduction;
(c)
The retirement exemption; and
(d)
The small business asset roll-over.
Calculation 5 – determining the capital gains
4.9
[determine capital gains] s 102-5(1) – your assessable income includes your net capital
gain (if any) for the income year.
3 step process for net capital losses – see s 102-10
4.10
Calculation 1 – add up the capital losses you made during the income year – also add up
the capital gains you made.
4.11
Calculation 2 – subtract your capital gains from your capital losses.
4.12
Calculation 3 – if the calculation 2 amount is more than zero, this is your net capital loss
for the income year – and it can be carried forward to the next year.
Question 2 – How do you comply with CGT?
4.13
[compliance] s 100-55 – the following must be done:
(a)
Declare any net capital gain as assessable income in your income tax return; and
(b)
Defer any net capital loss to the next income year for which you have capital gains
that exceed the capital losses for the income year.
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Topic 5
Deductions
1
Introduction
General principles
1.1
1.2
1.3
Deductions are the counter of ordinary income and statutory income. There are two main
types of deductions:
(a)
Ordinary deductions; and
(b)
General deductions
Deductions are dealt with in Div 8:
(a)
s 8-1 – general deduction provision;
(b)
s 8-5 – specific deduction provision – i.e. the actual deductions are found
elsewhere, but s 8-5 brings them within deductions.
Deductions used to be called allowable deductions – now, they are just referred to as
deductions or not deductions.
Key points
1.4
Expenses incurred by taxpayers in earning assessable income may be deducted against that
income to reduce the taxpayer’s final tax liability – NB claiming deductions we are not entitled
to is fraud.
1.5
Expenses may be immediately deductible under the general deduction provision in s8-1 of
ITAA 1997 or under a specific deduction provision. Expenses that are not immediately
deductible may be deducted over a number of years in certain circumstances.
1.6
Taxpayers are required to maintain adequate records when claiming a deduction for an
expense – i.e. you need to maintain your receipts etc so as to prove your deductions
(substantiation requirements).
1.7
[general deductions] s 8-1 – Expenses must be incurred by the taxpayer in earning
assessable income or necessarily incurred in carrying on a business to earn assessable
income to be deductible under s 8-1 of ITAA 1997.
1.8
[negative limbs] s 8-1 – An expense that is capital or capital in nature, private or
domestic, incurred in earning exempt or non-assessable non-exempt income or specifically
denied by another provision in the income tax legislation cannot be deducted under s 8-1 of
ITAA 1997.
1.9
[reasonable apportionment] s 8-1 – Taxpayers may claim a deduction for a part of an
expense where only a part of the expense satisfies the requirements of s 8-1 of ITAA 1997,
e.g. an expense partly incurred to earn assessable income and partly incurred for private
purposes.
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The nature of deductions
1.10
A loss or outgoing that you can deduct under s8-1 is called a general deduction;
1.11
An amount that you can deduct under another provision of the ITAA97 is called a specific
deduction: s8-5 considers these (e.g. depreciation).
Deductions = (general deductions + specific deductions) – exclusions (see Div 36).
1.12
[both general and specific] s 8-10 – deductions can be both general and specific, in these
cases:
(a)
General rule – usually the specific deduction provision will apply by the deduction
should apply based on whatever is the most appropriate.
(b)
In some situations specific provisions might limit the claimable amount in which case,
you would go to the general provision to get a bigger deduction.
(c)
E.g. professional memberships/subscriptions max amount is $42.00 specifically,
unless you can demonstrate the outgoing was incurred in gaining/producing income
then you can claim the full amount under the general provision.
Substantiation: Div 900
1.13
[substantiation] s 900-10 – deduction must be substantiated – provides that, in
order to deduct certain types of losses or outgoings, the taxpayer must substantiate them in
accordance with the relevant provisions, namely:
(a)
work expenses must be substantiated in accordance with Subdiv 900-B;
(b)
car expenses must be substantiated in accordance with Subdiv 900-C; and
(c)
business travel expenses must be substantiated in accordance with Subdiv 900-D.
1.14
Sometimes it is simple enough to keep a travel diary and you do not claim excessive amounts
(and it is a genuine business trip) – however, other expenses you will probably need a receipt
(name of supplier, amount, date, what you’re getting etc).
1.15
If things are under $10, they can be diarised – so there is no need to have proper
substantiation.
2
General deductions
Introduction
Limbs
2.1
2.2
General deductions have:
(a)
2 positive limbs; and
(b)
4 negative limbs.
In order to be a general deduction you must:
(a)
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(b)
2.3
2.4
2.5
If you satisfy any of the negative limbs – your deduction is excluded.
[positive limbs] s 8-1 – You can deduct from your assessable income any loss or outgoing
to the extent that:
(a)
(positive limb 1) it is incurred in gaining or producing your assessable income; or
(b)
(positive limb 2) it is necessarily incurred in carrying on a *business for the
purpose of gaining or producing your assessable income.
[negative limbs] s 8-1 – However, you cannot deduct a loss or outgoing under this section
to the extent that:
(a)
(negative limb 1) it is a loss or outgoing of capital, or of a capital nature; or
(b)
(negative limb 2) it is a loss or outgoing of a private or domestic nature; or
(c)
(negative limb 3) it is incurred in relation to gaining or producing your *exempt
income; or
(d)
(negative limb 4) a provision of this Act prevents you from deducting it.
You only need to satisfy 1 positive limb for the expense to be deductible, but if 1 negative
limb is satisfied, it will be clawed back out.
Positive limbs
Introduction
2.6
(positive limb 1) To be deductible under the first limb, a loss or outgoing must be
relevant and incidental to gaining or producing assessable income (applicable to all taxpayers
– this includes employees).
2.7
(positive limb 2) To be deductible under the second limb, a loss or outgoing must be
part of the cost of trading operations to produce income:
2.8
(a)
applies only to taxpayers who are carrying on a business – it is much narrower;
(b)
apply the income provisions for what constitutes a business, there is an argument
that this limb may be broader, but Kerrie thinks the first limb will usually do the job.
See Ronpibon Tin – both limbs cover similar ground. The argument is though that the 2nd
limb extends the possibility of deductions for businesses.
Common elements
2.9
The following elements are common to both positive limbs:
(a)
Loss or outgoing:
(b)
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(i)
doesn’t need to actually be positive expenditure;
(ii)
see Charles Moore – employee robbed with days takings, it was held to be a
deduction (despite not being an outgoing);
Must be incurred – this is an accounting concept see TR 97/7 (see further below) –
i.e. subjected itself completely to the liability;
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(c)
Gaining or producing your assessable income;
(d)
Apportionment; and
(e)
Sufficient connection between losses and outgoings.
Gaining or producing your assessable income
2.10
You are not allowed a deduction for expenditure incurred in producing another taxpayer’s
assessable income. See FCT v Munro:
FCT v Munro
Facts
•
TP borrowed money from the bank to buy shares for family members and make an interest
free loan to a Co.
•
The taxpayer attempted to claim a deduction for the interest paid to the bank.
Held - HCA
•
Interest is not deductible because it was not wholly and exclusively under which laid out
or expended for the production of assessable income.
•
Now, however, the test is not wholly and exclusively but rather, to the extent that
therefore, the TP would be able to get a deduction for the interest referable to funds used to
buy the TP’s own shares.
•
The other interest payments would not be deductible as they were not incurred in deriving TP
income, but rather the income of family members.
Nexus test
2.11
The loss or outgoing must have some link with the production of assessable income or the
carrying on of a business.
2.12
Cases indicate that this requires the loss or outgoing to be:
2.13
(a)
Incidental and relevant – to the taxpayer’s income producing/business activities;
and
(b)
Have the essential character of an income producing/business expense.
The courts talk about expenditure incurred in gaining/producing assessable income
and not income that puts you in a position to produce assessable income – e.g. an alarm
clock merely puts you in a position to be able to go to work.
W Nevill & Co Ltd v FCT (1937)
Facts
•
TP was Co who employed 2 MD’s and this simply wasn’t working – decided to terminate one
director and did so with a compensation payment.
•
FCT tried to argue it wasn’t a deduction b/c it was not incurred in deriving assessable income.
•
TP argued that it was deductible as it was saving on future salary costs and it would improve
the efficiency of the business which in turn would increase assessable income.
Held – HCA
•
Court found for the taxpayer, agreeing that it did satisfy the positive limbs – ‘no expense
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W Nevill & Co Ltd v FCT (1937)
increases a taxpayers assessable income, but an expense which improves business efficiency
and operation is incurred in deriving assessable income’
•
expense which reduces TP’s future expenditure is derived in incurring assessable income’.
2.14
See also Lunney v FCT – travel to and from work is not deductible, essential character was
not an income producing expense.
Necessarily incurred in carrying on a business
2.15
The word “necessarily” is not given its strict dictionary meaning of unavoidable, inevitable or
compulsory.
2.16
“probably it is intended to mean no more than clearly appropriate or adapted for” – scope of
second limb broadened – see Ronpibon Tin.
2.17
Questions to ask are:
2.18
(a)
Is there a commercial connection between the expenditure and the business?
(b)
What are the economic results achieved?
See W Nevill & Co Ltd above.
FCT v Snowden and Willson Pty Ltd
Facts
•
TP carried on a business which included speculative house-building.
•
Attacks on the Co in parliament and accusations of dishonesty led to a Royal Commission.
•
The Co incurred considerable legal costs for representation before the Commission.
Held – HCA
•
Company was entitled to deductions in respect of these expenses under the second positive
limb of s 51(1), now s 8-1.
•
It depended upon the exercise of reasonable commercial judgement.
Involuntary Expenses
2.19
Charles Moore v FCT (1956) – Court – involuntary, unforseen etc losses may still be taken to
be incurred in earning assessable income – it was in the course of carrying on a business,
which included banking the daily earnings.
Connection with income earning activities
2.20
The expense does not need to actually produce any assessable income. It is enough if there
is a connection between the expenditure and the possibility of assessable income.
2.21
The assessable income may never eventuate or may be in the past or future – see FCT v
DP Smith – expenses in relation to insurance policies are deductible, where the policy is
actually being drawn from – even if the expenses were not in the same year as the income
being earned from the policy.
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Temporal connection
2.22
The question here is at what time does the expense need to be incurred in the context
of the earning of the income?
2.23
Expense incurred in earning income in future years may be deductible – see Steele v
DFCT:
Steele v FCT
Facts
•
TP purchased property for use in a business investment.
•
TP still had interest and claimed those as deductions.
•
They were claimed on the basis that the expenses were incurred to derive future assessable
income.
•
FCT sought to deny the deduction on the basis that the expenses were incurred prior to the
derivation of assessable income.
Held
•
2.24
TP was entitled to a deduction as there was a sufficient nexus or connection between the
expenses and the intended derivation of income.
Expenses incurred in setting up a business are considered preliminary and therefore not
deductible – see Softwood Pulp and Paper Ltd:
Softwood Pulp and Paper Ltd
Facts
•
New paper production industry in SA.
•
Feasibility studies were undertaken and it was found to not be viable, so the project was
cancelled.
•
Co had other income and attempted to claim a deduction.
Held
•
Court rejected the claim for the deduction.
•
The evidence was that the project never proceeded past a preliminary stage.
•
A good example of where expenditure was incurred but business is not established.
•
If the business had actually been established then a deduction might be available.
•
NB – cost of incorporation is not allowed under general provisions – i.e. black hole
expenditure but now under specific provisions it can be written off over 5 years (see
below) – s 40-880.
2.25
2.26
Expenses incurred in establishing a new component of a taxpayer’s business are also not
usually deductible – see Griffin Coal Mining Co Ltd v FCT.
Past Income – once again can be deductible – see Placer Pacific Management Pty Ltd v
FCT:
Placer Pacific Management Pty Ltd v FCT
Facts
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Placer Pacific Management Pty Ltd v FCT
•
The taxpayer incurred expenses in satisfying obligations arising out of its previous business of
manufacturing conveyor belts.
•
FCT said the connection b/w the expense and earning income had been broken, they related
to past activities.
Held
•
The Court allowed the taxpayer a deduction for the expenses on the basis that they arose out
of or were caused by the taxpayer’s past activities manufacturing conveyor belts from which it
earned assessable income.
•
the fact that that business had since ceased was therefore irrelevant.
•
the court was looking for a causal connection – was the expense caused by the TP’s prior
income earning activities?
Characterising losses and outgoings
2.27
This focuses on anti-avoidance where a taxpayer creates a deduction – e.g. A pays a
friend B twice as much as what an employee would be paid to do job X.
2.28
The court can take either of 2 approaches in this situation:
(a)
Legal rights approach – court will look at the objective circumstances of the
outgoing, the full amount would be deductible.
(b)
Purposive approach – the court will examine the taxpayer’s subjective purpose for
incurring the expenditure.
2.29
Courts have tended to adopt both depending on the type of expenditure and the outcome –
where reasonably commercially realistic (i.e. if it is realistic, they’ll allow the deduction).
2.30
Generally the court will go to the purposive approach when income is derived where the
outgoing is greater than the income or produces no income or when the connection between
expenditure and income activities is not clear – e.g. manufacturing plan $10k in gardening
a connection – minor expenditure – reasonable but $10k is excessive.
2.31
See Magna Alloys – whether a legal expense incurred in defending criminal charges for
inappropriate business practice was deductible, the principle still remains:
(a)
The outgoing must be reasonably seen as desirable or appropriate to pursue the
business ends (determined objectively);
(b)
If so, whether the person carrying on the business so saw it (subjective).
Fletcher v FCT
Facts
•
Extent to which interest payable by a partnership under a complex negatively geared annuity
scheme was deductible
•
Partnership had borrowed $2m for up to 15 years to purchase an annuity
•
Interest expense was to exceed the income produced for the first five years (i.e. resulting in
losses for the partnership)
•
Income was to exceed interest expense in the last five years (but could opt out before this
point)
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Fletcher v FCT
Held – HCA
•
Deductibility depended upon whether the arrangement was structured, and expected to
be terminated before substantial amounts of assessable income began to be derived in
the latter part of the scheme
•
AAT: scheme was not intended to run its full course
•
The taxpayer's subjective purpose in incurring a loss or outgoing is normally irrelevant in
the case of a voluntary loss or outgoing, particularly where the outgoing gives rise to the
receipt of a larger amount of assessable income.
•
However, the taxpayer's and the taxpayer's advisers' intentions may be relevant, and in
some cases the decisive factor, if no income is produced or the relevant assessable
income is less than the amount of the outgoing
•
Put into ruling: TR 95/33 income tax: subsection 51(1) — relevance of subjective
purpose, motive or intention in determining the deductibility of losses and outgoings:
o
If, after weighing all the circumstances, including the direct and indirect
objectives and advantages, in a commonsense and practical manner, it can be
concluded that the expenditure is genuinely, and not colourably, used in an
assessable income-producing activity, a deduction is allowable for the loss or
outgoing.
o
However, if it is concluded that the disproportion between the outgoing and the
relevant assessable income is essentially to be explained by reference to the
independent pursuit of some other objective (eg to derive exempt income or the
obtaining of a tax deduction), then the outgoing must be apportioned between
the pursuit of assessable income and the other objective.
Grossly excessive expenditure (TR 2006/3)
2.32
Generally we leave it up to parties to be free to enter into contracts. The FCT has no right to
intervene in a private arrangement.
2.33
However, there are circumstances where he will (e.g. when the parties are not at arms
length; or for beneficiaries of a family trust where trust increases expenses for the Co to
claim a deduction for grossly excessive fees).
2.34
These will not be allowed unless there is a commercial explanation (objective) – see TR
2006/2:
(a)
Ordinarily, expenditure incurred in obtaining the supply of goods or services from
another party under a contract will be characterised by reference to the contractual
benefits passing to the taxpayer under the contract and the relationship that those
benefits have to the taxpayer's income earning activities or business.
(b)
This means that where the benefits conferred by a service arrangement provide an
objective commercial explanation for the whole of the expenditure made under the
service arrangement, then the service arrangement alone will suffice to characterise
the expenditure as expenditure that satisfies the positive limbs of section 8-1 of the
ITAA 1997.
(c)
Where, however, the benefits passing to the taxpayer under a service arrangement
do not provide an objective commercial explanation for the whole of the expenditure
then the service arrangement alone will not suffice, without more, to characterise the
expenditure. In that case a broader examination of all of the circumstances
surrounding the expenditure will be required to determine what the expenditure was
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for ('a broader examination'). Depending on the circumstances of the particular case,
this may include an examination of the relationship between the taxpayer and the
service entity, the manner in which the taxpayer and the service entity have dealt
with each other and the taxpayer's subjective purpose, motive or intention in
incurring the expenditure.
2.35
If it is grossly excessive presume that the expenditure was not wholly payable for the
purposes of the taxpayer’s income producing activities or business – note that Part IVA
ITAA36 may apply to certain service entity arrangements.
Negative limbs
Introduction
2.36
2.37
[negative limbs] s 8-1 – You cannot deduct a loss or outgoing under this section to the
extent that:
(a)
(negative limb 1) it is a loss or outgoing of capital, or of a capital nature; or
(b)
(negative limb 2) it is a loss or outgoing of a private or domestic nature; or
(c)
(negative limb 3) it is incurred in relation to gaining or producing your *exempt
income; or
(d)
(negative limb 4) a provision of this Act prevents you from deducting it.
The most difficult is working out whether you have capital expenditure or revenue
expenditure? – see Sun Newspapers & Associated Newspapers v FCT (1938)
Loss or outgoing of capital, or capital in nature
2.38
2.39
2.40
First – there is a distinction between revenue and capital expenditure:
(a)
Buying a factory – the basic cost is not deductible (this will form part of the factory’s
cost bases) – therefore, not deductible because of this first limb.
(b)
Recall – fruit and tree, this was a cost to acquire the tree.
(c)
The problem is when an established business and amounts of expenditure fall within
a grey area.
There are two UK tests which are used to distinguish between capital and revenue outgoings:
(a)
The once and for all test – see Vallambrosa Rubber Co Ltd v Farmer – capital
expenditure is spent once nad for all, income is recurring.
(b)
The enduring benefit test – see British Insulated & Helsby Cables v Atherton –
pension fund brought into existence an asset of enduring benefit – this was a capital
outgoing – TP put money into super fund for staff – also capital.
For the Australian position – see Sun Newspapers & Associated Newspapers v FCT:
Sun Newspapers & Associated Newspapers v FCT
Facts
•
Paid a rival not to publish newspapers;
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Sun Newspapers & Associated Newspapers v FCT
•
TP claimed deduction for payment – saying it would increase its business or goodwill – it was
a monopoly price paid for a capital asset;
Held – HCA
•
Here, the court agreed with the FCT – expense was not deductible;
•
The payment strengthened or confirmed the company’s business structure;
•
The guidelines for distinguishing between capital and revenue outgoings were laid down in
the Sun Newspapers case;
•
There it was pointed out that expenditure in establishing replacing and enlarging the profityielding (ie business) structure itself is capital and is to be contrasted with working or
operating expenses;
•
Dixon J laid down a test in the Sun Newspapers case involved three elements, although none
is in itself decisive:
2.41
o
the nature of the advantage sought (lasting qualities may play a part – i.e. lasting v
temporary benefit);
o
the way it is to be used or enjoyed (recurrence may play a part); and
o
the means adopted to get it (periodic payment or final/only payment).
The problem is the application of Dixon J’s tests is not conclusive and they can be relied upon
to argue completely the opposite things, see Hallstroms v FCT:
Hallstroms v FCT
Facts
•
A manufacturer of fridges incurred legal expenses in opposing the extension of a patent.
Held – HCA
•
Here, the majority of the HCA found the expenses were deductible as they were incidental to
the derivation of income as they were incurred to protect the taxpayers existing rights;
•
They weren’t acquiring a new right, rather they were protecting an existing right;
•
NB – Dixon J was in dissent:
o
The differences between capital and revenue corresponds to the differences between
the acquisition of the means of production and the use of them
o
Noted the fact that the outgoings were of a large sum and that the chief objective of
the outgoings was to strengthen and preserve the taxpayer’s existing business
organization and to acquire an asset
Broken Hill Theatres v FCT
Facts
•
The taxpayer operated a number of movie theatres.
•
Incurred legal costs in order to successfully oppose a new exhibitor obtaining a licence to
operate a movie theatre.
•
TP argued unsuccessfully that annual expense didn’t provide a lasting benefit therefore
was revenue expenditure.
Held -
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Broken Hill Theatres v FCT
•
The court didn’t agree – saying the application costs to keep a competitor out were capital,
because the advantage sought was to be free from competition.
•
This was so, even though it was only for 12 months, because:
•
o
expense made once and for all;
o
lasting benefit to the business; and
o
reduced competition with the taxpayer’s business.
Advantage being sought was to be free from competition, even though it only lasted 12
months it was an enduring benefit.
BP Australia v FCT
Facts
•
BP entered into an exclusive trade-tie agreement to supply petrol.
•
Retailers contracted to exclusively sell fuel (in lump sum payments.
Held – HCA
•
The amount was capital.
Held – PC
•
Costs were deductible on revenue amount:
o
Considered 3 factors in Sun Newspapers and found that the 3rd factor was irrelevant.
o
1st factor – nature of the advantage sought expenses were designed to increase
sales.
o
2nd factor – manner in which it is used it was revenue because the benefit was to
be used to sell petrol and therefore became part of the ordinary process of selling
petrol.
Private or domestic in nature
2.42
Expenditure of a private or domestic nature on, for example, food and drink, other living
expenses, normal travel from home to work and back, householder's insurance and motor
vehicle insurance (except to the extent that the vehicle is used for income-producing
purposes), is non-deductible – it merely puts you in a position to be able to work and earn
assessable income:
(a)
See Lodge v FCT – child care expenses are private in nature and are merely used to
put you in a position to work it is no different to the alarm clock example.
(b)
See Janmour Nominees Pty Ltd – only there as a matter of caution – whether it can
come under the positive limbs is irrelevant because it is expressly excluded under the
second limb.
FCT v Cooper
Facts
•
Rugby player, was told he needed to bulk up for the next season and was told he needed to
eat red meet and drink more beer.
Held
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FCT v Cooper
•
The court agreed with the FCT that these expenses simply put the taxpayer in a position to
be able to work.
•
They weren’t incurred in carrying out the activities – in fact, they didn’t satisfy the first
positive limb and even if they did, they were private or domestic in nature.
Incurred in relation to gaining or producing exempt income
2.43
You cannot deduct a loss or outgoing to the extent that it is incurred in relation to gaining or
producing your *exempt income (or non-assessable non-exempt income) – this is a matching
principle.
Where another provision in the ITAA prevents the TP from a deduction
2.44
The main exclusions that would fall under this limb are:
(a)
Fines and penalties – see s 26-5:
(b)
(i)
Penalties or fines imposed as a result of breaches of the law are specifically
excluded from deductions.
(ii)
Even in the absence of this special rule, the courts have consistently held that
penalties and fines are not deductible, either on public policy grounds or
because their verty nature severs them from expenses of trading – see
Herald and Weekly Times v FCT.
Provisions for accumulated employee leave (i.e. don’t get a deduction until paid)
– see s 26-10:
(i)
Employers are not entitled to claim deductions for provisions in their accounts
to cover employees’ entitlements to annual leave, long service leave or other
kinds of leave.
(ii)
An employer can claim a deduction for leave payments in the year in which
payment is made to the employee, or, if the employee is deceased, to a
dependent or personal representative – see s 26-10(1).
(iii)
E.g. if someone doesn’t taken holidays for 3 years – employer will get a
deduction for 12 weeks in 3 years.
(iv)
[accrued leave transfer payments] s 25-10(2) – where an employee
goes to a new employer, the old employer would pay the new employer an
accrued leave transfer payment and a deduction would then be available.
(c)
Relative’s travel expenses – see s 26-30;
(d)
Payments of wages to associates (i.e. not reasonable to employ spouse for
$250,000 a year as a secretary) – see s 26-35:
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(i)
Where a partnership makes a payment or incurs a liability – e.g. salary or
interest, to a person who is associated with a partner – i.e. related entity, and
that payment or liability that otherwise qualifies as a deduction to the
partnership is unreasonable in amount, the FCT may reduce the deduction to
the partnership.
(ii)
Not denied entirely, but limited to a reasonable amount.
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130
(iii)
Reasonableness is based on a commercial standard.
(iv)
The amount that is disallowed is neither assessable income nor exempt
income of the related entity – see s 26-35(4) – i.e. an amount paid to a
spouse but disallowed is not assessable income of the spouse.
(v)
The FCT can amend an assessment at any time in order to give effect to s
26-35(4) – time limits for amending assessments in s 170 do not apply.
(e)
Family maintenance payments – see s 26-40;
(f)
Recreational and leisure facilities (no deduction for memberships of golf clubs
etc) – see ss 26-45 and 26-50:
(i)
(ii)
(g)
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Fees paid to social and sporting clubs – are generally not deducitble
regardless of the business use made of the club by the member:
(A)
[definition] s 26-45 – meaning of a recreational club is a Co
established or carried on mainly to provide drinking, dining,
recreation or entertainment facilities for the use or benefit of its
member s- e.g. tennis clubs, golf clubs, the Qld club etc.
(B)
[deduction for FBT] s 26-45(3) – this section does not prevent a
deduction if the outgoings are incurred by the employer in providing
a fringe benefit to an employee – i.e. part of their salary package.
Expenditure relating to leisure facilities and boats – are generally not
deductible unless used for specified business purposes:
(A)
This includes tennis courts, bowling greens, holiday houses,
swimming pools and ski lodges.
(B)
[provision for employees] s 26-50(3) – where the leisure facility
is provided mainly for the taxpayer’s employees – e.g. a staff
swimming pool, or for the care of its employee’s children – e.g. a
playground.
Bribes to officials (you cannot deduct bribes to Australian officials) – see ss26-52
and 26-53:
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(i)
No deduction is available for bribes paid to public officials — in addition, such
bribes do not form part of the cost base of any relevant asset for CGT
purposes – see ss26-52 and 26-53.
(ii)
A “bribe” is an amount incurred in providing a benefit (i.e. any advantage)
that is not legitimately due to another person, where the amount is incurred
with the intention of influencing the public official in the exercise of the
official's duties in order to obtain or retain business or a business advantage.
(iii)
Applies to domestic and international bribes
(iv)
In the case of overseas bribes – not a bribe if the provision of the benefit
does not contravene the law of the foreign country or the amount is incurred
for the sole or dominant purpose of expediting or securing the performance
of routine government actions of a minor nature
(v)
Note: AWB incident.
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131
(h)
Entertainment expenses (you cannot claim lunches with clients) – see Div 32:
(i)
[deduction not available] s 32-5 – a deduction is not available, except in
very limited circumstances for expenditure incurred in relation to
entertainment.
(ii)
This prohibition extends to entertainment in the form of food, drink or
recreation or accommodation or travel to do with providing entertainment by
way of food, drink or recreation – see s 32-10(1):
Entertainment is provided even if business discussions or transactions
occur – e.g. a business lunch with clients.
(B)
Recreation includes amusement, sport and similar leisure-time
pursuits and would include recreation and amusement in vehicles,
vessels or aircraft – e.g. joyflights, sightseeing tours etc.
(iii)
Common examples include – business lunches, cocktail parties, tickets to
events, sightseeing etc. It also covers accommodation and travel associated
with these items and incidental items such as entertainment allowances.
(iv)
Note – that a deduction is not denied for a loss or outgoing incurred in
providing entertainment by way of a fringe benefit – see s 32-20:
(v)
(i)
(A)
(A)
This exception does not apply to the extent that the taxable value of
the fringe benefit is reduced.
(B)
The amount of the reduction is equal to the amount of the cost of
entertaining the 3rd party.
Note – the table in Div 32-B sets out exceptions.
Non-compulsory uniforms – see Div 34.
Apportionment: ‘To the extent that…’
2.45
See – Ronpibon Tin – for expenditure to form an allowable deduction as an outgoing incurred
in gaining or producing the assessable income it must be incidental and relevant to that end –
2.46
See also – Ure v FCT – where interest was apportioned base on how much was actually paid
by the taxpayer.
Common general deduction types
Introduction
2.47
The following are examples of common general deductions:
(a)
Expenses incurred in gaining employment – usually a point too soon;
(b)
Clothing expenses;
(c)
Relocation expenses
(d)
Home office expenses;
(e)
Education expenses;
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(f)
Interest;
(g)
Legal expenses; and
(h)
Travel expenses.
Expenses incurred in gaining employment
2.48
Generally incurred at a point too soon, i.e. they put the taxpayer in a position to work – FCT
V Maddalena:
(a)
Will not be deductible if they are only putting the person in the position of being able
to derive assessable income;
(b)
You need to actually be deriving assessable income as a result.
Relocation Expenses
2.49
Generally incurred at a point too soon – i.e. they put the taxpayer in a position to work.
2.50
They are also of a private or domestic nature – Fullerton v FCT:
2.51
(a)
Either had to accept a transfer or be retrenched;
(b)
He was reimbursed for some of his relocation costs;
(c)
But he tried to claim a deduction for the rest which was unsuccessful.
Therefore, they are likely to fail on too limbs.
Child care expenses
2.52
Put the taxpayer in a position to earn income, not incurred in earning assessable income –
see Martin v FCT – regardless of whether the taxpayer was self-employed or an employee.
2.53
Fed Govt – childcare benefits and the childcare rebate – the question will be whether the
childcare rebate is means tested.
Travel Expenses
2.54
Deductibility depends on the type of travel – see Colling v FCT:
(a)
To and from work – not going to happen – at a point too soon (this is the general
premise);
(b)
Outside normal work hours – Colling – allowed this is fairly limited in the sense that
the person was working at home (it doesn’t apply to everyone on call/going home
late);
(c)
Itinerant workers – not talking about fruit pickers in North Qld – means people who
don’t have a fixed place of work (e.g. travelling sales people – travel b/w home and
work is deductible);
(d)
Carrying bulky items – see the case of someone who had to carry large musical
instruments – also tradesmen;
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(e)
Alternative workplace – if Kerrie taught here and at Ipswich she would get a
deduction b/w her alternate workplaces – on the basis that they are related:
(i)
see Payne’s Case (2001) – TP tried to claim deduction b/w day job and
farming business – Court said you can’t do that, b/c they are 2 different jobs;
(ii)
s 25-100 – now allows a statutory deduction.
Self-education expenses
2.55
TR98/9 - where the self-education expenses are directly relevant to the activities by which a
taxpayer currently derives assessable income, or is likely to lead to an increase in income
from those activities, the relevant expenses are allowable as a deduction:
(a)
e.g. MBA whilst accountant;
(b)
see the Youth Allowance case – the connection b/w the expenses and the Youth
Allowance – see FCT v Anstis – note the FCT is appealing this decision, and has
issued guidance that it will not be followed until the appeal decision is know.
2.56
But note – that you still need to satisfy the nexus test b/w the loss/outgoing and the deriving
of assessable income.
2.57
Nexus test – must establish a nexus between the education and derivation of income – a
student at school or university could not claim a deduction for fees because the nexus
between the education and the eventual derivation of income is insufficient:
(a)
If a skilled person undertakes a refresher course or seminar in his/her field of
expertise designed to maintain a level of knowledge that will be deductible.
(b)
Also where a skilled person undertakes a course to increase chances of promotion or
as a requirement of business. Though be careful when embarking on a course in
order to enter a new field of employment.
2.58
[definition of self-education expenses] s 82A(2) – self education expenses are
expenses related to a course of education provided by a school, college, university or other
place of education. (Defined in the s82A(2) ITAA36 as a prescribed course of education).
2.59
The course must be undertaken to gain formal qualifications for use in carrying on a
profession, business or trade or in the course of employment.
2.60
If the self education is being undertaken to obtain employment the expenditure will not be
deductible.
2.61
Can claim for the following types of expenditure:
2.62
(a)
Textbooks.
(b)
Stationery.
(c)
Student Union Fees.
(d)
Decline in the value of a computer used to undertake the course.
(e)
Course Fees
Deductible under s8-1 subject to 2 limitations:
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(a)
2.63
s 82A ITAA36 – deduction only allowed to the extent that the net amount of
expenses exceeds $250.
(i)
Though - TR 98/9 allows a taxpayer to reduce the $250 by the amount of
non-deductible expenses associated with education
(ii)
e.g. parking costs, cost of childcare.
(b)
s 26-20 ITAA97 – denies deductions for HECS payments – note that PLT would be a
deductible expense.
(c)
Does not cover fringe benefits - e.g. an employer who pays an employee’s HECS will
generally be entitled to a deduction (but also be liable to FBT).
Note the following examples:
FCT v Hatchett – deduction allowed to complete teacher’s higher certificate, but not
(a)
for a BA b/c it would not necessarily lead to more pay, promotion etc.
FCT v Studdert – flight engineer who took flying lessons and claimed the flying
(b)
lessons on the basis they would make him a better engineer and was actually
successful – Kerrie thinks this is quite clever – he argued they would improve his skills
– FCT argued they would lead to a new job.
Home office expenses
2.64
Distinguish business premises from area used for convenience – e.g. where taxpayer uses
some portion of his/her home as business premises, then an appropriate proportion of the
expenses relating to the home may be deductible.
2.65
Where the taxpayer maintains an office or study which is used for business purposes as a
matter of convenience (as opposed to necessity) then:
2.66
(a)
no deduction for e.g. interest, rates - private or domestic nature of expenditure
(b)
but could deduct for depreciation, electricity provided there is a sufficient nexus
between the expense and the income generation.
Home office expenses are divided into 2 categories:
(a)
Running expenses – electricity, depreciation on furniture etc;
(b)
Occupancy expenses – how much it actually costs to be in the residence.
Swinford v FCT
Summary
•
distinguish business premises from area used for convenience
•
e.g. where taxpayer uses some portion of his/her home as business premises, then an
appropriate proportion of the expenses relating to the home may be deductible.
•
Where the taxpayer maintains an office or study which is used for business purposes as a
matter of convenience (as opposed to necessity) then no deduction is allowed for occupancy
expenses (e.g. interest, rates) - private or domestic nature of expenditure - but could deduct
depreciation, electricity, etc provided there is a sufficient nexus between the expense and the
income generation
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2.67
If it is a genuine home office you get a deduction for a proportion of running and occupancy
expenses – this is hard to do if you have another place of business.
2.68
If it is a mere convenience you only get a deduction for your running expenses.
FCT v Faichney
Summary
•
Research scientist had a lab at CSIRO but worked weekends and evenings in his home study
– i.e. it was a home office of convenience.
•
Deductions denied for interest payments on his home, but was allowed deductions for
depreciation of desk, bookshelves, carpets, curtains in the study, and a proportion of his
electricity bill attributable to heating and lighting in the study was also depreciable – i.e. a
proportion of running expenses.
Handley v FCT
Summary
•
Barrister purchased a home because it had a room suitable for use as a study.
•
He also maintained chambers in the city and worked from home 20 hours per week for 45
weeks of the year.
•
He received only a proportion of running expenses and no occupancy expenses. He could not
get deductions for interest payments or rates and insurance premiums.
FCT v Forsyth
Facts
•
Barrister – 1981: TP & wife purchased house as trustee of Family Trust aim to provide
family home and then rented one of the rooms to the barrister and allowed him to occupy the
rest if bills paid.
•
Then tried to claim deduction for rent.
Held
•
Failed.
•
Had city chambers, therefore the home office was a mere convenience.
•
Rent paid was not allowed as a deduction - office used for convenience rather than
compulsion.
2.69
TR 93/30 – what constitutes various expenses:
(a)
Ruling draws a distinction between occupancy expenses and running costs:
(i)
“occupancy expenses” - rent, home loan interest, rates and insurance
premiums.
(ii)
“running costs” - heating, cooling, lighting, cleaning.
(b)
where the home is a place of business, a proportion of both kinds of expenses may
be deductible.
(c)
where the home office is used merely for convenience, only a proportion of the
running expenses can be deducted.
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2.70
NB – sometimes you don’t want to get all these exemptions because you will lose your CGT
exemption when you sell it – so don’t get too greedy.
Clothing Expenses
2.71
Conventional clothing is not deductible, except:
(a)
Abnormal cost to the taxpayer
(b)
Expenditure created by taxpayer’s working conditions,
2.72
See – Edwards – allowed deduction on ordinary clothing, b/c she was secretary to the
governor and this was a deduction.
2.73
Occupational specific clothing and compulsory uniforms may be deductible:
(a)
i.e. hats if you’re working outside, sunscreen as a PE teacher, air hostesses –
stockings and shoes (e.g. half-size bigger) but not moisturiser;
(b)
uniforms – if things have a logo on them will have a tax deduction;
(c)
occupational specific – steel capped boots for a builder.
Interest expense
2.74
In determining the deductibility of interest, the courts have looked at the purpose of the
borrowing and the use to which the borrowed moneys have been put.
2.75
The interest must be incurred “in the course of” an income-producing or business activity to
be deductible – i.e. there must be a nexus.
2.76
Various CL tests have been established to determine whether the interest expenditure falls
within the general deduction provision:
(a)
Prevailing use test – deductibility depends upon the use to which the borrowings is
put:
(i)
Don’t look at the security over which the borrowings are take;
(ii)
Not a case of borrow money over rental property and using money to buy a
main residence;
(iii)
Purpose = main residence interest is not deductible;
(iv)
If security = main residence to buy a rental property than interest is
deductible.
Steele v FCT
Facts
•
TP acquired land in 1980 with the idea of building a motel.
•
Plans were drawn up, made council applications but development never went ahead.
•
Property was eventually sold in 1987.
•
Holding costs (including interest) were incurred between 1980-1987 and some limited income
(<4% of the holding costs) derived from agistment of horses.
Held – HCA
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Steele v FCT
•
That the capital asset has produced no income is no reason to conclude that the interest is of
a capital nature.
•
Simply because the loan was used to acquire a capital asset which has not yet produced
income does not mean that interest payable on these borrowings should be treated as capital.
Legal Expenses
General principles
2.77
The character of legal expenses follows the purpose of incurring the expense.
2.78
Some legal expenses are clearly of a capital nature – e.g. conveyancing costs in connection
with the purchase of real estate, legal fees in connection with the purchase or establishment
of a business or other capital asset for use in a business.
2.79
Some are clearly of a revenue nature – e.g. legal costs of recovering business debts – what
about business expenditure – see below.
2.80
Others are clearly of a non-deductible private nature – e.g. costs of conducting typical
Family Court proceedings – this is a grey area and there are lots of cases on this.
2.81
The following are examples of deductible legal expenses:
2.82
(a)
costs of defending proceedings for the unauthorised use of a trademark;
(b)
costs of patent infringement action;
(c)
costs of defending an employee against corruption charges and assault charges;
(d)
costs incurred by an employee to prevent defamatory statements being made by a
colleague;
(e)
damages paid in settlement of a misrepresentation claim against an estate agent;
(f)
costs and damages of an employer in an employee's personal injuries claim against
the employer;
(g)
costs of a landlord in ejectment proceedings against a rent-defaulting tenant;
(h)
damages and costs of a newspaper in defending a libel action – see Herald and
Weekly Times (1932) 48 CLR 113;
(i)
costs incurred by a company in supporting an application by an ex-director for leave
to resume his activities as a director notwithstanding a prior conviction – Magna
Alloys & Research 80 ATC 4542); and
(j)
costs of defending an action for wrongful dismissal brought by a former director.
The following are non-revenue legal expenses:
(a)
costs of settlement of breach of contract action, the result being that the taxpayer
was free to reorganise its trading structure and method;
(b)
costs of defending the legal validity of a contract on the basis of which the viability of
the taxpayer's business depended;
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3
(c)
costs of defending a driving charge where the taxpayer's employment was conditional
on holding a driver's licence;
(d)
trustee's expenses of opposition to an action for the trustee's removal;
(e)
publisher's costs of defence to criminal libel prosecution;
(f)
costs of eviction proceedings against a tenant whose term had expired;
(g)
costs of action for damage done to a rent-producing property;
(h)
costs of a public servant's defence in inquiry on charges of failure to obey an order;
(i)
legal expenses incurred in seeking to regain employment by a policeman who was
dismissed following a Police Integrity Commission inquiry;
(j)
costs of a company in resisting winding-up action by a dissident shareholder;
(k)
costs of preparing a contract for performance of services and payment of royalties;
(l)
costs of resisting land resumption and disputing the compensation amount; and
(m)
payments made by a solicitor suspended from practice to cover legal and
investigation costs incurred by the Law Society where the payment was a prerequisite
to resumption of practice.
Specific Deductions
Introduction
3.1
In addition to the general deduction rule, taxpayers may claim a deduction for various
expenses under a specific deduction provision.
3.2
Most specific deduction provisions are contained in Div 25 of ITAA 1997, but a number of
specific deduction provisions are contained in other Divisions of the legislation.
3.3
[specific deductions available] s 8-10 – a specific deduction provision provides taxpayers
with a deduction for a specific type of expense. There is no need to satisfy a nexus, merely,
meet the requirements of the section.
3.4
[both types of deduction] s 8-10 – where a taxpayer is entitled to deduct an expense
under both the general deduction provision and a specific deduction provision, the taxpayer
should deduct the expense under the specific deduction provision as it is the more
appropriate provision.
3.5
Note the following examples of specific deductions:
(a)
Bad debts;
(b)
Tax losses;
(c)
Losses from non-commercial business activities;
(d)
Tax related expenses;
(e)
Borrowing expenses;
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(f)
Losses by theft; and
(g)
Travel between workplaces.
Tax related expenses
3.6
[deduction for tax related expenses] s 25-5 – allows a deduction for expenditure where
it is incurred by a taxpayer to the extent that it is for:
(a)
Managing the taxpayer’s income tax affairs;
(b)
Complying with an obligation imposed by a Cth law in relation to the income tax
affairs of an entity; or
(c)
The general interest charge on unpaid tax and penalty and underpayments of tax.
3.7
Under s 8-1 tax related expenses would be deductible if related to carrying on a business,
but individuals would be denied a deduction as the expenditure would be private.
3.8
Note the following subsequent provisions:
(a)
[PAYG] s 25-25(2) – denies a deduction for expenditure for income tax or amounts
withheld under PAYG – see exclusions below.
(b)
[capital expenditure] s 25-25(4) – can’t deduct capital expenditure but
expenditure is not necessarily capital expenditure simply because the taxpayer’s tax
affairs relate to matters of a capital nature – e.g. expenditure on a private ruling on
whether certain property can be depreciated is not capital expenditure.
3.9
See Falcetta v FCT – expenditure on work in relation to penalty notices was deductible but
expenditure on work relating to the winding up of certain entities and the establishment of a
new one was not deductible.
3.10
Note – that where a recoupment of a deductible amount is received, this recoupment is then
included in the taxpayer’s assessable income – e.g. the taxpayer’s objection against an
assessment is allowed and a filing fee is refunded. If a deduction is allowed for the filing fee,
the refund must be included in the taxpayer’s assessable income in the year of the refund.
3.11
Expenditure incurred by a taxpayer to the extent that it is for managing the taxpayer's
income tax affairs or complying with an obligation imposed by a Commonwealth law in
relation to the income tax affairs of an entity is deductible.
Repairs
Introduction
3.12
[deduction for repairs] s 25-10(1) – you can deduct expenditure you incur for repairs to
premises (or part of premises) or a *depreciating asset that you held or used solely for the
*purpose of producing assessable income – you would have thought s 8-1 would have
covered it – but this is still there.
3.13
[part deductions available] s 25-10(2) – part deductions available – no deduction for
capital expenditure.
3.14
[not for capital expenditure] s 25-10(3) no deduction for capital expenditure
What is a repair?
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3.15
Repair is not defined in the ITAAs. The ATO has ruled on this though.
3.16
TR 97/23 – definition of a repair:
(a)
A question of fact and degree in each case having regard to the appearance, form,
state and condition of the particular property at the time the expenditure is incurred
and to the nature and extent of the work done to it.
(b)
A repair involves a replacement or renewal of a worn-out or dilapidated part of
something but not of the whole thing, i.e. the entirety:
(c)
(i)
Cases focus on part v entirety;
(ii)
E.g. fence – it is a standalone object – therefore capital expenditure and not
a repair to a rental property.
Determining what is the entirety is a question of fact in each case and often causes
difficulty.
Essential attributes
3.17
3.18
Repair is the restoration of an income-producing item to its previous condition:
(a)
Key question – is whether the item has been restored to its former level of efficiency.
(b)
Not necessary that the materials used are the same as the original’s or that it is
restored exactly to its former physical form.
(c)
See W Thomas & Co v FCT – pre-emptive repairs are deductible.
An item must be in need of restoration before it can be ‘repaired’ for tax purposes – see Case
J47 – deduction denied for shortening awning when it was functioning efficiently.
3.19
A repair involves replacement or renewal of a part of an item rather than the entire item:
(a)
Replacing item A with item B does not restore item A to its former level of efficiency
but rather replaces one item (an entirety) with a different one goes beyond a
deductible repair.
(b)
See Lucott v Wakely and Wheeler – repair is restoration by renewal or replacement of
subsidiary parts of a whole.
3.20
Examples include – replacing windows, rusty gutters, rupping up carpet and polishing
floorboard is a repair of the floor. Also – oiling, brushing or cleaning items otherwise in good
working condition to prevent future deterioration would not constitute repairs but may be
deductible under s 8-1 (where they satisfy those requirements) – see TR 97/23.
3.21
Defining an entirety – identification of entirety depends upon the facts of a particular case:
(a)
Courts have looked to functionality test – i.e. an entity capable itself of performing
a separate function – but this was criticised by Kitto J in Lindsay v FCT.
(b)
Courts have also asked whether the item is separately identifiable as a substantial
item of equipment – i.e. the entirety – or whether it is physically commercially
and functionally an inseparable part of a large unit which is the entirety – see
Samuel Jones & Co v IRC.
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3.22
3.23
The following cases provide useful examples of entireties:
(a)
See W Thomas & Co Pty Ltd v FCT – TP claimed a deduction for repairs to gutters,
roof, walls and 2 floors of a building. Related to a repair because the building was
the whole therefore they were deductible.
(b)
See FCT v Western Suburbs Cinemas Ltd – roof of a cinema was held to be part of
the whole or entirety of the cinema (which was the entirety) – it was not allowed, but
for other reasons, the roof was not standalone, it was part of the whole of the
building.
(c)
See Lindsay v FCT (HCA) – replacing a slipway in a shipyard was replacing the
entirety. 2 slipways, on reconstructed. Held to be a standalone item, separate
purposes – therefore the entirety and non-deductible.
(d)
See Case J47 – no deduction for shortening an awning when the awning was working
perfectly well.
Hypothetical example:
(a)
Mr Fermier and Mr Agricola are neighbouring farmers affected by a severe bushfire.
(b)
Mr Fermier restores his existing fencing to good condition by mending it and replacing
damaged sections, e.g., the fence on the northern boundary.
(c)
Mr Agricola replaces the entire fencing surrounding his property.
(d)
Mr Fermier is entitled to claim a deduction for the cost of repairing his fencing under
s 25-10. The entirety is the total fencing so replacing the fences on the northern
boundary is a replacement of a subsidiary part of the whole fencing.
(e)
However, Mr Agricola’s expenditure is not deductible under s 25-10 because the
whole fencing was replaced, making it a reconstruction of the entirety. The total
fencing is not a subsidiary part of the rural property or of anything else. To replace
entire fencing with new fencing is to replace one capital asset with another capital
asset. The cost is therefore of a capital nature.
(f)
Mr Agricola’s fences however, are depreciable assets – see below.
Notional repairs
3.24
Notional repairs – i.e. what the repair expense would have been had it been carried out
(rather than a capital improvement): FCT v Western Suburb Cinemas – no deduction for
claiming your own time as a deduction.
FCT v Western Suburbs Cinemas
Facts
•
Replaced a ceiling with a new one, using better materials.
•
This was found to be an improvement.
•
The TP then argued he was entitled to equivalent deduction had they just repaired the ceiling
(if the old materials had been available).
Held – HCA
•
It was not deductible in both cases.
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FCT v Western Suburbs Cinemas
•
Kitto J rejected this claim – deduction is only available for what has actually been done and
not what might have been done.
•
This principle was applied in W Thomas & Co v FCT (see above).
Non-deductible repairs
3.25
[expressly excluded] s 25-10(3) – this expressly precludes a deduction where the
expenditure on repairs is of a capital nature:
(a)
Additions;
(b)
Improvements; and
(c)
initial repairs.
Additions
3.26
This is not a repair because it will result in an expansion of the basic capital asset structure –
this contributes to the cost bases for CGT purposes.
3.27
You may also get a capital works deduction under Div 43 or a capital allowances
deduction under Div 40 (not repairs).
3.28
Deduction is also not available where the renovation work is so extensive so as to change the
item’s character – i.e. transform a water tank into a boiler.
Improvements
3.29
While a repair restores an item to its former condition, an ‘improvement’ makes the item
functionally better than it previously was.
3.30
More likely to be an improvement where:
3.31
(a)
reduces likelihood of future repairs, has longer life, improves efficiency;
(b)
more expensive than original materials
Less likely to be an improvement where:
(a)
has disadvantages as well as advantages e.g. longer wearing floor may be harder to
walk on than carpet;
(b)
cheaper than using original materials – i.e. polishing floor boards is cheaper than
replacing the carpet.
3.32
Consider the above in the context of polished floor boards over carpet – this will likely be a
repair.
3.33
It does not matter if different or modern materials are used provided the new materials do
not significantly improve the item’s functional efficiency –i.e. an additional function which
the item did not have previously.
3.34
See – FCT v Western Suburbs Cinema – where the replacement of a ceiling with fibro
sheeting was an improvement because the fibro had a number of advantages over the
previous ‘tin test’ materials – this reduced the likelihood of repairs in the future.
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3.35
3.36
Note that TR 97/23 suggests the following factors will point to an improvement rather than
a repair:
(a)
The modification work has effected an improvement to the asset;
(b)
There is greater efficiency of function of the property;
(c)
There is an increase in the value of the asset;
(d)
The expenditure reduces the likelihood of future repairs.
Note that TR 97/23 considers the following things to be improvements, not repairs:
The replacement of a dilapidated ceiling with a new and better ceiling – see Western
(a)
Suburbs Cinema;
(b)
The replacement of canvas awnings on the balconies of holiday flats with sound
resistant ones – see Case M60;
(c)
The replacement of a rotten wooden floor in a block of flats with a better, longer
lasting and more moisture resistant one – see Case N61; and
(d)
Landscaping or insulating a home.
Example
3.37
Sam Tabernarius, a shopkeeper, decides to replace the awning of his shop with a more
modern and aesthetic equivalent.
3.38
There is nothing to be restored, no decayed or worn out parts to be renewed and nothing
loose or detached which requires fixing – this expenditure involved is not for repairs – the
awning being in good repair before the work was done. Therefore no deduction under s 2510.
Example
3.39
Elle Bashful uses her truck for income producing purposes. She replaces the truck's worn out
petrol engine with a diesel engine with a much greater economy of operation.
3.40
The engine is not an entirety but a subsidiary part of the truck.
3.41
However, the costs relate to an improvement of the truck because the replacement of the
engine involved a significantly greater efficiency in the truck’s function.
3.42
The engine is a major and important part of the truck and is a new and better engine with
considerable advantages over the old one, including the advantage that it reduces the
likelihood of future repair bills. The costs are of a capital nature and are not deductible under
s 25-10.
3.43
A deduction for depreciation may be allowable – see below.
Example
3.44
Gurgler Pty Ltd needs to replace the impellor in a pump it has used for five years. A new
impellor made from stainless steel would cost $8,000. If the original cast iron impellor is
replaced with another cast iron one, it would cost about $4,000. The stainless steel impellor is
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chosen because it will provide improved functional efficiency for the pump. It will perform
more efficiently as an impellor and will last three to four times longer than the cast iron type.
3.45
This improves efficiency and is therefore an improvement.
Initial Repairs
3.46
If an asset is in disrepair at the time of its acquisition, the cost of ‘initial repairs’ to remedy
those defects is of a capital nature and non-deductible – treated as part of the cost base and
is not deductible.
3.47
The rationale is – this is because these are not ordinary ‘wear and tear’ repairs during the use
of the item to produce assessable income.
3.48
Law Shipping Co v IR Commrs – a ship was bought in 1919. At the time of purchase the ship
required repairs to be deemed seaworthy. Costs of repairs was held to be capital in character
and non-deductible – i.e. because the asset was in disrepair at the time of purchase, the
initial repairs were capital in nature – see TR 97/23 which applies this case in Australia.
3.49
Note – this will apply even if the taxpayer did not know the asset required initial repairs at
the time of purchase.
Example
3.50
William Infelix purchases a house that was ostensibly in good repair. To make it more
attractive to prospective tenants, minor repairs and renovations are undertaken.
3.51
During the course of these repairs and renovations, William discovers that the woodwork is
seriously affected by the ravages of white ants. Substantial expenditure is incurred to
remedy the problems caused by the white ant infestation to restore the property to a state in
which it is suitable for occupation by tenants.
3.52
The minor repairs and renovations are initial repairs. Their costs are of a capital nature and
therefore non-deductible.
3.53
Substantial expenditure is incurred to remedy the problems caused by the white ant
infestation to restore the property to a state in which it is suitable for occupation by the
tenants.
3.54
The expenditure incurred in these circs to fix the white ant problem, existing at the date of
purchase is also of a capital nature and is therefore non-deductible under s 25-10.
3.55
The fact that William was unaware of the problem when he purchased the house and the fact
that he would have paid a lower purchase price if he had known of the need for repairs do
not alter the capital nature of the expense.
Combination of repairs and non-deductible renovations
3.56
If deductible and non-deductible repairs are properly regarded as being separate and
unconnected, then the cost of the repairs will be deductible.
3.57
If the repairs are part of the non-deductible work, the repairs will take on the non-deductible
character and the taxpayer will be unable to obtain any deduction – see FCT v Western
Suburbs Cinema.
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Payment for lease obligation to repair
3.58
A taxpayer can deduct an amount paid for failing to comply with a lease obligation to make
repairs to premises where the premises are used or have been used by the taxpayer for the
purposes of producing assessable income.
Repairs to assets used only partly for income-producing purposes
3.59
An apportionment is applicable here – see TR 97/23 – i.e. where a home office sits on part
of the property.
3.60
Non-capital expenditure on repairs to property used only partly for business or incomeproducing purposes is deductible only to the extent that is reasonable – s 25-10(2) – e.g.
genuine home office – could have an apportionment.
ATO ID 2003/22
Facts
•
The taxpayer has owned and rented a residential property for many years. While the property
was tenanted, the taxpayer replaced the old kitchen fittings, including the cupboards. The old
cupboards had deteriorated through water damage and wear and tear.
•
The new fittings are of a similar size, design and quality as the originals. The new cupboards
are of the same type and standard of material (or the modern equivalent of that material) as
the old ones. The layout and design of the kitchen did not alter substantially from that of the
original.
•
The differences are:
•
o
the old sink was replaced with a smaller sink and, as a consequence, provided more
bench top space; and
o
a removable cupboard replaced the space previously available for a dishwasher.
Is this a repair?
Answer – ATO Interpretive Decision
•
Issue: Can the taxpayer deduct expenditure on the replacement of kitchen cupboards
installed in a rental property as repairs under section 25-10 of the Income Tax Assessment
Act 1997 (ITAA 1997)?
•
Decision: No. The taxpayer cannot deduct the expenditure as repairs under section 25-10 of
the ITAA 1997 because it is capital in nature.
•
It is a whole, it is a separately identifiable capital items with their own function and therefore
an entirety in themselves.
•
Not yet challenged, but doesn’t make sense practically – a kitchen must be part of a house.
Tutorial Question on Deductions
Facts
•
Bruce owns a house which he rents out to tenants. In November, the hot water system
breaks down.
•
He replaces it with a new hot water system, which is more energy efficient, at a cost of $900.
•
The plumber who installs the system accidentally puts his foot through the ceiling of the
laundry and pays to have the damage repaired.
•
Afterwards, the tenant complains to Bruce that the whole ceiling now needs repainting.
Bruce agrees to do this himself and while he is at it also decides to paint the walls.
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Tutorial Question on Deductions
•
The cost of the paint is $350. In the process of painting, Bruce accidentally drips a fair
quantity of paint on the tiled floor.
•
The tenant again complains and Bruce agrees to purchase 14 new tiles if the tenant will lay
them.
•
He is unable to find new tiles that match the existing ones, and has to purchase second hand
tiles. These cost $100.
•
Are any of Bruce’s expenses deductible against his income from rent?
Answers
•
•
•
•
Replace hot water service:
o
Not deductible per s 25-10 since a repair is a replacement of a part and not the
entirety per Lindsay v FCT (1961) 106 CLR 377
o
Also, it is a capital expense and not deductible under para 8-1(2)(a) per Sun
Newspapers Ltd v FCT (1938) 61 CLR 337.
o
However, note that these costs are depreciable per s 40-25.
Ceiling damages
o
Not deductible per s 25-10 and s 8-1 per Munro, since these costs were not incurred
by the taxpayer.
o
These costs were paid by plumber.
Painting ceiling and walls
o
The costs of painting the ceiling are deductible per s 25-10: W Thomas & Co Pty Ltd v
FCT (1965) 115 CLR 58.
o
The costs of painting the walls are not deductible per s 25-10 as not in need of
restoration: Case J47 77 ATC 437.
o
It could be argued that these costs may be deductible under s 8-1 (general
maintenance of the property) as there is sufficient connection between the expense
and assessable income.
Tiles $100
o
The costs of tiles are deductible per s 25-10: W Thomas& Co
o
The tiles are not an improvement, nor a replacement of an entirety.
•
Can’t get a deduction for what is saved
•
Pay kids at arms length
Bad debts
3.61
Bad debts are only available where the taxpayer uses the accruals basis (because amounts
are not included under the cash basis until they are actually received – see below).
3.62
Accountants will know that there is normally a provision for bad debts on the accounts,
however, in tax terms this does not count towards a deduction, this applies only under s 2535.
3.63
[balancing adjustment] s 25-35 provides a balancing adjustment which offsets the
amount previously returned as income and puts the taxpayer in the same position as if the
original amount had not been returned as income (accruals basis):
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3.64
3.65
(a)
Taxpayer will be in the same position as if the amount had not been declared as
income.
(b)
However timing effects will kick in where the income may be returned in year 1 and
the compensating deduction not claimed until a year later.
[deduction] s 25-35(1) – a taxpayer can deduct a debt (or part of a debt) written off as
bad in an income year, if:
(a)
It was included in the taxpayer’s assessable income for either that year or an earlier
income year; or
(b)
It is in respect of money that the taxpayer lent in the ordinary course of a money
lending business (only at the time the loan is made, not the time the debt is written
off – see TR 92/18).
Deduction is for bad debts written off during the year:
(a)
i.e. you include $1,000 and realise the person who owes that has gone broke – see if
you satisfy the requirements of s 25-35, then, include it as a deduction.
(b)
Note – you don’t get a deduction for provision of doubtful debts account – note
the requirements below.
Requirements
3.66
3.67
There must be a debt in existence:
(a)
Not deductible if the debtor is released from the obligation to repay the debt.
(b)
See Point v FCT – where there is no debt, there is nothing to be incurred, therefore,
no deduction.
The debt must have gone ‘bad’:
(a)
A debt is bad when a reasonable business person would regard it as unlikely that the
debt will be repaid – see Case X9.
Note – this means it must be reasonably regarded as irrecoverable – see GE Crane
(b)
Sales v FCT.
(c)
3.68
Bad debts have been defined as – on an objective view, irrecoverable – see TR
92/18.
The debt (or part of the debt) must have been written off as bad in the income year:
(a)
s 25-35 does not prescribe any particular method by which a debt must be written
off.
(b)
Any written entry which clearly discloses the taxpayer’s intention to treat the debt as
bad will suffice.
(c)
Commissioner would be satisfied where writing a debt off as bad was authorised at a
board meeting or where a financial controller recommended in writing that a debt be
written off and this was accepted in writing by the MD – see TR 92/18.
(d)
A mere mental resolve, not evidenced in writing will not suffice.
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(e)
3.69
Note – to satisfy the technical requirements of s 25-35 the debt must be written off
during the income year (i.e. before midnight 30 June where the income year is to 30
June). If it is not written off until later, the deduction would be available in the next
income year – see Point v FCT.
The debt must have been included in the taxpayer’s assessable income or have been money
lent:
(a)
Included in the taxpayer’s assessable income – the person who writes off the debt
must be the person who originally included the amount in their assessable income.
(b)
Have been in respect of money that the taxpayer lent in the course of a business of
lending money:
(i)
In respect of extends to any interest and associated costs – see FCT v
National Commercial Banking Corporation of Australia.
(ii)
The Taxpayer must be in the business of lending money at the time the
money was lent, but the taxpayer does not have to be carrying on such a
business when the amount is written off – see TR 92/18.
(iii)
See FCT v Bivona – where TP borrowed money from overseas and then onlent to the holding Co of a group of Co’s of which the TP was a member.
Holding Co on lent the money to its subsidiaries. 90% of the TP’s income
was from interest, of which 83% came from the holding Co. This was held to
be a business of money lending.
3.70
[where debt is bought] s 25-35(2) – a taxpayer who buys a debt in the ordinary course
of a money lending business can claim a deduction for writing off that debt as bad in the
income year, up to the amount of the expenditure incurred in buying the debt.
3.71
Note - we could probably use s 8-1, but s 25-35 is more correct, if you don’t satisfy these
requirements, then try s 8-1.
Payments to Associations
3.72
[membership expenses] s 25-55 – Allows a deduction for payments for memberships of a
trade, business or professional association and limited to $42:
(a)
Under general deductions provisions a legal academic who is a member of the Bar
Association would be able to claim the whole amount as a deduction – i.e. this
requires a nexus.
(b)
However, if a legal academic was a member of an engineering association they would
only be able to deduct $42 under s 25-55.
Travel between work places
3.73
[unrelated workplaces] s 25-100: A specific deduction is available for revenue expenses
for travel directly between unrelated workplaces:
3.74
Note – under s 8-1 you:
(a)
can deduct for travel between related workplaces;
(b)
but you cannot deduct for travel between unrelated workplaces;
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3.75
In Payne’s Case they were unrelated workplaces and the HC disallowed this – so now, we
have s 25-100 – which was enacted to overcome this problem.
3.76
This requires travel between a place where the taxpayer is engaged in income-producing
activities or business activities and a second place if:
(a)
the individual incurs transport expenses in travelling directly between workplaces;
(b)
the purpose of travel to the second workplace is to engage in income-producing
activities or business activities;
(c)
at the time of travel between workplaces the income-earning activities at the first
workplace had not permanently ceased;
(d)
the taxpayer does not reside at either place.
Borrowing expenses
3.77
[deduction available] s 25-25(1) – allows a deduction of expenditure incurred in
borrowing money, to the extent that the money is used for the purpose of producing
assessable income:
(a)
Expenditure includes – procuration, legal, valuation and survey fees, stamp duty and
loan guarantee insurance.
(b)
Interest payable on the money borrowed is deductible generally under s 8-1 (see
above).
3.78
Expenditure incurred in borrowing money or in the discharge of a mortgage is normally
regarded as capital expenditure and non-deductible.
3.79
The period of the loan is the actual period of the loan or 5 years, whichever is the shorter –
see s 25-25(5).
Losses by theft
3.80
[deduction available] s 25-45 – A loss of money, cause by theft, stealing, embezzlement,
larceny, defalcation or misappropriation, by an employee or agent of the taxpayer is
deductible in the year in which it is discovered if the money was included in the taxpayer’s
assessable income of that or an earlier year.
3.81
The following are helpful in determining whether this applies:
3.82
(a)
Loss of money must be by an employee or agent – i.e. not their spouse, but may be
a nexus under s 8-1.
(b)
Cheques forged by an employee are deductible under s 8-1.
Example:
(a)
Bob and Tom are partners in an electrical components business. On preparation of
their monthly accounts in March 2006, they discovered that a former employee had
misappropriated $5,000 in cash.
(b)
This would be deductible under s 25-45 because it was misappropriation by an
employee or agent and would be deductible for the year it was ascertained.
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(c)
Note – if Bob or Tom had misappropriated the money, a deduction would not be
allowed as the loss would not be attributable to an employee or agent – rather, a
partner – see s 25-45(b).
Car expenses
Introduction
3.83
Deductions for travel expenses are general deductions under s 8-1, but for car expenses Div
28 also applies – i.e. this tells you how to calculate car expenses.
3.84
Motor vehicle expenses incurred in the course of deriving assessable income or in carrying on
businesses are allowed as deductions.
3.85
Under Div 28 – motor vehicle expenses incurred in the course of deriving assessable income
or in carrying on business are allowable deductions – this includes:
(a)
Interest;
(b)
Lease payments;
(c)
Fuel;
(d)
Oil;
(e)
Depreciation;
(f)
Maintenance;
(g)
Registration;
(h)
Insurance etc.
3.86
For this Div to apply, you must be an individual or a partnership.
3.87
Regard must be had for Div 28 (ss 28-1 to 28-185):
(a)
4 alternative methods for calculating deductions for car expenses where a taxpayer
owns/hires/leases a car;
(b)
This also takes into account expenses relating to that car, including: interest, lease
payments, fuel, oil costs, depreciation, maintenance, registration, insurance examples.
Available methods
3.88
Provided a taxpayer fulfils the requirement, they get to choose one from the following each
year:
(a)
Cents per KM;
(b)
1/3 of actual expenses;
(c)
12% of original cost; and
(d)
Log book,
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3.89
Obviously, this will change as a taxpayers individual circumstances change etc and you can
choose, for each income year, which method gives the biggest deduction and can change
methods from year to year.
Cents per kilometre - Div 28-C
3.90
Can only be used for first 5,000 business kms.
3.91
[calculation] s 28-25 (cents per km rate (see below) x business kms traveled)
3.92
Note that no substantiation rules apply – it is just a reasonable estimate, up to 5,000 km.
Cents per km rate
Kms travelled
Engine Capacity –
non rotary engine
0– 1,600
1,601 – 2,600
2,601 +
3.93
KM Rate 2008-09 (cents)
Engine Capacity –
rotary engine
0– 800
801 – 1,300
1,300 +
63
74
75
This is the method you would use if you don’t run up too many business kilometres – i.e.
taxpayers who do minimal driving for work purposes and any excess is disregarded.
12% of original value - Div 28-D
3.94
This applies only where >5000 business kms travelled
3.95
[calculation] s 28-45: deduction = 12% acquisition cost of car (or 12% of motor vehicle if
leased). Pro-rata if not owned for whole income year.
3.96
Amount cannot exceed car depreciation limit: 2008/09 = $57,180 – see s 42-80).
3.97
There are no substantiation requirements here either.
1/3 of actual expenses - Div 28-E
3.98
This only applies where > 5000 business kms travelled.
3.99
You also need substantiation of expenses – ss 900-80 to 900-95 – i.e. must be able to show
receipts etc.
3.100
[calculation] s 28-70: take 1/3 of each car expense incurred by the taxpayer during the
year
Log book method - Div 28-G
3.101
Needs substantiation and need to keep a log book which records all details (see below).
3.102
Amount of each car expense multiplied by business use percentage (i.e. amount of business
travel kms as a percentage of total kms, based on log book records).
Substantiation rules for car expenses
3.103
This are found in Div 900C – Special substantiation rules apply to claims for car expenses
incurred in relation to travel within Australia –see Div 28: s 28-1 to 28-185.
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3.104
These rules apply to employees as well as to other recipients of withholding payments, selfemployed persons and partnerships including at least one individual taxpayer, but not to
companies or trusts.
3.105
The substantiation rules for car expenses calculated under the log book method or the onethird of actual expenses method are set out in ITAA97 Subdiv 900-C (s 900-70; 900-75).
3.106
(actual car expenses) if a taxpayer wishes to claim car expenses by reference to actual
expenses apportioned between income-producing use and private use of the car, the
expenses must be substantiated under ``the log book method''. Under this method, claims
must be supported by written evidence, log book records and odometer records.
3.107
Example
(a)
A taxpayer's total car expenses, including depreciation, for the income year amount
to $9,000 and the business proportion of these expenses is 70%. Where the
requirements of the log book method are satisfied, the taxpayer's deduction for car
expenses would be calculated as 70% × $9,000 = $6,300.
Extent of substantiation required
3.108
3.109
3.110
3.111
Log book method:
(a)
Log books required to be kept for at least 12 weeks in the first year and then every
five years;
(b)
Odometer records required;
(c)
Written evidence of expenses (receipts, etc) required; and
(d)
Fuel and oil expenses may be substantiated by odometer records.
One-third of actual car expenses method:
(a)
Written evidence of expenses required – i.e. you don’t need a “log book” but you do
need a record;
(b)
Log book records not required; and
(c)
Fuel and oil expenses may be substantiated by documentary evidence or by odometer
records.
12% of original value method
(a)
No substantiation required
(b)
Number of business kilometres based on reasonable estimate.
Cents per kilometre method
(a)
Substantiation records not relevant.
(b)
Number of business kilometres based on reasonable estimate.
Example of car expenses
Scenario
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Example of car expenses
•
The taxpayer leases a motor car during the income year, travels 30,000 km in the car
during the year, and incurs the following expenses:
•
Insurance (comprehensive) ......................................................................... $720
•
Lease payments ......................................................................................... $3,500
o
Don’t need to own the car!
•
Petrol and oil.............................................................................................. $3,000
•
Registration and third party insurance ......................................................... $590
•
Repairs ...................................................................................................... $960
•
Total ..................................................................................................... $8,770
•
The cost of the car for the purposes of the 12% method is $24,000
Answer assuming 22,000 km
•
Log book method: ..................................................................................... $6,431
•
One-third of actual car expenses method: ................................................... $2,923
•
12% of original value method: ................................................................... $2,880
•
Cents per kilometre method: ...................................................................... $3,500
o
Can only use 5,000kms
Would use the log book method
Answer assuming 8,000 km
•
Log book method: ..................................................................................... $2,339
•
One-third of actual car expenses method: ................................................... $2,923
•
12% of original value method: ................................................................... $2,880
•
Cents per kilometre method: ...................................................................... $3,500
Would use the cents per kilometer method
Gifts
3.112
Division 30 – Allows a deduction for a gift or contribution to a ‘deductible gift recipient’.
3.113
Under this provision donations can be money or property – but it can’t just be to anyone,
rather it must be to a deductible gift recipient.
3.114
There are requirements to be a DGR however, the organisation must be registered as such
(and is broader than just charities, i.e. the university is a DGR).
3.115
The gift must be a true gift – with no expectation of material advantage in return (i.e.
voluntary) – therefore, donating $1 million on the basis that your child is allowed into law
school, would not be deductible.
Prior year losses
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Principles
3.116
Div 36 allows tax losses to be carried forward indefinitely (for individuals) – i.e. it used to not
be allowed. Businesses however cannot use these losses due to continuity rules – however,
individuals can. NB – CG losses are quarantined.
3.117
Losses incurred prior to 1 July 1989 could only be carried forward for a period of 7 years.
3.118
Remember – exempt income is relevant for losses.
Example
3.119
Ian incurred a loss of $7,000 in Year 1. In Year 2 he has assessable business income
($18,000), allowable business deductions ($13,000) and net exempt income ($300).
3.120
His 1 year loss is brought forward and is offset as to $300 against the net exempt income and
as to $5,000 against the taxable income of $5,000 ($18,000-$13,000).
3.121
The year 1 loss unrecouped as at the end of Year 2 ($7,000-$5,300) – i.e. $1,700 may be
carried forward for deduction against income of Year 3 and so on.
3.122
The rule is – you must offset your loss against exempt income first.
4
Capital Allowances
Key Points
Introduction
4.1
Div 40 – deals with capital allowances – it allows a deduction where we have capital
expenditure:
(a)
Expenses which are not immediately deductible because they are capital may be
deductible over a number of years under the capital allowances regime.
(b)
The cost of acquiring a depreciating asset used for income-producing purposes is one
of the main categories of capital expenditure which is deductible under the capital
allowances regime –see Div 40.
(c)
The holder of a depreciating asset used for income-producing purposes is entitled to
a deduction in an income year for the decline in value of the depreciating asset for
that year.
(d)
The decline in value of a depreciating asset is calculated in accordance with either the
diminishing value method or the prime cost method.
4.2
Upon disposal of a depreciating asset taxpayers will have an assessable income or allowable
deduction amount (a balancing adjustment).
4.3
Business taxpayers may be entitled to deduct capital expenses which are not otherwise taken
into account under the income tax legislation over a period of five years under s 40-880.
4.4
Capital expenses incurred in constructing a building used for income-producing purposes may
be deductible under the capital works provisions in Div 43.
4.5
Note that it is an estimate over its (the assets) life.
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Expenditure on depreciating assets
Deductions for depreciating assets
4.6
The cost of a depreciating asset is generally of a capital nature and is therefore not
immediately deductible as an ordinary business expense
4.7
However, deductions may be available for the decline in value of a depreciating asset used
for income-producing purposes.
4.8
Under those rules a deduction is available for the decline in value of a depreciating asset, to
the extent that the asset is used for a taxable purpose.
Deducting amounts for depreciating assets
4.9
4.10
[deducting for depreciating assets] s 40-25(1) – you can deduct an amount equal to
the decline in value for an income year (as worked out under this Division) of a *depreciating
asset that you *held for any time during the year:
(a)
everything is contained in Div 40; and
(b)
there are * terms – which will be defined.
Note – must be held for a taxable purpose (i.e. deduction is reduced by the amount that it
is not used for a taxable purpose – see s 40-25(2).
‘taxable purpose’
4.11
4.12
[definition] s 40-25(2) – taxable purpose means:
(a)
The purpose of producing assessable income; or
(b)
The purpose of exploration or prospecting; or
(c)
The purpose of mining site rehabilitation; or
(d)
Environmental protection activities.
Under this provision you can apportion an asset that is partly income producing and partly
private.
Circumstances in which Div 40 has no application
4.13
Depreciation assets allocated to a low-value pool.
4.14
Cars whose expenses are substantiated under the 1/3 of actual expenses, cents per km or
12% original value methods.
4.15
Assets whose costs can be written off under other capital write-off regimes, e.g.
(a)
Assets used in research and development – if deductible under those provisions;
(b)
Capital works; and
(c)
Assets associated with investment in Australian films.
What is a depreciating asset?
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4.16
[definition] s 40-30(1) – a depreciating asset is an asset that has a limited *effective life
and can reasonably be expected to decline in value over the time it is used, except:
(a)
Land:
(b)
Improvements or fixtures are treated as if they were separate assets from the
land;
(ii)
Not buildings – these come under capital works provisions;
(iii)
A building may be a depreciating asset where the building can be
characterised as more than a convenient setting for the taxpayer’s operation
and an essential part of the efficient and economic operation of the business
– see Wangaratta Woollen Mills Ltd v FCT: a specifically designed and built
dyehouse was used by a yarn dyeing business).
(iv)
Note - Draft Taxation Ruling TR 2007/D4: if the item “forms part of the
premises”
(A)
e.g. permanently attached to or merged into – it would not generally
be plant – such an item may be plant where it is a definable element
in the service which the business provides and for which its
customers are prepared to pay.
(B)
e.g. sporting memorabilia decorating the bar area of a hotel (such
items retain their separate identity and do not form part of the
premises and would be depreciable as plant
an item of *trading stock:
(c)
4.17
(i)
(i)
an immediate deduction is generally available for the cost of trading stock in
the year when it becomes trading stock on hand.
(ii)
trading stock provisions take precedence over Div 40 – see below.
an intangible asset, unless it is mentioned in subsection (2):
(i)
mining quarrying or prospecting rights/information;
(ii)
items of intellectual property;
(iii)
in-house software (2.5 years 4 years effective life change in budget);
(iv)
more intangible assets are mentioned in s 40-30(2).
All sorts of things:
(a)
Computers;
(b)
Machinery;
(c)
Office furniture;
(d)
Cars etc;
(e)
Library (as a lawyer) – e.g. CLR and the bookshelves.
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4.18
Plant –means the same as depreciating asset and replaces the deduction for depreciation of
plant which was previously available under former div 42:
(a)
However the concept of plant remains relevant to other provisions – see in particular
the cost of plant is excluded form expenditure deductible under the capital works
provisions and is therefore subject to the uniform capital allowance system.
(b)
See Yaramouth v France – defined plant as whether apparatus is used by a business
man for carrying on his business – i.e. the tools of a trade, whether physical or
intellectual (Lindley LJ).
Holding a depreciating asset
4.19
An entity can only deduct an amount for the decline in value for an income year of a
depreciating asset if the entity held the asset during the income year.
4.20
There is a table in s 40-40 which outlines who will be the holder of an asset in specified
circumstances (that is generally the legal owner):
4.21
(a)
There may be exceptions where the economic owner is the owner of the asset.
(b)
E.g. a hire-purchase agreement – lessee will be the owner – the person who bares all
risks and benefits associated with the asset – see TR 05/20.
Note that an entity can only deduct an amount for the decline in value for an income year of
a depreciating asset if the entity ‘held’ the asset during the income year
Deduction for decline in value
4.22
General rules for calculating the decline in value of a depreciating asset – see s40-65.
4.23
There are two choices:
(a)
[diminishing value] s40-70 or s40-72: diminishing value / reducing balance default method – assumes that more value is lost in the initial years e.g. cars.
(b)
[prime cost] s40-75: prime cost / straight line assumes the same value is lost
each year - prime cost - Intellectual property – depreciates at the same rate.
4.24
A depreciating asset starts to decline in value from its “start time” (s40-60(1)) being the time
at which the entity first uses the asset or has it installed ready for use for any purpose
4.25
Taxation Determination TD 2007 / 5: tangible depreciating asset acquired for the sole
purpose of being used in a business that has not yet commenced does not start to decline in
value until the business commences
4.26
A choice must be made by the day a taxpayer lodges its income tax return for the income
year to which the choice relates, or within such further time allowed by the Commissioner –
once made, that choice applies to that income year and all later income years (s40-130)
4.27
A taxpayer may be able to deduct the asset’s cost and therefore not have to choose between
two methods where:
(a)
The asset is used for exploration or prospecting for minerals or quarry materials,
obtainable by mining operations – see s40-80(1); or
(b)
The cost of the depreciating asset does not exceed $300 – s 40-80(2).
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4.28
In certain circumstances, the taxpayer is required to use a particular method rather than
being able to choose – see s 40-65.
Diminishing value method – where asset is first held on or after 10 May 2006
4.29
Depreciation is a good way to encourage businesses to buy things – because you then get a
deduction for it – and make it bigger by increasing it by a certain %.
4.30
[calculation] s40-72(1) – you work out the decline in value of a *depreciating asset for
an income year using the diminishing value method in this way:
‫ ݁ݏܽܤ‬
%
200
365
′ ‫ ݏ‬
4.31
This method allows you to claim $2,000 in the first year – b/c you lose most of your value in
the first few years.
4.32
What you then do is claim your $2,000 and then, your base becomes $8,000 etc – and then
in your next year, you’ll get a $1,600 deduction etc.
Diminishing value method – where asset is first held pre-10 May 2006
4.33
[calculation] s40-70(1) – you work out the decline in value of a *depreciating asset for an
income year using the diminishing value method in this way:
‫ ݁ݏܽܤ‬
4.34
%
150
ᇱ
365
‫ ݏ‬
Here, there is only a speed up of 150%.
Prime cost
4.35
[calculation] s 40-75(1) – you work out the decline in value of a *depreciating asset for
an income year using the prime cost method in this way:
ᇱ ‫ ݏ‬
4.36
%
100
ᇱ
365
ܽ‫ ݏ ݁ݏݏ‬
There are some intangible assets where you are stuck using the prime cost method – e.g.
software licence – this makes sense, b/c it doesn’t depreciate in value in the first year than
what it will in subsequent years – i.e. an even decline in value.
Base value
4.37
For the year in which the start time occurs, the base value is the cost.
4.38
For subsequent years base value means the sum of its opening adjustable value and
any element included in the second element of tis cost for the year – see s 40-70(1).
4.39
(opening adjustable value) means cost less accumulated decline in value from the end of
the previous year.
Asset’s cost
4.40
[work out asset’s cost] s 40-175 – two elements make up the cost of an asset:
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(a)
First – amount paid to hold the asset – see s 40-185 or the market value of the
non-cash benefit.
(b)
Second – amount paid for each economic benefit that has contributed to bringing
the asset to its present condition – see s 40-190(2) – e.g. expenditure incurred to
modify or move the asset.
Effective Life
4.41
[definition] s 40-95 – defines ‘effective life’, the taxpayer must:
(a)
choose the effective life determined by the Commissioner; or
(b)
Self-assess the effective life.
4.42
The ATO puts out TR’s on ‘effective life’ frequently – at present, computers have a 3 year
effective life.
4.43
This allows you to bring forward your deduction – b/c it is an estimate and we need to do a
balancing adjustment at the end.
4.44
Alternatively, the taxpayer may estimate it themselves:
4.45
4.46
(a)
The effective life adopted by a taxpayer must relate to the total estimated period the
asset can be used by any entity for the purpose of producing assessable or exempt
income, of exploration or prospecting, of mining site rehabilitation or environmental
protection activities – see s 40-105.
(b)
Therefore the effective life of the asset may include a period of time even if the
taxpayer expects to dispose of the asset before its effective income-producing life is
over.
Examples of taxpayer estimates:
(a)
According to a manufacturer's specifications, a new photocopier is capable of
producing one million copies before needing to be replaced. When purchased new,
Copy Co expects that, as used in its business, it will produce half a million copies in
two years. It is therefore reasonable to conclude that the copier has an effective life
of four years, even if Copy Co's intention is to sell the copier after two years to
someone else who may use it more or less heavily;
(b)
The operators of a luxury hotel chain refurbish every five years. Carpets and curtains
are scrapped. TVs are sold at auction. If the TVs had continued to be used by the
hotel chain instead of being sold, they would have required replacement after another
two years. The effective life of the carpets and curtains is five years and the effective
life of the TVs is seven years.
Commissioner's determination:
(a)
The Commissioner publishes recommended periods of effective life which taxpayers
may optionally adopt as a safe harbour estimate for a depreciating asset – see s 40100.
(b)
These are generally fairly generous.
(c)
The Commissioner's latest determinations of effective life are contained in Taxation
Rulings.
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(d)
TR 07/3 – explains the methodology used and determinations of the effective life of
depreciating assets.
Example of depreciation
Scenario
•
Ralph purchases machinery for $100,000 on 1 August in year 1. He self-assesses its effective
life to be five years and first uses the asset on 5 September in year 1. The machinery is used
exclusively in carrying on his business.
•
If a taxpayer doesn’t elect one method or the other – it is assumed they are using the
diminishing value method.
Answer: Diminishing value method
•
Assume the asset is a post 9 May 2006 asset.
Year 1:
$100,000
x 365-66
x
200% =
365
•
5
The opening adjustable value in year 2 is $67,233.
Year 2:
$67,233
x 365
x
200% =
365
•
$32,767
$26,893
5
The opening adjustable value in year 3 is $40,340.
Answer: Prime cost method
Year 1:
$100,000 x 365-66
x 100% =
365
Year 2:
$100,000 x 365
5
x 100% =
365
•
$16,383
$20,000
5
Year 3 will be the same as Year 2
Exceptions
Immediate deduction for low-cost assets
4.47
This rule overrides the depreciation rules.
4.48
An asset used predominantly for the purpose of producing assessable income that is not
income from carrying on a business and which has a cost that does not exceed $300 is
deemed to have a decline in value equal to its cost – see s 40-80(2).
4.49
Business assets are not included in this exception but may be subject to pooling – i.e. low
value pooling (see below).
4.50
E.g. last year Kerrie bought a new printer, she’s not carrying on a business, she can use that
rule and get an immediate deduction, even though it is a capital asset.
Low value pools
4.51
[low cost assets] s40-420 – taxpayers may elect to claim deductions for the decline in
value of depreciating assets costing less than $1,000 through a low-value pool – see s 40420 to 40-445) – i.e. you can put them together – and any taxpayer can do this (but
businesses use it most).
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4.52
[low value assets] s 40-425(5) – a low value asset is an asset whose decline in value was
calculated using the diminishing value method – it can also be pooled where its adjustable
value is less that $1,000.
4.53
Note – that this applies regardless of the effective life and there is an unlimited total asset
value in this pool.
Decline in value of a low-value pool
4.54
4.55
The decline in value of a low-value pool for an income year is the sum of 37.5% of:
(a)
The closing pool balance for the previous income year.
(b)
The taxable use percentage of the opening adjustable value of low-value assets
allocated to the pool for that year.
(c)
For assets that have already been there.
Further deductions of half that rate (ie 18.75%) are allowed for the taxable use percentage of
– costs of low-cost assets allocated to the pool during the year.
Car Depreciation Limit
4.56
4.57
A limit is placed on the first element of the cost of cars over a certain price – see s 40-230:
(a)
For cars first held in the 2003/04 to 2006/07 financial years, the limit is $57,009.
(b)
For cars first held in the 2007/08 financial year, the limit is $57,123.
(c)
For cars first held in the 2008/09 financial year, the limit is $57,180.
This means:
(a)
if a car is bought in July 2006 for $60,000, the deduction for the decline in value of
the car is calculated as if the first element of cost were only $57,009.
(b)
if a car is bought in July 2007 for $60,000, the deduction for the decline in value of
the car is calculated as if the first element of cost were only $57,123.
Balancing Adjustments
General principles
4.58
Recall, depreciation is just an estimate – so, what happens if we don’t hold it for the full life –
this is when balancing adjustments come in.
4.59
Balancing adjustments operate to either include amounts in assessable income or to provide
deductions where a balancing adjustment event occurs.
4.60
Balancing adjustment events:
(a)
An entity stops holding a depreciating asset (asset is sold, lost or begins to be held as
trading stock);
(b)
An entity stops using a depreciating asset for any purpose and expects to never use it
again;
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(c)
An entity that has not used a depreciating asset, decides never to use it; and
(d)
An entity changes its interests or holding in a depreciating asst.
Amount of Balancing Adjustment
4.61
4.62
[amount will be included] s 40-285(1) – an amount is included in your assessable
income if:
(a)
a *balancing adjustment event occurs for a *depreciating asset you *held and:
(b)
the asset's *termination value is more than its *adjustable value just before the event
occurred.
[deductions] s 40-285(2) – you can deduct an amount if:
(a)
a *balancing adjustment event occurs for a *depreciating asset you *held and:
(b)
the asset's *termination value is less than its *adjustable value just before the event
occurred.
4.63
(termination value) generally includes the amounts that a taxpayer is taken to have
received under the balancing adjustment event – e.g. cash and non-cash benefits received for
the sale of an asset.
4.64
Note – the following additional information:
(a)
[CGT consequences] s 118-24 – if a depreciating asset is used wholly for taxable
purposes this generally creates a balancing adjustment and there are no capital gains
tax consequences.
(b)
[apportionment] s 40-290 – if not used wholly for taxable purposes, the balancing
adjustment is reduced by the proportion of the use that is for non-taxable purposes.
(c)
Where the balancing adjustment is reduced to take account of the use of the
depreciating asset for non-taxable purposes, CGT event K7 may happen at the time
of the balancing adjustment event.
Example of depreciation and balancing adjustments
Scenario
•
A depreciating asset purchased on 1 July Year 1 for $3,000 was scrapped on 31 March Year 4
when its residual scrap value at market price was $600.
•
Its decline in value was calculated using the prime cost method over five years.
Answer
Cost
....................................$3,000
Less: full decline in value for Year 1,
Year 2, Year 3 and nine months for Year 4 .............. ...
2,250
Adjustable value at 31 March Year 4
............................... .....
750
Less: scrap value
.....................................
600
Balancing deduction
..................................
$150
•
Thus, in Year 4, the taxpayer can claim a total deduction of $600, ie nine months decline in
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Example of depreciation and balancing adjustments
value ($450) and a balancing deduction ($150).
Example of depreciation and balancing adjustments
Scenario
•
A depreciating asset purchased on 1 July Year 1 for $4,000 was sold for $2,600 on 31
October Year 4.
•
Its decline in value was calculated under the diminishing value method over five years.
Answer
Cost
....................................$4,000
Less: Year 1 decline in value
......................................1,200
Opening adjustable value Year 2
......................................2,800
Less: Year 2 decline in value
...................................... 840
Opening adjustable value Year 3
......................................1,960
Less: Year 3 decline in value
...................................... 588
Opening adjustable value Year 4
......................................1,372
Less: Decline in value for four months to 31 October Year
Adjustable value at 31 October Year 4
....................
.................... .... 139
............ ......$1,233
•
Thus, in Year 4, a deduction of $139 is allowed for the decline in value of the asset and a
balancing adjustment of $1,367 (ie $2,600 - $1,233) is assessable or otherwise offset.
Note that the diminishing value method rate is 200% (rather than 150%) if the asset started
being held on or after 10 May 2006.
•
If for some reason we have an asset that in fact appreciates in value – you do not go to the
CGT provisions.
Black hole expenditure
4.65
[allows deduction] s 40-880 – (applies after 1 July 2005) allows a deduction over 5 years
for certain business capital expenditure that would not otherwise be deductible – the
expenditure must not be already deductible, capitalised, amortised or capped in some way
under another provision this is a last resort.
4.66
[note exceptions] s 40-880(1) – the expenditure will be deductible over 5 years, only if:
4.67
(a)
It is not already taken into account;
(b)
A deduction is not denied by some other provision of the income tax law; and
(c)
The business is, was or is proposed to be carried on for a taxable purpose – note s
40-25(7) above.
For a business to be proposed to be carried on, the taxpayer must demonstrate a
commitment to commence the business s 40-880(7) provides guidance on the level of
commitment required – e.g. it is proposed to carry on the business within a reasonable time
(this can be demonstrated by a business plan, establishment of premises or capital
investment in business assets)
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4.68
[exclusions] s 40-880(5) specifically excludes certain amounts from being deductible – see
also s 40-880(9).
4.69
These are generally incurred at a point too soon – these used to be called black hole
expenditure because you lost the benefit of them – i.e. not capital (and couldn’t include them
as a cost base) – but they didn’t satisfy general or specific deductions.
Capital works
4.70
Div 43 – provides deductions for expenditure on income-producing buildings and other
capital works – depends on the date, it can be either 2.5% or 4% - see s 43-25.
4.71
This includes a wide range of structures, and extensions and alterations and improvements to
structures. They can be divided into three categories:
4.72
(a)
Buildings;
(b)
Structural improvements; and
(c)
Environmental protection earthworks – see s 43-20.
Note – that land is not included (see above).
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Topic 6
Tax accounting and trading stock
5
Introduction
5.1
This topic deals with issues to do with tax accounting that are different to usual accounting
practices:
(a)
the tax period;
(b)
timing of income;
(c)
timing of deductions; and
(d)
trading stock.
5.2
Each will be examined in turn.
6
Period and timing issues
The tax period
6.1
6.2
6.3
6.4
The tax year generally runs:
(a)
1 July to 30 June; and
(b)
This year is the 08-09 year.
[accounting period] s 18 ITAA36 – the taxpayer can apply to the commissioner for a
substituted accounting period:
(a)
This is not about convenience, rather, there must be a valid reason for applying nor is
it about saving tax;
(b)
Leave to adopt a substituted period will be granted only in special circumstances and
is restricted to business taxpayers (particularly company tax payers);
The test – see IT 2630– this is so, provided there is a substantial business need – see for
example:
(a)
An Australian subsidiary with a foreign parent, which operates under a different tax
period; or
(b)
If you have stock on hand at the end of a year, you need to conduct a stocktake –
e.g. primary production, it is very difficult b/c the stocktake may extend over several
months and it’s difficult to know when to run your tax period – i.e. cattle season is
April – November, therefore difficult to account in June.
The only other time leave may be granted is where there is a serious distortion – i.e.
expenses are all in 1 financial year, but the revenue is all in another.
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Timing of income
Introduction
6.5
[applicable to ordinary income] s 6-5 – only s 6-5 talks about income being derived,
statutory income provisions talk about income being – received, arises, and payable to you.
Therefore, these sections only apply to ordinary income.
6.6
This explains when income is derivied – because, that is the point when it is assessable –
see s 6-5.
6.7
‘Derived’ is not defined in the ITAA97 or ITAA36 (despite being referred to in Div 6): must
reflect the taxpayer’s true income – Carden’s Case:
6.8
(a)
Court talked about the timing of the income, when you recognise the income as being
a correct reflex of the taxpayers situation;
(b)
We care about when it is derived because we account for tax on a fixed accounting
period, so we need to work out what income and deductions fall within that period –
i.e. whether it is assessable income for the 08-09 year.
When defining the meaning of ‘derived’ the courts have applied two alternative accounting
methods:
(a)
The cash basis – when you actually get the money, that’s when you derived it:
(b)
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(i)
Used by most individuals;
(ii)
Income is in the year it is actually or constructively received (see above);
(iii)
May be in the form of cash or its equivalents (see above);
(iv)
It is also referred to as receipts basis;
(v)
If you work in year 1 and are paid in year 2 you are actually paying tax at a
later date – i.e. how wages work;
(vi)
The alternative is to hang onto cheques to bank in July, so you don’t have to
pay tax on them until the next year – or, you madly pay expenses in June so
that you can deduct them – but note:
(A)
See Tilley v the Officer Receiver – the handing over of a cheque is
regarded as payment; and
(B)
See Ulrick v Inland Revenue Commissioner – cannot avoid derivation
of income by not banking the cheque
The accruals basis – or an earnings basis – this is not when you’ve received it, but
rather, when the right to receive it comes into being:
|
(i)
This is when the right to receive the money comes into being;
(ii)
It is also referred to as earnings basis;
(iii)
Works in progress are not taken into account;
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167
(iv)
Rather it is when all of the events have occurred – e.g. when good are sold,
delivered, and/or when services are rendered.
Salary and wages, interest, and rent
Salary and wages are derived when received – see Brent v FCT:
6.9
(a)
This applies when derived for current or past purposes – i.e. back pay, retrospective
award increases – these will be assessed in the year you actually receive them example:
(b)
6.10
(i)
Kerrie does work in June, in year 1;
(ii)
She gets paid, in July, in year 2;
(iii)
That income is assessed on 1 July in year 2 – because that is when it is
received.
Note – you cannot defer pay by attempting to hold a cheque, it will be assessed when
you received the cheque – see Case D62.
Interest is derived when received or credited – see TR 98/1, there are exceptions:
(a)
Interest from business of money lending carried on by taxpayer;
(b)
Interest derived by a finical institution;
(c)
Interest from the everyday provision of credit,
These are assessed on an accruals basis – see Australian Guarantee Corporation – banks and
other financial institutions accrue income.
6.11
Rent is derived when it is received.
Income from professional practices
6.12
This is a little more complicated, as it is no longer an employer/employee relationship.
6.13
See TR 98/1 (applicable to all sources of income) – weigh up the relevant factors:
6.14
(a)
Size of business – smaller the business the more likely it will be on a cash basis;
(b)
Circulating capital and consumables;
(c)
The use of capital items to produce income – indicates an accruals basis;
(d)
Credit policy and debt recovery; and
(e)
Books of account – what is your accountant doing?
Note that this is not always clear, so the cases can assist and also – note with partnerships,
when a new partner comes in, there is a new partnership created.
Carden’s Case (1983) 63 CLR 108
Facts
•
Dr Carden had his own practice and no one else worked with him.
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Carden’s Case (1983) 63 CLR 108
•
He always recognised his income on a receipts basis.
•
He then died – the issue arose for the FCT that potentially some income would fall through
the cracks, unless he changed to an accruals basis.
Held – HCA (Dixon J)
•
The Court said the Dr should have been using the cash basis, but then it was ok for the FCT
to change to the accruals basis for assessing the personal representative, after the Dr’s
death.
•
The Court said it was ok to change, because, before the death the fees were based on the
Dr’s personal services – i.e. what he did that earned the money.
•
When it became an issue for the estate, the money earned was part of the capital assets
(money) of the estate – thus, the nature actually changed.
•
Dixon J: we use the account method that yields ‘a substantially correct reflex of the
taxpayer’s true income’
•
The Court outlined the following considerations:
o
the nature of the profession concerned; and
o
the actual mode in which it is practised.
FCT v Firstenberg (1976) 6 ATR 297
Facts
•
The Commissioner sought to assess a solicitor who practised as a sole practitioner on an
accruals basis.
•
The solicitor had always operated on a cash basis, which means some income was deferred
(potentially) – but an accruals basis brings it forward to the date when the bills are sent out.
•
The FCT said professional practice should be working on an accruals basis.
Held
•
The FCT lost, the Court found for the taxpayer – it is a question of fact in each case.
•
The Court stressed that for a 1 man practice that person is earning the fees, so they derive
the income when it is actually received.
•
Forcing him to run his tax on an accruals basis would be unduly burdensome and a 1 man
practice is not much different to being a salary earner.
•
He is much more likely to have circulating capital.
•
The Court held that in the case of a one-person professional practitioner, the essential feature
of income “derived” was “receipt”.
•
Here, note that it was a solicitor’s firm, but the size of the firm that was determinant (and
there were precedents suggesting that accruals are appropriate for firms).
Henderson v FCT (1970) 119 CLR 612
Facts
•
This involved a large firm of accountants – there were 19 partners and 295 employees.
•
The taxpayer was a partner in a firm of accountants which had lodged its returns on a cash
basis.
•
Wanted to change to accruals/earnings basis, but in this case, the FCT said it should be
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Henderson v FCT (1970) 119 CLR 612
earned on an accruals basis.
•
The FCT didn’t want this to happen, because, there would be a gap in the tax:
•
This meant that amounts billed in the 64-65 year but received in the 65-66 year would escape
taxation.
o
Year 1 tax on cash basis – therefore, some bills will be sent out, but money not paid
till the next year;
o
Year 2 tax on accrual basis – those bills sent out in Year 1 would become tax-free
(because they were accrued in a previous tax year).
•
The FCT argued that he should continue to work on a cash basis, or if, in the year there was
a change, they should be able to take into account the lost amounts.
•
Neither of the taxpayers arguments work – the FCT failed and the Court said they should
change.
Held
•
•
•
•
HCA that the correct method was the accruals basis
Stated that only fees which have matured into recoverable debts should be included as part
of earnings
Held that accruals would have been appropriate for 64-65, but as the return could no longer
be reopened, they amounts could not be assessed
Consequence:
o Yr 1: cash basis issuing invoices that would otherwise be included in year 2’s
income
o Yr 2: accruals basis so the only assessable income is that which was invoiced in year
2
o Effect: invoices issued in year 1 that is received in year 2 escapes taxation
Income from business
6.15
This is business, business, i.e. buying and selling goods (e.g. widgets).
6.16
Generally, the accruals basis is appropriate – it is unlikely to work on a cash basis. However,
there is the proviso that there must be a recoverable debt – the bill must have been sent out
– see FCT v Australian Gas Light Co (1983) (FCA):
FCT v Australian Gas Light Co (1983) FCA
Facts
•
Company manufactured and supplied gas to domestic customers.
•
This was done on the basis of the units recorded on the metre.
•
They sent out bills quarterly to customers after reading the metres.
•
They had some customers who had quarters which ran across two years – i.e. gas received in
year 1, bill sent out in year 2.
•
The taxpayer didn’t take into account supplies that were made before June 30 that hadn’t
been billed yet.
•
FCT assessed the taxpayer on the basis that it had derived income from the sale of gas
delivered prior to the end of the year, even though no invoice had been issued to the
customers.
Held – FCA
•
The FCT lost – the TP argued it didn’t derive income until it invoiced the customers, even if it
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FCT v Australian Gas Light Co (1983) FCA
had provided the goods
•
It was held that no debt or obligation on the part of the consumer arose until the metre had
been read, and an account based on that metre reading had been sent out.
•
Appeal to the FCFCA was rejected. Special leave was refused by the HCA.
Pre-paid income
6.17
This is the situation where goods or services have been paid for, but they have not been
provided. This is also known as advanced income/payments.
6.18
This only applies to the accruals basis.
6.19
Where the income is subject to a contingency there may be the deferral of the recognition of
that income: Arthur Murray v FCT (1965) 114 CLR 314:
Arthur Murray v FCT (1965) 114 CLR 314
Facts
•
Arthur Murray was a dance studio and it involved dance lessons.
•
You paid for a block of dance lessons, and the k said you wouldn’t get a refund if you missed
any of the lessons/pulled out.
•
However, as a general practice they would refund, because they paid money into an
unearned income account – from which refunds were given.
•
However, the FCT argued all income should be treated as assessable whether it had been
applied as income or not.
Held – HCA
•
Found for the taxpayer – it was not all assessable – the key was the separate account (they
didn’t treat it as earned until the lesson actually took place).
•
The amounts received for services to be given in future years were not earned until the
services were actually discharged – i.e. until the lesson took place without refund.
•
The Court said you should only take into account the income that had actually been earned,
and that was, after the lesson had occurred.
•
The fact that the taxpayer had the separate account and treated the amount separately – see
TR98/1 – looks at the keeping of the accounts.
6.20
Where would this apply now? – Kerrie thinks magazine subscriptions and the money would be
transferred monthly into their earnings – see for example Country Magazine.
Deemed derivation
6.21
s 6-5(4) and s 6-10(3):
(a)
You are taken to have derived the income as soon as it is applied or dealt with in any
way on your behalf or as you direct
(b)
“Doctrine of Constructive Receipt” – e.g. if you direct it to be paid to someone
else to pay your bills – this is still income derived to the taxpayer.
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Examples
6.22
6.23
Keith – the handyman:
(a)
Keith is a handyman who contracts with people to do a variety of jobs including
repairing fences, fixing household items and small painting jobs. As part of this work,
Keith is occasionally required to supply materials such as wood, nails and paint.
(b)
Keith accounts for the income from the receipts basis.
(c)
The materials purchased and used by Keith do not significantly contribute to his Y.
Keith is not considered to rely, to a sig degree, on circulating K or consumables to
produce Y. Keith’s Y is considered to be derived from his services or personal efforts
(d)
It is considered that, for the purposes of tax, a substantially correct reflex of Keith’s
business income is given by use of the receipts method
Tammie – the dentist:
(a)
Tammie is a dentist who runs her own practice. Tammie employs another qualified
dentist, Brian, two full time dental assistants and one full time receptionist/secretary.
Although the majority of the patients who attend the practice are seen by Tammie,
Brian performs work independently of Tammie and the income Brian generates is
significant.
(b)
The equipment Tammie owns and uses in her business includes expensive and
specialised dental chairs, drills and an X-ray machine. While Tammie requests
patients pay at the time of each consultation, she regularly allows credit to patients
and sends a reminder of the amount outstanding where necessary.
(c)
Relevant factors are:
(d)
(i)
The income generated by Brian is significant;
(ii)
Tammie relies on capital items, i.e. the equipment she owns and uses in the
business; and
(iii)
She extends credit and has procedures for the collection of debts,
It is considered that, for purposes of tax, a substantially correct reflection of
Tammie’s business income is given by use of the earning method.
Timing of deductions
Introduction
6.24
[incurring of deductions] s 8-1 – the timing of deductions is generally governed by when
an expense is ‘incurred’ under s 8-1.
6.25
The meaning of incurred differs from the meaning of derived – the Courts have interpreted
incurred differently to how they have interpreted derived, 2 situations:
(a)
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A taxpayer makes a payment for an outgoing during the income year – this is
straightforward – i.e. you’ve paid it and it’s a deduction; or
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(b)
A taxpayer has not made a payment for an outgoing during the year – this is more
contentious – it will still be a deduction whether on a cash or accruals basis – see
Citilink.
TR 97/7 - Summary
6.26
6.27
The Commissioner states the following general rules which are regarded as settled by case
law:
(a)
a taxpayer need not actually have paid any money to have incurred an outgoing
provided the taxpayer is definitively committed in the year of income. It must be a
presently existing liability to pay a pecuniary sum;
(b)
a taxpayer may have a presently existing liability, even though the liability may be
defeasible by others
(c)
a taxpayer may have a presently existing liability, even though the amount of
the liability cannot be precisely ascertained, provided it is capable of
reasonable estimation (based on probabilities);
(d)
whether there is a presently existing liability is a legal question in each case,
having regard to the circumstances under which the liability is claimed to arise;
(e)
in the case of a voluntary payment (where the money ceases to be the taxpayer's
funds) a presently existing liability is not required, and the expense is incurred
when the money is paid.
As long as the taxpayer has committed themselves to the liability – the taxpayer will usually
get a deduction.
FCT v Citylink Melbourne Ltd (2006) 62 ATR 648
Facts
•
Fairly complex set of facts.
•
The TP entered into an agreement with the Vic, which provided them with a lease of land on
which they constructed a freeway and had the right to charge tolls.
•
The life of the agreement was no more than 53.5 years, at which time the infrastructure
would be transferred to State ownership.
•
In return for these rights, the TP payed a $100 token rental charge per year and a ‘base
concession fee’ of $95.6m per year for the 1st 25 years sliding down to a much smaller
amount after year 35.
•
An additional fee was payable if the profits exceeded a modelled expected return.
•
Said that TP could satisfy the obligation by issuing a non-interest bearing debt notes at face
value.
•
The agreement provided for variable redemption dates based on a number of contingencies.
•
As a result of the contingencies, the payment dates were deferred for more than 3 decades.
•
Evidence indicated the present value of the notes was an incredibly small amount of the face
value.
•
TP claimed a deduction in the years in which the notes were issued – argued they didn’t have
to wait until they paid them.
•
Com argued they were capital amounts relating to the TP obtaining a monopoly, or
alternatively, capital outgoings akin to form a profit distribution (failed on this point).
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FCT v Citylink Melbourne Ltd (2006) 62 ATR 648
•
Com argued in the alternative that they weren’t incurred in the year the notes were issued,
but only when the obligation to make the payments crystallised (so in 30 years) (failed
again).
Held – HCA
•
HC Held the amount were revenue in nature as they referred to the TP’s right under the
contract in the year in which the notes were issued.
•
Held that the TP incurred the face value of the notes in the year they were issued as the TP
has subjected itself to the obligation in that year.
•
The obligations were also referable to those years as the liability to pay the fees arose in
those years and this conclusion was not affected by the fact that actual payment would occur
many years in the future.
•
A taxpayer who satisfied a revenue payment obligation by issuing a debt note payable in the
future received an immediate deduction – despite the fact that the debt may not have been
paid for up to 35 years.
•
NB – no similar cases since Citylink.
•
It came down to being good contract lawyers – gave huge deductions without paying
anything out.
•
NB – the govt in 2006 proposed ‘taxation of final arrangements’ legislation, which would treat
amounts as present values, rather than the nominal values – Mitchell doesn’t think this was
ever passed.
Prepaid Expenses
6.28
A prepaid expense is expenditure incurred that will cover periods in a later tax year(s), either
in whole or part. For example business lease payments.
6.29
Not immediately deductible. If expenditure satisfies the requirements of s 8-1 it will be
apportioned over the eligible service period, or 10 years if that is less.
6.30
Expenditure is immediately deductible if:
6.31
6.32
(a)
It is excluded expenditure.
(b)
The 12 month rule applies.
Excluded expenditure:
(a)
Amount is < $1,000
(b)
Payment of salary or wages
(c)
Payments under a court order of a law of the Commonwealth, State or Territories
(d)
Amounts of capital expenditure – NB dealt with under Div 40.
12 month rule, you need to have:
(a)
A Small Business Entity and non-business taxpayers.
(b)
Immediate deduction for full amount if period is does not exceed 12 months.
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(c)
6.33
7
Everyone else must apportion it – i.e. you can’t pay ten years of rent in year one and
then claim the full deduction.
Example of the 12 month rule:
(a)
Tom Pty Ltd is an eligible small business entity.
(b)
On 31 May 2007, it paid $15,000 for business advertising to cover the period 01 July
2007 to 30 June 2008 (396 days).
(c)
Because the eligible service period is longer than 12 months, the prepayment does
not satisfy the 12 month rule.
(d)
Tom Pty Ltd cannot claim an immediate deduction for the prepayment.
(e)
Instead the deduction for the expenditure must be apportioned over the eligible
service period as follows:
(i)
2006-07 = 15,000 x (30/396) = $1,136;
(ii)
2007-08 = 15,000 x (366 / 396) = $13,864.
Trading stock – Division 70
General principles
What this division is about?
7.1
This division provides for a matching principle – i.e. it matches up trading stock purchased
with trading stock sold – this is done through a surrogate formula and you don’t have to
actually follow the particular item.
7.2
[rationale for the division] s 70-1 – this Division deals with amounts you can deduct, and
amounts included in your assessable income, because of these situations:
(a)
you acquire an item of trading stock;
(b)
you carry on a business and hold trading stock at the start or the end of the income
year;
(c)
you dispose of an item of trading stock outside the ordinary course of business, or it
ceases to be trading stock in certain other circumstances
3 key features of tax accounting for trading stock
7.3
[purpose to produce result] s 70-5 – the purpose of income tax accounting for trading
stock is to produce an overall result that properly reflects your activities with your trading
stock during the income year.
7.4
There are 3 key features:
(a)
You bring your gross outgoings and earnings to account, not your net profits and
losses on disposal of trading stock.
(b)
Those outgoings and earnings are on revenue account, not capital account. As a
result:
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(c)
(i)
the gross outgoings are usually deductible as general deductions under
section 8-1; and
(ii)
the gross earnings are usually assessable as ordinary income under section 65.
Surrogate formula – you must bring to account any difference between the value
of your trading stock on hand at the start and at the end of the income year – i.e.
ensures you don’t buy a big amount of stock and not sell it to get a deduction.
What is “trading stock”?
7.5
Before we can value trading stock, we need to know what it is.
7.6
[broad definition] s 70-10, defines it broadly:
(a)
anything produced, manufactured or acquired that is held for purposes of
manufacture, sale or exchange in the ordinary course of business; and
(b)
live stock – see s 995-1 – does not include animals used as beasts of burdem,
working beasts in non-primary production,
i.e. it depends on the type and scope of the business – sometimes land can be trading stock
(i.e. a property developer) or shares can be trading stock (i.e. a stockbroker) – therefore,
sometimes trading stock is capital and sometimes income.
7.7
Keep in mind that this in an inclusive definition, so you take the ordinary meaning and add to
it anything in the definition.
7.8
Suttons motors – this was decided pre Div 70 – the meaning of the term upon which s 6(1)
ITAA36 builds is “that which is attributed to it by legal and commercial people for accounting
and other purposes”
The taxpayer’s purpose
7.9
The trading stock must be held for the purpose of manufacture, sale or exchange in the
ordinary course of business
7.10
This is a change from the ITAA36 which focused on why the property was acquired:
7.11
(a)
NB we care so much because if it is trading stock, it gets taken into account if we still
have it at the end of the year, whereas if it’s not, we get a deduction for its purchase
and we don’t have to worry about it – i.e. we generally don’t want things to be
trading stock, because if it is, you have to do an adjustment
(b)
Examples are taken from relevant TRs on this issue.
Example 1 – TR 98/7 – Tay Ke Way operates a fast food outlet. Tay provides, with the
take-away food which she sells in plastic containers with lids, some disposable cutlery, a
paper serviette and a refresher towel:
(a)
Plastic containers and lids are trading stock – they are needed to sell the goods;
(b)
But, disposable cutlery, paper serviettes and refresher towels are not trading stock,
these are held for a purpose ancillary to the business.
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7.12
7.13
7.14
Example 2 – TR 98/7 – Lighthead Ltd carries on a brewery business. Lighthead's beer
emerges from the production line in cans secured in six-packs bound in plastic binding and
packed in cardboard cartons of 24 cans. The cartons of beer are stored in this form for sales
to Lighthead’s customers:
(a)
The cans, plastic binding and cartons are acquired by Lighthead for use in the course
of the beer manufacturing process.
(b)
These items are acquired for purposes of either manufacture or sale in the ordinary
course of Lighthead's business and are 'trading stock' of the brewery.
(c)
If it is Lighthead's normal business practice to deliver cartons of beer to retail outlets
on shrink-wrapped, non-returnable pallets, the pallets and shrink-wrap plastic are
trading stock.
Example 3 – TR 98/8 – A1 Master Plumbing Services holds at all times a stock of PVC
pipes, elbow joints, tap washers, glue, etc., to repair customers' burst water pipes, down
pipes, drains, etc:
(a)
The PVC pipes, elbow joints and tap washers are trading stock. They are disposed of
by A1 Master Plumbing Services to its customers in the course, and as an essential
part, of performing its plumbing services and the pipes, elbow joints and tap washers
retain their individual character or nature.
(b)
The glue, on the other hand, is not trading stock. It is a consumable store because it
is destroyed or expended by use by A1 Master Plumbing Services in carrying on its
business and property in the glue does not pass, as glue, to customers.
Example 4 – TR 98/8 U-Bent-It panel beaters purchased replacement side panels, doors
and paint on 29 June 2006 for repair of a motor vehicle. No repair work had commenced on
the vehicle as at 30 June 2006:
(a)
Side panels and doors are trading stock – i.e. essential part of performing the
services and will be disposed of by U-Bent-It to its customers in the course of, and as
an essential part of performing its services.
(b)
Also the side panels and doors retain their individual character or nature.
(c)
The paint is not trading stock because when it is used in undertaking the repair of the
vehicle, the paint will no longer be in the same essential form, state or condition as it
was when it was held by U-Bent-It.
Division 70 & tax accounting
7.15
[income from trading stock] s 6-5 – sales of trading stock are assessable as income
(obviously, in the course of business etc)
7.16
[deductions from trading stock] s 8-1 – the cost of acquiring trading stock is deductible
(i.e. like any other expenditure)
7.17
[making of the adjustment] s 70-35 – the question for this topic is when is the
adjustment made:
(a)
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s 70-35 (2) – where the value of closing stock exceeds opening stock the difference
is included in assessable income:
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(b)
7.18
(i)
This is the situation where more stock is purchased than sold, so we get a
bigger deduction than we should have.
(ii)
Rather than reducing the deduction, it requires some of it to be included back
in income to reduce the size of the deduction.
s 70-35(3) – where the value of opening stock exceeds closing stock the difference
is included as an allowable deduction:
(i)
This deals with the opposite situation, where the difference is included as an
allowable deduction.
(ii)
Thus, a deduction is allowed again in the year it is actually sold.
[roll-over] s 70-40 – the closing value for one year becomes the opening value for the next
year – roll the value over from one tax year to the next.
Worked example
•
Year 1
o
Opening stock = $0
o
Purchases = $10,000
o
Sales = $0
o
Closing stock = $10,000
The increase in trading stock of $10,000 (from $0 to $10,000) is assessable and the purchase of
$10,000 is deductible and therefore the net tax effect is nil.
•
Year 2
o
Opening stock = $10,000
o
Purchases - $0
o
Sales = $15,000
o
Closing stock = $0
In the second year all the stock is sold and none is purchased. This means that the decrease of
$10,000 in trading stock (from $10,000 to $0) is deductible and the sales of $15,000 are assessable
giving rise to $5,000 assessable income.
When is a deduction available?
7.19
The stock does not actually need to be on hand, so long as the taxpayer has the power to
dispose of the goods – see All States Frozen Foods Pty Ltd:
All States Frozen Foods Pty Ltd
Facts
•
Taxpayer had goods being shipped in from overseas.
•
Price had been paid and had bills of lading – which he could have on-sold (as they are
negotiable instruments of title).
•
Hence the Taxpayer had the risk – i.e. if the goods had perished at sea.
•
Physical delivery did not occur until the next financial year.
•
The TP claimed the deduction but argued it wasn’t on hadn and didn’t have to be taken into
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All States Frozen Foods Pty Ltd
account until the goods were available for sale – i.e. in the following year.
Held
•
These were still held to be trading stock on hand – title had been passed (i.e. when he
received the bill of lading) – this was so notwithstanding there was no physical possession.
•
Physical possession was not as important as dispositive power over the goods.
7.20
See also – IT 2670 – trading stock is on hand when the taxpayer is in a position to dispose
of the stock on its own behalf.
FCT v Suttons Motors
Facts
•
TP’s role was to be the wholesale purchaser of vehicles from the finance company to the
parent co, who arranged the sale to retail customers.
•
Under a ‘floor plan’, the finance Co retained title to vehicles delivered to the TP, which stored
vehicles at the showrooms of SM, the retailer.
•
When SM entered into a contract to sell a car, the TP entered into a purchase contract with
the finance Co and paid for the vehicle.
•
One effect of this arrangement was that the liability to pay sales tax was deferred until the
vehicles were sold to final customers.
•
The issue was whether the TP was entitled to a deduction under the former s 82D ’36 which
turned on whether the vehicles were trading stock on hand.
Held
•
The vehicles were trading stock on hand when they were delivered to the TP although title
hadn’t passed.
•
Although the parent co wasn’t obliged to buy the cars, it was entitled to and was under a
commercial obligation to do so.
•
it is possible for stock to be held on paper so long as it is available to be sold or exchanged in
the ordinary course of the trade of a business.
Valuation of trading stock
7.21
The act does not prevent you from using a different method for valuing trading stock each
year.
7.22
[values to use] s 70-45 – this gives you the values – you must elect to use:
7.23
(a)
Cost – IT2350: absorption costing method is the correct means of ascertaining the
cost of trading stock on hand at the end of the year in a manufacturing business.
LIFO is not acceptable for taxation purposes;
(b)
Market selling value – Australasian Jam Co v. FCT - 'market selling value' means
the amount which will be realised in the company's own selling market in the ordinary
course of business; or
(c)
Replacement value – the price at which the taxpayer can replace the goods on the
last day of the year of income.
If you want to minimise tax, you are going to go with the lowest value:
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(a)
You don’t want stock on hand at the end of the year, because you have to write it
back in.
(b)
This is why businesses have sales before 30 June so that they can be low on stock –
but they do earn income when they sell it.
7.24
[equal value] s 70-40 – The value of an item at the beginning of a year must be the same
value as that adopted at the end of the preceding year – you can’t revalue it after close of 1
year.
7.25
[value below the above] s 70-50 – allows you to value below the other circumstances in
s 70-45 – you may value an item of your trading stock below all the values in s 70-45 if it is
warranted because of obsolescence or any other circumstances relating to that item if the
value you elect is reasonable:
(a)
Some books say that this is superfluous;
(b)
Kerrie disagrees, things may still have a market value but are not useful to the Co;
(c)
e.g. goods past their expiry dates – e.g. maintaining brand reputation – so you throw
them out, despite their potentially being a market;
(d)
What do you do if no-one wants a particularly design of jeans – someone will
probably pay – but in order to maintain a reputation, the Co may throw them out.
Transactions outside the ordinary course of business
Extraordinary disposals
7.26
This applies where you give away trading stock, or sell it at a heavily discounted price – it is
effectively an anti-avoidance provision – you are made to include the market value of the
goods.
7.27
[inclusion in assessable income] s 70-90(1) – if you dispose of an item of trading stock
outside the course of a business your assessable income includes the market value of the
item on the day of disposal:
7.28
(a)
This is where you sell it to a friend for half price;
(b)
This is where you donate the item to a local school;
(c)
All these things are outside the ordinary course of business, but it will be deemed to
be sold at market value – but will not be included as assessable income;
(d)
You will get a deduction if it is disposed to a DGR.
[amount received not included] s 70-90(2) – any amount you actually receive for the
disposal is not included in assessable income.
Starting to hold as trading stock an item already owned
7.29
This is the situation where you hold an item as trading stock (e.g. a car) and then you change
it to be capital and vice-versa.
7.30
[owned item becomes trading stock] s 70-30 – if a taxpayer starts holding as trading
stock an item which he/she already owns but does not hold as trading stock, the taxpayer is
treated as if just before the item became trading stock, the taxpayer has sold it to someone
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180
else for whichever the taxpayer elects of the item's cost or market value, and the taxpayer
bought it back for the same amount:
(a)
This is a pretend 3rd party situation – you pretend that the item has been sold to you;
(b)
E.g. used car yard – the car yard has its own car which it uses to do various business
things – this is not trading stock, rather a capital asset – it will be depreciated under
Div 40 – you then stick it in the car yard to sell and it becomes trading stock – for tax
purposes, you pretend it was sold and bought back (at cost or market value) – a
balancing adjustment is done under Div 40 – and it is gone from our asset register.
(c)
A full deduction is then available under s 8-1.
Ceasing to hold an item as trading stock
7.31
[trading stock becomes capital] s 70-110 – the taxpayer is treated as if he/she had sold
the item to someone else for its cost and immediately bought it back for the same amount –
to be used as capital:
(a)
Here, is the situation where an item of trading stock is taken to be used as a capital
asset;
(b)
Here, you will be treated as having sold the item at cost and bought it back for the
same amount;
(c)
The selling is income under s 6-5, but the buying back is a capital asset which can
then be depreciated under Div 40.
Private use example
7.32
It is not always the case that it ceases to be trading stock and starts to be a capital asset:
(a)
A milk bar proprietor took stock costing $1,100 for her own use. The market value of
this stock was $1,450.
(b)
This falls within s 70-110 – and the taxpayer would be treated as disposing of stock
at its cost and immediately reacquiring it at cost – the buying back is not a capital
asset, and therefore cannot be depreciated.
(c)
Therefore, there would be a disposal of stock for $1,100 and the proprietor would be
assessed on this amount as income.
Gift example
7.33
A father made a gift of 50 cattle, which had cost $10,000, to his son to help increase his son's
herd. At the date of the gift the cattle had a market value of $17,500.
7.34
The gift is not in the ord course of trading, so s 70-90 will apply a market value even though
the father received no consideration – thus, he is assessable on the $17,500.
7.35
But, how would you be picked up for this by the FCT?
(a)
Kerrie was reading an example of a plumber dealing in cash, and not putting it in as
income – and he was issuing receipts.
(b)
The FCT was successful in increasing his taxable income by $102,000 – the guy had
to pay 75% penalties – and he worked it out by obtaining bank accounts.
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Topic 7
Tax offsets, tax payable and tax administration
1
Tax payable
General principles
The formula
1.1
Where taxable income is defined as:
Tax payable
1.2
Represents the net amount of tax to remitted to the ATO by a taxpayer (assuming the net
amount is positive).
1.3
Tax payable is final element of the taxation process.
1.4
If after the application of taxation process, we determine that the net amount of tax is a
negative, then this will amount to a refund and the taxpayer will be owed money by the ATO
1.5
It is not until the ATO issues a tax assessment that tax will be payable – and from there, tax
payable is calculated.
Tax rates
1.6
These are found in the Income Tax Rates Act – we have a progressive system so tax is based
on the ability to pay.
1.7
This is where the difference between a marginal rate of tax and an average rate of tax
kick in.
Tax rates of resident individuals – see Income Tax Rates Act
Taxable income
Tax on this income
$0 – $6,000
Nil
$6,001 – $34,000
15c for each $1 over $6,000
$34,001 - $80,000
$4,200 plus 30c for each $1 over $34,000
$80,001 – $180,000
$18,000 plus 40c for each $1 over $80,000
Over $180,000
$58,000 plus 45c for each $1 over $180,000
NB – under the recent budget, the 40% bracket was to be reduced to 38% - this will kick in over the
next few years – the goal of this is to work towards eliminating the 40% bracket.
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Tax rates of foreign individuals – see Income Tax Rates Act
Taxable income
Tax on this income
$0 – $34,000
29c for each $1
$34,001 - $80,000
$9,860 plus 30c for each $1 over $34,000
$80,001 – $180,000
$23,660 plus 40c for each $1 over $80,000
Over $180,000
$63,660 plus 45c for each $1 over $180,000
Note – there is no tax-free threshold and no 15% bracket.
1.8
Recall – companies pay a flat rate of 30%.
PAYG – pay as you go
1.9
Replaced collection mechanisms such as PAYE, and provisional tax – note that businesses,
depending on the size may have to remit the tax monthly, quarterly or yearly.
1.10
Requires the payment or withholding of amounts from taxpayers income at regular intervals
throughout the year it is earned.
1.11
Note – this is not your final liability – it has to be adjusted at the end of the financial year
via a refund/payment mechanism – i.e. you will be asked to pay more if not enough tax was
withheld under PAYG or you will be given a refund if you have paid too much.
Help debt
1.12
Compulsory payments are made through the income tax system when income reaches a
certain level – these rates vary according to how much you earn.
Medicare levy
General principles
1.13
1.14
s 251S ITAA36 – medicare levy imposed upon:
(a)
taxable income of resident of Australia (not a company or person acting as
trustee); and
(b)
trustee in certain instances - pay tax on behalf of individuals – this has not been
looked at.
Basic amount 1.5% of taxable income – this may be altered in two circumstances:
(a)
When you are a low income earner – you pay the surcharge;
(b)
When you are a high income earner – you will have special exemptions.
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Example of the base case
1.15
Madeleine’s taxable income is $28,000. The Medicare levy is calculated as 1.5% of the
$28,000, ie, $420. Madeleine has to pay the levy in addition to her ordinary tax.
Relief for Low Income Earners
1.16
A taxpayer who qualifies as a low income earner is either fully or partially exempted from the
Medicare levy.
1.17
For taxpayers who do not receive the senior Australians tax offset or the pensioner tax offset,
the Medicare levy is calculated as follows:
(a)
Where their taxable income equal to or less than $17,309 → they will get a full
exemption from Medicare levy;
(b)
Where their taxable income is greater than $17,309 but less than $20,363 →
Medicare levy equal to 10 cents on every dollar of taxable income above $17,309.
High income earners – Medicare levy surcharge
1.18
Surcharge for high income earners (1%) without private patient hospital insurance –
on taxable income and reportable fringe benefits, (income above $70,000 for individuals and
$140,000 for couples).
(a)
If you are a couple you cannot argue to be taxed as individuals for the MLS.
(b)
Therefore both must pay the 1% surcharge even where only 1 is above the
individual threshold – e.g. total income of $180,000, with husband earning $130,000
and wife earning $50,000.
(c)
Also, both must pay even where the $130,000 earner has private health
insurance.
1.19
Don’t forget that this was talked about being increased on a sliding scale up to 1.5% when
couples earned $250,000 – obviously this hasn’t been passed and will be unlikely to get
through.
2
Tax offsets
General principles
What is a tax offset?
2.1
Offsets are incredibly valuable and save you tax dollar for dollar from income tax payable.
2.2
Tax offsets are subtracted from the income tax payable after it has been calculated. In
contrast, a deduction is subtracted from assessable income in calculating the taxable
income on which tax is payable.
2.3
The term ‘tax offset’ is a generic term used in ITAA97 to describe what in ITAA36 are called
‘rebates’ and ‘credits’ – the terms are used interchangeably and don’t mean anything different
to eachother – e.g. franking credits are still offsets.
2.4
[available tax offsets] s 13-1 – some of the highlights include:
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(a)
Social security and other benefits – see s 160AAA(3) ITAA36;
(b)
Low income earner entitlements – see s 159N ITAA36;
(c)
Dividend imputation and franking credits – see s 207-20; and
(d)
Dependant payments – see s 159J ITAA36.
2.5
Rebates are primarily attached to individual taxpayers.
2.6
Kerrie thinks that offsets are terrible and should not be in our tax system – they are a govt
spending program tied into our tax system – but instead of writing you a cheque they put it
into our tax system. They are never part of the budgetary process and aren’t part of govt
spending.
2.7
We have tax expenditures which are Govt Spending Programmes in our tax system, within
this, are our offsets. This also includes – small business immediate deductions on
expenditure on capital items – that is a tax expenditure.
2.8
Thus – these shouldn’t really be in our tax system – and should rather be done through
actual govt expenditure – this is something to think about:
(a)
Individuals it is more socially acceptable to have your tax reduced (i.e. welfare people
are stigmatised);
(b)
Therefore, think about these in terms of a govt spending paradigm.
2.9
Note that there is a general move to take these out of the tax system – e.g. the childcare
rebate etc.
2.10
In monetary terms, for last year there were $72 billion+ in tax ‘govt spending’ programmes –
nearly $30 billion actually related to superannuation (i.e. 15% concessional tax rate etc).
3 Types of Offsets
2.11
Provide tax relief for personal circumstances – e.g. social policy/welfare policy.
2.12
Give a credit for an amount of tax already paid – e.g. franking credits.
2.13
To provide an incentive – e.g. social policy such as superannuation reduced rate.
General principles for offsets
2.14
Lost if not used in an income year:
(a)
cannot be carried forward to a future income year (generally) – c.f. a capital loss (if
you can’t use it, you lose it).
(b)
E.g. low income earners get $750 offset – but, if you earn $0 you can’t carry it
forward.
2.15
[limit] s 160AD ITAA36 – cannot exceed the amount of tax “otherwise payable” by a
taxpayer: s 160AD (ITAA36) – basic tax payable can only be reduced down to 0.
2.16
Cannot be used to reduce:
(a)
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2.17
(b)
HELP (HECS); and
(c)
Superannuation contributions surcharge.
Sometimes these offsets may give rise to a refund – e.g. a dividend imputation, but the norm
is that offsets are lost if there is no basic tax payable.
Common offsets
Introduction
2.18
The offsets we will investigate further are – see s 13-1 for a complete list:
(a)
Dependant offset – see s 159J ITAA36;
(b)
Entrepreneurs offset – see Subdiv 61-J ITAA97;
(c)
Low income offset – see s 159N ITAA36;
(d)
Medical expenses offset – see s 159P ITAA36;
(e)
Dividend imputation offset – see s 207-20 ITAA97;
(f)
Private health insurance tax offset – see Subdiv 61-G – 61-H ITAA97;
(g)
Childcare offset – it is still called an offset but it is no longer part of our tax system
and goes through the Family Assistance Office – it didn’t work because of the rule
that you use it or you lose it.
(h)
Overseas defence force offset – see s 79B ITAA36;
(i)
Zone rebates – see s 79A ITAA36.
Dependant rebates
2.19
These are becoming increasingly irrelevant – it is being taken out of our tax system and put
under the heading of Family Assistance.
2.20
[dependant assistance] s 159J: Where, during the year of income, a taxpayer contributes
to the maintenance of a person specified (in this section referred to as a ''dependant'') and
that person is a resident, the taxpayer is entitled, in his assessment in respect of income of
that year of income, to a rebate of tax ascertained in accordance with this section.
2.21
Note that the amounts here vary, and it was limited by the introduction of the FBT.
2.22
Dependents – A taxpayer is entitled to a rebate in respect of a “dependant” provided that:
2.23
(a)
The taxpayer contributes to the maintenance of that dependant;
(b)
Both the taxpayer and the dependant are residents; and
(c)
The “SNI” (separate net income) of the dependant is less than the prescribed amount
Rebates are available for:
(a)
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2.24
(b)
A child-housekeeper of the taxpayer – not sure who would ever get that these days;
(c)
An invalid relative of the taxpayer – certain requirements such as medically certified;
and
(d)
A parent of the taxpayer or of the taxpayer’s legal or de facto spouse – but it does
not cover grandparents.
Rebate levels:
(a)
Spouse - $2,159 – but is now means tested at $150,000;
(b)
Child-housekeeper – literally where a child runs the household:
(i)
$2,051 – where there is a notional class 3 or 4 rebate;
(ii)
$1,711 – where there is no notional rebate.
(c)
Invalid Relative - $792; and
(d)
Parent - $1,583.
2.25
Note that the family tax benefit regime replaced benefits from having children.
2.26
Effect of family tax benefit B – these are benefits depending on what income the
household earns and how many children they have. Essentially, low income earners, with
children will get the Family Tax Benefit Part B. The details here are incredibly confusing and
no one really knows what is going on.
2.27
It allows one parent to stay at home and look after the kids and get a tax offset as a result.
2.28
From 1 July 2000 no:
2.29
2.30
(a)
dependent spouse rebate; or
(b)
child-housekeeper rebate
(c)
if taxpayer or spouse eligible for Family Tax Benefit (FTB) Part B – i.e. this takes
priority.
[separate net income] s 159J(4) – the dependants rebates available to a taxpayer reduce
by $1 for every $4 by which the dependant's separate net income during the year exceeds
$282:
(a)
This is not the same as taxable income – i.e. deductions, includes some nondeductible expenses.
(b)
E.g. child care costs, some aounts are expressly included in the separate net income
– i.e. government benefits.
[not the same as taxable income] s 159K(6) – the ‘separate net income’ of a
dependant is not the same as his/her taxable income:
(a)
Includes assessable and exempt income;
(b)
Excludes some deductions – i.e. donations are not taken into account b/c they are
not work related but travel to and from work are;
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2.31
2.32
(c)
Includes some non-deductible expenses; and
(d)
Excludes expressly certain amounts (e.g. benefits)
Example – Jack contributes to the maintenance of Jill (his wife), who has no separate net
income.
(a)
Question 1: If Jack has no children, what is he entitled to?
(b)
Question 2: If Jill had a SNI of $1,482, what is the rebate?
(c)
Question 3: If Jack also contributed to the maintenance of his invalid brother, who
earned $855 SNI, what is the rebate available to Jack?
(d)
Question 4: If Jack has one dependent child, Josie, aged 13, who is cared for by Jill,
and Jill is eligible for FTB Part B for the whole income year, and no other person is
entitled to such benefit, is Jack entitled to any spouse rebate?
Answer:
(a)
Scenario 1 – he is entitled to claim the maximum spouse rebate of $2,159.
(b)
Scenario 2
(c)
(i)
Maximum spouse rebate
(ii)
Reduction for SNI (1/4 x (1,482-282))
(iii)
Spouse rebate allowable
$2,159
300
$1859
Scenario 3
(i)
Maximum invalid relative rebate
(ii)
Reduction for SNI (1/4 x (855-282))
(iii)
Invalid relative rebate allowable
$ 792
143
$ 649
(d)
NB – Jack can get both rebates in scenarios 2 and 3.
(e)
Scenario 4 – Jack will not be entitled to any spouse rebate if Jill is entitled to the FTB.
(f)
The only time you will get the spouse rebate is where only one works and there are
no children.
Entrepreneurs’ tax offset
2.33
[availability] s 61-500 – this was available from 1 July 2005. It is a 25% tax offset where
the Simplied Tax System turnover is less than $50,000. It is not available where the STS
turnover is $75,000 or more.
2.34
It covers the whole of a taxpayers income, not just their income from the business with the
STS turnover – this is because people were working salaried jobs and had a business on the
side.
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Low income earners rebate
2.35
[availability of the rebate] s 159N – a rebate is available for taxpayers whose taxable
income in a year of income is less than $60,000.
2.36
The maximum rebate is $1,200, reduced by four cents for every $1 by which the taxpayer's
taxable income exceeds $30,000. If you are earning below $6,000 you don’t get the rebate,
b/c of the tax free threshold.
2.37
Example – a taxpayer has a taxable income of $35,000 in 2008/09. The taxpayer is entitled
to a low income earners rebate as follows:
(a)
Maximum rebate
$1,200
(b)
Reduction (35,000-30,000) x .04
$ 200
(c)
Section 159N rebate
$1,000
Medical expenses rebate
2.38
[availability of the rebate] s159P – a rebate is available to a taxpayer whose net medical
expenses in the year of income exceed $1,500. Must be in respect of a taxpayer or a resident
dependent – see s 159P(4):
(a)
legal or defacto spouse;
(b)
child under 21;
(c)
person in respect of whom the taxpayer is entitled, or notionally entitled, to a
dependent rebate.
2.39
The amount of the rebate is 20% of the excess over $1,500.
2.40
Does not include reimbursements from Medicare or Health Funds.
2.41
[definition of medical expenses] s 159P(4) – is widely defined for the purposes of the
medical expenses rebate to cover:
2.42
(a)
Payments to doctors, nurses, chemists, dentists, opticians and optometrists.
(b)
It also covers payments for therapeutic treatment, medical or surgical appliances, the
maintenance of a trained guide dog and remuneration paid to an attendant of an
invalid or blind person.
Example – of the medical expenses rebate:
(a)
During the income year, R incurs medical expenses of $12,700 in respect of his
seriously ill wife. He is a member of a health fund which reimburses him $10,200. R's
net medical expenses are therefore $2,500 (ie $12,700 - $10,200).
(b)
He is entitled to a rebate of – 20% x ($2,500 - $1,500) = $200.
Private health insurance tax offset
2.43
After 1 January 1999 - three ways to take incentive:
(a)
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2.44
(b)
direct payment from govt; or
(c)
tax offset
Applicability, they:
(a)
must have appropriate private health insurance
(b)
premium paid in the year in which they claim the offset
2.45
Offset is generally 30% of the amount paid for the cover.
2.46
The norm is to just assign the right to the health insurance co, and pay them less – e.g. if a
$1000 policy, you pay them $700, and assign them the right to the $300
2.47
Can also claim it through the tax system – pay the full premium and then claim the
rebate – e.g. if a $1000 policy, pay $1000, then claim a $300 rebate from the govt
2.48
Note that this may change as a result of the budget – it depends on what the Senate will do.
Zone Rebate
2.49
A rebate of tax is available to individuals who are classed as residents of specified remote
areas of Australia. The idea is, it is expensive to live in these areas, and therefore you should
be rewarded for going there. These areas comprise two zones, Zone A and Zone B – see
s 79A ITAA36.
2.50
Zone A comprises those areas where the factors of isolation, uncongenial climate and the
high cost of living are more pronounced:
(a)
i.e. the really bad area;
(b)
this is around $1,300-$1,400 a year;
(c)
Kerrie’s sister lives in Groot Island (off the NT) and they get a Zone A rebate of about
$1,400 a year.
2.51
Zone B comprises the less badly affected areas – e.g. Darwin, Mt Isa, Alice Springs, Cairns –
rebates are between about $300 - $400.
2.52
The rebate for ordinary Zone A residents is accordingly higher than the rebate for ordinary
Zone B residents.
2.53
A special category of zone allowances is available to taxpayers residing in particularly isolated
areas (the ''special areas'') within either zone – these are the really bad areas.
2.54
Problem now – a lot of these zones are now high income mining towns so miners are
getting paid well and claiming an offset.
2.55
These historically made sense, but now, with the mining boom people go to these areas to
earn megabucks and they still get these things. This probably breaches horizontal equity (i.e.
earning the same money pay the same tax) – there could also be constitutional issues.
Overseas Defence Force Rebate
2.56
[availability of the rebate] s 79B – a special rebate is available to a taxpayer who serves
in a qualifying overseas locality as a member of the Australian Defence Forces (ADF):
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(a)
The section lists war zones; and
(b)
The amount is dependent on the time actually served overseas.
Dividend imputation
The classical system
2.57
This is all about the income that you get from shares – i.e. the shares are the tree (increasing
in value as a capital gain), but the income is the dividend.
2.58
Companies pay tax in their own right, but trusts are treated like a conduit where the income
flows through to the beneficiaries.
2.59
The following is the classical system of dividend taxation:
(a)
Companies pay tax at 30% - this is because they are a separate legal entity;
(b)
then pay a dividend of say $70;
(c)
that is income in the hands of the shareholder, who will have to pay tax on it;
(d)
if the shareholder is in the 30% tax-bracket, they will have to pay $21 tax on the $70
dividend they receive;
(e)
therefore, $49 is going to the shareholder and $51 is going to the ATO;
(f)
this is an example of a classical system where the company and the shareholder are
both taxed – i.e. the same income is taxed twice.
Statutory dividend imputation system – s 207-20 ITAA97
2.60
We now have a dividend imputation system:
(a)
this passes on the tax paid by the company to the shareholder (i.e. as a benefit);
(b)
this is done by a grossing-up and credit mechanism:
(i)
it grosses the dividend up to pre-taxed profits;
(ii)
taxes the shareholder on that amount; and
(iii)
provides a credit for the tax already paid by the company (to the
shareholder).
2.61
Under the imputation system, where a franked dividend (i.e. a taxed dividend), the
dividend is taxed already in the hands of the company.
2.62
Dividends are taxed as statutory income under s 44(1) ITAA36, but the imputation regime
is in s 207-20 ITAA97.
(a)
Where a dividend is paid by a resident company to a resident shareholder, the
assessable income of the shareholder includes, in addition to the amount of the
dividend, the franking credit attached to the dividend;
(b)
but the shareholder is entitled to a tax offset equal to the franking credit included in
assessable income.
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s 44(1) ITAA36 – Dividends
44(1) [Shareholder assessable income]
The assessable income of a shareholder in a company (whether the company is a resident or a nonresident) includes:
(c)
if the shareholder is a resident:
(d)
(i)
dividends (other than non- share dividends) that are paid to the shareholder
by the company out of profits derived by it from any source; and
(ii)
all non- share dividends paid to the shareholder by the company; and
if the shareholder is a non-resident:
(e)
(i)
dividends (other than non- share dividends) paid to the shareholder by the
company to the extent to which they are paid out of profits derived by it from
sources in Australia; and
(ii)
non- share dividends paid to the shareholder by the company to the extent to
which they are derived from sources in Australia; and
if the shareholder is a non-resident carrying on business in Australia at or through a
permanent establishment of the shareholder in Australia, and the company is a
resident:
(i)
dividends (other than non- share dividends) that are paid to the shareholder
by the company and are attributable to the permanent establishment, to the
extent to which they are paid out of profits derived by the company from
sources outside Australia; and
(ii)
non- share dividends that are paid to the shareholder by the company and
are attributable to the permanent establishment, to the extent to which they
are derived from sources outside Australia.
This subsection does not apply to a dividend (or non-share dividend) to the extent to which another
provision of this Act that expressly deals with dividends includes some or all of the dividend (or nonshare dividend) in, or excludes some or all of the dividend (or non-share dividend) from, the
shareholder's assessable income.
s 207-20 ITAA97 – General rule – gross-up and tax offsets
207-20(1) [Rule]
If an entity makes a * franked distribution to another entity, the assessable income of the receiving
entity, for the income year in which the distribution is made, includes the amount of the * franking
credit on the distribution. This is in addition to any other amount included in the receiving entity's
assessable income in relation to the distribution under any other provision of this Act.
207-20(2) [Application to the taxpayer]
The receiving entity is entitled to a * tax offset for the income year in which the distribution is made.
The tax offset is equal to the *franking credit on the distribution.
Franking credits in practice
2.63
Section 207-20 contains the imputation provisions:
(a)
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(b)
this is achieved by a gross up and credit mechanism
Franking Credit Formula
2.64
Gross up dividend by – s 207-20(2) – the gross-up amount:
company tax rate
1 – company tax rate
2.65
An example, where a company pays the company tax rate of 30%.
2.66
Taxable income
2.67
tax (30%)
2.68
After tax profits
70
2.69
Dividend paid
70
100
30
Shareholder level (shareholder in 45% bracket)
2.70
Dividends (s44(1))
70
2.71
Gross up amount (s207-20(1))
30
2.72
Taxable income
100
2.73
Tax at highest rate (45%)
45
2.74
Franking Rebate (s207-20(2))
30
2.75
Net Tax Payable
$15 (i.e. they pay the extra $15)
Shareholder level (shareholder in 30% bracket)
2.76
Dividends (s44(1))
70
2.77
Gross up amount (s207-20(1))
30
2.78
Taxable income
100
2.79
Tax at 30% bracket (30%)
30
2.80
Franking Rebate (s207-20(2))
30
2.81
Net Tax Payable
$ 0 (i.e. they don’t have to pay tax)
Shareholder level (shareholder in 15% bracket)
2.82
Dividends (s44(1))
70
2.83
Gross up amount (s207-20(1))
30
2.84
Taxable income
100
2.85
Tax at 15% bracket (15%)
15
2.86
Franking Rebate (s207-20(2))
30
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2.87
Net Tax Payable
- $15 (i.e. they get money back).
2.88
i.e. the taxpayer receives a refund – i.e. can get an amount back, when your highest marginal
rate is less than the company tax rate.
2.89
Don’t forget to check whether the dividends are fully franked, or only partly franked – this will
effect how much you get back as franking rebate.
2.90
There could be changes to this system as a result of the Henry Review – be careful that
these changes do/don’t come about – he is taking into account the current cycle and taking a
medium to long-term view.
Dividend advices
2.91
Unfranked dividends – no imputation credit
2.92
Partially franked dividend – franked and unfranked component – i.e. franked to 60% - 30/70
x 60% to work out imputation credit.
3
Self-assessment
3.1
The income tax system is Australia operates using the principle of self assessment.
3.2
That is a taxpayer will complete their own taxation return with the assistance of material
available from the Australian Taxation Office (ATO), for example:
(a)
TaxPack – can include E-Tax; or
(b)
by having the return professionally completed by a registered taxation agent.
3.3
They then ‘lodge’ the completed taxation return with the ATO (by the required date for
lodgement).
3.4
The Commissioner for Taxation will then accept the taxation return as lodged, and will issue a
Notice of Assessment based on the disclosed taxable income and other information contained
in that return.
3.5
The ATO does not physically check (or assess) the return other than for arithmetic checks on
the totals of assessable income, deductions and tax offsets.
3.6
The Notice of Assessment will list the following and a copy of a Notice of Assessment is
attached at the Appendix to this Topic:
3.7
(a)
Taxpayer’s details and the relevant tax year.
(b)
Taxable Income and the tax payable on that taxable income.
(c)
Medicare Levy, Surcharge, and FEE-Help payments, if applicable.
(d)
Any tax offsets allowed.
(e)
Any prepayment of the tax payable – see PAYG.
[assessment of return] s 166 – gives power to the CoT to assess the return. The CoT
may also ‘amend’ or vary a taxpayer’s assessments after it has issued to correct errors or
disclosure failures by the taxpayer.
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3.8
[amended assessments] s 167 – a taxpayer may also request, in writing, to have a
particular tax assessment reviewed to correct an error and if the ATO will not agree to this
correction, the taxpayer can have the issue further examined in the Administrative Appeals
Tribunal (AAT) or the Federal Court.
3.9
To assist taxpayers in meeting their tax obligations by lodging a correct tax return the ATO
has various levels of technical support.
(a)
Telephone enquiries by providing an Oral Ruling on an issue of tax law.
(b)
Private Rulings.
(c)
Public Rulings, including TaxPack and other ATO publications.
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