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Taxation Law & Practice

Learner’s Guide - 2013

This Learner’s Guide should be read and used in conjunction with the textbook Taxation Law & Practice - 2nd Edition. It is not suitable for stand-alone use, nor is it intended that it be utilised as a substitute for the textbook.

ISBN: 978 192 157 9875 Second Edition - January 2013

Published by Tekniks Publications P.O. Box 210 Bondi NSW 2026 Phone: (02) 8012 3606

Taxation Law & Practice – Learner’s Guide

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Taxation Law & Practice

Learner’s Guide - 2013

Contents

Page

Unit 1 Introduction to the Taxation System 3

Unit 2 Calculation of Income Tax 5

Unit 3 Assessable Income - Personal 7

Unit 4 Assessable Income - Business 9

Unit 5 Capital Gains 12

Unit 6 Deductions – General & Specific 18

Unit 7 Trading Stock 26

Unit 8 Tax Accounting 28

Unit 9 Small Business Entities 30

Unit 10 Partnerships 32

Unit 11 Trusts 34

Unit 12 Companies 36

Unit 13 Taxation Administration 38

Unit 14 Tax Planning and Anti-Avoidance 42

Unit 15 Fringe Benefits Tax 45

Unit 16 Goods and Services Tax 47

Unit 17 Income Tax Cases 50


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Unit 1 Introduction to the Taxation System

The critical learning requirements of this topic are:

Understanding the concepts of taxable income, income year, derivation of income, and the accounting methods used to determine assessable income.

Recognise the purpose and types of Activity Statements. Identify the requirements to be a registered BAS agent.

Overview Income tax is a direct tax levied exclusively by the Commonwealth Government.

The principal Commonwealth legislation that deals with income tax is the Income Tax Assessment Act 1936 (ITAA36) and the Income Tax Assessment Act 1997 (ITAA97).

In addition, ancillary legislation such as the Income Tax Rates Act 1986, the Medicare Levy Act 1986, the Fringe Benefits Tax Act 1986 and a variety of other Acts all play a role in the administration and effect of the Australian income tax system.

Sources of Taxation Law There are three sources of taxation law. These are:

Statute law in the form of taxation legislation enacted by the Commonwealth Parliament. Case law created by the Courts and Administrative Appeals Tribunal in interpreting Statute

law.

Legally binding rulings and determinations made by the Australian Taxation Office (ATO).

Important Definitions Income Tax Income tax is tax imposed upon the taxable income of individuals, companies, and some other entities, (s.3-5 ITAA97).

Taxable Income Taxable income equals assessable income less deductions, (s.4-15 ITAA97).

Assessable Income

Assessable income consists of income according to ordinary concepts, or “ordinary income”, (s.6-5 ITAA97) and statutory income, (s.6-10 ITAA97). These are examined in later units.

Deductions There are two categories of deductions – general, (s.8-1 ITAA97) and specific, (s.8-5 ITAA97). These are examined in later units.

Income Year The year of income for tax purposes is normally the financial year, (s.4-10 ITAA97), ie. 1 July to 30 June.

Derived Income is assessable when it has been derived, i.e. either actual physical receipt by the taxpayer, or if an amount is applied or dealt with on the taxpayer’s behalf, (s.6-5 ITAA97).


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Other Readings and Activities

Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 1 Parts 1.1 to 1.5

Accounting Methods For tax purposes there are two methods used to determine taxable income – cash (receipts) basis and accruals (earnings) basis. TR 98/1 Income tax: determination of income; receipts versus earnings

Activity Statements There are two types of activity statement:

The Business Activity Statement (BAS), which must be completed by those taxpayers who are required to report GST in that activity statement period.

The Instalment Activity Statement (IAS), which applies to those not registered for GST, taxpayers with investment income and GST-registered businesses who are required to report GST on a quarterly basis but have other monthly reporting obligations.

BAS Service Providers

Registered BAS agents can charge a fee for providing BAS services to a taxpayer. BAS agents must be registered with the TPB. A BAS agent may be an individual, partnership or company.

Legislative requirements for registration, qualifications and relevant experience for BAS agents are contained in the Tax Agent Services Regulations 2009.



End of Chapter Review Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 1 Review Questions 1.1 to 1.6


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Unit 2 Calculation of Income Tax


Recognising the components in the calculation of taxable income and tax payable.

Applying the income tax rates to calculate tax payable for resident and non-resident taxpayers.

Calculating the Medicare Levy, Medicare Levy Surcharge, Low Income tax offset, and tax-free threshold using the current rates and thresholds.

Calculation of Taxable Income

GROSS RECEIPTS less EXEMPT INCOME equals ASSESSABLE INCOME less DEDUCTIONS equals TAXABLE INCOME

Calculation of Tax Payable

TAX ON TAXABLE INCOME less NON-REFUNDABLE TAX OFFSETS equals NET TAX PAYABLE plus MEDICARE LEVY, MEDICARE LEVY SURCHARGE and HELP less TAX CREDITS REFUNDABLE TAX OFFSETS PAYG PAYMENTS equals REFUND DUE OR BALANCE PAYABLE

Income Tax Rates Refer to the textbook for the current year tax rates for resident individuals.

Medicare Levy Most individual resident taxpayers are liable to pay a Medicare Levy up to 1.5% of their taxable income for the income year, (s.251S ITAA36). Where a taxpayer either ceases to be a resident of Australia or becomes a resident for tax purposes during an income year, the Medicare Levy is charged only on taxable income derived whilst an Australian resident.

For married Couples (includes de facto couples and sole parents) no Medicare Levy is payable if a couple’s combined taxable income is ≤ a threshold, plus an additional amount for each dependent child or student. Low income earners also do not pay Medicare levy.

Refer to the textbook for the current year thresholds for resident individuals.

Medicare Levy Surcharge (MLS)

Single individual taxpayers without private patient hospital health insurance whose income for surcharge purposes exceeds an annual threshold are liable to pay a Medicare Levy Surcharge. The MLS is income tested against income tier thresholds.

For married and de facto couples and individuals with dependants, the MLS also applies when combined income for surcharge purposes exceeds the relevant income threshold. This income threshold increases by $1,500 for each dependent child excluding the first.


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A dependant is an Australian resident who is:

A spouse, even if they worked during 2012/13 and had their own income,

Any child under 21 years of age, or

Any child aged 21 years or more but under 25 years of age who is a full-time student

A member of a couple who would otherwise be liable for the MLS based on total family income is not required to pay the surcharge where the total of that person’s taxable income plus reportable fringe benefits does not exceed the individual low income threshold amount.

Refer to the textbook for the current year MLS rates and income thresholds for resident individuals.

Low Income Tax Offset A maximum low income tax offset may apply where taxable income is ≤ $37,000, (s.159N ITAA36). A partial low income tax offset applies where taxable income is in the range $37,001 up to the cut-off threshold. Individual taxpayers whose taxable income is above the cut-off threshold are ineligible for the Low Income tax offset.

The Low Income tax offset is a non-refundable tax offset meaning that it can only reduce tax on taxable income to nil and no further.

Refer to the textbook for the current year thresholds for resident individuals.

Tax-free Threshold The standard taxable income threshold before income tax applies is $18,200. When a taxpayer either becomes or ceases to be an Australian resident taxpayer, the standard threshold may be pro-rated for that year of income.

Non-resident Taxpayers Different tax rates apply to non-resident taxpayers.

Refer to the textbook for the current year tax rates for non-resident individuals.



End of Chapter Review

Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 1 Review Questions 2.1 to 2.6


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Unit 3 Assessable Income - Personal


Identifying the types of income from personal services that are assessable. Identifying the types of receipts from property that are assessable,

particularly dividends, employee share schemes and foreign income. Calculating taxable income and tax payable of a taxpayer in receipt of franked

dividends. Calculating taxable income and tax payable (including the Foreign Income tax

offset) of a taxpayer in receipt of foreign income.

Income from Personal Services Direct compensation

All remuneration for personal services, whether received in the capacity of an employee or otherwise in connection with employment or personal services, is income according to ordinary concepts and, therefore, assessable under s.6-5 ITAA97.

Allowances Amounts in the form of allowances paid to an employee by an employer are assessable under s.15-2 ITAA97.

Voluntary Payments or Gifts A voluntary payment or gift which is a product of employment or services rendered is assessable income, even if paid by a third party. However, a voluntary payment or gift that is not related in any way to personal exertion is not assessable income.

Compensation Receipts Periodical payments of workers compensation received and periodical payments under an accident/disablement policy for whole or partial loss of wages are assessable under s.6-5(1) ITAA97.


Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 3 Part 3.1 Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 3 Review Questions 3.1 to 3.3

Income from Property and Foreign Income Income from property in the form of interest, royalties, rental income and dividends are assessable income, (s.6-5 ITAA97). Dividends All dividends received by a taxpayer are assessable income. They may be franked or unfranked dividends, (s.44 ITAA36). Franked dividends have an assessable franking credit attached to them representing any tax paid on that income by the company prior to distribution. A refundable franking tax offset equal to the amount of the franking credit is then allowed in the calculation of tax payable.


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Foreign Income Income derived by Australian resident taxpayers from all sources (i.e. within and outside of Australia) is assessable unless a specific exemption applies (s.6AB ITAA36). The net amount of assessable foreign income is grossed up by the amount of any foreign tax paid on that income by the taxpayer. This grossed up amount is included as part of the taxpayer’s assessable income.

Foreign Income Tax Offset

In order to avoid double taxation of foreign income upon which foreign tax has been paid, but which is also included in a taxpayer’s Australian taxable income, a foreign income tax offset (FITO) is allowed for the foreign tax paid, (Div.770 ITAA97). Refer to the textbook for the formula to calculate the FITO limit. If the foreign tax paid is no more than $1,000 no calculation of the FITO limit is necessary. The taxpayer simply claims the available amount as the FITO. Where foreign tax paid exceeds $1,000 the taxpayer may elect to claim a FITO of only $1,000. Other Readings and Activities

Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 3 Part 3.2



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Unit 4 Assessable Income - Business


Understanding the concepts of ordinary income, statutory income, and the principles of assessability, particularly in relation to residency and source of income.

Distinguishing between a business and a hobby for tax purposes and identifying the types of receipts that are assessable income of a business.

Overview Under the definition contained in s.6-1(1) ITAA97, assessable income consists of “ordinary income and statutory income”.

Statutory Income

Statutory income is defined by s.6-10 ITAA97 as any amount which is not ordinary income and which is included in assessable income by a specific section of the ITAA36 or ITAA97.

Ordinary Income Ordinary income is defined by s.6-5(1) ITAA97 to mean income according to ordinary concepts. The question of what is and what is not ordinary income is an important issue in the study of taxation. As the ITAA97 does not provide any specific guidance on what is meant by income according to ordinary concepts, a substantial body of case law has evolved to identify the various factors that indicate whether an amount is income according to ordinary concepts. In determining whether an amount is income, the courts have said that it must be determined ‘in accordance with the ordinary concepts and usages of mankind’ (Scott v. C of T (NSW)). When making the decision, ordinary commercial and accounting practices may assist (Arthur Murray v. FCT). The courts have developed a number of tests that will assist in determining whether an amount is income or not. Note however these are indicators only and not decisive in themselves. These principles do not apply in relation to statutory income.

An amount that is capital is not income according to ordinary concepts. However, amounts received from the use of property (e.g. rents, royalties, interest and dividends) are assessable income (Eisner v. Macomber).

Income is a regular, recurrent, periodic amount (FCT v. Dixon; FCT v. Blake). An isolated transaction is more likely to be capital in nature.

Amounts that are incidental to employment or services rendered are income (Kelly v. FCT; FCT v. Smith; Scott v. FCT).

A gain from an isolated transaction received in the course of carrying on a business is income (FCT v. Myer Emporium). The question of whether a business is being carried on is a matter of fact, which will be discussed further in the context of allowable deductions.

An amount that is not convertible into money is not income (FCT v. Cooke & Sherden).

An amount received in replacement of income takes on an income character (Liftronic v. FCT).

Refer to the textbook for examples of ordinary income.


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Determination of Assessability In attempting to resolve whether or not a particular receipt is assessable income in the hands of the taxpayer, the following questions may need to be considered:

(i) Is the taxpayer a resident of Australia? (s.6 ITAA36) (ii) What is the source of the taxpayer’s income? (iii) Has the income been derived? (iv) Is the receipt a capital receipt? (v) Is the receipt exempt from tax?

Residence The standards the ATO uses to determine residency status are not the same as those used by the Department of Immigration and Citizenship. There are four main tests for residency. These are:

Resides

Domicile

183 day rule

Superannuation

The ATO considers an individual to be an Australian resident for tax purposes if: (a) they have always lived in Australia or have come to Australia and live here permanently, or (b) have been in Australia for more than half of a tax year and for most of that time have been in

the one job and lived at the same place, unless their usual home is overseas and they do not

intend to live in Australia.

Source of income (s.6-5 ITAA97). As a general rule an Australian resident taxpayer is assessed on their worldwide sources of income.

Type of income Source

Sale of goods The place where the contract of sale was entered into or where value was added, e.g. in manufactured goods (C of T v. Kirk)

Sale of other property

The place where the sale contract was entered into, except that:

shares are located where the company conducts its operations (Australian Machinery & Investment v. DFCT)

property is located where the property is situated

Lease contracts In relation to real estate, the place where the property is located (Rhodesia Metals Ltd (in liq.) v. C of T). In relation to personal property, the place where the lease contract is entered into

Services Normally the place where the work is performed (FCT v. Efstathakis). However, where the services are particularly specialised or can be performed anywhere:

the place where the contract was entered into (FCT v. Mitchum), or

the place where payment was made (Evans v. FCT)

Interest The place where the loan contract was entered into, or where the funds were advanced (FCT v. Spotless Services Ltd)

Dividends The place where the profits that gave rise to the dividend were made (Esquire Nominees v. FCT)

Royalties Re the right to use property, the place where the property is located. Re the right to use intellectual property, the place where the contract is entered into (FCT v. United Aircraft Corporation (1943) 68 CLR 525). However, where an Australian business pays a royalty to a non-resident, it is deemed to be sourced in Australia under s.6C ITAA36.


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Derivation of income Income is assessable when it has been derived, i.e. either actual physical receipt by the taxpayer, or if an amount is applied or dealt with on the taxpayer’s behalf, (s.6-5 ITAA97).

Capital Receipts Receipts which are capital in nature are not assessable as ordinary income. However, they may be assessable as statutory income, or alternatively may be covered by the Capital Gains Tax provisions (covered in Unit 5).

Generally, the characteristics of a capital receipt are as follows:

It relates to a one-off or non-recurring transaction.

The transaction represents the realisation or sterilisation of an asset. In cases relating to the development and sale of property that has been used in a business, the sale of that property may be income if it has been organised in a way that indicates that the owner has undertaken a new business venture in relation to the development and sale of that property (Scottish Australian Mining v. FCT).

The proceeds are usually received as a lump sum, although if the proceeds are received by instalments it will not change the character of the principal amount (Californian Oil Products v. FCT). However, any interest component will be assessable income.

If an amount is received as compensation in relation to an asset it will be capital in nature. However, if a single unallocated amount is received in full compensation for a claim, which may include an income component, the full amount is treated as being capital in nature (McLaurin v. FCT).

Exempt Income Exempt income is not included in assessable income, (s.6-20 ITAA97).

Summary of Principles of Assessability

The general principles relating to the assessability of income for Australian resident taxpayers and non-residents is found in the following table:

Taxpayer Australian source income Overseas source income

Resident Assessable Assessable

Non-resident Assessable Not assessable

Note the above Table should be considered only as a guide to the general principles. Exceptions to these guidelines frequently occur – these will be considered in later notes.




Income from Business The gross earnings or proceeds from conduct of a business are assessable as ordinary income. A “business” is defined by s.995-1(1) ITAA97 as “any trade, profession, calling or vocation but not as an employee”.

Refer to the textbook for a summary of the main indicators of carrying on a business.


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Case law has led to the “commercial basis test”, that is, is the activity being conducted in a commercial/business-like manner? Some of the relevant factors include:

The degree of system and organisation used. Where the activity is conducted on a systematic and organised basis, it is more likely to be considered a business. This is especially so where the activities have a commercial basis. The application of business methods and practice are in this sense of some importance (Ferguson v. FCT; Martin v. FCT).

Scale of activities. The size and scale of the activities are important. Are the activities of such a scale that whatever is produced is in excess of that which would be required for the taxpayer’s personal use? The smaller the level of activity the more likely it is to be characterised as a hobby (Fairway v. FCT; FCT v. J. R. Walker).

Repetitive transactions. A business activity is associated with regular and repetitive transactions, although this is not necessarily decisive as even isolated transactions may be regarded as a business (IRC v. Livingston).

Profit motive. A business operation is usually carried on in order to make a profit. Consequently, the presence of such a factor will be indicative of business activities. It is not necessary that profits are earned immediately but the expectation of profits in the future is a supportive factor of a business (Thomas v. FCT).

Type of activity. Where the goods are unsuitable for personal or domestic use this will be more indicative of a business (Edwards v Bairstow).

Refer also Scottish Australian Mining v. FCT and FCT v Whitfords Beach Ltd. and TR 97/11 Income tax: am I carrying on a business of primary production?

Business vs. Hobby Business Income is assessable, and expenses are generally deductible.

Hobby Income is not assessable, and expenses are not deductible. Betting and Gambling Wins Betting and gambling wins and losses form part of a taxpayer’s assessable income only where the taxpayer is held to be carrying on a business of betting or gambling. This is very rarely the case, although a few exceptions do occur.

Prizes and Awards Windfall gains such as a lottery or competition win are generally not assessable. However, where the taxpayer regularly appears in, for example, quiz shows, any prizes or appearance fees received may be assessable.

Other Specific Business Receipts These include:

Receipts for cancellation/variation of business contracts

Profits from isolated transactions

Bounties and Subsidies

Insurance recoveries

Illegal business activities

Foreign exchange gains are assessable as ordinary income.

Refunds and Recoveries of deducted items




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Unit 5 Capital Gains


Understanding the factors relevant in determining whether a CGT liability exists.

Identifying the elements contained in the cost base of a CGT asset. Calculation of a net capital gain using the Frozen Indexation, Discount and

Other methods. Calculation of capital losses. Applying the principles of the main residence exemption to capital gain

calculations. Applying the CGT provisions as they apply to a dwelling used partly for an

income producing purpose. Identifying the CGT concessions applicable to small businesses. Applying the small business CGT concessions to calculate a net capital gain. Understanding the roll-over provisions as they apply to CGT asset transfers. Understanding the CGT consequences arising upon the death of a taxpayer.

Overview A capital gain or loss only applies if a CGT event happens to a CGT asset that has been acquired and disposed of after 19 September 1985. Assets acquired before 20 September 1985 are outside the provisions of capital gains tax. A taxpayer’s assessable income includes any net capital gain for the income year, (Part 3-1 ITAA97).

Important Definitions

CGT Asset A CGT asset is any form of property (e.g. goodwill, foreign currency, shares), or a legal or equitable right that is not property, (Div. 108 ITAA97).

CGT Event CGT events are covered in Div. 104 ITAA97. The 12 categories of CGT events are:

Disposal of a CGT asset – CGT event A1 (Subdiv.104-A)

Use and enjoyment of the asset before title passes – CGT event B1 (Subdiv.104-B)

End of a CGT asset – CGT events C1-C3 (Subdiv.104-C)

Bringing into existence a CGT asset – CGT events D1-D4 (Subdiv.104-D)

Events relating to trusts – CGT events E1-E9 (Subdiv.104-E)

Events relating to leases – CGT events F1-F5 (Subdiv.104-F)

Events relating to shares – CGT events G1 and G3 (Subdiv.104-G)

Special capital receipts – CGT events H1 and H2 (Subdiv.104-H)

Australian residency ends – CGT events I1 and I2 (Subdiv.104-I)

CGT events relating to rollovers – CGT events J1, J2, J4-J6 (Subdiv.104-J)

Other CGT events – CGT events K2-K12 (Subdiv.104-K)

Events relating to consolidated groups and MEC groups – CGT events L1-L8 (Subdiv.104-L)

The specific time that a CGT event occurs is important as it is relevant for working out whether or not the capital gain or loss affects the taxpayer’s taxable income for the income year or for another income year.


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Net Capital Gain A net capital gain is assessable. It is the total of a taxpayer’s capital gains for an income year reduced by capital losses made by that taxpayer.

Capital Loss A capital loss cannot be used to reduce other types of assessable income. It must be written off against other capital gains as follows: (i) in the same year of income, or, (ii) if no capital gain exists in the year of the capital loss, carried forward to a future year(s)

when it can be offset against a capital gain.

Categories of Assets All assets are subject to the capital gains tax rules unless they are specifically excluded. Particular CGT provisions apply to three categories of assets. These are:

Collectables A collectable asset is defined as a collectable item kept mainly for personal use or enjoyment with a cost of acquisition exceeding $500, (Subdiv.108-B ITAA97).

Personal-use assets Personal-use assets are CGT assets, other than collectables, which are used or mainly kept by the taxpayer for personal use or enjoyment (Subdiv.108-C ITAA97). Such assets are not usually subject to capital gains tax. However, where a personal use asset is acquired for $10,000 or more it is subject to the capital gains tax provisions when it is disposed of.

Any capital gain is disregarded if the asset was acquired for less than $10,000. However, for tax purposes, a taxpayer cannot make a capital loss on a personal-use asset.

Separate CGT assets Land, buildings and structures, strata title units and capital improvements to land are taken to be assets that are not personal-use assets and are exceptions to the common law principle that what is attached to the land is part of the land (Subdiv.108-D ITAA97).

Exemptions The following assets are specifically exempted from capital gains tax:

• Sale of main place of residence, including adjacent land of up to 2 hectares (Subdiv.118-B ITAA97)

• Betting and gambling wins (s.118-37 ITAA97) • Any personal-use asset acquired for less than $10,000 (s.118-10 ITAA97) • Trading stock (s.118-25 ITAA97) • Collectables costing $500 or less (s.118-10 ITAA97) • Compensation for damages or injury (s.118-37 ITAA97) • Motor vehicles designed to carry < 9 passengers or a load of < 1 tonne and motor cycles

(s.118-5 ITAA97)




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Calculation of Capital Gains The general formula to calculate a capital gain is:

CAPITAL GAIN = CAPITAL PROCEEDS FROM DISPOSAL less COST BASE of ASSET

Cost Base The cost base of a CGT asset includes the capital costs of both acquisition and disposal. It is made up of five elements. The amount for each element is added together to work out the total cost base of a CGT asset, (s.110-25 ITAA97). The five elements are:

First element: Acquisition costs

Second element: Incidental costs

Third element: Non-capital costs associated with owning the asset

Fourth element: Enhancement costs

Fifth element: Title costs

Methods of Calculating a Capital Gain There are three methods used to calculate a capital gain. These are:

Frozen Indexation method

Discount method

Other method Frozen Indexation Method Under this method an indexed cost base is calculated (Div.114 ITAA97). An indexed cost base is the cost base of a CGT asset adjusted for the effects of inflation by using the Consumer Price Index (CPI). Each amount included in an element of the cost base (except costs in the third element - non-capital costs of ownership) is increased by an indexation factor. The following formula is used:

Indexation factor = CPI for quarter when CGT event happened CPI for quarter in which expenditure was incurred

The indexation factor derived from the above CPI ratio must be calculated to three decimal places before being applied against the cost base of an asset.

For capital gains tax purposes, indexation was frozen at 30 September 1999 which means that the September 1999 Quarter CPI of 123.4 also applies to assets disposed of after that date.

Discount Method Under this method a capital gain is reduced by a relevant discount percentage only after all available capital losses have been applied (Div.115 ITAA97). The discount percentage is the percentage by which the capital gain is reduced. It is 50% for individuals and trusts, and 331/3% for complying superannuation entities and eligible life insurance companies. Companies are not entitled to discount capital gains.

Other Method This method is used only where a CGT asset is acquired and disposed of within 12 months. The cost base of the asset is simply subtracted from the capital proceeds of disposal.


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Summary The following Table shows the circumstances necessary for use of each method:

Date Asset Acquired

Method Acquired pre 21 September 1999 Acquired on or after 21 September 1999

Frozen Indexation

Yes (when asset held 12 months or more) Method not applicable

Discount Yes (when asset held 12 months or more) Yes (when asset held 12 months or more)

Other Yes (when asset held less than 12

months) Yes (when asset held less than 12 months)


Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 5 Parts 5.5 and 5.6

Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 5 Review Questions 5.1 to 5.8, and 5.10 to 5.14

Calculation of Capital Losses A capital loss is not a deduction and cannot be used to reduce other types of assessable income. Instead, it must be written off against other capital gains (s.100-10 ITAA97).

A capital loss which arises on the disposal of a collectable asset may only be offset against a capital gain arising from the disposal of another collectable asset (s.108-10 ITAA97).

In determining a capital loss, no element in the cost base is ever indexed. The formula to calculate a capital loss is:

CAPITAL LOSS = REDUCED COST BASE – CAPITAL PROCEEDS FROM DISPOSAL

Indexation is not applied to a capital loss situation. Essentially, the reduced cost base is the historical cost plus expenses less deductions. In practice, the reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element.

Other Readings and Activities Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 5 Part 5.7

Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 5 Question 5.9

Keeping of Records Any person who has acquired a CGT asset after 19 September 1985 is required to keep records which enable the ready ascertainment of the date of acquisition, amounts which form part of the cost base, and the date of disposal and the consideration received.

Main Residence Exemption A taxpayer’s dwelling, owned by an individual and normally occupied as the taxpayer’s main residence, is usually exempt from CGT (Subdiv.118-B ITAA97). A dwelling is a unit of residential accommodation (s.118-115). A dwelling also includes a maximum of two hectares of adjacent land when it is used primarily for private or domestic purposes (s.118-120).


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Absence from main residence A taxpayer who initially occupies a dwelling as a main residence and then ceases to occupy it, can choose to continue to have the dwelling treated as the main residence (s.118-145).

In this case, the main residence exemption can still apply as follows:

For a maximum of 6 years if the dwelling is used to produce assessable income while the taxpayer is absent (e.g. rental income)

A taxpayer is entitled to another maximum period of 6 years each time the dwelling again becomes and ceases to be the main residence.

• Indefinitely if the dwelling is not used to produce assessable income Partial main residence exemption A partial main residence exemption is calculated using the following formula (s118-185):

Capital gain or loss x Non-main residence days Days property owned

Part Income Producing Use If a dwelling is used partly as a main residence and partly as a place of business then the business proportion of the house is subject to CGT upon disposal (s118-190). The cost base for CGT purposes will be the market value of the house on the day it was first used for an income producing purpose (s.118-192). Any capital gain is determined by apportioning the whole gain between residential use and income producing use. The proportion is normally based on a floor area or time basis. Home first used to produce income after 20 August 1996 There is a special rule where a main residence is first used for income producing purposes after 20 August 1996 (s.118-192). In this situation, the cost base for determining the capital gain will be the market value of the dwelling on the date that it was first used for an income producing purpose.




Small Business Relief There are four Capital Gains Tax (CGT) concessions specifically for small businesses. These concessions reduce capital gains. The small business relief CGT concessions which apply to CGT events on or after 21 September 1999 are:

15 year asset exemption (Subdiv.152-B ITAA97)

50% active asset reduction (Subdiv.152-C ITAA97)

Retirement exemption (Subdiv.152-D ITAA97)

Small business roll-over relief (Subdiv.152-E ITAA97) To qualify for the concession a small business taxpayer must satisfy the following basic conditions (Subdiv.152-A ITAA97):

The taxpayer owns the asset that is subject to a CGT event

Events would otherwise have resulted in a capital gain

Net asset value test

The asset is an active asset


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Net asset value test A taxpayer’s total net value of business assets (both passive and active assets) must not exceed $6 million when the CGT event happens.

Active asset An active asset is one that the entity owns and uses (or holds ready for use) in carrying on a business. It includes intangible assets such as goodwill.

CGT Concessions 15 year asset exemption A small business taxpayer may choose to be exempt from CGT when they sell an asset they have owned for 15 years (not necessarily continuously) if they are aged 55 years or over and retiring, or if they are permanently incapacitated at the time of the CGT event. When the 15 year asset exemption applies, any capital gain is disregarded. Also, the other three small business concessions therefore do not apply.

50% active asset reduction A small business taxpayer can elect to reduce their capital gain by 50% on the sale of an active asset. This reduction is in addition to the 50% CGT discount available for assets held for 12 months or more. If the 50% active asset reduction concession is chosen by a small business taxpayer, then this concession generally applies before either the small business retirement exemption or roll-over relief concessions apply.

Small Business Roll-over Relief

A small business taxpayer can choose to roll-over all or part of a capital gain from the sale of a business asset if they acquire a replacement asset or make improvements to an existing asset within the replacement asset period.

The replacement asset can be acquired one year before or two years after the last CGT event in the income year for which the roll-over is chosen.

Retirement exemption

A requirement for eligibility for the retirement exemption is that the small business taxpayer be aged 55 years or over at the time of the CGT event. Therefore, where a taxpayer is aged 55 years or over they can elect to be exempt from CGT on the sale of a small business asset up to a capital gain lifetime limit of $500,000.

A small business taxpayer can choose to roll-over all or part of a capital gain from the sale of a business asset if they acquire a replacement asset or make improvements to an existing asset (i.e. within the replacement asset period). The replacement asset can be acquired one year before or two years after the last CGT event in the income year for which the roll-over is chosen.


19

Asset Transfers - Roll-over Provisions Roll-over relief (i.e. deferral of capital gains tax liability) is provided for certain transactions.

There are two types of roll-overs. These are:

Replacement-asset Roll-overs (Div.124 ITAA97)

Same-asset Roll-overs (Div.126 ITAA97)

CGT Consequences of Death Special CGT rules apply when a taxpayer dies and an asset owned by that taxpayer just before death passes to the taxpayer’s deceased estate or to a beneficiary of that estate (Div.128 ITAA97).

A CGT asset passes to a beneficiary of the deceased taxpayer’s estate when the beneficiary becomes the owner of the asset:

Under the deceased’s will, or

By operation of intestacy law if no will When a taxpayer dies, assets that pass to a beneficiary of the taxpayer’s estate or to the legal representative are taken to have been acquired by them on the date of the taxpayer’s death.

The beneficiary (or estate trustee) who actually owns the property when there is a subsequent CGT event in relation to that asset will bear any CGT liability.




End of Chapter Review

Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 5 Review Question 5.19


20

Unit 6 Deductions - General & Specific


Understanding the general principles of deductibility under s.8-1. Identifying deductions available to business, employees, for rental

properties, travel, self-education and home office. Understanding the methods available to determine motor vehicle expense

deductions and the calculation of motor vehicle expense deductions. Calculation of deductions for prepaid expenses. Understanding the substantiation requirements. Identifying and determining losses and outgoings specifically made

deductible by the ITAA. Determining the cost of a depreciating asset. Calculating the decline in value deductions using the Prime Cost and

Diminishing Value methods Calculating the balancing adjustment arising on the disposal of an asset. Calculating the deduction of a motor vehicle subject to the car limit. Applying the principles of low value asset pooling. Applying the principles of SBE pooling. Calculation of deductions for capital works expenditure.

Overview In Unit 1 we learned that Taxable Income equals Assessable Income less Deductions and that there are two categories of deductions – general and specific.

General Deductions Under s.8-1 s.8-1(1) ITAA97 provides the general formula to determine whether deductions are allowable. It states “You can deduct from your assessable income any loss or outgoing to the extent that: (a) It is incurred in gaining or producing your assessable income, or (b) It is necessarily incurred in carrying on a business for the purpose of gaining or

producing your assessable income”.

These are known as the “positive limbs”. One of these conditions must be met to claim a deduction.

However, under s.8-1(2) ITAA97 no deduction is allowed under s.8-1(1) for losses or outgoings that are:

Capital in nature

Private or domestic in nature

Incurred in relation to producing exempt income

Specifically not deductible by another section of the ITAA

These are known as the “negative limbs”. None of these conditions may be met for a deduction to be claimed.

For an amount to be deductible under s.8-1(1) ITAA97 there must be a connection between the loss or outgoing and the gaining or production of assessable income.

Refer to the textbook for examples of losses and outgoings that are specifically not deductible.


21

A deduction is allowed ‘to the extent that’ it is incurred for the relevant purpose. This gives the authority to allow a part of the expenditure when it is for mixed purposes (Ure v. FCT; Fletcher v. FCT). In TR 95/33 there is a discussion of how the subjective purpose of a taxpayer can be determined where there is more than one purpose to incurring the expenditure. Apportionment may also be required if the loss or outgoing relates to more than one year of income (Coles Myer Finance v. FCT).

Business Expenses Ordinary recurring operating expenses of a business are deductible. Normally, capital expenditure is not deductible. However, certain types of business capital expenditure related to either commencing or ceasing a business are specifically made deductible.

Under s.40-880 ITAA97, 20% of any expenditure is deductible in the income year in which it is incurred and the balance is allocated equally to each of the next four income years. The deduction is in equal proportions over five years for capital expenditure incurred: (a) In relation to a business (b) In relation to a business that used to be carried on (c) In relation to a business proposed to be carried on (d) To liquidate or deregister a company, to wind up a partnership, or to wind up a trust

that carried on a business.

Employee Expenses An employee is entitled to a deduction for expenses incurred in deriving assessable income, provided they are not of a private, capital or domestic nature (s.8-1 ITAA97).

Rental Deductions Rental income and expenses must be attributed to each co-owner according to their legal interest in the property, despite any agreement between co-owners, either oral or in writing, stating otherwise. Thus, the net rental income (i.e. rental income less rental deductions) derived from jointly owned property is normally allocated in equal shares between the owners.

Travel Expenses Employees

Employee travel expenses are deductible provided they are incidental and relevant to an employee earning their wage/salary.

Travelling to and from work is private in nature and not deductible (Lunney v FCT)

Travelling between related places of employment is deductible under s.8-1 ITAA97 (FC T v Collings; FCT v Payne)

Travelling between unrelated places of employment is deductible under section 25-100 ITAA97.

Self-employed persons Basically, the same principles apply to the deductibility of travel expenses incurred by taxpayers who are self-employed as they do to employees.

However, if part of the business/professional activity is conducted at the taxpayer’s residence, then travel is undertaken from that place of business to another place where the business/professional activity is carried on, the cost of the travel is deductible.


22

Self-education Expenses

Self-education expenses incurred by a taxpayer may be deductible where there is a connection between the course and income production.

Generally, self-education expenses incurred for “short-term refresher courses” (i.e. in keeping up-to-date or to better enable oneself to carry out one’s existing duties or to earn one’s present income) are fully deductible.

Where a new or additional qualification is sought which cannot be classified as a short-term refresher course, there must be a connection between the taxpayer’s profession, occupation, trade or business and the course of study. Further, the connection must extend to the taxpayer’s income production in that particular occupation, in that the course of study must lead to the possibility of an increase in the taxpayer’s income.

Limit on self-education expenses

Although self-education expenses are deductible, s.82A ITAA36 provides that only the excess of expenses over $250 is deductible for self-education expenses which fall within the definition of “expenses of self-education”.

Although the first $250 of self-education expenses incurred do not qualify as a deduction where they are classed as expenses of self-education, this $250 may be reduced by certain expenses that are not allowable as a deduction. Refer TR 98/9 Income tax: deductibility of self-education expenses incurred by an employee or a person in business. and

FCT v Finn

FCT v Highfield

FCT v Studdert

Home Office Expenses Where a taxpayer maintains a study to carry out work not convenient to do at their normal place of employment, home office expenses are deductible. Similarly, where a taxpayer actually carries on a business from their home, home office expenses are also deductible. To qualify for a deduction, there must be a clearly recognisable and separate place set aside. Refer TR 93/30 Income tax: deductions for home office expense. and

Handley v FCT

FCT v Forsyth

Swinford v FCT





23

Motor Vehicle Expenses Motor vehicle expenses (applies to cars as defined in s. 995-1). incurred in the course of deriving assessable income as an employee, as an investor, or in carrying on a business are deductible.

There are four different methods of claiming car expenses under Division 28 ITAA97:

Cents per Km method Log Book method 1/3 of Actual Expenses method 12% of Original Value method

Summary of Requirements for each Method

Cents per Km 12% of Original Value

1/3 of Actual Expenses

Log Book

Eligibility Rules Limited to a maximum of 5,000 kms

Business/employment use must exceed 5,000 kms

Business/employment use must exceed 5,000 kms

Car must be owned or leased

Expense Base Business kms Original value (subject to a car limit)

Car running expenses Car running expenses

Calculation Multiply by cents per km

Multiply by 12% Multiply by 1/3 Multiply by % business use

Substantiation required?

No No Yes Yes

Prepaid expenses

The treatment of prepaid deductible expenditure varies depending upon the status of the taxpayer, the nature of the expense, and if the taxpayer is a small business entity (Subdiv.H ITAA36). As a general rule, prepaid expenditure must be apportioned over the period in which the relevant service was provided (s.82KZMF ITAA36). 12 month rule

A 12 month rule allows an immediate deduction for prepayments where the:

payment is incurred for a period of service not exceeding 12 months, and,

the period of service ends in the next income year.

For all taxpayers who are not SBE taxpayers or individuals incurring non-business expenditure, there is no immediate deduction for prepaid expenditure. The deduction must be claimed proportionately over each income year to a maximum of 10 years.

Substantiation All documentary evidence must be retained by the taxpayer and kept for 5 years from the date of lodgement of the tax return in which the claim was made (s.900-25(1) ITAA97). Special substantiation rules apply to the work expenses of employees. A work expense is an expense incurred by a taxpayer in producing wages or salary.

Written evidence is required to substantiate all work expenses except where total claims are ≤ $300. It this case receipts are not required, but the taxpayer must keep a record of how the claim was calculated. Once $300 is exceeded, however, the entire amount must be substantiated.

The $300 limit applies to the sum of work-related expenses but does not include claims for car, reasonable overtime meal allowances expenses, and travel allowance expenses that require written evidence (s.900-35(1) ITAA97).


24




Specific Deductions Under s.8-5 ITAA97 a specific deduction is a loss or outgoing for which the ITAA specifically allows a deduction. The following is a list of specific deductions available under the ITAA97 provisions:

Tax-related expenses

A deduction is available for expenditure incurred in connection with the administration or management of a taxpayer’s income tax affairs (s.25-5 ITAA97).

Repairs

Expenditure incurred by a taxpayer for repairs, not being of a capital nature, to any premises, plant, tools, machinery, etc. used or held to produce assessable income is a deduction (s.25-10 ITAA97).

Refer cases:

Lindsay v FCT

Rhodesia Railways Ltd v Collector of Income Tax

W Thomas & Co Pty Ltd v FCT

Western Suburbs Cinemas Ltd; FCT v

Lease Document expenses

A deduction is allowed for expenses incurred for the preparation, registration, stamping, etc. of lease documents in relation to income producing property (s.25-20 ITAA97).

Borrowing expenses

Expenses incurred in borrowing money to be used for producing income are deductible, (s.25-25 ITAA97), as follows: • Expenses ≤ $100 - immediate deduction. • Expenses > $100 - must be apportioned over the life of the loan, but to a maximum

period of 5 years.

Discharge of Mortgage expenses

A deduction is allowed for expenses incurred on the discharge of a mortgage provided the loan or property was used to produce assessable income (s.25-30 ITAA97).

Bad Debts

Only actual bad debts written off are allowed as a deduction (s.25-35 ITAA97).


25

Loss through theft or embezzlement by employees

Losses through theft or embezzlement are deductible where made by an employee (s.25-45 ITAA97).

Subscriptions to Associations

A deduction is allowed for payments of amounts for membership of a trade, business or professional association, including initial joining fees, up to a maximum of $42 for each association (s.25-55 ITAA97). Also, this deduction is not limited to persons who actively exercise the trade, business or profession. It can be claimed by persons such as retired members.

Election expenses - Federal and State Government

A deduction is allowed in full regardless of the candidate’s success or failure (s.25-60 ITAA97).

Election expenses - Local Government

A deduction of up to $1,000 maximum in seeking election to local government is allowed (s.25-65 ITAA97).

Excessive Payments to Relatives

The amount deductible for payments made to associated persons can be restricted to an amount which the Commissioner considers reasonable (s.26-35 ITAA97). Reasonable is based upon factors such as the type of work performed, hours worked, and award rates.

Gifts and Donations Gifts and donations are covered by Division 30 ITAA97. Deductions for gifts are claimed by the person or organisation that makes the gift (the donor). A donor can be an individual, company, trust or other type of taxpayer. To be tax deductible a gift must: be made to a deductible gift recipient (DGR) really be a gift be a gift or money or a certain type of property, and comply with any relevant gift conditions Tax deductible gifts include gifts of money of $2 or more, trading stock, property valued at >$5,000, property purchased during the 12 months before the gift was made, and listed shares valued at $5000 or less and acquired at least 12 months before the gift was made to the deductible gift recipient. Deductible Gift Recipients Deductible gift recipients (DGRs) are endorsed by the ATO, or listed by name in the tax law.

Endorsed DGRs The only DGRs that do not need to be endorsed are those listed by name in the income tax law including prescribed private funds.


26

There are two types of DGR endorsement: Where an organisation is endorsed as a whole (e.g. public hospitals and public

universities) and Where an organisation is endorsed for the operation of a fund, authority or institution

that it owns or includes (e.g. school building funds and council libraries). To be endorsed as a DGR, an organisation must:

Have an Australian business number

Fall into a DGR general category or operate a fund, authority or institution that falls into a DGR general category

Have acceptable rules dealing with the transfer of surplus gifts and deductible contributions on winding up or revocation of endorsement

Satisfy the gift fund requirements (if applicable), and

Be in Australia or its fund, authority or institution is in Australia, unless it is an ancillary fund.

DGRs listed by name Deductible gift recipients (DGRs) listed by name in the tax law include organisations such as Amnesty International Australia, Australian Conservation Foundation and the RSPCA.

Superannuation contributions by employers and self-employed taxpayers Under s.280-10 ITAA97 superannuation contributions are deductible as follows:

Self-employed Self-employed taxpayers under age 75 can claim a full deduction for contributions they make into complying superannuation funds.

To be eligible, less than 10% of their total assessable income must be derived from employment as an employee (s.290-60 ITAA97). Total income includes assessable income plus reportable fringe benefits. This is known as the 10% rule and is only relevant where the taxpayer is self-employed and has employment and other income.

Employers Employers are able to claim a full deduction for all superannuation contributions made to complying superannuation funds on behalf of eligible employees (i.e. employees aged less than 75 years) (s.290-60 ITAA97).

Employees Employees can only deduct contributions they make in respect of themselves if less than 10% of their total assessable income (plus reportable fringe benefits) for the income year is attributable to employment or similar activities.

Payments of Income Tax

Payments of income tax are not deductible.



Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 6 Review Questions 6.10, 6.11, 6.23 to 6.26 and 6.37

http://ato.gov.au/nonprofit/content.asp?doc=/content/8782.htm

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s995.1.html#deduct

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s995.1.html#make

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s995.1.html#assessable_income

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s995.1.html#fringe_benefit

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s995.1.html#income_year

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s995.1.html#income_year


27

Depreciation (decline in Value) A deduction is available for the decline in value (depreciation) of a depreciating asset that is held by the taxpayer at any time during the year. The deduction is reduced to reflect the extent to which the asset was used during the year for a purpose other than a taxable purpose (s.40-25 ITAA97). A depreciating asset starts to decline in value when the taxpayer first uses it or has it installed and ready for use (s.40-60 ITAA97).

Important Definitions Depreciating asset A depreciating asset is defined as an asset that has a limited effective life and that is reasonably expected to decline in value over the time that it is used.

Cost of an asset The cost of a depreciating asset consists of a first element of cost and a second element of cost.

First element of cost This is generally the consideration paid by the taxpayer to acquire an asset (s.40-180 ITAA97).

Second element of cost This is generally the consideration provided by the taxpayer to bring the asset to its present condition and location (s.40-190 ITAA97).

Prime Cost method (s.40-75 ITAA97) The formula is: Cost x days held

Effective Life 365

Diminishing Value method The formulas for the 2011/12 income tear are: Asset acquired pre 10 May 2006 (s.40-70 ITAA97)

Base value x days held x 150% Effective Life 365

Asset acquired on or after 10 May 2006 (s.40-72 ITAA97)

Base value x days held x 200% Effective Life 365 Effective life The effective life of a depreciating asset is the total estimated period the asset can be used by an entity for the purpose of producing assessable income.

Taxpayers may make their own estimate of an asset’s effective life (s.40-105 ITAA97) or alternatively adopt on the ATO’s recommended period of effective life (s.40-100 ITAA97).

Low cost items An immediate 100% deduction is available for depreciating assets costing $300 or less for non-business taxpayers (i.e. employees and landlords) (s.40-80(2) ITAA97). Other Readings and Activities



28

Disposals of Depreciable Assets Unless the termination value of a depreciating asset exactly equals its adjustable value, then a balancing adjustment arises. A balancing adjustment is calculated by comparing the termination value and the adjustable value of the asset. The tax implications are as follows:

A balancing adjustment which is a loss on disposal is a deduction (i.e. where termination value is less than adjustable value) (s.40-285(2) ITAA97).

A balancing adjustment which is a gain on disposal is assessable income (i.e. where termination value is greater than adjustable value) (s.40-285(1) ITAA97).

Motor Vehicles Motor vehicles are subject to a car limit for decline in value calculation purposes. The 2012/13 car limit is $57,466. The car limit represents the maximum depreciable cost base of a motor vehicle.

The car limit also applies to the original value of a motor vehicle when claiming a deduction for motor vehicle expenses using the 12% of Original Value method (see Unit 9). When a motor vehicle subject to a cost limit is disposed of, the consideration received must be adjusted by calculating a reduced consideration which is then comparable to the adjustable value of the motor vehicle.




Low Value Asset Pooling Non-business taxpayers and non-small-business entities may elect to claim deductions for decline in value of depreciating assets costing less than $1,000 (low-cost assets) through a low-value pool (s.40-420 ITAA97). A depreciating asset whose decline in value was calculated using the diminishing value method for a previous income year can also be pooled where its opening adjustable value is less than $1,000.

The decline in value of a low-value pool is:

Where depreciating asset is acquired in a previous year - 37.5% of the asset’s opening adjustable value

Where depreciating asset is acquired in the current year - 18.75% of the cost of the asset

Small Business Entities Taxpayers Small Business Entities (SBE) have access to immediate write-off for depreciating assets costing less than $6,500, and a simple pooling arrangement for other depreciating assets. These concessions are outlined in Subdivision 328-D ITAA97.

Under the small business entities concessions, depreciating assets costing $6,500 or more are automatically pooled into a small business general asset pool.

Capital Works Expenditure Division 43 ITAA97 sets out the rules for working out allowable deductions for certain capital expenditure on income producing buildings and other capital works.


29

The term capital works covers a wide range of structures, and can be divided into three categories. These are buildings, structural improvements, and environment protection earthworks. The deduction available is either 2.5% or 4% depending on when construction commenced and how the capital works are used.




Additional Cases – See Chapter 17

AGC (Advances) Ltd v FCT

Amalgamated Zinc (de Bavay’s) Ltd v FCT

FCT v Brown

Charles Moore & Co (WA) Pty Ltd v FCT

Europa Oil (1) – IRC v Europa Oil (NZ) Ltd

Europa Oil (2) – Europa Oil (NZ) Ltd v CIR (NZ)

Ferguson v FCT

Herald & Weekly Times v FCT

Imperial Chemical Industries of Australia & New Zealand Ltd v FCT

Law Shipping Co Ltd v Inland Revenue Commissioners

Lindsay v FCT

Magna Alloys & Research Pty Ltd v FCT

Phillips; FCT v

Placer Pacific Management Pty Ltd v FCT

Rhodesia Railways Ltd v Collector of Income Tax

Snowden & Wilson Pty Ltd; FCT v

Steele v DFCT

Ure v FCT

W Nevill & Co Ltd v FCT

W Thomas & Co Pty Ltd v FCT

Wangaratta Woollen Mills Ltd v FCT

Western Suburbs Cinemas Ltd; FCT v


30

Unit 7 Trading Stock


Identifying the methods permitted to value trading stock for tax purposes. Use of the ATO’s standard values for goods taken from trading stock for

private use. Calculation of net business income including trading stock.

Overview Under s.70-10 ITAA97 trading stock is defined as “anything produced, manufactured, acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business, and livestock”.

Trading stock is taken into account in determining the net business income of a taxpayer. For tax purposes it is brought to account in the same way as in the normal accounting calculation of gross profit.

However, where the taxpayer is classified as a small business entity, simplified trading stock rules apply. Where the difference in opening and closing balances of trading stock is $5,000 or less, a small business entity can choose not to:

• account for the change in value of trading stock

• value each item of trading stock on hand at the end of the year of income

Small Business Entities are discussed in Unit 7.

Refer FCT v Sutton Motors and All States Frozen Foods v FCT

Valuation of Trading Stock Under s.70-45(1) ITAA97 trading stock can be valued at either:

(i) Cost price (ii) Market Selling Value (iii) Replacement Value (iv) Special valuation method

Also, the taxpayer may use any of the three permitted options in calculating their trading stock value. The method chosen may be varied from year to year. Furthermore, the taxpayer may adopt a different basis of valuation for each class of trading stock, and even for each individual item of each class of trading stock. Where trading stock consists of raw materials, work-in-process and finished goods, the taxpayer may elect to value each component separately using a different basis for each.

Refer Phillip Morris v FCT and Cecil Bros Pty Ltd v FCT

Obsolete Trading Stock Where the value of trading stock is less than its cost price, market selling value or replacement value due to obsolescence or any special circumstance (e.g. discontinuation of a product line), the taxpayer may elect to use a reasonable value which is a fair and reasonable trading stock value (s.70-50 ITAA97).


31

Not Included in Trading Stock Consumables

Consumable stores such as materials and items which are used and consumed in making trading stock are not trading stock (e.g. fuel, oils). Such expenses are normally deductible under s.8-1 ITAA97.

Spare parts Spare parts which are held for maintenance and repair purposes and not held for re-sale are also not part of trading stock. Expenditure on spare parts is therefore normally a deduction.

Drawings of Trading Stock Where an item of property stops being held as trading stock but continues to be owned by the taxpayer, it is treated as if it had been sold to someone else so that the cost of the item is included in the taxpayer’s assessable income. This also applies where the taxpayer withdraws trading stock for their personal use or consumption.

In many businesses difficulties arise in keeping appropriate records. As a result, there are standard values provided by the ATO for goods taken from trading stock for private use.

The 2012-13 standard values per ATO TD 2013/3 are as follows:

Type of business Amount (excl-GST) for

adult/child over 16 yrs

$

Amount (excl-GST)

for child 4-16 years

$

Bakery 1,310 655

Butcher 780 390

Restaurant/cafe (licensed) 4,350 1,695

Restaurant/cafe (unlicensed) 3,390 1,695

Caterer 3,670 1,835

Delicatessen 3,390 1,695

Fruiterer/greengrocer 760 380

Takeaway food shop 3,270 1,635

Mixed business (includes milk bar, general store and convenience store)

4,070 2,035





32

Unit 8 Tax Accounting


Identifying the features of the cash basis and accruals basis in determining assessable income.

Calculation assessable income using the cash basis and accruals basis.

Identifying specific aspects relevant to the timing of income and deductions.

Distinguish between permanent differences and timing differences.

Understanding the features of the tax payable method and tax effect accounting.

Reconciling accounting profit to taxable income.

Derivation of Income

It is not only necessary to consider whether or not an item is income, but also whether it has been derived. S.6-5(4) ITAA97 explains that income is considered to have been derived as soon as the amount is applied or dealt with in any way by the taxpayer directly or on their behalf. Therefore, physical receipt of income is not essential in order for it to be assessable.

Accounting Methods

For tax purposes, there are two different methods of calculating income. These are:

Cash (or receipts) basis.

Accruals (or earnings) basis.

Cash basis

The cash basis means that income is derived when cash is received, or constructively received, by the taxpayer. This method applies to salary/wage earners, most investment income, and can be used by some business taxpayers. Constructive receipt is when income has not been received as cash but has been credited and made available to the taxpayer.

Accruals basis

Under the accruals basis assessable income is derived when the right to receive income arises. This will generally be when a business raises an invoice to a customer. Refer Carden’s Case, Henderson v FCT and Barratt & Ors v FCT

Timing of Income The question of when income is derived depends on the nature of the income and, in some cases, on the nature of the income-earning activities of the taxpayer who derived the income.

Incurring a Loss or Outgoing To be deductible in a particular year, the expenditure must generally have been incurred in that year (s.8-1 ITAA97). There is no statutory definition of "incurred" but some general rules have been developed by case law and TR97/7 to assist in determining whether an expense has been incurred.


33

Expenditure is incurred when the taxpayer is definitively committed to the expenditure, or the liability is enforceable at law (FCT v. James Flood). TR 97/7 sets out the following factors in determining whether an expense has been incurred:

The expense need not have been paid, but there must be a presently existing liability to pay a sum of money (W Nevill & Co v. FCT).

There may be a presently existing liability even though it may be defeasible by others (FCT v. Commonwealth Aluminium Corp).

There may be a liability even though the exact amount may not be able to be precisely determined, as long as it can be reasonably estimated (ANZ Banking Group v. FCT).

The existence of a liability is a matter of law, which must be determined by reference to the facts of the case.

Actual payment of an amount is sufficient to establish that the expense has been incurred.

Refer also New Zealand Flax Investments Ltd v FCT

Timing of Deductions Refer to the Textbook for a list of specific examples of when particular losses or outgoings have been incurred:

Accounting for Income Tax The accounting profit (or loss) of a business may not necessarily be the same as profit (or loss) for tax purposes. This is due to the different timing and treatment of various transactions under accounting and tax rules.

These may be temporary differences, e.g. the timing is different for the derivation of income or incurring of a loss, or a permanent difference, e.g. certain expenses for accounting purposes may never be deductible for income tax purposes.

Refer to the Textbook for examples of transactions which are treated differently for accounting and tax purposes:

Methods of Tax Accounting There are two methods of accounting for income tax in the accounts of a business. Which method to use depends on whether or not the business is a reporting entity.

Tax Payable Method

The tax payable method of accounting for income tax is generally used by non-reporting entities. Under this method, income tax expense is equal to the amount of tax payable to the ATO on that period's taxable income.

Tax Effect Accounting

Tax effect accounting must be used by reporting entities and may also be used by non-reporting entities that choose to prepare their financial statements in accordance with the Accounting Standards. Under tax effect accounting, income tax expense is determined based on accounting profit or loss for the period, rather than taxable income.





34

Unit 9 Small Business Entities


Recognising the tax concessions available to small business entities. Calculation of the entrepreneur’s tax offset. Understanding of the prepaid expenditure provisions applicable to small

business entities.

Overview A range of small business concessions under the income tax, GST and FBT regimes are available to entities which satisfy the small business entity test criteria. An entity will be classified as a “small business entity” if it:

Carries on a business, and,

Satisfies a $2 million aggregated turnover test

A small business entity may be an individual, partnership, company or trust.

Small Business Entities Concessions An entity which satisfies the small business entity test criteria can choose to access the various concessions. These are:

Simplified depreciation rules – Subdivision 328-D ITAA97 (discussed in Unit 6)

Simplified trading stock rules – Subdivision 328-E ITAA97 (discussed in Unit 7)

Accounting for GST on a cash basis and paying GST by quarterly instalments

Various Capital Gains tax concessions – Division 152 ITAA97 (discussed in Unit 5)

A small business entity can choose whether or not to access any one or more of these concessions.

Simplified Depreciation Rules - Pooling of assets

Allocation of depreciable assets into a general small business pool.

Immediate write-off of assets costing less than $6,500, and the first $5,000 of a motor vehicle acquired on or after 1 July 2012.

Simplified Trading Stock rules

Where the difference in opening and closing balances of trading stock is $5,000 or less, an SBE taxpayer can choose not to:

Account for the change in value

Value each item of trading stock on hand at the end of the year of income

CGT Concessions for Small Business

There are four CGT concessions specifically for small business entities. These concessions are discussed in Unit 5.





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Prepaid expenses A prepaid expense is expenditure for things to be done (in whole or in part) in a later income year. Generally, the prepayment rules mean that deductions for certain prepaid expenses of $1,000 or more must be apportioned over the income years that the goods or services are provided. Prepaid expenditure of less than $1,000 is immediately fully deductible. However, small business entities that meet the 12 month rule, can choose to deduct those prepaid expenses immediately (s.82KZM ITAA36). Generally, a prepaid expense is immediately deductible to an SBE taxpayer if:

The payment is made for a period of service of 12 months or less, and,

The period of service ends no later than the last day of the next income year.

This 12 month rule applies to both deductible business expenditure and deductible non-business expenditure incurred by a small business entity that chooses to use this concession. Where a prepayment does not meet the 12 month rule an immediate deduction cannot be claimed. Small business entities must apportion the deduction over the period of service (to a maximum of 10 years). Other Readings and Activities




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Unit 10 Partnerships


Identifying who are dependents of a taxpayer for tax offset purposes. Calculation of s.90 partnership net income and preparation of a Statement of

Distribution. Calculation of uncontrolled partnership income penalty tax. Understanding the tax effect of trading stock and depreciable asset

revaluations where a structural change to a partnership occurs.

Overview Discuss the requirements of a partnership for tax purposes and apply the Act to determine net partnership income, individual partner’s income and tax position.

A partnership is not a separate taxable entity. However, a Partnership tax return (Form P) must be lodged. A Partnership tax return requires the completion of a Statement of Distribution which shows for each partner their share of s.90 Partnership Net Income (PNI) and any franking credits.

Each partner is individually taxed on their share of partnership net income. It must be included as assessable income in the partner’s individual income tax return. If there is a partnership loss, then each partner’s share of the loss is a deduction in their own income tax return.

Refer Yeung & Anor v FCT

Important Definition

Partnership Net Income (PNI) PNI is defined by s.90 ITAA36 as the balance left after deducting from the partnership assessable income all allowable deductions and allowable losses.

Determination of s.90PNI These following transactions are not considered in determining s.90 PNI:

Salaries paid to partners

Interest on capital paid to partners (see FCT v Beville)

Interest received from partners on drawings/overdrawn current accounts

Instead they are treated as distributions of profits.

Alternatively, the following transactions are considered in determining s.90 PNI:

Interest expense on a loan (advance) made by a partner to the partnership is a deduction for the partnership (see Leonard V FCT).

Interest received from a loan (advance) made by the partnership to a partner is assessable income of the partnership.

Partnership Losses A partnership cannot carry forward a loss for deduction against income in a future year. Instead losses are distributed to the individual partners.

Partnership Capital Gains A capital gain or loss is not included in the calculation of s.90 PNI. Instead, the individual partners are assessed on their respective shares of any capital gain/loss.


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Miscellaneous A partnership is not allowed a deduction for contributions made to superannuation funds on behalf of the partners, or for premiums paid by the partnership on the life of a partner. Instead, these payments are instead deductions for the partners individually.




Uncontrolled Partnership Income A penalty tax imposed on the income of partners who do not have real and effective control and disposal over their share of partnership net income. This applies only to persons aged 18 years and over on the last day of the partnership’s income year.

Structural Changes to Partnerships Stock values Where trading stock is disposed of outside the normal course of business activity, then the disposal is caught under the provisions of s.70-90 ITAA97.

A change in the ownership of partnership business due to formation, admission or dissolution is treated for tax purposes as a notional disposal of the trading stock by the old owner(s) to the new owner(s). Under s.70-90 ITAA97 any profit resulting from revaluation is included in the assessable income of the old owner(s).

Under s.70-100(4) ITAA97 an agreement can be made between the old and new owners that s.70-90 does not apply.

Depreciable assets Where there is a partial change in the holding of a partnership asset, or where an asset becomes a partnership asset (e.g. where a partnership is created, varied or dissolved) an adjustment may be required under the balancing adjustment rules.




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Unit 11 Trusts


Understanding terminology peculiar to trust law. Calculation of s.90 trust net income and the preparation of a Statement of

Distribution. Identifying where liability to pay tax rests – the beneficiary or the trustee. Understanding trust tax law in relation to deceased estates. Understanding the tests which must be satisfied in order to carry forward

trust losses.

Overview This unit discusses the taxation aspects of trusts. The major difficulty lies in determining on whom, and in what circumstances, does the tax burden fall - on the trustee or the beneficiary?

A trust of property or income may be described as a fiduciary obligation imposed upon a person (trustee) to hold trust property or income for a particular purpose, or for the benefit of others (beneficiaries). Trusts are created for many purposes and come in many forms such as:

Trusts created to hold investment assets separately from personal or business assets, to provide staff and/or equipment, or to act as an employer entity capable of making available superannuation benefits.

Trusts set up under a will to ensure that the members of the deceased's family are provided for from the deceased's estate.

Superannuation (trust) funds established to provide superannuation benefits.

Property trusts used to hold property for the benefit of unit holders.

A trust is not a separate taxable entity. However, a Trust tax return (Form T) must be lodged for a trust estate irrespective of the amount of income derived by the trust. The tax return requires the completion of a Statement of Distribution for each beneficiary.

Important Terminology Settlor Trust Property Trustee Beneficiaries Corpus Trust Deed

Trust Estate Present Entitlement Legal Disability Will Trusts Trust Inter Vivos Vesting Day

Refer to the textbook for full explanation of each of the above terms.

Net Trust Income (NTI) Net Trust Income is defined by s.95 ITAA36 as assessable income less deductions.

Liability to Tax Trust income is taxed either to the beneficiary or to the trustee as follows:

• The beneficiary is assessed if he/she is presently entitled to income of the trust estate, and is not under a legal disability - s.97(1) ITAA36.

• The trustee is assessed on behalf of a beneficiary who is presently entitled but is under a legal disability - s.98 ITAA36.

• The trustee is assessed on net income of the trust estate to which no beneficiary is presently entitled - s.99 or s.99A ITAA36.


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Ordinary marginal tax rates apply under s.99, whereas under s.99A a flat penalty rate of 45% applies. The concept of ‘present entitlement’ was considered in FCT v. Whiting and in Taylor & anor v. FCT. The beneficiary must be entitled to immediate payment, whether or not payment is made.

Discretionary Trusts Discretionary family (inter vivos) trusts are used in tax and asset protection planning and may be set up during the settlor’s lifetime. This type of trust provides a very flexible means to split income between family members with the aim of achieving maximum tax savings. The trustee usually has the discretion to vary proportions passed on to beneficiaries, or even vary the beneficiaries.

Under s.101 ITAA36 where a trustee is given the discretionary power to make payments out of trust income to benefit a beneficiary, such payments are deemed to be distributions of income to which the beneficiary is presently entitled.

Deceased Estates Deceased estates arise from the death of a taxpayer and are treated as trusts for tax purposes and the executor or administrator of a deceased estate is the trustee. The executor is responsible for the collection of the deceased’s assets, payment of any outstanding debts, and the distribution of the balance of the trust estate to the beneficiaries in accordance with the terms of the will or legislation (if no will). Probate The executor needs to obtain probate before they can distribute the assets of the deceased estate to the beneficiaries. Probate is granted by the Supreme Court in the state or territory in which the will is lodged. Granting of probate means that the court recognises the will as being both valid and authentic.

Until probate is granted, any income derived by the trust estate is regarded as income to which no beneficiary is presently entitled and is therefore assessed under s.99 or s.99A ITAA36.

Trust Losses Trust losses are not distributed to the beneficiaries, but instead loss must be carried forward.

Special trust loss tests apply to certain types of trusts such as discretionary and fixed trusts. These tests must be satisfied before a carry forward trust loss can be deducted against current year trust income. The tests are:

50% Stake test

Income Injection test

Pattern of Distributions test

Control test

Other Readings and Activities Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 11 Parts 11.1 to 11.13



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Unit 12 Companies


Understanding the continuity of ownership and same business tests. Identifying the R&D tax concessions available to eligible companies, and

calculating the R&D tax offset. Calculating taxable income and tax payable of a company. Preparing Franking accounts. Calculating entries for breaching the benchmark rule - under-franking and

over-franking Calculating franking deficit tax.

Overview This Unit discusses the calculation of taxable income and tax payable by a company and preparation of franking accounts.

A company, when it is registered is taxable in its own right (s.4-1 ITAA97). A company is normally required to lodge a Company tax return - Form C - by the date on which it is required to pay its final tax liability. Companies are taxed at a flat rate of tax (there is no tax-free threshold). For the 2012/13 year of income the company tax rate is 30%.

Calculation of Taxable Income The taxable income of a company is calculated in much the same way as for an individual taxpayer engaged in business (s.4-15 ITAA97). Companies are subject to restrictions on the deductibility of tax losses and bad debts, and some special concessions for tax purposes exist. Therefore, the accounting net profit/loss of a company will not necessarily equal its taxable income because an Income Statement is prepared according to accounting standards, whereas taxable income is calculated according to tax laws.

Tax Losses To be able to claim a deduction for a carry forward loss, a company must satisfy either the continuity of ownership test or the same business test.

The continuity of ownership test requires that shares carrying more than 50% of all voting, dividend and capital rights must be owned at all times during the year of recoupment of the tax loss and during the actual loss year (s.165-12 ITAA97).

The same business test requires that a company carry on the same business in the recoupment year as it carried on immediately before a change in the beneficial ownership of its shares (s. 165-13 ITAA97).

Commencing the 2012/13 income year, companies are able to carry-back tax losses to offset previous year profits so as to provide a refund for tax previously paid.

Bad Debts A company is allowed a deduction only for bad debts actually written off, provided it satisfies either the continuity of ownership test or the same business test.

Research and Development expenditure Under Division 355 ITAA97 a tax offset is available to eligible companies for eligible expenditure incurred on R&D activities. Refer to the textbook for tax offset rates for the current income year.

Capital Gains The CGT discount method does not apply to companies.


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Capital Losses Capital losses of a company are subject to the continuity of ownership and same business test provisions.


Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 12 Parts 12.1 to 12.12 Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 12 Review Questions 12.1 to 12.5

Imputation System Companies which pay franked dividends must keep records to verify the amount of the franking credits passed on to their shareholders in a franking account (s.205-5 ITAA97). A franking account is an account that a corporate tax entity maintains to keep track of the income tax credits it can pass on to its members.

The franking account is credited with franking credits and debited with franking debits. A franking surplus exists when franking debits < franking credits (i.e. a credit balance). A franking deficit exists when franking debits > franking credits (i.e. a debit balance).

Benchmark Rule The benchmark rule requires that a corporate tax entity must frank all frankable dividends made during a franking period at the benchmark franking percentage (s.203-25 ITAA97). The benchmark franking percentage is the same as the franking percentage for the first frankable distribution made by the entity within the franking period. The benchmark rule does not apply to listed public companies (s.203-20 ITAA97).

The following penalties are imposed on a corporate tax entity that breaches the benchmark rule:

Over-franking tax If the actual franking percentage of a frankable distribution exceeds the benchmark franking percentage over-franking tax arises. Under-Franking debit If the actual franking percentage of a frankable distribution is less than the benchmark franking percentage an under-franking debit entry arises. The amount of under-franking tax is calculated on the same basis as over-franking tax. Franking Deficit Tax Franking deficit tax arises only where a company has a franking deficit at the end of the year (s.205-45 ITAA97). The franking deficit tax amount is the same as the amount of the deficit balance of the franking account.

Tax Collection Companies pay their tax under the PAYG system either in a single lump sum or in quarterly instalments. The payments will be made in conjunction with the lodgement of a Business Activity Statement (BAS) each quarter.





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Unit 13 Tax Administration


Identify the features of the Taxpayers Charter. Identification of the requirements concerning lodgment of income tax

returns. Understanding the principles of self-assessment. Identifying the types of assessment. Understanding the post assessment review and audit process. Recognise the various types of tax rulings that can be made by the ATO. Understanding the principles of negotiated settlements, payment of tax, the

ATO’s access to information and rights of recovery, and the freedom of information and privacy provisions.

Explain the operation of the uniform administrative penalty regime. Distinguish between objections, appeals and reviews.

Taxpayers Charter The Taxpayers' Charter (the charter) explains what taxpayers can expect from the ATO in all dealings with them. The charter is for everyone who deals with the ATO on tax, superannuation, excise and the other laws that the ATO administer. It sets out the way the ATO conducts itself when dealing with taxpayers.

Lodgment of Returns As per s.161 ITAA36 every person must, if required by the Commissioner, lodge an income tax return. The due date for self-lodgement by individuals, partnerships and trusts is 31 October following the end of the year of income.

A resident individual must lodge an income tax return for the 2012/13 income year where any of the following apply:

Taxable income exceeded $18,200 for the income year.

Amounts of PAYG tax were withheld from income derived.

Tax was withheld from interest or dividends under the Tax File Number provisions.

They became or ceased to be a resident of Australia for tax purposes.

They were a minor (i.e. under 18 years of age) at 30 June and derived non-wage or salary income in excess of $416.

They were issued with an assessment under the Child Support (Assessment) Act.

They carried on a business in Australia.

They have prior year losses or a loss in the current year.

They were entitled to a distribution from a trust or had an interest in a partnership.

They had exempt foreign employment income and $1 or more of other income.

They had a Reportable Fringe Benefit amount on their Payment Summary.

Recipients of the SAPTO and other government allowances or pensions, but subject to income level thresholds.

Generally, income tax returns must be lodged by 31 October following the end of the year of income for individuals, partnerships and trusts.


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Tax Agent Lodgment Program Although taxpayers must normally lodge their own income tax returns by a fixed date each year, special extension arrangements are made for clients of tax agents under the tax agent Lodgment Program.

Penalties for Late Lodgement of Returns Taxpayers who fail to lodge an income tax return are liable to pay a General Interest Charge (GIC). Refer to the Textbook for the current income year GIC rates. Types of Assessments

Original assessments

Default or Arbitrary assessments

Special Assessments

Amended Assessments

Notice of Assessment

A Notice of Assessment is an itemised account issued by the ATO of the amount of tax liability on a taxpayer’s taxable income based on the information provided on that tax return.

Statement of Account

The statement of account is designed to keep taxpayers up-to-date with their tax account. It provides a summary of payments and transactions made during the statement period and shows any amounts the taxpayer needs to pay or refunds due to them.

Post-Assessment Reviews and Audits

After the Notice of Assessment has been issued (individuals) or deemed assessment submitted (companies and superannuation funds), some assessments are either reviewed or audited to ensure compliance with tax law.

Reviews A review or audit usually involves looking at a taxpayer’s tax affairs to ensure the information they have given us is accurate and that they have complied with their tax obligations. If the ATO find evidence during a review that the taxpayer has not met their tax obligations, it may decide to conduct an audit.

Audits A tax audit is a systematic examination of a taxpayer’s income tax affairs by the ATO to determine whether or not the taxpayer has fully complied with the tax laws. The ATO’s Compliance Program includes the following types of audit:

• Research audits.

• Primary audits.

• Business audits.

• Complex audits

• Special audits

Negotiated Settlements Generally, the ATO will not forego tax properly payable. However, in some circumstances the strict application of this rule will be relaxed where there is a need for the good management of the taxation system, overall fairness and the best use of ATO and other community resources. Negotiated settlements may occur at any time and will be settled on a case-by-case basis.


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A negotiated settlement is appropriate where the cost of litigation is considered likely to outweigh any possible benefits, a case is problematic in its outcome, or where the settlement will achieve compliance by the taxpayer for the current and/or future years in the most cost effective way.

Taxation Ruling System There are six types of Rulings for income tax purposes that set out the ATO’s interpretation of the law. These are:

Oral Rulings.

Public Rulings.

Private Rulings.

Product Rulings.

Class Rulings.

Tax Determinations.

ATO’s Access to Information The ATO’s access to information gathering powers allow it to:

Gain access to premises and documents, Require a person to attend an interview and to provide information and evidence, Require documents to be produced, and, Require information to be given.

Commissioner’s right of access s.263 ITAA36 gives ATO officers the right of full and free access to all buildings, places, books, documents, papers, etc. for the purpose of obtaining tax related information. ATO officers cannot remove original documents without a Court order or warrant, but have the right to make copies, extracts, etc.

Commissioner’s power to obtain information s.264 ITAA36 empowers the Commissioner to request, by notice in writing, that the taxpayer or any other person:

• Provide all required information.

• Produce all documents as required.

• Attend and give evidence concerning income or assessment of the taxpayer under investigation.

Refer FCT & Ors v Citibank Ltd

Freedom of Information and Privacy The ATO is subject to freedom of information legislation, which means that taxpayers are able to view their tax files.

Payment of Tax Income tax can be paid directly to the ATO, at any Post Office, by Electronic Funds Transfer (EFT), and by credit card using the Government EasyPay website or telephone service.

Interest on Early Payments An income tax payment for certain tax debts will qualify for early payment interest if it is paid more than 14 days before the due date for payment.

https://www.optussmartpay.com/governmenteasypay-ato


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Early payment interest is payable on the following:

Income tax, including Medicare Levy.

Shortfall Interest charges.

Higher Education Loan Programme (HELP) repayment amounts.

Extension of Time for Payment The Commissioner may grant an extension of time for payment of income tax, and/or may permit the tax to be paid by instalments.

Relief in Cases of Hardship The Commissioner has discretionary authority to grant a taxpayer total or partial release from payment of a tax liability (including penalty taxes), but not from tax instalment deductions.

Recovery of Tax Income tax, when due and payable, becomes a debt to the Commonwealth of Australia. Unpaid tax after the due date attracts a penalty.

Rights of Recovery Persons Holding Money for the Taxpayer Unpaid tax owing to the ATO may be recovered after written notice (“third party notice”) from the taxpayer or from any persons holding money on the taxpayer’s behalf (e.g. financial institutions) or who owe or may become liable to owe money to the taxpayer. However, a “third party notice” cannot be used by the ATO to deprive a taxpayer of all of their income flow.

Liquidators and Receivers Under TAA Sch 1 Subdiv 260-B and 260-C a liquidator of a company or receiver for debenture holders must notify the Commissioner within 14 days of the fact of:

(i) Their appointment to the position, and, (ii) Taking possession of the company’s assets. The ATO will then advise of the total amount

of tax due and payable.

The liquidator or receiver can use company assets to pay secured or preferred debts (e.g. unpaid wages) but cannot settle ordinary debts without first making allowance for any tax liability.

Trustees of Deceased Taxpayers The Commissioner may recover unpaid tax owing at the time of the taxpayer’s death from the trustees of the deceased’s estate




Penalty Tax and Tax Offences - Overview Penalty taxes differ from tax offences in that penalties are imposed by way of additional tax, whilst tax offences are prosecuted by the Courts. Thus, a taxpayer who fails to comply with provisions of the TAA may be faced with either additional penalty tax or a court prosecution, but not both.


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Penalties A taxpayer is liable to pay penalty tax and, in certain circumstances, a Shortfall Interest Charge (SIC) where the requirements of the taxation laws have not been met.

A penalty may be payable where:

• Taxpayer fails to lodge an income tax return or other document by the due date • Taxpayer refuses or fails to provide information • Taxpayer fails to keep or furnish records • Taxpayer has a shortfall amount • The Commissioner has applied an anti-avoidance provision • Tax is paid after the due date

Shortfall Amounts A shortfall amount is the difference between tax payable in accordance with the law (proper tax) and tax payable based on the taxpayer’s tax return (statement tax).

There is a scale of penalties that applies for shortfall amounts. The actual amount of the tax shortfall penalty imposed upon a taxpayer is based upon consideration of the following factors: • Intentional disregard of tax law • Recklessness • Lack of reasonable care • No reasonably arguable position • Private Ruling disregarded

Administrative Penalties Refer to the textbook for the types of culpable behaviour falling under the heading of administrative penalties, and the applicable base penalty percentages. Shortfall Interest Charge (SIC) The SIC applies to income tax shortfalls for the period before assessments are amended. Generally, the SIC applies from the date due for payment of the earlier, understated assessment until the day before the ATO issues the notice of amended assessment.

Refer to the textbook for the SIC rates for the 2012/13 income year. Failure to Lodge Return on Time (FTL) A penalty applies for failing to lodge an income tax return and/or other documents by the due date. A penalty amount is worked out based upon the base penalty amount. The base penalty amount is one penalty unit ($170) for each 28 days (or part thereof) that the tax return or tax document remains outstanding. The amount of the penalty liability increases according to the size of the entity. Late Payment Penalties A General Interest Charge (GIC) applies to the late payment or underpayment of a range of taxes, the late lodgment of various returns, late payment of penalties or the failure to make deductions and other payments under the PAYG system. Refer to the textbook for the GIC rates for the 2012/13 income year.


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Tax Offences In certain circumstances, the Commissioner may prosecute a taxpayer instead of imposing penalty tax. If a taxpayer is liable to pay penalty tax and a prosecution is instituted, then that taxpayer ceases to be liable to pay the penalty tax, even if that prosecution is later withdrawn.

Other Readings and Activities Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 13 Part 13.17


Objections, Appeals and Reviews - Overview A taxpayer who is dissatisfied with an assessment, amended assessment or other taxation decision, such as a Private Ruling issued by the ATO, may challenge that decision.

Objections Any taxpayer who is dissatisfied with their assessment or other taxation decision may make written objection to the ATO. An objection must be in the prescribed format and state fully and in detail the reason why the taxpayer considers the ATO is incorrect and the grounds the taxpayer is relying on.

Objections are not confined to assessments. An objection can be lodged against any of the following ATO decisions (Taxation Decisions):

Assessments and amended assessments (including income tax, franking account, fringe benefits, some penalties, shortfall interest charge, superannuation contributions surcharge, termination payments surcharge);

Foreign tax credits or a double tax agreement;

Private Rulings; and

Other ATO decisions specifically relating to the taxpayer (e.g. remission of penalties and PAYG).

Time limit for Objection

To be valid an objection must be made within the prescribed time limit. For assessments and amendments in 2004/05 and later income years the time limits are:

• Individuals who meet certain criteria and SBE taxpayers .............................. 2 years • All other taxpayers ......................................................................................... 4 years

This means that for taxpayers with simple tax affairs the time for lodging objections is 2 years.

Outcome of Objections The Commissioner must consider a taxpayer’s objection and then serve the taxpayer with written notice of the decision. The Commissioner may allow or disallow an objection either wholly or in part.


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Reviews and Appeals If a taxpayer is dissatisfied with the outcome of an objection (i.e. because of full or partial disallowance of the objection by the Commissioner), then the taxpayer may within 60 days of being served with the notice of disallowance of the decision either:

(i) Apply to the Taxation Appeals Division of the Administrative Appeals Tribunal (AAT) for a review of the decision, or

(ii) Appeal to the Federal Court against the decision.

Some of the factors that a taxpayer should consider in deciding whether to apply to the AAT for a review of, or appeal to the Federal Court against, the Commissioner’s decision on an objection are: • Type of Case • Nature of proceedings • Publicity • Costs • Rights of appeal

Generally, where the amount of tax in dispute is <$5,000, the Small Taxation Claims Tribunal will be a far more suitable forum than the Federal Court or the AAT.

Small Taxation Claims Tribunal (STCT) If the amount of tax payable in dispute is < $5,000, the taxpayer may elect that the matter be dealt with by the Small Taxation Claims Tribunal (STCT).

The Small Taxation Claims Tribunal provides a cheaper and less formal means of resolving tax disputes, in particular by encouraging mediation.




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Unit 14 Tax Planning and Anti-Avoidance


Identifying the types of tax planning. Identifying the tax planning methods. Understanding the principles of salary sacrifice, negative gearing, and

superannuation co-contributions. Understanding the anti-avoidance provisions used by the ATO. Understanding the role played by Project Wickenby in fighting tax crime. Recognising the specific types of tax crime. Understanding how the ATO targets tax crime.

Overview This Unit is designed to impart an understanding of tax planning techniques and to identify the anti-avoidance provisions of the ITAAs.

Tax planning can be defined as the process of organising a taxpayer’s affairs within the law so as to minimise liability to tax.

Important Definitions Structural planning Structural tax planning involves the consideration and selection of the type of business structure most suitable to the taxpayer to reduce overall tax liability (e.g. partnership, company or trust).

Procedural (transactional) planning Procedural tax planning relates to daily decisions and planning in matters such as: • The maintenance of records to ensure that deductions can be substantiated • The valuation of trading stock at the end of the year • The most tax-effective way of financing the business enterprise

Tax Avoidance Tax avoidance is the organisation of a taxpayer’s affairs so that the minimum tax liability arises whilst, at the same time, complying with the letter of the law.

Tax Evasion Tax evasion is illegal. It is the non-payment of tax that would otherwise be payable if the taxpayer had made full and true disclosure of all assessable income and deductions.

Tax Planning Methods Minimised tax liability can be achieved by any of the following methods:

Reducing Assessable Income A popular method to reduce assessable income for employees is salary packaging or salary sacrifice. Salary packaging is an arrangement by which an employee agrees to forego part of their pre-tax salary or wages in return for the employer providing another benefit using the amount “sacrificed”. The benefit received is not assessable income of that taxpayer. Instead, the benefit becomes a fringe benefit and is subject to fringe benefits tax payable by the employer.


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Typical salary sacrifice arrangements involve wages or salary being sacrificed in return for benefits such as:

Superannuation

Concessionally taxed fringe benefits such as cars under the Statutory formula method

Benefits which are exempt from FBT

Expenses payment fringe benefits

Increasing Deductions and Tax Offsets

Deductions may be increased by negative gearing and by deductible superannuation contributions. Also, take advantage of the Superannuation Co-contribution provisions.

Reducing Rate of Tax/Defer payment of tax For example, the averaging provisions applicable to primary producers and special professionals.

Diverting Income Diverting income by means of income splitting in family situations is a common practice for partnerships and discretionary trusts.

Select the tax planning “vehicle” This involves determining the most appropriate structure to conduct business – sole trader, partnership, discretionary trust or private company.

Anti-Avoidance Legislation There are three types of anti-avoidance provisions in the Income Tax Acts:

Provisions that have anti-avoidance mechanisms built in. o For example, in s. 8-1, the cases of Fletcher v. FCT and Ure v. FCT demonstrate that

expenses incurred for the purpose of avoiding tax are not deductible

Specific anti-avoidance provisions which are provisions specifically introduced to deal with particular types of planning. o For example, the prepayment provisions (e.g. s. 82KZM ITAA 1936) were

introduced to curb abuse of s. 8-1.

General anti-avoidance rules (GAARs) which are aimed at anti-avoidance generally. o The GAARs for income tax are found in Part IVA of ITAA 1936.

To determine if Part IVA applies, follow these steps:

Step 1: Is there a scheme? o S.177A ITAA36; FCT v Hart

Step 2: Is there a person who entered into or carried out the scheme with a sole or dominant purpose to obtain a tax benefit? Step 3: What is the tax benefit? Step 4: Who is the relevant taxpayer that got the tax benefit? o S.177D ITAA36; FCT v. Consolidated Press Holdings; FCT v. Spotless Services

Step 3: What is the tax benefit? o S.177C ITAA36; PS LA 2005/24

Step 4: Who is the relevant taxpayer that got the tax benefit? o FCT v. Peabody


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Tax Crime

The most common methods of criminal attack are: Identity crime. Secret offshore dealings. High-volume, low-value suspect transactions. Credit and refund fraud. Illicit tobacco growing and trading.

Tax crime is often associated with other crimes, and the ATO co-operates with other agencies to investigate serious breaches.

Project Wickenby Project Wickenby is an ongoing multi-agency taskforce which aims to protect the integrity of Australian financial and regulatory systems by preventing people from promoting or participating in the abuse of tax or secrecy havens.

The Project Wickenby taskforce works with Australian and international agencies to detect, deter and deal with: Tax avoidance and evasion. Breaches of financial laws and regulations. Attempts to defraud the community including investors and creditors. Money laundering. Concealment of income or assets. Types of Tax Crime

Common types of tax crime are: Tax refund fraud. Scams, including refund scams, email scams, phone scams, recalculation of your

refund scams, and money transfer scams. Illegal tobacco growing and trading. Offshore dealings in tax havens. Role of Taxpayers

Taxpayers can help combat tax evasion and tax crime by making a voluntary self-disclosure or by reporting suspected tax evasion/tax crime of third parties. All information is treated confidentially by the ATO. Other Readings and Activities Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 14 Parts 14.8 to 14.13

End of Chapter Review Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 14 Review Questions 14.12 to 14.16

http://www.ato.gov.au/individuals/content/00092180.htm

http://www.ato.gov.au/corporate/content.asp?doc=/content/88713.htm&page=75#P1134_156767





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Unit 15 Fringe Benefits Tax


Distinguishing between Type 1 and Type 2 fringe benefits. Identifying the various types of fringe benefits. Calculating the taxable value and FBT payable of a range of fringe benefits. Recognising exempt fringe benefits. Understanding the FBT concessions as they apply to non-profit organisations.

Overview This Unit will cover the types of benefit attracting fringe benefits tax, the rate of fringe benefits tax, and the method of assessment and payment of fringe benefits tax. A fringe benefit is broadly defined under s.136 FBTAA to include any right, service, privilege or facility provided as part of, or in place of, a salary package to reduce the income tax liability of the employee. A benefit can be the:

Use of something

Ownership of something

Enjoyment of a privilege or facility

Fringe Benefits Tax (FBT) is payable by the employer (s.68 FBTAA). The FBT year runs from 1 April to 31 March and a FBT return must be prepared and lodged by 21 May following the end of the FBT year.

Calculation of FBT Payable There are four steps to be followed in calculating FBT:

Step 1 Identify the type of fringe benefit Step 2 Calculate the taxable value of the fringe benefit Step 3 Gross-up the taxable value of the fringe benefit Step 4 Multiply the FBT rate of 46.5% by the grossed-up taxable value of the fringe benefit

The value of a fringe benefit must be grossed up before calculating the amount of FBT payable as follows:

Type 1 Fringe Benefits

Where GST is included in the employer’s costs of providing a fringe benefit, and the employer is able to claim an input tax credit, the benefit is known as a Type 1 fringe benefit. The Type 1 gross-up factor is 2.0647.

Type 2 Fringe Benefits

Fringe benefits that are not Type 1 benefits are known as Type 2 fringe benefits. Benefits will be Type 2 where the cost to the employer of providing the benefit did not include GST or, where GST was charged, the employer was not eligible to claim an input tax credit in its BAS. The Type 2 gross-up factor is 1.8692.

Reportable Fringe Benefits Where the value of certain fringe benefits provided to a taxpayer by an employer exceeds $2,000 in a FBT year, the employer must record the grossed-up taxable value of those benefits on the employee’s Payment Summary (s.135P FBTAA).


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Types of Fringe Benefits There are many different types of fringe benefits including car fringe benefits, loan fringe benefits, expenses payment fringe benefits, housing fringe benefits, entertainment fringe benefits and car parking fringe benefits.

Car fringe benefits The provision of a car fringe benefit is a common occurrence. It generally arises when a car that is owned or leased by an employer is used privately by an employee, or made available for their private use.

There are two methods which can be used to find the taxable value of the car benefit provided to the employee. These are the:

Statutory Formula method (s.9 FBTAA) The Statutory Formula method operates on a per-vehicle basis by applying a statutory percentage to the cost price of the vehicle. The percentage is based on the number of kilometres travelled during the tax year. The availability of the vehicle for private use by the employee and any running cost paid by the employee are also taken into account.

Operating Cost method (s.10 FBTAA) This method uses the total operating costs of the vehicle during the year of tax. These include actual vehicle running costs, deemed costs for depreciation, and imputed interest.

Exempt Fringe Benefits There are many types of work-related fringe benefit that are specifically exempt from FBT. Exempt fringe benefits include the provision of minor, infrequent benefits costing less than $300 (s.58P FBTAA), portable electronic devices used for work (s.58X FBTAA) and trade or professional journal subscriptions (s.58Y FBTAA).

Non-profit Organisations FBT concessions apply to certain benefits provided by the following organisations such as:

Public benevolent institutions (other than hospitals) and health promotion charities Public and non-profit hospitals and public ambulance services Religious institutions Non-profit companies

Public benevolent institutions, health promotion charities, rebatable employers, religious institutions, non-profit organisations are allowed to provide FBT-free benefits to their employees up to a maximum capped threshold of $30,000 of the grossed-up taxable value of fringe benefits for each employee. For public hospitals, non-profit hospitals and public ambulances services the level of the concessional FBT treatment is at a maximum capped threshold of $17,000 of the grossed-up taxable value of fringe benefits provided to each employee.





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Unit 16 Goods and Services Tax


Understanding the principles the GST Act 1999, and the mechanics of the GST, including registration rules, GST supplies, and accounting for GST.

Understanding the GST attribution rules, the types of GST attribution transactions.

Understanding the principles of the margin scheme. Calculating the margin using the consideration and valuation methods. Identifying the compliance requirements. Making for GST errors and adjustments.

Goods and Services Tax (GST) The Goods and Services Tax is primarily administered by the GST Act 1999. The 10% GST only applies to a transaction that is a taxable supply or taxable importation. Under the GST system, entities registered or required to be registered for GST must charge and are liable for GST when they sell or supply goods or services as part of their business (s.9-5 GST Act). These are termed taxable supplies. If the entity acquires goods or services as part of their business, it is able to claim a credit for the GST that has been included in the price. This is called an input tax credit because it is a credit on business inputs.

An entity carrying on an enterprise is not required to register for GST if annual turnover is less than $75,000 ($150,000 for non-profit organisations). If the entity is not registered, GST is not payable on supplies made. However, unregistered entities will not be entitled to claim input tax credits for GST included in the price paid for goods and services acquired.

Registration is central to administering the GST system. Without registration, GST cannot be charged and GST input credits cannot be claimed.

If an entity is registered or required to be registered for GST it will be: • Required to pay GST on a sale or supply.

• Able to claim input tax credits for GST included in the price of supplies acquired for use in carrying on the enterprise.

• Required to lodge Business Activity Statements (BAS).

GST Supplies There are three types of GST supply. These are: • Taxable supplies. • GST-free supplies. • Input-taxed supplies

Accounting for GST Entities will either use the cash basis or the accruals (non-cash) basis of accounting to record GST and input tax credits. An entity is able to account for GST on a cash basis if its annual turnover is equal to or below $2 million. In this case there is a GST liability or obligation when payment for a good or service is actually received. Alternatively, an input tax credit for the GST can only be claimed when payment is made by the entity to a supplier of a good or service.


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An entity which accounts for the GST on an accruals basis will have a GST liability or obligation when it issues a tax invoice to its consumers. Input tax credits will be claimed by an entity only when it receives a tax invoice from its suppliers or payment for the good or service has been made.




GST Attribution Attribution is the term used in the GST law to describe the way GST payable, input tax credits and adjustments are accounted for in order to work-out the net amount of GST for a tax period. GST payable, input tax credits and adjustments are attributed to tax periods rather than being remitted or refunded each time a taxable supply, creditable acquisition or adjustment is made.

Refer GSTR 2000/29

GST Attribution Rules The most basic attribution rule is whether the business accounts for GST on a cash basis or on an accruals basis.

Cash basis

If GST is accounted for on a cash basis, GST payable on a taxable supply is attributed to the tax period when the consideration for the supply is received, but only to the extent that the consideration is received in that tax period (i.e. sales are accounted for in the period when an invoice for the sale is issued).

Accruals basis

If a business does not account for GST on a cash basis, it therefore attributes all the GST payable on a taxable supply to the earlier of the tax periods when:

Any of the consideration for the supply is received; or,

An invoice is issued for the supply.

GST Attribution transactions

These are:

Attribution on Land Sales

Attribution on Lay-bys

Supply of goods on approval or on sale or return terms

Floor Plan arrangements

Hire purchase contracts

Consideration Central to the operation of the attribution rules is the receiving and providing of consideration. A taxable supply or a creditable acquisition applies at the time consideration is made. The Commissioner has made a number of specific rulings in GSTR 2003/12 as to when consideration is deemed to be given or have occurred for the various payment instruments that may be used in transactions.


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GST and the Margin Scheme

The Margin Scheme is a way of working out the GST payable when property that is part of a business is sold. The Margin Scheme can only be applied if the sale of the property is taxable.

The margin scheme cannot be used on property sales if the business originally purchased the property as fully taxable and the margin scheme was not used. In this situation the business may be able to claim the GST included in the purchase price if the property is going to be used for business purposes.

When using the Margin Scheme, the amount of GST a business must pay on a property sale is equal to one-eleventh of the margin. Development costs are not taken into account in calculating the margin. The margin is not:

The profit margin - unlike an accounting profit margin, the margin on the sale does not take into account costs incurred to develop the new property or subdivide the land.

The selling price minus a valuation of the property for a property purchased after 1 July 2000.

Worked out the same way as a capital gain - it is possible that a taxpayer has to still pay GST under the margin scheme when they have no capital gain for income tax purposes.

There are two methods which can be used to work out the margin. These are:

The Consideration method.

The Valuation method. Consideration method

This method can be used regardless of when the property was purchased. The margin, using the consideration method, is the difference between the property’s selling price and the original purchase price. The following are not included as part of the purchase price:

Costs for developing the property.

Legal fees.

Stamp duty.

Other related purchase expenses. Valuation method

This method can only be used where the property was originally by the seller before 1 July 2000. The margin, using the valuation method, is the difference between the properties selling price and the value of that property as at 1 July 2000. The valuation method can only be used if there is an approved valuation of the property as at 1 July 2000. Refer GSTR 2000/21 Goods and services tax: the margin scheme for supplies of real property held prior to 1 July 2000 Other Readings and Activities Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 16 Parts 16.6 and 16.7



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Reporting and Compliance Requirements Entities with monthly tax periods, (i.e. entity’s whose turnover is $20 million or more), must lodge their BAS and pay the net amount of GST within 21 days after the relevant tax period has ended.

Entities with a quarterly tax period must lodge their BAS and pay their net GST as follows:

Quarter Due Date

1 July – 30 September 28 October

1 October – 31 December 28 February

1 January – 31 March 28 April

1 April – 30 June 28 July In the event of a refund the ATO will directly deposit funds via direct debit into the entity’s nominated bank account which was provided upon registration. If the entity is a GST instalment payer, (i.e. is they do not complete actual GST accounts and, therefore figures, until the end of the year), they must pay the GST pre-determined amount by the ATO on their BAS for the relevant tax period.

GST Errors and Adjustments GST errors For tax periods starting on or after 1 July 2012, if a business makes an error they can only make the correction in a later BAS within the period of review for the assessment for the tax period in which the error occurred. Generally, an assessment can be amended only within four years from the day the Notice of Assessment is given to the taxpayer.

A business can make the corrections on its next activity statement, only if the net effect (i.e. the total GST effect of all the errors) is within the ATO’s correction limit thresholds based upon the size of the business - refer to Textbook. GST adjustments GST adjustments arise when:

A customer opts for an early payment discount that may be present on an invoice as an incentive to pay,

If goods are returned and refund is granted,

A bad debt arises, or

There was a previous miscalculation for the GST liability or credits. These are known as adjustment events. GST adjustments are attributable to the tax period in which the entity first becomes aware of the increasing or decreasing adjustment. Refer GSTR 2000/24 ‘Goods and services tax: Division 129 – making adjustments for changes in extent of creditable purpose’

Other Readings and Activities Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 16 Parts 16.8 and 16.9


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Unit 17 Tax Cases


Understanding case law in relation to income tax matters. Refer to the Textbook for a detailed list of tax cases. Other Readings and Activities Taxation Law & Practice, Cooper, Taggart & Cliff, Chapter 17

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