Australian master financial planning guide 2019/20. [22nd edition.]
 9781925894301, 1925894304

Table of contents :
Product Information
INCOME TAX
CALCULATION OF INCOME TAX AND MEDICARE LEVY, INCLUDING TAXATION OF MINORS
PAYMENT OF INCOME TAX AND COLLECTION SYSTEMS
WITHHOLDING TAX ON DIVIDENDS, INTEREST AND ROYALTIES
ASSESSABLE INCOME AND EXEMPT INCOME
DEDUCTIONS
TAX OFFSETS
COMPANIES
PARTNERSHIPS
TRUSTS
CROSS-BORDER ISSUES
TAX AVOIDANCE
RULINGS
RETURNS, ASSESSMENTS AND REVIEW
PENALTIES
CAPITAL GAINS TAX
STEP 1: WHAT TRANSACTIONS ARE COVERED?
STEP 2: WHAT IS THE CAPITAL GAIN OR LOSS?
STEP 3: EXEMPTIONS, CONCESSIONS AND SPECIAL RULES
STEP 4: ROLLING OVER/DEFERRING A CAPITAL GAIN OR LOSS
STEP 5: CALCULATING THE TAX
SUMMARY — CHECKLISTS
FRINGE BENEFITS TAX
CALCULATING FBT
FBT EXEMPTIONS AND CONCESSIONS
FBT PLANNING
SUPERANNUATION
SUPERANNUATION IN AUSTRALIA
CONTRIBUTIONS TO SUPERANNUATION FUNDS
TAXATION OF FUNDS AND RSA PROVIDERS
WITHDRAWAL OF SUPERANNUATION BENEFITS
SUPERANNUATION GUARANTEE SCHEME
FOREIGN SUPERANNUATION FUNDS
SELF MANAGED SUPERANNUATION FUNDS
ESTABLISHING AN SMSF
FUND ACCOUNTS
THE TRUST DEED, SISA AND INVESTMENTS
SOCIAL SECURITY
CENTRELINK BENEFITS
DEPARTMENT OF VETERANS’ AFFAIRS BENEFITS
MEANS TESTS
HOUSING IN RETIREMENT
ASSESSMENT OF INVESTMENTS
WAITING PERIODS
STRATEGIES, TIPS AND TRAPS
LIFE AND PERSONAL RISK INSURANCE
OVERVIEW OF LIFE INSURANCE
THE IMPORTANCE OF LIFE INSURANCE
THE PLAYERS IN LIFE INSURANCE
TERM LIFE INSURANCE
TOTAL AND PERMANENT DISABILITY INSURANCE (TPD)
TRAUMA INSURANCE
INCOME PROTECTION
APPLYING FOR INSURANCE COVER
SELECTING THE AMOUNT OF COVER REQUIRED
INSURANCE FOR BUSINESSES
KEY PERSON INSURANCE
BUSINESS SUCCESSION PLANNING
LIFE INSURANCE INSIDE SUPERANNUATION
STEPPED VERSUS LEVEL PREMIUMS
GROUP INSURANCE COVER
CLAIMS PROCESS
LIFE INSURANCE COMPLAINTS PROCESS
LIFE INSURANCE FRAMEWORK AND REMUNERATION REFORMS
COMPLIANCE AND BEST PRACTICE FOR FINANCIAL ADVISERS
THE FRAMEWORK OF COMPLIANCE
BEST PRACTICE
REGULATION OF FINANCIAL SERVICES
ANTI-MONEY LAUNDERING AND COUNTER-TERRORISM FINANCING
CONSUMER PROTECTION
PRIVACY COMPLIANCE
COMPLAINTS HANDLING
INVESTMENT
CASH AND FIXED INTEREST
EQUITIES
PROPERTY
SPECIALIST ASSETS
INVESTMENT PRODUCTS
PERFORMANCE MEASUREMENT
SALARY PACKAGING
SALARY PACKAGING BASICS
HOW THE TAX RULES WORK
TAXABLE FRINGE BENEFITS
EXCLUDED FRINGE BENEFITS
EXEMPT FRINGE BENEFITS
REDUCTIONS IN FBT
CASE STUDIES
GEARING
GEARING
BORROWING
OTHER FORMS OF GEARED INVESTMENTS
FAMILY HOME
HOME OWNERSHIP
TAX AND THE FAMILY HOME
TAXES IMPOSED ON RESIDENT NON-OCCUPYING OWNERS
DEDUCTIBILITY OF HOME EXPENDITURE
TAXES ON FOREIGN RESIDENTS
GST IMPLICATIONS
GOVERNMENT GRANTS AND ASSISTANCE
ACQUISITION/CONSTRUCTION OF FAMILY HOME
FAMILY BREAKDOWN AND THE FAMILY HOME
RENTING OUT THE HOME
DISPOSAL
FINANCIAL PLANNING FOR THE FAMILY
FINANCIAL GOALS
DEBT MANAGEMENT STRATEGIES
CHILD CARE
INVESTING FOR CHILDREN’S EDUCATION
GOVERNMENT ASSISTANCE FOR EDUCATION COSTS
SAVING FOR CHILDREN
TAXATION ISSUES RELATING TO THE INCOME OF CHILDREN
GOVERNMENT ASSISTANCE
CHILD SUPPORT
ESTATE PLANNING
REDUNDANCY, EARLY RETIREMENT AND INVALIDITY
TERMINATION OF EMPLOYMENT
GENUINE REDUNDANCY AND EARLY RETIREMENT SCHEME
INVALIDITY
OTHER ISSUES REGARDING TERMINATION PAYMENTS
PLANNING TO RETIRE
RETIREMENT
WHY NOT SUPERANNUATION?
CONTRIBUTING TO SUPERANNUATION
CGT AND SMALL BUSINESS
PRESERVATION
OTHER PLANNING ISSUES
RETIREMENT INCOME STREAMS
INCOME IN RETIREMENT
TRANSFER BALANCE CAP AND STARTING AN INCOME STREAM
INCOME STREAM TYPES
RETIREMENT PORTFOLIO CONSTRUCTION
MAXIMISING RETIREMENT INCOME — STRATEGIES
TAXATION OF INCOME STREAMS
COMPLYING INCOME STREAMS
DEATH BENEFIT FROM INCOME STREAMS
RETIREMENT LIVING AND AGED CARE
HOME CARE
INDEPENDENT LIVING ARRANGEMENTS
RESIDENTIAL AGED CARE
FINANCIAL AND ESTATE PLANNING ON FAMILY BREAKDOWN
PROPERTY SETTLEMENT
SUPERANNUATION AND FAMILY BREAKDOWN
TAXATION AND FAMILY BREAKDOWN
STAMP DUTY AND FAMILY BREAKDOWN
LAND TAX AND FAMILY BREAKDOWN
FAMILY TRUST ELECTIONS
MAINTENANCE
OTHER ISSUES
ESTATE PLANNING AND THE CONSEQUENCES OF DEATH
ESTATE PLANNING
WILLS
CAPITAL GAINS TAX AND DECEASED ESTATES
DISCRETIONARY WILL TRUSTS
PLANNING OPPORTUNITIES OF DISCRETIONARY WILL TRUSTS
RESTRICTED TRUSTS
NON-ESTATE ASSETS
FURTHER PLANNING OPPORTUNITIES
POWERS OF ATTORNEY
CONSEQUENCES OF DEATH
DISTRIBUTING THE ASSETS
TAX RULES THAT APPLY TO DIFFERENT TYPES OF ESTATE ASSETS
RULES THAT APPLY TO DIFFERENT TYPES OF ENTITLEMENTS UNDER WILLS
RULES THAT APPLY TO DIFFERENT TYPES OF BENEFICIARIES
HOW DEATH AFFECTS A PERSON’S BUSINESS
ESTATE INCOME AND TESTAMENTARY TRUSTS
WHAT TAX RETURNS ARE NEEDED
HOW DEATH AFFECTS OTHER TAXES AND BENEFITS
RATES AND TABLES
INCOME TAX RATES
EMPLOYMENT-RELATED PAYMENTS
CAPITAL GAINS
FRINGE BENEFITS
PENSION TABLES
INDEXATION
PAYMENT OF SUPERANNUATION BENEFITS
SUPERANNUATION CONTRIBUTIONS
SUPERANNUATION GUARANTEE CHARGE
SOCIAL SECURITY
ONLINE INVESTING
INTRODUCTION
ONLINE INVESTING RESOURCES
FUNDAMENTAL RESEARCH
TECHNICAL ANALYSIS
NON-SHARE INVESTMENTS
MANAGED FUNDS AND SUPERANNUATION
TRACKING THE BUSINESS CYCLE ONLINE
INTERNATIONAL INVESTING
ADVANCED INVESTING
EXCHANGE-TRADED PRODUCTS
FINANCIAL PLANNING ONLINE
INDEX
A
B
C
D
E
F
G
H
I
J
K
L
M
N
O
P
Q
R
S
T
U
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W
Y

Citation preview

Product Information

Disclaimer No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publication is sold on the terms and understanding that: (1) the authors, consultants and editors are not responsible for the results of any actions taken on the basis of information in this publication, nor for any error in or omission from this publication, and (2) the publisher is not engaged in rendering legal, accounting, professional or other advice or services. The publisher, and the authors, consultants and editors, expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this publication. Without limiting the generality of the above, no author, consultant or editor shall have any responsibility for any act or omission of any other author, consultant or editor.

About Wolters Kluwer Wolters Kluwer is a leading provider of accurate, authoritative and timely information services for professionals across the globe. We create value by combining information, deep expertise, and technology to provide our customers with solutions that improve their quality and effectiveness. Professionals turn to us when they need actionable information to better serve their clients. With the integrity and accuracy of over 45 years’ experience in Australia and New Zealand, and over 175 years internationally, Wolters Kluwer is lifting the standard in software, knowledge, tools and education. Wolters Kluwer — When you have to be right. Enquiries are welcome on 1300 300 224. ISBN 978-1-92589-430-1 © 2019 CCH Australia Limited First published.................................... September 1998

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22nd edition.................................... August 2019

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Foreword The Wolters Kluwer Australian Master Financial Planning Guide is Australia’s leading publication on financial planning topics. This 22nd edition of the Guide maintains its straightforward, practical style, and includes many case studies and examples. The financial planning industry continues to be dynamic. As always, financial advisers have an important role to play in guiding their clients through the constant change and to help them achieve their financial objectives. The Guide is an invaluable resource to help advisers and other financial planning professionals navigate the changes. The Guide has been updated for all financial planning developments which take effect from 1 July 2019, and includes discussion of the proposed measures in the 2019 Federal Budget. To keep up to date with financial planning developments throughout the year, Wolters Kluwer offers the Financial Planning Navigator. The Financial Planning Navigator is an online, searchable subscription product and is based on the content of the Guide. It is updated on a regular basis throughout the year. The Guide has been updated by a wide range of experts from both industry and academia. Wolters Kluwer thanks the valued team of authors for their contributions. For a detailed list of all the changes included in this edition of the Guide, see the “What’s New in the 2019/20 Guide” on page xiii. Wolters Kluwer Acknowledgments Wolters Kluwer wishes to thank the valued team of authors for their contributions and the following people who supported this publication. Regional Commercial Director — Lauren Ma Head of Content APAC — Research and Learning — Diana Winfield Senior Editor — Tina Doan Production Coordinator — Nathan Grice

About the Authors Louise Biti, CFP®, SSA, CTA, MTax, BEc, BA(AS), DipFP, has been providing technical analysis and support in relation to legislative issues and financial planning strategies to advice professionals for over 20 years. She has broad experience across taxation, superannuation, aged care, estate planning and social security legislation. Louise is a previous Director of the Financial Planning Association and SMSF Association boards and has been awarded the FPA’s Distinguished Service award. Currently she is a member of the Aged Care Financing Authority. Louise is a regular speaker at industry conferences and is often quoted in the media. Jennifer Brookhouse, BComm, Diploma of Financial Planning, is Senior Technical Consultant with NAB at MLC Technical Services. Prior to this role, she was Head of Technical Services for Zurich Financial Services and National Technical Manager at ING. In both these roles, she was responsible for the analysis and interpretation of technical issues relating to superannuation, social security and taxation legislation.

Gaibrielle Cleary, BEc, LLB, LLM (U Syd), is the Head of Tax in Australia at Mazars. Gaibrielle practises in all areas of direct and indirect taxation. Previously, she has been the in-house counsel for an ASX listed company and practised at leading international law and accounting firms. She is one of the authors of Wolters Kluwer’s Small Business Tax Concessions Guide, and has also written for a number of taxation publications, including Wolters Kluwer’s Federal Tax Reporter. Graeme Colley, CA SSA, teaches as an adjunct lecturer at the UNSW and WSU in taxation, superannuation and self managed superannuation funds to post-graduate students. He has also held positions with the SMSF Association as Head of Technical and Professional Standards, National Technical Manager with ING and also has considerable superannuation experience with the ATO. Kim Guest is a Senior Technical Manager at FirstTech. Kim joined FirstTech, the Colonial First State technical team in May 2012. Prior to joining FirstTech, Kim was the Technical Services Manager at Count Financial. Kim has over 16 years’ experience in the financial planning industry, holding several roles including Technical Analyst, Business Analyst and Paraplanner. Kim also has significant experience with Centrelink and aged care having worked as a Financial Information Service Officer and Policy Officer in the Financial Industry Network Support Unit of Centrelink. Kim provides technical information and strategy advice on a range of areas specialising in social security, aged care and superannuation. Kim holds a Bachelor of Economics and a Diploma of Financial Planning. Loretta Iskra, CFP®, AFP®, MFin-Res, MFP, BCom, DipFP, AdvDipAcctg, is a Lecturer at the University of Wollongong. She has been involved in the finance industry for over 20 years and is also a Certified Financial Planner. Loretta combines her unique practitioner expertise to develop her research and teaching priorities, contributing to the areas of financial planning, superannuation and retirement planning. Loretta is also a member of the Financial Planning Academics Forum, a specialist group that aims to develop research and teaching strategic objectives for financial planning. Currently she is involved in a research project examining retirement product options and the cost of advice. Loretta also provides media commentary on areas associated with superannuation, baby boomers and retirement. James Leow, LLB (Hons), MTax (UNSW), is a tax and superannuation writer. He is co-author of the Wolters Kluwer Master Superannuation Guide and also writes for a number of other Wolters Kluwer publications. Heino Ling, FCPA, CPA (FPS), CA, MBA, CFS, AFP®, AFA, QPIA®, BA, F Fin, AdvDipFS (FP), Dip Finance & Mortgage Broking, LREA & Auctioneer, Registered Tax Agent, AFAIM, MFAA Credit Adviser™, JP, has a great depth of experience and knowledge from over 40 years’ experience in the financial services industry. He has held executive positions in life offices, banks, consulting companies, superannuation and financial planning organisations and has held a personal Australian Financial Services and a Australian Credit Licence. He has been a member of the course advisory committee for NSW TAFE’s Bachelor of Finance (Financial Planning) degree and is currently Principal Consultant at Heino Ling Consulting Services. Jenneke Mills is a Technical Manager with NAB at MLC Technical Services. Her current role includes supporting financial advisers and other key stakeholders with the interpretation and application of legislation relating to super, SMSFs, retirement planning, taxation, social security and aged care. Jenneke has also previously worked as a Financial Adviser. Jenneke has tertiary qualifications in Commerce, Financial Planning and Economics. Shirley Murphy, BA (Hons), LLB (Hons), has, for many years, taught undergraduate and postgraduate tertiary students in the areas of taxation and superannuation. Shirley is co-author of Wolters Kluwer’s Australian Master Superannuation Guide. She has also previously contributed to a number of other Wolters Kluwer publications including the Australian Master Tax Guide and Australian Superannuation Law & Practice. Andrew Simpson, BA, LLB, LLM (Comm law), is a Principal of Maurice Blackburn Lawyers and is the National Leader of its Wills and Estates Division. Anna Tabas, BComm/BArts, Graduate Diploma of Chartered Accounting and a Registered Tax Agent, is a Finance and Operations Manager and a member of the Management Team at Preacta Pty Ltd where she is responsible for the financial compliance and strategy of the company. Prior to this, she was a Financial Accountant at Social Enterprise, MTC Australia and a Tax Accountant at Crispin and Jeffery

Accountants. Nabil Wahhab, BEc LLB (Hons), is a Director of York Law Family Law Specialists, a specialist boutique family law firm in Sydney. He is an Accredited Family Law Specialist and a trained mediator. Nabil’s main practice is to advise and represent clients on complex family financial and tax issues in property settlements. He regularly publishes on financial and estate planning issues and presents on family law issues to lawyers, accountants and financial advisers on taxation, financial and estate planning issues in family law. He also regularly represents third parties in family law financial settlements. He is also on the panel of solicitors that represent children in family law parenting matters. Mary Zachariah, BBus, MTax is a senior content specialist, writing mainly for the Wolters Kluwer Australian Federal Tax Reporter and the Australian Master Tax Guide. Mary has practiced in both direct and indirect taxation areas and was previously a tax manager in a major international accounting firm.

Checklist of Terms This quick checklist explains terms which are used throughout the Guide. ABN

Australian Business Number

AFCA

Australian Financial Complaints Authority

AML/CTF

Anti-money laundering and counter-terrorism financing

APRA

Australian Prudential Regulation Authority

ASIC

Australian Securities and Investments Commission

ATC

Australian Tax Cases (Wolters Kluwer), from 1969

ATI

Adjusted taxable income

ATO

Australian Taxation Office

AWOTE

Average weekly ordinary time earnings

CGT

Capital gains tax

CIPR

Comprehensive Income Products for Retirement

CPI

Consumer Price Index

ETP

Employment termination payment

FBT

Fringe benefits tax

FOFA

Future of Financial Advice

FPA

Financial Planning Association

FSG

Financial Services Guide

FSR

Financial Services Reform

GST

Goods and services tax

ITAA36

Income Tax Assessment Act 1936

ITAA97

Income Tax Assessment Act 1997

LIF

Life insurance framework

PAYG

Pay As You Go

PDS

Product Disclosure Statement

RoA

Record of Advice

SG

Superannuation guarantee

SIS

Superannuation Industry (Supervision)

SISA

Superannuation Industry (Supervision) Act 1993

SISR

Superannuation Industry (Supervision) Regulations 1994

SMSF

Self managed superannuation fund

SoA

Statement of Advice

TAA

Taxation Administration Act 1953

TAP

Term allocated pension

TBC

Transfer balance cap

TFN

Tax file number

What’s New in the 2019/20 Guide Chapter 1 Income tax • The low and middle income tax offset has been increased from 1 July 2019.....................................¶1055 • The instant asset write-off threshold has been increased to $30,000.....................................¶1-283 • Taxation Determination TD 2018/9 addresses the ATO’s views on the impact an early trustee resolution will have on present entitlement.....................................¶1-510 Chapter 2 Capital gains tax • If a taxpayer grants an easement, profit à prendre or licence over an asset, CGT event D1 (the creation of rights) rather than CGT event A1 (the disposal of an asset) happens (Taxation Determination TD 2018/15).....................................¶2-110 • Certain trust split arrangements will result in the creation of a trust by declaration or settlement and this can cause a CGT event E1 to happen (Draft Taxation Determination TD 2018/D3).....................................¶2-110 • The government has proposed an increase in the CGT discount, from 50% to 60%, for Australian resident individuals investing, either directly or indirectly through certain trusts, in qualifying affordable housing.....................................¶2-215 • Managed investment trusts (MITs) and attribution MITs will be prevented from applying the 50% CGT discount at the trust level for payments made from 1 July 2020.....................................¶2-215 • MIT investors are required to adjust the cost base of their MIT units for distributions made in 2017/18 and future income years for any CGT concession amounts.....................................¶2-250 • Amendments have been proposed to ensure that the small business CGT concessions will no longer be available to partners who alienate their income by creating, assigning or otherwise dealing in rights to the future income of a partnership.....................................¶2-310 • A company that carries on a business in a general sense, as described in Taxation Ruling TR 2019/1, but whose only activity is renting out an investment property, cannot claim the small business concessions in relation to that investment property (Taxation Determination TD 2019/D4).....................................¶2-320 Chapter 3 Fringe benefits tax • Practical Compliance Guideline PCG 2018/3 sets out the ATO’s compliance approach to determining

the private use of vehicles with respect to exempt car benefits and exempt residual benefits.....................................¶3-200 • The ATO has finalised its consultation on the FBTAA definition of “taxi” in light of the Federal Court decision in Uber B.V. v FC of T and has advised its compliance approach for the 2019 FBT year.....................................¶3-600 • Taxation Ruling TR 2019/3 explains when certain benefits provided by registered religious institutions to religious practitioners will be exempt from FBT.....................................¶3-650 • The matters that will possibly attract the ATO’s attention when determining compliance with the FBT obligations are advised.....................................¶3-800 Chapter 4 Superannuation • From 1 July 2019, individuals aged 65 to 74 with a total superannuation balance below $300,000 may be able to make personal contributions for 12 months from the end of the financial year in which they last met the work test.....................................¶4-205 • The transfer balance cap for 2019/20 is $1.6 million (unchanged from 2018/19).....................................¶4-227 • A Bill which proposed that the outstanding balance of a limited recourse borrowing arrangement be included in a member’s total superannuation balance in an SMSF or small APRA fund lapsed when Parliament was prorogued for the 2019 federal election.....................................¶4-233 • The concessional contributions cap is $25,000 and the non-concessional contributions cap is $100,000 for 2019/20 (both unchanged from 2018/19)....................................¶4-234; ¶4-240 • Single Touch Payroll reporting applies to all employers from 1 July 2019 regardless of the number of employees.....................................¶4-510 • A Bill which proposed that individuals with income exceeding $263,157 for a financial year from multiple employers could nominate to exempt certain income from SG lapsed when Parliament was prorogued for the 2019 federal election.....................................¶4-520 • A Bill that proposed a 12-month amnesty for employers who underpaid their SG contributions lapsed when Parliament was prorogued for the 2019 federal election.....................................¶4-560 • A Productivity Commission final report (backed by findings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry) recommends that members have a single default superannuation account and that default accounts are carried over by members when they change jobs.....................................¶4-580 Chapter 5 Self managed superannuation funds • It was proposed in the 2019 Federal Budget that SMSFs would be required to comply with SuperStream arrangements from 2021.....................................¶5-350 • The interest rate for related party loans for 2019/20 is 5.94% for real property and 7.94% for listed shares.....................................¶5-360 • New cases on the validity of certain death benefit nominations have been included.....................................¶5-700 Chapter 6 Social security • The Pension Loan Scheme was extended from 1 July 2019 to all clients of Age Pension age, including maximum rate age pension. In addition, the maximum amount of top-up payments was increased from 100% to 150% of the maximum rate of age pension.....................................¶6-050

• The Pension Work Bonus was expanded from 1 July 2019 to include income from self-employment that involves personal exertion. In addition, the amount of Pension Work Bonus increased from $250 to $300 per fortnight.....................................¶6-140 • Deeming rates have been reduced effective from 1 July 2019.....................................¶6-600 • A new category of income stream, called lifetime income streams, applies from 1 July 2019. Lifetime income streams include immediate and deferred lifetime annuities. Grandfathering applies to lifetime income streams commenced prior to 1 July 2019......................................¶6-640 Chapter 7 Life and personal risk insurance • Details on the levels of underinsurance in Australia have been updated.....................................¶7-070 • The analysis on the incidence of death and disability has been updated.....................................¶7-075 • The information on genetic testing has been updated for details on the FSC moratorium, which applies from 1 July 2019.....................................¶7-410 • Commentary on insurance within inactive accounts has been updated to reflect the new opt-in rules that commenced from 1 July 2019. These changes modify the 2018 Federal Budget measure, which proposed to apply opt-in for small balances and young members.....................................¶7-890 • The information on the Insurance in Superannuation Voluntary Code of Practice has been updated.....................................¶7-890 • New content has been added to discuss ASIC’s claims and complaints comparison tool available on the MoneySmart website.....................................¶7-978 • The commentary on the life insurance framework and remuneration reviews has been updated.....................................¶7-990–; ¶7-998 • A new section has been added to include commentary on key proposals affecting life insurance from the Royal Commission.....................................¶7-999 Chapter 8 Compliance and best practice for financial advisers • The government’s proposed ban on grandfathering commissions has been included.....................................¶8-020 • The commentary in relation to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has been updated with the addition of details on the Final Report.....................................¶8-020 • A new section has been added to include details of ASIC’s first conflicted remuneration court action.....................................¶8-150 • Although property is excluded as a financial product, ASIC considered that a recommendation to an SMSF trustee to purchase an investment property constituted financial product advice.....................................¶8-220 • The FASEA education requirements and continuing professional development that apply from 1 January 2019 have been included.....................................¶8-260 • The commentary has been updated to include reference to AFCA as the sole EDR body.....................................¶8-610 Chapter 9 Investment

• ASIC preferred Standard Risk Measures have been included.....................................¶9-080 • The ATO has given notice that it will collect data from cryptocurrency designated service providers to identify individuals or businesses who have or may be engaged in buying, selling or transferring cryptocurrency.....................................¶9-375 • This chapter has been updated with market results for the period ending 31 December 2018. Chapter 10 Salary packaging • The definition of car in relation to depreciation limits has been added.....................................¶10-310 • The small business thresholds for FBT exemptions have been updated.....................................¶10-520 • All case studies have been updated for 2019/20 tax rates, including changes to the lower and middle income tax offset. Chapter 11 Gearing • The proposed changes to negative gearing announced in the 2019 Federal Election have been included.....................................¶11-150 • Non-residents’ potential entitlement to capital gain tax concessions is discussed.....................................¶11-240 • Reserve Bank of Australia (RBA) rates have been updated.....................................¶11-400 Chapter 12 Family home • The changes to the stamp duty surcharge rates for foreign residents are discussed.....................................¶12-075 • The changes to first home owner grants in Australian Capital Territory and Northern Territory have been incorporated.....................................¶12-091 • The proposed introduction of a federal scheme to provide assistance to first home owners by enabling purchases with 5% deposit has been included.....................................¶12-091 • The commentary has been updated to reflect changes to benefits available for first home buyers.....................................¶12-092 Chapter 13 Financial planning for the family • Newly legislated changes to the HELP repayment thresholds and repayment rates have been included.....................................¶13-410 • FTB A and B payment rates and income thresholds have been updated to reflect the 2019/20 financial year.....................................¶13-715; ¶13-720 • The Child Care Subsidy income thresholds and subsidy percentages have been updated to reflect the 2019/20 financial year. Of note, the subsidy percentage has been significantly reduced for those earning income at certain levels. An updated case study demonstrates how entitlement to the subsidy is calculated.....................................¶13-730 Chapter 14 Redundancy, early retirement and invalidity • The government has proposed to increase the age from 65 to 67 to align to the increase in age pension age to allow individuals to receive the tax concessions upon receipt of genuine redundancy or early retirement payments.....................................¶14-220 • All case studies and examples have been updated for 2019/20 rates and thresholds.

Chapter 15 Planning to retire • New criteria for the release of superannuation benefits on compassionate grounds and severe financial hardship grounds have been included.....................................¶15-400 • All case studies have been updated to reflect the 2019/20 indexed rates and thresholds. Chapter 16 Retirement income streams • The deferral of the introduction of Comprehensive Income Product for Retirement (CIPR) regime has been updated.....................................¶16-130 • The status of the government’s retirement income covenant has been updated.....................................¶16-135 • The lifetime income stream comparison table has been updated for 1 July 2019 changes to the social security assessment.....................................¶16-195 • Content has been updated for changes to the social security rules of pooled lifetime income streams from 1 July 2019.....................................¶16-330 • Details on the impact of not paying the minimum annual income of a transition to retirement pension have been included.....................................¶16-585 • The discussion on exempt current pension income (ECPI) has been updated, including proposed changes from 1 July 2020.....................................¶16-700 • All case studies have been updated for indexation and rate changes that apply from 1 July 2019, including the low and middle income tax offset (LMITO). Chapter 17 Retirement living and aged care • All case studies have been updated to reflect the new rates and thresholds that apply from 1 July 2019. Chapter 18 Financial and estate planning on family breakdown • A new example has been added regarding the Family Court’s assessment of contributions made in short relationships and/or marriages when one spouse has an overwhelming initial contribution as compared with the other spouse.....................................¶18-110 • The commentary on CGT rollover relief on family breakdown has been updated and includes a summary of the first instance and appeal decision in the matter of Ellison v Sandini Pty Ltd.....................................¶18-505 Chapter 19 Estate planning and the consequences of death • The commentary on the effect of divorce on the validity of a will has been updated.....................................¶19-085 • The content relating to Powers of Attorney has been updated to reflect the considerable changes that have occurred across Australia.....................................¶19-455 • The commentary on the applicability of CGT and the main residence has been updated.....................................¶19-605 • The section dealing with the CGT consequences of an estate distribution of an asset to a nonAustralian resident has been re-worked.....................................¶19-765 • The commentary on the estate treatment of depreciable assets has been updated.....................................¶19-810

Chapter 20 Rates and tables • Where available, all taxation, superannuation and social security rates and thresholds have been updated for 2019/20. Chapter 21 Online investing • New content has been added on Generation Z.....................................¶21-960

INCOME TAX The big picture

¶1-000

Calculation of income tax and Medicare levy, including taxation of minors Taxable income

¶1-050

Tax payable

¶1-055

Self-assessment

¶1-060

Tax losses

¶1-065

Taxation of minors

¶1-070

Medicare levy and surcharge

¶1-075

Interaction between income tax and FBT

¶1-090

Payment of income tax and collection systems Financial year and income year

¶1-100

Collection of tax

¶1-105

Failure to quote TFN to investment body

¶1-115

Australian Business Number

¶1-120

Withholding tax on dividends, interest and royalties Dividend, interest and royalty withholding tax

¶1-150

Assessable income and exempt income Annual basis of taxation

¶1-250

Assessable income

¶1-255

Exempt income

¶1-260

Income from personal services and pensions

¶1-265

Income from investments

¶1-270

Transactions in property and securities, other financial dealings and life assurance ¶1-275 Partnership and trust income

¶1-280

Small business entities

¶1-283

Employment termination payments (ETPs) and superannuation lump sums

¶1-285

Superannuation income streams

¶1-290

Capital gains tax

¶1-295

Deductions Annual basis of taxation

¶1-300

General and specific deductions

¶1-305

Business deductions

¶1-310

Employment and self-employment deductions

¶1-320

Deductions for investors and landlords

¶1-325

Depreciating assets

¶1-330

Capital works expenditure

¶1-335

Other capital allowances

¶1-340

Deductible gifts and donations

¶1-345

Tax offsets What are tax offsets?

¶1-350

Concessional rebates and offsets

¶1-355

Companies Method of taxing company income

¶1-400

Imputation system

¶1-405

Partnerships Wide definition of partnership for tax purposes

¶1-450

Method of taxing partnership net income or loss

¶1-455

Exceptions: direct application of law to partners

¶1-460

Assignment of partner’s interest in partnership

¶1-465

Trusts What is a trust?

¶1-500

Method of taxing trust income or loss

¶1-505

When is a beneficiary presently entitled?

¶1-510

Beneficiary under a legal disability

¶1-515

No beneficiary presently entitled to income of deceased estate

¶1-520

Restrictions on deductions for trust losses

¶1-525

Tax consequences of a trust vesting

¶1-530

Cross-border issues Resident vs non-resident

¶1-550

Source of income

¶1-555

Thin capitalisation

¶1-560

Australians investing overseas

¶1-565

Accruals taxation system

¶1-570

Foreign income tax offset

¶1-575

Foreign losses

¶1-580

Tax avoidance How the law deals with tax avoidance

¶1-600

Specific anti-avoidance provisions

¶1-605

Distribution washing provisions

¶1-607

General anti-avoidance provisions: Pt IVA

¶1-610

Transfer pricing

¶1-615

Rulings Role of rulings

¶1-650

Rulings binding on Commissioner

¶1-660

Objection and review of rulings

¶1-665

Returns, assessments and review Tax returns

¶1-700

Tax assessments

¶1-705

Review of assessments and other decisions

¶1-710

Penalties Scheme of income tax penalties

¶1-750

Administrative penalties

¶1-755

Offences against the taxation laws

¶1-760

¶1-000 Income tax

The big picture This chapter provides an introduction to key concepts of Australia’s income tax system. It should assist with understanding the more detailed discussion of specific areas of the income tax law in other chapters. Calculation of tax ....................................¶1-050 • Income tax is payable for each financial year by individuals and companies and by some other entities, such as corporate limited partnerships, superannuation funds and trustees of trusts (in respect of certain trust income). The income of partnerships and trusts is generally taxed in the hands of the partners and beneficiaries. Individuals who are Australian residents, and some trustees, are also liable to pay the Medicare levy each year. • Under Australia’s self-assessment system, assessments of taxable income and tax payable are initially based on the information shown in the taxpayer’s income tax return, with the Australian Taxation Office (ATO) having wide powers to amend assessments in the light of subsequent audits. Taxable income is calculated by subtracting deductions from assessable income. A tax loss arises if deductions exceed the assessable income and any net exempt income. The tax loss may be a deduction in a later year. • Assessable income consists of income according to ordinary concepts (eg salary or wages) and statutory income, being amounts that are made assessable income by specific provisions of the law, such as the capital gains tax (CGT) provisions. Exempt income and non-assessable non-exempt income are not included in assessable income (eg income that is a fringe benefit). • Deductions include losses or outgoings incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for that purpose. Losses or outgoings of a capital, private or domestic nature are not deductible. Deductions are also allowed under specific provisions of the law, such as the depreciation and gift provisions. • Tax payable is the amount remaining after subtracting tax offsets from gross tax. The gross tax of an individual is calculated by applying progressively greater marginal rates to successive slices of taxable income, the bottom slice for residents being tax-free. The gross tax of a company is calculated by applying a single rate to the whole of the taxable income. Examples of tax offsets are the concessional rebates and foreign tax credits. Excess tax offsets (apart from imputation credits)

are generally not refundable and cannot be offset against later years’ tax. Collection of tax ....................................¶1-105 • Income tax is usually collected in instalments before a person’s actual tax liability for the year can be calculated. Amounts are paid, usually at regular intervals, under the Pay As You Go (PAYG) system as income is earned during the year, and these amounts are credited in payment of the tax assessed. PAYG withholding applies to salary and wage earners and the PAYG instalments system applies to taxpayers, including companies, with business and/or investment income that is not subject to PAYG withholding. Individuals who have an Australian Business Number (ABN) can enter into a voluntary agreement with a payer to have PAYG withholding apply to payments for the performance of work or services. • Non-residents who derive dividends (other than most franked dividends), interest or royalties from Australia generally pay the tax on that income as a flat rate final withholding tax, collected by the payer under the PAYG withholding system. Non-final CGT withholding applies to the disposal of certain taxable assets by a non-resident. Companies ....................................¶1-400 • Companies are taxed as separate legal entities. The tax paid by Australian resident companies is then imputed, or credited, to resident individual shareholders when they are assessed on franked dividends. Franked dividends paid to non-residents are not included in assessable income and are generally exempt from withholding tax. • Companies are not entitled to a deduction for prior years’ losses unless the company satisfies either a continuity of ownership or same business test. Wholly owned groups of companies, trusts and partnerships can choose to be taxed as a single consolidated entity. Partnerships and trusts ....................................¶1-450, ¶1-500 • Partnership and trust income is taxed to the partners and to the trust beneficiaries who are presently entitled to the income, which retains its character in their hands (eg franked dividends). Trustees may be taxed on some trust income (eg income to which no beneficiary is presently entitled). Some provisions of the law (eg the CGT provisions) apply directly to partners and not to the partnership. Partnership losses are allocated to the partners but trust losses are carried forward in the trust as deductions from future trust income, subject to conditions. Limited partnerships and some public unit trusts are taxed as companies. Cross-border issues ....................................¶1-550 • A person’s country of residence and the source of income are fundamental determinants of liability for Australian income tax. Australian residents are taxed on income from all sources, while nonresidents are taxed only on income from Australian sources. Agreements between Australia and other countries for the avoidance of double taxation override domestic law and allocate taxing rights on certain income to Australia or the other country. An agreement may, for example, include rules for determining whether a person is a resident of Australia or the other country. • An Australian resident with foreign investments is taxed on investment income actually derived, and can also be taxed on an accruals basis on certain income derived by non-resident entities or accumulated through certain offshore investments. A credit for foreign tax paid is allowed against Australian tax on foreign income. Foreign losses may be deducted against both Australian-sourced and foreign-sourced income. Tax avoidance ....................................¶1-600 • Specific anti-avoidance provisions deal with particular tax avoidance practices and a general antiavoidance provision can apply to arrangements as a last resort after the application of all other provisions of the law have been considered. A determination can be made under the general provision to cancel a tax benefit of a kind to which the provision applies. Specific measures deal with distribution washing arrangements. Another anti-avoidance provision deals with transfer pricing arrangements to shift profits out of Australia. Other processes, obligations, rights and penalties ....................................¶1-650

• Taxpayers are obliged to keep records, provide information and lodge returns. Failure to meet obligations under the income tax law may give rise to penalties. The Commissioner makes private, public and oral rulings, binding on the Commissioner, on the way in which, in the Commissioner’s opinion, particular provisions of the law apply. Taxpayers can apply to the Administrative Appeals Tribunal (AAT) for a review of certain decisions of the Commissioner, or appeal to the Federal Court.

CALCULATION OF INCOME TAX AND MEDICARE LEVY, INCLUDING TAXATION OF MINORS ¶1-050 Taxable income Income tax is worked out by reference to the taxable income of a taxpayer for an income year. The formula for working out the taxable income of an individual or a company (¶1-400) is:

Taxable income = assessable income (¶1-250) − deductions (¶1-300)

Partnerships (¶1-450) and trusts (¶1-500) generally are not treated as taxpayers and do not have a taxable income. There are, however, exceptions to the general rule. A partnership is taxed as a company if the liability of any partner is limited. Some public unit trusts are also taxed as companies. Trustees of superannuation funds, approved deposit funds (ADFs) and pooled superannuation trusts (PSTs) are liable to pay tax on the taxable income of the fund or trust.

¶1-055 Tax payable The formula for working out tax payable on taxable income is:

Tax payable on taxable income = gross tax − tax offsets (¶1-350)

Examples of tax offsets are the low income tax offset (“LITO”), the private health insurance offset, the franking credit offset, the foreign income tax offset and the tax offset for investments in early stage innovation companies. If total tax offsets exceed the gross tax, no tax is payable but the taxpayer is generally not entitled to a refund of the excess. However, some taxpayers, primarily individuals and superannuation funds, who receive franking credits are entitled to a refund if their franking credits exceed tax payable. The private health insurance offset is also a refundable offset. Gross tax of individuals The gross tax of an individual for 2019/20 is calculated according to the following scale of rates (excluding Medicare levy*): Slice of taxable income ($)

Marginal rate of tax (%) Resident

Non-resident

 1–18,200

Nil

32.5

18,201–37,000

19

32.5

37,001–90,000

32.5

32.5

90,001–180,000

37

37

180,001+

45

45

* Non-residents are not liable for the Medicare levy.

For 2019/20, residents are entitled to a LITO of $445 for taxable income less than $37,000. The rebate reduces by 1.5 cents for every dollar by which the taxable income exceeds $37,000 with no rebate applying on taxable incomes of $66,667 or more. The rebate is not available for “unearned” income of minors (¶1-070). In addition, a low and middle income tax offset (“LMITO”) is available to individuals with relevant taxable income that does not exceed $126,000. The amount of the LMITO is: • for taxpayers with income not exceeding $37,000 — $255 • for taxpayers with income exceeding $37,000 but not exceeding $48,000 — $255 plus 7.5% of the amount of the income that exceeds $37,000 • for taxpayers with income exceeding $48,000 but not exceeding $90,000 — $1,080, and • for taxpayers with income exceeding $90,000 — $1,080 less 3% of the amount of the income that exceeds $90,000. The effect of the existing LITO and LMITO means no income tax (excluding Medicare levy) is payable in 2019/20 until the resident’s taxable income exceeds $21,884. Example Carol is a teacher whose salary for the year ended 30 June 2020 is $41,000. Carol earned interest income of $200. During the year she incurred $800 of work-related expenses (union fees, reference books and depreciation on library), made tax-deductible gifts totalling $300 and paid $100 to have her tax return prepared. Carol’s tax liability for 2019/20 is calculated as follows:

$  Salary

61,000

Interest

    200

ASSESSABLE INCOME

$61,200

Less: $ Work-related expenses

800

Gifts

300

Tax return preparation

100

TAXABLE INCOME Gross tax payable (excluding Medicare) at 2019/20 rates on a taxable income of $60,000 (see the table at ¶20-010)

  1,200 $60,000 11,047

Less: LITO ($445 − ([60,000 − 37,000] × 1.5%)) LMITO:

100   1,080

Ordinary tax payable

9,867

Plus: Medicare levy (2% × $60,000)

   1,200

TAX PAYABLE (including Medicare levy)

$11,067

Individuals deriving income from an unincorporated small business are entitled to the “small business tax offset” which effectively provides a discount of 8% on the income tax payable on that business income subject to a maximum cap of $1,000 per year (see ¶1-283). For more information about the calculation of income tax, see ¶20-010 to ¶20-030. Special rules modify the calculation of gross tax on certain income. Examples are unearned income of minors (¶1-070) and the taxable income of primary producers. Gross tax of companies The gross tax of a company is calculated by applying a single rate to the whole of the company’s taxable income. The applicable company tax rate will depend upon the classification of the company. The general company tax rate is 30%. However, where a company is a base rate entity a lower tax rate of 27.5% applies (see ¶1-400). For more information about tax rates for companies and life assurance companies, see ¶20-070.

¶1-060 Self-assessment The Commissioner makes an assessment of an individual’s taxable income and tax payable on the basis of the information contained in the person’s income tax return (¶1-700) without examining the return in detail. This process is known as “self-assessment”. The Commissioner issues a notice of assessment (¶1-705) to an individual taxpayer requiring payment of any balance of tax payable but not collected under the Pay As You Go (PAYG) system (¶1-105) or refunding any excess amount collected. In the case of a company, the Commissioner is deemed to have made an assessment of the taxable income and tax payable specified in the tax return. The tax return is deemed to be a notice of assessment. This process is known as “full self-assessment”.

¶1-065 Tax losses If the deductions of a company, trust or individual exceed the assessable income and any net exempt income (¶1-260) for an income year, the resulting tax loss can be a deduction in calculating taxable income (net income in the case of a trust) in later years. There is no ability to carry back losses. A partnership can also make a loss for an income year, but the loss is allocated to the partners rather than being carried forward in the partnership. The tax treatment of losses of companies, partnerships and trusts is discussed at ¶1-400, ¶1-455 and ¶1-525 respectively.

¶1-070 Taxation of minors A person who is under 18 years of age at the end of the income year (a minor) is effectively taxed on unearned income, whether derived directly or through a trust, is taxed at the marginal rate of 45% for 2019/20 unless the minor was engaged in a full-time occupation at the end of the year or for at least three months during the year. Income derived by a minor from property received from a deceased estate is excluded. Certain disabled children and double orphans are also exempt from the rules. If the unearned income is $416 or less, the tax payable is nil. The LITO and the LMITO is not available for minors to offset unearned income (though it can offset income from ordinary employment). For more details of the tax calculation for minors, see ¶20-040.

Unearned income The types of income that constitute unearned income are not spelled out in the law. Unearned income is assessable income other than: • employment income • reasonable business income (having regard to the minor’s participation in the business) • income from a deceased estate or the investment of a range of property, including inherited property, property transferred to the minor as a result of a family breakdown, death benefits from life assurance or superannuation and certain compensation payments. A family breakdown occurs when a marriage or de facto relationship (including same sex) breaks down or where a child support order is made for the benefit of a child whose parents were not living together as spouses when the child was born. The taxation of minors in relation to family breakdown is covered in Chapter 18. Unearned income therefore includes income, such as dividends, interest and rents, from the investment of property acquired by the minor in ways other than those mentioned. As beneficiary of a trust If a minor is a beneficiary of a trust, the portion of the minor’s share of the net income of the trust that is attributable to unearned income is also subject to these rules. The income is taxed to the trustee at the rates that would have applied if the minor had derived the income. Business income of a trust is unearned income, as is employment income unless the minor does the work. A deceased estate’s income is not unearned income.

¶1-075 Medicare levy and surcharge A Medicare levy is payable by an individual who is a resident at any time during an income year. The levy is a fixed percentage of taxable income. The rate for 2019/20 is 2%. Low income individuals may pay no levy or a reduced one (¶20-020). A Medicare levy surcharge is imposed on high income taxpayers who do not have adequate private patient hospital insurance. These taxpayers are required to pay a levy surcharge on the whole of their taxable income, reportable fringe benefits and the net amount on which the family trust distribution tax has been paid. The Medicare levy surcharge applies on a tiered system. The relevant tiers for 2019/20 are as follows: Tier

Single Income Threshold

Families Income Threshold

Rate of Levy Surcharge

Nil

Up to $90,000

Up to $180,000

Nil

1

$90,001–$105,000

$180,001–$210,000

1%

2

$105,001–$140,000

$210,001–$280,000

1.25%

3

$140,001 and over

$280,001 and over

1.5%

“Families” includes couples and single parent families. The relevant families income thresholds increase by $1,500 for each independent child after the first. While the income thresholds are generally indexed annually, the above thresholds are frozen until 2020/21. The income for surcharge purposes is the total of the following amounts: • taxable income for the income year • reportable fringe benefits total • reportable superannuation contributions, and

• total net investment loss. Example For 2019/20, Neil has taxable income of $135,000, reportable superannuation contributions of $10,000 and no reportable fringe benefits or investment loss. Neil is married to Nancy who has taxable income of $80,000 and no reportable fringe benefits, reportable superannuation contributions or investment loss. Neither of them has adequate private patient hospital cover, nor do they have dependent children or receive trust distributions. They will both have to pay the additional 1.25% levy surcharge on their taxable income because their combined income for surcharge purposes is $225,000, being over $210,000 but below $280,000, even though Nancy earned less than $90,000. Consider if instead, Neil had taxable income of $135,000 and reportable superannuation contributions of $10,000 but Nancy’s taxable income was only $42,000. As their combined income is $177,000, being under the $180,000 threshold, neither of them would be required to pay the levy surcharge, notwithstanding that Neil’s income for surcharge purposes exceeds the single threshold of $90,000.

A trustee is generally liable to pay the Medicare levy in respect of a share of the net income of a trust (¶1505) to which a resident beneficiary, under a legal disability, is presently entitled, or to which no beneficiary is presently entitled. In the latter case special shade-in rules may apply. For more information about the calculation of the Medicare levy and Medicare levy surcharge, see ¶20020.

¶1-090 Interaction between income tax and FBT Income tax is not payable by employees on certain benefits which are dealt with under fringe benefits tax (FBT), such as car benefits and loan benefits. The value of such a benefit does not have to be included in the employee’s assessable income. FBT contains rules for working out the taxable values of benefits but FBT does not apply to certain specified benefits, such as salary or wages and contributions by employers to complying superannuation funds. For more details on the operation of FBT, see ¶3-000 and following. Reporting of benefits on payment summaries The value of certain fringe benefits is taken into account for the purpose of applying certain income tests, eg in determining liability to the Medicare levy surcharge, Higher Education Loan Programme (HELP) and Higher Education Contribution Scheme (HECS) debt repayments, the entitlement to concessions for personal and spouse superannuation contributions and the imposition of Div 293 tax on concessional superannuation contributions. For this purpose, employers are required to record on payment summaries the grossed-up taxable value of the benefits provided to the employee during the FBT year where the value of the benefits exceeds $2,000. Some fringe benefits do not have to be reported, including car parking fringe benefits, remote area benefits and meal entertainment fringe benefits. Salary sacrifice An employee’s after-tax position may be improved by replacing salary with certain benefits that are subject to concessional FBT treatment or are specifically exempt from FBT. Improvement will be evident where the FBT taxable value is such that the employer can meet the costs of both the benefit and the FBT out of the forgone salary and the employee’s benefit is greater than could have been acquired with the after-tax salary. A common example is a car benefit. Unless the benefit provided is concessionally taxed (for example, superannuation, a laptop, portable electronic equipment or a car benefit), there is generally little advantage to salary sacrificing benefits unless the employee is on the top marginal tax rate or works for a non-profit organisation. Further, care needs to be taken in salary sacrificing certain benefits as the usual concessional treatment for such benefits may be lost (eg in-house benefits). For more detailed information, see ¶10-010.

PAYMENT OF INCOME TAX AND COLLECTION SYSTEMS ¶1-100 Financial year and income year Income tax is payable for a financial year but is calculated by reference to taxable income for an income

year. The income year of an individual is also the financial year for which tax is payable. In contrast, a company’s income year is the year before the financial year for which tax is payable. Most taxpayers (including companies) are required to pay most of their tax during the income year through the PAYG instalment system (¶1-105).

¶1-105 Collection of tax Taxpayers are required to pay all or most of their annual tax liability before the actual tax payable on their taxable income can be worked out on assessment. Amounts are paid at regular intervals as income is earned during the year, and these amounts are credited in payment of the tax assessed. The system for collecting these advance payments of tax is called Pay As You Go (PAYG) and has two components: • PAYG withholding • PAYG instalments. PAYG withholding Payments subject to PAYG withholding are called “withholding payments”. The entity making the withholding payment is obliged to withhold an amount from the payment and pay the amount withheld to the Commissioner. The amount required to be withheld is worked out under withholding schedules that are available from the Australian Taxation Office (ATO). Withholding payments include the following: • payments of salary or wages, directors’ fees, superannuation pensions, annuities, taxable social security pensions and benefits, payments on retirement in lieu of unused annual leave or long service leave and ETPs (¶1-285) • payments for a supply (including supplies of goods, services and advice) where the payee does not quote its Australian Business Number (ABN) (¶1-120) • payments arising from an investment where the payee does not quote its tax file number (TFN) or ABN to the investment body (¶1-115) • dividends, interest or royalties paid to non-residents. The amount withheld is not to exceed the withholding tax (if any) payable in respect of the relevant dividend, interest or royalty (¶1-150) • a payment covered by a voluntary agreement between the payer and payee under an arrangement for the performance of work or services, where the payee is an individual and has an ABN. Agreements do not have to be lodged with the Commissioner, but must be in the approved form and must quote the payee’s ABN. A copy of the agreement must be kept by both parties for five years after the last payment covered by the agreement. Either party may terminate the agreement, in writing, at any time • the disposal of taxable Australian property (including indirect interests and options or rights to acquire such property) by a foreign resident is subject to limited exclusions (¶1-295). Variation of PAYG withholding amounts The Commissioner of Taxation has discretion to vary prescribed PAYG withholding rates if total amounts withheld for the income year are likely to significantly exceed the tax payable. Application forms are available from the ATO. Reasons for applying for a variation of withholding amounts could include: • an expected loss on another income-earning activity such as a negatively geared investment • expected significant work-related expenses • the receipt of an allowance from an employer for a tax-deductible purpose, eg travel • prior year losses • known or expected entitlement to offsets on franked dividends to offset tax payable on salary or

wages. The Commissioner will not approve a variation if any of the taxpayer’s tax returns are outstanding. The Commissioner cannot vary a withholding amount in relation to an investment where the investor does not quote a TFN or ABN. Other special cases PAYG withholding amounts may be lower in a range of circumstances: • The amount withheld can be reduced if a superannuation pension or annuity qualifies for a rebate or has a tax free component. • The rates of withholding from payments in respect of accrued leave on termination of employment generally match the rates of tax, some of which are concessional, that apply to such payments. Those rates of tax are set out at ¶1-265. • Where the disposal of the taxable Australian property by a foreign resident taxpayer would give rise to a tax loss and the taxpayer obtains a variation of the withholding. Employers may also be required by the Department of Human Services to make deductions of child maintenance from an employee’s salary or wages. PAYG instalments The PAYG instalment system applies to taxpayers who have business and/or investment income that is not subject to PAYG withholding. The system applies to individuals, companies and superannuation funds, corporate unit trusts, public trading trusts and, generally, to trustees who are assessable on trust income. PAYG instalments are payable only if the Commissioner gives the taxpayer an “instalment rate”. The instalment rate is, broadly, the taxpayer’s notional tax (ie a modified tax on taxable income) for the latest year for which an assessment has been made, expressed as a percentage of the taxpayer’s “instalment income” for that year. Individual taxpayers are liable for instalments where they have gross business or investment income of $4,000 or more ($1 or more for non-residents) in their most recent tax return unless one of the following applies: • the adjusted balance of the taxpayer’s last assessment was less than $1,000 • the taxpayer’s notional tax was less than $500 • the taxpayer is entitled to the seniors and pensioners tax offset. Companies, superannuation funds and self managed superannuation funds (SMSFs), including those registered for GST, are not required to pay PAYG instalments if their notional tax is less than $500, even if their instalment rate is greater than 0%, unless: • their business and/or investment income (excluding capital gains) in their most recent income tax return is $2 million or more, or • the taxpayer is the head of a consolidated group. Instalment income for a period (eg an income year or a quarter of an income year) is the taxpayer’s ordinary assessable income (eg business income) derived during the period, excluding amounts that are subject to PAYG withholding. Deductions for expenditure in the period are not taken into account. Nor, generally, is statutory income, such as capital gains and imputation credits. Complying and noncomplying superannuation funds, ADFs and PSTs have to include statutory income in their instalment. Partnerships do not have to pay PAYG instalments, but they need to calculate instalment income so that the partners can include their share in their individual instalment incomes. Quarterly instalments

The general rule is that taxpayers are required to pay their PAYG instalments quarterly unless the taxpayer has base instalment income of $20 million or more and monthly instalments are required (see below). For taxpayers who pay their GST monthly, the due dates for PAYG instalments are 21 October, 21 January, 21 April and 21 July. For other taxpayers, the due dates are 28 October, 28 February, 28 April and 28 July. Quarterly instalments are not payable if the taxpayer is eligible to pay a single annual instalment and chooses to do so (see below). Certain primary producers, sportspersons, authors and artists are required to pay only two PAYG instalments, for the third and fourth quarters. The amount of a quarterly instalment for an individual, or for a company or superannuation fund whose previous year’s instalment income is $2 million or less, is calculated by the Commissioner on the basis of the taxpayer’s latest assessed tax, with an adjustment for movements in Gross Domestic Product (GDP), and notified to the taxpayer. Alternatively, the instalment may be based on the taxpayer’s estimate of the current year’s tax liability net of PAYG withholding credits. These rules also apply to a company or fund whose previous year’s instalment income is over $2 million if it is eligible to pay a single annual instalment but does not choose to do so. A taxpayer not eligible to pay its quarterly instalments on the above basis, or one that is eligible but chooses not to pay on the above basis, must calculate its quarterly instalment by multiplying its instalment rate by its instalment income for the quarter. The instalment rate is either the one given by the Commissioner or one chosen by the taxpayer, although the general interest charge may be payable if an instalment based on the taxpayer’s instalment rate is too low. Monthly instalments A taxpayer will generally be required to make monthly PAYG instalments if they have a base assessment instalment income of $20 million or more and they are one of the following: • corporate tax entity (eg companies) • superannuation fund • trust • sole trader • large investor. However, such entities that lodge their GST quarterly or on an annual basis will only be required to pay monthly if its threshold is at least $100 million and it is not a head company to a consolidated group or a provisional head company of a multiple entry consolidated group. A head company of a consolidated group or a provisional head company of an MEC group will be a monthly payer if their threshold amount is equal to or greater than the $20 million threshold, regardless of the GST reporting requirements. An entity cannot object to being required to make instalments on a monthly basis. The amount of the instalment is generally calculated as the instalment income for the month multiplied by the instalment rate. However, there is an additional simplified method for calculating the instalments that may be applied unless the entity is notified by the ATO that it cannot use that method. This simplified method allows for the taxpayer to make a reasonable estimate of the instalment income for the first two months of a quarter to which it can apply the instalment rate. In the third month of each quarter the taxpayer calculates the total instalment income for the quarter and subtracts the estimates used in the first two months. The payment in the third month will be the balance remaining for the quarter, multiplied by the applicable instalment rate. A monthly instalment is due on or before the 21st day of the following month, or, if the entity is a deferred business activity statement (BAS) payer, by the 28th of the following month. All monthly PAYG instalments must be lodged and paid electronically. Annual instalment A taxpayer who is otherwise liable to pay quarterly instalments and meets certain requirements at the end of the first quarter for which an instalment would otherwise be payable can choose instead to pay one

annual PAYG instalment. Two of those requirements are that the taxpayer is neither registered, nor required to be registered, for GST, and that the notional tax most recently advised to the taxpayer by the Commissioner (ie a modified latest assessed tax) is less than $8,000. The taxpayer must notify the Commissioner of this choice, in the approved form, on or before the due date for the first quarterly instalment. The amount of an annual instalment is generally calculated by multiplying the Commissioner’s instalment rate by the taxpayer’s instalment income for the income year. Unlike the calculation of quarterly instalments, the taxpayer cannot choose an instalment rate. Alternatively, the taxpayer can choose to pay as its PAYG annual instalment either the notional tax amount most recently notified by the Commissioner (ie a modified tax on the most recently assessed taxable income) at least 30 days before the instalment due date, or the taxpayer’s estimate of the current year’s tax liability net of PAYG withholding credits (benchmark tax). If the taxpayer’s estimate of annual or quarterly tax payable is inaccurate, penalties may apply. Example In 2018/19, Miguel derived $25,000 salary, $20,000 business income and $2,000 interest. He incurred $5,000 in business expenses. On 31 August 2019, the Commissioner gives Miguel an instalment rate of 29.07%. Miguel is therefore liable to pay PAYG instalments for 2019/20. At 30 September 2019, Miguel is not registered, nor required to be registered, for GST, and the notional tax amount most recently notified to him by the Commissioner is $5,000 (in relation to 2019/20). Miguel is therefore eligible to pay an annual PAYG instalment and notifies the Commissioner on 30 September 2019 that he chooses to pay an annual instalment. On 1 April 2020, the Commissioner notifies Miguel that his notional tax amount in relation to 2019/20 is $5,100. While Miguel considers the Commissioner’s instalment rate too high he does not choose to estimate his benchmark tax for 2019/20. Miguel’s annual PAYG instalment for 2019/20 is therefore $5,100. Upon lodgement of his 2019/20 tax return he will be entitled to refund for any tax overpaid.

¶1-115 Failure to quote TFN to investment body Every taxpayer can apply to the ATO for a TFN. The TFN system enables the ATO to match income disclosed in tax returns with information obtained from other sources. Investors who make certain types of investments should quote their TFN (or, in the case of a business investment, their ABN — ¶1-120) to the investment body, otherwise the investment body must generally withhold an amount on account of tax from any income payable on the investment. The amount withheld is 47% of the payment being the top marginal rate plus the Medicare levy. A credit for the amount withheld is allowed on assessment. The TFN quotation rules apply to, for example: • interest-bearing accounts and other deposits with banks and other financial institutions • loans to government bodies and companies • units in unit trusts • shares in public companies • notionally accrued interest on deferred interest investments (but the investment body can recover the withheld amount from the investor). Exemptions from TFN rules Exemptions from the TFN rules apply in regard to: • accounts or deposits with financial institutions where the annual interest is less than $120 (although exploitation of the threshold may be an offence). This annual limit may be increased to $420 in some situations where the investor is under 16 years of age • people receiving age or other specified social security pensions

• dividends or interest received by non-residents that are subject to withholding tax • fully franked dividends on shares in public companies.

¶1-120 Australian Business Number The Australian Business Number (ABN) is a business identifier which facilitates businesses’ dealings with the government. To get an ABN, an entity must apply to be registered on the Australian Business Register. The Commissioner is the Registrar. An ABN is available to companies, government entities, other entities carrying on an enterprise in Australia, and other entities required to register for the GST. Activities as an employee do not constitute an enterprise. The following examples illustrate the significance of ABNs under the tax laws: • an entity required to register for the GST must have an ABN • quoting an ABN can ensure that certain payments are not subjected to PAYG withholding (¶1-105) • ABNs are used by businesses in business activity statements notifying the ATO of their obligations to make periodic tax payments, such as GST, PAYG withholding, PAYG instalments and fringe benefits tax (FBT) instalments (¶1-090) • charities seeking tax exemption and entities seeking deductible gift recipient status must obtain an ABN.

WITHHOLDING TAX ON DIVIDENDS, INTEREST AND ROYALTIES ¶1-150 Dividend, interest and royalty withholding tax Non-residents who derive dividends, interest or royalties from residents are generally liable to pay income tax as a withholding tax on the gross amount of that income at specified flat rates. The withholding tax provisions extend to interest and royalties derived by residents in carrying on business through a permanent establishment overseas which is paid by: • another resident and it is not wholly incurred by the payer in carrying on a business in a foreign country through a branch in that country, or • a non-resident and it is wholly or partly incurred in carrying on business in Australia through a branch. Withholding tax is a final tax liability on the income and is collected by way of PAYG withholding by the payer. Income on which withholding tax is payable is not included in the recipient’s assessable income. Exclusions from withholding tax There are significant exclusions from the withholding tax provisions. For example, franked dividends are generally not subject to withholding tax. Nor are interest payments on borrowings raised outside Australia by means of publicly offered debentures. Interest and royalties are not liable to withholding tax if the interest is derived by a non-resident carrying on a business in Australia at or through a permanent establishment in Australia. Rates of withholding tax Where dividends (generally unfranked dividends), interest or royalties are subject to withholding tax, the rates are generally as shown in the following table. No DTA*

DTA*

Dividends

30%

15% (generally)

Interest

10%

10%

Royalties

30%

10% (generally)

* A double taxation agreement between Australia and the non-resident’s country of residence.

ASSESSABLE INCOME AND EXEMPT INCOME ¶1-250 Annual basis of taxation Taxable income for an income year is calculated by subtracting from assessable income all deductions. Assessable income includes income according to ordinary concepts derived during the income year. The calculation of tax payable for a year therefore depends not only on whether certain income is derived but also on when the income is derived. In addition, progressive marginal tax rates for individuals mean that the timing of income derivation can have a significant effect on the total amount of tax payable over two or more years. When is income derived? The time at which income is derived can vary according to the nature of the income and the incomeearning activities of the taxpayer. For example: • salary or wages, directors’ fees, interest derived by an individual and rent are generally derived when received. Income that is not actually received can be constructively received, and therefore be deemed to be derived. An example is where interest is credited on a savings bank deposit • trading income is generally derived when the right to receive it arises as a debt due and owing • a professional person assessed on an accruals basis is taken to have derived fees when a recoverable debt is created by, for example, sending an account to the client • the yield from discounted or other deferred interest securities with terms exceeding 12 months is assessed as the income accrues over the term rather than when received on maturity • dividends are included in the assessable income of a shareholder when they are paid, credited or distributed to the shareholder. A dividend is therefore taxable in the year the dividend cheque is posted to the shareholder even though the cheque is not received until the following year. A dividend in the form of fully paid bonus shares is included in assessable income when the bonus shares are issued. Example On 30 June 2020, Magnus received a wages payment of $2,000 (one week in advance, one week in arrears), and rental income of $1,000 from his rental property (payment is required on the last day of the month for the following month). He has a term deposit for which the term expires on 30 June 2020. However, the bank does not credit his cheque account with the interest until 2 July 2020. On 2 July 2020, he also receives a dividend cheque of $500 which was posted by the company on 30 June 2020. Magnus’ assessable income for 2019/20 includes the: • full $2,000 of the wages payment • rental income of $1,000 • dividend of $500. The interest will form part of Magnus’ assessable income for 2020/21.

¶1-255 Assessable income Assessable income consists of ordinary income and statutory income, although some ordinary income and some statutory income can be exempt income. Exempt income is not assessable income. The assessable income of an Australian resident (¶1-550) includes ordinary income and statutory income from all sources (¶1-555), whether in or out of Australia, during the income year. The assessable income of a non-resident includes ordinary income and statutory income from Australian sources only.

The GST payable on a taxable supply is excluded from the supplier’s assessable income and exempt income. It falls into another category called non-assessable non-exempt income. Ordinary income Ordinary income is income according to ordinary concepts. The characteristics of income according to ordinary concepts, such as regularity of receipt, have been identified in decided cases over many years. Earnings from personal services, business receipts, interest and rents are examples of ordinary income. Special provisions of the law sometimes modify the way in which ordinary income is included in assessable income. For example: • annuities are included in assessable income under a provision that excludes from assessable income the part of the annuity that represents the return of a portion of the purchase price of the annuity. The excluded amount is calculated in accordance with a formula contained in the provision • a non-cash business benefit may be treated as ordinary income even if it is not convertible into money (convertibility into money being a usual condition of an amount being ordinary income), provided the benefit is otherwise of an income nature. A non-cash business benefit arises when property or services are provided to a business taxpayer in connection with a business relationship. Income versus capital Receipts of capital, such as a gain on disposal of an asset, are not ordinary income, and are therefore not assessable income unless included as statutory income as, say, a component of a net capital gain under the capital gains tax (CGT) provisions (see Chapter 2). A lump sum received on commutation of a superannuation pension or annuity, for example, would not be ordinary income, although the special provisions dealing with ETPs may treat some part of the lump sum as statutory income. In characterising a receipt as capital or income, it is the character of the amount in the hands of the recipient that matters. A payment that is income in the hands of the recipient may nevertheless be a capital payment, and therefore not a tax deduction, for the payer. Statutory income An amount is statutory income if it is not ordinary income but is included in assessable income by a specific provision of the income tax law. For example, a special provision includes in assessable income an amount that is a royalty in the ordinary sense of the word but is a capital receipt rather than income according to ordinary concepts. Such an amount is statutory income.

¶1-260 Exempt income If an amount is exempt income, it is not assessable income and therefore not taxable. Net exempt income (see below) can reduce the amount of a tax loss incurred in an income year and also reduce the extent to which a tax loss is available for set off against assessable income of a later income year. Exempt income is made up of: • ordinary income or statutory income that is made exempt by a provision of the law • ordinary income that the law excludes, expressly or by implication, from being assessable income (and is not non-assessable non-exempt income). Some examples of exempt income are: • some pensions paid under foreign laws that are, broadly, related to enemy persecution during the Second World War or to disability arising from participation in a resistance movement during that war • periodic maintenance payments to a spouse or former spouse • earnings of a resident taxpayer from at least 91 days’ continuous employment in a foreign country, including in some cases earnings that are also exempt from income tax in the foreign country, provided the income is earned as: – an aid or charitable worker employed by a recognised non-government organisation

– a government aid worker, or – a government employee deployed as a member of a disciplined force. • some scholarships and bursaries received by full-time students. Net exempt income A person’s net exempt income for an income year is the excess of total exempt income for the year over the sum of the losses and outgoings (other than capital ones) incurred in deriving the exempt income and any foreign taxes payable on that exempt income. Net exempt income may reduce the amount of current year or carry forward losses available to a taxpayer. Non-assessable non-exempt income Non-assessable non-exempt income is a third category of income recognised by the income tax law. Nonassessable non-exempt income is ordinary or statutory income that is expressly made neither assessable income nor exempt income. As non-assessable non-exempt income is not assessable income, it is not taken into account in working out a taxpayer’s taxable income for an income year. As the amount is also not exempt income, it is not taken into account in working out a taxpayer’s tax loss for an income year or in working out how much of a prior year tax loss is deductible in an income year. Some examples of non-assessable non-exempt income are: • the GST payable on a taxable supply • amounts subject to family trust distributions tax • foreign-sourced ordinary income derived by a temporary resident • dividends, interest and royalties that are subject to withholding tax when derived by non-residents • exempt payments made by mining companies for the benefit of Aborigines or Aboriginal representative bodies.

¶1-265 Income from personal services and pensions Earnings from providing personal services, whether under a contract of employment or some other contract for services, are assessable income. Assessable amounts include salary and wages, long service leave pay, directors’ fees and commissions. The earnings are assessable in the year of receipt, not necessarily in the year in which the services are provided. The following benefits are not assessable income: • an employer’s contributions to a complying superannuation fund for an employee’s benefit. The contributions are deductions for the employer and taxable in the hands of the fund (although taxpayers with combined income and concessional superannuation contributions in a year exceeding $250,000 are personally taxed an additional 15% on those concessional contributions — see ¶4-225) • benefits received by employees for frequent flyer points accumulated as a result of travel paid for by the employer. The reason is that the benefit does not arise from the employment relationship (where a non-cash benefit does arise from an employment relationship, the value of the benefit is generally subject to the FBT provisions (¶1-090) and is not included in the employee’s assessable income) • amounts received from pastimes, hobbies or windfall gains, including general gambling and lotto wins • gifts that are not related to personal services. Alienation of personal services income

Individuals are prevented from reducing or deferring their income tax by diverting their personal services income through a company, partnership or trust. Any diverted personal services income is included in the assessable income of the individual who performs the services, after allowing for certain costs incurred by the interposed entity. This rule does not apply where the interposed entity derives the income from conducting a personal services business or the income is promptly paid to the individual as salary or wages. Employee share acquisition schemes Benefits in the form of discounts on shares or rights acquired under an employee share acquisition scheme are taxed under special provisions. The rules have changed over time depending upon the date of acquisition of the shares or rights. The following applies to shares or rights acquired from 1 July 2015. The general rule is that a discount (being the market value less consideration paid) received on a share or right is included in assessable income in the year of acquisition. This general rule does not apply and the tax will be deferred until a later time where: • the shares are acquired under a capped salary sacrifice scheme under which an employee can obtain no more than $5,000 worth of shares and there is no real risk of the forfeiture of those shares • the shares or rights are acquired under a scheme for which there is a real risk of forfeiture of the shares or rights • the rights are acquired under a scheme that does not contain a real risk of forfeiture provided the scheme rules state that tax deferred treatment applies and the scheme genuinely restricts an employee from immediately disposing of the rights. The deferral is only available where the scheme meets certain qualifying conditions. Where the deferral applies, the discount is included in the recipient’s assessable income at the earliest of the following times: • in the case of a share, there is both no longer a real risk of losing the share and no restriction preventing the taxpayer from disposing of the share • in the case of a right, when there are no longer any genuine restrictions on the disposal of the right and there is no real risk of the taxpayer forfeiting the right, or the time when the right is exercised and there is neither a real risk of the taxpayer forfeiting the resulting share or a genuine restriction on the disposal of the resulting share • cessation of employment, and • the end of 15 years after the acquisition of the share or right. In addition, an exemption of $1,000 is available to be claimed by a taxpayer that is required to include the discount in their assessable income in the year of acquisition, if certain conditions are met and the individual has an adjusted taxable income (see ¶1-355) of less than $180,000. Further, in relation to interests received in certain small start-up companies, the taxpayer may be eligible for: • in relation to certain shares — an income tax exemption for the discount received. The shares will be subject to CGT provisions with a cost base reset at market value, and • in relation to certain rights — the deferral of income tax on the discount. The rights will be taxed under the CGT provisions with the rights having a cost base equal to the taxpayer’s cost of acquisition. Any shares acquired pursuant to the exercise of such rights are treated as having been acquired at the time the rights were acquired for determining whether the shares have been held for at least 12 months to apply the CGT discount. Dividend equivalent payments

A “dividend equivalent payment” is a cash payment paid by a trustee of a trust funded from dividends (or income from other sources) on which the trustee has been assessed in previous income years because no beneficiary of the trust was presently entitled to the income. The amount of the dividend equivalent payment is usually calculated by reference to the amount of the dividends (or other income) received by the trustee during a certain period, less the amount of tax paid by the trustee on that income. A dividend equivalent payment paid by a trustee under an employee share scheme is assessable to an employee as ordinary income where the payment has a sufficient connection with the employee’s employment, according to Taxation Determination TD 2017/26 (which applies to dividend equivalent payments paid under the terms and conditions attached to ESS interests granted on or after 1 January 2018). The circumstances in which the Commissioner accepts that a dividend equivalent payment is not for, or in respect of, services provided as an employee, and therefore is not assessable to an employee as remuneration under s 6-5, are contained in Appendix 2 to TD 2017/26. For further information on employee share schemes, see ¶10-470. Pensions Most social security and veterans’ entitlement pensions paid to people of pensionable age are assessable income, but a tax offset is available. For details of the Senior Australians and pensioner tax offset (SAPTO), see ¶1-355. Certain war-time persecution pensions are exempt from tax (¶1-260). The tax treatment of annuities and superannuation pensions is outlined at ¶1-290 and covered in detail at ¶16700. Termination of employment If an employee is paid an amount in consequence of the termination of employment, the amount is generally taxable under special rules applicable to ETPs. Termination payments that are excluded from ETP treatment are dealt with at ¶1-285, eg the tax-free amount of a genuine redundancy payment or an early retirement scheme payment. The special rules that apply to payments in lieu of unused annual leave and payments in lieu of unused long service leave are outlined below. Payments in lieu of unused annual leave A payment that is in respect of unused annual leave and made in consequence of retirement from, or the termination of, employment is assessable in full and taxed at normal marginal rates. If, however, the payment is for leave accrued in respect of service before 18 August 1993 or the payment is made under an approved early retirement scheme, or as a consequence of bona fide redundancy or invalidity, a tax offset ensures that the rate of tax payable on the payment does not exceed 30% plus Medicare levy. Payments in lieu of unused long service leave Amounts paid in respect of accrued long service leave in consequence of retirement from, or the termination of, employment are included in assessable income and taxed in accordance with the following table. Amount included in assessable income

Rate of tax

(a) 5% of amount paid in respect of long service leave that accrued before 16 August 1978

Normal marginal rates

(b) Whole amount paid in respect of long service leave that accrued after 15 August 1978 and also paid in respect of a bona fide redundancy or invalidity or an approved early retirement scheme

Not greater than 30% plus Medicare levy*

(c) Whole amount paid in respect of long service leave that accrued between 16 August 1978 and 17 August 1993 inclusive and not covered by (b)

Not greater than 30% plus Medicare levy*

(d) Whole amount paid in respect of long service leave that accrued after 17 August 1993 and not covered by (b)

Normal marginal rates

* A rebate of tax applies to limit the rate.

Payments made in respect of unused long service leave on the death of a person are exempt from tax if paid directly to the person’s beneficiaries or to the trustee of the deceased’s estate. Example Johan voluntarily retired on 16 August 2019 from the company he had worked for since 16 August 1977 (42 years). He was paid $100,000 in respect of his unused long service leave accrued over the employment. This payment will be taxed as follows (for simplicity, years have been used to allocate the payments, rather than days): Amount before 16 August 1978 1/42 × $100,000 = $2,380 $119 (ie 5% × $2,380) included in taxable income and taxed at marginal rates (plus Medicare levy) Amount between 16 August 1978 and 17 August 1993 15/42 × $100,000 = $35,714 $35,714 to be included in taxable income and taxed at marginal rates but not more than 30% (plus Medicare levy) Amount after 17 August 1993 26/42 × $100,000= $61,904 $61,904 to be included in taxable income and taxed at marginal rates (plus Medicare levy).

¶1-270 Income from investments Assessable income of resident individuals generally includes amounts derived as dividends, interest or rents and most returns from holding other investments such as units in unit trusts. The various kinds of investments and the returns on those investments are discussed in detail in Chapter 9. The gearing of investments is discussed in Chapter 11. Deductions for expenditure incurred in connection with the derivation of investment income are discussed at ¶1-325. Dividends Resident shareholders are assessable on dividends paid out of any company profits, including capital profits and profits that are exempt from tax. Dividends include any distributions made by a company to its shareholders, including certain distributions made in a return of capital. A reversionary bonus on a life assurance policy is not a dividend. Nor, generally, are bonus shares issued on or after 1 July 1998. Dividends are included in the assessable income of a shareholder when they are paid, credited or distributed to the shareholder. Therefore, a dividend is taxable in the year the dividend cheque is posted to the shareholder even though the cheque is not received until the following year. Payments or loans by private companies to shareholders or associates may be deemed to be payments of dividends, as may excessive remuneration for the services of past or present shareholders or associates. The taxation of companies and the operation of the company imputation system are covered at ¶1-400 and ¶1-405. Franked dividends Where a franked dividend is paid to a resident individual shareholder, the consequences are: • both the dividend and the amount of the attached franking credit (reflecting tax paid by the company) are included in the shareholder’s assessable income • the shareholder is entitled to a franking offset equal to the franking credit • the offset can be set off against tax on any income, but not against the Medicare levy. Any excess credits are refundable. Where franked dividends are received through trusts and partnerships, the franking credits and corresponding franking rebates are generally apportioned between the beneficiaries or partners according to their share in the net income or loss of the partnership or the net income of the trust. Where permitted by the trust deed, franked distributions can be streamed for tax purposes if beneficiaries are made “specifically entitled” to those amounts. The concept of “specifically entitled” is discussed further at ¶1-

505. Note that where the trust is a discretionary trust a family trust election may be required to allow the benefit of the franking credits to flow through to the relevant beneficiaries. The law contains a rule to deter companies from the practice of “streaming” dividends in a way that ensures that franking credits are received by shareholders who benefit most. See also the discussion of the Pt IVA general anti-avoidance provisions at ¶1-610. Franked dividends paid to non-residents are not included in the non-resident’s assessable income and are generally exempt from withholding tax. Unfranked dividends paid to non-residents are not generally included in assessable income but are liable to withholding tax. Example Frank received a $3,000 dividend that was fully franked dividend at the 30% rate on 1 October 2019 with attached imputation credits of $1,286. Aside from the dividends, he made a loss during the year due to a negatively geared investment. In respect of the dividend, Frank includes $4,286 in his taxable income (dividend amount and imputation credit). After including the negatively geared investment, Frank has a taxable income of $1,000. The tax payable on Frank’s taxable income is nil. He is therefore entitled to a refund of the whole of the imputation credit of $1,286.

Interest For most taxpayers interest from any source is generally assessable income when it is received, although that rule is modified in detailed guidelines issued by the Commissioner about when interest is derived by financial institutions. An amount of interest that is made available to the lender — such as interest on a fixed deposit that is added to the capital — is regarded as received, and therefore assessable, even though it has not actually been received. Special rules There are many specific rules (both interpretative and legislative) that either exclude interest from assessable income or declare when it is derived and by whom. For example: • interest is not generally assessable where a person is not entitled to interest on a savings account that is set off against the person’s mortgage account under an “interest offset” arrangement • interest on joint bank accounts is assessable according to the beneficial interests of the account holders. The beneficial interests will be assumed to be equal unless there is evidence to the contrary • interest on a child’s savings account is assessable to the parent if the parent provided the money and controls the use of the interest. If the money in the account really belongs to the child, the child is taxed on the interest • special rules apply to the interest and other unearned income of minors (¶1-070) • income in the form of the deferred yield on certain discounted and deferred interest securities is taxed as the deferred yield (the excess of the redemption price over the issue price) accrues rather than when it is received on redemption of the security. The security must have an expected term of more than a year and a deferred yield greater than an amount equivalent to 1.5% of the redemption price for each year of the term of the security • interest derived from Australia by a non-resident is generally subject to a final withholding tax at a flat rate of 10%. If the interest is paid as an outgoing of an overseas business, withholding tax is not payable. If withholding tax is payable, the interest is not included in the non-resident’s assessable income • deemed interest on cash holdings or low interest bank accounts that is taken into account for social security purposes is not assessable income. Rents Rental income is generally assessable when received. Co-owners of property are generally assessable

according to their legal interests in the property. Unit trusts and other investment funds Distributions out of income of a unit trust are assessable income of the unitholder, generally in the year in which the income is derived by the trust rather than the year in which the distribution is made. A distribution out of capital would not be assessed to the unitholder unless the amount was included in assessable income of the trust, eg as a net capital gain under the CGT provisions, or it gave rise to a taxable capital gain pursuant to CGT event E4 in the hands of the beneficiary. The taxation of trust income is discussed at ¶1-500 and following. The taxation of capital gains is discussed at ¶1-295 and in Chapter 2. Any ongoing commission paid by an investment fund to an investment adviser in relation to an investor’s investment in the fund is considered to be assessable income of the investor if the adviser is under an obligation to pass the commission on to the investor. The income earned on amounts contributed by a taxpayer or an employer of a taxpayer to a superannuation or rollover fund or to a retirement savings account (RSA) is assessable income of the fund or RSA provider and not the taxpayer. The taxation of this income is discussed in Chapter 4.

¶1-275 Transactions in property and securities, other financial dealings and life assurance Property The proceeds of the sale of an asset do not give rise to assessable income if the taxpayer is merely realising the asset, even in the most advantageous way. If, however, the activities surrounding the sale constitute a business venture or profit-making undertaking, eg an extensive program of developing land for sale, the profit on sale is assessable income. In both situations the CGT provisions (¶1-295) may apply if the asset was acquired after 19 September 1985, but only to the extent that the gain is not assessable under other parts of the law. The gain may be smaller under the CGT provisions for an individual, trust or complying superannuation fund because the gain is discounted. Property investments are discussed at ¶9-310. Securities Any gain on the disposal or redemption of a security that is: • not indexed, does not bear deferred interest • issued at no, or a low, discount, is assessable in the year of disposal or redemption. Examples of such securities are debentures, bills of exchange, bank accounts, fixed deposits and other debt instruments (¶9-110 and following). The gain is not subject to the CGT provisions. A loss on disposal or redemption of such a security is generally a deduction in the year of disposal or redemption. For securities issued after 7.30 pm 14 May 2002 that convert or exchange into ordinary shares, no gain or loss arises from the disposal or redemption of the security in two specified circumstances. This means an investor who holds a relevant financial instrument through conversion or exchange will not be subject to tax until it is ultimately sold. Gains from the mere realisation of other securities or of shares are not assessable as ordinary income, although the CGT provisions may apply to all or part of the gain. If shares are sold cum dividend, the purchaser is assessable on the dividend when paid. Foreign exchange gains and futures profits A foreign exchange gain is assessable as ordinary income where, for example, a liability incurred in a foreign currency is discharged and the liability was for the purchase of trading stock or where a profit is made from speculating in currency variations. Foreign currency gains and losses are brought to account when realised, regardless of whether there is an actual conversion of foreign currency amounts in Australian dollars. Financial institutions are exempt

from the application of these rules. Foreign currency gains and losses are treated as having a revenue character, subject to limited exceptions where the foreign currency gain or loss is closely linked to a capital asset. Foreign exchange gains of a private or domestic nature are only assessable in limited circumstances. Profits from speculative dealings on the futures market are also generally assessable as ordinary income. Futures are discussed at ¶9-335. Life assurance Life assurance or endowment policies are assessed as follows: • the lump sum proceeds of life assurance or endowment policies are not assessable income, whether received on maturity, forfeiture or surrender of the policy • amounts received as bonuses, other than reversionary bonuses, on life assurance policies are assessable income • if the risk under a policy commenced after 7 December 1983, reversionary bonuses are assessable in full if received within eight years of the commencement of the risk. Two-thirds of any reversionary bonus received in the ninth year is assessable as is one-third of any such bonus received in the 10th year. Amounts assessable under these attract a tax rebate of 30% which can be set off against the tax otherwise payable on income from any source. Insurance bonds are discussed at ¶9-600.

¶1-280 Partnership and trust income Partners in partnerships are assessable in their individual capacities on their shares of the net income of the partnership. Similarly, beneficiaries of trusts who are presently entitled to a share of the income of a trust are assessable in their individual capacities on their share of the net income of the trust. The income is included in the individuals’ assessable incomes of the income year in which the partnership or trust derives the income, whether or not the amounts have been distributed. Partnerships and trusts are discussed at ¶1-450 and ¶1-500 respectively. The gross proceeds of a business are assessable income. For example, where the sales and purchases of shares are sufficient to constitute the carrying on of a business, the shares would then be trading stock (¶1-300) and, if unsold, would have to be brought to account at the beginning and end of each income year in working out taxable income. Proceeds of the sale of such shares would be included in assessable income and not subject to CGT.

¶1-283 Small business entities Small business entities (ie entities that are carrying on a business during the year of income that satisfy the relevant “aggregated turnover” test) are entitled to tax advantages of special income tax concessions and CGT concessions. The aggregated turnover threshold for the concessions is generally $10 million. However, different thresholds apply for the following: • the CGT small business concessions to which a $2 million threshold applies (see ¶2-300), and • the small business tax offset to which a $5 million threshold applies (see below). Small business tax offset Individuals deriving income from an unincorporated small business are entitled to the “small business tax offset” which effectively provides a discount on the income tax payable on that business income subject to a maximum cap of $1,000 per year (see ¶1-283; ITAA97 Subdiv 328-F). The discount is 8% for unincorporated small business entities with an aggregated annual turnover of less than $5 million. An individual is entitled to the small business tax offset for an income year where either:

• the individual is a small business tax entity for the income year (eg sole trader), or • has assessable income for the income year that includes a share of the net income of a small business entity that is not a corporate tax entity (eg a trust or partnership). The amount of the offset is equal to 8% of the following: The individual’s total net small business income for the income year The individual’s taxable income for the income year

×

The individual’s basic income tax liability for the income year

For these purposes, the individual’s total net small business income for the income year means so much of the sum of the following that does not exceed the individual’s taxable income for the income year: • where the individual is a small business entity — the individual’s net small business income for the income year, and • the individual’s share of a small business entity’s net small business income for the income year that is included in assessable income (excluding that of a corporate tax entity) less relevant attributable deductions to that share. An entity’s net small business income is the result of: • the entity’s assessable income for the income year that relates to the entity carrying on a business disregarding any net capital gain and any personal services income not produced from conducting a personal services business • LESS: the entity’s relevant attributable deductions attributable to that share of assessable income. If the result is less than zero, the net small business income is nil. Relevant attributable deductions are deductions attributable to the assessable income other than taxrelated expenses, gift and contributions or personal superannuation contributions under Subdiv 290-C. The discount rate will increase to 13% in 2020/21 and to 16% in 2021/22 but the amount of the offset continues to be capped at $1,000. Instant asset write-off (special depreciation) A small business entity may elect to apply simplified depreciation rules. The simplified depreciation rules entitle a small business entity to claim an immediate tax deduction (also known as the instant asset writeoff) for the full cost of an asset purchased on or after 7.30 pm on 12 May 2015 for less than $30,000 that is first used or installed ready for use from 7.30 pm on 2 April 2019 to 30 June 2020. The deduction is available in the year when it is first used or installed ready for use. For assets that were first used or installed ready for use prior to 7.30 pm on 2 April 2019, the threshold for the instant asset deduction is as follows: • prior to 28 January 2019 — $20,000 • between 28 January 2019 and 7.30 pm on 2 April 2019 — $25,000. Assets that are not entitled to the instant write-off must be included in a single depreciating pool with a diminishing rate of 30% (15% for the first year). Note that the instant asset write-off is also available for medium-sized businesses (see ¶1-330). Other income tax concessions Small business entities may elect to take advantage of various income tax concessions including: • small business restructure rollover — an optional income tax and CGT rollover available for the transfer of assets as part of a restructure which involves a change of legal structure without a change

in the ultimate legal ownership of the assets. • trading stock concessions — the entity is not required to undertake a stocktake or account for changes in the value of trading stock at the end of an income year where the change in value from the start to the end of the year is $5,000 or less. • prepayments — an entitlement to an immediate deduction for certain prepaid expenditure. • start-up costs — an immediate deduction for professional expenses that are associated with starting a new business. • FBT exemption for multiple work-related portable devices.

¶1-285 Employment termination payments (ETPs) and superannuation lump sums The taxation of termination payments differs depending upon whether the payment is an employment termination payment (ETP) or a superannuation lump sum. ETPs

Superannuation lump sums

• “life benefit termination payments” received in consequence of termination of employment, eg on resignation, retirement, redundancy or invalidity, including “golden handshakes” (¶14-250)

• payments from superannuation funds or RSAs, excluding payments such as pensions (¶4-420)

• “death benefit termination payments” received in consequence of termination caused by death (¶14-250)

• payments from ADFs (¶4-420)

Payments that are not ETPs Payments that are not ETPs include payments in lieu of unused annual leave or unused long service leave (¶1-265). Genuine redundancy payments and early retirement scheme payments paid after 30 June 1994 up to certain limits are tax-free and not ETPs. The limit for 2019/20 is $10,638 plus $5,320 for each completed year of service. Any amount over this limit is taxed as an ordinary ETP. The taxation of life benefit termination payments Life benefit termination payments may be subject to concessional rates of tax if: • the amount is taken in cash, and • it is received within 12 months of the termination (unless it is a genuine redundancy payment or the Commissioner allows a longer time). ETPs are not able to be paid into superannuation. Life benefit termination payments from employers are comprised of the following two components: • a tax free component, and • a taxable component. The tax free component comprises any invalidity amount and the pre-July 1983 amount. This component is non-assessable, non-exempt income and therefore not subject to tax. The invalidity segment is calculated as the portion of the payment that represents the period between termination and the person’s last retirement day. An ETP contains an “invalidity segment” if: • the payment was made to the person because they can no longer work because of ill health • the person stopped working before they reached their last retirement day, and

• two medical practitioners have certified that it is unlikely the person can ever work again in a role for which they are qualified. The pre-July 1983 segment is calculated as the portion of the payment that represents the individuals’ service period prior to 1 July 1983. The taxable component is the whole of the termination payment amount reduced by the tax free component. Where there is no invalidity component, this will be the post-June 1983 component. The taxable component is included in assessable income. However, a tax offset may be available to limit the effective tax payable as detailed below plus the Medicare levy. The calculation of the tax offset depends on the type of ETP paid. The ETP cap applies to a: • payment pursuant to an early retirement scheme or bona fide redundancy (part exceeding the tax free component) • compensation payment for personal injury, unfair dismissal, harassment or discrimination • payment because of an employee’s permanent disability, and • lump sum payment paid on the death of an employee. In 2019/20, the taxable component of an ETP subject to the ETP cap is as follows: Amount of benefit

If recipient is aged 55 and over

If recipient is aged under 55

(column 1) ($)

Tax on column 1

% on excess (max marginal rate)**

Tax on column 1

% on excess (max marginal rate)

Nil

Nil

15

Nil

30

210,000*

31,500

45

63,000

45

* Note that this cap is indexed for future years. This amount is available each time an employee receives an ETP from an employer, unless an ETP has already been received by the employee in that same year or in respect of the same termination. ** The rates set out in the table are the maximum marginal tax rates that apply. The Medicare levy may also be payable on the life benefit termination payments.

However, for all other ETPs (eg a golden handshake, gratuities, payment in lieu of notice or unused sick leave) the offset is the lesser of the ETP cap and the amount worked out under the whole-of-income cap. The whole-of-income cap limits the tax offset to that part of the ETP takes the person’s total annual taxable income (including the ETP) to no more than $180,000. The balance is taxed at the top marginal rate of tax. Example Dennis is made redundant from his position at Panache Power in August 2019 after working there for 13 years. He is 63 years old. He receives a payment of $300,000 in relation to his bona fide redundancy. There is neither a pre-June 1983 nor an invalidity segment included in the payment. Since Dennis’ other income for the year is $200,000 (and he is therefore in the top marginal tax bracket), concessional rates will apply to the whole of the payment as the ETP relates to a genuine redundancy and only the ETP cap will apply. The tax he will pay on the ETP, excluding the Medicare levy is:

Amount

Maximum tax rate

Tax payable

Exempt component

$79,798

Nil

Nil

The ETP cap

$210,000

15%

$31,500

Excess (balance of payment)

$10,202

45%

$4,591

Total tax payable

$36,091

Note that if the facts were different such that Dennis was merely terminated from employment, as opposed to receiving a bona fide redundancy, the payment would be subject to the whole-of-income offset. In such a case the whole of the payment would be subject to the top marginal tax rate of 45% (excluding Medicare levy) due to the whole-of-income cap of $180,000 being exceeded by the other income Dennis derived in the year.

The taxation of death benefit termination payments The taxation of death benefit termination payments is discussed at ¶4-420. Superannuation lump sums The taxation of superannuation lump sums depends upon whether the payment is from a taxed source or an untaxed source. A taxed source refers to payments made from complying superannuation funds and RSAs. An untaxed source refers to payments from an untaxed superannuation fund such as a state superannuation fund or a non-resident superannuation fund and also to payments directly from an employer. Taxation of superannuation lump sum benefit payments from a taxed source Lump sum benefits paid from a taxed source to an individual aged 60 or over are tax-free. Lump sum benefits paid from a taxed source to an individual who is below age 60 have two components: • a tax free component, and • a taxable component. The tax free component comprises the following components: • the “contributions segment”, which includes all contributions made since 1 July 2007 that have not been included in the assessable income of the superannuation provider, for example, the person’s non-concessional contributions, and • the “crystallised segment”, which is calculated by assuming that an ETP representing the full value of the superannuation interest is paid just before 1 July 2007. The crystallised segment contains the following previous elements: – the pre-July 1983 component: the proportion of a payment, excluding the above components, that relates to service before 1 July 1983. The method of apportioning a payment between service up to 30 June 1983 and service from 1 July 1983 is on a time basis, according to the eligible service period. Where a payment is from an employer-sponsored superannuation fund, the eligible service period is the combined periods of employment and fund membership. Where a payment is from a fund for the self-employed, the eligible service period is the period of fund membership. The pre-July 1983 component is calculated as the lesser of: (Total ETP – concessional – post-June 1994 invalidity component – excessive component – CGT-exempt)

×

pre-July 1983 service period total service period



Undeducted contributions

OR (Total ETP – concessional – post-June 1994 invalidity component – excessive component – CGT-exempt)

– the CGT exempt component: this amount arose out of the disposal of the assets of a small business (¶15-200) – the post-June 1994 invalidity component: this component was paid when disability caused employment to cease and resulted in the recipient being unlikely to be able to be employed in any capacity for which he/she was reasonably qualified

– the concessional component: this component was paid from employer-sponsored superannuation funds up to 30 June 1994 and represented payments in relation to redundancy, approved early retirement schemes and invalidity, and – undeducted contributions up to 1 July 2007: the part of the ETP represented by superannuation contributions made after 30 June 1983 (other than by an employer) that were not income tax deductions of the contributor. The taxable component is tax-free up to the low-rate threshold of $210,000 for 2019/20 and taxed at a maximum rate of 15% above the threshold. For those under the age of 55, this component is taxed at a maximum rate of 20%. The taxed component currently comprises the following components: • the post-June 1983 component: which represents the total ETP reduced by all the other components, and • the non-qualifying component. Note that the Medicare levy may also be payable upon any superannuation benefit where a tax rate greater than zero per cent applies. Example Delores retired from her job at age 58 on 31 July 2019 and, having already a substantial private income, has decided to spend her accumulated retirement funds on a house in the country. She had a salary in 2019/20 of $150,000, private income consisting of interest of $50,000 and her superannuation payout is $290,000 (with an exempt component of $50,000 and a taxable component of $240,000). Her employer paid her a “golden handshake” of $5,000 with no exempt component. The taxation of Delores’ superannuation payout and “golden handshake” (excluding Medicare levy), and the amount she will be able to apply towards the cost of her house, are illustrated below.

Component amount

Assessable amount

$

$

– tax free component

50,000

Nil

– taxable component

240,000

ETP component

Tax rate applied

Tax payable*

ETP after tax

$

$

Nil

Nil

50,000

210,000

up to low rate cap (max rate): 0%

Nil

210,000

30,000

above low cap rate (max rate): 15%

4,500

25,500

5,000

marginal rate: 45%

2,250

2,750

$6,750

$288,250

Superannuation lump sum

Golden handshake – taxable component

5,000 $295,000

*As Delores’ taxable income exceeds the whole-of-income cap of $180,000, the golden handshake is subject to marginal rates, not the concessional ETP rates.

Taxation of superannuation lump sum benefit payments from an untaxed source Lump sum benefits paid from an untaxed source to an individual aged 60 or over are taxed at the maximum rates shown in the following table for 2019/20.

Amount of benefit (column 1) ($)

Tax on column 1

% on excess (max marginal rate)*

Nil

Nil

15

1,515,000**

227,250

45

* The rates set out in the table are the maximum rates excluding any applicable Medicare levy. The amount is included in the person’s assessable income for the year and an offset against tax payable is calculated to effectively reduce the marginal tax rate to the maximum applicable. ** The untaxed plan cap amount is indexed annually.

Lump sum benefits paid from an untaxed source to an individual being from preservation age to 59 are taxed at the maximum rates shown in the following table for 2019/20. Amount of benefit (column 1) ($)

Tax on column 1

% on excess (max marginal rate)*

Nil

Nil

15

210,000**

31,500

30

1,515,000***

423,000

45

* The rates set out in the table are maximum rates excluding Medicare levy. The amount is included in the person’s assessable income for the year and an offset against tax payable is calculated to effectively reduce the marginal tax rate to the maximum applicable. ** The low rate cap amount is indexed annually. It is $210,000 for 2019/20 ($205,000 for 2018/19). *** The untaxed plan cap amount is indexed annually. It is $1,515,000 for 2019/20 ($1,480,000 for 2018/19).

Lump sum benefits paid from an untaxed source to an individual younger than preservation age are taxed at the maximum rates shown in the following table for 2019/20. Amount of benefit (column 1) ($)

Tax on column 1

% on excess (max marginal rate)*

Nil

Nil

30

1,515,000

454,500

45

* The rates set out in the table are maximum rates excluding Medicare levy. The amount is included in the person’s assessable income for the year and an offset against tax payable is calculated to effectively reduce the marginal tax rate to the maximum applicable.

Note The $1,515,000 threshold in the above tables applies on a lifetime basis to each member of the fund. It is also indexed to AWOTE and increases in amounts of $5,000. Note also that the Medicare levy is also payable upon any superannuation benefit where a tax rate greater than zero percent applies.

Rollover of superannuation benefits ETPs cannot be rolled into superannuation funds. Superannuation benefits, however, may be able to be rolled over and are not assessable to the extent they are rolled over into a complying superannuation fund or ADF, into an RSA or used to purchase certain annuities (including allocated annuities that comply with relevant standards) from a life office, friendly society, trade union or employee association. When funds are rolled over from an untaxed fund to a taxed scheme, the transferring untaxed fund must

withhold tax at the top marginal tax rate for amounts above $1,515,000. The first $1,515,000 of the benefit transferred will be treated as a taxable contribution by the receiving fund, and the remainder will form part of the exempt component in the receiving fund and not be taxed further. Certain forms and documentation need to be maintained for a rollover of superannuation monies. These are discussed at ¶4-430.

¶1-290 Superannuation income streams The following table shows the maximum tax rates that apply to superannuation income streams. The Medicare levy is also payable upon any superannuation benefit where a tax rate greater than zero per cent applies. Age

Superannuation income stream — element taxed in the fund

Superannuation income stream — element untaxed in the fund

Aged 60 and above

– Tax-free

– Tax free component is tax-free – Marginal tax rates and 10% tax offset

Preservation age to age 59

Below preservation age

– Tax free component is tax-free

– Tax free component is tax-free

– Taxable component taxed at marginal tax rates with 15% tax offset

– Taxable component is taxed at marginal tax rates with no tax offset

– Tax free component is tax-free

– Tax free component is tax-free

– Taxable component taxed at marginal tax rates (no tax offset)

– Taxable component is taxed at marginal tax rates with no tax offset

– A disability superannuation income stream receives a 15% tax offset The tax treatment of superannuation income streams is covered in detail from ¶16-700 onwards.

¶1-295 Capital gains tax Where an asset acquired after 19 September 1985 is disposed of, the CGT provisions generally apply to any gain or loss on the disposal. If, however, a gain is assessable under some other provision, the CGT gain is reduced by the amount assessable under that other provision. Gains on the disposal of most depreciating assets are dealt with under the capital allowances provisions (¶1-330) and also under the CGT provisions where there is some private use. The CGT provisions include in a taxpayer’s assessable income only the net capital gain for the income year. To calculate the net capital gain, the total of the taxpayer’s capital gains for the year (excluding any exempt gain by a small business taxpayer on an asset owned for 15 years) is first reduced by any capital losses made during the year. Any net capital losses from earlier years are then deducted. The result is further reduced by any discounts on particular gains and then by any concessions for small business taxpayers (see below). Individuals and trusts can apply the general CGT discount to their capital gains on assets owned for at least 12 months by the relevant percentage. The relevant percentage for individuals that have been Australian residents (other than temporary residents) for the whole period of ownership is 50%. The percentage rate is reduced to take into account any part of the ownership period during which an individual was a foreign resident or a temporary resident on or after 8 May 2012, subject to transitional rules. However, where the individual was either a foreign resident or a temporary resident as at 8 May

2012 and makes a capital gain from a CGT event after that date, the 50% discount is only available for any capital gain accrued up to 8 May 2012 provided the individual obtains a market valuation of the relevant CGT asset as at that date. If no valuation was obtained and the individual was a foreign resident or a temporary resident at all times since 8 May 2012, no discount will be available. The relevant percentage for trusts is 50%. The discount for complying superannuation funds is one-third. The gain to be discounted is worked out without indexation of the cost base of the asset. If the asset was acquired before 21 September 1999, the individual, trust or superannuation fund can alternatively choose to calculate a capital gain on the basis of the asset’s indexed cost base, but with indexation frozen at 30 September 1999. Companies are not entitled to discount their capital gains but are entitled to use the “frozen indexation” basis for assets acquired before 21 September 1999. As mentioned, trusts generally calculate their capital gains in the same way as individuals. Where permitted by the trust deed a capital gain may be streamed to a particular beneficiary by making them “specifically entitled” to the capital gain made by the trust. In this case the beneficiary is effectively treated as having made the capital gain. Alternatively, a trustee of a resident trust can choose to be assessed on a capital gain of the trust if no amount of the trust property referable to the capital gain is paid or applied for the benefit of a beneficiary. The concept of “specifically entitled” is discussed further at ¶1-505. To the extent that a beneficiary is not made specifically entitled to a capital gain and the trustee does not make the choice, the capital gain will be allocated to the beneficiaries of the trust on a proportionate basis in accordance with their present entitlement to the share of the trust income (after excluding amounts to which a beneficiary was made specifically entitled). Where the discount method is chosen by the trust, a beneficiary receiving a part of the gain is required to gross up the share of the gain to remove the effect of the discount and any discount under the CGT small business concessions before calculating the beneficiary’s net capital gain. The beneficiary’s net capital gain is calculated by including the grossed-up share of the gain from the trust with any other capital gains made during the year and deducting any current year and prior year capital losses. The beneficiary’s discount (if any) can then be applied to the grossed-up share of the trust’s capital gain included in the beneficiary’s net capital gain. The CGT provisions are very extensive and are covered in detail in Chapter 2. Some significant features are, however, mentioned here. Main residence and other exemptions The capital gain or loss on the disposal of a dwelling will be disregarded where the owner of the dwelling occupied it as their main residence throughout the period of ownership. If the dwelling was the main residence of the owner for only part of the period of ownership, only part of the capital gain or loss will be disregarded. In the 2017 Federal Budget, the government had proposed that the main residence exemption no longer be available for foreign residents from 9 May 2017. However, existing properties held before this time will remain entitled to the exemption until 30 June 2019 under a grandfathering provision. This provision has not passed into law as yet. The main residence exemption is detailed in Chapter 12. The CGT provisions also do not apply to the disposal of most life assurance policies (eg on payout), private motor cars or trading stock or to gambling and lottery wins. Special rules apply to gains and losses on the disposal of assets kept for personal use such as works of art and jewellery. Disposal of small business assets Any entity that is a CGT small business entity or satisfies a maximum net asset value test may be entitled to one or more of the four CGT concessions available for a capital gain arising on the disposal of an active asset owned by the entity. For CGT purposes, a CGT small business entity is an entity that carries on a business during the income year and which, generally speaking, has an “aggregated turnover” of less than $2 million in either the previous or current income year. Alternatively, the concessions are available where the net value of all CGT assets of the taxpayer, “affiliates” and “connected entities” do not exceed $6 million. The concessions are available to an individual, a company or a trust. A disposal of shares in a company or interests in a trust is potentially eligible for the concessions where the shares or interests themselves are active assets and certain ownership levels are satisfied. The CGT small business concessions are as follows:

• The gain may be exempt if the asset was owned by the taxpayer for at least 15 years and occurs in relation to the retirement of the taxpayer or CGT concession stakeholder (as relevant) over the age of 55 or in the event of their permanent incapacitation. • The gain may attract a 50% exemption. The exemption applies to the gain remaining after any application of the general discount (see above). • The gain may be exempt if the capital proceeds are used in connection with the retirement of the taxpayer or a stakeholder (as relevant) up to specified limits. If the taxpayer or stakeholder is under 55, the gain must be rolled over to a complying superannuation fund or RSA. • A rollover may permit the gain to be deferred. The gain can be deferred for at least two years. A longer deferral will apply where the taxpayer acquires a replacement asset within a specified period. The gain is deferred to the extent that it does not exceed the cost base of the replacement asset. Non-resident CGT withholding A non-final withholding tax is imposed on the disposal of taxable Australian property (including indirect interests and options or rights to acquire such property) by a foreign resident, excluding where any of the following applies: • the relevant CGT asset has a market value of the asset less than $750,000 • the transaction is conducted through a stock exchange or a crossing system • the transaction is an arrangement that is already subject to an existing withholding obligation • the transaction is a securities lending arrangement, or • the transaction involves a vendor that is subject to formal insolvency or bankruptcy proceedings (TAA Sch 1 s 14-200; 14-215). The purchaser is required to withhold and remit to the ATO 12.5% (or such varied amount as approved by the Commissioner) of the proceeds from the sale. The withholding is required on or before the day the purchaser becomes the owner of the asset (usually at settlement) and must be paid to the ATO without delay. Assets passing on death A person’s death generally does not constitute a disposal of the person’s assets for CGT purposes. Where a person dies after 19 September 1985, the legal personal representative or beneficiary to whom an asset passes is deemed to have acquired it when the deceased died — at market value if the deceased acquired the asset before 20 September 1985, otherwise generally at the asset’s cost base at the date of the deceased’s death.

DEDUCTIONS ¶1-300 Annual basis of taxation Income tax is an annual liability worked out by reference to a taxpayer’s taxable income for an income year. Taxable income is calculated by subtracting from assessable income all general and specific deductions (¶1-305). The calculation of tax payable for a year therefore depends not only on whether expenditure is deductible but also on when the deduction is allowable. In addition, progressive marginal tax rates for individuals mean that the timing of deductions can have a significant effect on the total amount of tax payable over two or more years. Deduction when expenditure incurred A loss or outgoing is generally deductible in the income year in which the expenditure is incurred.

Expenditure can be incurred without payment being made as long as the taxpayer is definitively committed to the payment and the expenditure is properly referable to the income year. Interest expenditure, for example, is a deduction in the income year in which the interest becomes due and payable. Deductions for expenditure incurred in advance of the provision of services are generally apportioned evenly over the period during which the services are to be provided. Trading stock Expenditure on acquiring trading stock of a business is deductible when the expenditure is incurred. The income tax law ensures, however, that the deduction is effectively deferred to the income year in which the trading stock is sold by taking unsold stock into account at the end of an income year and at the beginning of the next year. The amount taken into account excludes any GST input tax credit arising on acquisition of the stock. The shares of an individual who is a share dealer are trading stock, but shares that are merely held by the individual for resale at a profit are not trading stock. The land of a land dealer can also be trading stock. Small business entities do not need to account for small changes in the value of stock during an income year (¶1-280).

¶1-305 General and specific deductions The income tax law classifies deductions as general and specific. General deductions A general deduction is any loss or outgoing to the extent that it is incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for income-producing purposes. A loss or outgoing may be deductible even though it does not produce assessable income in the year in which it is incurred. The loss or outgoing must, however, be expected to produce assessable income and have the essential character of an income-producing expense. A bad debt arising out of business activities of earlier years may be deductible despite the business having in the meantime ceased operations. Interest on business loans may also be deductible after the business ceases operations. Non-deductible losses or outgoings Examples of losses or outgoings that are not deductible are: • losses or outgoings of a capital, private or domestic nature (eg child care expenses) • losses or outgoings incurred in producing exempt income • expenditure incurred in producing the income of some other person. For example, interest on a loan taken out by a parent would generally not be deductible if the borrowed money was passed on interest-free to a daughter for use in her business to produce her assessable income • payments of income tax • interest on money borrowed to pay a personal income tax liability or a personal superannuation contribution. Expenditure incurred both in producing assessable income and for private purposes needs to be apportioned into its deductible and non-deductible components. Specific deductions Some amounts are deductible under specific provisions of the law. These are called specific deductions. Some examples are deductions for repairs, prior years’ losses, a partner’s individual interest in a partnership loss and depreciation in respect of capital expenditure. Specific deductions are not necessarily in respect of expenditure related to income-producing activities, eg deductions for certain gifts (¶1-345). In addition, some specific provisions of the law either deny deductions that would otherwise be allowable or limit the amount of a deduction. For example, salary or wages paid to a relative (eg a spouse or child)

or paid by a private company to a shareholder is not deductible to the extent that the payment exceeds a reasonable amount. As a further example, under the commercial debt forgiveness rules, a debtor whose debt is forgiven may be denied a range of deductions, such as in respect of all or part of a prior year’s loss.

¶1-310 Business deductions As mentioned above, a person carrying on business can deduct losses or outgoings that are necessarily incurred in carrying on the business to produce assessable income. The person carrying on the business is the best judge of what is necessary. The expenditure does not have to be unavoidable to qualify as a deduction. A person carrying on a profession or trade is in business. A person engaging in share trading, for example, may be in business but it would depend on all the facts. Some indicators are the scale of operations, the frequency of transactions, the profitability of the activities and whether the person conducts the activity full-time and keeps adequate records. Some examples of deductible business expenses are: • the usual recurring operating expenses of a business • the cost of keeping abreast of business trends • pay-roll tax, sales tax and FBT (¶1-090) — but not GST (to the extent entitled to an input tax credit), and • certain business-related capital expenditure is deductible on a straight-line basis over five years (eg expenditure to establish a business structure or expenditure to convert an existing business structure to a different structure). Some examples of non-deductible expenses are: • private travel and capital costs to expand a business structure • dividends paid by companies. Individuals are limited in offsetting losses from non-commercial business activity against other assessable income. Such losses can be offset against other income only if at least one of several statutory tests is satisfied, eg that the assessable income from the activity is at least $20,000. Notwithstanding the satisfaction of a statutory test a taxpayer is only able to apply a non-commercial loss where the taxpayer’s adjusted taxable income for the year is less than $250,000.

¶1-320 Employment and self-employment deductions Employees and self-employed persons are entitled to deductions for expenditure incurred in gaining or producing assessable income. Examples are: • the cost of renegotiating an employment agreement • the cost of travelling between two or more different places of work (including, in the case of a selfemployed person, different locations of the same income-producing activity) • depreciation on computers and tablets used for work • technical journals • membership of unions or professional associations • tax return preparation and other professional tax advice • expenses of overseas travel by professional persons and academics, whether employees or self-

employed, to keep abreast of new developments or attend conferences • net self-education expenses exceeding $250 connected with the production of assessable income, but not if the study is directed at new income-producing activities. Some examples of non-deductible expenditure are: • expenses incurred by an employee in getting or changing jobs or moving to a job — because the expenditure is incurred too soon to be regarded as incurred in gaining or producing assessable income • child care expenses. Home office Where part of a home is set aside as an office, some part of the outgoings on the home may be deductible. If the home, or a particular part of it, is a real place of business (eg where a professional conducts a private consultancy practice in an area of the home that is set aside and used exclusively for that purpose, is clearly identifiable as a place of business visited by clients and is not readily adaptable for domestic use), the range of deductions is greater than if the person has a usual place of work away from the home and uses, exclusively, a part of the home as a convenient place to carry out some incomeproducing work. Where the home is a real place of business, deductions are generally available for: • a proportion of home loan interest, rates, house insurance, heating, lighting and maintenance • depreciation, insurance and repairs on equipment and fittings, such as desks, curtains and light fittings • work-related telephone calls from home and a proportion of the rental of the home telephone, but not the cost of installing a home telephone. If the home office does not qualify as a place of business, deductions are not available for home loan interest, rates or house insurance.

Caution While deductions can normally be obtained for a portion of the running expenses for items such as telephones, heating and lighting, it may not be possible to secure deductions for connection fees for these items. Other occupancy expenses such as rates, home loan interest or house insurance will only be deductible where the home is used as a real place of business.

Clothing Expenditure by an employee on conventional clothing generally is not deductible, but the cost of occupation-specific clothing (eg that worn by a nurse) generally is. The cost of non-conventional uniforms which an employee is compelled to wear is generally deductible, but if the uniform is not compulsory, a deduction is denied unless the design of the uniform is properly registered. Expenditure on items of protective clothing such as aprons, hard hats and steel capped boots is also deductible. The receipt of an allowance from an employer for clothing or uniforms does not necessarily mean that the employee’s expenditure on conventional clothing is deductible. Substantiation Where work expenses of employees, such as meals, tools and trade journals, exceed $300 in total in an income year, the employee must generally satisfy substantiation rules to deduct the expenses. That broadly requires the employee to obtain written evidence of the expense from the supplier and keep it for five years. The degree of substantiation required in respect of car expenses of employees and self-

employed persons varies according to the person’s chosen method of claiming deductions. The $300 substantiation-free threshold is not available for car expenses. Commissioner’s guidelines for particular occupations The Commissioner has issued rulings and guidelines about deductions for people in particular occupations, such as employee cleaners, hospitality industry employees, police officers, teachers, nurses, airline industry employees, real estate industry employees and employee lawyers (see www.ato.gov.au/Individuals/Income-and-deductions/Deductions-you-can-claim/Deductions-for-specificindustries-and-occupations/). Superannuation contributions Employees and self-employed persons may be entitled to tax concessions for contributions to a superannuation fund or RSA. The tax treatment of superannuation contributions is covered from ¶4-200 to ¶4-245.

¶1-325 Deductions for investors and landlords A person who derives investment income, such as rents, dividends or interest, can deduct expenditure incurred in connection with the derivation of that income. Deductions include interest on money borrowed to acquire the investment, ongoing expenses of deriving the income and, in certain circumstances, investment losses. Interest Interest on money borrowed to acquire, say, a rental property, shares in a company or units in a property trust, is generally fully deductible if it is reasonable to expect that rents, dividends or assessable trust distributions will be derived. In determining the purpose to which borrowed funds are put, eg to acquire a rental property, the ATO traces the flow of borrowed funds to establish their usage. The security used for such a borrowing has little relevance in determining the deductibility of interest. Interest can be fully deductible in an income year even though it exceeds the investment income of that year (negative gearing). But if, at the outset, the investment is not expected to turn positive over its full term, the interest deduction in each income year is likely to be at least partly disallowed. Additional interest payable under linked and split loan facilities is not deductible. Interest referable to the capital protection component of limited recourse loans entered into on or after 16 April 2003 is also not deductible. Ongoing expenses Deductible ongoing expenses in deriving investment income include: • expenses of collecting the income, bookkeeping expenses and audit fees • certain fees paid to an investment adviser (see below) • costs of travelling interstate to consult a broker • the cost of financial magazines • bank charges • borrowing expenses (spread over the shorter of the loan period and five years), and mortgage discharge expenses, including legal expenses connected with the borrowing or discharge • repairs, rates and land tax, insurance, advertising and the legal costs of recovering arrears of rent • expenses connected with the preparation and registration of leases • depreciation of furniture and fittings (although from 1 July 2017 this is limited to the cost of actual outlays incurred by the taxpayer and exclude outlays by a previous owner)

• the cost of replacing small items such as crockery and linen. Travel expenses related to inspecting, maintaining or collecting rent for a residential property are not deductible (ITAA97 s 26-31; Law Companion Ruling LCR 2018/7). Repairs versus improvements While the costs of repairs to income-producing property are deductions, the costs of improvements are not. A repair involves the replacement or renewal of a worn-out part so as to restore, but not significantly improve, the functional efficiency of a thing without changing its character. Example Fencing around David’s rental property has been damaged by termites. David replaces the damaged wood panes. Replacing the damaged panes of the fence would be repairs and tax deductible. At the same time David replaces the wood pergola in the backyard with an electric vergola. The replacement of the former wood pergola with the upgraded electric vergola is an improvement to the property.

The cost of initial repairs to remedy defects in an asset at the time of acquisition is also not deductible but is included in the cost base of the asset for CGT purposes or its cost for depreciation purposes. Partial deduction A landlord’s deductions may be reduced where only part of the property is rented or where the property is let or available for let for only part of the year. Where only part of the property is let, deductions are normally allowed according to the proportion of the floor area that is rented. Where a holiday house, say, is let for only part of the income year, deductions are normally allowed according to the proportion of the year for which the house was let, including periods during which bona fide efforts were made to obtain tenants. Financial advice fees The ability to claim a deduction for a fee paid to a financial adviser depends upon the services which are provided in relation to the fee. A taxpayer will not be entitled to deduction for a fee paid to a financial adviser for developing or drawing up an initial investment plan. Such a fee is not deductible as it is considered to be both of a capital nature and a preliminary expense incurred for the purpose of deriving assessable income, as opposed to being a fee incurred in the course of gaining or producing assessable income. An on-going management fee or retainer paid to a financial adviser in relation to the servicing of the income producing investments will be deductible. To the extent that the management fee relates to investments which are not held for the purpose of producing assessable income, a deduction will not be available. Accordingly, where the taxpayer holds a mix of investments held for both income and nonincome producing assets, only a portion of the fee will be deductible. Fees which are paid to a financial adviser for advice regarding the change in mix of the investments held are generally considered to relate to the general management of investments. Such fees will be deductible unless the advice constitutes the drawing up of an investment plan. Where a taxpayer has investments and pays a financial adviser for drawing up a new investment plan, the fee is considered to be of a capital nature and not deductible. The fee may be included in the cost base of assets acquired. For further explanation see Taxation Determination TD 95/60. Note that if a deduction is claimed for expenditure on financial advice and the taxpayer subsequently receives compensation because the advice is found to be inappropriate (or simply not given), the amount received as a refund or reimbursement will constitute assessable income in the year in which it is received (see ATO website for further information). Losses on investments Losses on investments such as shares and securities are deductible only if the taxpayer is carrying on a business of investing for profit or of trading in investments. Whether a person is carrying on such a

business depends on all the facts. Some relevant factors are the frequency, volume and scale of transactions and whether they are carried out in a business-like way.

¶1-330 Depreciating assets The income tax law allows deductions for the decline in value of depreciating assets to the extent the asset is used to produce assessable income or is installed ready for use for that purpose. The deduction is available to an entity that “held” the asset at any time during the income year. This is generally the owner, but another entity may be taken to hold the asset and be entitled to depreciation deductions, for example: • a lessor, eg a finance company, of a depreciating asset that is attached as fixtures to another entity’s land, where the lessor has the right to recover the asset • a lessee of land who affixes a depreciating asset to the land and has a right to remove the asset — while the right to remove the asset exists • a lessee of land who makes an improvement (whether a fixture or not) to the land (eg an in-ground watering system) that the lessee is not entitled to remove — while the lease exists • a hirer under a hire purchase agreement. A depreciating asset is an asset that has a limited effective life and is reasonably expected to decline in value over the time it is used. Land and items of trading stock are not depreciating assets. Most intangible assets are also excluded, but some are specifically included, eg items of intellectual property and inhouse software. With effect from 1 July 2017 the deduction for depreciation on an asset used in relation to a residential rental property is limited to new assets and not previously used assets. In this manner, a deduction for depreciation on second hand assets and assets acquired on the purchase of the property from the former owner will is not available. The formulae for calculating the decline in value of a depreciating asset for an income year are: Prime cost method cost  effective life 

×

days held  365 

For assets held before 10 May 2006

base value  effective life 

×

days held  365 

×

150%

For assets acquired after 10 May 2006

base value  effective life 

×

days held  365 

×

200%

Diminishing value method

Taxpayers can make their own estimate of the effective life of an asset or rely on the Commissioner’s determination. This choice, and the choice of method, must be made for the year in which the asset is first used by the taxpayer for any purpose or is installed ready for use. The method chosen for a particular asset applies to that asset for all income years. The base value of a depreciating asset for a year is generally its opening adjustable value (ie broadly its cost less its decline in value up to the start of the year).There is an immediate write-off for depreciating assets costing $300 or less and used predominantly in deriving non-business income. Depreciating assets costing less than, or written down to less than, $1,000 each, can be pooled and a single deduction claimed for the decline in value of the pool for the year. There are special depreciation rules available to small business entities which are detailed in ¶1-330. For assets that are both acquired and first used or installed ready for use in the period from 7.30 pm on 2 April 2019 to 30 June 2020, businesses with an aggregated annual turnover from $10 million to less than

$50 million are entitled to claim an immediate write-off of all depreciating assets (including motor vehicles) with a cost less than $30,000. Balancing adjustment When a depreciating asset is disposed of, there is usually a balancing adjustment. A deduction is allowed if the sale price is less than the asset’s adjustable value, and any excess of sale price over adjustable value is assessable. The balancing adjustment is reduced to the extent that the asset was used for nontaxable purposes. Example Frank sold a piece of equipment he used for income-producing purposes for $30,000. It cost $70,000 new and had been depreciated down to $20,000. The balancing adjustment of $10,000 is included in assessable income.

Balancing adjustments may be rolled over in certain circumstances, eg when an asset is transferred as a result of a marriage breakdown. The transferee then becomes entitled to depreciation deductions on the same basis as applied to the transferor, and a balancing adjustment is not calculated until the transferee ultimately disposes of the asset.

¶1-335 Capital works expenditure Deductions are available for capital works expenditure on constructing buildings, such as factories, shops and home units, and on structural improvements. The capital works must be used in a deductible way during the income year and, for capital works started before 1 July 1997, must have been intended for use for a specified purpose at the time of completion. What constitutes being used in a deductible way varies according to when construction of the capital works commenced. The owner of capital works is generally entitled to an annual deduction of between 2.5% and 4% of the capital expenditure, even if the owner did not incur the original expenditure. Unlike depreciating assets, there is no specific balancing charge on the disposal of a building for which the capital works deduction was available. However, any deduction claimed for capital works on a building acquired by a taxpayer after 13 May 1997 or for improvements made after 30 June 1997 will reduce the cost base of the building for CGT purposes (¶2-200).

¶1-340 Other capital allowances Many other kinds of capital expenditure can also be written off as deductions. The write-off can be either immediate or over a period of years, depending on the kind of expenditure. For example, taxpayers engaged in mining and quarrying operations are entitled to deductions for exploration or prospecting expenditure and for expenditure on rehabilitating former mine sites. Other examples are the deductions for pooled project expenditure (infrastructure expenditure and mining capital and transport expenditure) and expenditure on environmental protection activities. The deduction or offset available for expenditure on research and development is discussed below. For assets acquired after 13 May 1997, deductible capital expenditure is generally excluded from the cost base of the asset for CGT purposes (¶2-200). Research and development A research and development (R&D) tax incentive applies. The incentive currently available is as follows: • a 43.5% refundable tax offset for eligible entities with an aggregated group turnover of $20 million or less • a 38.5% non-refundable tax offset for all other eligible entities. Unused non-refundable tax offsets may be able to be carried forward to future years. A limit of $100 million applies on the amount of R&D expenditure that a company can claim as an offset at

the accelerated rates under the incentive. If a company exceeds this amount, the offset claimable on that excess expenditure is reduced to the relevant company tax rate. Eligible entities are essentially companies incorporated in Australia, foreign incorporated companies that are Australian residents and foreign incorporated non-resident companies that carry on business through a permanent establishment in Australia and that are resident in a country that Australia has a double tax agreement with. Partnerships between such entities are also eligible. However, corporate limited partnerships and exempt entities are not eligible. The refundable tax credit will not be subject to an expenditure cap and will be available to small companies in a tax loss with no limit on the level of R&D expenditure they undertake. The definition of eligible R&D activities is categorised as either “core” or “supporting” R&D activities. Core R&D activities are experimental activities: • whose outcome cannot be known in advance on the basis of current knowledge but can only be determined by applying a systematic progression of work that is based on principles of established science and proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions, and • that are conducted for the purpose of generating new knowledge (including new knowledge in the form of new or improved materials, products, devices, processes or services). Certain specified activities are excluded. Supporting R&D activities are activities directly related to core R&D activities.

¶1-345 Deductible gifts and donations Deductions are allowable for any non-testamentary gift of $2 or more in money or property (eg shares) made to certain nominated funds, institutions and other bodies in Australia. The deduction is available to any person, including individuals, companies and partnerships, and is available to both residents and non-residents. If the gift is of property, it must have been purchased within the previous 12 months, unless the property is valued by the Commissioner at more than $5,000 or is a work of art, a national heritage property or trading stock. Recipients of deductible gifts can either be in the general categories listed in the income tax law or be identified by name in the law. The general categories include: • public or non-profit hospitals • public benevolent institutions • public universities • registered environmental and cultural organisations • approved overseas aid funds. Deductions are only available for gifts made to political parties and independent politicians up to $1,500 where the gift is made by an individual other than in the course of carrying on a business. A deduction can be claimed where a taxpayer enters into a perpetual conservation covenant over the taxpayer’s land with an authorised body for no consideration. The deduction is equal to the decrease in the market value of the land that is attributable to the covenant. Gifts are generally not deductible unless the recipient is registered with the ACNC Commissioner or specifically listed by name in the law. To be registered, the recipient requires an ABN (¶1-120). Gifts of works of art that qualify under the Cultural Gifts Program are exempt from CGT. Also, deductions for gifts of property to certain environmental, cultural and heritage organisations may be spread over five income years. A similar spreading is available for deductions for gifts of property valued by the Commissioner at over $5,000 and for deductions in respect of grants of conservation covenants.

A deduction is also available for contributions to a deductible gift recipient where a minor benefit is received in return. An individual can claim a deduction where the value of the contribution is more than $150 and the minor benefit received in return is not more than the lesser of $150 or 10% of the value of the contribution. This deduction would apply where, for example, a person pays to attend a charity ball.

TAX OFFSETS ¶1-350 What are tax offsets? Tax offsets, most of which are rebates, directly reduce the tax payable by taxpayers on their taxable income. Deductions, on the other hand, reduce taxable income and therefore reduce tax payable by a smaller amount. Some offsets are discussed elsewhere in this chapter, eg the rebates for assessable life assurance reversionary bonuses (¶1-275), ETPs (¶1-285) and certain payments in lieu of unused annual leave and unused long service leave (¶1-265) and the franking offset on franked dividends paid by resident companies to resident individual shareholders (¶1-400, ¶1-405). Other tax offsets are discussed in other chapters, eg the rebates for superannuation contributions. Most tax offsets apply only to individual taxpayers. Exceptions to this include the foreign income tax offset, the franking offset, the R&D incentive and the tax offset for an investment in an early stage innovation company. The sum of a taxpayer’s tax offsets for an income year generally cannot exceed the tax otherwise payable for the income year (ie any excess is not refundable and cannot be carried forward to later income years) and tax offsets cannot be set off against the Medicare levy (¶1-075) or any other tax liability. For example, there is no ability to obtain a refund of or carry forward any excess foreign income tax offset. However, any excess private health insurance tax offset (¶1-355) or franking offset for individuals is refundable. Any excess tax offsets arising from an investment in an early stage innovation company can be carried forward to later income years.

¶1-355 Concessional rebates and offsets Individuals may be entitled to a range of so-called concessional rebates and offsets, such as the low income rebate, the low income aged persons rebate, the medical expenses rebate, the private health insurance tax offset and the dependent (invalid and carer) tax offset (¶20-040). Small business income tax offset Individuals deriving income from an unincorporated small business entity with aggregated annual turnover of less than $5 million are entitled to the “small business tax offset” which effectively provides a discount of 8% of the income tax payable on that business income subject to a maximum cap of $1,000 per year. See ¶1-283 for details of the offset. Low income tax offset The LITO is available to persons whose taxable income is less than $66,667 (see ¶1-055) Low and medium income tax offset The low and medium income tax offset (LMITO) is available to persons whose taxable income is less than $126,000 (see ¶1-055). The LMITO is not available for minors with unearned income and can be applied in conjunction with the LITO. Senior Australians and pensioners tax offset The senior Australians and pensioners tax offset (“SAPTO”) is available to persons of Age Pension age (eg self funded retirees) and recipients of certain pensions, allowances and benefits under the Social Security Act 1991 and the Veterans’ Entitlements Act 1986, which are known as “rebatable benefits”. The amount of the offset available depends upon the person’s rebate income (being the sum of taxable income, reportable superannuation contributions, total net investment loss and adjusted fringe benefits). A married person with unused offset can transfer the unused amount to a spouse who has a tax liability.

The LITO and LMITO (see ¶1-055) may also be available where SAPTO does not eliminate tax altogether. For more details on SAPTO, see ¶20-043. Taxpayers entitled to an amount of SAPTO are eligible for an increased income threshold at which they are exempt from paying the Medicare levy or pay a reduced levy. Private health insurance tax offset Individuals are entitled to a tax offset for the cost of the premiums on a private health insurance policy which provides hospital or ancillary cover, or both. The private health insurance tax offset is means tested and applies as follows: INCOME THRESHOLDS Singles

$0–$90,000

$90,001–$105,000

$105,001–$140,000

$140,001 and above

Families*

$0–$180,000

$180,001–$210,000

$210,001–$280,000

$280,001 and above

Maximum Rate#

Tier 1

Tier 2

Tier 3

Aged under 65

25.059%

16.706%

8.352%

Nil

Aged 65–69

29.236%

20.883%

12.529%

Nil

Aged 70 or over

33.413%

25.059%

16.706%

Nil

* Families threshold includes couples and single parents and is increased by $1,500 for each dependent child after the first. # These rates apply for premiums paid after 1 April 2019. The rates will decrease by in accordance with the Rebate Adjustment Factor for premiums paid after 1 April 2020.

If the offset exceeds the tax otherwise payable, the excess is refundable. A person can choose to have premiums reduced instead of claiming the tax offset. Offset for investments in an early stage innovation company (ESIC) Investors are entitled to a non-refundable carry forward offset for qualifying investments in an early stage innovation company (“ESIC”) of 20% of the amount paid for a fresh issue of shares. As flow through entities, trusts and partnerships are not entitled to the offset in their own right. However, members of the trust or partnership can obtain the benefit of the investments made by the entity. The conditions to be an ESIC are detailed in s 360-40 of ITAA97. In general terms, an Australianincorporated company will qualify as an ESIC if it is at an early stage of its development (generally incorporated within three years) and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return. Further conditions require that the company is not listed on the ASX and in the previous income year to investment the company must not have derived assessable income of more than $200,000 or incurred expenses of more than $1 million. The offset that may be claimed in an income year is capped at $200,000 (ie investments up to $1 million). However, a total investment limit of $50,000 a year applies to retail (non-sophisticated) investors. Such retail investors receive no offset if this limit is exceeded. To be eligible for the offset, an investment cannot exceed 30% of the interests in the relevant ESIC. Investments entitled to the tax offset are exempt from capital gains tax for the first 10 years of the investment (excluding capital gains made in the first 12 months of ownership). Film concessions There are three refundable tax offsets which are available for company taxpayers investing in the Australian screen media:

• the producer offset — for Australian expenditure in making Australian films • the location offset — for Australian production expenditure • the PDV offset — for post, digital and visual effects production in Australia. These refundable offsets are only available for company taxpayers.

COMPANIES ¶1-400 Method of taxing company income Companies are taxed as separate legal entities and, like individuals, pay tax on their taxable income (¶1050). Unlike individuals, tax is paid at a flat rate on the whole of a company’s taxable income. The general tax rate for companies is 30%. A company that is a base rate entity is entitled to a lower corporate tax rate of 27.5%. An entity is a base rate entity if no more than 80% of its assessable income is base rate entity passive income and it has an aggregated turnover below $50 million. The tax rate for base rate entities will be further reduced to 26% for the 2020/21 income year and 25% for the 2021/22 and later income years. Base rate entity passive income includes: • dividends other than non-portfolio dividends • franking credits on such dividends • non-share dividends • interest income (some exceptions apply) • royalties and rent • gains on qualifying securities • net capital gains • income from trusts or partnerships, to the extent it is referable (either directly or indirectly) to an amount that is otherwise base rate entity passive income. Certain limited partnerships and public trading trusts are taxed as if they are companies. Dividends paid by a company are included in the assessable income of a resident shareholder and taxed at marginal rates but the imputation system (¶1-405) enables a shareholder to receive franking credits for the tax paid by the company on the income distributed. The tax treatment of dividends in the hands of shareholders, including non-resident shareholders, is discussed at ¶1-150 and ¶1-270. Companies are generally required to appoint a public officer to be answerable for doing the things required of the company for tax purposes. In addition, directors and other officers of a company can be liable for the company’s default in certain circumstances. Payment arrangements for company tax are outlined at ¶1-105. Debt and equity The law contains rules to distinguish between equity in a company and debt. The distinction is based on the economic substance of the relevant arrangement under which the interest in the company arises. A debt interest arises where there is an effective obligation on the company to return an amount at least equal to the issue price. Equity includes shares, interests that are convertible into shares and interests that provide returns that are contingent on economic performance — but if an interest is a debt interest it is not treated as equity. A return paid on a debt interest may be deductible. A return on a debt interest (including a dividend on a share that is defined as a debt interest) is deductible to the extent it would be if it were interest, but the

dividend is not frankable under the imputation system. The deduction for a return on a debt interest is limited to the rate of return on an ordinary debt interest (ie where returns are not contingent on economic performance) plus 150 basis points. A return on a non-share equity interest (ie an equity interest that is not solely a share) is not deductible but may be frankable. Note that related party at-call loans of companies whose turnover is less than $20 million in a year are treated as debt interests. Losses If a company’s deductions exceed its assessable income and any net exempt income, the resulting tax loss can be a deduction in calculating taxable income in later years. Companies will only be entitled to the deduction where the company satisfies either the continuity of ownership or same business test. However, a more flexible similar business test is proposed to be introduced for losses made in 2015/16 and later income years. A company may choose the amount of prior year losses they want to deduct in an income year. Generally, resident companies in the same wholly owned group cannot transfer losses between each other unless they form part of the same consolidated group (see below). The head company of the consolidated group is then entitled to a deduction for the tax loss. A company is a resident if it is incorporated in Australia or, not being incorporated in Australia, carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are Australian residents. Example VS Pty Ltd, a resident company, has taxable income of $20,000 for the year ended 30 June 2020 but has tax losses of $50,000 from several years ago. During the year VS Pty Ltd was taken over, with 100% of its shares now held by new owners. It also changed the nature of its operations significantly. VS Pty Ltd will not be able to utilise any of the losses in the company structure. It cannot satisfy the continuity of ownership or same business test and therefore cannot utilise its own losses.

Companies are not able to “carry back” losses to offset past profits. Excessive remuneration Where a company that is a private company for tax purposes excessively remunerates a past or present shareholder or associate for services rendered, the excess over what is reasonable is not deductible. The excess is assessable to the person as a deemed dividend that is not frankable under the imputation system (¶1-405). A company is a private company for tax purposes if it is not a public company for tax purposes. Examples of companies that are public companies for tax purposes are listed companies, subsidiaries of listed companies and government-controlled companies. Loans by private company A private company may be deemed to have paid a dividend simply by paying or lending an amount to a shareholder or associate, forgiving a debt owed to the company by such a person, providing such a person use of an asset for less than arm’s length consideration or having an unpaid present entitlement owing from a trust. Specified transactions are excluded from the rules, including payments to shareholders in their capacity as employees, the payment of genuine debts owed by the company to the person, loans and payments to other companies and loans pursuant to written agreements that meet the prescribed minimum interest rate and maximum loan term. These deemed dividends are generally not frankable, ie they cannot have franking credits attached. However, the Commissioner can exercise a discretion to allow franking credits to be attached to such a dividend where the dividend arose as a result of honest mistake or inadvertent omission. The discretion will only be exercised if the dividend is taken to be paid to a shareholder of the company, as opposed to an associate of a shareholder. The Board of Taxation released a report on the deemed dividend rules relating to private company loans for their effectiveness and whether they can be simplified. The report has identified that the rules are complex, inflexible and costly to comply with. The rules fail to achieve an appropriate balance between ensuring taxpayers are treated fairly, promoting voluntary compliance and discouraging non-compliance. The rules can also operate as an unreasonable impediment for businesses operating through a trust that

wish to fund their growth by reinvesting profits back into the business. The report includes a number of recommendations to ease the compliance burden and lower the cost of working capital for companies. Changes to the rules based on the recommendations are proposed to be implemented from 2020/21. Special rules Certain types of entities that are companies for tax purposes receive special tax treatment on all or part of their income. They include life assurance companies, co-operatives, credit unions, friendly societies, trade unions and pooled development funds (these are now being phased out) and early stage venture capital limited partnerships (ESVCLP). Consolidation of entity groups Wholly owned groups of companies, trusts and partnerships can choose to be treated as a single consolidated entity for income tax purposes. The main features of the group consolidation regime are: • the head company of a wholly owned group of entities can make an irrevocable choice to consolidate with its wholly owned Australian subsidiaries for income tax purposes. All of the wholly owned consolidated subsidiaries become subsidiary members of the consolidated group with the head company • a consolidated group is treated as a single entity for tax purposes during the period of consolidation • intra-group transactions are ignored for tax purposes • tax matters other than income tax, such as FBT, are not included within the consolidation regime and they continue to be the responsibility of the individual entities in the group. A withholding obligation of a subsidiary also falls outside the consolidation regime, as it relates to the income tax payable by a third party.

¶1-405 Imputation system Tax paid by Australian resident companies is “imputed” to resident individual shareholders when they are paid franked dividends. That is, the dividend and a franking credit (an amount equal to the company tax attributable to the dividend as allocated by the company) are both included in the shareholder’s assessable income and taxed at marginal rates, and the shareholder is allowed a tax offset (a “franking tax offset”) equal to the franking credit. Excess franking credits are refundable for certain taxpayers but not for most company types. However, excess franking credits in a company are converted into tax losses for the year. Franking credits received by a trust that has a tax loss or nil net income will generally be lost. The tax treatment of dividends, both franked and unfranked, in the hands of residents and non-residents is discussed at ¶1-270. Like individual shareholders, most superannuation funds and ADFs are entitled to the franking tax offset, as are life assurance companies in respect of franked dividends derived from assets included in their insurance funds. Also, resident companies are entitled to the franking tax offset when they are paid franked dividends. Companies, non-complying superannuation funds and non-complying ADFs cannot receive a refund of excess franking credits on dividends received. A holding period rule requires taxpayers to hold shares at risk for more than 45 days (90 days for preference shares) in order to qualify for franking credits and offsets. The 45-day holding period must occur during the period starting on the day after the taxpayer acquires the shares and ending on the 45th day after the shares become “ex-dividend”. Subject to limited exceptions, discretionary trusts will need to make a family trust election to enable its beneficiaries to receive the benefit of its franking credits. Individuals who do not satisfy the holding period rule may nevertheless be entitled to up to $5,000 of franking rebates in relation to an income year. Entities such as complying superannuation funds, life assurance companies and widely held trusts can elect to be taken to be qualified for franking credits or rebates up to a limit calculated in accordance with a statutory formula.

Other anti-avoidance provisions dealing with franking credit trading and dividend streaming schemes are referred to below and at ¶1-605 and ¶1-610. Franking accounts and rules for franking dividends The imputation provisions provide that only frankable distributions can be franked and only where they are made by a franking entity (that satisfies a residency requirement at the time). A distribution will only be franked where the entity allocates franking credits to the distribution. Franking entities basically include companies and similar entities, but not non-fixed or discretionary trusts. An entity can determine the extent (up to 100%) to which it will frank its dividends. The main limitations are: • the maximum franking credit rule, which limits the credits that can be allocated • a benchmark rule, which provides that all frankable distributions within a franking period have to be franked to the same extent. The maximum franking credit that can be allocated to a frankable distribution is equal to the maximum amount of tax that the entity making that distribution could hypothetically have paid on the profits underlying the distribution. To calculate the maximum franking credit, the formula is: Amount of the frankable distribution

  (corporate tax rate for imputation purposes)    (1 − corporate tax rate for imputation purposes) 

×

The “corporate tax rate for imputation purposes” is generally the entity’s corporate tax rate for the income year of payment worked out on the assumption that the company’s aggregated turnover for the income year is equal to its aggregated turnover for the previous income year. Example In 2018/19, Imagine Pty Ltd has an aggregated turnover of $30m. In 2019/20, its aggregated turnover increased to $55m. Therefore, for 2019/20, Imagine Pty Ltd will have: • a corporate tax rate of 30% (having regard to its aggregated turnover of $55m in 2019/20) • a corporate tax rate for imputation purposes of 27.5% (having regard to its aggregated turnover of $30m in 2018/19). Where Imagine pays a fully franked dividend of $7,000 in 2019/20, the maximum franking credit that can be attached to the frankable distribution is $2,655 worked as follows:

$7,000

×

27.5%  72.5% 

=

$2,655

In the circumstances, the maximum franking credit will be: • where the company has a corporate tax rate for imputation purposes of 27.5% — 37.93% of the distribution • in any other case — 42.86% of the distribution.

A private company’s franking period is the same as its income year, ie 12 months. For other companies, the franking period is generally six months. Special rules cause franking debits to arise where a company enters into a dividend streaming arrangement. Dividends are streamed where, broadly, a company directs franked dividends to shareholders who are able to fully use the franking tax offset to offset tax otherwise payable while directing unfranked dividends to shareholders (eg non-residents) who are unable to use the franking tax offset. Other anti-avoidance provisions are mentioned at ¶1-605 and ¶1-610. Franking credits can arise from a number of events, including paying a PAYG instalment and receiving a franked dividend. Franking debits can arise in a variety of circumstances, including an amendment of an assessment that reduces tax payable and the payment of a franked dividend.

Franking accounts are expressed in dollars of tax paid, rather than the corresponding amount of after-tax taxable income. Example The aggregated annual turnover of ABC Pty Ltd for 2018/19 was $51m and for 2019/20 is $55m. The corporate tax rate for 2019/20 is 30% giving rise to a tax liability of $300,000 for the year based on $1m profit. When this tax is paid, it will give rise to a credit in the company’s franking account of $300,000. ABC’s corporate tax rate for imputation purposes for 2019/20 is also 30% (based on turnover of $51m in 2018/19). Where ABC pays a $700,000 fully franked dividend in 2019/20, the franking credit attached will be $300,000. If instead ABC only had an aggregated annual turnover of $45m in 2018/19, the corporate tax rate for 2019/20 would still be 30% giving rise to a tax liability of $300,000 for the year. This will give rise to a credit in the franking account of $300,000. However, its corporate tax rate for imputation purposes for 2019/20 is 27.5%. If ABC pays a fully franked dividend of $700,000 in 2019/20, the franking credit attached to the dividend will be $265,517.

If a company taints its share capital account by transferring amounts from other accounts to it (eg by capitalising profits), a franking debit arises and subsequent distributions from the account are treated as unfrankable and unrebatable dividends. If the company elects to untaint the account, a further franking debit may arise and the company may also be liable to pay untainting tax. Below is an illustration of straightforward movements in a franking account of a company that is subject to both a corporate tax rate and a corporate tax rate for imputation purposes of 27.5%. Date

Details

Debit $

Credit $

Balance $

1 July 2019

Opening balance





300,000

28 July 2019

PAYG instalment of $65,000



65,000

365,000

30 September 2019

Fully franked dividend of $200,000 received from public company ($200,000 × 30/70)



85,714

450,714

28 October 2019

PAYG instalment of $65,000



65,000

515,714

28 February 2020

PAYG instalment of $65,000



65,000

580,714

22,500



558,214



65,000

623,214

284,483



338,731





338,731

20 March 2020

Refund on assessment of $22,500

28 April 2020

PAYG instalment of $65,000

22 June 2020

Payment of fully franked dividend of $750,000 ($750,000 × 27.5/72.5)

30 June 2020

Closing balance (this will be the opening balance on 1 July 2020)

Removal of tax preferences Taxing shareholders on dividends has the effect of removing any tax preferences the company may have enjoyed. That is, if a company receives exempt or concessionally taxed income, that exemption or concession is effectively lost when the income is distributed to individual shareholders as dividends. Generally, such dividends can only be franked to an extent which reflects the lower tax paid by the company because of the exemption or concession. Tax preferences are lost in many other situations too, eg where depreciation deductions for tax purposes exceed the depreciation charged in the company’s accounts, effectively exempting some profit from tax or the concessional tax rate for corporate small business entities. Partners in partnerships and beneficiaries of trusts, on the other hand, generally do not

lose tax preferences when income is distributed.

PARTNERSHIPS ¶1-450 Wide definition of partnership for tax purposes A partnership for tax purposes means an association of persons carrying on business as partners in the general law sense or an association of persons in receipt of income jointly, but not including companies. This extended definition has the effect that, for example, persons receiving rents as joint owners of rental property, whether joint tenants or tenants in common, are partners for tax purposes even though they may not be partners at general law because their association and activities as landlords may not amount to carrying on business. Joint ownership of other income-earning investments, such as shares, may also constitute a partnership for tax purposes. Companies, trustees and minors can all be partners. In the case of jointly owned rental properties and other investments, the ATO does not usually require the lodgment of a partnership tax return.

Whether a partnership exists is a question of fact. The intention to act as partners is essential but the conduct of the parties must also support that intention. A partnership agreement is not conclusive evidence of the existence of a partnership, but it is significant, as long as the parties act in accordance with the agreement. The Commissioner has published his views on the factors that tend to support the existence of a business partnership. Despite the existence of a partnership where a partner over 18 years of age does not have real and effective control of the partner’s share of partnership income, further tax may be payable so as to, broadly, bring the rate of tax on that uncontrolled partnership income to 45% for 2019/20, being the top marginal rate. A new partnership comes into existence when a partner in an existing partnership dies or retires or when a new partner is admitted.

¶1-455 Method of taxing partnership net income or loss Partnerships are not taxable on their income (except limited partnerships, which are taxed as companies). Instead, partners are assessed individually on their respective interests in the net income of the partnership. The net income of a partnership is its assessable income, calculated as if the partnership were a resident taxpayer, less its total deductions. If a partnership exists for tax purposes only, ie the partners are not carrying on a business but are in receipt of income jointly, the partners’ shares of partnership net income are determined by their interests in the income-earning property. Although a partnership is not liable to tax, it is still required to lodge an income tax return. Partners derive their share of the partnership net income when partnership accounts are taken, generally at the end of the income year even if the income distribution does not occur until the next income year. Partnership income retains its character in the hands of the partners. Accordingly, where partnership income includes franked dividends, for example, the dividends and the corresponding franking credits and franking tax offsets are apportioned between the partners according to their shares in the partnership net income or partnership loss (see below). Similarly, foreign source income and related foreign income tax offsets retain their identity upon apportionment between the partners. Individuals are entitled to a discount on the income tax payable, up to a maximum of $1,000, on the business income derived from a partnership that is a small business entity pursuant to the small business income tax offset. The discount is currently 8% in 2019/20 (¶1-283). Partnership loss A partnership loss arises when the deductions exceed the assessable income. However, a partnership loss is not trapped inside the partnership and carried forward as a deduction against future income of the partnership. Rather, the partners are allowed a deduction for their individual interest in the partnership loss. If the partnership is carrying on a business, the non-commercial loss rules must be satisfied before an individual partner can offset their partnership loss against other income. The individual interest of a partner in any exempt income (¶1-260) of a partnership is taken into account in calculating and deducting the partner’s own tax losses. Non-resident partners Non-resident partners are not assessed on any part of an individual interest in partnership net income that is attributable to foreign source income derived during a period when the partner was not a resident. Similar rules apply to non-resident partners’ interests in a partnership loss. Interest on partnership borrowings A business partnership is entitled to a deduction for interest on borrowings used to replace working capital of the partnership, thus allowing partners to withdraw the amount of capital contributed and so reduce the net worth of each partner’s interest in the partnership. A deduction is not allowable to the extent the loan replaces capital represented by internally generated goodwill or an unrealised revaluation of assets. A partnership of joint owners of rental property would not be entitled to a deduction for interest on a loan to replace their equity in the property unless their activities as landlords constituted a business partnership under the general law. Partner’s salaries and payments to associated persons

Salaries paid to partners are really distributions of the partnership net income. Partnership salaries are not deductible to the partnership, but rather are a way of distributing the net income of the partnership between the partners by allowing some partners to receive larger amounts for their proportionately larger contribution to the partnership. A partnership is not entitled to a deduction for superannuation contributions made in respect of a partner. If a partnership makes a payment or incurs a liability, eg for salary or interest, to a relative of a partner or to another associated person or entity, a deduction is allowed only to the extent that the amount is reasonable having regard to commercial practice. The disallowed amount is generally not assessable income of the recipient.

¶1-460 Exceptions: direct application of law to partners Some provisions of the income tax law apply directly to the partners and do not affect the calculation of the partnership net income or partnership loss. Examples are the provisions allowing deductions for investment in Australian films and the CGT provisions (see Chapter 2). On disposal of a partnership asset, no capital gain or loss arises to the partnership under the CGT provisions. The gain or loss is taken into account in working out whether each partner’s assessable income includes a net capital gain.

¶1-465 Assignment of partner’s interest in partnership A partner may be able to assign an interest, or a part of an interest, in a partnership to, for example, a spouse so as to shift to the spouse the liability for income tax on the portion of partnership net income that is attributable to the assigned interest. The assignment is, however, treated as a disposal of the relevant part of the partner’s interest in the partnership for CGT purposes. That, in turn, is treated as a disposal or part disposal of the partner’s interests in each of the partnership assets.

TRUSTS ¶1-500 What is a trust? The income tax law contains special rules for taxing the net income of a trust estate. A trust estate (in this chapter called a trust) is property that is vested in a person (the trustee) and held by the trustee for the benefit of other persons (the beneficiaries) under a fiduciary obligation imposed on the trustee. The trustee must act in accordance with the terms of that obligation. A deceased estate is a trust for tax purposes both before and after administration of the estate is completed. The income of unit trusts is generally taxed under the rules applying to trust income, but some public unit trusts are taxed as companies.

¶1-505 Method of taxing trust income or loss A trust is not liable as a separate taxpayer to pay tax on the income of the trust, but it is still required to lodge tax returns. The rules for taxing trust income are set out below. The government has indicated that it proposes to rewrite the rules regarding the taxation of trusts as a result of the High Court’s decision in FC of T v Bamford & Ors; Bamford & Anor v FC of T 2010 ATC ¶20-170 (Bamford). Trustees are only liable as trustees to pay tax on trust income in the limited circumstances provided for by these rules. Any such liability is in the trustee’s representative capacity rather than in a personal capacity. A trust can incur a loss for an income year. If it does, the loss is carried forward and may be allowable as a deduction in a later year (¶1-525). Calculation of net income of trust The tax base for trusts is the net income of the trust. The net income of a trust is its total assessable income calculated as if the trustee were a resident taxpayer, less all deductions. The question of whether a receipt is income is determined by tax law principles rather than by trust law. For example, a capital gain would be capital under trust law, but may be assessable income for tax purposes.

Distributed income retains its character Trust income retains its character in the hands of beneficiaries. Accordingly, where trust income includes franked dividends, for example, the attached franking credits and corresponding franking tax offsets flow through to beneficiaries, or the trustee, in proportion to their share of the net income of the trust that is attributable to the dividends (see below). Where permitted by the trust deed, a beneficiary may be made specifically entitled to franked dividends (¶1-270) and capital gains (¶1-295). The tax law does not provide for streaming of other types of income. Foreign source income retains its identity when it flows through to beneficiaries and a foreign income tax offset is available to the beneficiary for its share of the foreign income tax paid by the trustee. Foreign source income is included in the net income of a trust but whether and how it is taxed to beneficiaries or the trustee depends on the operation of the rules set out below. Net income for tax purposes vs net income in trust law It is possible for the net income of a trust for tax purposes to be different from the net income calculated according to trust law, eg if a receipt is treated as income for tax purposes and capital for trust purposes or if depreciation deductions for tax purposes exceed the depreciation charged in the trust’s accounts. If the net income for trust purposes exceeds the net income for tax purposes, the excess is generally not assessable. If the net income for tax purposes exceeds the net income for trust purposes, the ATO will generally assess the beneficiaries on the excess in proportion to their share of the distributable income. The case of Bamford also raised the question of whether different types of income (eg dividends, capital gains, foreign income) could effectively be streamed for taxation purposes or whether beneficiaries are simply taxed on their proportionate interest in the net income of the trust. The tax law specifically permits capital gains and franked dividends to be streamed to beneficiaries where permitted by the relevant trust deed. To the extent that such amounts are not streamed in this manner they will be apportioned between the beneficiaries proportionately to their share of the trust income. Rules for taxing net income of trust The taxation of trust income depends upon whether: • a beneficiary is “specifically entitled” to a streamed amount • a beneficiary is presently entitled to the income (¶1-510). The treatment will then vary depending upon whether the beneficiary: – is under a legal disability (¶1-515), and – is a resident, or • no beneficiary is presently entitled to the income (¶1-520). Beneficiary specifically entitled Where permitted by the trust deed a beneficiary may be streamed capital gains and franked distributions of a trust fund. In such a case the beneficiary is considered to be specifically entitled to the relevant amount. Where the beneficiary is specifically entitled to a capital gain the beneficiary will effectively be treated as if it made the capital gain itself. Where the beneficiary is specifically entitled to a franked distribution the beneficiary is assessed on the amount of the franked distribution made by the trust and on the franking credits attached to that distribution. If the beneficiary that is specifically entitled to a share of the income of the trust is either under a legal disability (¶1-515) or is not a resident (¶1-550) at the end of the income year, the trustee may be assessed and liable to pay tax on those amounts. The trustee will also be taxed where it chooses to be assessed on a capital gain of the trust if no amount of trust property referable to the capital gain is paid or applied for the benefit of a beneficiary. Beneficiary presently entitled Where a beneficiary is presently entitled (¶1-510) to a share of the income of the trust (excluding the amounts a beneficiary is specifically entitled to), the beneficiary’s assessable income includes that share

of the net income of the trust if the beneficiary is not under a legal disability (¶1-515) and is a resident at the end of the income year. A beneficiary is assessable on a share of trust income in the year in which the trust derives the income even if it is not distributed until the following income year (eg a distribution from a cash management trust). The distribution itself will not be taxed. The assessable share does not include any income that is attributable both to foreign sources and to a period when the beneficiary was not a resident. However, such foreign source income is generally assessable income of the beneficiary on distribution if the beneficiary is a resident at any time during the year of distribution. An exempt entity is treated as being presently entitled to any amount of the trust’s income unless it has been paid or notified of their entitlement within two months of the end of the income year. Such amounts will be assessed to the trustee if the requirements are not met. Where a beneficiary is presently entitled to a share of the income of the trust but is either under a legal disability (¶1-515) or is not a resident (¶1-550) at the end of the income year, the trustee is liable to pay tax on that share of the net income of the trust. The trustee is not assessable on any income that is attributable both to foreign sources and to a period when the beneficiary was not a resident. In the case of a beneficiary who is not a resident at the end of the income year, the beneficiary is also assessed on the share of trust income on which the trustee has been assessed but is allowed a credit for the tax paid by the trustee and a refund of any excess. Trustees of certain closely held trusts (eg discretionary trusts) with a presently entitled beneficiary that is a trustee of another trust must disclose to the Commissioner the identity of the ultimate beneficiaries of certain net income and tax-preferred amounts of the trust. The purpose is to ensure that the ultimate beneficiaries (eg individuals) pay tax on their share of the income. Failure to disclose will result in tax at the highest marginal rate being imposed on the net income. Ultimate beneficiary statements do not have to be lodged unless the trustee has an ultimate beneficiary non-disclosure tax liability for the year or the Commissioner requests a statement. The closely held trusts measures do not apply to: • complying superannuation funds, complying ADFs and PSTs • deceased estates for five years after the death • fixed unit trusts wholly owned by tax-exempt persons, or • listed unit trusts. Example The GT Trust has received income for the year of $65,000 and incurred deductions of $27,000. The net income of the trust is $38,000. Any beneficiary who is presently entitled to a share of this income and is not under a legal disability will be assessed on that share of the net income.

Individuals are entitled to a discount of 8% on the income tax payable, up to a maximum of $1,000, on the business income received as a beneficiary of a trust that is a small business entity pursuant to the small business income tax offset (¶1-283). No beneficiary presently entitled The balance of the net income of the trust, ie net income to which no beneficiary is either specifically entitled or presently entitled (¶1-520) or accumulating income, is assessed to the trustee, generally at the maximum marginal personal tax rate. If the income has a foreign source, the trustee is assessable only if the trust is a resident trust, ie at any time during the income year either a trustee is a resident or the central management and control of the trust is in Australia. Foreign source income that has accumulated in a non-resident trust without being taxed in the hands of the beneficiary or trustee is generally assessable on distribution to a beneficiary who is a resident at any time during the year of distribution. A non-resident trust is a trust that does not have a resident trustee and its central management and control is outside Australia. Additional tax may be payable in such a case by way of interest. Special rules apply to the income of transferor trusts (¶1-570). Distributions to superannuation funds

Distributions by trusts to superannuation funds are taxed at 47%, except where the fund has a fixed entitlement to the income. If the fixed entitlement is acquired under a non-arm’s length arrangement, any distribution in excess of an arm’s length amount is also taxed at 47%. Arm’s length distributions to complying superannuation funds with fixed entitlements are taxed at 15%. Exempt income Exempt income of a trust is also allocated among beneficiaries, who are presently entitled and not under a legal disability, according to their individual interests in the exempt income. A prior year’s trust loss, however, must first be set off against exempt income of the trust of the current year before any exempt income is allocated to beneficiaries. Consolidation of entity groups Wholly owned groups of companies, trusts and partnerships can choose to be treated as a single consolidated entity for income tax purposes. For further details, see ¶1-400.

¶1-510 When is a beneficiary presently entitled? Generally speaking, a beneficiary is presently entitled to trust income if the beneficiary has an indefeasible, absolutely vested, beneficial interest in possession of the income, the income is legally available for distribution and the beneficiary can demand immediate payment. The beneficiaries of a deceased estate, for example, are generally not presently entitled until the residue of the estate can be ascertained with certainty. Taxation Determination TD 2018/9 outlines the Commissioner’s views on the impact an early trustee resolution will have on present entitlement. The Commissioner states that an early trustee resolution is not ordinarily effective to make a beneficiary presently entitled to income of the trust estate at that time, given the uncertainty as to whether any distributable income will exist for the year. However, the Commissioner notes that it may be possible to make an effective early resolution appointing income before the end of the income year where it is clear that the trust has income available for distribution and an irrevocable resolution is made to appoint income to the beneficiary. TD 2018/9 also considers whether a beneficiary of a discretionary trust who borrows money at interest and on-lends it to the trustee of a discretion trust interest-free can deduct the interest under s 8-1. For the interest (or any part of it) to be deductible: • the beneficiary must be presently entitled to the trust income at the time the interest expense is incurred, and • the expense has a nexus with the income to which the beneficiary is presently entitled. Beneficiary deemed presently entitled A beneficiary who is not otherwise presently entitled is deemed to be presently entitled to trust income if: • the beneficiary has a vested and indefeasible interest in the income. If such a beneficiary is an individual, the income is generally assessed to the trustee rather than to the beneficiary, or • the trustee exercises a discretion to pay or apply trust income to or for the benefit of the beneficiary. For income to be applied for the benefit of a beneficiary it must be immediately and irrevocably vested in the person. In a further statutory expansion of the concept of presently entitled, a person with an interest in a nonresident trust is deemed to be a beneficiary presently entitled to a share of the income of the trust, the share being calculated according to special rules.

¶1-515 Beneficiary under a legal disability Beneficiaries are under a legal disability if they cannot give a discharge for money paid to them, eg minors and bankrupts. Where a beneficiary under a legal disability derives income from more than one trust, or from other sources (such as interest or dividends) as well as the trust, the beneficiary is required to lodge a tax return and is assessed on all of the income, including trust income that is assessed to the

trustee. The beneficiary is entitled to a credit for the tax paid by the trustee on the beneficiary’s share of trust income, but is not entitled to a refund if the tax paid by the trustee exceeds the tax for which the beneficiary would otherwise be liable. Unearned income of a trust to which a minor is presently entitled can be taxed at the highest marginal tax rate (¶1-070). Example Matthew, who is 15 and therefore under a legal disability, is absolutely entitled to a one-fifth share of the income of the First Trust, although he cannot actually receive it until he is 18. The net income of the First Trust is $30,000, and the trustee is therefore liable to pay tax on Matthew’s share of $6,000. Matthew is also a discretionary beneficiary of the Second Trust. In the relevant year, the trustee of the Second Trust pays $2,000 towards Matthew’s school fees. Matthew is deemed to be presently entitled to the $2,000 and the trustee is liable to pay tax on it. In addition, Matthew earns $3,000 from regular part-time work at the local supermarket. Matthew is assessable on $11,000 ($6,000 + $2,000 + $3,000), but the tax he would otherwise pay is reduced by the aggregate of the tax paid by the trustees.

¶1-520 No beneficiary presently entitled to income of deceased estate Before the administration of a deceased estate (a trust for tax purposes) is complete the income is treated as income to which no beneficiary is presently entitled unless some interim distribution of residue is made, in which case the beneficiaries are treated as presently entitled to the distribution. Amounts received by the trustee which would have been assessable to the deceased had they been received before death are treated as income to which no beneficiary is presently entitled. These amounts include investment income, ETPs (¶1-285) and certain fees for professional services, but payments for unused annual leave and unused long service leave are exempt from tax. Where the trustee of a deceased estate is taxed on income to which no beneficiary is presently entitled, the general individual rates (or similar) are likely to apply for a period of up to three years from death rather than the highest marginal rate (which applies generally to trust income to which no beneficiary is presently entitled).

¶1-525 Restrictions on deductions for trust losses A trust loss is not shared among beneficiaries in the way net income of a trust is or in the way partnership losses are shared among partners. Rather, the loss is carried forward in the trust and may be allowed as a deduction in calculating the net income of the trust in subsequent years. Losses are deductible only if the trust satisfies comprehensive tests which relate to ownership, control and trading in units and which restrict the practice of injecting income into loss trusts as a tax shelter. Only the last of these tests applies to family trusts, and then only in a limited way. Family trusts A family trust that survives an income injection test (see below) is allowed a deduction for a prior year loss if it is a family trust at all times during the income year in which the loss was incurred, the income year in which the loss is to be deducted and all intervening years. A trust is a family trust for the purposes of the trust loss rules if it satisfies a family control test and the trustee has made a family trust election, generally in the trust’s tax return for the income year from which the election is to take effect. The election must specify an individual as the person on whom the family group is based. The family control test is satisfied if the individual and/or other family members control the trust. The law contains a comprehensive list of the relationships that qualify people as family members and sets out, in detail, what constitutes control. Control may be exercised through interposed entities. A family trust or interposed entity may be subject to family trust distribution tax on any distribution made to a person outside the family group, which is widely defined for this purpose. The family trust distribution tax rate is 47% for 2019/20. A family trust may be denied a deduction for a prior year loss where assessable income is injected into the trust under a scheme to take advantage of the deduction and, broadly, to give the trustee or a beneficiary and an outsider benefits under the arrangement. This rule does not, however, prevent members of the family group injecting income into the trust for their benefit.

¶1-530 Tax consequences of a trust vesting

A trust vests when interests in the trust property are vested in interest and possession. Most trust deeds will specify a date when interests in the trust will vest and outline the consequences of the vesting date occurring. This is to ensure that the trust does not breach the rule against perpetuities. Taxation Ruling TR 2018/6 sets out the Commissioner’s provisional views on the tax consequences of a trust vesting and the ability to validly amend a trust deed. The Commissioner notes the following: • Prior to a trust vesting it may be possible for the trustee or court to amend the vesting date of the trust. However, once the vesting date has passed it is not possible to amend the vesting date. This is because the interests in the trust property are fixed at law. Behaviour of the trustee and beneficiaries in a way that is consistent with the terms of the trust before vesting will not be sufficient to extend the vesting date (see example 1 of TR 2018/6). Extension of the vesting date is subject to the rule against perpetuities which limits extension to a statutory perpetuity period. • The vesting of the trust itself will not cause the trust to come to an end or a new trust to arise. However, circumstances may arise where parties to a trust relationship act in a manner that results in creation of a new trust. • Vesting of a trust may result in capital gains tax issues, such as CGT event E5 or E7 occurring. Vesting of a trust in itself will not generally result in CGT event E1 occurring (see ¶2-110). • In the income year when a trust vests different beneficiaries may be presently entitled to the trust income before and after the vesting date. For example, a trustee of a discretionary trust may exercise their discretion to appoint income of the trust to particular beneficiaries. However, after vesting the beneficiaries who are “takers on vesting” will have a fixed entitlement to income of the trust estate and will be assessable on their share of the trust net income. The Commissioner will accept an allocation of trust estate income before and after the vesting date, undertaken on a fair and reasonable basis, having regard to relevant circumstances. Any purported distribution by the trustee after vesting is not consistent with the fixed interests of “takers on vesting” is void. The ATO has established a webpage detailing the meaning of a trust vesting and the consequences associated with vesting.

CROSS-BORDER ISSUES ¶1-550 Resident vs non-resident There are major differences in the way Australian residents and non-residents are taxed under Australian income tax law. Tax consequences of being a resident • A resident is assessable on income derived from all sources, whether in or out of Australia, unless an exempting provision applies. Some examples of exempt income are given at ¶1-260. • A resident is assessable on an accruals basis on certain income attributed to the resident as the income is derived by certain controlled foreign companies or by certain non-resident trusts (transferor trusts) to which the resident transferred property or provided services. • A resident is subject to the Medicare levy and potentially the Medicare levy surcharge (if adequate private health insurance is not held). • A resident individual who is a shareholder in an Australian company is entitled to a franking tax offset in respect of franked dividends paid by the company. • A resident is entitled to an offset for foreign tax paid on income from sources outside Australia. • A resident is entitled to the CGT discount on a capital gain arising from assets held for at least 12 months.

Tax consequences of being a temporary resident • Foreign sourced income, other than income derived from foreign employment or services, is not taxable in Australia. • Not liable for capital gains tax unless the relevant asset is taxable Australian property. • Not eligible for the CGT discount for holding an asset for at least 12 months. • Special rules apply to capital gains on shares and rights acquired under employee share schemes. • Interest paid foreign residents is not subject to withholding tax. Tax consequences of being a non-resident • A non-resident is assessable only on income from Australian sources (¶1-555). • A non-resident’s assessable income does not include dividends, interest or royalties on which final withholding tax is payable (¶1-150) or franked dividends that are exempt from withholding tax. • A non-resident individual is not entitled to concessional rebates/offsets or the tax-free threshold (¶1355). • A non-resident is not liable for the Medicare levy or Medicare levy surcharge. • Partners in partnerships and beneficiaries of trusts are not assessed on income derived from foreign sources while the partner or beneficiary was a non-resident. • Subject to certain transitional rules, a non-resident is not entitled to the CGT discount on asset held for at least 12 months. • A non-resident is subject to non-resident CGT withholding tax of 12.5% (unless varied) on the disposal of certain taxable Australian property. • With effect from 9 May 2017, it is proposed that the main residence exemption will not be available to a non-resident, subject to grandfathering of properties held as at that date to 30 June 2019. • Special CGT rules apply (see Chapter 2). Who is an Australian resident? Individuals An individual is regarded as an Australian resident for income tax purposes if the person either resides in Australia within the ordinary meaning of the term or satisfies one of three statutory tests set out in the income tax law. Ordinary meaning of reside A person who permanently dwells in Australia would usually be considered to reside in Australia. Because it is possible to reside in more than one country at a time, a person who lives permanently abroad may still be an Australian resident if, for example, the person makes visits to Australia as part of the regular order of the person’s life. Statutory tests for residence The income tax law also treats as Australian residents individuals who: • are domiciled in Australia, unless the person’s permanent place of abode is outside Australia. In the absence of evidence of a permanent place of abode outside Australia, a person who leaves Australia with the intention of returning within two years will normally remain an Australian resident • spend more than half the income year in Australia, unless their usual place of abode is outside

Australia and they do not intend to take up residence in Australia, or • are members of a Commonwealth Government superannuation scheme (or are the spouse or child under 16 years of a person who is a contributing member). A person that is a resident in accordance with the tests above who is in Australian on a temporary visa, is not an Australian resident within the Social Security Act 1991 and does not have a spouse of a resident within the Social Security Act 1991 is a temporary resident for tax purposes. Companies A company is a resident if it is incorporated in Australia or, not being incorporated in Australia, carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are Australian residents. Other entities The income tax law also contains definitions of a resident superannuation fund, a resident trust estate and a resident public unit trust for specified purposes of the law. Residency status of common situations The following table lists some common situations showing whether the individual would generally be considered a resident or non-resident (note that exceptions exist and professional advice should be sought). Note that residency status may also be affected by double taxation agreements (see below). Situation

Residency status

– goes overseas temporarily, and – does not set up a permanent home in another country

– may continue to be treated as an Australian resident for tax purposes

– is an overseas student enrolled in a course at an – generally treated as an Australian resident Australian institution that is more than six months (potentially temporary resident) for tax purposes long – is visiting Australia for more than six months and for most of that time works in the one job and lives at the same place

– generally treated as an Australian resident (potentially temporary resident) for tax purposes

– is holidaying in Australia, or – is visiting for less than six months

– will generally not be considered an Australian resident for tax purposes

– migrates to Australia, and – intends to reside in Australia permanently

– generally considered to be Australian resident for tax purposes from the date of arrival – likely to be a temporary resident while on a temporary visa

– leaves Australia permanently

– will generally not be considered an Australian resident for tax purposes, from the date of departure

Double taxation agreements Australia’s double taxation agreements with other countries reserve taxing rights over certain classes of income (eg most pensions, purchased annuities and income from independent professional or personal services) to the country of residence of the person deriving the income. The agreements use the countries’ domestic rules to classify each person as a resident of either Australia or the other country but contain “tie breaker” tests to deal with situations where a person would be a resident of both Australia and the other country. The tests have the effect of deeming the dual resident to be a resident solely of one country or the other. Double taxation agreements are also discussed at ¶1-555.

¶1-555 Source of income Like residence, the source of income is a fundamental determinant of liability for Australian income tax. For example: • non-residents are generally assessable only on income from sources in Australia • there are comprehensive rules for taxing residents on foreign source income (¶1-570), allowing offsets for foreign tax paid (¶1-575) • under double taxation agreements between Australia and other countries, income may be taxed in the country in which the income has its source unless taxing rights over the income are reserved entirely to the country of residence (¶1-550) of the person. A deemed source in one or the other country is attributed by agreements to some classes of income, otherwise the source is determined under the laws of each country. If the country of residence and the source country both tax the income, the country of residence allows a credit for the tax levied by the source country. Source of particular classes of income Ascertaining the source of income has been described as a practical, hard, matter of fact process to be determined separately in each case. The following is a guide to the source of some classes of income: • The source of a dividend is the place where the company paying the dividend made the profits out of which the dividend is paid. • The source of interest is generally the place where the loan contract was entered into. • The Commissioner considers the source of pensions to be where the pension fund is located but the source of annuities to be where the annuity contract is executed. • The source of income from personal services is generally the place where the services are performed, but where special knowledge or creativity is involved the source is likely to be the place where the contract was made.

¶1-560 Thin capitalisation The “thin capitalisation” rules may disallow a proportion of the interest (and other finance expenses) attributable to debt used to finance the Australian operations of Australian and foreign multinational investors. The rules are designed to prevent such investors allocating a disproportionate amount of debt to their Australian operations in order to exploit the more favourable tax treatment of debt compared to equity. The thin capitalisation rules do not apply where the total of the taxpayer’s annual interest and other debt deductions is $2 million or less. Where the thin capitalisation rules apply, debt deductions are reduced to the extent that the debt used to fund an entity’s Australian operations exceeds a specified maximum. If the entity is a foreign-controlled Australian company, trust or partnership or the entity is a foreign entity that operates in Australia, the maximum permissible ratio of debt to equity is 1.5:1. A higher arm’s length limit can be substituted where justified. These limits also apply to an Australian entity with foreign operations, but it may be able to use a higher limit again, based on the level of debt it uses in its worldwide operations. The thin capitalisation rules do not apply to such Australian entities (other than foreign-controlled ones) if at least 90% of their assets are Australian assets. Different debt limits apply to financial entities and authorised deposit-taking institutions (ADIs) such as banks. For an outline of how the tax law determines what is debt and what is equity, and how it treats returns on debt and equity interests, see ¶1-400.

¶1-565 Australians investing overseas An Australian resident with foreign investments can have the following amounts included in assessable income:

• income, such as dividends, interest and rent, actually derived by the resident • the resident’s share of certain income derived by non-resident entities or accumulating through certain offshore investments, ie the resident is assessed on an accruals basis (¶1-570) without actually deriving the income. An offset is allowed for foreign tax paid (¶1-575). The thin capitalisation rules may restrict deductions for interest (¶1-560).

¶1-570 Accruals taxation system Australian residents are taxed on a share of the income of certain foreign entities which is not comparably taxed overseas. Taxing the resident on an “accruals” basis as the income is derived by the foreign entity prevents tax deferral and avoidance. There are two separate groups of accruals taxation rules, being the controlled foreign company (CFC) and transferor trust provisions. Controlled foreign companies The controlled foreign company (CFC) rules include in the assessable income of Australian resident controllers (attributable taxpayers) of a CFC a share of, broadly, the CFC’s income from investments and from transactions with associates (attributable income). The rules do not generally apply, however, if the CFC derives more than 95% of its income from genuine business activities. There are also significant exclusions from the attributable income of a CFC (eg franked dividends). The rules apply differently according to whether the CFC’s country of residence is included in one of two categories listed in the law or is an unlisted country. A resident who has more than a specified control interest (including associates’ interests) in a CFC is an attributable taxpayer in relation to the CFC. The law also contains control tests to determine whether a company is a CFC and tests to determine the percentage of a CFC’s attributable income that is attributable to a particular attributable taxpayer. Where a resident’s assessable income has included an amount of attributable income from a CFC, the subsequent distribution of the income by the CFC to the resident is exempt from tax if the resident can establish that the distributed amount has already been attributed. A resident can maintain an attribution account for this purpose. Transferor trusts The “transferor trust” rules include in the assessable income of a resident (an “attributable taxpayer”) income derived by a non-resident trust to which the resident has transferred property or provided services (attributable income). As a separate rule, income distributed by a non-resident trust to a resident beneficiary may attract additional tax if the income has not been subject to the transferor trust rules or otherwise taxed to the trustee or beneficiary when derived. For the purposes of the rules, the attributable income of a non-resident trust is broadly based on the trust’s net income, reduced in several ways (eg by amounts that, broadly, are assessable in Australia to the trustee or a beneficiary as the income is derived). The whole of the attributable income of the trust can be attributed to each attributable taxpayer, subject to reduction by the Commissioner where there is more than one transferor. In some cases, the amount included in the attributable taxpayer’s assessable income is determined by reference to a deemed rate of return on the property transferred. Whether a resident is an attributable taxpayer depends on, among other things, whether the transfer was to a discretionary trust and whether the transfer was at arm’s length. The rules do not apply where transfers are made to non-resident family trusts. As with CFCs, attributable income of a non-resident trust is not assessable to the resident transferor when the income is distributed.

¶1-575 Foreign income tax offset The foreign income tax offset (FITO) system allows taxpayers to claim a foreign income tax offset where they have paid foreign tax on amounts included in their assessable income (ITAA97 Div 770).

Under the FITO system the offset is allowed for the income year in which the foreign tax is paid. There is no quarantining of offsets to particular classes of income. The offset may also extend to foreign tax on certain non-assessable income, ie amounts paid out of income previously attributed from a CFC. It is generally not a requirement that the taxpayer be a resident, though in practice this will normally be the case. Normally, the tax must have been paid by the person claiming the offset, though there are exceptions in certain situations, such as where the tax has been deducted at source, or otherwise paid on the taxpayer’s behalf. Special rules also allow the offset to be claimed where foreign tax is paid by CFCs on attributed income. The rules governing attributed income have been considerably simplified, eg by eliminating the need to trace through attributed tax accounts. The offset may be adjusted where the amount of foreign tax is refunded or inflated. For more details on FITO, see Chapter 21 of the CCH Australian Master Tax Guide (59th ed).

¶1-580 Foreign losses Foreign losses are able to be offset against both Australian-sourced and foreign-sourced income. There is no ability for non-utilised foreign losses to be carried forward.

TAX AVOIDANCE ¶1-600 How the law deals with tax avoidance The income tax law deals with tax avoidance in several ways: • specific anti-avoidance provisions deal with particular tax avoidance practices • the general anti-avoidance provisions of the Income Tax Assessment Act 1936 Pt IVA apply to an arrangement as a last resort only after the application of all other provisions of the law has been considered • Income Tax Assessment Act 1997 Div 815 deals with transfer pricing arrangements to shift profits out of Australia. Further, the general deduction provision of the law, which allows deductions for losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, may disallow a deduction to the extent it is incurred in the pursuit of a tax minimisation objective. There would then be no need for recourse to either the general or a specific anti-avoidance provision.

¶1-605 Specific anti-avoidance provisions Arrangements to which specific anti-avoidance provisions apply include: • dividend streaming and franking credit trading, such as: – the streaming of dividends, or of dividends and other benefits, to provide franking credit benefits – the streaming of capital benefits and dividends – dividend substitution schemes • where excessive wages are paid to relatives • non-arm’s length and other unacceptable transactions relating to R&D expenditure • arrangements to shift value involving interests in companies and trusts • arrangements which take advantage of the tax-exempt status of charitable trusts

• where property income is derived by a minor • where a tax-exempt entity is interposed between an Australian resident payer and a non-resident recipient of dividends, interest or royalties • the alienation of personal services income to interposed entities (¶1-265) • the multinational tax avoidance rules that apply to artificial or contrived arrangements to avoid the attribution of business profits to a taxable permanent establishment in Australia of a multinational entity with worldwide turnover of $1 billion or more • where an entity engages in conduct that results in either the promotion of a tax exploitation scheme, or in conduct that results in a scheme that has been promoted on the basis of conformity with a product ruling, but implemented in a materially different way from that described in the product ruling.

¶1-607 Distribution washing provisions To counteract the practice of “distribution washing” (also known as “dividend washing”), special measures in ITAA97 s 207-157 apply. “Distribution washing” essentially refers to the process whereby shareholders who place a relatively high value on franking credits (such as superannuation funds, income tax exempt not-for-profit entities and other shareholders with low marginal tax rates) sell shares on an ex-dividend basis and purchase shares on a cum-dividend basis (in the period after a share goes ex-dividend). This practice enables the shareholder to receive two sets of dividends and claim two sets of franking credits, although in substance, they only ever held one parcel of shares at any point in time. The shareholders who buy ex-dividend shares and sell cum-dividend shares are those who place a relatively low value on franking credits (such as non-residents). The process results in the transfer of value of franking credits from shareholders who should not be able to use them to those who can. In accordance with the special measures, where a taxpayer receives franked distributions due to distribution washing, the taxpayer will not be entitled to a tax offset or the taxpayer will be required to include the amount of the franking credit in their assessable income. For these purposes, the distribution washing rules will apply to a franked distribution received in respect of a membership interest (the “washed interest”) where: • the washed interest was acquired after the member or a connected entity of the member disposed of a substantially identical membership interest, and • a corresponding distribution was made to the member or a connected entity in respect of the substantially identical interest. However, where a connected entity has disposed of the substantially identical interest, the dividend washing rules will only apply if it would be concluded that either the disposal or the acquisition took place only because at least one of the entities expected or believed that the other transaction had or would occur. The term substantially identical interest is a flexible concept to accommodate a wide variety of financial instruments that currently exist as well as new instruments that may be created in the future. For example, an interest will be substantially identical where it is fungible with, or economically equivalent to, the washed interest. However, the distribution washing measures do not apply to an individual that does not receive more than $5,000 in franking credit offset entitlements in a year. In addition to the distribution washing measures, the Commissioner may also apply the general antiavoidance provisions under ITAA36 Pt IVA (see ¶1-610) to a distribution washing arrangement. The potential application of franking credit trading scheme provisions in ITAA36 s 177EA of Pt IVA are addressed in Taxation Determination TD 2014/10. Despite the exemption from the distribution washing

measures, individuals who do not receive more than $5,000 in franking credits in an income year are still potentially subject to the anti-avoidance provisions in ITAA36 s 177EA. The ATO has issued a bulletin about dividend washing arrangements that are intended to provide imputation benefits to Australian taxpayers (including individuals and superannuation funds) who are not the true economic owners of shares (Taxpayer Alert TA 2018/1). The ATO considers that s 177EA could apply to these arrangements

¶1-610 General anti-avoidance provisions: Pt IVA The general anti-avoidance provisions (ITAA36 Pt IVA) authorise the Commissioner to cancel a tax benefit obtained by a taxpayer in connection with a scheme where it would be concluded that a person who entered into the scheme did so for the sole or dominant purpose of enabling the taxpayer (or the taxpayer and others) to obtain a tax benefit in connection with the scheme. Part IVA has been applied to a variety of schemes, including a scheme to exempt interest from Australian tax by giving the interest a foreign source, and several schemes to split personal exertion income where the income flowed predominantly from personal services rather than from business assets. Virtually any arrangement or course of conduct, whether carried out alone or with others, can be a scheme. Tax benefit Part IVA applies where a taxpayer obtains a tax benefit in connection with a scheme. A tax benefit has been obtained in connection with a scheme if as a result of the scheme: • an amount is not included in the taxpayer’s assessable income where the amount would have, or might reasonably be expected to have, been included • a deduction is allowable to the taxpayer where the deduction would not have, or might reasonably be expected not to have, been allowable • a taxpayer is not liable to pay withholding tax on an amount where that taxpayer would have, or could reasonably be expected to have, been liable to pay the withholding tax • a capital loss for CGT purposes is incurred by a taxpayer where the capital loss would not have, or might reasonably be expected not to have, been incurred • a foreign income tax offset is allowable which would not have, or might reasonably be expected not to have, been allowable • an amount is not included in a taxpayer’s assessable income because of a dividend stripping scheme (a deemed tax benefit) • a disposition of shares or an interest in shares (ie franking credit trading) and the payment of a franked dividend would, but for Pt IVA, give rise to a franking credit in the hands of the taxpayer (this is called a “franking credit benefit”). The “would have” and “might reasonably be expected to have” limbs are alternative bases on which a tax benefit can be demonstrated. Where obtaining a tax benefit depends on the “would have” limb, that conclusion must be based solely on a postulate that comprises all of the events or circumstances that actually happened or existed other than those forming part of the scheme. Where obtaining a tax benefit depends on the “might reasonably be expected to have” limb, that conclusion must be based on a postulate that is a reasonable alternative to the scheme, having particular regard to the substance of the scheme and its effect for the taxpayer, but disregarding any potential tax costs. Sole or dominant purpose The application of Pt IVA starts with the consideration of whether, having regard to matters specified in the law, it can be objectively concluded that a person participated in the scheme for the sole or dominant purpose of securing a particular tax benefit in connection with the scheme. That conclusion may be reached even though the particular course of action bears the character of a rational commercial decision

or the purpose was that of the taxpayer’s professional adviser. For franking credit trading schemes the relevant purpose need not be the sole or dominant purpose. There is no purpose test for dividend stripping schemes. Mass-marketed tax schemes Part IVA has been applied by the ATO to mass-marketed tax-effective schemes. In recent years the Commissioner has been taking a tougher stance on tax scheme promoters, more than doubling the number of tax officers involved in its scheme task force and increasing its budget. There has been particular focus in relation to the offshore schemes under the widely publicised Project Wickenby.

¶1-615 Transfer pricing The transfer pricing provisions provide a legislative framework for dealing with arrangements under which profits are shifted out of Australia, primarily through the mechanism of inter-company and intra-company transfer pricing. Transfer pricing allows an Australian resident to reduce assessable income or increase deductions by, for example, reducing selling prices or inflating purchase prices in non-arm’s length dealings. The transfer pricing provisions are contained in ITAA97 Subdiv 815-B (entities), 815-C (permanent establishments) and 815-D (trusts and partnerships) and align the application of the arm’s length principle in Australia’s domestic law with international transfer pricing standards. The transfer pricing rules apply where an entity would otherwise obtain a tax advantage in Australia from cross-border conditions that are inconsistent with the internationally accepted arm’s length principle. Where this applies, the rules provide that the entity’s Australian tax position is determined as if the arm’s length conditions in fact existed. The arm’s length principle applies: • to relevant dealings between both associated and non-associated entities, and • to attribute an entity’s actual income and expenses between its parts. The purpose of the provisions is that, irrespective of whether the entities are related, the amount brought to tax in Australia from non-arm’s length dealings should reflect the economic contribution made by the Australian operations. The transfer pricing rules are “self-executing” in their operation, rather than relying on a determination by the Commissioner. Entities are required to determine the overall tax position that arises from their arrangements with offshore parties on the basis of independent commercial and financial relations or (in the case of the permanent establishment of an entity, on the basis of arm’s length profits) occurring between the entities or the parts of the entity. However, the provisions have a de minimis rule, pursuant to which no penalty is imposed where the scheme shortfall amount is equal to, or less than, the “reasonably arguable threshold”. The threshold is $10,000 or 1% of income tax payable by the entity for the income year. For trusts and partnerships, the threshold is $20,000 or 2% of the entity’s net income for the year. Where an entity would be liable for an administrative penalty under the transfer pricing rules, it will only be able to obtain a reduction of that penalty on the grounds that it has a reasonably arguable position where the entity keeps records that: • are prepared before the time by which the entity lodges its tax return for the relevant income year • are in English, or readily accessible or convertible into English, and • explain the particular way in which the transfer pricing provision applies (or does not apply), and why the application of the provisions in that way achieves consistency with the relevant OECD guidelines and regulations. The ATO has developed simplified record keeping options for certain eligible businesses to use to minimise some of their record keeping and compliance costs associated with the transfer pricing rules.

The ATO has issued various taxation rulings and guidance on the application of the transfer pricing rules including: • Taxation Ruling TR 2014/8 (transfer pricing documentation requirements) • Practice Statement PS LA 2014/2 (administration of transfer pricing penalties) • Practice Statement PS LA 2014/3 (simplifying transfer pricing record keeping) • Draft Practice Statement PS LA 3673 (guidance for transfer pricing documentation), and • Taxation Ruling TR 2014/6 (application of s 815-130, about the relevance of actual commercial or financial relations to arm’s length conditions). Also see the ATO publication entitled “Simplifying Transfer Pricing Record Keeping” on its website at www.ato.gov.au. Since 1 January 2016, multinational companies with worldwide turnover of $1 billion or more are required to provide country-by-country statements to the Commissioner on an annual basis to assist the Commissioner with carrying out transfer pricing risk assessments. Further a diverted profits tax will apply to large multinational corporations with global annual revenue of $1 billion or more. The diverted profits tax is applied at the rate of 40% on profits that are artificially diverted from Australia.

RULINGS ¶1-650 Role of rulings The Commissioner can make private, public and oral rulings, binding on the Commissioner, on the way in which, in his opinion, a particular income tax law or FBT law applies in relation to an arrangement. Rulings are intended to help reduce taxpayers’ uncertainty about the application of the law in a selfassessment environment where the Commissioner makes assessments (or, in the case of companies, is deemed to make assessments) without a technical examination of the information contained in a taxpayer’s return and is given wide powers to amend assessments in the light of subsequent audits — generally for up to four years after tax became due and payable under the original assessment. For assessments in respect of the 2004/05 and later income years, the period is only two years for most individuals and small business entities (¶1-280). A person can object against an unfavourable private ruling (¶1-665). All private rulings are available on a public database with taxpayer identifiers deleted. Individual taxpayers are able to obtain oral rulings in respect of non-complex non-business matters. The Commissioner also issues other types of guidance including Law Companion Rulings and Practical Compliance Guidelines. Types of public rulings and ATO advice Product rulings Product rulings are binding public rulings on the availability of claimed tax benefits from investment “products”. A product refers to an arrangement in which a number of taxpayers individually enter into substantially the same transactions with a common entity or a group of entities. The product may be described as an investment arrangement, a tax-effective arrangement, a financial arrangement or an insurance arrangement. Product rulings are designed to protect investors, provided the arrangement is carried out in accordance with details provided by the applicant and described in the product ruling. Individual investors do not need to apply for private rulings on the arrangement. Promoters, or the persons involved as principals in the carrying out of the arrangement, may apply for a product ruling. A written application is required and a draft of the proposed product ruling must also be provided in the specified format.

Class rulings Class rulings are binding public rulings on the application of tax laws to specified classes of persons (participants) in relation to particular arrangements, such as employee retention bonus schemes, employee share and option plans, bona fide redundancy plans, corporate or industry restructures and scrip-for-scrip rollovers. Class rulings will not be given in relation to investment schemes or similar products — the promoters of such schemes can apply for a product ruling (see above). As with product rulings, the aim of the class rulings system is to provide certainty to participants and eliminate the need for individual applications for private rulings. Taxpayer alerts The ATO issues “Taxpayer alerts” as an early warning to taxpayers of significant new and emerging tax planning issues or arrangements that the ATO has under risk assessment. The alerts, which are not public rulings, are available on the ATO website ATO assist. Law Administration Practice Statements The ATO issues “Law Administration Practice Statements” that provide direction to ATO staff on the approaches to be taken in performing their duties. They are not used to provide interpretative advice and do not convey extra statutory concessions to taxpayers but outline the approach that should be taken. Law Companion Rulings Law Companion Rulings (“LCR”) express the Commissioner’s view on how recently enacted law applies to taxpayers. They seek to provide insight into the practical implications of new law in ways that may go beyond mere questions of interpretation. Practical Compliance Guidelines Practical Compliance Guidelines (“PCG”) provide broad compliance guidance in respect of significant law administration issues. They may include administrative safe harbour approaches which the Commissioner will administer the law in accordance with provided they are followed in good faith. While a PCG is not generally a public ruling and is not legally binding, they represent guidance material on how the ATO will allocate its compliance resources according to assessments of risk. Scope of rulings Rulings can be made on any matter involved in the application of a relevant tax law provision including the administration and collection of taxes. The ATO can provide rulings on ultimate questions of fact, such as the residency status of a taxpayer and whether a business is being carried on. Private rulings must be applied for, and can apply only to the particular person whose arrangement is the subject of the application, and only in respect of a particular income year, whether the current year or a past or future year. Public rulings are generally initiated by the Commissioner and can apply to classes of persons and in relation to classes of arrangements. Product rulings and class rulings can be applied for.

¶1-660 Rulings binding on Commissioner A ruling is binding on the Commissioner where a taxpayer has relied on the ruling. The Commissioner may apply a relevant provision of the law as if the taxpayer had not relied on the public ruling, if doing so would produce a more favourable result for the taxpayer. A ruling is not binding on the Commissioner if it has been nullified because of subsequent legislative change that causes the law that was ruled on to not apply to the arrangement. Nor is a ruling binding if it has been properly withdrawn by the Commissioner, or if the arrangement implemented is different from the one ruled upon. Example Big Wheels Pty Ltd makes and sells bicycles. It has incurred significant legal costs trying to stop a competitor from using a similar trade name. The company does not know whether these expenses are deductible and so decides to apply to the Commissioner for a private ruling. The Commissioner advises that the expenses would be deductible. Big Wheels Pty Ltd relies on the ruling to claim the deduction. However, when the company is subject to a tax audit three years later, the auditor holds that the expenses were non-

deductible. Big Wheels can rely on the private ruling given by the Commissioner as they have relied upon it to claim the deduction. The deduction is allowed, even if the ruling is shown to be incorrect.

¶1-665 Objection and review of rulings A person who is dissatisfied with a private ruling can object against it (¶1-710) within a specified period — generally the four years following the due date for lodgment of the person’s tax return for the income year to which the ruling relates (see also ¶1-705). This period is reduced to two years for most individuals and for small business entities. If dissatisfied with the Commissioner’s objection decision, the person can seek review of the decision by the Administrative Appeals Tribunal (AAT) or appeal to the Federal Court (¶1-710). A review cannot consider facts other than those identified by the Commissioner as being part of the arrangement that was the subject of the ruling. There is no right of objection against a public ruling or an oral ruling.

RETURNS, ASSESSMENTS AND REVIEW ¶1-700 Tax returns A person must lodge a tax return if required to do so by the Commissioner in the relevant Legislative Instrument made annually. The Legislative Instrument also specifies the date by which returns must be lodged. Individuals, partnerships and trusts are generally required to lodge by 31 October following the end of the income year. The Legislative Instrument for 2018/19 was issued on 10 May 2019. Companies and superannuation funds are expected to lodge their returns for 2018/19 in accordance with the ATO’s lodgment program. Details of this program can be found on the ATO website at www.ato.gov.au. Taxpayers are liable to pay an administrative penalty for late lodgment (¶1-755). Failure to lodge a return is an offence (¶1-760). The Commissioner can grant extensions of time to lodge returns.

¶1-705 Tax assessments The Commissioner makes an assessment of an individual’s taxable income and tax payable on the basis of the information contained in the return without examining the return in detail. This process is known as “self-assessment”. The Commissioner issues a notice of assessment to the individual requiring payment of any balance of tax payable not collected under the PAYG system (¶1-105). The assessment system for companies is known as “full self-assessment”. Here, the Commissioner is deemed to have made an assessment of the taxable income and tax payable specified in the company’s tax return. The Commissioner can make a default assessment if a taxpayer fails to lodge a return or the Commissioner is dissatisfied with a return. Taxable income under the default assessment is the amount upon which, in the Commissioner’s judgment, income tax ought to be levied. Amendment of assessments The Commissioner has the power to amend any assessment by making such alterations or additions as he/she thinks necessary, even though tax has been paid. Where there has been avoidance of tax due to fraud or evasion, the amendment can be made at any time. Otherwise, the amendment must generally be made within four years from the date on which tax became due and payable under the assessment. This period is reduced to two years for most individuals and for small business entities.

¶1-710 Review of assessments and other decisions Objection

A taxpayer who is dissatisfied with an assessment can object to the Commissioner against it and, if not satisfied with the Commissioner’s decision on the objection, either apply to the AAT for review of the decision or appeal to the Federal Court against the decision. The procedures for exercising these rights are contained in general provisions in the Taxation Administration Act 1953 which apply not only in relation to income tax assessments but also in many other situations where a person is specifically given the right to object against a decision or determination of the Commissioner. The procedures apply, for example, where: • a person is dissatisfied with a determination on a taxpayer’s claim for foreign income tax offsets • a superannuation fund member is dissatisfied with certain features of an assessment of superannuation contributions surcharge • a person is dissatisfied with a private ruling. A person’s objection against an assessment must set out the grounds on which the person relies but the objection can generally only challenge the Commissioner’s application of the substantive law and not the process by which the assessment was made. Objection against “self-assessment” An objection can be lodged against an assessment even though the assessment was made under the “self-assessment” system solely in reliance on the information contained in the taxpayer’s return, including, in the case of a company, an assessment that was deemed to have been made on that basis. This can happen where the taxpayer, wishing to avoid the risk of administrative penalty, files the return on the basis of the Commissioner’s view of the law as expressed in a ruling but then seeks to challenge that view. Review of objection decision by AAT or Federal Court A taxpayer who is dissatisfied with the Commissioner’s objection decision may apply to the AAT for a review of the decision or appeal to the Federal Court. In either case, the taxpayer has the burden of proving that the assessment is excessive and is generally limited to the grounds stated in the objection. Costs associated with a review or appeal are generally deductible. AAT hearings are generally held in private and the reasons for the decision do not reveal the taxpayer’s identity. AAT proceedings are generally less formal than a court. The AAT need not apply the laws of evidence, may exercise all of the Commissioner’s powers and discretions, and may confirm, vary or set aside the Commissioner’s objection decision. An appeal to the Federal Court against an objection decision is heard by a single judge. The court cannot interfere with the exercise of a discretion by the Commissioner unless the discretion was not exercised in accordance with law. The court may make such order in relation to an objection decision as it thinks fit, including an order confirming or varying the decision. The Commissioner or the taxpayer can appeal to the Federal Court from a decision of the AAT on a question of law. The Federal Court can make such order as it thinks fit. It could, for example, remit the matter to the AAT to be heard again. The Commissioner or the taxpayer can appeal to the Full Federal Court from a decision of a single judge, whether the decision is on an appeal against an objection decision or on an appeal against an AAT decision. An appeal can be made from an order of the Full Federal Court to the High Court, but only with the special leave of the High Court. The Commissioner must give effect to the decision of the AAT or the order of the Federal Court when that decision or order is final, generally by amending the assessment. A decision or order is final once the time for any further appeal has expired. Judicial review of Commissioner’s decisions If the law does not specifically give a person the right to object against a decision of the Commissioner, the further rights of review by the AAT and appeal to the Federal Court just discussed are not available. Some of these decisions may be reviewable by the Federal Magistrates Court or the Federal Court under the Administrative Decisions (Judicial Review) Act 1977. A breach of natural justice, an improper exercise of power or an error of law, for example, would be grounds for review of a decision. Examples of

decisions that could be open to this form of administrative review are a refusal to grant a remission of GIC or an extension of time to pay tax and a refusal to vary PAYG withholding amounts.

PENALTIES ¶1-750 Scheme of income tax penalties Three kinds of penalty may be imposed for failure to comply with the requirements of the income tax law and for other specified behaviour related to the operation of the income tax law: • the general interest charge (GIC) or the shortfall interest charge (SIC) • administrative penalties imposed by the income tax law • a fine or a term of imprisonment imposed by a court in respect of an offence. If a particular act or omission of a person attracts both a liability for administrative penalty and the institution of a prosecution for an offence, the administrative penalty is not payable. General interest charge (GIC) The GIC is payable if an amount owing to the Commissioner is not paid on time, and in certain other circumstances. Examples are: • late payment of tax due on assessment or amendment • late payment of a PAYG instalment (¶1-105). The GIC is calculated daily on a compounding basis. The rate is adjusted quarterly. The GIC is deductible. Shortfall interest charge (SIC) For assessments relating to the 2004/05 and later years, the shortfall interest charge applies instead of the GIC to the period from which the shortfall arose to the date the tax is due and payable. After that date the GIC applies to both the tax shortfall and any SIC accumulated to that point. The SIC is four percentage points lower than the general interest charge. The SIC is deductible.

¶1-755 Administrative penalties Administrative penalties are imposed for a range of taxation offences, including: • failure to lodge activity statements, returns and other documents on time • making false or misleading statements, or in respect of income tax laws or taking positions in statements that are not reasonably arguable • scheme benefits relating to schemes, and • failure to make a statement required for determining a tax-related liability. Where a taxpayer fails to lodge a return or other document by the due date, the penalty which may be imposed will depend upon the size of the entity as follows: Type of entity

Penalty

Small entity

Base penalty of one penalty unit for each 28-day period or part thereof not lodged, up to a maximum of five penalty units

Medium entity

Double the base penalty

Large entity

Five times the base penalty

Significant global entity

500 times the base penalty

A penalty unit equates to $210. Where the document is necessary for the Commissioner to determine the taxpayer’s tax liability accurately and the Commissioner determines that liability without the assistance of the document, the taxpayer is also liable to a further administrative penalty of 75% of the liability. This behaviour also constitutes an offence. Administrative penalties may also be applied where: • a taxpayer fails to keep or retain records as required, fails to retain or produce a declaration about an agent’s authority to lodge a tax return or fails to give reasonable facilities to a taxation officer exercising access powers — the penalty in each case is 20 penalty units. The behaviour also constitutes an offence • a taxpayer has a “shortfall amount” (an understatement of tax liability) caused by specified behaviour, such as failing to take reasonable care (for details of the behaviours and the penalty, see the table below). Some shortfall behaviour could also constitute the offence of making a false or misleading statement or omitting something which makes the statement misleading, eg where statements giving rise to a shortfall exhibited intentional disregard of the law or deliberate evasion (see the table below). SIC and GIC will also be payable on the shortfall in tax if it is not paid on time • the Commissioner has applied an anti-avoidance provision, eg if Pt IVA is applied the penalty is 50% of the resulting increase in tax payable (25% if the taxpayer’s position is reasonably arguable). The penalties are double where the entity is a significant global entity. “Shortfall amount” administrative penalties Culpable behaviour

Penalty (% of shortfall)

Intentional disregard of the law (deliberate evasion)

75

Recklessness about correct operation of the law

50

Failure to take reasonable care to comply with the law

25

Treatment of law in statement not reasonably arguable

25

These penalties are doubled for significant global entities. Administrative penalties for shortfalls and for tax avoidance provisions applying can be increased in certain circumstances, eg if the taxpayer takes steps to prevent the Commissioner from discovering the shortfall or the applicability of the tax avoidance provision or was liable to pay the same penalty in an earlier accounting period. Conversely, administrative penalty can be reduced if the taxpayer voluntarily tells the Commissioner about the matter. The Commissioner has the discretion to remit administrative penalty.

¶1-760 Offences against the taxation laws A person is guilty of an offence for failing in specified ways to comply with the requirements of the taxation laws and for various other specified forms of behaviour related to the operation of the taxation laws, such as: • making a false or misleading statement • falsifying records with intent to deceive • structuring investments to ensure that TFN withholding tax is not payable on investments where the person has not quoted a TFN.

Some offences, if committed by a natural person, are punishable by a fine and/or imprisonment. Others are punishable only by a fine. The penalties are substantial and are higher for second and subsequent offences, ranging from a fine of 20 penalty units for certain first offences to a fine equal to 100 penalty units and/or two years’ imprisonment for certain second and subsequent offences by an individual (fine of 500 penalty units if committed by a company). In addition, a convicted person may be ordered by the court to pay up to twice or three times the tax sought to be avoided. A penalty unit equates to $210. Fines of up to 120 penalty units and/or two years imprisonment (or 600 penalty units if committed by a company) can be imposed for obstructing ATO officers. Prosecution prevails over penalty tax If particular behaviour attracts both a liability for an administrative penalty and the institution of a prosecution for an offence, the administrative penalty is not payable. An example is where a person fails to lodge an income tax return. Example Richard has deliberately not included some income in his return. After an ATO audit, he was found to have not included $50,000 for two consecutive years. Administrative penalty is imposed for the first year at the rate of 75% of the tax avoided. Richard will also be liable to pay GIC in relation to the underpaid tax. In relation to the second year, the Commissioner decided to prosecute Richard for recklessly making false and misleading statements. Administrative penalty in respect of the shortfall is therefore not payable for the second year. But note that, if convicted, Richard could be ordered by the court (for a first offence) to pay up to double the amount of tax sought to be avoided.

Company officers An officer of a company, such as a director or secretary, is liable to be prosecuted for a taxation offence committed by the company as if the person had committed the offence, although the Commissioner will usually institute prosecution action against the company rather than the officer.

CAPITAL GAINS TAX The big picture

¶2-000

How CGT works

¶2-050

Step 1: What transactions are covered? CGT events and CGT assets

¶2-100

List of CGT events

¶2-110

Step 2: What is the capital gain or loss? Cost base calculation — the information you need

¶2-200

Cost base modifications and special rules

¶2-205

Capital proceeds rules

¶2-208

Calculating the capital gain or loss

¶2-210

Discount capital gain

¶2-215

Who makes the capital gain or loss?

¶2-220

Step 3: Exemptions, concessions and special rules Types of exemption/concession/special rules

¶2-250

Exemption for pre-CGT assets

¶2-260

Exempt assets, proceeds and transactions

¶2-270

Foreign residents and temporary residents — exemptions and withholding tax ¶2-280 Small business CGT concessions

¶2-300

Basic conditions and additional basic conditions

¶2-310

Maximum net asset value test

¶2-315

Active assets

¶2-320

Significant individual test

¶2-323

CGT concession stakeholder

¶2-325

15-year asset exemption

¶2-336

50% active asset exemption

¶2-337

Small business retirement exemption

¶2-338

Small business replacement asset rollover

¶2-339

Special rules for personal use assets and collectables

¶2-340

Other exemptions or loss-denying transactions

¶2-343

Earnout arrangements

¶2-345

Separate asset rule

¶2-350

Options

¶2-355

Special rules for beneficiaries of a trust

¶2-360

Step 4: Rolling over/deferring a capital gain or loss

Deferring capital gains and losses

¶2-400

Typical rollover situations

¶2-410

Step 5: Calculating the tax Net capital gains and losses

¶2-500

Overlap with other tax rules and avoidance schemes

¶2-520

Keeping records: asset registers

¶2-530

Summary — checklists CGT planning checklist

¶2-600

Taxpayer alerts

¶2-650

CGT topical checklist

¶2-700

¶2-000 Capital gains tax

The big picture This step-by-step checklist sets out how you work out if there is a capital gains tax (CGT) liability in any particular case. Each step is cross-referenced to the explanations in this chapter. Step 1: What transactions are covered? • The situations and transactions which are covered by the CGT rules are listed at ¶2-100. These are called “CGT events”. • If there is no CGT event involved, the CGT rules do not apply and the matter is dealt with under the ordinary tax rules. • If there is a CGT event involved, the CGT rules apply. Step 2: If the CGT rules apply, what is the capital gain or capital loss? • There will be a capital gain if the proceeds from the event exceed the cost base of the asset (¶2200), as adjusted for inflation where relevant. There will be a capital loss if the reduced cost base of the asset exceeds the proceeds (¶2-210). • If there is neither a capital gain nor a capital loss, there are no CGT consequences. This can happen where the proceeds exceed the reduced cost base, but do not exceed the cost base (¶2-210). • Special rules apply in determining who made the capital gain or loss where partnerships, trusts, bankrupts or liquidated companies are involved (¶2-220). Step 3: Is there an exemption, concession or special rule? • If there is either a capital gain or a capital loss, the following extra factors come into play: – whether the taxpayer is an individual, a trust, a superannuation entity or a life insurance company that is entitled to a CGT discount or cost base indexation option (¶2-215) – whether the taxpayer is a resident or a foreign resident. Generally, foreign residents are only subject to the CGT rules on their taxable Australian property (¶2-280) – whether an exemption or concession applies. For example, exemptions apply to assets acquired before 20 September 1985 (¶2-260), motor cars, a person’s main residence (¶2-

270) and certain small business asset disposals (¶2-300) – whether there are any other special rules, eg those relating to personal use assets and collectables (¶2-340), earnout rights (¶2-345) or capital improvements (¶2-350). Step 4: Is the capital gain or loss rolled over? • In certain situations, a capital gain or loss is “rolled over”. In certain other situations, a rollover is optional (¶2-400). • If it is rolled over, the gain or loss is deferred. It is not taken into account until the relevant asset is affected by a later CGT event (eg it is disposed of again). Usually the pre-CGT status of the asset is also preserved (¶2-400). Step 5: Calculating the tax • If there is a capital gain: – is the gain reduced by the CGT discount? This is available only for eligible taxpayers (¶2215) – is the amount otherwise assessable under the ordinary tax rules? If so, the capital gain is reduced or eliminated accordingly to avoid double taxation (¶2-520), or – are there any other capital gains during the income year? These are aggregated with the relevant gain to determine the total capital gain (¶2-500). • If there is a capital loss: – are there any other capital losses during the income year? These are aggregated with the relevant loss to determine the total capital loss (¶2-500). • Do total capital gains for the year exceed total capital losses? – if the total capital gains exceed the total capital losses for the year, there is a net capital gain for the year, which is added to the taxpayer’s other assessable income (¶2-500) – if the total capital losses exceed the total capital gains, there is a net capital loss which can be offset against capital gains realised in subsequent years (¶2-500) – if the total capital gains are equal to the total capital losses, they cancel each other and there are no CGT consequences.

¶2-050 How CGT works A person sells shares or shares are declared worthless by a liquidator . . . An investor sells a rental property . . . A beneficiary inherits an estate . . . A businessperson sues for damages . . . A deposit is forfeited . . . A trust is set up . . . A person sets up a home office . . . A person stops being an Australian resident. All of these are situations where the capital gains tax (CGT) rules may apply. The CGT rules have such a wide scope that they potentially apply to any transaction that involves changes in property or legal rights. They must be kept in mind when planning any financial transaction. Scope of this chapter This chapter explains the main features of the CGT rules, with particular emphasis on those aspects which may affect financial planning. The CGT rules take up hundreds of pages of legislation. The explanations in this chapter necessarily

involve a lot of simplification given the wide scope of the CGT regime. Comprehensive commentary may be found in other Wolters Kluwer services such as the Australian Master Tax Guide, the Australian Federal Income Tax Reporter and the Capital Gains Tax Planner. The Australian Taxation Office (ATO) also provides a vast range of CGT rulings and determinations and other information on its legal database and website (see www.ato.gov.au/Law; www.ato.gov.au/General/Capital-gains-tax/), including information and guidance on CGT issues under development (see www.ato.gov.au/General/ATO-advice-and-guidance/Advice-under-developmentprogram/Advice-under-development---capital-gains-tax-issues). What are the CGT rules? The CGT rules are part of the income tax law and are currently contained in the Income Tax Assessment Act 1997 (ITAA97). Before they were introduced, the income tax law had mainly been concerned with ordinary income, not capital gains. In the case of an investment property, for example, the rent would have always been caught by ITAA97 because it was ordinary income. But if you sold the property itself for a profit, you would be making a capital gain. Until the introduction of the CGT rules, such a gain would generally not have been caught by ITAA97 unless you were in the business of selling properties. The CGT rules are designed to plug this gap. The situations where the CGT rules apply are called “CGT events”. The most common of these is where you dispose of an asset which you acquired after 19 September 1985. However, not all the transactions that come within the rules are so straightforward. As you can see from the situations referred to at the start of this paragraph, many of them do not even involve a disposal in the ordinary sense. There is also a wide range of exemptions, concessions and special rules that complicate the picture. In addition, capital gains and losses can be deferred (rolled over) in certain circumstances. Although capital gains are now taxed in a similar way to income, there are some important differences. For instance, the capital gains for CGT assets purchased before 21 September 1999 are generally calculated as the amount of the gains made after allowance is made for inflation (ie an indexing option is available so that the asset cost is indexed from the date of its purchase). However, no indexation adjustment is available for assets acquired on or after 21 September 1999 (¶2-210). Also, for individuals and certain other taxpayers (but not companies generally), the capital gains that are included in assessable income may be discounted by a specified percentage, ie the discounted capital gains are not taken into assessable income (¶2-215). Capital losses are treated quite differently. Firstly, no allowance is made for inflation. Secondly, they are not deductible against ordinary income, or against capital gains of previous years. They can only be offset against capital gains of the current or future years (¶2-500).

STEP 1: WHAT TRANSACTIONS ARE COVERED? ¶2-100 CGT events and CGT assets The situations in which the CGT rules apply are called “CGT events”. They cover a very wide range of financial dealings and situations (see ¶2-110). CGT assets Most of the CGT events (but not all) involve some sort of dealing with a “CGT asset”. This term is very widely defined. It includes any form of property and any legal or equitable right. Common examples of CGT assets are land, buildings, shares, units in a unit trust, options, foreign currency, business goodwill, rights under a contract, debts owed to you, and interests in partnerships. Other examples include farm-out arrangements (MT 2012/1 and 2012/2) and rights conferred by a franchise agreement (Inglewood & Districts Community Enterprises Ltd v FC of T 2011 ATC ¶10-202). This, of course, is not an exhaustive list. Some CGT assets are also subject to special concessions, eg pre-CGT assets, small business assets and a person’s main residence (¶2-250 onwards). Personal use assets (such as boats) and collectables (such as artwork or jewellery) are CGT assets, but special rules and thresholds apply to them (¶2-340).

Sometimes buildings and other capital improvements are treated as assets separate from the land (¶2350). ATO guidelines on the tax treatment of crypto-currencies for personal transactions and in business and in exchange transactions are found in www.ato.gov.au/General/gen/tax-treatment-of-crypto-currencies-inaustralia---specifically-bitcoin/ and Taxation Determinations TD 2014/25 (bitcoin is not a “foreign currency”), TD 2014/26 (bitcoin is a CGT asset, not “money”) and TD 2014/27 (bitcoin is trading stock if it is held for the purpose of sale or exchange in the ordinary course of a business). Ordering rules for CGT events or where events overlap The general rule is the relevant CGT event that applies in a situation is the one that is most specific to the situation (ignoring CGT event D1 and H2). If no CGT event covers the transaction, there will not be a capital gain or loss. However, sometimes a transaction is covered by more than one CGT event, or as some of the CGT events are expressed very broadly (eg the creation of “contractual or other rights” (CGT event D1), or the receipt of capital proceeds from an event which “occurs in relation to a CGT asset” (CGT event H2)), there may be an overlap of CGT events. The “most specific” rule is therefore subject to the following exceptions: (1) if the circumstances which give rise to CGT event J2 constitutes another CGT event, CGT event J2 applies in addition to the other event (2) if CGT event K5 happens because CGT event A1, C2 or E8 has happened, CGT event K5 happens in addition to the other event (3) if CGT events happen for which a capital gain or loss is taken into account in working out a foreign hybrid net capital loss amount, which is itself taken into account to see if CGT event K12 happens, CGT event K12 applies in addition to the other CGT events. If no CGT event (other than CGT events D1 and H2) happens, it is then necessary to consider whether these events may apply as residual events. Basically, CGT event D1 applies where contractual or other rights are created, and CGT event H2 applies where there is a receipt of money or other consideration as a result of an act, transaction or event occurring in relation to a CGT asset. The rule is as follows: • CGT event D1 is considered first, and if it happens, that event applies • if CGT event D1 does not happen, see if CGT event H2 happens. If it does, that event applies (ITAA97 s 102-25(3)). CGT event D1 and CGT event H2 come into play only if no other CGT event happens in a particular transaction. Because CGT events D1 and H2 are excluded from the “most specific” rule, they will not apply even if they are the most specific event in a particular situation. Example Eddy fails to complete a contract for the sale and purchase of land which creates a right in the seller to forfeit the deposit made under the contract. CGT event D1 (creation of rights, etc) is the most specific event. However, because the “most specific” rule does not apply to CGT event D1, Eddy must apply the next most specific event which is CGT event C2 (cancellation, surrender and similar endings), rather than CGT event D1.

CGT events are discussed further at ¶2-110.

¶2-110 List of CGT events This paragraph contains a list of the CGT events and a description of the main CGT events which may be relevant for financial planning, details of when the event occurs and how the capital gain or loss is calculated. The ITAA97 labels each CGT event with a letter (from A to L) which identifies its broad transactional grouping and a sequential number, eg CGT event C1, CGT event C2. Exceptions to a CGT

event happening may arise in certain circumstances so that it is important to refer to the CGT event provision in the ITAA97 in each case to ascertain whether there are exceptions available. The most common transaction that will have CGT consequences is CGT event A1, which happens when a person disposes of a CGT asset, eg if you sell or give away an asset. Other common CGT events from which a capital gain or capital loss may arise include when: ☐ an asset you own is lost or destroyed (the destruction may be voluntary or involuntary) ☐ shares you own are cancelled, surrendered or redeemed ☐ a liquidator or administrator declares that shares or financial instruments you own are worthless ☐ you enter into an agreement not to work in a particular industry for a set period of time ☐ a trustee makes a non-assessable payment to you from a managed fund or other unit trusts ☐ a company makes a payment (not a dividend) to you as a shareholder ☐ you receive an amount from a local council for disruption to your business assets by roadworks ☐ you enter into a conservation covenant ☐ you dispose of a depreciating asset that you used for private purposes ☐ you stop being an Australian resident. Australian residents make a capital gain or capital loss if a CGT event happens to any of their assets anywhere in the world. As a general rule, a foreign resident makes a capital gain or capital loss only if a CGT event happens to a CGT asset that is taxable Australian property (¶2-280), but may make a capital gain or capital loss where the CGT event creates contractual or other rights (CGT event D1), or a trust over future property (CGT event E9). Disposal of a CGT asset (CGT event A1) • A CGT asset is disposed of, eg when you sell land. This is the most common type of CGT event. It covers the situation where there is a disposal of a CGT asset, whether because of some act or event or by operation of law. A disposal includes any change of ownership of the asset, such as gifting an asset, forfeiture of property under a state law, or a taxpayer ceasing to hold an asset as trustee of a trust and commencing to hold the asset in its own capacity (ID 2010/72). CGT event A1 also happened when there was a transfer of registration of shares in two public companies by a husband from his name to joint ownership with his wife (Murphy v FC of T [2014] AATA 461), and when the trustee of a family trust entered into a contract to sell its business (Case 7/2014 2014 ATC ¶1-069). There are many situations where there is no disposal (and CGT A1 does not happen), for example there is simply a change of trustee of a trust holding the asset, an asset vests in a trustee in bankruptcy or in a liquidator of a company, a bare trust is created by transferring an asset to a trustee, two or more CGT assets are merged into a single asset (TD 2000/10), or a partnership converts into a limited partnership (ID 2010/210). CGT event A1 occurs at the time of the making of the contract. If there is no contract, the event occurs at the time when the ownership changes (Case 2/2013 2013 ATC ¶1-051: event happened on execution of Heads of Agreement, rather than a formal contract; Scanlon & Anor v FC of T 2014 ATC ¶10-378: event occurred when two taxpayers countersigned a letter of offer from a purchaser to purchase their business, rather than on the day when the formal share purchase agreement was executed). Example Marco is selling his house and enters into a contract with Jane on 18 July 2019, at which time Jane pays Marco a deposit. The contract is settled on 31 August 2019 when Jane pays the balance of the purchase price to Marco. The time of the disposal of Marco’s house is the date he entered into the contract with Jane, ie 18 July 2019.

A capital gain from CGT event A1 happening is calculated as the capital proceeds less the cost base. A capital loss arises if the reduced cost base is less than the capital proceeds. A more complex example is the sale of an entitlement in a retirement village. In such a case, the capital proceeds from the event include any money received for the sale, the amount of any secured liabilities assumed by the new entitlement owner and the market value of any other property received, such as a right in the nature of a contractual promise by the purchaser to pay amounts to outgoing residents for unused rent in advance (TR 2002/14, PCG 2019/4: retirement village operators). Disposal of shares under a contract or a scheme of arrangement Taxation Ruling TR 2010/4 deals with the CGT consequences arising from CGT event A1 happening to a disposal of shares under a contract or under a scheme of arrangement under Pt 5.1 of the Corporations Act 2001 where the parties act at arm’s length. The ruling explains when a dividend declared or paid by an Australian resident company (the target company) to a resident shareholder who has disposed of shares in the target company under a contract of sale or scheme of arrangement will constitute capital proceeds from the disposal of the shares. In such cases, the dividend does not constitute part of the cost base of those shares for their purchaser. The ruling also explains the consequences for the vendor shareholder under s 118-20 (see below), where a dividend forms part of the capital proceeds from a disposal of shares. Rights and retail premiums under renounceable rights offers ATO guidelines on the CGT issues and taxation of rights granted, and retail premiums paid, to retail shareholders in connection with renounceable rights offers (to the extent the rights and premiums relate to shares held on capital account) are set out in Taxation Ruling TR 2017/4. Australian resident eligible shareholders and foreign resident ineligible shareholders covered by this ruling do not need to include anything in their assessable income upon the grant of the entitlement. Any retail premium received is treated as the realisation of a CGT asset. Deferred transfers of title (CGT event B1) • Use and enjoyment of an asset is granted before settlement of a sale, eg where a purchaser of land gets possession before the sale is completed. This event occurs when the use and enjoyment of the asset changes hands. Capital gains and losses are calculated as for disposals. Termination, loss or cancellation of a CGT asset (CGT events C1 to C3) • A CGT asset is lost or destroyed. If compensation is received, the event occurs at that time. Otherwise it occurs when the loss is discovered or the destruction occurred. Capital gains and losses are calculated as for disposals. Example A factory owned by TVM Pty Ltd was destroyed by fire on 1 August 2019. A claim for insurance was made on 2 August, but the insurance company disputed the claim and a final settlement was not made until 12 September 2019. The time at which TVM will be taken to have disposed of the building is 12 September 2019, ie when the compensation was received.

• A CGT asset is cancelled or surrendered. If there is a contract, the event occurs when the contract is entered into, otherwise it occurs when the asset “ends”. Capital gains and losses are calculated as for disposals. For example, CGT event C2 will apply on the maturity or close-out of a financial contract for differences, or when debts are extinguished (QFL Photographics Pty Ltd v FC of T 2010 ATC ¶10-152; Carberry v FC of T 2011 ATC ¶10-181: capital payment under the Groundwater Structural Adjustment Program; Case 6/2015 2015 ATC ¶1-077: right to be indemnified ending). In Coshott v FC of T 2015 ATC ¶20-508, the Federal Court remitted the case for redetermination as the AAT had failed to discharge its review function in relation to the assessment of the incidental costs incurred by the taxpayer in the second element of the cost base. The taxpayer had accepted there was a CGT event C2 which occurred at the time of execution of the deed of settlement in the negligence and breach of contract claim. • An option to acquire shares, trust units or debentures expires. This event occurs when the option

expires. The capital gain is calculated as the proceeds from granting the option less expenditure in granting it. The capital loss is calculated as the expenditure in granting the option less the proceeds. Retail premiums paid to shareholders where share entitlements are not taken up or unavailable Where a company grants rights (entitlements) to its existing shareholders that allow them to subscribe for an allotment of new shares in the company at an amount (the “offer price”), shareholders can choose not to exercise some or all of their entitlements, or are not eligible to receive an entitlement or are not permitted to exercise rights under it (in these respects, these shareholders are “non-participating shareholders”). Taxation Ruling TR 2012/1 provides guidelines on the taxation of retail premiums paid to shareholders in companies in respect of amounts subscribed for shares. Bringing a CGT asset into existence (CGT events D1 to D4) • Contractual or other rights are created, eg you enter into a restrictive covenant or grant an easement. The event occurs when the contract is entered into or the right is created. There will be a capital gain if the payment for the right exceeds the incidental costs of creating it. There will be a capital loss in the reverse situation. (This event is disregarded if it results in another CGT event occurring. It also does not apply when a loan is made or shares or units are allotted.) Whether a particular agreement involves a profit à prendre or a sale of goods will depend on the intentions of the parties determined from the terms of the agreement and other relevant circumstances. CGT event D1 (about the creation of rights) rather than CGT event A1 (about the disposal of an asset) happens if a taxpayer grants an easement, profit à prendre or licence over an asset. Consequently: • no part of the cost base of the asset can be taken into account in working out the amount of any capital gain or capital loss that arises from the grant • any capital gain or capital loss from the grant cannot be disregarded merely because the asset was acquired prior to 20 September 1985 • any capital gain from the grant is not a discount capital gain, and • the ITAA97 Div 118 exemption is not available if the grant relates to a main residence (as CGT event D1 is not one of the events listed in s 118-110(2) that is relevant to that exemption) (TD 2018/15). Example — grant of easement Jane owns a property on 1 January 1985. She granted an easement over the property on 1 January 2019 and received $40,000 and incurred $1,000 in legal expenses in relation to the grant. Jane will have a capital gain of $39,000 in respect of the grant of the easement (capital proceeds $40,000 less incidental costs $1,000). The capital gain is not a discount capital gain. Jane cannot disregard the capital gain even though the property over which the easement was granted was acquired before 20 September 1985 (a pre-CGT asset). Neither can she disregard the capital gain even if the property is her main residence.

• An option is granted. The event occurs at the time of the grant. There will be a capital gain if the payment for the grant exceeds the costs of granting it. There will be a capital loss in the reverse situation. For employees receiving options under an employee share scheme, the tax rules relating to employee share schemes will also need to be considered. • There is a grant of a right to income from mining. The event occurs when the relevant contract is made or, if there is no contract, when the right is granted. There will be a capital gain if the payment for the grant exceeds the costs of granting it. There will be a capital loss in the reverse situation. • A conservation covenant is entered into. The event occurs when a taxpayer enters into a conservation covenant over land that it owns. There will be a capital gain if the proceeds from the covenant exceed the cost base of the land apportioned to the covenant. There will be a capital loss in the reverse situation. There will be no capital gain or loss if the taxpayer acquired the land before 20 September 1985. If the taxpayer enters into the covenant for no material benefit and is entitled to a deduction, the capital proceeds are the deduction amount. But if there are no capital proceeds and no deduction, CGT event D1

will apply instead of CGT event D4. Trusts (CGT events E1 to E10) • A trust is created over a CGT asset. This is CGT event E1 which occurs when the trust is created (Oswal v FC of T 2013 ATC ¶20-403: family trust appointing assets for the absolute benefit of named beneficiaries; see also “Settlement and resettlement of trust issues” and Taras Nominees Pty Ltd As Trustee For The Burnley Street Trust v FC of T 2015 ATC ¶20-483 (Taras Nominees) below). A capital gain will arise if the proceeds exceed the asset’s cost base, or a capital loss will arise if the reduced cost base exceeds the proceeds. • A CGT asset is transferred to a trust. This is CGT event E2 which occurs when the asset is transferred (Healey v FC of T (No 2) 2012 ATC ¶20-365: beneficiary of a discretionary trust and share transactions concerning the trustee of the trust). There will be a capital gain if the proceeds exceed the asset’s cost base, and a capital loss if the reduced cost base exceeds the proceeds. In the following two circumstances, CGT event E1 or E2 does not occur: • where a person is the sole beneficiary of a trust that is not a unit trust and is absolutely entitled to the asset as against the trustee, or • the trust is created by transferring the asset from another trust and the beneficiaries and terms of both trusts are the same (formerly known as the “trust cloning exception” which ceased to apply to CGT events on or after 1 November 2008). The exception to CGT event E1 was held not to be available for the taxpayers in Kafataris & Anor v DFC of T 2008 ATC ¶20-048 who executed identical trust deeds over their respective interests in a property for the purpose of establishing superannuation funds for themselves. In Taras Nominees 2015 ATC ¶20-483, the Full Federal Court confirmed that CGT event E1 happened when land was transferred to a trustee to hold on trust for a joint venture development as the transferee did not maintain absolute entitlement as against the trustee or have sole beneficial entitlement. CGT event E2 did not happen as the there was no completed trust at the relevant time. Although the disposal of the land also means that CGT event A1 happened, CGT event E1 applied, being more specific to the taxpayer’s situation than CGT event A1 (s 102-25(1)). • A trust is converted to a unit trust. This is CGT event E3 which occurs when the trust is converted. There is a capital gain if the market value of the asset exceeds the cost base, and a capital loss if the reduced cost base exceeds the market value. • A trustee makes a capital payment to a beneficiary for a trust interest. This is CGT event E4 which occurs at the time of payment. There is a capital gain to the beneficiary if the non-assessable part of the payment exceeds the cost base of the trust interest. This event includes the situation where tax-free distributions are made by a trust to beneficiaries (¶2-205). The capital gain is equal to the excess and the cost base and reduced cost base of the unit or interest is reduced to nil. If the non-assessable part is not more than the cost base, there is no capital gain, but the cost base and the reduced cost base are reduced accordingly (see TD 93/170 and TD 93/171). CGT event E4 cannot produce a capital loss, and any capital gain will be disregarded if the taxpayer acquired the unit or interest before 20 September 1985. There are many situations when CGT event E4 does not happen — eg to the extent that the payment is reasonably attributable to an “LIC capital gain” made by a listed investment company, or if the payment involves CGT events A1, C2, E1, E2, E6 or E7 happening in relation to the trust unit or interest, or in relation to a unit or an interest in an attribution managed investment trust (AMIT) (as CGT event E10 will apply), or where the payment is to a beneficiary of a discretionary trust or a default beneficiary whose interest was not acquired for consideration or by way of assignment: TD 2003/28, or where a trust receives a tax-free capital gain under the early stage innovation company provisions. • A beneficiary becomes absolutely entitled to a trust asset. This is CGT event E5 which occurs when the entitlement arises. There is a capital gain to the trustee if the market value of the asset exceeds its cost base, and a capital gain to the beneficiary if the market value exceeds the cost base of the beneficiary’s capital interest. There is a capital loss to the trustee where the reduced cost base of the asset exceeds

the market value, and for the beneficiary where the reduced cost base of the capital interest exceeds the market value. Taxation Ruling TR 2018/6 notes that vesting of a trust may result in “takers on vesting” becoming absolutely entitled to the trust assets and CGT event E5 occurring. • A trustee disposes of a CGT asset to a beneficiary to end the beneficiary’s right to receive income (CGT event E6) or to an interest in capital (CGT event E7). The event occurs at the time of disposal. There is a capital gain to the trustee if the market value of the asset exceeds its cost base, and for the beneficiary if the market value exceeds the cost base of the beneficiary’s right to income/interest in capital. There is a capital loss to the trustee if the reduced cost base of the asset exceeds the market value, and to the beneficiary if the reduced cost base of the beneficiary’s right to income/interest in capital exceeds the market value. Taxation Ruling TR 2018/6 states that upon vesting of a trust CGT event E7 may occur (on actual distribution of CGT assets to beneficiaries), but will not occur if the beneficiaries are already absolutely entitled to the CGT asset against the trustee (see further below). • A beneficiary disposes of an interest in capital. This is CGT event E8 which occurs when the contract is entered into or, if there is no contract, when the beneficiary ceases to own the interest. There is a capital gain if the proceeds exceed an appropriate proportion of the trust’s net assets, and a capital loss in the reverse situation. • You agree to hold future property in trust. This is CGT event E9 which occurs at the time of the agreement. There is a capital gain if the market value of the property exceeds the incidental costs, and a capital loss in the reverse situation. • Annual cost base reduction exceeds cost base of interest in AMIT. This is CGT event E10 which happens to a taxpayer that holds a CGT asset that is a unit or interest in an AMIT, the cost base of that CGT asset is reduced due to tax-deferred distributions (s 104-107B) and the “AMIT cost base net amount” for the income year of the reduction exceeds the asset’s cost. The time of the CGT event is the time of the reduction. The capital gain is equal to the excess. Settlement and resettlement of trust issues The term “settlement” is not defined in ITAA97 and therefore takes its common law meaning. The meaning of settlement was addressed in Taras Nominees 2015 ATC ¶20-483, which held that CGT event E1 arose because a trust was created by settlement as a result of land being transferred by the taxpayer to a trustee to hold on trust for the benefit of others pursuant to a joint venture development. The arrangement was not excluded under s 104-55(5) as the taxpayer was not the sole beneficiary of the trust and/or was not absolutely entitled to the land as against the trustee. In accordance with Kafataris 2015 ATC ¶20-523 (see CGT event E1 above), the term “declaration” takes its ordinary meaning. A trust is created by “declaration” when it is created by the holder of an undivided legal interest in property using words or actions which sufficiently evidence an intention to create a trust over that property. In that case, the transfer of a jointly owned property by a husband and wife to a wholly owned company created a trust over the property by declaration or settlement and therefore gave rise to CGT event E1 (as opposed to CGT event A1). On resettlements, the question of whether a trust has sufficiently changed to the extent that there is no longer sufficient continuity between the trust as originally constituted and the trust in its current form is relevant in a number of taxation contexts. In FC of T v Clark & Anor 2011 ATC ¶20-236, the court examined the circumstances in which it may be concluded that the nature of a trust has so changed that the trust which had originally incurred capital losses is not the same trust for tax purposes as that which has derived gains against which the losses could be recouped. Although Clark’s case was about whether the changes in a continuing trust were sufficient to treat the trust as a different taxpayer for the purpose of applying a net capital loss, the ATO accepts that the principles in the case have broader application. For example, this may mean that a valid amendment to a trust, not resulting in a termination of the trust, will not of itself result in the happening of CGT event E1. If the terms of a trust are changed or amended pursuant to a valid exercise of a power within its trust deed or with the approval of a relevant court, neither CGT event E1 nor E2 happens. Examples are when amendments are made to add the spouses of children in the general beneficiaries class, expand the fund’s power to invest, or permit the trustee of the trust to stream income. Taxation Ruling TR 2018/6 states that a trust vesting will not of itself ordinarily cause a trust to come to an end and for the property to

be settled on the terms of a new trust. Therefore CGT event E1 will not occur only because a trust has vested. However, the actions of the parties to a trust relationship may be such that a new trust is created by declaration or settlement. (See example 4 in TR 2018/6.) The exceptions when CGT events E1 or E2 may happen are if the change or amendment causes the trust to terminate and a new trust to arise for trust law purposes, or the effect of the change or court approved variation is such that it leads to a particular asset being subject to a separate charter of rights and obligations, such as to give rise to the conclusion that that asset has been settled on terms of a different trust (TD 2012/21). Example — settling of trust asset on new trust The class of beneficiaries (objects) of the Rhoner Discretionary Trust consists of a large number of entities. The trustee has a wide range of powers, including the power to declare that particular assets of the trust are to be held exclusively for one of the trust objects to the exclusion of the other objects. In exercise of this power, the trustee amends the deed with the effect that the trustee commences to hold one of several assets forming part of the corpus of the trust (subject to the trustee’s other powers, such as its power of sale) exclusively in trust for Ms Rhone, one of the objects of the trust. While the amendment does not terminate the Rhoner Trust, its effect is to vary the trust obligations in respect of the asset concerned so as to cause the asset to be held on the terms of a new trust for the benefit of Ms Rhone as sole beneficiary. In such a case, CGT event E1 happens.

Other examples of changes/court approved variations include: • the addition of new entities to, and exclusion of existing entities from, class of objects, and • expansion of a power to invest, or the addition of a definition of income and power to stream, and extension of vesting date. Certain trust split arrangements with the features specified in Draft Taxation Determination TD 2018/D3 will result in the creation of a trust by declaration or settlement as the trustee will have new personal obligations and new rights have been annexed to property. This can cause CGT event E1 to happen. Leases (CGT events F1 to F5) • A lessor grants, renews or extends a lease. The event occurs at the start of the lease, renewal or extension. (If there is a lease contract, the event occurs when this was entered into.) There will be a capital gain to the lessor if the lease premium exceeds the expenditure relevant to the transaction. There will be a capital loss if the premium is less than that expenditure. • A lessor grants, renews or extends a long-term lease. The event occurs when the lease is granted, or the renewal or extension starts. There will be a capital gain to the lessor if the premium exceeds the cost base of the leased property. There will be a capital loss if the reduced cost base of the lease exceeds the premium. • A lessor pays the lessee to get the lease changed. The event occurs when the lease term is varied or waived. For the lessor, there will be a capital loss equal to the amount paid. For the lessee, the capital gain is calculated as the capital proceeds less the cost base of the lease. Shares (CGT events G1 and G3) • A company makes a capital payment for a shareholder’s shares (CGT event G1). This event occurs when the company makes the payment. There is a capital gain to the shareholder where the payment exceeds the cost base of the shares. See also ¶2-205. Example Kellville Pty Ltd, under a share buyback arrangement, makes a payment of $4 per share to obtain Sally’s shares in Kellyville. The cost base of Sally’s shares is $3 per share. The disposal will occur when the company pays Sally and she will make a capital gain of $1 per share in respect of the buyback.

• A liquidator or an insolvency practitioner (eg an administrator) declares that your shares are worthless (CGT event G3). This event occurs at the time of the declaration. The capital loss is equal to the shares’

reduced cost base. There can, of course, be no capital gain. Where shares and other securities in a company are declared to be worthless for CGT purposes, the declaration will cause CGT event G3 to occur and allow shareholders to choose to make a capital loss in respect of their shares. Without such a declaration, shareholders cannot choose to make a capital loss on “worthless” shares while the company continues to exist. Instead, they must create a trust over the shares if they wish to utilise their capital losses and incur any associated costs. The effect of CGT event G3 means that once it happens, the security holders do not have to incur the cost of establishing a trust and they can take account of worthless investments earlier, thus removing a disincentive to invest in shares and securities. Example Hilda purchased shares in Everlasting Insurance Ltd after 20 September 1985. The company commenced winding-up proceedings in July 2019. On 10 October 2019, the liquidator declared that there was no likelihood that shareholders of Everlasting Insurance Ltd would receive any further distribution in the course of winding up the company. CGT event G3 has happened in relation to Hilda’s shares. Hilda can choose to make a capital loss equal to the reduced cost base of her shares in Everlasting Insurance Ltd as at 10 October 2019.

Special receipts — forfeiting a deposit (CGT events H1 to H2) • A deposit is forfeited to you because someone else defaults. This event occurs when the deposit is forfeited, eg when a purchaser fails to complete the purchase. The capital gain is the amount of the deposit less any expenditure in connection with the prospective sale. There will be a capital loss if the incidental costs exceed the amount of the deposit. • Payment is received for an act, transaction or event which occurs to a CGT asset. This event happens, for example, if you receive a non-contractual inducement to build a factory on your land. This event occurs when the act, transaction or event occurs. There is a capital gain if the payment exceeds the incidental costs, and a capital loss in the reverse situation. This CGT event only applies if no other CGT event applies. Australian residency ends (CGT events I1 to I2) • An individual, company or trust stops being an Australian resident. This event occurs on the change of residency. For each CGT asset that is not taxable Australian property, there is a capital gain if the market value exceeds the cost base. There will be a capital loss if the reduced cost base exceeds the market value. There are various exceptions where CGT event I1 do not apply. (Different rules apply when a person becomes an Australian resident: ¶2-280.) Reversal of rollovers (CGT events J1 to J6) • A company ceases to be a member of a wholly owned group where there has previously been a rollover. This event occurs when the membership ceases. There is a capital gain if the market value of the asset exceeds its cost base, and a capital loss if the reduced cost base exceeds the market value. • A change in relation to a replacement asset or improved asset after a previous small business rollover. This event occurs when the change in status or circumstances happens. The capital gain is the capital gain applied in the rollover. There will be no capital loss (¶2-410). • A failure to acquire a replacement asset and incur fourth element costs after a small business rollover, or the acquisition costs or fourth element costs, or both, do not cover the disregarded capital gain. These events occur at the end of the replacement asset period. The capital gain is the difference between the disregarded capital gain and the amount incurred or the disregarded capital gain (¶2-339). • A trust fails to cease to exist after rolling over the trust’s assets to a company. This event occurs when the failure happens. There is a capital gain if the market value of the asset exceeds its cost base, and a capital loss if the reduced cost base exceeds its market value. Other CGT events (CGT events K2 to K12) • A bankrupt pays an amount in relation to a debt that was taken into account in calculating a net capital

loss. This event occurs when the payment is made. There will be a capital loss if the payment relates to a denied part of the loss. There cannot be a capital gain. • A deceased estate asset passes to an exempt or tax-advantaged entity. This event occurs when the person dies. There is a capital gain if the market value of the asset exceeds its cost base, and a capital loss if the reduced cost base exceeds the market value. • A CGT asset becomes trading stock. This event occurs at that time. There is a capital gain if the market value exceeds the cost base, and a capital loss if the reduced cost base exceeds the market value. • Special capital loss from collectable that has fallen in value. This event occurs when certain CGT events happen to shares in the company or interest in the trust that owns the collectable. There is a capital gain if the market value of the shares or interest (if there had not been a fall in value) exceeds the capital proceeds from the event. There will not be a capital loss. • You dispose of your pre-CGT interest in a company or trust that has post-CGT assets (¶2-260). This event occurs when another CGT event involving the shares or interest happens. There is a capital gain if the capital proceeds from the shares or interest (attributable to post-CGT assets owned by the company or trust) exceeds the assets’ cost base. There will not be a capital loss. • Balancing adjustment event happens to a depreciating asset. This is CGT event K7 which happens where a balancing adjustment event happens to a depreciating asset that has been used wholly or partly for non-business purposes. This can only apply to assets which are subject to the uniform capital allowances system, eg an asset acquired under a contract entered into after 30 June 2001. Where CGT event K7 happens, a capital gain or loss is calculated on the basis of the asset’s cost and termination value (instead of the usual CGT basis of cost base and capital proceeds), apportioned to reflect the taxable component of the decline in value. The gain or loss is treated as arising at the same time as the relevant balancing adjustment event. If the use of the asset is 100% taxable, CGT event K7 does not happen but a balancing adjustment will occur under the capital allowances system. If there is a mixed use (ie partly taxable and non-taxable), there may be both a balancing adjustment and a capital gain or loss (¶2-205). • Direct value shifts affecting your equity or loan interests in a company or trust, or entitlement to receive payments from an interest in venture capital investments. This event happens at the time the value decreases or on entitlement to receive payments. Special rules apply for working out the capital gain and there will be no capital loss. • Forex realisation gains or losses. This event happens at the time of the forex realisation event. The capital gain or loss is the forex realisation gain or loss (TD 2006/32: determination of non-forex component of the capital gain or loss). • Foreign hybrid loss exposure adjustment. This event happens just before the end of a year of income. Entity consolidation-related events (CGT events L1 to L8) Under the consolidation of entities regime in ITAA97, the head company of a wholly owned group of entities consolidates with its wholly owned Australian entities resulting in the consolidated group being treated as a single entity for income tax purposes. Non-income tax matters (eg goods and services tax (GST) or fringe benefits tax (FBT)) do not come within the consolidation regime and they continue to be the responsibility of the individual entities within the group. When consolidation happens, various cost setting rules are imposed. These events deal with those rules and the CGT consequences which will arise.

Checklist For financial planning purposes, the more common transactions that are likely to have CGT consequences include the following: ☐ A strata title unit or land and buildings is bought or sold.

☐ A deposit on buying an asset is forfeited to the seller. ☐ A share in a company or a unit in a unit trust is bought or sold. ☐ An item of property is destroyed. ☐ An asset or item of property is created. ☐ Shares are declared worthless by the liquidator of a company. ☐ Non-assessable payments are received from your investments in a unit trust or shares. ☐ An individual, company or trust ceases to be resident for tax purposes. ☐ A balancing adjustment event happens to a depreciating asset that is used wholly or partly for non-business purposes. ☐ A lease is granted or varied.

For relevant questions to ask so as to determine if a CGT liability may arise in respect of the more common assets or transactions, see ¶2-700.

STEP 2: WHAT IS THE CAPITAL GAIN OR LOSS? ¶2-200 Cost base calculation — the information you need Having established that your transaction involves a CGT event, the next step is to work out if there is a capital gain or loss. To do this, you will normally need to know the following. • When the CGT event occurred. This is important because: – events involving assets acquired before 20 September 1985 are generally exempt from the CGT rules (¶2-260) – the timing of the event and the date the asset was purchased may allow for indexation calculations (¶2-210) – the timing may also affect the tax year in which the capital gain or capital loss is taken into account (¶2-600). The CGT event will normally occur when the relevant contract is entered into or ownership changes. • The cost base of the asset (if you are calculating a capital gain) or the reduced cost base (if you are calculating a capital loss). The cost base and reduced cost base rules are discussed below. Modifications to the cost base rules and special rules that may apply in specific cases are discussed in ¶2-205. • The general rules on what constitute the capital proceeds of disposal and for certain CGT events, modifications to the capital proceeds rules. The proceeds generally mean the amount you received, or the value of property you received, as a result of the CGT event. It also covers amounts that you were entitled to receive, even if they are not yet in your hands, unless it is clear that they will never be received (¶2-208). Cost base of asset The cost base is used when calculating the capital gain you have made when a CGT event happens to a CGT asset that you own.

The cost base of a CGT asset may consist of five elements: • first element — the amount paid or payable to acquire the asset (or the market value of property you gave or transferred) • second element — the incidental costs incurred to acquire the asset or that relate to a CGT event (see below), but only if they are not tax deductible • third element — the costs of owning the asset that are not tax deductible (see below) • fourth element — capital expenditure incurred, the purpose or expected effect of which is to increase or preserve the asset’s value or that relates to installing or removing the asset • fifth element — capital expenditure incurred in establishing or defending your title to the asset (eg certain legal costs dealing with a deceased’s estate) (s 110-25). “Costs” can include giving property. Various exclusions and adjustments may apply when determining the cost base or reduced cost base (see below and ¶2-205). If the CGT was purchased before 21 September 1999, an “indexation” factor is included to allow for inflation (¶2-210). Where indexation is available, it applies to all elements except the third element. Second element — incidental costs There are a number of incidental costs you may incur in relation to a CGT asset (s 110-25(3)). Except for item (9), they are costs you may have incurred to acquire the CGT asset, or that relate to the CGT event (s 110-35). (1) remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser (Bosanac v FC of T 2019 ATC ¶10-499: commissions/fees). Tax advice can be included if it is provided by a recognised tax adviser (except expenditure for professional tax advice incurred before 1 July 1989) (2) costs of transfer (3) stamp duty or other similar duty (4) costs of advertising or marketing to find a seller or buyer (an example of marketing expenses is furniture hire to help sell an investment property) (5) costs relating to any valuation or apportionment (6) search fees relating to a CGT asset (these essentially relate to fees payable in checking land titles and similar fees and not costs such as travelling expenses to find an asset suitable for purchase) (7) cost of a conveyancing kit or a similar cost (8) borrowing expenses (such as loan application fees and mortgage discharge fees) (9) expenditure incurred by the head company of a consolidated group to a non-group member that reasonably relates to a CGT asset held by the head company (10) termination or similar fee (eg an exit fee) as a direct result of ownership of an asset ending (see below). Typically, termination fees (and exit fees) are contractual fees imposed by one party on the other as a result of the second party breaking the contract. The party that imposes a termination fee may effectuate this by withholding part of the proceeds due to the other party. In this situation, the taxpayer that has to pay the termination fee cannot reduce their capital proceeds by the amount of the withheld fee.

The costs incurred after a CGT event can be “related to” that CGT event for the purpose of working out incidental costs (Taxation Determination TD 2017/10). Example Luke sells his business on 1 January 2019. Under the contract of sale, Luke receives $5,000 for the goodwill of the business. A few months later, he is sued by the purchaser for misrepresenting the value of the goodwill. Luke incurs legal fees of $1,000 to defend the action. The legal fees of $1,000 are an incidental cost of Luke's CGT asset because the fees relate to the disposal of his goodwill.

Third element This element comprises the costs of ownership of a CGT asset (as distinct from costs of becoming the owner). You must have acquired the asset after 20 August 1991. Examples of costs in the third element are rates, land taxes, repairs and insurance premiums, non-deductible interest on borrowings to finance a loan used to acquire a CGT asset and on loans used to finance capital expenditure incurred to increase an asset’s value. Income-producing assets, such as shares or rental properties, do not have a third element generally as deductible expenses are excluded (s 110-25(4)). The cost base of collectables or personal use assets (¶2-340) does not include a third element. The third element is not indexed (if working out a capital gain), and is not used when working out a capital loss (see “Reduced cost base” below). Fourth element This element covers the costs incurred which are intended or expected to increase or preserve value of the CGT asset (s 110-25(5)). Note the characteristics of expenditure that can come within the fourth element as below: (1) The purpose of the expenditure need not increase the asset’s value. Instead, it is sufficient that the purpose or expected effect is to increase or preserve the asset’s value (eg legal and other expenses incurred to preserve the value of a rental property by opposing a nearby development that may adversely affect the property’s value, or costs incurred in unsuccessfully applying for zoning changes; Interpretative Decision ID 2012/46 — levy paid on conversion of overhead mains to underground cables; Coshott v FC of T 2015 ATC ¶20-508: assessment of the incidental costs, legal costs). (2) The expenditure need not be reflected in the state or nature of the asset at the time of the CGT event. (3) This element can include capital expenditure that relates to installing or moving the asset. (4) This element does not apply to capital expenditure incurred in relation to goodwill. The fourth element may be modified in certain situations involving leases (s 110-25(5), (5A), 112-80). Fifth element The fifth element is capital expenditure incurred to establish, preserve or defend the taxpayer’s title to the asset (s 110-25(6)). An amount of damages paid by a taxpayer to a potential purchaser upon the acceptance of the termination of contract to sell the asset following repudiation of the contract by the taxpayer may be included in the fifth element of the cost base of that asset (ID 2008/147). Reduced cost base The reduced cost base of an asset, which also has five elements like the cost base, is used to calculate a capital loss when a CGT event happens to a CGT asset that you own. In calculating the reduced cost base regardless of when the CGT event took place, the elements are never indexed for inflation (ie the indexation increases which may be allowed in working out the cost base of assets). All of the elements (except the third element) of the reduced cost base are the same as those for the cost

base of the asset (see above) (s 110-55). The third element, instead, does not include any amount to the extent that it is tax deductible (eg building write-off deductions). The third element therefore takes into account any assessable balancing adjustments for the asset (eg where the asset had depreciated) or any non-assessable recoupment amounts that had been received such as compensation received for damage to a property (for “Balancing adjustments and depreciating assets”, see ¶2-205). If an asset is owned partly for income-producing purposes, only a proportionate depreciation deduction is available. However, in working out the reduced cost base of the asset, the whole of the potential deduction is treated as if it were deductible. Exclusions from cost base or reduced cost base Certain expenditure or amounts do not form part of the cost base or reduced cost base of an asset (s 110-38, 110-45, 110-55). Some examples are the following: ☐ Expenditure incurred that relates to illegal activities for which a taxpayer has been convicted of an indictable offence. ☐ Expenditure to the extent that it is a bribe to a foreign public official or a public official. ☐ Expenditure to the extent that it is in respect of providing entertainment. ☐ Expenditure to the extent that s 26-5 prevents it being deducted, even if some other provision also prevents it being deducted (s 26-5 denies deductions for penalties). ☐ Expenditure that is for political contributions and gifts that are excluded from deduction under s 2622. ☐ The excess of boat expenditure over boat income that is excluded from deduction under s 26-47. ☐ Expenditure included in the cost base of an asset may be reduced to the extent that the taxpayer can deduct it, eg interest, or to the extent that a non-assessable recoupment is received in respect of it (see “Recoupments” in ¶2-205). ☐ Capital expenditure incurred by another entity such as a previous owner in respect of the asset which the taxpayer can deduct, eg under the capital works provisions, reduces the cost base of that asset (¶2-205). Where the benefit of a deduction is effectively reversed by a balancing adjustment, the relevant expenditure is increased. GST net input tax credits are excluded from all elements of the cost base and reduced cost base of a CGT asset (s 103-30). Adjustments to cost base or reduced cost base Adjustments to the cost base or reduced cost base may need to be made. For example, where compensation is paid to a taxpayer for inappropriate advice that causes loss on a currently held investment, the cost base or reduced cost base (depending on whether a gain or loss is made when the investment is disposed of) should be reduced by the amount of the compensation. If the compensation is paid after the investment has been disposed of, it should be treated as additional capital proceeds (¶2208). General rules modified in specific situations for many CGT assets The cost base rules may be subject to general modifications, while more specific cost base rules may also apply in certain cases including where a rollover occurs in respect of an asset (¶2-205).

¶2-205 Cost base modifications and special rules The general rules for working out the cost base and reduced cost base of a CGT asset (see ¶2-200) are subject to modifications in a number of circumstances. These modifications can be required at any time

from when a CGT asset is acquired to when a CGT event happens in relation to that CGT asset (s 112-5). Most modifications replace the first element of the cost base and reduced cost base of a CGT asset, ie the amount paid for the CGT asset (s 112-15). If a cost base modification replaces an element of the cost base of a CGT asset with a different amount, the CGT provisions apply as if that other amount was paid. The general modification rules cover: • market value substitution • split, changed or merged assets • apportionment • assumption of liability • look-through earnout rights • put options (s 112-15 to 112-37). Market value substitution rule The first element of the cost base and reduced cost base of a CGT asset acquired from another entity is its “market value” at the time of acquisition if: (i) the taxpayer did not incur expenditure to acquire it (except where the acquisition of the asset resulted from CGT event D1 happening or from another entity doing something that did not constitute a CGT event happening) (ii) some or all of the expenditure incurred to acquire it cannot be valued, or (iii) the taxpayer did not deal at arm’s length with the other entity in connection with the acquisition (s 112-20). A taxpayer relying on the market value substitution rule must provide sufficient evidence to prove the transaction was not at arm’s length (Healey v FC of T 2012 ATC ¶20-365). The cost base of a debt can be reduced below face value to market value in accordance with the market value substitution rule if parties entered into debt on non-arm’s length terms (QFL Photographics Pty Ltd v FC of T 2010 ATC ¶10-152). However, if the taxpayer did not deal at arm’s length with the other entity and the taxpayer’s acquisition of the CGT asset resulted from another entity doing something that did not constitute a CGT event happening (eg if the asset is a share in a company that was issued or allotted to the taxpayer by the company), then the market value is substituted only if the amount paid for the CGT asset is more than its market value at the time of acquisition. Also, the market value substitution rule does not generally apply to CGT assets in certain situations, such as: • a right to income from a trust (other than a unit trust or deceased estate) that is acquired for no consideration • a decoration awarded for valour or brave conduct that is acquired for no consideration • a contractual or other legal or equitable right resulting from CGT event D1 happening that is acquired for no consideration (see s 112-20(3) table). Split, changed or merged assets Special rules apply if a CGT asset is split into two or more assets or if it changes in whole or in part into an asset of a different nature, but only if the taxpayer remains the beneficial owner of the new assets after the change (s 112-25). A CGT event does not happen if a CGT asset is split or changed (TD 2000/10). However, the cost base

and reduced cost base of each new asset are calculated by working out each element of the cost base and reduced cost base of the original asset at the time of the split or change and apportioning them in a reasonable way. Strata title splitting One example of an asset being split is where a block of flats owned by a taxpayer under one title is converted by the taxpayer into strata title. The cost base and reduced cost base of each flat is a proportionate share of the cost base or reduced cost base of the original asset at the time when the original asset was converted to strata title. The cost base of each flat is indexed in the usual way as if it was acquired at the time when the original asset was acquired, taking into account its share of any cost base adjustments which happened up until the time of the split and the whole of any cost base adjustments in respect of that flat after the split. Similarly, the reduced cost base of each flat is worked out having regard to its share of any cost base reductions before the split and the whole of any cost base reductions in respect of the flat after the split.

Separate title Another example is where a taxpayer owns a house and adjacent land on the same title. If the taxpayer subsequently obtains a separate title for some of the adjacent land, the cost base and reduced cost base of the house and the land on which it is situated are reduced by the proportionate amount of the cost base or reduced cost base attributed to the adjacent land for which the separate title was obtained.

If two or more CGT assets are merged into a single asset, the merger is not a CGT event and each element of the cost base and reduced cost base of the new asset (at the time of merging) is the sum of the corresponding elements of each original asset (s 112-25(4)) (TD 2000/10). Apportionment If only part of the expenditure incurred in relation to a CGT asset relates to the asset, the relevant element of the cost base and reduced cost base of the asset only includes that part of the expenditure that is reasonably attributable to the acquisition of the asset (s 112-30). If a CGT event happens to some part of a CGT asset but not to the remainder of it, the cost base and reduced cost base of that part are calculated proportionately: the remainder of the cost base and reduced cost base of the asset is attributed to the part of the asset that remains (see example below). Example John acquired a truck for $24,000 and sells the motor for $9,000. Assume that the market value of the remainder of the truck is $16,000. The cost base of the motor is calculated as follows: $24,000 × $9,000 / $9,000 + $16,000 = $8,640. The cost base of the remainder of the truck is $24,000 − $8,640 = $15,360.

However, if an amount of the cost base and reduced cost base (or part of it) is wholly identifiable with the part of the asset to which the CGT event happened or to the remaining part, no apportionment is made. In such a case, the amount is allocated wholly to the relevant part of the asset. Examples where the apportionment rule applies are where a taxpayer disposes of three of 10 acres of land, where a taxpayer who owns a 30% interest in an asset disposes of a 20% interest or where the owner of an asset disposes of an interest (eg by contributing the asset to a partnership). Assumption of liability If a CGT asset is acquired from another entity and it is subject to a liability, the first element of the cost base and reduced cost base of the asset includes the amount of the assumed liability (s 112-35). Earnout arrangements Special tax rules apply for the treatment of earnout rights from 24 April 2015 (ITAA97 Subdiv 118-I). Where an acquisition of business assets involves a “look-through earnout right” entered into on or after 24 April 2015, the buyer’s cost base or reduced cost base of those assets: • excludes the value of the right

• is increased by any financial benefits provided by the buyer under the right, and • is reduced by any financial benefit the buyer receives under the right (s 112-36). As financial benefits under a look-through earnout right may be provided or received for up to four years after the acquisition, the amendment period for an assessment involving such a right is four years after the expiry of the right. In addition, a taxpayer is allowed to vary a CGT choice affected by financial benefit provided or received under the right. The variation must be made by the time the taxpayer is required to lodge the tax return for the income year in which the financial benefit is provided or received. Where an earnout is not a “look-through earnout right”, the Commissioner considers that: • under a standard earnout arrangement — the creation of an earnout right in the seller constitutes the giving of property by the buyer for the purposes of the cost base rules. Accordingly, when a buyer acquires a CGT asset in exchange for granting that right, the first element of the cost base of the asset includes the market value of the right (worked out at the time of acquisition). • for the seller — the first element of the cost base of the earnout right is that part (which may be all) of the market value of the original asset given by the seller in exchange for the right as is reasonably attributable to its acquisition (former Taxation Ruling TR 2007/D10: withdrawn because most earnout arrangements created on or after 24 April 2015 will qualify for look-through treatment under ITAA97 Subdiv 118-I). Put options The first element of the cost base and reduced cost base of a right to dispose of a share in a company that a taxpayer acquires as a result of CGT event D2 happening is the sum of: • the amount included in the taxpayer’s assessable income as ordinary income as a result of acquiring the right, and • the amount (if any) paid by the taxpayer to acquire the right (s 112-37). If a company issues tradable put options to a shareholder, the market value of the options at the time of issue is included in the shareholder’s assessable income (FC of T v McNeil 2005 ATC 4658). This amount is not taxed again if the shareholder makes a capital gain or loss when a subsequent CGT event happens to the rights or the shares disposed of as a result of the exercise of the rights (applicable to rights issued on or after 1 July 2001). Special rules modifying cost base and reduced cost base There are many other specific situations that may require the cost base and reduced cost base of a CGT asset to be modified (s 112-40 to 112-97). Subdivision 112-B contains a number of tables (each one covering a particular topic) which describe each situation that may result in a modification to the general cost base rules. In addition, Subdiv 112-C and 112-D explain how a replacement asset rollover and a same-asset rollover will modify the cost base or reduced cost base (see “Cost base modifications in rollover of assets” below). Some of the rules affecting specific types of investments, or in particular circumstances, which require adjustments to the cost base and reduced cost base are noted below. Recoupment — limited recourse loans with shortfall in asset value Expenditure does not form part of any element of the cost base or reduced cost base to the extent of any amount received as “recoupment” of it, except so far as the amount is included in the taxpayer’s assessable income (s 110-45(3) and 110-55(6)). If a taxpayer acquires a CGT asset with funds under a limited recourse loan, and the loan was not repaid by the agreed date either by defaulting or otherwise, the market value of the asset at the time is less than the loaned amount, and the lender’s rights are limited to the CGT asset that is the security for the loan, the taxpayer will need to reduce the cost base and reduced cost base of a CGT asset by the amount of the shortfall between the loaned amount used to acquire the asset and the asset’s market value under s

110-45(3) and 110-55(6) (ID 2013/64). A limited recourse loan protects the borrower from any potential economic loss caused by the reduction in value of the CGT asset. In this circumstance, by accepting the value of an asset that is worth less than the loaned amount as full satisfaction of the loan, the lender has compensated the taxpayer for any loss incurred as a result of the decrease in market value of the asset. By defaulting, the taxpayer has obtained an economic gain equivalent to the shortfall amount. That is, notwithstanding that the proceeds from the disposal of the underlying asset are insufficient to repay the loan in full, the taxpayer does not have to repay the shortfall amount. Therefore, the shortfall amount is regarded as having been indirectly received by the taxpayer as a reduction of the loaned amount, ie a “recoupment” under s 20-25 of the ITAA97. Bonus shares and units Bonus shares issued in place of an assessable dividend are taken to have been acquired at that time and their cost base includes the amount of the dividend. If not, they are taken to have been acquired at the same time as the original shares, with the result that they will be CGT exempt if the original shares were pre-CGT. If the original shares were post-CGT, the cost base of the bonus shares is calculated by spreading the cost of the original shares over the total number of original and bonus shares (ID 2013/19: bonus shares acquired before 1 July 1998 and disposed of subsequently). Similar rules apply to bonus units. Example Sam bought 400 shares in OPT Ltd for $1 each — 100 shares on 1 June 1985 and 300 shares on 27 May 1986. On 15 November 1986, Sam received 400 bonus shares from OPT Ltd, fully paid to $1. Sam did not have to pay anything for the bonus shares and no part of bonus shares was taxed as a dividend. The acquisition date of 100 of the bonus shares is 1 June 1985 (pre-CGT) and these bonus shares are not subject to CGT. The acquisition date of the other 300 bonus shares is 27 May 1986. Their cost base is worked out by spreading the cost of the original 300 shares Sam bought on that date over both those shares and the 300 bonus shares, ie the cost base of each share will now be 50 cents.

Cost base adjustments for non-assessable payments received If you receive non-assessable payments (not dividends) in respect of the shares or units that you hold without disposing of the shares of units, certain cost base adjustments may be required and a capital gain may arise. You cannot make a capital loss from a non-assessable payment. Company payments If a company makes a non-assessable payment to shareholders (eg a reduction of share capital, see CGT event G1 at ¶2-110), and the non-assessable payment amount is not more than the cost base of the shares, the cost base and reduced cost base of the shares are reduced by that amount. If the nonassessable payment amount is more than the cost base, you will make a capital gain equal to the excess. In this case, the cost base and reduced cost base of the shares are reduced to nil. Managed fund payments Non-assessable payments from a managed fund (eg a unit trust that is a property trust, share trust, equity growth trust, balanced trust) are quite common. The treatment of non-assessable payments is explained below. For the grossing-up rules for discounted capital gains, see ¶2-360. If non-assessable payments are received because you hold units in a unit trust (unit), they will be shown on the distribution statement received from the unit trust as: • tax-free amounts under s 104-71(3) of the ITAA97 (ie the unit trust has received certain tax concessions and can pay greater distributions to its unitholders). Unitholders are required to reduce the reduced cost base of their units by these amounts, not the cost base of the units. These amounts now only include infrastructure borrowing amounts under s 159GZZZZE and exempt income arising from shares in a pooled development fund under s 124ZM and 124ZN of the ITAA36 • CGT-concession amounts under s 104-71(4) (ie the unit trust’s CGT discount and capital losses components of any actual distribution) (see also ¶2-250 for MIT distributions)

• tax-exempted amounts under s 104-71(1) (ie generally made up of exempt income of the unit trust, amounts on which the trust has already paid tax or income repaid to the trust). Unitholders are not required to adjust either the cost base or reduced cost base of their units for these amounts, or • tax-deferred amounts (other non-assessable amount allowed to the trust on its capital gains and accounting differences in income) under s 104-71(1). Unitholders are required to reduce both the cost base and reduced cost base of their units by these amounts. Building allowance amounts paid on or after 1 July 2001 are treated as tax-deferred amounts.

Summary — effect on cost base and/or reduced cost base of units held: • tax-exempted amounts received — does not affect the cost base or reduced cost base • CGT-concession amounts received — does not affect the cost base or reduced cost base • tax-deferred amounts received — reduce the cost base and reduced cost base by the amount (if the tax-deferred amount is greater than the cost base of the unit or trust interest, the excess is a capital gain) • tax-free amount received — reduce the reduced cost base by the amount.

The indexation method may be used if the units or trust interest were bought before 21 September 1999. In that case, the discount method cannot be used to work out the capital gain when the units or trust interest are later sold. Adjustments to the cost base or reduced cost base of the unit are usually made at the end of the income year during which the payments are received, unless some other CGT event happens to the unit or trust interest during the year (eg the unit is sold), in which case the adjustments are made just before that CGT event and the adjusted cost base or reduced cost base are used to work out the capital gain or capital loss at that time. Dividend reinvestment plans If you participate in a dividend reinvestment plan, you are treated as if you had received a cash dividend and then used the cash to buy new shares. Shares acquired in this way, on or after 20 September 1985, are subject to CGT. Included in the cost base of the new shares is the price you paid to acquire them, ie the amount of the dividend. Example Natasha owns 1,440 shares in OPT Ltd. The shares are currently worth $8 each. OPT Ltd declared a dividend of 25 cents per share. Natasha could either take the $360 dividend as cash (1,440 × 25 cents) or receive 45 additional shares in the company ($360 ÷ $8). She decided to participate in the dividend reinvestment plan and received 45 new shares on 20 December 2019. For the income tax, Natasha must include the $360 dividend in her taxable income. For CGT, she has acquired the 45 new shares on 20 December 2019 for $360.

Issued or purchased rights, options There are no immediate CGT consequences if a shareholder (or unitholder) exercises rights to acquire additional shares, units or options, and did not pay anything for the rights. In effect, the CGT liability is rolled over (deferred) until the shares, units or options are themselves disposed of. In calculating the liability on that disposal, the cost base of those assets will include any amount paid to exercise the rights. In addition, if the original holding was pre-CGT, the cost price includes the market value of the rights at the time they were exercised. Similar rules apply where the rights were purchased from an existing shareholder (or unitholder), except that the cost base of the shares, units or options includes the purchase price for the rights as well as any

amount paid to exercise them. Convertible notes The conversion of a note into shares does not have any immediate CGT consequences. Instead, the CGT liability is rolled over until the shares themselves are disposed of. In calculating this liability, the cost base of those shares includes their market value at the date of conversion. However, if the note was not classed as a “traditional security”, the cost of the shares is instead taken to be the amount paid for the note plus the amount paid for the conversion. Part-disposal of parcel of shares A taxpayer who sells part of a holding of identical shares has the option of deciding which particular shares are being disposed of, or adopting the “first in, first out” method as a reasonable basis for identification. Alternatively, average cost may be used if the shares were acquired on the same day. This also applies to units in a unit trust. Employee share schemes An employee share scheme (ESS) is a scheme where shares or rights in a company are provided to an employee in relation to their employment. A share provides an employee with an ownership interest in a company, and a right enables an employee to acquire a share in a company at some point in the future. Some companies encourage employees to participate in ESSs by offering employees shares, stapled securities, or rights (including options) to acquire them (ESS interests), at a discount. The basic rule is that a discount received on a share or rights under an ESS interest is taxed primarily under the income tax rules pursuant to ITAA97 Div 83A. The taxation on a discount received on an ESS interest will only be deferred in the limited circumstances where there is a genuine risk of forfeiture or a salary sacrifice arrangement has been entered into. A capital gain or loss arising from a CGT event (other than CGT event E4, G1 or K8) that happens to an ESS interest will be disregarded to the extent that an amount will be, but has not yet been, included in the taxpayer’s assessable income (s 130-80(1)). Where the discount received on the ESS interest is included in the employee’s assessable income in the income year of acquisition, the first element of the cost base of an ESS interest will be its market value (s 83A-30). Where the taxing point of the ESS interest is deferred, for CGT purposes the recipient will be treated as having acquired the ESS interest at the ESS deferred taxing point for its then market value (s 83A-125). For ESS interests acquired after 30 June 2009, ITAA97 Div 83A contains specific rules about how tax applies to the ESS interests (ie to shares, stapled securities and rights to acquire them (including options)), that have been provided to employees at a discount. If ESS interests have not been granted at a discount, the benefits given to employees may be taxed under other provisions of the tax law, such as CGT. Concessions for interests in small start-up companies — CGT implications A small start-up concession is available if an ESS, the company in which the interest is issued, the employer and the employee meet certain conditions (ITAA97 s 83A-33). Basically, where the conditions are met, the employees of the start-up company do not include a discount on ESS interests acquired in their assessable income and are subject to the CGT rules below: • for shares — the discount is not subject to income tax and the share, once acquired, is then subject to CGT with a cost base reset at market value • for rights — the discount is not subject to upfront taxation and the right is then subject to CGT with a cost base equal to the employee’s cost of acquiring the right (ITAA97 s 83A-30(2) and 130-80(4)). There will be no CGT on the exercise of rights and the resulting acquisition of shares (due to the availability of a CGT rollover). However, upon exercise, the exercise price of the rights will form part of the cost base of the resulting shares. The employee will generally include any CGT in his/her assessable income (as part of working out the net capital gain or loss) on disposal of the resulting shares.

CGT discount The CGT discount rules (¶2-215) are modified in relation to ESS interests that are rights to acquire shares and that benefited from the small start-up concession. When determining the acquisition time for a share that has been acquired by way of exercising a right (ie the ESS interest), the acquisition time for CGT discount purposes is the time at which the right was acquired, and not the time at which the share was acquired. This will ensure that the CGT discount is available so long as the right and underlying share are sequentially held for 12 months or more (s 115-30(1) table, item 9A). Example: shares Tanya is issued with 20,000 shares in a small Australian start-up entity under an ESS. The shares at issue have a market value of $1 per share. Tanya contributes 85¢ per share under the scheme. On acquisition, Tanya receives a discount of $3,000 which is not included in her assessable income (ie not subject to income tax). After five years, the Australian start-up entity is sold under an arrangement where Tanya receives $1.50 per share for each of shares. Her shares will have a cost base for CGT purposes of $20,000. When Tanya sells her shares she has a discount capital gain of $5,000 which is included in her net capital gain or loss for the income year. If Tanya has no other capital gains or losses for that year, and no capital losses carried forward from a previous year, the $5,000 is then included in her assessable income in that income year.

Example: right Alex is issued with 10,000 options under an ESS operated by his small Australian start-up employer for no consideration which allow him to acquire 10,000 ordinary shares in his employer after paying an exercise price of $1.50 per right (which is more than the current market value of each share of $1 per share). After five years, Alex exercises each right by paying $15,000, and then immediately sells the shares for $2.00 each and receives proceeds of $20,000. On acquisition, Alex does not include any amount in his assessable income in relation to the discount received on his options. His options will have a nil cost base for CGT purposes. There will be no CGT on exercise of his rights and receipt of his shares (due to the availability of a CGT rollover). However, on exercise, the cost base of his shares will be $1.50 per share. On the sale of his shares Alex will have a discount capital gain of $2,500 that is included in his net capital gain or loss for the income year. If Alex has no other capital gains or losses for that year, and no capital losses carried forward from a previous year, the $2,500 is then included in his assessable income for the income year.

Note that the small start-up concession applies to the exclusion of all other ESS taxation rules, ie those eligible for the small start-up concession cannot access either the $1,000 upfront concession or the deferred taxation concession (ITAA97 s 83A-35(2)(c), 83A-105(1)(ab)). Shares or rights acquired under employee share trusts If a taxpayer acquires an ESS interest as a result of an interest held in an employee share trust, the taxpayer is treated for the purposes of the ESS and CGT provisions as being absolutely entitled to the share or right (s 130-85). The capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, will be disregarded to the extent that it results from either CGT event E5 or E7 from the disposal of share acquired by the trust as a result of exercising a right that was an ESS interest (s 130-90). Temporary residents Capital gains and losses realised on ESS interests acquired under an ESS will be eligible for the CGT exemption for temporary residents in a similar manner as other CGT assets, provided the taxing point has occurred under the Div 83A income tax provisions. The exemption for temporary residents will not apply to ESS interests that constitute taxable Australian property (¶2-280). Return of capital to shareholder or unitholder If a company returns capital to a shareholder and the payment exceeds the cost base of the shares, there will be a capital gain to the shareholder and the cost base of the shares will be reduced to nil. If the

payment does not exceed the cost base, the cost base is reduced by the amount of the payment. A similar rule applies where a trust (such as a property trust) makes a tax-free payment to a unitholder. Example Christine owns units in a unit trust that she bought on 1 July 2008 for $10 each. During 2019/20, the trustee makes two tax-free payments of $1 a unit. Christine’s cost base for the units would be reduced by $2 to $8. Therefore, if Christine were to subsequently sell her units for more than their cost base at the time, she will make a capital gain equal to that excess.

Gifts If the transaction is not on commercial terms, or is a gift, it is treated as if the asset had been transferred at market value. Mergers, splits The cost base has to be split up where the one transaction covers more than one asset, or involves a part-disposal of a single asset. Conversely, cost bases have to be combined where separate assets are merged. Value shifts The cost base of shares in a company may have to be adjusted where there has been a value shift between companies that are under common ownership. The same applies to the cost base of loans to the company. Income-producing buildings The cost base of an income-producing building acquired after 13 May 1997 is reduced by the amount of any capital write-off deductions allowed on the building. This measure is subject to transitional provisions. Balancing adjustments and depreciating assets CGT event K7 happens where a balancing adjustment event happens to a depreciating asset that has been used, or installed ready for use, wholly or partly for a non-taxable purpose (¶2-110). In broad terms, a taxable purpose is a business purpose. A capital gain or loss under CGT event K7 is calculated on the basis of the asset’s cost and termination value (instead of the usual CGT basis of cost base and capital proceeds). This is to ensure consistency of treatment between the capital allowance rules and the CGT rules. Any gain or loss is treated as arising at the same time as any balancing adjustment that may occur. If the use is 100% taxable, CGT event K7 does not apply. Instead, there will be a balancing adjustment under the capital allowances system. If the use is 100% non-taxable, there will be a capital gain/loss under CGT event K7 based on the difference between the asset’s termination value and its cost. In such a case, there will be no balancing adjustment. If there is partly taxable and partly non-taxable use, there may be both a balancing adjustment and a capital gain/loss. Any capital gain/loss is based on the difference between the termination value and the cost, apportioned to reflect the taxable component of the decline in value. Special rules apply to depreciating assets that have been allocated to a low-value pool. A capital gain or loss under CGT event K7 is ignored if the asset was acquired before 20 September 1985. If the private use of the asset is such that it falls within the personal use asset rules, capital gains are exempt if the asset was acquired for $10,000 or less and capital losses are ignored (¶2-340). The CGT discount can apply to capital gains made as a result of CGT event K7, but not the small business concessions (¶2-310). Cost base modifications in rollover of assets CGT rollovers are discussed in ¶2-410. A replacement asset rollover allows a taxpayer to defer the making of a capital gain or loss from one CGT event until a later CGT event happens (s 112-105). It involves the taxpayer’s ownership of one CGT asset ending and the acquisition of a replacement asset. If the original CGT asset was a post-CGT asset, the

first element of the replacement asset’s cost base and reduced cost base is replaced by the original asset’s cost base and reduced cost base at the time the taxpayer acquired the replacement asset (s 112110). In addition, some replacement asset rollovers involve other rules that affect the cost base or reduced cost base of a replacement asset. If the original CGT asset was a pre-CGT asset, the replacement asset is also taken to be a pre-CGT asset. A same-asset rollover allows one entity (the transferor) to ignore a capital gain or loss it makes from disposing of a CGT asset to, or from creating a CGT asset in, another entity (the transferee). Any capital gain or loss is deferred until another CGT event happens in relation to the asset in the hands of the transferee (s 112-140). If the CGT asset was a post-CGT asset in the hands of the transferor, the first element of the asset’s cost base and reduced cost base in the hands of the transferee is replaced by the asset’s cost base and reduced cost base in the hands of the transferor at the time the transferee acquired it (s 112-145). If the asset was a pre-CGT asset in the hands of the transferor, it continues to be a pre-CGT asset in the hands of the transferee.

¶2-208 Capital proceeds rules The capital proceeds from a CGT event are relevant to work out if you have made a capital gain or loss from a CGT event happening (¶2-200). Subject to certain modifications, the general rule is that the capital proceeds from a CGT event are the total of: • the money you have received, or are entitled to receive, in respect of the event happening, and • the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). A payment mechanism directing the consideration to a related party did not change or extinguish a taxpayer’s entitlement to receive the proceeds in respect of the disposal of a property magazine business (Quality Publications Australia Pty Ltd v FC of T 2012 ATC ¶20-317). There are six modifications to the general capital proceeds rule which may be relevant: 1. Market value substitution rule — if you do not receive any capital proceeds from a CGT event, the market value of the relevant CGT asset is taken to be the amount of the capital proceeds (ITAA97 s 116-30). From the 2006/07 income year, the market value substitution rule does not apply where CGT event C2 (¶2-110) occurs in relation to certain interests in widely held entities (ie a share in a company or a unit in a unit trust where the company has at least 300 members or the trust has at least 300 unitholders and neither has concentrated ownership). 2. Apportionment rule — if payments are received in connection with a transaction that relates to more than one CGT event or to a CGT event and something else, the capital proceeds for the respective CGT events are so much of the payments as are reasonably attributable to each CGT event (ITAA97 s 116-40). 3. Non-receipt rule — the capital proceeds from a CGT event are reduced if it is unlikely that you will receive some or all of those proceeds (ITAA97 s 116-45). However, this rule only applies if the nonreceipt did not arise because of anything you did or did not do and all reasonable steps were taken to enforce payment of the unpaid amount. The amount of the reduction is the unpaid amount. 4. Repaid rule — the capital proceeds from a CGT event are reduced by any part of them that is repaid by you and by any compensation paid by you that can reasonably be regarded as a repayment of part of them (ITAA97 s 116-50). However, the capital proceeds are not reduced by any part of the payment that is deductible. The payment can include giving property. 5. Assumption of liability rule — the capital proceeds from a CGT event are increased if the entity acquiring the relevant CGT asset acquires it subject to a liability by way of security over the asset

(ITAA97 s 116-55). In such a case, the capital proceeds are increased by the amount of the liability that the acquiring entity assumes. 6. Misappropriation rule — the capital proceeds from a CGT event will be reduced if an employee or agent misappropriates all or part of those proceeds. If the taxpayer later receives an amount as recoupment of all or part of the misappropriated amount, the capital proceeds will be increased by the amount received (ITAA97 s 116-60). Not all modifications can apply to all CGT events — see the table in ITAA97 s 116-25 which sets out what modifications can apply to a specific CGT event and the special rules (if any) applying to a particular event. For example, capital proceeds can include any payment you received for granting, renewing or extending the option. Also, the capital proceeds from the expiry, surrender or forfeiture of a lease include any payment (because of the lease ending) by the lessor to the lessee for expenditure of a capital nature incurred by the lessee in making improvements to the leased property.

¶2-210 Calculating the capital gain or loss Once you know the relevant cost base of the asset (¶2-200) and the capital proceeds, you can work out if there has been a capital gain or loss. You must first see whether the CGT assets to which the CGT event has happened fall into the categories below: • personal use assets (eg a boat, furniture and other household items for personal use and enjoyment) • collectables (eg jewellery, antiques) • land, buildings and capital improvements • active assets in a small business, or • other assets. This is because special rules apply for personal use assets and collectables (¶2-340), land, buildings and capital improvements (¶2-350) and active assets in a small business (¶2-300). Special rules also apply for beneficiaries who receive a trust distribution which has benefited from the discount capital gain or small business concessions (¶2-360). Taxation Ruling TR 2011/6 sets out the business-related capital expenditure (“blackhole expenditure” in s 40-880 of ITAA97) that can be taken into account when working out a capital gain or capital loss from a CGT event. Capital gain To work out if there has been a capital gain, you generally subtract the cost base from the proceeds of disposal. Indexation To calculate the cost base of a CGT asset that was purchased before 21 September 1999, you may need to allow for inflation. This inflation adjustment is called “indexation” because it is measured by increases in the Consumer Price Index (CPI). To index the cost base, you multiply it by the percentage increase in the CPI for the period from the quarter in which the asset was acquired until the September 1999 quarter, ie the indexed cost base is “frozen” at that point. The frozen indexed cost base method is an option for certain taxpayers to work out the capital gain only if the CGT asset was purchased before 21 September 1999 (¶2-215). If the CGT asset is purchased on or after 21 September 1999, there is no indexation of cost base for any taxpayer. Example Grace sold a parcel of Friendly Bank shares for $18,000 which she had purchased in June 1995 for $15,000. Brokerage and other

incidentals are $300. She chooses the indexation option (with indexation frozen up to the September 1999 quarter) to calculate the capital gain. The indexation number is 68.7 for the September 1999 quarter and 64.7 for the June 1995 quarter.

$  Capital proceeds

18,000

Less: (indexed) cost base: ($15,000 + $300) × 68.7/64.7

16,246

Capital gain

$1,754

If any part of the expenditure that was taken into account in the cost base was incurred in a quarter after the asset was acquired, indexation for that amount is calculated separately. This may apply, for example, where enhancement costs are later incurred on land that was earlier acquired. Indexation does not apply unless the person acquired the asset at least 12 months before the CGT event (TD 2002/10: (¶2-215), or to the third element of an asset’s cost base (¶2-200). Capital loss To work out if there has been a capital loss, you subtract the capital proceeds from the reduced cost base. The reduced cost base is not indexed. Example Trevor sells a parcel of Bonanza Mining shares for $5,000 which he had purchased for $12,000. Brokerage and other incidentals are $300.

$  Reduced cost base: $12,000 + $300 Less: capital proceeds Capital loss

12,300 5,000 $7,300

No capital gain or capital loss It can happen that a particular transaction does not produce either a capital gain or a capital loss. This will occur when the proceeds of sale are less than the (indexed) cost base, but equal to or more than the reduced cost base. In these cases, the CGT rules have no effect. Example Adam purchased pre-1 July 2001 plant for $120,000 and subsequently sells it for $85,000, at which time its adjustable value is $48,000. As a result of the disposal, an assessable balancing charge of $37,000 arises (ie $85,000 − $48,000). The reduced cost base of the plant is calculated as follows:

$  Cost of acquisition

120,000

Less: depreciation allowed

72,000

Adjustable value

48,000

Add: balancing adjustment

37,000

Reduced cost base

$85,000

As the reduced cost base is equal to the capital proceeds, neither a capital gain nor a capital loss arises.

Choice of CGT discount or indexation available in certain cases From 21 September 1999, the capital gains that are included in assessable income may be reduced by a CGT discount if the taxpayer is an individual, a trust, a complying superannuation entity or a life insurance company in respect of its complying superannuation (¶2-215). Calculating the tax To calculate a taxpayer’s tax liability in a year of income, all the capital gains and losses for the year are aggregated to see if there is a net capital gain or loss (¶2-500).

¶2-215 Discount capital gain A discount capital gain is a capital gain made by an “eligible taxpayer”, namely an individual, a complying superannuation entity (ie a complying superannuation fund, complying approved deposit fund (ADF) or PST), a trust, or a life insurance company in respect of its complying superannuation assets, from a CGT event happening after 11.45 am on 21 September 1999 to an asset owned by the taxpayer, where the gain is worked out without indexation of the asset’s cost base. CGT discount percentage A taxpayer’s taxable capital gain is calculated by applying the discount percentage to the discount capital gain (as calculated without indexation of the cost base) remaining after the application of any current year or prior year capital losses (s 102-5). The CGT discount percentage is: • for an individual or trust — 50%, so only half of the capital gain is included in assessable income. • for a complying superannuation entity or life insurance company — 33⅓%, so only two-thirds of the capital gain is included in assessable income. Resident shareholders in a listed investment company may also benefit from the CGT discount on assets realised by the company (see “Investments in listed investment companies” below). No or reduced CGT discount for certain foreign resident beneficiaries The general CGT rules that apply to foreign residents are discussed in ¶2-280. The CGT discount is not available, or must be pro-rated, for discount capital gains accrued after 8 May 2012, for a foreign resident and temporary resident individual who makes a discount capital gain, directly or indirectly, as a beneficiary of a trust where the trustee is assessed under the Income Tax Assessment Act 1936 (ITAA36) s 98. The 50% discount percentage is reduced for any periods in which the individual has been a foreign resident or a temporary resident during the period of ownership, subject to transitional rules for assets held as at that date (s 115-105, 115-110, 115-115): • for CGT assets held on 8 May 2018 — the calculation of the reduced discount percentage depends on the circumstances, including the asset acquisition date and the individual’s residency status on 8 May 2012. The acquisition date and eligible resident days may be affected where the individual directly holds the asset but is treated as having acquired the asset on an earlier date under s 115-30 (s 115105(3)) • for CGT assets acquired after 8 May 2012 by an individual who was a foreign or temporary resident for the entire period the CGT asset was held — the discount percentage is 0%, and • for CGT assets acquired before 9 May 2012, and CGT assets acquired after 8 May 2012 where the residency status of the individual owner changes during the time the CGT asset was held — the discount percentage is reduced proportionately to reflect the periods the individual was eligible for the CGT discount. In addition, regardless of whether the individual made the discount capital gain directly or as a result of being a beneficiary of a trust, individuals who were foreign or temporary residents on 8 May 2012 can

receive the CGT discount for the gains accrued before 8 May 2012 if a market valuation of the CGT assets at 8 May 2012 has been made. This is to preserve access to the full 50% CGT discount percentage for the accrued gain to date. Proposed measures 60% CGT discount for affordable housing The government has proposed an increase in the CGT discount from 50% to 60% from 1 January 2018 for Australian resident individuals investing, either directly or indirectly through certain trusts, in qualifying affordable housing (2017 Budget Paper No 2, p 290; Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No 2) Bill 2018 (lapsed)). No CGT discount for MITs and AMITs The proposal to prevent managed investment trusts (MITs) and attribution MITs (see (¶2-250)) from applying the 50% CGT discount at the trust level for payments will apply from 1 July 2020, instead of 1 July 2019 as announced in the 2018 Federal Budget. This measure will prevent beneficiaries that are not entitled to the CGT discount in their own right from getting a benefit from the CGT discount being applied at the trust level, and ensure that MITs and AMITs operate as genuine flow-through tax vehicles so that income is taxed in the hands of investors as if they had invested directly. MITs and AMITs that derive a capital gain will still be able to distribute this income as a capital gain that can be discounted in the hands of the beneficiary (2018 Budget Paper No 2, p 44; MYEFO 2018/19, December 2018). Asset held for 12 months minimum To be a discount capital gain, the eligible taxpayer must have owned the asset for “at least 12 months” before the CGT event that gave rise to the gain (ITAA97 s 115-25(1)). The 12-month rule means that a period of 365 days (or 366 in a leap year) must elapse between the day on which the asset was acquired and the day on which the CGT event happens (TD 2002/10). Note this interpretation similarly applies for cost base indexation purposes under ITAA97 s 114-10(1), ie indexation is only available for a CGT asset acquired at or before 11.45 am on 21 September 1999 and at least 12 months before the CGT event (¶2-210). In some cases, if you acquire an asset within 12 months of the CGT event happening you may still be eligible for the CGT discount. For example, assets acquired under certain same-asset or replacementasset rollover (¶2-410), or under the rules applying to deceased persons (¶19-555), will generally be treated (for the purposes of claiming the CGT discount) as having been owned for at least 12 months if the collective period of ownership is at least 12 months (Paule v FC of T; Hart v FC of T 2019 ATC ¶20689, appeal to Full Federal Court pending: no CGT discount in a Subdiv 124-M replacement-asset rollover, no sequential or combined operation in collective period; Mangat v FC of T [2018] AATA 301: cancellation of employee share scheme interests). Note that a pre-CGT asset of the deceased is taken to be acquired by the legal personal representative or beneficiary at the date of the death of the deceased for purposes of applying the 12-month test (see the example at ¶2-220). The CGT discount is not available for the following CGT events because the 12-month ownership rule cannot be satisfied — CGT events D1 to D3, E9, F1, F2, F5, H2, J2, J5, J6 and K10 (see ¶2-110 for details of these events). Gains which are not discount capital gains A capital gain from a CGT event is not a discount capital gain in two cases: (1) where the taxpayer makes a capital gain from a CGT event happening to an asset acquired by the taxpayer more than 12 months before the CGT event under an agreement entered into within that 12month period (2) where there is change to equity interests in a company or trust in certain circumstances.

The first rule prevents taxpayers from taking advantage of the CGT discount by artificially extending the period of ownership of the asset. The second rule is aimed at stopping taxpayers from obtaining the benefit of discount capital gains by purchasing assets through an existing company or trust and selling the shares or trust interest (which has been held for at least 12 months) even though the underlying asset has been held by the company or trust for less than 12 months (s 115-45). The rule does not apply to companies or trusts with 300 or more members or beneficiaries, unless there is “concentrated ownership” of the company or trust (s 115-50). Should you choose the CGT discount or indexation option to calculate your capital gains? There is no one factor which determines the basis to select the better option. The choice essentially depends on the type of asset you own, how long you have owned it, the dates you owned it and the past rates of inflation. Also, as capital losses must be offset against capital gains before the discount is applied, your choice may depend on the amount of capital losses you have available. For CGT assets acquired before 21 September 1999, you can choose the discount on the capital gain or include indexation when calculating the capital gain. If you choose the CGT discount, the capital gain is calculated without indexation of the asset’s cost base. If you choose the indexation option, the cost base is indexed but only up to the September 1999 quarter (ie indexation is frozen to that time). For CGT assets acquired on or after 21 September 1999, the indexation option is not available for all taxpayers. Summary of choice rules Asset acquired before 11.45 am on 21 September 1999 but CGT event happened after that time For assets owned for at least 12 months, you can choose to: (1) calculate the capital gain with a cost base that includes indexation frozen at 30 September 1999, or (2) calculate the capital gain without cost base indexation and reduce the non-indexed gain by the relevant CGT discount. If the assets are owned for less than 12 months, neither indexation nor the CGT discount is available. Asset acquired after 11.45 am on 21 September 1999 and CGT event happens after that time For assets owned for at least 12 months, you can reduce the non-indexed gain by the CGT discount. As noted above, cost base indexation no longer applies for all taxpayers for assets acquired on or after 21 September 1999. Asset owned by any other type of taxpayer (eg a company other than a life insurance company) They are not entitled to the frozen indexed cost base or CGT discount options. Trusts and beneficiaries The grossing-up rules for calculating the income of beneficiaries of a trust which has claimed the CGT discount and/or the 50% small business active asset reduction in its net income is discussed at ¶2-360. ATO guidelines — trust income Where an amount included in a beneficiary’s assessable income under ITAA36 s 99B(1) had its origins in a capital gain from non-taxable Australian property of a foreign trust, the beneficiary cannot offset capital losses or a carry-forward net capital loss (“capital loss offset”) or access the CGT discount in relation to the amount (Taxation Determination TD 2017/24). Example (from TD 2017/24) In June 2014, the trustee of a foreign trust for CGT purposes sells shares in an Australian public company that it had owned for five years. The trustee makes $50,000 capital gains in total. The shares are not taxable Australian property. In August 2016, the trustee distributes an amount attributable to the capital gains to Erin, a resident of Australia. Erin has a $40,000 net capital loss that she has carried forward from the 2013 income year. The capital gains are not taken into account in calculating the trust’s net income for the 2014 income year (ITAA97 s 855-10).

Erin must include the entire $50,000 in her assessable income under ITAA36 s 99B. She cannot reduce the amount by her net capital loss or by the 50% CGT discount.

The residency assumption in ITAA36 s 95(1) does apply for the purpose of ITAA97 s 855-10, which disregards certain capital gains of a trust which is a foreign trust for CGT purposes. Accordingly, where a CGT event happens to a CGT asset of such a trust and that asset is not “taxable Australian property”: • the trustee disregards any capital gain (or capital loss) from that event in calculating the net income of the trust under ITAA36 s 95(1), and • ITAA97 Subdiv 115-C does not treat the trust’s beneficiaries as having capital gains (or make the trustee assessable) in respect of the event (Taxation Determination TD 2017/23). However, if an amount attributable to such a gain is paid or applied for the benefit of a resident beneficiary of the trust, the amount may be included in the beneficiary’s assessable income under s 99B of the ITAA36. Investments in listed investment companies As a general rule, if you own shares and receive a distribution of a capital gain as a dividend, you do not benefit from any CGT discount that might have been available if you had been an eligible taxpayer (see above) and had made the capital gain directly. To address this anomaly, a special rule applies in the case of dividends received from listed investment companies (LICs). Resident shareholders in LICs can benefit from the CGT discount on assets realised by the LIC, provided that the assets have been held for more than 12 months. LIC shareholders who receive a dividend that is attributable to a capital gain will be allowed a deduction that reflects the CGT discount the shareholder could have claimed if they had made the capital gain directly. For example, if the shareholder is an individual or a trust, the deduction will be equal to 50% of the attributable part and, if the shareholder is a complying superannuation entity, the deduction will be 33⅓%.

¶2-220 Who makes the capital gain or loss? Normally it is obvious who has made the capital gain or loss. For example, if an asset is sold, it will be the seller, but special rules are necessary in particular cases so as to ensure that the CGT provisions look through certain nominee owners to the underlying owners of the CGT asset. Partnerships It is the individual partners who make the capital gain or loss, not the partnership itself. A proportionate share of the gain or loss is attributed to each partner, based on their interest in the partnership and what the partnership agreement says. If a partner retires, leaves or dies, the continuing partners are treated as if they had acquired a new asset consisting of the departing partner’s interest in the partnership assets. If a new partner is admitted, the original partners are treated as if they had disposed of an appropriate part of their interest in the partnership assets to the new partner. Tenants in common and joint tenants Two or more people may hold property (an asset) as tenants in common or as joint tenants. If a tenant in common dies, his/her interest in the property is an asset of the deceased’s estate. That is, it can only be sold or passed to a beneficiary by the legal personal representative of the estate. Each individual who owns a CGT asset as joint tenants is treated as if he/she owns a separate CGT asset, constituted by an equal interest in the asset, and is treated as if he/she owns an equal interest as a tenant in common (s 108-7). That is, if a joint tenant dies, his/her interest in the asset is taken to pass in equal shares to the surviving tenant(s), as if the interest is an asset of the deceased estate and the surviving tenants are beneficiaries. A joint tenant was liable to CGT on his share of the capital gain on the sale of an asset (property) even though he was on the title to protect the property from being sold by the

other joint tenant on a whim (Gerbic v FC of T [2013] AATA 664). The cost base rules relating to other assets of the deceased estate apply to the equal shares which pass to the surviving tenants (see further: ¶19-150, ¶19-555). For the 12-month ownership period rule for CGT discount purposes (¶2-215), a surviving joint tenant is taken to have acquired the deceased’s interest in the asset (or a share of it) at the time the deceased person acquired it. Example Tom and Jerry purchased land before 20 September 1985 as joint tenants. Jerry died in December 2018. For CGT purposes, Tom is taken to have acquired Jerry’s interest in the land at market value at the date of death. Tom therefore holds his 50% interest as a pre-CGT asset, and the inherited 50% interest as a post-CGT asset (ie acquired at market value in December 2018). If Tom sells the land within 12 months of Jerry’s death, Tom will qualify for the CGT discount as Tom is taken to have acquired the inherited interest at the time the deceased acquired it (ie before 20 September 1985) for the purpose of the 12-month ownership period rule.

The separate asset rule and the CGT consequences of a tenant in common acquiring the interest of another tenant in common is discussed in Taxation Determination TD 2000/31 (¶2-350). Bankruptcy, liquidation, trusts, security holders When a person becomes bankrupt and their assets pass to the trustee in bankruptcy, this in itself does not have any CGT consequences. What the trustee subsequently does with the assets is treated as if it had been done by the bankrupt person. This means that any capital gain or loss is made by the bankrupt, not the trustee. If a mortgagee exercises a power of sale over an asset, any capital gain or loss is made by the asset’s owner, not the mortgagee. If a liquidator sells assets of the company, any capital gain or loss is made by the company, not the liquidator. An issue on the disposal of the land of a company as part of a winding up where a capital gain is made is whether the liquidator is required (pursuant to ITAA36 s 254(1)) to retain an amount out of the sale proceeds to pay tax which is or will become due in respect of the gain. The Full Federal Court held in FC of T v Australian Building Systems Pty Ltd (in liq) & Ors 2014 ATC ¶20-468 that liquidators and receivers and managers cannot be held personally liable for any CGT liability subsequently assessed as due, where funds are remitted in the ordinary course and to secured creditors before the Commissioner issues an assessment. That is, in the absence of a notice of assessment, there could be no obligation to retain sale proceeds for tax which had not yet been assessed. The High Court has confirmed that the liquidators were not required by s 254(1)(d) to retain any amount from the proceeds of the sale of land sufficient to pay a liability for income tax that might arise in relation to the CGT event. The s 254 payment and retention obligations arose only on the issuing of a notice of assessment (2015 ATC ¶20-548; ATO Decision Impact Statements: B19/2015, B 20/2015). Although no obligation arises under s 254, a liquidator should retain, as a matter of prudential practice, an amount from the sale of an asset to satisfy a potential tax liability until the income tax position has been ascertained by way of an assessment for the tax year in which the CGT event occurred. Additional rules ensure the proper operation of the CGT law as below: • the treatment of a bankrupt individual as the owner of an asset, rather than the trustee in bankruptcy, extends to the small business “connected entity” test (ITAA97 s 104-10(7), 106-30(1), 109-15, 328125(1) note 1) • absolutely entitled beneficiaries, companies in liquidation and security providers are treated as the owners of certain assets for CGT purposes, including the “stakeholder” tests for scrip for scrip rollover and the small business connected entity test (s 104-10(7), 106-35, 106-50, 109-15, 328125(1) notes 1 and 2), and

• certain acts by a security holder which are treated as being done by the provider also applies to any act done in relation to maintaining a security, charge or encumbrance over an asset (s 106-60(2), 328-125(1) note 3). Trusts and absolutely entitled beneficiaries If an individual is a beneficiary of a trust and is absolutely entitled to a CGT asset as against the trustee of the trust (disregarding any legal disability, eg infancy or mental incapacity), the asset is treated as an asset of the individual (instead of the trust) for CGT purposes and for determining whether an entity is a small business entity. The CGT provisions therefore apply to an act done, in relation to the asset, by the trustee as if the individual had done it (s 106-50), and any capital gain or loss that arises belongs to the individual, not the trustee. With unit trusts and trust assets, the unit in the trust is treated as the relevant asset for CGT purposes (irrespective of any interest the unitholder has in the property of the unit trust at general law: see TD 2000/32). Therefore, unit trust holders are not subject to the general treatment that applies to those who are absolutely entitled for CGT purposes to the assets of a trust. Similarly, the entitlement of superannuation fund members to benefits is governed entirely by the SIS statutory regime and an entitlement to the fund’s assets does not arise under the CGT provisions. Fund members are therefore not treated as if they are absolutely entitled for CGT purposes to the assets of the fund or to assets held in the member’s account. Further guidelines on the concept of “absolute entitlement” in the CGT provisions, see Draft Taxation Ruling TR 2004/D25 and the Decision Impact Statement on Kafataris 2008 ATC ¶20-048. The grossing-up rules applying to the amount that is included in a beneficiary’s capital gains where a trust’s net capital gain has been reduced by the CGT discount (¶2-215) or the small business 50% active asset exemption (¶2-337), or both, are discussed in ¶2-360.

STEP 3: EXEMPTIONS, CONCESSIONS AND SPECIAL RULES ¶2-250 Types of exemption/concession/special rules If you determine that you have made a capital gain or loss as discussed in ¶2-200, the next step is to identify whether there are any relevant exemptions, concessions or special rules that apply. Exemptions or concessions may apply to: • pre-CGT assets — assets purchased before 19 September 1985 (¶2-260) • exempt assets — eg a person’s main residence (¶12-500), motor cars (¶2-270) • exempt receipts or proceeds — eg life insurance policy proceeds, compensation payments, superannuation payments (¶2-270) • small business entities — eg sale of assets of the entities (¶2-300) • particular taxpayers — eg foreign residents, temporary residents, trust beneficiaries (¶2-280, ¶2360). Special rules apply to: • collectables (eg jewellery) or personal use assets (eg furniture, household items) (¶2-340), or • land, buildings and capital improvements (¶2-350). The ITAA97 provides many other CGT exemptions and concessions which apply to particular entities, transactions and instruments, or in particular circumstances. This Guide provides only an outline of some exemptions and concessions. Readers should consult the CGT chapters in the Wolters Kluwer Australian Master Tax Guide or Federal Income Tax Reporter for details of all CGT exemptions and concessions

and additional commentary. Look-through tax treatment for instalment trusts A look-through tax treatment applies to instalment trusts under ITAA97 Div 235, applicable to assets acquired by the trustee of an instalment trust. The look-through ensures that, for most income tax purposes, the consequences of ownership of an instalment trust asset flow to the entity that has the beneficial interest in the asset, instead of the trustee. For these purposes, instalment trusts include instalment warrants, instalment receipts and limited recourse borrowing arrangements by superannuation funds (s 235-825). Where look-through applies, an asset held in an instalment trust is treated as an asset of the investor and investor is treated as having the asset in the same circumstances as the investor’s interest in the instalment trust (s 235-820). Among other consequences, this treatment ensures that CGT event E5 does not apply to the trustee on the payment of the final instalment, and neither of the absolutely entitled beneficiaries provisions nor the security holder provisions (¶2-220) apply to instalment trusts (s 235-845). Special disability trusts Special disability trusts (SDTs) are used to assist families and carers to make private financial provision for the current and future care and accommodation needs of a family member with severe disability (the principal beneficiary). The two key benefits of establishing an SDT are: • immediate family members making gifts to an SDT may access a concession of up to $500,000 (combined) from the gifting rules under the social security or veterans’ entitlements laws, and • the assets of an SDT (up to a certain amount, indexed annually) plus the principal beneficiary’s principal place of residence do not impact upon the principal beneficiary’s ability to access income support payments. To qualify for the concessions, the trust must be operated in accordance with Pt 3.18A of the Social Security Act 1991 or Div 11B of Pt IIIB of the Veterans’ Entitlements Act 1986. The CGT concessions below are available to SDTs: • Assets transferred into an SDT for no consideration will be exempt from CGT. • A trustee of an SDT that holds a dwelling for use by the principal beneficiary will qualify for the CGT main residence exemption to the extent the principal beneficiary would have, had the principal beneficiary owned the interest in the dwelling directly — this overcomes issues which may otherwise arise, eg the trustee of the SDT is holding the dwelling and is responsible for claiming the CGT main residence exemption, but the dwelling is used by the principal beneficiary as their main residence, or the principal beneficiary cannot access the exemption as he/she does not own the dwelling. • A recipient of a principal beneficiary’s main residence may be able to access a CGT exemption if the recipient’s ownership interest ends within two years of the beneficiary’s death. • SDTs established under the Veterans’ Entitlements Act 1986 will have the same taxation treatment as those established under the Social Security Act. CGT exemption for start-up investments Since 1 July 2016, a CGT exemption applies for investments made, whether directly or indirectly, in a start-up known as an Early Stage Innovation Company (“ESIC”). Generally, a company qualifies as an ESIC if it is at an early stage of its development and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return. Subdivision 360-A sets out the circumstances when an investor qualifies for the tax offset and the modifications to the CGT treatment of eligible investments, including the requirements to be an ESIC to report information about their investors to the Commissioner so that the ATO can assess whether these investors may qualify for the tax offset and the modified CGT treatment. An entity that is issued a share in an ESIC and is entitled to the tax offset under Subdiv 360-A (whether

received or not) will be taken to hold the shares on capital account and be subject to the CGT provisions (s 360-50(1), (2)). Special provisions apply to ensure a partner in a partnership is treated as an entity for these purposes (s 360-55). To the extent that a share in an ESIC is the subject of a same asset rollover or a replacement asset rollover (excluding the scrip for scrip rollover in Subdiv 124-M or the newly incorporated company rollover in Div 122), the acquiring entity is treated as acquiring the shares as at the date of the original investor (s 360-60, 360-65). Managed Investment Trusts Managed Investment Trusts (MITs) (as defined in ITAA97) are allowed to make an irrevocable election to treat gains and losses on eligible investments on capital account for taxation purposes if they satisfy the qualifying conditions in Subdiv 275-B. These trusts are referred to as attribution MITs (AMITs). Subject to integrity rules, the election makes the CGT provisions the primary code for taxing gains and losses on the MIT’s disposal of eligible investments and enables the MIT investors to obtain the benefit of any CGT tax concessions on distributions of capital gains. An eligible entity that does not make the election is forever subject to revenue treatment on such gains and losses. The key consequences for AMITs are as follows: • the trust will be treated as a fixed trust for income tax purposes • an attribution model applies to the MIT instead of the general trust provisions in ITAA36 Pt III Div 6. For income tax purposes, the trust will be able to attribute amounts of taxable income, exempt income, non-assessable non-exempt income, tax offsets and credits to members on a fair and reasonable basis in accordance with their interests as set out in the constituent documents of the trust, and • if a trust discovers a variance between the amounts actually attributed to members for an income year and the amounts that should have been attributed, the trust can reconcile the variance in the income year that it is discovered by using the “unders and overs” regime. The benefits that may accrue to AMIT members include the following: • a “character flow-through” model will apply to ensure that amounts derived or received by the trust that are attributed to members retain the character they had in the hands of the trustee for income tax purposes • double taxation that might otherwise arise is reduced because members will be able to make annual upward and downward adjustments to the cost bases of their interests in the trust, and • there is clearer taxation treatment of tax-deferred and tax-free distributions made by the trust. For distributions made in 2017/18 and future income years, MIT investors are required to adjust the cost base of their MIT units when the trust distributes an amount claimed to be non-assessable (the CGT concession amount) under ITAA97 s 104-71(4) table item 7 (s 104-71(6)). This means that MIT investors are not able to exclude the distributions they receive in relation to these non-assessable amounts in recalculating their cost base for CGT event E4 gains (s 104-107A).

¶2-260 Exemption for pre-CGT assets Most CGT events generally involve a CGT asset (¶2-100). In these cases, a CGT exemption applies if you acquired the asset on or before 19 September 1985 (commonly called a “pre-CGT asset”) so that any capital gain on the disposal of the pre-CGT asset is not subject to CGT, and any capital loss on the disposal cannot be taken into account under the CGT rules. Some important points to note include the following: • even though the CGT rules do not apply, the gain may be assessable under the ordinary tax rules (¶2520)

• in certain limited situations, a pre-CGT asset can be converted to a post-CGT asset and therefore lose its exempt status. Under the “majority underlying interest” rule in s 149-30(1) of ITAA97, an asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985 (ID 2011/101: no new shareholders; ID 2011/107: new shareholder) • the CGT rules may apply where a taxpayer disposes of pre-CGT shares in a private company (or interests in a private trust) whose post-CGT assets, other than trading stock, comprise 75% of its net worth. In such a case, there will be a capital gain if the proceeds from the disposal which are attributable to the value of the post-CGT assets exceed the cost base of those assets. An asset is not a pre-CGT asset if it was acquired after 19 September 1985. The exception is where a CGT rollover is available, in which case an asset’s pre-CGT status may be preserved notwithstanding that it has been disposed of after 19 September 1985. Rollovers are explained at ¶2-400.

¶2-270 Exempt assets, proceeds and transactions CGT exemptions or transactions which have no CGT consequences are diverse, as outlined below (not an exhaustive list). Exempt assets Certain assets are specifically exempted from the CGT rules. The exempt assets include: • a taxpayer’s main residence. This exemption is reduced on a pro-rata basis if the residence was also used for business activities (eg a home office). Special rules apply where the residence is vacated or changed, or if it is inherited. The main residence exemption is examined in detail in Chapter 12 • a car, motor cycle or similar vehicle • a valour or brave conduct decoration (unless you purchased it) • an asset used solely to produce exempt income • trading stock of a business • active assets, including goodwill, of a small business. This exemption is part of the small business concessions (¶2-300). Proceeds Certain types of proceeds or receipts are excluded from the CGT rules. These include: • grants from certain schemes (eg Unlawful Termination Assistance scheme, Alternative Dispute Resolution Assistance Scheme) • compensation or damages for work-related wrongs or injuries (Daniels v FC of T [2012] AATA 792: assessable gains on disposal of shares) • personal injury compensation or damages • exempt capital gains under the small business retirement concessions (¶2-338) • competition prizes, gambling wins and losses • proceeds of life insurance policies • benefits payments from superannuation funds, approved deposit funds or retirement savings accounts. Transactions

Certain types of transactions are excluded from the CGT rules. These include: • a capital loss made by a lessee from the expiry, surrender, forfeiture or assignment of a lease, provided that the lease was not used mainly for business purposes (this exemption does not apply to leases for 99 years or more) • conversion by a building owner to strata title • issues or allotments of shares or trust units • disposals of rights to mine in certain cases • gifts made by will under the Cultural Bequests Program • gifts of cultural property made under the Cultural Gifts Program • a capital gain or loss made by an indigenous person or indigenous holding entity where it arises in relation to a CGT asset that is either a native title or the right to be provided with a native title benefit • certain foreign currency hedging transactions (see further ¶2-343). From 2009/10, a general exemption from CGT applies to capital gains or capital losses arising from a right or entitlement to a tax offset, deduction or similar benefit (ITAA97 s 118-37(1)). Examples of when this may arise are gains derived by a person who has a right to receive an urban water tax offset on the satisfaction of the right, or a person’s right to receive a reduction in land tax under an Australian law, or under the law of a foreign country.

¶2-280 Foreign residents and temporary residents — exemptions and withholding tax A foreign resident or the trustee of a foreign trust for CGT purposes is subject to CGT only in respect of a CGT asset that is taxable Australian property (ITAA97 s 855-10). That is, any capital gain or capital loss from a CGT event is disregarded if the CGT event happens in relation to any other type of CGT asset. Where an Australian tax treaty applies to a foreign resident in relation to a CGT event, the definition of real property should be read in conjunction with the definition in the treaty (FC of T v Resource Capital Fund III LP 2014 ATC ¶20-451: US Double Taxation Convention). Foreign residents, foreign trusts and taxable Australian property A “foreign resident” means a person (including a company) who is not a resident of Australia for tax purposes and a “foreign trust for CGT purposes” means a trust that is not a resident trust for CGT purposes (¶1-550). The following assets are taxable Australian property: (1) taxable Australian real property (2) an indirect interest in Australian real property (3) a business asset of a permanent establishment in Australia (4) an option or right to acquire any of the CGT assets in items 1 to 3, or (5) a CGT asset that is deemed to be taxable Australian property where a taxpayer makes an election on ceasing to be an Australian resident (see below). The taxable Australian property listed above replaced the categories of assets that were collectively referred to as “assets having the necessary connection with Australia” for which foreign residents were subject to CGT before 12 December 2006. The taxable Australian property concept has significantly

narrowed the range of assets on which foreign residents are subject to Australian CGT. CGT assets cannot be covered under more than one item. The business assets of an Australian permanent establishment do not include CGT assets that are also covered under items 1, 2 or 5. Similarly, if a CGT asset comes within both items 2 and 5, that asset is considered to be taxable Australian property as a result of item 5. A similar rule is not required for a CGT asset that is both an indirect Australian real property interest (item 2) and an option or a right to acquire that asset (item 4). An indirect interest in Australian real property can only occur where an actual holding exists, as opposed to a right or an option. Rights and options are specifically excluded from “participation interests”. Item 1 — Taxable Australian real property A CGT asset is taxable Australian real property (TARP) if it is real property situated in Australia or a mining, quarrying or prospecting right where the minerals, petroleum or quarry materials are situated in Australia (s 855-20, 855-25). If the sum of the market values of the entity’s assets that are TARP exceeds the sum of the market values of the assets that are non-TARP, any capital gain or capital loss is not disregarded and may be included in the assessable income of the non-resident. Capital gains made by non-residents on the sale of TARP do not qualify for the 50% CGT discount from 8 May 2012. For non-residents who chose to value their TARP assets on 8 May 2012, the portion of the capital gain accrued before that date is still eligible for the CGT discount when the asset is eventually sold, while any gain that accrues after that date is not (¶2-215). Item 2 — Indirect Australian real property interest Among other objects, the foreign resident CGT regime in Div 855 of ITAA97 ensures that interests in an entity remain subject to Australia’s CGT laws if the entity’s underlying value is principally derived from Australian real property by providing that a capital gain realised by a foreign resident on an “indirect Australian real property interest” (see s 855-25) cannot be disregarded (s 855-5). This ensures that a capital gain or capital loss made by a foreign resident may be disregarded only if the relevant CGT asset is not: • a direct or indirect interest in Australian real property, or • an asset used in carrying on a business through a permanent establishment in Australia. An indirect Australian real property interest exists where a foreign resident has a membership interest in an entity (eg a shareholding in a company, a beneficial interest in a trust or a partnership interest, but not a debt interest) and that interest passes the non-portfolio interest test and the principal asset test. Generally, an indirect Australian real property interest includes a significant interest (generally a stake of 10% or more) in an entity whose underlying value is principally derived from Australian real property. The non-portfolio interest test is consistent with the pre-12 December 2006 tax regime whereby foreign residents with a 10% or greater interest in a public company or unit trust are subject to Australian CGT. A membership interest held by a taxpayer (holding entity) in another entity (the test entity) passes the nonportfolio test if the sum of the direct participation interests of the holding entity and its associates in the test entity is at least 10% (ITAA97 s 960-195). The principal asset test requires a comparison of the sum of the market values of the entity’s taxable Australian real property (TARP) assets with the sum of the market values of its assets that are not taxable Australian real property (non-TARP) assets. The test basically determines when an entity’s underlying value is principally derived from TARP (ITAA97 s 855-30). A membership interest held by a foreign resident holding entity in the test entity passes the principal asset test if more than 50% of the market value of the test entity’s assets is attributable to TARP. An asset of an entity for the purposes of the principal asset test is anything recognised in commerce and business as having economic value to the entity at the time of the relevant CGT for which a purchaser of the entity’s membership interests would be willing to pay (ID 2012/14: cash received and intercorporate loan under an enforceable right to the payment of money under an intercorporate loan agreement). For the treatment of inter-company loans under the principal asset test, see ID 2012/14, and for discussion of the potential for the principal asset test resulting in asset duplication, see Taxpayer Alert TA 2008/20. The Full Federal Court has held that a Cayman Islands partnership was not prevented from being assessed

on a capital gain on the sale of Australian shares in a mining company as a result of the Australia–U.S. Double Tax Agreement. It also held that the underlying value of the partnership’s assets for the purposes of the “principal asset” test in s 855-30 was to be determined as if the assets were offered for sale as a bundle, and not on a stand-alone basis (Resource Capital Fund III LP 2014 ATC ¶20-451; 2019 ATC ¶20691 on valuation methods for applying the principal asset test). Where the assets of two or more entities are included in the principal asset test, the market value of new non-TARP assets arising from certain arrangements between those entities will be disregarded. In particular, certain assets that relate to liabilities located elsewhere in the corporate group will not be counted because they do not represent the group’s underlying economic value so as to prevent the double counting of those non-TARP assets. The principal asset test applies on an associate-inclusive basis (for the purpose of determining the market value of a taxable Australian real property asset) for foreign residents with indirect interests in Australian real property from 7.30 pm (AEST) on 9 May 2017. This is intended to ensure that foreign tax residents cannot avoid a CGT liability by disaggregating indirect interests in Australian real property. Item 3 — Permanent establishment in Australia Item 3 covers assets that a foreign resident has used at any time in carrying on a business through a permanent establishment in Australia. A capital gain or loss made from an asset that was used in carrying on a business through a permanent establishment in Australia is proportionately reduced if it was used in this way for only part of the period from when the taxpayer acquired it to when the CGT event happened. For the purposes of working out whether a foreign resident has used a “permanent establishment” in carrying on a business in Australia, the expression will have its meaning under any relevant tax treaty or, if no treaty exists, the default statutory definition. Item 5 — Changing residency status CGT events I1 and I2 (¶2-110) happen when a taxpayer stops being a resident and is deemed to have disposed of its CGT assets. Assets excluded from this rule include pre-CGT assets or assets that are taxable Australian property. Conversely, subject to certain exceptions for temporary residents, where a taxpayer changes from being a foreign resident to an Australian resident, that event is deemed to trigger an acquisition of that person’s assets (other than pre-CGT assets and taxable and Australian property) at the time of becoming a resident (see below). The general effect of the above is that, from 12 December 2006, foreign investors can no longer avoid Australian CGT consequences by holding their Australian assets through interposed entities. This overcomes the tax anomaly that would otherwise arise between foreign residents investing directly in Australia and those who invest indirectly. Previously, the disposal of an interposed entity by a foreign resident would not have triggered an Australian CGT liability whereas the direct sale of Australian assets would. Foreign resident capital gains withholding payments Withholding tax applies to payments made to foreign residents who dispose of certain taxable Australian property under contracts entered into on or after 1 July 2016 at the rate of 12.5% (increased from 10% from 1 July 2017). This will require the purchaser to withhold tax of the purchase price (based on first element of the cost base) and to pay that amount to the ATO. The withholding tax regime applies to disposals of taxable Australian property, being: • real property in Australia (land, buildings, residential and commercial property) • lease premiums paid for the grant of a lease over real property in Australia • mining, quarrying or prospecting rights • interests in Australian entities whose majority assets consist of the above such property or interests (ie indirect interests) • options or rights to acquire the above property or interest.

The tax withholding regime does not cover the following: • real property transactions with a market value under $750,000 (reduced from $2 million from 1 July 2017) • transactions listed on an approved stock exchange (with some exceptions) • transactions where the foreign resident vendor is under external administration or in bankruptcy • the non-resident vendor (owner) has obtained a clearance certificate from the ATO (see below). Notification of payment and ATO clearance certificate Where an amount is required to be withheld, the purchaser must complete an online Purchaser payment notification form www.ato.gov.au/Forms/Foreign-resident-capital-gains-withholding-purchaser-paymentnotification-online-form-and-instructions/, which contains details of the vendor, purchaser and the asset being acquired (TAA Sch 1 s 16-150; 16-140). A vendor may apply for an ATO clearance certificate at any time they are considering the disposal of real property, which can be before the property is listed for sale. A clearance certificate will be valid for 12 months and it must be valid at the time the transaction is entered into to avoid the tax withholding obligation. Guidelines on paying and reporting withholding amounts are available in Law Companion Rulings LCR 2016/5, LCR 2016/6 and LCR 2016/7 and fact sheets at www.ato.gov.au/Tax-professionals/TP/CGTwithholding-and-indirect-Australian-real-property-interests and www.ato.gov.au/General/Capital-gainstax/In-detail/Calculating-a-capital-gain-or-loss/Capital-gains-withholding--Impacts-on-foreign-andAustralian-residents/. Interests in managed funds or other fixed trusts To provide comparable tax treatment between direct and indirect ownership of interests in fixed trusts, foreign residents that have an interest in managed funds (or other fixed trusts) whose assets are not taxable Australian property are subject to tax as follows: • a capital gain or loss made by a foreign resident from a CGT event happening to an interest in a fixed trust (eg disposal of the interest) is disregarded if enough of the trust’s underlying assets are not taxable Australian property • a capital gain made by a foreign resident beneficiary in respect of an interest in a fixed trust is disregarded if the gain relates to an asset that is not a taxable Australian property • an exception to CGT event E4 (capital payments to beneficiaries) is available for distributions of foreign source income from the trustee of a trust to a foreign resident beneficiary. Foreign resident becoming a resident If a foreign individual or company becomes an Australian resident or a trust becomes a resident for CGT purposes, the special cost base and acquisition rules below apply in respect of each CGT asset of the taxpayer just before becoming a resident: • the asset is deemed to have been acquired by the taxpayer at the time of becoming a resident, and • the first element of the cost base and reduced cost base of the asset at the time the taxpayer becomes a resident is its market value at that time. One effect of the first point is that the taxpayer will qualify for the CGT discount only if the asset has been held for at least 12 months since becoming a resident, even if the asset was owned before that time. With respect to the second point and employee share schemes, if the taxpayer owns a qualifying share or right for which the cessation time is yet to happen, the cost base of the share or right is its market value when the cessation time occurs. In all other cases, the first element of the cost base and reduced cost base of the share or right is its market value at the time the taxpayer becomes a resident.

CGT concessions for temporary residents Individuals who qualify as “temporary residents” are exempt from Australian tax on certain foreign source income or capital gains. In this respect, they will be treated similarly to foreign residents, even though in many cases they would normally have been classed as residents for tax purposes. A “temporary resident” is: • a person who holds a temporary visa under the Migration Act 1958 (ie generally expatriates on temporary visas) • not an Australian resident within the meaning in the Social Security Act (most expatriates on temporary visas cannot access social security benefits available to Australian citizens or permanent visa holders), and • does not have a spouse who is an Australian resident within the meaning in the Social Security Act. A person may be a temporary resident irrespective of whether they are a resident or a foreign resident under the normal tax rules. There is no set time limit on how long a person can be a temporary resident. The CGT-related concessions for temporary residents are summarised below. Capital gains and losses Capital gains and losses made by a temporary resident are treated as if they had been made by a foreign resident. Broadly, this means that capital gains and losses are ignored for tax purposes unless the asset concerned is taxable Australian property. For example, capital gains from the sale of Australian real estate and shares in Australian private companies will continue to be taxable, while gains in respect of portfolio interests in Australian public companies and unit trusts will be exempt. An exception applies for gains derived as a result of services or employment provided in Australia, including gains in respect of shares or rights acquired under an employee share/option scheme where the employment in relation to which the shares or rights were granted is in Australia or the shares or rights are taxable Australian property. Normally, when a foreign resident becomes an Australian resident, special rules apply to set a cost base for certain assets held by the person (see above). This will not apply, however, where the person is a temporary resident immediately after becoming an Australian resident. Ceasing to be a temporary resident Where a person ceases to be a temporary resident but remains an Australian resident (eg becomes a permanent resident), it will be necessary to establish a cost base and a nominal acquisition date for any CGT assets that are brought within the CGT net by virtue of the change of residency status. The affected assets are those owned just before the change of status, and which were acquired after 19 September 1985 and are not taxable Australian property. For these assets, the first element of the cost base or reduced cost base is deemed to be its market value at the time that the person ceased to be a temporary resident and the asset is taken to have been acquired at that time.

¶2-300 Small business CGT concessions A CGT small business entity (taxpayer) may be eligible for one or more of the following CGT concessions in ITAA97 Div 152: • the 15-year asset exemption (¶2-336) — which exempts any capital gain on the disposal of an asset held for at least 15 years when the taxpayer retires or is incapacitated • the 50% active asset exemption (¶2-337) — which exempts any capital gain on the disposal of an active asset • the small business retirement exemption (¶2-338) — which exempts capital gains on the disposal of assets (up to a lifetime limit of $500,000 for each individual) in connection with retirement of the

individual • the small business asset rollover (¶2-339) — which defers any CGT liability on the disposal of assets if the capital proceeds from the disposal are used to buy another business asset (¶2-410). Basic conditions to be met Section 152-10 sets out the basic conditions that all taxpayers must satisfy in relation to a CGT event before they are entitled to concessions in relation to a capital gain, namely: (a) the entity must be a CGT small business entity or a partner in a partnership that is a CGT small business entity, or the net value of assets that the entity and related entities own must not exceed $6 million, and (b) the CGT asset must be an active asset. The following additional basic conditions must be satisfied for a capital gain arising in relation to a share in a company or an interest in a trust (the object entity): • if the taxpayer does not satisfy the maximum net asset value test, the taxpayer must have carried on a business just before the CGT event • the object entity must either be a CGT small business entity or satisfy the maximum net asset value test (applying a modified rule about when entities are “connected with” other entities), and • the share or interest must satisfy a modified active asset test that applies a look-through to the activities and assets of the underlying entities. Other general rules related to the small business CGT concessions Many other general rules affecting the operation of the small business CGT concessions must also be considered or may apply in particular cases (see ¶2-260). General approach to claiming the concessions The CGT concessions should be accessed in the following order for maximum effect: (1) first the 15-year asset exemption, as this will eliminate any capital gain in its entirety (2) after offsetting capital losses against the capital gain, the CGT discount (if eligible) (3) the 50% active asset exemption (4) the retirement exemption (subject to the $500,000 lifetime limit) (5) the replacement asset rollover relief. A taxpayer can choose not to apply the 50% active asset exemption and instead claim the retirement exemption or business asset rollover relief, or both, in respect of the capital gain. Further information The rules governing the small business concessions are complex and a detailed discussion is outside the scope of this Guide. ATO guidelines and further information and commentary are available from: • the ATO’s Capital gains tax Guide — www.ato.gov.au/Forms/Guide-to-capital-gains-tax-2018/ • Wolters Kluwer’s Australian Master Tax Guide and Small Business Concessions Guide. Small business CGT concessions — simplified flow chart

¶2-310 Basic conditions and additional basic conditions The basic conditions below must be satisfied by all taxpayers to qualify for a small business CGT concession: (1) a CGT event (other than CGT event K7: see below) happens in relation to your CGT asset and the event would have resulted in a capital gain (2) at least one of the following applies: – you are a CGT small business entity (see below) for the income year – you do not carry on business (other than as a partner) but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you (passively held assets) – the total net value of your assets and of related entities is $6 million or less (the maximum net asset value test: ¶2-315)

– you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in a partnership asset or an asset you own that is not an interest in a partnership asset (partner's assets) but is used in the business of the partnership, and (3) the CGT asset satisfies the active asset test (¶2-320) (ITAA97 s 152-10). If the CGT asset is a share or an interest in a trust, additional basic conditions must then be complied with — see “Additional basic conditions — CGT asset is a share or interest in a trust” below. CGT small business entity An entity is a “CGT small business entity” if it carries on a business and satisfies the $2 million aggregated turnover test (see below). The term “business” is defined broadly for tax purposes and it includes any profession, trade, employment, vocation or calling, but not occupation as an employee. The term “CGT small business entity” (with a $2 million turnover test) is used for the purposes of CGT concessions, as opposed to the “small business entity” concept (with a $10 million turnover test) which is used for the purposes of eligibility for other small business tax concessions such as the simplified depreciation rules, simplified trading stock rules, and small business income tax offset (ITAA97 s 328-10, 328-110–328-120; Doutch v FC of T 2016 ATC ¶20-592; [2017] HCASL 85) (¶1-283). The small business “connected entity” test and scrip for scrip “stakeholder” test (¶2-410) are used to determine whether an entity has the capacity to control or influence another entity by having regard to the ownership of interests in that other entity. These tests apply having regard only to the legal ownership of the relevant interests, rather than who benefits from the ownership. As a result, the tests apply to interests held by life insurance companies, superannuation funds and trusts in the same way that they apply to other types of entities. If an entity (the first entity) directly controls a second entity, and that second entity also controls a third entity, the first entity is taken to control the third entity (s 328-125(7)). The indirect control test is designed to look through business structures that include interposed entities. This ensures consistency with direct ownership structures (see below) when determining whether an entity controls another entity in an interposed structure based on legal ownership of the relevant interests. Absolutely entitled beneficiaries, bankrupt individuals, companies in liquidation and security providers are treated as the owners of an asset for the purpose of the CGT provisions and the connected entity test (see ¶2-320). Turnover threshold test An entity can satisfy the $2 million test in one of three ways: (1) the entity’s aggregated turnover for the previous income year was less than $2 million (2) the entity’s aggregated turnover for the current income year, worked out as at the first day of the income year, is likely to be less than $2 million, or (3) the entity’s aggregated turnover for the current income year, worked out as at the end of the current income year is actually less than $2 million. The term “likely” means on the balance of probabilities, and whether an entity’s aggregated turnover is likely to be less than $2 million is an objective test. Most small business entities which have an aggregated turnover in the previous income year of less than $2 million will only need to consider the test in (1). However, even if the entity’s previous year aggregated turnover was greater than $2 million, the entity will satisfy the $2 million aggregated turnover test if it is likely that its aggregated turnover for the current income year will be less than $2 million. The reference to “as at the first day of the income year” means that the assessment is based on the entity’s state of affairs as at the first day of the income year, and not that the assessment must be made on the first day of the income year.

Example Ron is carrying on a business in the 2018/19 income year. He has not assessed his eligibility as a small business entity. On 1 January 2019, Ron starts thinking about selling one of his business assets and wishes to determine whether he satisfies the small business entity test to have access to the small business CGT concessions. Ron can work out his aggregated turnover as at 1 July 2018. However, he may do this at any time in the income year and undertaking the calculation in January 2019 does not affect the result.

To stop larger businesses from artificially splitting their operations to gain access to the concessions, an aggregation rule requires the annual turnover (or net assets) of other entities that are affiliates or are connected to be aggregated for the small business entity and maximum net asset value tests. Small business entity test modification — passively held assets When determining whether the small business entity test is met, special rules apply under ITAA97 s 15210(1A) or (1B) to calculate the aggregated turnover for passively held assets (see below). For this purpose, an entity (the deemed entity) that is an affiliate of, or is connected with, the owner of a passively held CGT asset is treated as an affiliate of, or connected with, the entity that uses the passively held asset in its business (the test entity) if the deemed entity is not already an affiliate of, or connected with, the test entity (ITAA97 s 152-48(2)). Apart from partnerships, a taxpayer with an active asset has to be either a small business entity or satisfy the maximum net asset value test to qualify for the small business concessions (s 152-10(1)(c)). A taxpayer who owns a CGT asset (and does not carry on a business other than as a partner in partnership; see example below) that is used in a business by the taxpayer’s affiliate or an entity connected with the taxpayer is able to access the small business concessions via the $2 million aggregated turnover test (small business entity test) if the conditions in s 152-10(1A) are met. Example Peter owns land that he leases to a company he wholly owns, Petey Farm Pty Ltd, which uses the land in its farming business. Peter does not carry on a business. Peter may be able to access the small business concessions via the small business entity test depending on the aggregated turnover of Petey Farm Pty Ltd as that company, which is connected with Peter, uses Peter’s land in carrying on its business.

Passively held assets — partners and partnership assets The CGT regime operates on the basis that a partner in a partnership carries on a business. The partner is considered to carry on the business of the partnership collectively with the other partners. Individual partners make capital gains when a CGT event happens in relation to a partnership asset. An individual partner (or partners) in a partnership can access the small business CGT concessions via the small business entity test if an asset is owned by the partner, but is used in the partnership. The conditions that must be met for passively held assets in a partnership are set out in ITAA97 s 152-10(1B). Example Beau and Irene each own 50% of a supermarket building which is used in the business of a partnership carried on by Beau, Jack, Casey and Irene. The partnership trades under the name “A-One Supermarket”. Beau and Irene may be able to access the small business concessions in relation to their respective shares of the building via the small business entity test, depending on the aggregated turnover of the partnership calculated respectively for Beau and Irene. The aggregated turnover of A-One Supermarket must be calculated separately for Beau and Irene taking into account any entities that are affiliates of, or connected with, each of them respectively.

To limit the tax planning opportunities that may otherwise be available, a special rule deals with the situation where a person makes his/her CGT asset available for use in the business of more than one partnership of which the person is a partner. These opportunities arise because the partnerships do not have to be connected with the person (the test entity) under s 152-10(1B). If the partnerships are not

connected with each other and they are not connected with the test entity, each partnership would then be able to calculate its aggregated turnover without having to include the annual turnover of any of the other partnerships. In these circumstances, the rule treats each partnership that is not already connected with the test entity as being connected (s 152-48(3)). Example Ralph owns a CGT asset that he makes equally available for use in the businesses of two partnerships, Partnership One and Partnership Two, of which he is a partner. The partnerships are not connected with each other or Ralph. Ralph sells the asset (being each of Ralph’s interests in the asset) that is used separately in the businesses Ralph carries on in the two partnerships. Even though the partnerships are not otherwise connected with each other, they are taken to be connected with each other under the special rule in s 152-48(3). To determine if the $2m aggregated turnover test is met, the aggregated turnover of each partnership will include the annual turnover of the other partnership.

Businesses that are winding up and passively held assets The rules in s 152-10(1A) and (1B) to increase access to the small business concessions for passively held assets via the small business entity test rely on the CGT event happening in an income year in which the asset is being used in an entity connected with the taxpayer, or the taxpayer in partnership (or held ready for use in, or inherently connected with a business carried on by the taxpayer’s affiliate). For non-passively held assets, access to the concessions is possible where the CGT event happens in a later year than that in which the asset owner ceased to carry on a business if the CGT event occurs in a year that the business is being wound up (s 328-110(5)). In such a case, the rules treat: • the entity (including a partner) as carrying on the business at a moment in time in the CGT event year, and • the CGT asset as being used in, held ready for use in, or inherently connected with the business at that same time in the CGT event year (s 152-49(2)). An entity is deemed to carry on a business in an income year if the entity is winding up a business it formerly carried on, and it was a small business entity in the income year that it stopped carrying on the business (s 328-110(5)). Proposed changes — partners alienating income Treasury has released draft amendments to the ITAA97 to ensure that the small business CGT concessions will no longer be available to partners who alienate their income by creating, assigning or otherwise dealing in rights to the future income of a partnership, applicable to assigned rights from 8 May 2018. This integrity measure is aimed at taxpayers, including large partnerships, that are able to inappropriately access these concessions in relation to their assignment of a right to the future income of a partnership to an entity without giving that entity any role in the partnership (www.treasury.gov.au/consultation/c2018-t311508). Additional basic conditions — CGT asset is a share or interest in a trust To be eligible to claim the small business CGT concessions, a taxpayer must satisfy the basic conditions set out in s 152-10(1) in relation to the capital gain (see above). The following additional basic conditions must be satisfied if the CGT asset is a share in a company or an interest in a trust (the object entity): (1) either the taxpayer must be a CGT concession stakeholder (see ¶2-325) in the object entity just before the CGT event, or (2) entities that are CGT concession stakeholders in the object entity must have small business participation percentage totalling at least 90% in the taxpayer (3) unless the taxpayer satisfies the maximum net asset value test, the taxpayer must have carried on a business just prior to the CGT event

(4) the object entity must be a CGT small business entity for the income year or satisfy the maximum net asset value test, and (5) the shares or interests in the object entity must satisfy a modified active asset test that looks through shares in companies and interests in trusts to the activities and assets of the underlying entities (ITAA97 s 152-10(2)). The modified active assets test deals with when entities are “connected with” other entities, whereby: (i) the only CGT assets or annual turnovers considered were those of the object entity, each affiliate of the object entity and each entity controlled by the object entity in the way described by ITAA97 s 328-125; (ii) each reference to 40% therein was 20%; and (iii) there was no s 328-125(6) determination in force under which certain entities were treated as not controlling others. The modified active asset test for this purpose is the active asset test as prescribed in s 152-35 (see ¶2320) subject to the assumption in s 152-10(2A). That is: • the financial instruments and cash must be inherently connected with the business and were not acquired for a purpose that included assisting an entity to satisfy this test, and • all shares and units held by the object entity are excluded. Instead, a look-through approach will be taken with the underlying assets of the later company or trust. The additional basic conditions apply on an entity basis and are intended to prevent the small business concessions from being inappropriately applied to interests in large businesses. A taxpayer at the top of a chain of companies or trusts may not qualify for the concessions in respect of shares or interests it holds (eg because the chain includes an entity with an interest in a large business), but another taxpayer in the same chain of companies or trusts may qualify for the concessions in respect of shares or interests it holds in a small business. The modified active assets test is discussed further in ¶2-320. General rules affecting the small business concessions The following general points must be noted with respect to the Div 152 small business CGT concessions: • Additional conditions must be satisfied in order to access the 15-year asset exemption (¶2-336), the retirement exemption (¶2-338) and the replacement asset rollover concession (¶2-339) (s 152-10(3)). By contrast, the 50% active asset exemption (¶2-337) requires only the basic conditions to be met. • Before applying the concessions, a capital gain must first be reduced by capital losses (if any). This is not required if claiming the 15-year asset exemption as the whole capital gain amount will be exempt. • The concessions are not available to a capital gain that arises from CGT event K7 happening (see below). • The 15-year exemption and 50% active asset reduction do not apply to CGT events J2, J5 and J6 (about previous applications of the small business rollover relief: see ¶2-339). • Where CGT event D1 applies (about creating rights: ¶2-110), the first and third basic conditions (see above) are replaced with the condition that the right created by the taxpayer that triggers CGT event D1 must be inherently connected with a CGT asset of the taxpayer that satisfies the active asset test (s 152-12) (see “CGT event D1 happening” in ¶2-320). CGT event K7 — Depreciating assets and small business CGT concessions Under the uniform capital allowances (UCA) system, any gain or loss from a depreciating asset (see ¶1330) is included in assessable income or deductible (as a balancing adjustment) to the extent the asset was used for a taxable purpose. However, a taxpayer will make a capital gain or capital loss from a depreciating asset to the extent that the asset was used for a non-taxable purpose (ie private purposes). In that case, CGT event K7 happens when a balancing adjustment event occurs (¶2-110). The small business concessions are not available for a capital gain that arises from CGT event K7 happening. This is because the concessions relate to the use of an asset in a small business, while a capital gain from CGT event K7 on the other hand arises only from the private use of an asset. Therefore,

to the extent that an asset is used in small business, CGT event K7 never applies and the small business concessions are not available when that event happens. Note, however, that if a taxpayer makes a capital gain as a result of CGT event K7, the taxpayer can claim the CGT discount on the gain, where eligible (¶2-205).

¶2-315 Maximum net asset value test An entity that does not satisfy the small business entity test (based on aggregated turnover) may still be eligible for the small business CGT concessions if the maximum net asset value test (in ITAA97 s 152-15) is met (see ¶2-310). An entity will satisfy the maximum net asset value test if, just before the CGT event that results in the capital gain, the sum of the following amounts do not exceed $6 million: (i) the net value of the CGT assets of the entity (ii) the net value of the CGT assets of any entities “connected with” the entity (iii) the net value of the CGT assets of any of the entity’s affiliates or entities connected with the entity’s affiliates (not including assets already counted in (ii)). Affiliates Only an individual or company can be an affiliate of another entity. Entities (for tax purposes) such as trusts, partnerships, and superannuation funds are not capable of being the affiliates of an entity. An individual or a company is your affiliate if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company. However, an individual or a company is not your affiliate merely because of the nature of the business relationship that you and the individual or company share. A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership. A similar rule applies to directors of the same company and trustees of the same trust, or the company and a director of that company. The assets of an affiliate are not included in the maximum net asset value test if those assets are not used, or held ready for use, in a business carried on by the entity or by an entity connected with the entity. Example Shane operates a pub as a sole trader. His wife, Sherry, carries on her own cleaning business (unrelated to Shane’s business). Sherry, who owns the land and building from which Shane’s pub business is conducted, leases the building to Shane. Sherry is Shane’s affiliate. When determining whether Shane satisfies the maximum net asset value test, he includes the market value of the land and building owned by Sherry (because it is used in his pub business) but does not include Sherry’s other assets used in her cleaning business (because they are not used in the pub business).

Guidelines on how an unpaid present entitlement of a beneficiary connected with a trust is treated for the purposes of working out whether the trust satisfies the maximum net asset value test are set out in Taxation Ruling TR 2015/4. Net value of CGT assets The net value of the CGT assets of an entity is the sum of the market values of those assets less any liabilities of the entity relating to those assets (ITAA97 s 152-20). The assets to be included in determining the net value are not restricted to business assets. All CGT assets of the entity are taken into account, with certain exceptions (see below). Provisions for long-service leave, annual leave, unearned income

and tax liabilities are taken into account when determining the net value of CGT assets of an entity (TD 2007/14: what liabilities are included). Excluded from the calculation of net value of the CGT assets are certain interests in connected entities, such as shares, units or other interests (apart from debt) held in the connected entity. This is to avoid double counting as the net value of the CGT assets of the connected entity is already included in the test (s 152-20(2)(a)). If the small business entity is an individual, the following assets are disregarded when working out the net value of the CGT assets: • assets being used solely for the personal use and enjoyment of the individual or the individual’s affiliates over the ownership period of the asset (except a dwelling, or an ownership interest in a dwelling, that is the individual’s main residence, including any relevant adjacent land) (ID 2011/37: dwelling; ID 2011/39–41: personal use of a holiday house by an individual’s spouse and children under the age of 18 and by others, with and without rent; Altnot Pty Ltd v FC of T 2013 ATC ¶10-305: spouse and personal use and enjoyment test) • rights to amounts payable out of, or to an asset of, a superannuation fund or an approved deposit fund • insurance policies on the life of an individual (s 152-20(2)(b)). It is important to note that the maximum net asset value test: • takes into account a negative net asset value of a connected entity • takes into account the assets and related liabilities of an entity and provisions for annual leave, longservice leave, unearned income and tax liabilities • in relation to a partnership, applies only to the individual partners in the partnership, and • in relation to the assets of an individual, includes only the proportion of a dwelling that was used for income-producing purposes (TD 2007/14). In working out the net value of an individual’s CGT assets, an apportioned amount of the value of certain dwellings that have been used to produce assessable income is included (see s 152-20(2A)). If an individual’s dwelling was used during all or part of its ownership period to produce assessable income and the individual satisfied ITAA97 s 118-190(1)(c) about interest deductibility to some extent, then a reasonable proportion of the value of the dwelling is included having regard to the extent of interest deduction (ID 2011/38: dwelling in s 152-20(2A) only refers to a dwelling that is an individual’s main residence). If an asset is disregarded (eg personal use assets and main residence), any related liability is also disregarded as the liability is unconnected with assets included in the net asset value calculation. In Case 2/2010 2010 ATC ¶1-021, the AAT held that it would make no sense to exclude liabilities that are inextricably connected to the sale where it is the disposal of the asset that creates the CGT event and determines the market value of the asset which, in turn, allows the extent of the capital gain to be ascertained. To avoid double counting, the value of interests in entities connected with the taxpayer or the taxpayer’s affiliates is disregarded, as the assets underlying these interests are already counted. However, this excludes liabilities relating to such disregarded interests with the result that the liabilities are never taken into account in the net asset value calculation. As this calculation process effectively disadvantages taxpayers (as it excludes liabilities that are indirectly related to assets whose gross value has been included in the net asset calculation), liabilities relating to disregarded interests in entities connected with a taxpayer or the taxpayer’s affiliates are taken into account in calculating the net asset value (s 15220(2)(a)). Example Danny owns all the shares in AT Pty Ltd. The net asset value of AT Pty Ltd is $1m. Danny has net assets of $5.2m (not counting the

value of his shareholding in AT Pty Ltd). Previously, Danny was required to work out his maximum net asset value as $6.2m, which includes AT Pty Ltd’s net asset value of $1m but excludes the value of Danny’s shares in AT Pty Ltd. Danny still owes $500,000 that he borrowed to acquire the shares in AT Pty Ltd. Danny’s $500,000 liability incurred to acquire the shares in AT Pty Ltd is excluded from the calculation, resulting in a net asset value of $6.2m. However, this has excluded a liability that is related (indirectly) to assets whose market value has been included elsewhere in the net asset calculation. Danny can include the $500,000 liability in the calculation, resulting in a maximum net asset value of $5.7m.

For cases dealing with the application of the net asset value test, see: FC of T v Byrne Hotels Qld Pty Ltd 2011 ATC ¶20-286: meaning of “liabilities” and “contingent liabilities”; Phillips v FC of T 2012 ATC ¶10245: restructuring of a company group; Syttadel Holdings Pty Ltd v FC of T 2011 ATC ¶10-199, Venturi v FC of T 2011 ATC ¶10-200: market value of assets and objective business valuation; White & Anor v FC of T 2012 ATC ¶20-301, Miley v FC of T 2017 ATC ¶10-640: value of shares in a company; Cannavo v FC of T 2010 ATC ¶10-147: debts and calculation of the threshold; Bell v FC of T 2013 ATC ¶20-380: contingent liability, not a presently existing legal obligation; Excellar Pty Ltd v FC of T 2015 ATC ¶10-391: cash is an asset, liabilities are included in calculation at GST-inclusive value. Connected with An entity is “connected with” another entity if either entity “controls” the other entity in the way described in s 328-125, or both entities are controlled in the way described in s 328-125 by the same third entity. An entity controls another entity if the first entity, its affiliates, or the first entity and its affiliates: • beneficially own, directly or indirectly, interests in the other entity that carry between them the rights to at least 40% (the “control percentage”) of any distribution of income or capital by the other entity, except where the other entity is a discretionary trust — there are special rules for discretionary trusts • if the other entity is a company — beneficially own, or have the right to acquire beneficial ownership of, shares in the company that carry between them the right to at least 40% of the voting power of the company, or • if the other entity is a discretionary trust (see below) — are the trustee of the trust (other than the Public Trustee of a state or territory) or have the power to determine the manner in which the trust powers to make payment of income or capital are exercised (Gutteridge 2013 ATC ¶10-347; Altnot 2014 ATC ¶20-454: wife of a sole director of a taxpayer company was “connected with” the taxpayer company, ATO Decision Impact Statement Ref VID 280 of 2013). The “connected with” test has regard only to the legal ownership of the relevant interests, not who benefits from the ownership. Thus, interests held by life insurance companies, superannuation funds and trusts are covered even though the entities do not own these interests for their own benefit, but rather for the benefit of their policy holders, members or beneficiaries. Also, absolutely entitled beneficiaries, companies in liquidation and security providers are treated as the owners of assets for the purposes of the CGT provisions.

¶2-320 Active assets A CGT asset satisfies the active asset test if it is an “active asset” (see below) of the taxpayer: • for a total of at least half of the period from when the asset is acquired until the CGT event, or of ownership. • if the asset is owned for more than 15 years — for a total of at least seven and a half years during that period (s 152-35). If a business ceased to be carried on in the last 12 months (or any longer period the Commissioner allows), the relevant period is from the acquisition date until the cessation of business date.

The asset does not need to be an active asset just before the CGT event. The relevant period is from when the asset is acquired until the CGT event.

Example Judy ran a florist business from a shop that she has owned for eight years. She ran the business for five years, and then leased it to an unrelated party for three years before selling it. The shop satisfies the active asset test because it was actively used in Judy’s business for more than half the period of ownership, even though the property was not used in the business just before it was disposed of.

Example Alice ran a farming business on a property that she has owned for 17 years. She ran the farm for three years, and then leased it to an unrelated party for five years. She then ran the farm for another five years before retiring and leasing the farm for another four years before selling it. The farm satisfies the active asset test because it was actively used in Alice’s farming business for at least 7½ years, even though the period was not continuous and the property was not used in the business just before it was disposed of.

What is an active asset? An “active asset” is a CGT asset: • that the taxpayer owns (whether a tangible or intangible asset) and the asset is used (or held ready for use) in carrying on a business carried on (whether alone or in partnership) by the taxpayer, the taxpayer’s associates or another entity connected with the taxpayer • an intangible asset the taxpayer owns and the asset is inherently connected with the business (eg goodwill or the benefit of a restrictive covenant) (s 152-40(1)). The AAT held that land used by a taxpayer in the course of his business to store work equipment, tools and materials was an active asset. Section 152-40(1)(a) only required the asset to be used “in the course of carrying on a business”, encompassing, necessarily, a fairly wide range of activities (Eichmann v FC of T 2019 ATC ¶10-489). Other examples of active assets include the following: trade debtors, intellectual property, a taxi licence, an interest in property from which a business is carried on, poker machine entitlement under a hotelier’s licence and the freehold of a hotel. Not active assets Assets that are not active assets include shares or units that fail the 80% test (see below), financial instruments (eg loans, debentures, share options), and assets whose main use is to derive interest, annuities, rent (eg from investment properties) or royalties. An exception applies where the main use of an asset for deriving rent was only temporary, or the asset is an intangible asset that has been substantially developed so that its market value has been substantially enhanced (see “Investment property” below). Example Andrew owns several investment properties which are all rented out. The properties are not active assets as they are used mainly to derive rent. It is not relevant that Andrew is in the rental properties business. Edward owns a motel (land and buildings) from which he runs a motel business (ie B&B and related motel activities). The motel is an active asset as it is not mainly used to derive rent. By contrast, amounts paid by residents of a mobile home park in return for the right to occupy residential sites were characterised as rent and, therefore, the asset owned by the owner and operator of the mobile home park was not an active asset (Tingari Village North Pty Ltd 2010 ATC ¶10-131).

Other examples of non-active assets are: Australian currency, a bank account, an asset disposed of by the legal personal representative who did not carry on the deceased person’s business and commercial rental properties (Rus v FC of T 2018 ATC ¶10-478; [2018] AATA 1854: largely vacant land). Investment property A company that carries on a business in a general sense as described in Taxation Ruling TR 2019/1 but whose only activity is renting out an investment property cannot claim the Div 152 small business

concessions in relation to that investment property. While a company may be considered to be carrying on a business under Taxation Ruling TR 2019/1, where its investment property is used to derive rent, the question of whether the investment property is an active asset under s 152-40 and satisfies the active asset test in s 152-35 is a separate consideration for the purposes of Div 152. In particular, s 152-40(4)(e) excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary). Such assets are excluded even if they are used in the course of carrying on a business (Draft Taxation Determination TD 2019/D4). Death of a taxpayer If an individual carrying on a business dies and his/her assets devolve to the individual’s legal personal representative (LPR), the active asset test is applied to the LPR in relation to any capital gain made when the LPR sells the assets. The LPR (a beneficiary of the individual, a surviving joint tenant, or the trustee or beneficiary of the trust established by the will of the individual) is eligible for the small business CGT concessions where: (1) the asset is disposed of within two years of the date of death (or any extended period allowed by the Commissioner), and (2) the asset would have qualified for the concessions if the deceased had disposed of the asset immediately before death (s 152-80). Where business has ceased Where a business has ceased, an asset that was an active asset before cessation of the business may qualify for the small business concessions if it is sold within 12 months of cessation of business or any extended period allowed by the Commissioner. It is sufficient for the asset to be an active asset for the lesser of half the period of ownership or seven and a half years, irrespective of whether the business itself has actually ceased. CGT event D1 happening Where CGT event D1 happens (about creating contractual or other rights: ¶2-110), the “active asset” test does not apply. Instead, it is a basic condition that the created right which triggers CGT event D1 must be inherently connected with a CGT asset of the taxpayer that satisfies the active asset test. This effectively enables the ownership and active asset tests to be satisfied in relation to intangible assets (eg a restrictive covenant), which are assets created in another entity without it being “owned” by the taxpayer making the capital gain. Example Bob, a butcher operating as a sole trader, agrees to sell the assets of his business to Friendly Meats. As part of the agreement, Bob undertakes not to operate a butchery business within 5 km of the current business. In return for this, undertaking Friendly Meats pays Bob an amount of $10,000. The $10,000 is a capital gain arising from CGT event D1 as Bob creates a right, being a restrictive covenant, in Friendly Meats. This right qualifies as an active asset because it is inherently connected with other CGT assets of Bob that satisfy the active asset test.

A capital gain made from CGT event D2 happening (about granting, renewing or extending an option) qualifies for small business CGT relief as the CGT event happens “in relation to” the asset in respect of which the option is granted (the underlying asset) (ID 2011/45). Shares and units — 80% test A share in a company or a unit in a unit trust can be an active asset if the company or unit trust is an Australian resident and the active assets of the company or unit trust have a market value of at least 80% of the market value of all its assets. The 80% “look-through” test is applied to the active assets of a company or trust to determine whether shares in the company or interests in a trust qualify as active assets. Cash and financial instruments inherently connected with the business are counted in the 80% test. The test does not need to be applied

in circumstances where it is reasonable to conclude that the test is met and the test does not fail only because of a breach of the threshold that is temporary in nature. Under this modified active assets test, for the lesser of seven and a half years or at least half the period a taxpayer has held the share or interest, at least 80% of the sum of the total market value of the assets below must have related to assets that are active assets, or cash or financial instruments that are inherently connected with a business carried on by the object entity or a later entity: • total market value of the assets of the object entity (disregarding any shares in companies or interests in trusts), and • total market value of the assets of any entity (a later entity) in which the object entity had a small business participation percentage of greater than zero, multiplied by that percentage (s 152-10(2A) (a) and (b)). Further, if these assets are held by a later entity, the assets will only be active at a time if the later entity is an entity: • that is, at the relevant time, either: (i) a CGT small business entity; or (ii) satisfies that maximum net asset value test in relation to the capital gain, and • in which the taxpayer has a small business participation percentage of at least 20% or is a CGT concession stakeholder at the relevant time. An entity is treated as controlling another entity at a time if it has an interest of 20% or more in that other entity at that time, rather than 40% or more. This means that more entities are considered to be “connected with” one another for the purpose of this test and need to count the assets or turnover of the other entity towards their aggregate turnover or total net CGT assets. Also, in working out if one entity controls another for these purposes, any determinations by the Commissioner under ITAA97 s 328-125(6) are disregarded. Effectively, the active asset test in s 152-35 is modified to adopt a look-through approach. Rather than treating shares or interests as active assets based on the activities of the underlying company, the modified test looks through such membership interests to include the proportionate amount of the value of the assets of later entities to which the interests ultimately relate. Furthermore, the modified test only treats assets as “active” if they meet additional requirements. Assets that are not cash or financial instruments must be used in carrying on the business of a later entity (see above) that does not have both significant turnover and assets. Assets that are cash or financial instruments must be inherently connected with such a business. However, the inclusion of cash and financial instruments is subject to an integrity rule. If cash or financial instruments acquired or held for a purpose that includes ensuring the entity satisfies the additional basic conditions, they are disregarded. The rule is similar to the integrity rule for pre-CGT assets in s 104-230(8). Finally, the assets must also be held by an entity in which the taxpayer either has a small business participation percentage of 20% or more or is a CGT concession stakeholder. An individual is a CGT concession stakeholder in a company or trust if, broadly, the individual or their spouse has a CGT small business participation percentage of 20% or more in the company or trust (s 152-50, 152-55, 152-60). This condition prevents the concession from being available for interests in entities if most of the value of the assets of the entity is unrelated to its business activities. In such cases, while the entity carries on a small business, most of the value of the interest held by the taxpayer is not attributable to the small business and it is not appropriate for the small business concessions to apply to the disposal of the interest. The condition also recognises that an investment is effectively passive in nature if an entity has an interest of less than 20% in another entity.

¶2-323 Significant individual test The significant individual test in ITAA97 s 152-50 is relevant in two main situations: (1) if the CGT asset for which the CGT concession is claimed is a share in a company or an interest in

a trust (see “Additional basic conditions — CGT asset is a share or interest in a trust” in ¶2-310), or (2) if the concession claimed specifically requires the test to be met (eg the retirement exemption: ¶2338, the replacement asset rollover in certain circumstances: ¶2-339). The significant individual test enables up to eight taxpayers to benefit from the full range of small business concessions (eg five taxpayers or four taxpayers and their spouses). An individual is a “significant individual” in a company or trust if the individual has a small business participation percentage (which can comprise direct and indirect percentages) in the company or trust of at least 20% (s 152-55). A person’s direct small business participation percentage in a company is the percentage of voting power that the person is entitled to exercise and any dividend payment or capital distribution that the person is entitled to receive. With a fixed trust, a person’s direct small business participation percentage is the percentage of the income and capital of the trust that the person is beneficially entitled to receive. With a discretionary trust, a person’s direct small business participation percentage in the trust is the percentage of distributions of income and capital that the person is beneficially entitled to during the income year if the trust made a distribution of income or capital. If the trust did not make a distribution of income or capital during the income year, it will not have a significant individual during that income year. When determining an entity’s direct small business participation percentage in a trust under items 2 or 3 of the table in s 152-70(1), the references to distributions of “income” do not necessarily mean income according to ordinary concepts. They mean the income of the trust, determined according to the general law of trusts, to which a beneficiary could be entitled. Depending on the deed and/or actions of the trustee, this may be an amount that differs from the ordinary income of the trust (ID 2012/99). If a person has different percentages in a company or a trust, their participation percentage is the smaller or smallest percentage. Example Peter has shares that entitle him to 30% of any dividends and capital distributions of ABC Co. The shares do not carry any voting rights. Peter’s direct small business participation percentage in ABC Co is 0%.

A person’s indirect small business participation percentage in a company or trust is calculated by multiplying the entity’s direct participation percentage in an interposed entity with the interposed entity’s total participation percentage (both direct and indirect) in the company or trust (see examples below).

¶2-325 CGT concession stakeholder A “CGT concession stakeholder” of a company or trust means: • a significant individual (¶2-323) of the company or trust, or • a spouse of a significant individual where: – for a company, the spouse holds legal or equitable interests in any number of shares in the company – for a fixed trust, the spouse is beneficially entitled to any income and capital of the trust, or – for a discretionary trust, the spouse is beneficially entitled to any income or capital distribution made in the year from the trust. CGT concession stakeholders are entitled to the small business concessions in respect of the capital gain they make on the shares or interests in a trust they own, provided they also satisfy the relevant conditions for the concession claimed.

Example 1

Individual 1 is a significant individual of Company B as he/she has an indirect interest of 66.6% in Company B. Individual 2 is a significant individual of Company B as he/she has a direct interest of 33.3%.

Example 2

Scenario 1 — asset sale Assume that the assets of C Co are sold and the proceeds of sale are distributed. A1 and A2 will each qualify as significant individuals as they have at least 20% of the shares in C Co (they are also CGT concession stakeholders). B1 and B2 can also qualify provided Trust B makes a distribution of all of its income and capital for the relevant income year (or at least 33.33% of its income or capital) to B1 and/or B2. If B1 were to receive the distribution, B1 will be a significant individual and a CGT concession stakeholder. B2 will also be a CGT Concession Stakeholder as B2 is the spouse of a significant individual (B1) with an interest in C Co. Scenario 2 — share sale Assume that the B family decides to sell its interests in C Co, and all the shares of B1, B2 and Trust B in C Co are sold. As the CGT asset in question is a share in a company, two additional basic conditions must both be satisfied (see “Basic conditions” above). That is, the company must pass the significant individual test and the person who owns the shares must be a CGT concession stakeholder in the company. These conditions are met because the company has at least one significant individual (both A1 and A2). B1 will be a significant individual (on the basis of the distribution — see Scenario 1) and a concession stakeholder. Accordingly, B1 will qualify for the small business concessions. B2 will also qualify for the concessions, being a CGT concession stakeholder as the spouse of a significant individual. Trust B does not qualify for the concessions because it must be a CGT concession stakeholder. A CGT concession stakeholder is either a significant individual or a stakeholder spouse of a significant individual. Trust B (as a discretionary trust) is neither a significant individual (not an individual) nor a spouse. Accordingly, Trust B does not qualify for any of the concessions.

¶2-336 15-year asset exemption The 15-year asset exemption allows a capital gain arising from a CGT event (other than CGT event K7) happening to an asset of a small business entity to be exempt from CGT if the following conditions are

met: (1) the basic conditions discussed at ¶2-310 are satisfied for the gain (2) the entity owns the asset for any period or periods totalling 15 years during the period of ownership (3) if the CGT asset is a share in a company or an interest in a trust, at all times during the period the asset was owned, the company or trust had a “significant individual” (¶2-323) (4) if the entity is an individual, the individual is aged 55 or over at the time of the CGT event and retires or is permanently incapacitated (5) if the entity is a company or trust, the entity had a significant individual throughout the period that the entity owned the asset (this person need not be the significant individual during the whole period), and the individual who was the significant individual just before the CGT event was aged 55 or over and retires or was permanently incapacitated at that time. If a capital gain of a company or trust is exempt under the 15-year asset concession, any payment that the company or trust makes to an individual who was a CGT concession stakeholder (¶2-325) is also exempt if it is made before the later of: • two years after the CGT event, or • if the relevant CGT event occurred because of the disposal of a CGT asset — six months after the latest time a possible financial benefit becomes or could become due under a look-through earnout right relating to that CGT asset and the disposal (s 152-125(1)). The exemption in this case is limited to the percentage interest of the CGT concession stakeholder in the company or trust. Example Peter is a significant individual of Company X, owning 60% of the shares in the company, and his wife, Janne, owns the remaining 40%. The company makes a capital gain of $10,000 and claims the 15-year exemption as both Peter and Janne are 58 years of age and are planning to retire. Six months after the CGT event, Company X distributes the amount of the exempt capital gain to Peter and Janne as CGT concession stakeholders. The amount that is exempt is calculated as follows: For Peter: 60% of $10,000 = $6,000. For Janne: 40% of $10,000 = $4,000. If Company X were to distribute $8,000 each to Peter and Janne, they can exclude an amount of $6,000 and $4,000 from their assessable incomes, respectively, for the income year, with the balance likely to be assessable as a dividend (ITAA97 s 152125(3)).

¶2-337 50% active asset exemption A small business entity may claim a 50% exemption of the capital gain arising from a CGT event (other than CGT event K7: ¶2-310) happening to an active asset of the entity if the basic conditions discussed at ¶2-310 are satisfied. The capital gain must be reduced by any capital losses before it is reduced by the 50% active asset exemption. The small business entity can choose the order in which capital gains are reduced by its capital losses. If the CGT discount (¶2-215) also applies, it applies before the 50% active asset reduction. Therefore, if the small business entity is an individual, and the capital gain has already been reduced by the 50% CGT discount, the 50% active asset exemption then applies to that reduced gain so that only 25% of the original capital gain is taxable. The capital gain may then be further reduced by the small business retirement exemption (see ¶2-338), where that exemption is available. Example

Laura operates a small cleaning business. She disposes of a CGT asset that she has owned for two years and used as an active asset of the business and makes a capital gain of $17,000. She qualifies for, and claims, both the CGT discount and 50% active asset exemption. Laura also has a capital loss in the income year of $3,000 from the sale of another asset. Laura’s net capital gain of $3,500 for the year is calculated as below: Step 1: $17,000 − $3,000 = $14,000 Step 2: $14,000 − (50% CGT discount × $14,000) = $7,000 Step 3: $7,000 − (50% active asset exemption × $7,000) = $3,500

¶2-338 Small business retirement exemption The small business retirement exemption allows a capital gain arising from a CGT event (other than CGT event K7: ¶2-310) happening to a CGT asset of a small business taxpayer to be exempt from CGT to the extent that the taxpayer who controls the business elects to treat the proceeds as a retirement benefit. An individual taxpayer does not need to cease business activities or retire in order to choose the exemption. It is not necessary to receive actual capital proceeds from a CGT event in order to access the retirement exemption. For example, the exemption is available where a capital gain is made from gifting an active asset and the market value substitution rule applies or where CGT event J2, J5 or J6 (¶2-339) happens. Taxpayers who are eligible to claim this exemption are individuals carrying on business as a sole trader, partnership, private company or trust. Different conditions apply depending on whether the taxpayer is an individual or a company or trust. Individual A small business entity that is an individual can choose the retirement exemption to disregard all or part of a capital gain remaining after other concessions have applied if: • the basic conditions discussed at ¶2-310 are satisfied • the amount chosen to be disregarded (the exempt amount) is specified in writing, and • for an individual under age 55, the individual contributes an amount equal to the exempt amount to a complying superannuation fund or retirement savings account (RSA) when making the choice (if the CGT event is J2, J5 or J6) or in other cases, at the later of receiving the proceeds from the event or making the choice (s 152-305(1), 152-315). The contribution may be satisfied by transferring real property instead of money to the superannuation fund or RSA (ID 2010/217). Where the capital proceeds from a CGT event are received by an individual in instalments, the contributions are required to be made by the later of the time of the choice and the receipt of the instalment (up to the CGT exempt amount). Where the basic conditions are met, the executor of a deceased estate when preparing outstanding income tax returns of the deceased can make a choice under s 152-305(1) to disregard all or part of a capital gain made by the deceased before his death (ID 2012/39). An individual who wishes to defer or delay making a contribution can roll over the capital gain by using the small business rollover (¶2-339). Company or trust A small business entity that is a company or trust (other than a public entity) can choose the retirement exemption to disregard all or part of a capital gain remaining after other concessions have applied if: • the basic conditions are satisfied • the entity satisfies the significant individual test (¶2-323) • the amount chosen to be disregarded (the exempt amount) is specified in writing. If there are two CGT concession stakeholders (¶2-325), the company or trust must specify each stakeholder’s percentage of the exempt amount; these percentages must add up to 100%, although one may be 0%

• the company or trust makes a payment to each of its CGT concession stakeholders, worked out by reference to each individual’s percentage of the exempt amount, by the later of seven days after the choice is made to disregard the capital gain or after receiving an amount of capital proceeds from the CGT event, and • if a stakeholder is under 55 years of age just before the payment is made, the company or trust must make the payment by way of a contribution to a complying superannuation fund or an RSA for the stakeholder and by notifying the fund or RSA provider that the payment is a CGT retirement exemption amount (ID 2010/217: payment to the fund in specie). CGT retirement exemption limit The exempt amount under the retirement exemption is limited to a lifetime “CGT retirement exemption limit” of the individual taxpayer or the CGT concession stakeholders of the company or trust. An individual’s lifetime limit is $500,000 reduced by any previous small business retirement exemptions. Therefore, a company or trust with two CGT concession stakeholders will effectively have a limit of $1 million ($500,000 for each stakeholder). Other key points The small business CGT retirement exemption applies appropriately to capital proceeds received by individuals in instalments (s 152-305(1)). Small business taxpayers do not need to satisfy the basic conditions for the small business CGT retirement exemption if the capital gain arises from CGT event J5 or J6 (s 152-305(4)). CGT event J5 happens if the taxpayer does not acquire a replacement asset or incur relevant improvement expenditure by the end of the two-year replacement asset period. CGT event J6 happens if the cost of the replacement asset or the amount of the improvement expenditure (or both) is less than the amount of the capital gain originally deferred (see ¶2-110, ¶2-339). Example Albert sells his entire business with the intention of purchasing a new business. He claims the small business rollover. At that time he is also eligible to claim the retirement exemption. Albert is unable to find a suitable replacement asset within two years and decides instead to retire from business. Typically, CGT event J5 is triggered and as Albert has not acquired a replacement asset or incurred the relevant improvement expenditure, he would not normally satisfy the basic conditions for accessing the retirement exemption so the capital gain from CGT event J5 cannot be disregarded. The modification of the operation of s 152-305(1)(a) and (2)(a) to make satisfying the basic conditions for the retirement exemption unnecessary if the gain arises from CGT events J5 or J6 means that Albert can access the retirement exemption in these circumstances as he is no longer required to meet the basic conditions in relation to his capital gain from the J5 event.

The small business CGT retirement exemption enables CGT exempt payments to flow through small business structures involving interposed entities ultimately to a CGT concession stakeholder without adverse tax consequences (s 152-310(3), 152-325(1)). To ensure that there is no tax impact on the interposed entity, the indirect payments are: • non-assessable non-exempt income of an interposed entity • not deductible from an interposed entity’s assessable income, and • neither a dividend nor a frankable distribution. Division 7A dealing with loans to shareholders and s 109 of the ITAA36 (the deemed dividend provisions) do not apply to payments made to CGT concession stakeholders to satisfy the retirement exemption conditions (s 152-325(9)–(11)). Case study A practical analysis and case study of the small business retirement exemption is provided at ¶15-210.

¶2-339 Small business replacement asset rollover The small business rollover concession enables a small business entity to defer making a capital gain from a CGT event happening in relation to an active asset if it acquires replacement assets in certain circumstances. However, if the use of the replacement asset later changes or in certain other circumstances (ie CGT event J2, J5 or J6 happens: see below), the deferred capital gain will crystallise and the entity will make a capital gain equal to the capital gain deferred. The crystallised capital gain may be eligible for deferral under a further application of the small business rollover concession but is not eligible for the CGT discount or 50% active asset exemption. A small business entity can choose to obtain a rollover if: • the basic conditions (see ¶2-310) are satisfied • the entity chooses one or more CGT assets as replacement assets within the period starting one year before and ending two years after the last CGT event happens in the income year for which it is choosing the rollover (replacement asset period) • the replacement asset is acquired within that same period (the Commissioner may extend the time limit) • the replacement asset is an active asset when it is acquired, or an active asset by the end of two years after the last CGT event happens in the income year for which it is choosing the rollover, and • if the replacement asset is a share in a company or an interest in a trust, the entity or a connected entity must be a significant individual of that company or trust just after it acquires the share or interest. Where a CGT event involves a look-through earnout right, the end of the replacement asset period is extended to be six months after the expiration of the right (s 104-190(1A)). Amount of gain deferred If the replacement asset rollover is chosen, the amount of capital gain remaining after other concessions have applied is disregarded to the extent it does not exceed the total of: • the acquisition consideration of the replacement asset (ie the first element of the cost base of the replacement asset), and • any incidental costs associated with that acquisition (ie the second element of the cost base of the replacement asset). If any capital gain cannot be so disregarded, a capital gain is made equal to that amount. Example An entity made an original capital gain of $100,000 which was reduced to $25,000 under other concessions. If the total of the first and second elements of the cost base of the replacement asset is $20,000, $20,000 can be disregarded under the rollover leaving a final capital gain of $5,000.

CGT events J2, J5 or J6 happening — reversal of concession A reversal of the small business asset rollover concession will arise if CGT events J2, J5 or J6 happen. • CGT event J2 happens if a taxpayer chooses a CGT asset as a replacement asset and there is a change in relation to the replacement asset or improved asset (eg the asset stops being an active asset or certain CGT events happen in relation to the asset, or the asset becomes trading stock, or the taxpayer starts to use the asset solely to produce exempt income).

• CGT event J5 happens if a taxpayer fails to acquire a replacement asset and to incur fourth element expenditure after a replacement asset rollover. • CGT event J6 happens if the cost of acquisition of a replacement asset or amount of fourth element expenditure, or both, is not sufficient to cover the disregarded capital gain under the rollover (see ¶2110).

¶2-340 Special rules for personal use assets and collectables Personal use assets “Personal use assets” include assets used or kept mainly for personal use or enjoyment (eg furniture, household items, electrical goods, a boat). They do not include land and buildings or collectables. They can also arise from certain associated transactions, eg a right or option to purchase such an asset. Any capital loss that is made from a personal use asset is disregarded, regardless of its acquisition cost (s 108-20). A capital loss cannot be made from the disposal of shares in a company or interest in a trust that owns a personal use asset that has declined in value. If a CGT event happens to a personal use asset that was acquired for $10,000 or less, any gain is disregarded, ie it is exempt from the CGT rules. If it was acquired for more than $10,000, it can give rise to a capital gain, but not a capital loss. If a number of personal use assets that would usually be sold as a set is disposed of individually, the CGT exemption applies only if the set was acquired for $10,000 or less. Collectables Assets that are “collectables” include artwork, jewellery, antiques, coins, medallions, rare folios, manuscripts or books, stamps and first day covers, including an interest in these items, or an option or debt arising from the item: Favaro v FC of T 96 ATC 4975; ID 2011/9 (now withdrawn as a restatement of the law) in regard to artwork held as a long-term investment in the expectation of capital appreciation. A collectable that is acquired for $500 or less is exempt from the CGT rules, so that there will be no capital gain or loss (ie it is disregarded) when a CGT event happens to it. Any capital loss from collectables can only be offset against capital gains from other collectables (s 10810). Capital losses derived from the disposal of indirect interests in collectables (eg shares in a company that owns a collectable) are treated as losses from collectables. The cost base of a personal use asset or collectable does not include costs such as interest on a loan used to finance the acquisition of the asset, repair costs or insurance premiums (¶2-200). If a number of collectables that would usually be sold as a set is disposed of individually, the CGT exemption applies only if the set was acquired for $500 or less. Working out capital gains and losses from collectables A capital gain from a collectable can qualify as a discount capital gain. A taxpayer can choose the order in which the capital gain from collectables is reduced by capital losses from collectables. If some or all of a capital loss from a collectable cannot be applied in an income year, the unapplied amount (a net capital loss from collectables) can be applied in the next income year for which the taxpayer has capital gains from collectables that exceed capital loss from collectables. An ordinary capital loss cannot generally be made from the disposal of shares in a company or an interest in a trust that owns a personal use asset which has declined in value. Example Amelia sells five collectables over a two-year period as follows:

Income year

Cost base and reduced

Cost base

Capital

Collectable

Collectable

of disposal

cost base

(indexed)

proceeds

gain (loss)

A

Year 1

$1,500

$1,520

$1,800

$280

B

Year 1

$1,000

$1,020

$680

($320)

C

Year 2

$2,020

$2,070

$3,000

$930

D

Year 2

$4,000

$4,080

$3,860

($140)

E

Year 2

 $600

 $650

 $475

($125)

For the first income year, Amelia has a net collectable loss of $40, ie $320 (Asset B) − $280 (Asset A). For the second income year, Amelia (using the indexation method) makes a capital gain of $625, calculated as follows: $930 (Asset C) − $140 (Asset D) − $125 (Asset E) − $40 (Year 1 collectable loss) = $625 Note: In the second year, Amelia would be better off using the discount method. On this basis, the net capital gain would be: 50% × ($980 (Asset C) − $140 (Asset D) − $125 (Asset E) − $40 (Year 1 collectable loss)) = $337.50

¶2-343 Other exemptions or loss-denying transactions A capital gain or capital loss from certain transactions and in particular circumstances may be disregarded for CGT purposes. Leases not used for income-producing purposes A capital loss a lessee makes from the expiry, surrender, forfeiture or assignment of a lease (except one granted for 99 years or more) is disregarded if the lessee did not use the lease solely or mainly for income-producing purposes (s 118-40). Strata title conversions If a taxpayer owns land on which there is a building, the building is subdivided into stratum units and each unit is transferred to the entity having the right to occupy it just before the subdivision, a capital gain or loss made by the taxpayer from transferring the units is disregarded (s 118-42). In such situations, a rollover is also available for the occupiers of the building in relation to the change in the nature of their rights of occupation. Mining rights of genuine prospectors A capital gain or loss from the sale, transfer or assignment of rights to mine in certain areas of Australia is disregarded if the income from the sale, transfer or assignment is exempt because of former s 330-60 (about genuine prospectors) (s 118-45). Foreign currency hedging contracts A capital gain or loss from a hedging contract entered into solely to reduce the risk of financial loss from currency exchange rate fluctuations is disregarded (s 118-55). Gifts of property A capital gain or loss from a testamentary gift of property is disregarded (s 118-60) if it arises from a testamentary gift that would have been deductible under s 30-15 if it had not been a testamentary gift. As an anti-avoidance measure, if a testamentary gift is reacquired for less than market value by either the estate of the deceased person or an associate of the deceased person’s estate, the rules relating to the effect of death on CGT assets will apply. Relationship breakdown settlements Capital gains and losses arising from relationship breakdown settlements are generally disregarded. A capital gain or loss that is made as a result of CGT event C2 happening to a right (¶2-110) is disregarded if: • the gain or loss is made in relation to a right that directly relates to the breakdown of a relationship between spouses, and

• at the time of the trigger event, the spouses involved are separated and there is no reasonable likelihood of cohabitation being resumed (s 118-75). A “spouse” includes a member of a same-sex couple. Native title and rights to native title benefits A capital gain or loss made by a taxpayer that is either an indigenous person or an indigenous holding entity is disregarded where the gain or loss happens in relation to a CGT asset that is either a native title or the right to be provided with a native title benefit, and the gain or loss happens because of one of the following: • the taxpayer transfers the CGT asset to one or more entities that are either indigenous persons or indigenous holding entities • the taxpayer creates a trust that is an indigenous holding entity over the CGT asset • the taxpayer’s ownership of the CGT asset ends (eg by cancellation or surrender), resulting in CGT event C2 happening in relation to the CGT asset (s 118-77). Norfolk Island residents Since 1 July 2016, Norfolk Island residents are fully subject to Australia’s income tax and CGT. Under a transitional rule, capital gains or losses on CGT assets held by Norfolk Island residents before 24 October 2015 are disregarded, if the resident would have been entitled to an exemption on those gains under the law that existed before 1 July 2016, by treating such assets as if they were acquired prior to 20 September 1985 (Income Tax (Transitional Provisions) Act 1997 (ITTPA) s 102-25(2)). Other transactions and circumstances Other transactions and circumstances in which a CGT exemption may be available include those involving foreign branch gains and losses of companies, external territories, securities lending arrangements, superannuation payments, life insurance companies and demutualisation of insurance companies, offshore banking units, cancellation and buyback of shares, calculating the attributable income of a CFC, and registered emissions units or a right to receive an Australian carbon credit unit (s 118-15).

¶2-345 Earnout arrangements An earnout arrangement is an arrangement whereby as part of the sale of a business or the assets of a business, the buyer and seller are not able to agree on a fixed payment and instead agree that subsequent financial benefits may be provided, based on the future performance of the business or a related business in which the assets are used. Earnout arrangements are therefore commonly used in the sale of businesses where there is difficulty agreeing about the value of the business. In this situation, the earnout arrangement allows parties to reach a mutually acceptable arrangement despite differences in how the parties value the business by linking additional financial benefits (or, for a reverse earnout, refunds of prior financial benefits) to the future economic performance of the business. In a standard earnout arrangement, the buyer agrees to pay the seller additional amounts if certain performance thresholds are met within a particular time. In a reverse earnout arrangement, the seller agrees to repay amounts to the buyer if certain performance thresholds are not met within a particular time. Some earnout arrangements combine the features of both a standard earnout and a reverse earnout as both the buyer and seller may be obligated to provide financial benefits depending on performance. Look-through earnout rights The tax treatment affecting earnout arrangements depends on whether the earnout right is a “lookthrough earnout right”.

A right will be a “look-through earnout right” where the conditions in s 118-565(1) are satisfied. The five-year requirement in s 118-565(1)(e) is treated as having never been satisfied where the arrangement includes an option to extend or renew that arrangement, or the parties enter into another arrangement over the CGT asset, so that a party could receive financial benefits over a period ending later than five years after the end of the income year in which the CGT event happens (s 118-565(2)). A look-through earnout right also includes a right to receive future financial benefits that are for ending such a defined look-through right, provided the arrangement does not result in a breach of the five-year limitation (s 118-565(3)). CGT treatment of qualifying earnout arrangements The look-through CGT treatment of qualifying earnout arrangements under Subdiv 118-I has the effect of: • disregarding any capital gain or loss relating to the creation of the right • for the buyer — treating financial benefits provided (or received) under the right as forming part of (or reducing) the cost base of the business asset acquired • for the seller — treating financial benefits received (or provided) under the right as increasing (or decreasing) the capital proceeds of the business asset sold. For these purposes, a “financial benefit” means anything of economic value and includes property and services (s 974-160). A taxpayer disregards the capital gain or loss relating to the creation of the right arising from: • CGT event C2 (about cancellation of a CGT asset: ¶2-110) in relation to a right received, or • CGT event D1 (about the creation of a right: ¶2-110) for a right created in another entity (s 118-575). Most earnout arrangements created on or after 24 April 2015 will qualify for look-through treatment under Subdiv 118-I. In other cases, see the Commissioner’s view on the CGT consequences in former Draft Taxation Ruling TR 2007/D10 (withdrawn). CGT small business concessions The CGT small business concessions (¶2-300 and following) apply to a sale of assets involving a lookthrough earnout right by extending both the time to choose to apply the concessions and the replacement asset period.

¶2-350 Separate asset rule If an individual owns an interest in a CGT asset and they acquire another interest in that asset, the interests remain separate CGT assets for CGT purposes and do not become a single asset (Taxation Determination TD 2000/31). The interests are separate CGT assets whether the first interest was acquired before 20 September 1985 (a pre-CGT interest) or was acquired on or after 20 September 1985 (a post-CGT interest). When a CGT event affecting the interests happens (eg CGT event A1 when the asset is sold), the consequences are: • there is a separate date of acquisition for each interest • there is a separate cost base for each interest, and • capital proceeds are determined separately for each interest (see “Interest in land” below). Interest in land The general rule is that what is attached to land becomes part of the land. Special rules apply for determining whether a building or structure constructed on land or other capital improvement should be treated as an asset separate from the land. This will affect CGT calculations because the separate asset will have its own cost base and date of acquisition.

The main rules are: • a post-CGT building constructed on land acquired before 20 September 1985 (pre-CGT land) is treated as a separate asset from the land. This means, for example, that it will not enjoy the exemption normally available for pre-CGT assets • a building constructed on post-CGT land is treated as a separate asset from the land if the disposal of the building would have been covered by the balancing adjustment rules, eg for depreciated assets, R&D buildings • if post-CGT land is amalgamated with adjacent pre-CGT land, the two blocks are treated as separate assets (see “Adjacent land” below) • a capital improvement (eg fencing) which is made to pre- or post-CGT land is treated as a separate asset from the land if its disposal would have been covered by the balancing adjustment rules • a post-CGT capital improvement (including an intangible capital improvement: see example below) to a pre-CGT asset is treated as a separate asset if, at the time a CGT event happens to the original asset, the cost base of the improvement is more than both the specified threshold for the year (see “CGT improvement threshold” below) and 5% of the capital proceeds received from the CGT event. Example Tom and Jerry jointly purchased land in 1982 to build a holiday house. Jerry sold his 50% interest to Tom in 1998 (this interest then became a separate post-CGT asset for Tom). Any capital gain or capital loss Jerry made from the sale of his interest is disregarded for CGT purposes because it was a pre-CGT interest. If Tom later sells the land, the sale proceeds are attributed 50% to the pre-CGT interest and 50% to the post-CGT interest. Any capital gain or capital loss Tom makes on his pre-CGT interest in the land is disregarded for CGT purposes. If Tom makes a capital gain on his post-CGT interest in the land it would be taken into account in calculating his net capital gain or net capital loss for the income year. If Tom decides to sell only a 50% interest in the land, he can: • sell either his (50%) pre-CGT interest or his (50%) post-CGT interest, or • sell two 25% interests in the land (being 50% of his pre-CGT interest and 50% of his post-CGT interest).

CGT improvement threshold The improvement threshold is determined for two purposes — ITAA97 s 108-70 (about when a capital improvement to a pre-CGT asset is a separate asset) and s 108-75 (about capital improvements to CGT assets for which a rollover may be available). The improvement threshold, which is indexed annually, is $153,093 for 2019/20 ($150,386 for 2018/19) (ITAA97 s 108-70(2) and (3), 108-75). Adjacent land and subdivision of land If you acquire land on or after 20 September 1985 that is adjacent to land that you already owned as at 20 September 1985, it is taken to be a separate CGT asset from the original land if you amalgamate the two titles. Example: adjacent land On 2 June 1984, Danielle bought a block of land. On 10 July 2019, she bought an adjacent block. Danielle amalgamated the titles to the two blocks into one title. The second block is treated as a separate CGT asset acquired on or after 20 September 1985 and is, therefore, subject to CGT when a CGT event happens to it.

Example: intangible capital improvement John, a farmer, holds pre-CGT land; that is land acquired before 20 September 1985. John obtains council approval on 5 July 2019

to rezone and subdivide the land. Those improvements may be separate CGT assets from the land (TD 2017/1).

Collectables An interest in a collectable is itself a collectable. A capital gain or capital loss made from an interest in a collectable is disregarded if the market value of the entire collectable at the time the interest is acquired is $500 or less (see ¶2-340). If you acquire a further interest in the collectable after the market value of the entire collectable has increased to more than $500, a capital gain or capital loss may be made from the further interest. If you last acquired the interest in a collectable before 16 December 1995, a capital gain or capital loss is disregarded if you acquired the interest for $500 or less (ITTPA s 118-10). Example Sally and Janet each acquire a 50% interest in a painting in 1999, each paying 50% of the then market value ($400) of the painting. They have each acquired a collectable (being their interest in the painting) for $200. In a later year, Sally acquires Janet’s 50% interest in the painting for $600. The painting’s market value at that time is $1,200. Sally has acquired another collectable (being the further 50% interest) for $600. Sally now has two separate assets (being the two 50% interests she acquired separately). Disposal for $2,000 — Sally disposes of the painting for $2,000. $1,000 of the sales proceeds is attributed to each of the two interests in the painting. Sally’s capital gain on the sale of her 1999 interest is disregarded because the market value of the painting in 1999 was less than $500. Sally makes a capital gain on the later year interest in the painting of $400 ($1,000 less $600, ignoring indexation). Disposal for $1,000 — Assume that the value of the painting has depreciated and Sally disposes of it for $1,000. In this case, the capital loss on the 1990 interest is disregarded. Sally makes a $100 capital loss on the later year interest (ie $600 – $500) which is available to offset against capital gains she makes from other collectables (if any).

Earnout rights — sale of business The ATO considers that an earnout right that is created under an arrangement to sell a business is treated as an asset that is separate to the business. The tax treatment of earnout rights on a sale of a business under a “look-through earnout right” arrangement entered into on or after 24 April 2015 is discussed in ¶2-345.

¶2-355 Options An option is a CGT asset. There are basically two kinds of options — a “call” option where a person grants another person an option to acquire an asset from the first person, and a “put” option where a person grants another person an option to require the first person to acquire an asset from the other person. The rules apply to an option for the disposal of assets or the issue of a share in a company, and, from 27 May 2005, to an option to create an asset. The rules also apply to the renewal or extension of an option in the same way as they apply to the granting of an option. For example, the rules apply to an option to grant a lease or easement or an option to issue units in a unit trust. Grant of option If a taxpayer grants an option to an entity, CGT event D2 happens. It follows that a capital gain (or in some cases, a capital loss) may be made by the grantor of an option in the income year in which the option is granted. If, however, the option is subsequently exercised, any capital gain or capital loss made from the grant of the option is disregarded. To work out if the grantor of an option makes a capital gain or capital loss on the grant, the capital proceeds from the grant of the option are compared with the expenditure incurred by the grantor to grant the option. The capital gain or capital loss is the difference between the two amounts. If an option is exercised, it may be necessary to apply for an amendment of an assessment for an earlier year of income (eg the grantor has a net capital gain for the earlier year as a result of granting the option).

Where an option (whether a call or a put option) is granted, the grantee acquires the option when it is granted. The cost base and reduced cost base of the option to the grantee is determined in accordance with the ordinary cost base rules (¶2-200). Thus, the option fee and any incidental costs (eg legal fees and stamp duty) will be included in the cost base. Exercise of option The date of acquisition (or disposal) of a CGT asset acquired (or disposed of) on the exercise of an option applies is the date of the transaction entered into as a result of the exercise of the option, and not the date that the option was granted (CGT Determination TD 16). When an option is exercised, the usual CGT rules are modified. However, these modifications do not apply where the special CGT rules dealing with certain rights and options issued by a company or trust are involved (see below). A capital gain or loss the grantor or grantee of an option makes from the option being exercised is ignored. The cost base and reduced cost base of the option are modified for both the grantor and grantee. In the case of a call option, the first element of the grantee’s cost base and reduced cost base for the asset acquired is what the grantee paid for the option plus any amount paid by the grantee to exercise that option. In addition, the capital proceeds for the grantor are worked out in the same way. However, if the option was granted pre-CGT and exercised post-CGT, the first element of the cost base and reduced cost base of the acquired asset includes the market value of the option at the time of exercise. In the case of a put option, the first element of the grantor’s cost base and reduced cost base for the asset acquired is the amount the grantee paid for the asset it was required to purchase because the grantee exercised the option, reduced by the amount received by the grantor for granting the option. In addition, the second element of the grantee’s cost base and reduced cost base for the asset disposed of to the grantor includes any payment the grantee made to acquire the option. Example 1 Jessica gives Mary an option to buy an investment asset for $80,000. Mary pays $10,000 for the option, and later exercises it. The first element of her cost base and reduced cost base for the asset includes the $10,000 she paid for the option. Accordingly, the first element of her cost base and reduced cost base for the asset is $90,000 (ie $80,000 + $10,000).

Example 2 Peter owns 5,000 shares in ABC Ltd. Gillian gives Peter an option which, if exercised, would require her to buy the shares for $1 each. Peter pays Gillian 20 cents per share for the option. Peter exercises the option and Gillian pays $5,000 for the shares. The first element of Gillian’s cost base and reduced cost base for the shares is $4,000 (ie $5,000 − $1,000). In working out whether Peter makes a capital gain or loss on the sale of the shares, the second element of his cost base and reduced cost base includes the $1,000 he paid for the option.

Options — company shares and units in unit trust Companies and trustees of a unit trust may issue call options to their shareholders and unitholders, and companies may issue put options to their shareholders. Under a call option, the company or trustee issues the shareholders or unitholders with rights to buy additional shares in the company or additional units in the trust. Under a put option, a company issues its shareholders with rights to sell their shares back to the company. The High Court held that the market value of tradeable put options issued by a company to its shareholders was assessable as ordinary income at the time of issue of the options (FC of T v McNeil 2007 ATC 4223). On the CGT issue in that case, the court said that neither the creation of the sell-back rights nor the payment to the taxpayer could be said to have occurred in relation to a CGT asset then owned by the taxpayer as the taxpayer’s ownership of the relevant shares at the time of the events was irrelevant to their occurrence. Options and withholding tax Law Companion Ruling LCR 2016/7 provides guidelines on withholding tax implications on the

acquisitions of options to acquire TARP or indirect Australian real property interests, or acquisitions of TARP or indirect Australian real property interests as a result of exercising an option, under transactions entered into on or after 1 July 2016, where the vendor of the asset is a relevant foreign resident (¶2-280).

¶2-360 Special rules for beneficiaries of a trust Special rules apply to a beneficiary of a trust who is taxed under the trust provisions of the ITAA36 on a share of the net income of the trust where the net income included a net capital gain. To determine the share of net income of a trust estate to be included in a beneficiary’s assessable income under ITAA36 s 97(1)(a), the beneficiary must calculate how much of the income of the trust estate they are (or are taken to be) presently entitled to, as percentage share of that income, and apply that percentage to the net income of the trust estate (ie the “proportionate approach” to the assessment of trust net income). If a trust has made a capital gain or received a franked distribution to which no beneficiary is specifically entitled, the proportionate approach may also be relevant to the application of Subdiv 115-C and 207-B of the ITAA97. These rules ensure that the capital losses of the beneficiary are taken into account against the grossedup capital gains, ie before any CGT discount (¶2-215) or small business concessions (¶2-300). They also prevent the benefit of the discount capital gain concessions from flowing through to beneficiaries who are not entitled to the discount capital gain concession (eg a company). Effectively, the beneficiary must calculate the amount of the trust distribution that is attributable to each trust gain. The beneficiary is then deemed to have a capital gain in respect of each trust gain grossed-up as below. CGT concession in trust gain

Deemed capital gain grossed-up by multiplying gain by:

None

1

Discount capital gain

2

Active asset discount

2

Both discount capital gain and active asset discount

4

Using the above calculation, the beneficiary effectively grosses up that part of their share of the net income of the trust attributable to a capital gain that has been discounted or has received small business relief. This amount is treated as a capital gain of the beneficiary for the purposes of calculating the net capital gain for the year. The deemed capital gain is then used to calculate the net capital gain of the relevant beneficiary by taking into account the beneficiary’s entitlement to the discount capital gain and/or the small business concession, where applicable. The beneficiary is entitled to a deduction for the trust distribution amount that is attributable to the net capital gain of the trust so as to avoid double taxation. Example A fixed trust makes a capital gain of $1,000 when it disposes of a CGT asset that it acquired in April 1999. In calculating the net income of the trust, the trustee claims the 50% CGT discount resulting in a discounted capital gain of $500 (assuming that no small business relief is available). A company that is presently entitled to the net income of the trust is the sole beneficiary. The beneficiary company will gross up the discounted capital gain component to $1,000 and can apply capital losses against that $1,000 plus the $500 trust distribution. A company is not eligible to claim a CGT discount, so it must include the whole $1,500 in its assessable income for the year. The company is entitled to a $500 deduction, that being the relevant amount of the trust estate’s net capital gain. The effect for the company beneficiary is as follows.

$ Net trust income on which beneficiary is assessable

500

Discounted capital gain grossed-up (× 2)

1,000

Deduction for net trust income

(500) $1,000

This achieves the same result as if the beneficiary had made the net capital gain directly.

The trustee of a resident testamentary trust can choose to be assessed on the capital gains that would otherwise be assessed to an income beneficiary or the trustee would otherwise be liable to tax on the gains on behalf of such a beneficiary under ITAA36 s 98 (ITAA97 s 115-230). Where a choice is made in respect of a beneficiary’s share, the consequences are: • the share is taken not to be included in the assessable income of the beneficiary (for the purposes of s 97, 98A and 100 of the ITAA36: ¶1-500 onwards) • the trustee is not assessed, and is not liable to pay tax, in respect of the share under s 98. Instead, the trustee will be assessed on the beneficiary’s share under s 99A or (at the Commissioner’s discretion) s 99 of ITAA36. Streaming capital gains to a beneficiary “specifically entitled” A trust’s capital gains and franked distributions can be streamed to beneficiaries for tax purposes by making those beneficiaries “specifically entitled” to those amounts, if permitted by the trust deed. Franked distributions and franking credits are discussed in ¶1-405. If a trust estate makes a capital gain, s 115-228 of the ITAA97 sets out the amount (if any) of that gain to which a beneficiary of the trust is treated as being specifically entitled. A beneficiary specifically entitled to a capital gain will generally be assessed on that gain, regardless of whether the benefit the beneficiary receives or is expected to receive is income or capital of the trust. That is, unlike before, a beneficiary may be assessed based on a specific entitlement to a capital gain of the trust, even though the beneficiary does not have a present entitlement to income of the trust estate. Capital gains to which no beneficiary is specifically entitled will be allocated proportionately to beneficiaries based on their present entitlement to income of the trust estate (excluding franked distributions to which any entity is specifically entitled). If there is some of this income to which no beneficiary is entitled, the trustee may be assessed for tax on that income under s 99 or 99A of the ITAA36. Two conditions must be satisfied for a beneficiary to be “specifically entitled” to a capital gain derived or a franked distribution received by a trust: • Entitlement condition — the beneficiary must have received, or reasonably expected to receive, financial benefits that are referable to the capital gain (reduced by any relevant losses) or franked distribution (reduced by directly relevant expenses). • Recording condition — the beneficiary’s entitlement to the amount must be recorded as an amount referable to the capital gain or franked distribution in the trust’s accounts or records (ITAA97 s 115228). Whether a beneficiary can be specifically entitled to a capital gain or franked distribution is a question of fact. For example, when a beneficiary becomes absolutely entitled to a trust asset, it may be reasonable to expect the beneficiary will receive the net financial benefit referable to the deemed (trust) capital gain from CGT event E5 (ID 2013/33). In this case the financial benefit referable to the capital gain is the asset itself (or the value of that asset) and the absolutely entitled beneficiary is, in accordance with the terms of the trust created by the will, the only one that is expected to receive the asset (and thus that benefit). The accounts or records of the trust would include the trust deed itself, statements of resolution or distribution statements, including schedules or notes attached to, or intended to be read with them. A record merely for tax purposes is not sufficient.

For a capital gain, the conditions must be met no later than two months after the end of the income year in which the capital gain is made (or, for a franked distribution, by the end of the income year in which the distribution is received). If permitted by the trust deed and the conditions are met, the capital gain or franked distribution amount to which the beneficiary is specifically entitled is calculated as below: Step 1 — work out the beneficiary’s entitlement as a percentage of the total financial benefits referable to the capital gain (reduced by any losses applied consistent with the application of capital losses for tax purposes) or franked distribution (net of direct expenses) Step 2 — apply that percentage to the gross capital gain or franked distribution (s 115-228). For a capital gain, the total financial benefits referable will generally equal the capital gain as calculated for trust purposes less any losses the trustee has applied against the gain, to the extent that the corresponding capital losses were applied against that gain for tax purposes. For a franked distribution, the total financial benefits referable will generally equal the franked distribution less any directly relevant expenses. The above rules allow the trustee of a resident trust to choose to be assessed on a capital gain, provided no beneficiary has received or benefitted from any amount relating to the gain during the income year, or within two months of the end of the income year, and for the trustee to choose to pay tax on behalf of a beneficiary that is unable to immediately benefit from the gain.

STEP 4: ROLLING OVER/DEFERRING A CAPITAL GAIN OR LOSS ¶2-400 Deferring capital gains and losses In some situations you can defer a capital gain or loss which would otherwise arise when a CGT event occurs (eg when you dispose of an asset). This means that instead of CGT applying at that time, it is deferred until there is another CGT event affecting that asset, or its replacement. This deferral is called a rollover. Typically, rollovers are available where: • the disposal does not really involve any change in the underlying ownership of the asset, eg where an asset is transferred from one group company to another, or from a partnership to a wholly owned company • the disposal has been forced on the person, eg where a person is forced to replace an asset which has been destroyed, or there is a split up of family assets on marriage breakdown, or • there are policy reasons, eg certain disposals of small business assets which are replaced. Generally, a rollover will mean that: • an asset which was pre-CGT retains its exempt pre-CGT status despite the disposal; however, this is not always the case (eg the rollover for small business assets) • the CGT liability of the person acquiring the asset is calculated as if that person had purchased the asset for an amount equal to the indexed cost base of the original owner. Some types of rollover are automatic (eg on marriage breakdown), but most require the taxpayer to make a specific choice for rollover to apply. This is important, because sometimes you may not wish to defer a capital gain or loss. For example, you may want to realise a loss so it can be offset against some other capital gain that you have derived. Or it may be preferable for a gain or loss to be attributed to the original owner rather than the person who acquired the asset. The general rules for making a choice are set out in s 103-25 of the ITAA97 (ID 2003/103: extension of time to make a choice where a taxpayer is unaware of availability of a concession).

The more common circumstances of same asset and replacement asset rollovers are noted in ¶2-410.

¶2-410 Typical rollover situations There are two main types of rollovers — a replacement-asset rollover and a same-asset rollover (the main rollover relief provisions are noted below). A replacement-asset rollover involves a CGT event happening in relation to an asset, which the taxpayer no longer owns after the rollover. Instead, the taxpayer owns a different asset (ie the replacement asset) after the rollover. In such a case, any capital gain or loss arising from the CGT event which gave rise to the rollover is deferred until a later time when a CGT event happens to the replacement asset. The CGT characteristics of the original asset are transferred to the replacement asset. In the case of a replacement-asset rollover, any CGT liability remains with the taxpayer, even though that liability arises in relation to a different asset (some examples are listed below). A same-asset rollover involves a CGT event happening in relation to an asset which changes hands from one taxpayer to another, with the rollover attaching to the asset in the hands of the transferee. In such a case, any capital gain or loss from the CGT event arising in the hands of the transferor is ignored. Any capital gain or loss which later arises from another CGT event happening to the asset is only relevant for the transferee taxpayer. The CGT characteristics of the rolled over asset are transferred with the asset, from the transferor to the transferee. In the case of a same-asset rollover, any CGT liability is transferred from one taxpayer to another, though that liability attaches to the same asset (some examples are listed below). Same asset rollover ☐ transfer of a CGT asset to a wholly owned company (Subdiv 122-A; ID 2014/14: cost base of preCGT asset acquired) ☐ transfer of a CGT asset of a partnership to a wholly owned company (Subdiv 122-B) ☐ transfer of a CGT asset of a trust to a company under a trust restructure (Subdiv 124-N) ☐ marriage/relationship breakdown and asset transfers from one spouse to the other, or from a company or trust to a spouse (Subdiv 126-A: see below) ☐ transfer of a CGT asset between certain related companies (Subdiv 126-B) (ID 2012/56: legal merger of two companies of the same wholly owned group carried out under the law of a foreign country) ☐ CGT event happens because a trust deed of a complying approved deposit fund, a complying superannuation fund or a fund that accepts worker entitlement contributions is changed (Subdiv 126C) ☐ splitting superannuation interests in a marriage/relationship breakdown — transfers of assets from one small superannuation fund to another complying superannuation fund (Subdiv 126-D) ☐ beneficiary becomes absolutely entitled to a share following a scrip for scrip rollover (Subdiv 126-E) ☐ when assets are transferred between fixed trusts which have the same beneficiaries with the same entitlements and no material discretionary elements (Subdiv 126-G) ☐ where an interest holder exchanges shares in a company or units in a unit trust for shares in another company as part of a restructure (Div 615) ☐ transfers of assets as part of a change of legal structure without a change in the ultimate legal ownership (Subdiv 328-G) (see “Small business restructure rollover” below). Replacement asset rollover ☐ disposal or creation of asset(s) of a business to a wholly owned company by an individual, or a

trustee or a partner (Subdiv 122-A and 122-B) ☐ asset compulsorily acquired, lost or destroyed (ie involuntary disposal of asset) (Subdiv 124-B) ☐ renewal or extension of a statutory licence (Subdiv 124-C) ☐ strata title conversions (Subdiv 124-D) ☐ exchange of shares in the same company or of units in the same unit trust (Subdiv 124-E) ☐ exchange of rights or options to acquire shares in a company (ie share splits or consolidations) or to acquire units in a unit trust (ie unit splits or consolidations) (Subdiv 124-F) ☐ exchange of shares in one company for shares in an interposed company (Subdiv 124-G) ☐ exchange of units in a unit trust for shares in a company (Subdiv 124-H) ☐ rollover for change of incorporation (Subdiv 124-I) ☐ renewal or extension of Crown lease or conversion of Crown lease to freehold (Subdiv 124-J) ☐ rollover for depreciable plant (Subdiv 124-K) ☐ renewal or extension of prospecting or mining right, or conversion of prospecting right to mining right (Subdiv 124-L) ☐ scrip for scrip rollover (Subdiv 124-M) ☐ Medical defence organisation (MDO) interest exchange rollover (Subdiv 124-P) ☐ trust restructuring and transfers of assets to company in exchange for shares (Subdiv 124-N) ☐ reorganisation of stapled entities (Subdiv 124-Q) ☐ securities lending arrangements (ITAA36 s 26BC) ☐ demergers rollover relief (Div 125). Rollover relief in special situations and transitional relief ☐ death of the primary owner of CGT assets (s 128-10; see Chapter 19) ☐ rollover relief for transfers of assets when superannuation funds merge (not applicable to SMSFs) as part of the MySuper products reforms (Div 310) ☐ rollover relief for a mandatory transfer of a member’s superannuation interest to a MySuper product in another superannuation fund or within the same superannuation fund, as part of the MySuper reforms (Div 311) ☐ transitional CGT relief for superannuation funds (so as to comply with the transfer balance cap requirements and the exclusion of transition to retirement income streams (TRIS) from being superannuation income streams in the retirement phase from 1 July 2017) (ITTPA Subdiv 294-B) (Law Companion Ruling LCR 2016/8). Rollovers — foreign interest holders in a restructure Some CGT rollovers for entity restructures require that all of the interest holders must exchange their interests in the original entity for interests in the new entity and that each interest holder owns the same, or substantially the same, percentage of interests in the new entity as previously owned in the original entity (see, for example, the “same ownership requirements” in Subdiv 124-G, 124-H, 124-I, 124-N, 124-

Q and 126-G, and Div 125). Where a share sale facility is used to deal with the interests of a foreign interest holder, the same ownership requirements generally cannot be satisfied as the interests are now owned by the share sale facility and not the foreign interest holder. For CGT events happening after 7.30 pm on 11 May 2010, entities in a restructure can use a share or interest sale facility to deal with foreign held interests. This is achieved by treating a foreign interest holder as owning the relevant interest in an entity at a time the share sale facility owns the interest in that entity for the purposes of the relevant CGT entity restructure rollover provisions. This treatment ensures that entities can use a share sale facility in a restructure to deal with the interests of foreign interest holders without interest holders that are Australian residents for tax purposes (or foreign residents with taxable Australian property) automatically failing the same ownership requirements. The treatment also ensures that ownership requirements are appropriately maintained. Compulsory acquisition rollovers If a CGT asset owned by you is compulsorily acquired, you may choose a CGT rollover with the effect that a capital gain that would otherwise be recognised when the transfer of the asset occurs is disregarded, and recognition of the accrued capital gain is deferred until there is a later disposal of (or other CGT event happens to) the asset. The compulsory acquisitions rollover also preserves the pre-CGT exempt status of replacement assets if the original asset had that status. Compulsory rollover relief is available if the asset: • is compulsorily acquired by an Australian government agency (ie by the Commonwealth, a state or a territory or by an authority of the Commonwealth, a state or a territory) • is wholly or partly lost or destroyed, or • is an expired lease that is not renewed. You will also be able to choose a CGT rollover and/or a balancing adjustment offset in the following circumstances: • when the asset is disposed of to a private acquirer who has recourse to compulsory acquisition under a statutory power other than a compulsory acquisition of minority interests under company law, and • when land (and any depreciating asset fixed to the land), which was compulsorily subject to a mining lease, is disposed of to the lessee. Small business asset rollovers A small business taxpayer can obtain CGT rollover relief on the disposal and replacement of some or all of its active assets where certain conditions are met (see ¶2-339). Example James owns 50% of the shares in ABCco and XYZco, ie he is a significant individual of both companies. The companies are also connected with James because he controls them. ABCco owns land which it leases to James for use in a business. It sells the land at a profit and buys shares in XYZco. The replacement asset test is satisfied because James is connected with ABCco and is a significant individual of XYZco.

Rollover relief when trusts are restructured Optional CGT rollover relief is available to facilitate trust restructuring arrangements. This applies where: • a trust disposes of all of its assets to a company on or after 11 November 1999 • the beneficiaries’ interests in the trust are exchanged for shares in the company in the same proportion as they owned interests in the trust.

Rollover relief is available for both the trust and its beneficiaries, but not to discretionary trusts. If the trust does not cease to exist within six months from the time of transferring the assets, the benefit of the rollover is reversed (CGT event J4: ¶2-110) unless the failure to transfer the assets is outside the control of the trustee. Small business restructure rollover Optional rollover relief is available for the transfer of assets as part of a change of legal structure without a change in the ultimate legal ownership of the assets (ITAA97 Subdiv 328-G). To qualify, the conditions in s 328-430 must be met — namely, there is a “genuine restructure” (Law Companion Ruling LCR 2016/3 explains what is “genuine restructure”), the parties to transaction are eligible entities, ultimate economic ownership of the assets is maintained, the transferred asset is an eligible asset that satisfies the active asset test, the parties satisfy the residency requirement and a choice is made for the rollover relief. The assets covered by the rollover relief are CGT assets, trading stock, revenue assets and depreciating assets (s 328-455; 40-340) (Law Companion Ruling LCR 2016/2 provides examples of rollover). The rollover relief provides for tax neutrality so that there will be no direct income tax consequences arising from the transfer of asset pursuant to the rollover, including the potential application of Div 7A where the transfer may otherwise be treated as a deemed dividend (see s 328-450 and example). Depreciating assets transferred under Subdiv 328-G will not result in a balancing adjustment, typically in restructures where the trustees of trusts transfer depreciating assets to beneficiaries, or by companies to shareholders (Taxation Administration (Remedial power — Small Business Restructure Rollover) Determination 2017) (/F2017L01687). Marriage/relationship breakdown rollovers Marriage or relationship breakdown rollover relief is available if certain CGT events happen (involving an individual and his/her spouse, or involving a company or trustee and an individual’s spouse or former spouse) because of: • an order of a court under the Family Law Act 1975 (or a corresponding foreign law) • a maintenance agreement approved by a court under the family law (or a corresponding agreement under a foreign law), or • a court order made under a state or territory law relating to the breakdown of de facto marriages (eg the Property (Relationships) Act 1984 (NSW) or the Property Law Act 1958 (Vic)). The CGT events that are relevant to marriage breakdown rollover relief are of two types — disposal cases (CGT events A1 and B1) and creation cases (CGT events D1, D2, D3 and F1). CGT rollover relief is also available for assets transferred to a spouse or former spouse under a binding financial agreement or arbitral award under the family law, or a written agreement under a state, territory or foreign law relating to de facto marriage breakdowns where the agreement is similar to a binding financial agreement. This will allow spouses to settle property issues without involving the courts, thus avoiding potential costly and protracted litigation. The Full Federal Court has held that a taxpayer was not entitled to CGT marriage breakdown rollover relief for the transfer of shares made at the instance of the husband, allegedly in accordance with directions given by his former wife and pursuant to orders of the Family Court (Ellison & Anor v Sandini Pty Ltd & Ors; FC of T v Sandini Pty Ltd & Ors 2018 ATC ¶20-651). For a practitioner article, see “CGT marriage breakdown rollover — the Sandini case revisited” by Andrew Henshaw, in CCH Tax Week ¶256 (2018). Marriage breakdown financial planning issues are discussed in detail at ¶12-200 and in Chapter 18. Scrip for scrip rollover relief Scrip for scrip rollover relief is available when interests held by a taxpayer in one entity are exchanged for replacement interests in another entity, typically as a result of a takeover offer or merger. In FC of T v

Fabig 2013 ATC ¶20-413, the court when determining whether an exchange is made as a consequence of a single arrangement requirement held that relief was not available on the sale of the taxpayers’ shares in one company for shares in another company because they did not satisfy the requirement in ITAA97 s 124-780(2)(c) that participation in the sale was available on substantially the same terms for all shareholders (see also ATO Decision Impact Statement Ref No: NSD 247 of 2013). The rollover only applies when the exchange would otherwise result in a capital gain, ie if a capital loss would arise, there is no rollover. Where the rollover applies, the capital gain arising from the exchange of the original asset is disregarded. The amount included in the first element (acquisition cost) of the cost base of the replacement interest is calculated on the basis of a reasonable apportionment of the cost base of the original asset. The reduced cost base is worked out on a similar basis. An exchange of interests must arise under an arrangement in which all owners of voting shares in the original entity (apart from the acquiring company) can participate on substantially the same terms. It is not necessary that the acquiring company have any shares in the original company before launching a takeover bid (TD 2000/51). For a case which examined whether pre-contractual offers could form a single arrangement thus allowing a share exchange to qualify for scrip for scrip rollover, see Dickinson v FC of T 2013 ATC ¶20-413. In the case of a trust, the arrangement must be from a fixed trust and for the acquisition of trust voting interests or, if there are none, for units or other fixed interests in the trust. This can include the exchange of an interest (not being a unit) in a trust for a unit in a unit trust (TD 2002/22). Certain tax avoidance schemes connected with scrip for scrip rollover, in particular an arrangement in which taxpayers seek to use the rollover to obtain the benefit of a capital gain without paying CGT, are examined in Taxation Ruling TR 2005/19.

STEP 5: CALCULATING THE TAX ¶2-500 Net capital gains and losses Capital gains and losses are calculated separately for each CGT event that occurred during the tax year. Assuming that the capital gain or loss is not exempt and is not being rolled over, the next step is to work out the tax liability. A taxpayer’s assessable income includes any net capital gain made for the income year. The net capital gain is worked as follows. Step 1: Capital gains made during the income year are reduced by capital losses made during the income year. You can choose the order in which the capital gains are reduced (see “Applying capital losses” below), subject to some specific rules which permit or require you to disregard certain capital gains or losses when working out net capital gain. Step 2: If the capital gains are more than the capital losses, the difference is then reduced by any unapplied net capital losses carried forward from earlier income years. Again, you can choose the order in which the capital gains are reduced. Step 3: Each amount of a discount capital gain remaining after Step 2 is reduced by the relevant discount percentage (¶2-215). Step 4: If any of the taxpayer’s capital gains (whether or not they are discount capital gains) qualify for any of the small business concessions (¶2-300), those concessions, as appropriate, are applied to each capital gain. Step 5: The sum of the amounts of capital gains remaining after Step 4 will be your net capital gain for the income year. Capital losses If your capital losses in an income year exceed your capital gains in that year, you have a “net capital loss” for the income year (ITAA97 s 102-10). That amount is not deducted against other assessable income which you may have in the income year. However, it can be carried forward without a time limit so

that it can be offset against any capital gains which may be realised in subsequent years. Therefore, to the extent that a net capital loss cannot be used to offset capital gains in an income year, it can be carried forward to a later income year. For 1996/97 and later income years, net capital losses attach to the year in which they were made. Unrecouped losses for income years up to 1995/96 attach to the 1995/96 income year. Example During the tax year, Laurence realised capital gains of $120,000 and capital losses of $90,000. Laurence therefore has a net capital gain of $30,000 for the year, which is added to his other assessable income for that year. If instead Laurence had realised capital gains of $25,000 and capital losses of $60,000, he would have a net capital loss of $35,000 for the year. This can be carried forward and offset against capital gains realised in later years. Applying other exemptions Certain CGT events require a taxpayer to disregard a capital gain or loss (eg if CGT event A1 happens to a CGT asset acquired by the taxpayer before 20 September 1985). In other cases, exemptions may apply to reduce or disregard the capital gain or loss. In calculating the capital gain that is subject to the discount (Step 3), the taxpayer takes these general exemptions into account before offsetting any available capital losses and applying the CGT discount.

Example Rohan bought some shares for $50,000 in earlier years which he sold in the current year for $75,000. Rohan has prior year net capital losses of $4,000, as well as a current year capital loss of $6,000 from other asset sales, and he chooses to apply the than to index the cost base. Shares:

$  Capital proceeds:

75,000

Less: cost base

50,000

Capital gain

25,000

Rohan will then apply his capital losses as follows:

Capital gain

25,000

Less: current year loss

6,000

Less: prior year losses

 4,000

Capital loss

15,000

Rohan can then apply the CGT discount to calculate his net capital gain:

Capital loss

15,000 × 50%

Net capital gain

 7,500

Applying capital losses A taxpayer may choose to apply capital losses against capital gains in any order. In most cases, the best outcome will be achieved if capital losses are applied against capital gains in the following order: (1) to capital gains that are not entitled to receive any indexation of the cost base, or any CGT discount (eg assets owned for less than 12 months or assets acquired by companies after 30 June 1999), or any benefit of the CGT small business concessions (2) to capital gains calculated with the asset’s indexed cost base (3) to discount capital gains that are not eligible for the CGT small business concessions

(4) to capital gains that are eligible for the CGT small business concessions but are not discount capital gains (5) to discount capital gains that are eligible for the CGT small business concessions. If you choose to claim the frozen indexation option, capital losses will be applied against the capital gain arising after deducting the cost base, including any indexed elements, from the capital proceeds. If the indexation option is not chosen, or it is not available, the capital gain is calculated by deducting the nonindexed cost base from the capital proceeds. Capital losses are applied against the capital gain before it is reduced by the CGT discount. Previous years’ net capital losses Net capital losses from previous income years must be applied in the order in which they were made. Subject to this rule, you can choose to apply any prior year net capital losses against capital gains for the income year in any order. Any prior year net capital losses will be applied against the current year capital gains before applying the CGT discount (Step 2 above). If a capital gain remains after applying all available capital losses, the remaining capital gain is reduced by the appropriate CGT discount (if available) (Step 3 above). If any of the capital gains qualify for small business concessions, those concessions are then applied against each qualifying capital gain (Step 4 above). The remaining amount is the taxpayer’s net capital gain for the year. Example Adam acquired shares in a listed public company in June 2008 and units in a listed unit trust in May 2009. Adam has a carried forward net capital loss of $12,000 from the 2018/19 income year and incurred a further capital loss of $6,000 in 2019/20. In September 2019, Adam sells the shares and makes a capital gain of $4,000. In February 2020, he sells the units and makes a capital gain of $22,000. Adam may choose to apply his capital losses in any order, but he must apply his current and prior year losses against discount gains before reducing them by the discount percentage. He decides to apply the $6,000 current year loss first against the $4,000 gain realised in September 2019. The remaining $2,000 current year loss balance and the prior year net capital loss of $12,000 are applied against the discount gain of $22,000, resulting in a nominal gain after losses of $8,000. The nominal gain is reduced by the CGT discount (50% for individuals), leaving a net capital gain of $4,000 to be included in assessable income for 2019/20.

¶2-520 Overlap with other tax rules and avoidance schemes It is possible that the same transaction can be caught by the ordinary tax rules as well as the CGT rules. In these cases, the ordinary tax rules take priority — any amount that is assessed under the ordinary tax rules will reduce the amount of capital gain. This is intended to avoid a taxpayer being taxed twice on the same gain. Often the amount assessable under the ordinary tax rules is bigger than the amount assessed under the CGT rules. This will typically be because the CGT rules allow for the cost of the asset to be indexed in certain circumstances, so reducing the capital gain. In the case of a business’s trading stock, capital gains and losses are generally disregarded (¶2-270) and the tax position is governed entirely by the ordinary trading stock provisions in the ITAA97. GST and input tax credits are generally disregarded in CGT calculations. For example, this means that the cost base of an asset does not include amounts corresponding to input tax credits to which the taxpayer is entitled, and the capital proceeds do not include any GST component of the consideration. Benefits under employee share schemes are taxed under special rules in the ITAA97, with special CGT rules to ensure that there is no double taxation (¶2-205). A taxpayer’s capital gains are treated as separate net income, and this will affect the taxpayer’s claim for dependent rebates. Avoidance schemes

When considering the effectiveness of any plan or arrangement to minimise the effect of CGT, a taxpayer and/or tax planner or adviser should bear in mind the possible application of any specific provisions of an anti-avoidance nature in the CGT provisions themselves, as well as the possible operation of the general anti-avoidance provisions in Pt IVA of the ITAA36. The ATO has issued many taxpayer alerts on avoidance schemes which may have CGT consequences (available at law.ato.gov.au/).

¶2-530 Keeping records: asset registers You must keep records of every act, transaction, event or circumstance that may be relevant to working out whether you have made a capital gain or capital loss from a CGT event happening. The records must be in English (or be readily accessible in or translatable to English) and must show: • the date the asset was acquired, its cost or market value • the date the asset was disposed (or CGT event happening), and the proceeds received or market value of asset • costs associated with acquiring and selling the asset, such as stamp duty, commissions, advertising and legal fees, interest, fees paid to agents and accountants • costs associated with holding the asset that are not tax deductible, including improvements, rates, land tax, insurance, repairs and interest on money borrowed to acquire the asset • indexation adjustments (where relevant for assets acquired before 21 September 1999: ¶2-210) • particulars of the people, businesses or organisations involved in the transaction • market valuations, if required, and • records from the previous owner, particularly if the asset was inherited. Examples of the types of records you may need to keep include receipts for the expenditures incurred, including whether a tax deduction has been claimed for an item of expenditure. Accurate records are particularly essential, for example, in keeping track of share transactions, bonus share issues and shares acquired under dividend reinvestment schemes, and assets that are inherited. Your CGT records must be kept for five years after the last relevant CGT event occurs. (Typically this means five years after the asset is disposed of.) You do not have to keep records if the transaction is exempt from CGT. If you wish, you can transfer the information from these records to a CGT asset register that is certified by a tax agent or other authorised person. Entries in this register have to be kept for the usual five-year period after the relevant CGT event occurs. However, the source documents relating to the entry need only be kept for five years after the entry is made. Tax loss records You should also keep records relating to a net capital loss for an income year which you may be able to apply against a capital gain in a later year. The records relevant to the ascertainment of that loss must be kept for longer than the record retention period prescribed under income tax law. In particular, the records must be kept until the later of: • the end of the statutory record retention period, and • the end of the statutory period of review for an assessment for the year of income when the tax loss is fully deducted or the net capital loss is fully applied. There is no time limit on how long you can carry forward a net capital loss, but you will need to keep your

records for five years after you have claimed the last of it. For example, if you carry forward a net capital loss for 15 years before it is all claimed, you will need to keep your records for 20 years (ie from when you incurred the original net capital loss to five years after you claimed the last of it). Also, where a formal dispute arises in relation to a loss, the records must be retained until any objection or appeal in relation to the loss is finally determined. The ATO’s CGT record-keeping tool is available at www.ato.gov.au/calculators-and-tools/capital-gains-tax-record-keeping-tool.

Caution Good record-keeping is generally essential for various reasons: • it makes good business sense • to be able to work out CGT liabilities for transactions which may have occurred some time in the past • to identify the costs which comprise the cost base or reduced cost base • in case they are needed in an ATO review or audit.

SUMMARY — CHECKLISTS ¶2-600 CGT planning checklist The special rules applying to CGT can open up some planning possibilities. You should adopt a logical and methodical approach to CGT issues, applying a step-by-step approach that ensures all relevant aspects that may relate to a CGT transaction are properly considered. Here are some to keep in mind (see also “Taxpayer alerts” at ¶2-650 and the CGT topical checklist at ¶2-700).

Checklist ☐ Maximise the cost base ☐ Do the calculations for each asset disposed of to ascertain whether to choose the CGT discount or frozen indexation option when calculating capital gains (the frozen indexation option is not available for assets purchased after 20 September 1999: ¶2-215) ☐ Ensure that capital losses are utilised ☐ Examine the availability of, and use exemptions and concessions ☐ Examine the availability of, and use, rollovers to best advantage ☐ Keep tax in perspective

Maximise the cost base The higher the cost base, the lower the assessable capital gain. In maximising the cost base, remember that:

• if you purchase by instalments, the whole amount of those instalments is taken into account in calculating the cost base • capital enhancements can form part of the cost base — the purpose or effect expenses must be to increase or preserve the asset’s value, or relate to installing or removing the asset • you may need to take care in situations where the cost base has been reduced (¶2-205) • you should ascertain whether the CGT discount or frozen cost base option is more beneficial for each asset that is disposed of (¶2-215) • records of eligible expenditure should be kept (¶2-200, ¶2-530). CGT events and timing Where more than one CGT event can apply to a situation, carefully consider the implications: • look at the rules for each of the potentially applicable events to determine the three key factors — timing, calculation of gains/losses, and concessional rules (for a list of CGT events, see ¶2-110) • if more than one event could potentially apply, seek to ensure that the most specific event will be the one that is most advantageous in terms of the key factors • on timing of CGT events, postpone triggering events likely to give rise to capital gains occurring at or shortly before the end of the income year in order to maximise the period of grace before the tax liability arises. Selling or holding on to assets The time when you buy and sell an asset can make a big difference to the CGT liability, for example: • selling an inherited family home within two years of inheritance should be considered as the property will keep its main residence exemption for this period (¶19-605) • to be eligible for the CGT discount, assets must be owned for at least 12 months, with some exceptions where a rollover is involved (¶2-215) • before selling a pre-CGT home, consider renting it out and buying a new residence for owner occupation, or • the capital gain on a disposal is assessable in the year of disposal, so deferring the disposal can defer the tax to that year. This can be particularly beneficial if that year is a low-income year. Ensure that capital losses are utilised Capital losses can only be offset against current or future capital gains, so: • depending on your circumstances, it may be a good idea to bring forward a disposal so as to realise an inevitable capital loss which can be offset against gains in that year • be aware that a person’s capital losses will generally be lost when the person dies. Use exemptions and concessions Examine all the possible exemptions and concessions that may be available: • some assets are exempt in all circumstances (eg cars). Others are only exempt if they are not resold (eg pre-CGT assets), so think carefully before realising appreciating pre-CGT assets. Others are exempt only if they are used in particular ways (eg main residence) or if the taxpayer satisfies special conditions (eg the rules for the small business concessions) • some exemptions automatically apply when all the conditions for it are satisfied (eg the main

residence exemption), and you cannot choose that the exemption does not apply • be aware too that seemingly innocuous events, such as a change in partnership interests (¶2-220), or a change in the underlying interests in a company or trust (¶2-260), can have the effect of destroying the exempt pre-CGT status of an asset. If an exempt asset and a taxable asset are sold together for an overall price, care should be taken not to undervalue the exempt asset • exercise care so that a change in circumstances or change in use of a replacement asset will not trigger CGT event J2, J5 or J6 which will result in a reversal of the rollover concession and in the crystallisation of a previously deferred capital gain (¶2-339) • maximise your main residence exemption by purchasing an adjoining block (and building a tennis court, for example), as the family home is exempt from CGT along with any surrounding land not exceeding two hectares. Use rollovers to best advantage Rollovers can be a useful way to preserve the exempt pre-CGT status of assets, or to defer the realisation of a capital gain. However, as noted at ¶2-400, rollovers may not be appropriate if, for example, you wish to realise a capital loss on the asset, or if the transferee is a higher-rate taxpayer. You need to check in each case whether the rollover is automatic or optional (ie you must make a choice for the rollover to apply) and the exact consequences, as these may vary. Keep tax in perspective CGT, ordinary tax and other taxes such as stamp duty are only part of the picture. In any transaction, non-tax factors — including commercial considerations, cash flow, market conditions and the taxpayer’s personal situation — obviously must be taken into account. The fact that one course of action has the best tax result does not necessarily mean that it is the best course to take, or even that it should be taken at all.

¶2-650 Taxpayer alerts From time to time, the ATO issues Taxpayer Alerts which set out the areas of concern involving significant new tax planning issues and arrangements under examination where the ATO has not yet come to a concluded view. Financial and tax advisers should bear in mind that the ATO may not agree with the tax benefits being claimed with respect to a particular arrangement. Taxpayer Alerts cover a diverse range of concerns across CGT and other taxes as well as related regulatory issues and they should be carefully considered in all cases when planning commercial and personal transactions. Alerts with particular relevance to CGT planning include the following: • arrangements to exploit mismatches between trust and taxable income (TA 2013/1: see below) • purported alienation of income through discretionary trust partners (TA 2013/3: see below) • arrangements using a trust structure to ensure that, on the sale of the CGT assets to an arm’s length party, the taxable capital gains are streamed to a tax-preferred entity (such as a charity) while the original asset owners receive the sale proceeds free of CGT liability (TA 2003/3: see below) • profit washing schemes involving a trust and loss entity by using tax losses in an unrelated entity (wash sales) and restructuring a business so that the business income passes through a chain of trusts to a loss company (TA 2005/1) (see also Taxation Determination TD 2005/34, Taxation Ruling TR 2008/1) • stapled securities arrangements where an Australian resident public company issues a stapled security made up of a note and a preference share to resident investors (TA 2008/1)

• borrowing arrangements, and non-arm’s length arrangements under which a SMSF derives income through a direct or indirect interest in a closely held trust (TA 2008/3, TA 2008/4) • profit washing scheme using a trust and a loss entity similar to those covered by TA 2005/1 (TA 2008/15) • foreign residents attempting to avoid Australian CGT by certain “staggered sell-down” arrangements (TA 2008/19) • foreign residents exploiting asset valuations to avoid CGT (TA 2008/20) • individual shareholders re-characterising capital losses as revenue losses (TA 2009/12: see below) • artificially creating capital losses through default beneficiary arrangement to offset capital gains (TA 2009/14: see below) • circumvention of in-house asset rules by SMSFs using related party agreements (joint ventures) (TA 2009/16) • buying insurance bonds issued from tax haven entities (TA 2009/17) • discretionary option arrangements (TA 2009/18) • non-market value acquisition of shares or share options by an SMSF (TA 2010/3) • non-disclosure of foreign source income by Australian tax residents (taxable capital gains may arise to the taxpayer on the disposal of offshore assets) (TA 2012/1) • accessing private company profits through a dividend access share arrangement attempting to circumvent taxation laws (a taxing event may generate a capital gain under CGT event K8 for the original shareholders of the target company by virtue of the ITAA97 Div 725 direct value shifting rules) (TA 2012/4) • deduction generation from purported purchase of offshore “emission units” that do not exist at the time of the arrangement (the grant, exercise and/or end of the put option results in a CGT event happening and a capital gain or loss for the grantor and/or participant; a capital gain (eg CGT event K1 happening) from the delivery of the units, or the transfer or holding of the units in the participant’s registry account) (TA 2012/6) • SMSFs and limited recourse borrowing arrangements to acquire property (unit trust may incur a CGT liability for the disposal of the property, and the members and SMSF may be required to include a capital gain in their assessable income an amount on redemption of their units in the unit trust) (TA 2012/7) • arrangements to exploit mismatches between trust and taxable income (TA 2013/1: see below) • purported alienation of income through discretionary trust partners (TA 2013/3: see below) • trusts mischaracterising property development receipts as capital gains (TA 2014/1) • dividend stripping arrangements involving the transfer of private company shares to a self-managed superannuation fund (TA 2015/1). Advisers and taxpayers should also be mindful that certain transactions may trigger a specific antiavoidance or the general anti-avoidance provisions (see ¶1-600) or may be a tax exploitation scheme for the purposes of Div 290 of Sch 1 to the Taxation Administration Act 1953. Penalties under the income tax laws are discussed in ¶1-750. Arrangements to exploit mismatches between trust and taxable income

Taxpayer Alert TA 2013/1 warns about artificial arrangements where a deliberate mismatch is created between the amounts beneficiaries are entitled to receive from a trust and the amounts they are taxed on. The arrangement concerns a situation where a trust has generated a small amount of income and a large capital gain during the year. The trust distributions are made in such a way that one beneficiary receives the funds generated from the capital gain, tax free, while another beneficiary (a new incorporated company) receives the tax liability attached to that capital gain. The newly incorporated company receives no funds from the capital gain to pay this tax liability, and winding-up proceedings are commenced. This process is designed to avoid the payment of tax on the large taxable capital gain. Purported alienation of income through discretionary trust partners Taxpayer Alert TA 2013/3 warns about arrangements where an individual purports to make the trustee of a discretionary trust a partner in a firm of accountants, lawyers or other professionals (firm), but fails to give legal effect to that structure or fails to account for its tax consequences. For example, an individual purports to alienate income attributable to his/her professional services to a trustee partner, so that income that would otherwise be assessable to the individual is the income of a different entity. This may occur as the result of the assignment of an existing partnership interest, or by the creation of a new interest. The ATO’s concerns include: whether the transactions are legally effective; whether any transactions intended to make the trustee a partner in the firm give rise to or increase a net capital gain for the individual in the year of income (such as whether a CGT event has happened to an interest held by the individual in a partnership, what capital proceeds are associated with the event, and whether the individual’s net capital gain is reduced by the CGT discount or small business concessions in ITAA97 Div 152, and whether the general anti-avoidance rules in Pt IVA of the ITAA36 apply to cancel tax benefits obtained by the individual. CGT avoidance using a trust structure Taxpayer Alert TA 2003/3 warns about CGT avoidance arrangements using a trust structure which seek to ensure that, on the sale of CGT assets to an arm’s length party, the taxable capital gains are streamed to a tax-preferred entity (such as a charity) while the original owners of the assets receive the sale proceeds free of any CGT liability. These arrangements have the following features: (1) Assets owned by an individual or under a partnership or trust structure are disposed of to a special purpose company (SPC) and rollover relief is claimed under Div 122. (2) A “bare” trust (First Trust) is created over the SPC assets with the sole beneficiary of the trust being the SPC. The trust deed allows further beneficiaries to be appointed with the consent of the original beneficiary. First Trust is a discretionary trust but is referred to as a hybrid or convertible trust. (3) SPC consents to the trustee appointing new beneficiaries of the First Trust which are trustees of other trusts and may be associates of the promoter of the arrangement. (4) A second trust is created (Second Trust) of which the beneficiaries are the original owners of the assets. The assets are then sold to this Second Trust for a nominal amount. However, the promoter argues that this sale for CGT purposes is deemed to have occurred at market value. This means that the First Trust has a deemed capital gain and the Second Trust acquires the assets with a market value cost base. (5) The Second Trust sells the assets for market value to a third party purchaser. (6) The Second Trust claims to have no taxable capital gain and distributes the sale proceeds (after deducting the promoter’s fees) to the original owners in an arguably tax-free manner, eg as a loan or capital distribution. (7) The First Trust returns the deemed assessable capital gain and distributes this to the newly appointed beneficiaries which, in turn, distribute this income to a beneficiary which has significant capital losses or is tax exempt, such as a charity. No funds are actually received by the charity or other beneficiary.

Shareholders re-characterising capital losses as revenue losses The ATO has warned about arrangements where taxpayers seek to re-characterise their shareholding status from a long-term capital investor to a trader in shares (Taxpayer Alert TA 2009/12). The taxpayers involved would have claimed the CGT discount on previous receipts, but are now realising losses which they seek to claim as tax deductions against ordinary income (as opposed to capital losses which can only be offset against capital gains). These arrangements have features that are substantially equivalent to the following: (1) The taxpayer is an individual investor who holds shares. (2) The taxpayer has previously disposed of shares realising a profit, and treated that profit as a capital gain. This is done on the basis that the shares were held with the intention of benefiting from a long-term increase in capital value and/or the receipt of dividend income during the holding period. The taxpayer’s records are maintained on this basis. (3) As the taxpayer is an individual and had held the shares for more than 12 months, the taxpayer claimed the 50% CGT discount in their income tax return for each of the relevant financial years. (4) The value of shares still held by the taxpayer decreases as a result of market conditions and the taxpayer has an unrealised loss in respect of those shares. (5) The taxpayer may receive advice from a tax professional or financial advisor regarding the deductibility of losses incurred on the sale of shares for the current income year, including the benefits of being regarded as holding shares as a share trader when making such a loss. (6) Without changing the economic substance of their shareholdings, the taxpayer decides to arbitrarily re-characterise their shareholding in order to claim the net loss from their sale as a revenue deduction pursuant to s 8-1 of the ITAA97, on the basis that the taxpayer is now carrying on a business of share trading (as opposed to carrying forward capital losses indefinitely to be offset against any future capital gains, as would be the case for an investor). (7) To support a contention that the taxpayer is carrying on a business of share trading, the taxpayer may artificially adopt specific practices to present a pretence of being a share trader, but with no objective, material change in either the nature of investments held (or sold) or their holding activities. Some of these practices (which in the relevant circumstances a reasonable person would regard as artificial and contrived) may include: • purchasing or selling shares on a more regular basis (often with small net volumes), ie “window dressing” • creating a trading plan for their share transaction activities with a newly stated goal of maximising profit — even though the shares sold will generate a loss rather than a profit • increasing recording of time spent per week on the investment process (without any significant change in the total value of transactions), and • maintaining additional records to evidence share transactions including additional reliance on guidance from others (without any significant change in the total value of transactions). (8) The taxpayer subsequently decides to dispose of the shares to realise the net loss. (9) The change in approach is applied on a prospective basis only, such that only future transactions are affected, even though there has been no substantive change in objective facts between the current year and previous years. Example

The following is an example of a taxpayer’s arrangement in a particular case: • January 2009 — taxpayer purchased 100,000 listed shares in an entity. • May to December 2010 — taxpayer disposed of 50,000 shares and was assessed on the capital gain/loss. With a capital gain, the taxpayer claimed the 50% CGT discount (¶2-215). Any net capital loss incurred was offset against current or future capital gains in accordance with ITAA97 Div 102 (¶2-210). • October 2011 — the stock market crashed. • November 2011 — taxpayer disposed of remaining 50,000 shares at a net loss and claims an immediate deduction against other incomes, rather than carrying forward the loss as a capital loss.

Artificially creating capital losses through default beneficiary arrangement to offset capital gains Taxpayer Alert TA 2009/14 warns about arrangements where a taxpayer with a current or future capital gain attempts to artificially create an offsetting capital loss by becoming a default beneficiary for a discretionary trust (for no consideration) and then transferring their interest in that trust (for no consideration). These arrangements have the following features: (1) A trust is established for the benefit of discretionary objects. (2) The deed for that trust confers discretionary powers of appointment of income and capital on the trustee or a third party appointor. (3) The trust has a named default beneficiary who on the termination date will take any trust capital that has not been appointed. (4) The default beneficiary may also be one of the discretionary objects. (5) The default beneficiary does not give any money or property to acquire the interest in the trust capital. (6) The default beneficiary assigns all their interests (default and discretionary interests) in the trust to a third party (for example, a spouse). (7) The assignment of rights to trust capital is said to produce entitlement to a capital loss for the default beneficiary (under CGT event E8).

¶2-700 CGT topical checklist The checklist below is adapted from the CGT checklist published by the ATO. It sets out the relevant questions to ask in respect of the more common CGT assets or circumstances and serves as an alert to the possibility of a capital gain or loss arising in the current year or in future, and the need to keep appropriate records. This checklist is not exhaustive and may be used in conjunction with the planning checklist at ¶2-600. Real estate — current year CGT impacts ☐ Have you sold or given away real estate in the past financial year (including your main residence)? ☐ Has there been a change to the title of real estate that you owned (or partially owned) at the start of the year? ☐ Have you granted an option, conservation covenant or other right (eg an easement over real estate) in the year? ☐ Have you granted, changed or varied a lease over your real estate in the past year? ☐ Has any building or capital improvement on your land been destroyed in the past year? ☐ Did you receive compensation in the past year in respect of real estate you own?

☐ In the past year, have you sold any rights you held in real estate (eg contractual rights relating to an off-the-plan purchase)? Real estate — future year CGT impacts ☐ Do you own real estate (including an inheritance) that is not your main residence (eg land, investment property or holiday house)? ☐ Do you own real estate that is your main residence and it is: – used as a place of business or to derive rent or has not been your main residence the whole time you owned it – situated on more than two hectares of land, or – a different home from your spouse or dependent child (under 18 years old)? ☐ Have you made any capital improvements to any real estate that you own? ☐ Have you subdivided or amalgamated any real estate that you own? Shares and investment units ☐ Do you own any shares, units in a unit trust or other investments (eg convertible notes)? ☐ Did your interests change during the year (ie they were sold, transferred, cancelled or ended)? ☐ Did your interests in an employee share scheme change? ☐ Did you receive compensation in the past year in respect of any investments you own? ☐ Did you receive a non-assessable payment from a company or trust in which you have an investment? ☐ Did you receive a distribution from a trust that includes a capital gain? ☐ Has the trustee provided you with a statement indicating how they calculated the trust’s capital gain? ☐ Has the entity in which you own an investment been involved in a takeover, demerger, demutualisation or merger, or gone into liquidation, or conducted a share buyback? ☐ Did you acquire any of your shares or units: – under a dividend or distribution reinvestment plan – under a bonus issue, or – as the result of the exercise of a right or option to acquire additional shares/units? Trust distributions ☐ Are you a beneficiary of a trust (ie other than one in which you hold units as an investment)? ☐ Have you received a distribution from a trust that includes a capital gain? ☐ Has the trustee of a trust provided you with a statement indicating how it has calculated the trust’s capital gain in respect of a distribution to you? ☐ Have you received a distribution from a trust that includes a non-assessable payment, and has the trustee provided you with a statement indicating the nature of the distribution (eg tax-free amount, CGT concession amount, tax-exempted amount, tax-deferred amount)?

Business ☐ Do you own a small business or have an interest in one? ☐ Did you dispose of all or some of the assets of a business during the year? ☐ If you did dispose of any business assets, did you account for GST on those assets? ☐ Did you acquire a business or business assets during the year? Marriage/relationship breakdown ☐ Have you acquired an asset, or an interest in one, from your former spouse/partner after a marriage/relationship breakdown? ☐ Did you acquire the asset as the result of a court order, consent order, an arbitral award, or a binding financial agreement or similar agreement under a state law? Deceased estates ☐ Are you the legal personal representative (LPR) or beneficiary of a deceased person’s estate? ☐ Have you (as the LPR) distributed, or have you (as a beneficiary) received a distribution of, an asset from the deceased estate? Other CGT events, assets or capital proceeds ☐ Has your interest in a collectable acquired for more than $500 changed (including items such as art, antiques, valuable metals, jewellery, coins or medallions, rare books and manuscripts, and postage stamps)? ☐ Has your interest in a personal use asset acquired for more than $10,000 changed (including items such as boats, furniture, electrical goods and household items)? ☐ Have you received or become entitled to a capital payment (including compensation, restrictive covenants, contingent payments, or other consideration for an act, transaction or event)? Record keeping ☐ Have you kept appropriate records of your CGT assets to enable you to calculate the correct amount of a capital gain or loss made when a CGT event happens? ☐ Are you aware of the need to keep these records for five years after the last relevant CGT event? ☐ Are you aware that an asset register may enable you to discard records that would otherwise need to be kept? ☐ Do you have a prior year capital loss that has been carried forward? ☐ Have you considered the GST implications in relation to your CGT events?

FRINGE BENEFITS TAX The big picture

¶3-000

What is FBT?

¶3-050

The FBT basics

¶3-100

Who pays FBT?

¶3-150

Reportable fringe benefits

¶3-155

What is a fringe benefit?

¶3-200

Calculating FBT How is the amount of FBT calculated?

¶3-300

Calculating taxable values

¶3-400

Car benefits

¶3-410

Car parking fringe benefits

¶3-420

Expense payment benefits

¶3-430

Loan fringe benefits

¶3-440

In-house benefits

¶3-445

Living-away-from-home allowance fringe benefit

¶3-450

The “otherwise deductible” rule

¶3-500

Employee contribution towards a benefit

¶3-550

FBT exemptions and concessions Exemptions from FBT

¶3-600

Exempt employers and rebatable employers

¶3-650

Other FBT concessions and caps

¶3-700

FBT planning Reducing your FBT liability

¶3-800

Salary packaging or sacrifice

¶3-850

Impact on employees of reportable fringe benefits ¶3-900 Fringe benefits — interaction with other taxes

¶3-950

¶3-000 Fringe benefits tax and financial planning

The big picture What is fringe benefits tax?: Fringe benefits tax (FBT) is a tax on employers which is levied on the value of fringe benefits provided to employees in respect of their employment in an FBT year. The effect of FBT is to impose tax on employee remuneration, regardless of whether it is in the form of cash salary or fringe benefits. An FBT year runs from 1 April to the following 31 March. The principal legislation dealing with FBT is the Fringe Benefits Tax Assessment Act 1986 (FBTAA) and Fringe

Benefits Tax Assessment Regulations 2018. FBT is imposed by the Fringe Benefits Tax Act 1986. ¶3-050 When does FBT apply?: For FBT to apply: • there must be an employer–employee relationship ¶3-100 • a benefit must be provided in respect of the employment relationship ¶3-100. Who pays FBT?: FBT is payable by the employer. ¶3-150 Reportable fringe benefits: An employer is required to report the grossed-up taxable value of fringe benefits (except excluded benefits) where the value of the benefits exceeds $2,000. ¶3-155 Benefits — valuation and exemption: Benefits are divided into categories for valuation and exemption purposes. Any fringe benefit which is not exempt and does not fall into a specific fringe benefit category is valued as a residual fringe benefit. ¶3-200 How is FBT calculated?: FBT is levied on the “fringe benefits taxable amount”, ie the taxable value grossed-up by the relevant factor. ¶3-300 Calculating taxable values: Each benefit category has specific rules for calculating the fringe benefits taxable value: • car parking ¶3-410 • car parking benefits ¶3-420 • expense payment benefits ¶3-430 • loan benefits ¶3-440 • in-house benefits ¶3-445 • living-away-from-home allowance benefits ¶3-450. The “otherwise deductible rule”: The taxable value of a fringe benefit provided to an employee can be reduced under the “otherwise deductible rule”. ¶3-500 Employee contribution: If an employee makes a contribution towards the provision of a benefit, the taxable value of the benefit is reduced by the amount of the contribution. ¶3-550 Exemptions and concessions: There are several reasons why a benefit provided to an employee may not attract FBT. They may be exempt benefits (¶3-600) or the employer may be classed as an exempt or rebatable employer. ¶3-650 Reducing an FBT liability: An employer may negotiate strategies to reduce or eliminate its FBT liability. Strategies have to be looked at in al total remuneration context (ie total employment cost) for each employee as they may have tax consequences depending on the employee’s particular circumstances. ¶3-800 Reducing the impact of reportable fringe benefits on employees: There are some considerations an employee may take to reduce the impact of reportable fringe benefits. ¶3-900

¶3-050 What is FBT? An FBT year begins on 1 April and ends on 31 March. Fringe benefits tax (FBT) applies to the value of benefits provided by an employer or associates of the employer to a past, present or future employee in respect of the employee’s employment (fringe benefits).

It also applies to benefits provided to an associate of the employee (eg a spouse or partner, including a same-sex partner). FBT is payable at the FBT rate (see below) on benefits provided to resident employees except where the employee’s salary or wages is exempt from income tax, and to non-resident employees with Australiansourced salary or wages income. FBT is based on self-assessment by an employer, and any FBT amount payable is paid by the employer, generally in four instalments. The FBT regime taxes the benefits provided to employees so that, unless the fringe benefits are concessionally taxed, it makes little difference whether the benefits are provided to the employees directly or by additional cash salary. Whether an employee is remunerated on a salaryonly basis or with a combination of benefits, the amount of tax payable should be the same. FBT is applicable regardless of whether the employer is exempt from income tax or other taxes. Public benevolent institutions, public and not-for-profit hospitals, public ambulance services and certain other tax-exempt entities such as charitable institutions are exempt from FBT or are entitled to a tax rebate for FBT up to an annual cap per employee (see ¶3-650). Generally, the employer can claim a tax deduction for the cost of providing fringe benefits and the FBT paid (¶3-950). For the interaction of FBT and goods and services tax (GST), see ¶3-950. FBT rate The FBT rate is 47% for the FBT year ending 31 March 2019 (the same as the previous year).

¶3-100 The FBT basics A fringe benefit is a benefit provided in respect of employment. Therefore, for an FBT liability to arise, the following must be present: • an employer–employee relationship • a benefit provided to the employee (or employee’s associate) in respect of the employee’s employment. Providing benefit in lieu of cash remuneration to employee A person is an employee if cash remuneration paid to the person in the same context as that in which the benefit was provided would be treated as salary or wages for Pay As You Go (PAYG) purposes. The employer is liable for FBT regardless of whether it is a sole trader, partnership, trustee, corporation, unincorporated association, government department or authority (¶3-150). Benefit provided in respect of employment relationship A benefit must be provided by an employer or associate of the employer to the employee or the employee’s associate (see below) in respect of the employment of the employee. The term “benefit” is defined widely and will catch virtually most benefits provided to an employee in respect of employment (¶3-200). However, there are some exceptions or exemptions (see “Some benefits are not fringe benefits” below). A key test is that the benefit is provided in respect of the employee’s employment. For example, a benefit provided to a person as a shareholder or as a gift is not a fringe benefit. A mere causal link with employment of the employee is not sufficient. The courts have considered the expression “in respect of” in various statutory contexts. In the FBT context, the Full Federal Court noted that: “what must be established is whether there is a sufficient or material, rather than a causal connection or relationship between the benefit and the employment”. The court also suggested that it would be useful to ask “whether the benefit is a product or incident of the employment” (J & G Knowles & Associates Pty Ltd v FC of T 2000 ATC 4151).

Example An industrial award requires an employer to reimburse an employee for the employee’s home telephone rental cost. The reimbursement is a fringe benefit (ie a benefit provided in respect of employment) if the reimbursement was made only because of the award provisions and would not have been made for a non-employee.

A particular employee (rather than a group of employees) must be identified with a fringe benefit provided by an employer. When determining whether there is a “fringe benefit”, it is necessary to identify, at the time a benefit is provided, a particular employee in respect of whose employment the benefit is provided. Whether a particular employee can be so identified and whether that gives rise to a fringe benefit are questions of fact to be determined on a case-by-case basis (FC of T v Indooroopilly Children Services (Qld) Pty Ltd 2007 ATC 4236; ID 2007/194: discretionary trust for employees; employee remuneration trust: ¶3-430). In Indooroopilly, the shares provided to the trustee (which constituted the contribution to the employee remuneration trust) were not provided in respect of the employment of any particular employee; also, not all of the employees capable of benefiting would in fact receive a benefit. That is, only some employees may subsequently benefit and their identity was not known. For a case where a fringe benefit was held to be provided in respect of a particular employee based on the particular facts of the case, see Caelli Constructions (Vic) Pty Ltd v FC of T 2005 ATC 4938 (¶3-200). Associates, relatives, friends and arrangements The term “associate” is defined by reference to its meaning in the income tax Acts. An “associate” of a person includes relatives, partners, trustees and beneficiaries, and related companies (FBTAA s 136(1), 159). A friend of an employee is generally not an “associate” under the tax law. However, a third party can be deemed to be an employee’s associate if the third party receives a benefit provided under an “arrangement” between the employer and employee (FBTAA s 148(2)). An “arrangement” is defined widely in s 136(1). It means: • any agreement, arrangement, understanding, promise or undertaking (express or implied), and whether or not enforceable, or intended to be enforceable, by legal proceedings, and • any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. Accordingly, if a benefit is provided to a friend of an employee under an “arrangement” between the relevant parties, the friend (as the recipient of the benefit) qualifies as an associate and the benefit provided can be a fringe benefit (ID 2010/97). Example By reason of an employment relationship, an agreement is entered into whereby the employer provides the employee’s friend (who is not an employee or associate) with the ongoing use of a car. The car is owned and maintained by the employer. Each use of the car by the employee’s friend is the provision of a “benefit” (¶3-200) and may be a fringe benefit.

Key question — whether a benefit is provided in respect of employment is a fringe benefit The key question for an employer to ask is: “Would the benefit have been provided if the recipient had not been an employee?” Some benefits are not fringe benefits The more common forms of fringe benefits are discussed at ¶3-200. Not all benefits provided in respect of employment are fringe benefits. The main benefits expressly excluded as fringe benefits by the FBTAA definition of “fringe benefit” include: • salary or wages

• a benefit that is an exempt benefit • employee share acquisition scheme benefits — benefits to employees from the acquisition of shares, or rights to acquire shares, are not fringe benefits if the schemes comply with the income tax law (¶3600) • superannuation contributions (in cash or in specie) — but not contributions provided for an associate of an employee • a superannuation benefit (within the meaning of the Income Tax Assessment Act 1997 (ITAA97) • employment termination payments (including early retirement scheme or genuine redundancy payments, certain unused leave payments) — lump sums (or property) given to an employee in consequence of the termination of employment • payments of a capital nature • dividends, and • certain payments made by partnerships and sole traders to relatives or associates that are deemed not to be assessable income (see “Certain payments or benefits are not fringe benefits” at ¶3-600). Benefits which are stated not to be “fringe benefits” under the FBTAA are not the same as “exempt benefits”, which are fringe benefits but are expressly not subject to FBT — see “Exempt employers” (3650) and “Exempt benefits” (¶3-600). Reimbursing volunteer workers for out-of-pocket expenses does not make them employees. In most cases, benefits provided to genuine volunteer workers (eg accommodation and basic meals) do not give rise to a fringe benefit (ATO factsheet “Volunteers and FBT”, www.ato.gov.au/non-profit/yourworkers/your-volunteers/volunteers-and-fbt/). Other examples of benefits that are not fringe benefits include: (a) accommodation and meals provided in the family home to children of a primary producer who works on the family farm (b) board provided in the family home to a son who is apprenticed to his father as a motor mechanic (c) birthday presents given by parents to their children who work in a family small business (d) wedding gifts given to a child by the parents where the child has worked in the family business, and (e) an interest-free or low-interest loan given by parents to a child to purchase a matrimonial home. In the cases above, the benefits and gifts have been given in an ordinary family setting as a normal incidence of family relationships, rather than being provided in respect of either past or current employment of the recipients (MT 2016). What to do if you provide fringe benefits? The following is a summary of the things that an employer needs to do if it provides fringe benefits: • identify the employee receiving the benefit • calculate how much FBT is payable • keep the necessary FBT records • register with the Australian Taxation Office (ATO) for FBT purposes • report the fringe benefits on the employee’s payment summary

• report the fringe benefits on the ATO form and pay FBT to the ATO. Scope of this chapter and additional guidelines The FBT regime is wide-ranging and a comprehensive coverage of the FBT rules is beyond the scope of this Guide. This chapter covers the features of the main fringe benefits and operation of the key FBT rules, with particular focus on the more common benefits and aspects which may impact on financial planning. Case studies on salary packaging are covered in Chapter 10 of this Guide. Comprehensive FBT commentary may be found in other Wolters Kluwer tax services, such as the Australian FBT commentary service and Australian Master Tax Guide. The ATO provides detailed information on the operation of the FBT regime in: • “Fringe benefits tax — a guide for employers” (www.ato.gov.au/general/fringe-benefits-tax-(fbt)/indetail/fbt---a-guide-for-employers/) and “Fringe benefits tax for small business” (www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/In-detail/Getting-started/FBT-for-small-business), and • Advice under development — FBT issues www.ato.gov.au/General/ATO-advice-and-guidance/Adviceunder-development-program/Advice-under-development---FBT-issues/.

¶3-150 Who pays FBT? FBT is payable by the employer, regardless of whether the employer is a sole trader, partnership, trustee, corporation, unincorporated association, government department or authority. The tax is payable whether or not the employer is liable to pay other taxes such as income tax. FBT is paid by the employer even where the fringe benefits are provided by an associate of the employer (eg a related company, relatives or partners), or by a third party under an arrangement with the employer or associate. The term “arrangement” is defined widely in the FBTAA. It can include an understanding between two or more persons and need not necessarily be evidenced in writing or by a verbal agreement. It can cover any scheme, plan, proposal, action, course of action or conduct, including an action taken by one person without the knowledge of the other party (see “Associates, relatives, friends and arrangements” in ¶3100). Generally, employers may claim the cost of providing fringe benefits and the amount of FBT paid as income tax deductions. A benefit is subject to FBT in an FBT year FBT is imposed on the employer in the FBT year in which the benefit is actually provided to the employee or employee’s associate. The FBT year runs from 1 April to 31 March. When is FBT incurred by an employer? An FBT liability imposed under s 5 of the Fringe Benefits Tax Act 1986 on an employer’s FBT taxable amount in a year of tax arises at the end of that year of tax, and the employer has a presently existing liability at that time for the amount of the FBT payable. That is, an FBT liability for an FBT year, assessed under an assessment made by the Commissioner, is incurred for the purposes of s 8-1 of the ITAA97 (the general deduction for tax purposes), regardless of how FBT is assessed (Taxation Ruling TR 95/24). Therefore, if an FBT assessment is issued for an earlier year, the FBT is incurred in that earlier year rather than in the year in which the assessment is issued (Taxation Determination TD 2004/20). A later refund or reduction of the FBT liability as a consequence of an amended assessment is an assessable recoupment (Taxation Determination TD 2004/21) (see also ¶3-800). Non-resident employers Subject to certain exceptions, a non-resident employer who pays an Australian resident for work performed overseas is subject to withholding obligations in accordance with s 12-35 of Sch 1 to the Taxation Administration Act 1953 (TAA) if the employer has a “sufficient connection with Australia” (this is

a matter of statutory interpretation having regard to the PAYG withholding provisions in the TAA). A nonresident employer will have a sufficient connection to Australia if it has a physical business presence in Australia, eg the employer carries on an enterprise or income-producing activities in Australia and has a physical presence in Australia. These circumstances are most likely to arise in the case of a multinational business which carries on business in Australia. If a withholding obligation applies, the employer will also have FBT obligations for any benefit provided in respect of the employment of that person (Taxation Determination TD 2011/1). Example Molly (an Australian resident for tax purposes) is employed as a project manager working in the Australian operations of a nonresident company. The company transfers Molly overseas for five months to work on a new project. The company continues to carry on business and maintains a physical presence in Australia. Molly’s wages are assessable income in Australia, and the company has an obligation to withhold tax from the salary paid to her. Molly is provided with a car while overseas, and is reimbursed for some additional living expenses. As amounts must be withheld from her salary, the employer would have FBT obligations in respect of the benefits provided to her.

Example Lauren (an Australian resident for tax purposes) works for an Australian subsidiary of an international hotel chain as an events manager. She was offered a six-month overseas secondment with the group’s global parent company, which is a non-resident for tax purposes and does not carry on business in Australia. While on secondment, she will be employed and paid by the parent company. Her employer, being the non-resident parent company not carrying on business in Australia and with no physical presence in Australia, has no obligation to withhold Australian tax from the salary paid to her. As there is no obligation to withhold, no obligations under the FBTAA can arise to her non-resident employer in respect of any benefits provided to her. Lauren will be required to include this employment income and the value of any benefits received from the non-resident employer in her Australian assessable income.

¶3-155 Reportable fringe benefits An employer is required to report to the ATO the grossed-up taxable value of fringe benefits (except excluded benefits) provided to an employee on the payment summary given to the employee where the value of the benefits exceeds $2,000 in the FBT year. The value of the “reportable fringe benefits amount” (RFBA) is not included in the employee’s assessable income, but is used to determine the employee’s entitlement to certain income-tested tax concessions and liability to income-tested surcharges (¶3-900). The RFBA is based on the fringe benefits provided for the FBT year (1 April to 31 March) for the corresponding income year (1 July to 30 June). From 1 July 2018, an employer may choose to report an employee’s RFBA (or reportable employer superannuation contributions: see below) under the single touch payroll (STP) reporting rules in the TAA. FBT rate for reporting on payment summary When determining the amount to be shown on the payment summary for the 2019/20 FBT year, the employee’s individual fringe benefits amount is grossed-up using the rate of 1.8868. The FBT gross-up rate of 2.0802 (which is used when the employer is able to claim GST credits for benefits provided to the employee) is not used to calculate the employee’s reportable fringe benefits amount as that rate only applies to the calculation of an employer’s FBT liability (¶3-300). Allocating fringe benefits between employees The requirement to report fringe benefits on payment summaries means that employers have to allocate the value of fringe benefits to individual employees. Where a benefit is provided to two or more employees, the amount reported is the share that reasonably reflects the benefit received by each employee. An agreement between the employee and employer relating to a reasonable method of apportionment may be used to allocate the taxable value of a benefit for employees. The value of all fringe benefits, other than excluded fringe benefits, must be allocated to the relevant

employees. Some exempt benefits need to be reported Some benefits which are exempt from FBT may still need to be reported on the employee’s payment summary. These are benefits that are exempt only because they are provided to: • certain live-in residential care workers where the employer is a government body, religious institution or a non-profit company, or • employees of public benevolent institutions, including employees who work in public hospitals. The FBT exemptions for these benefits continue to apply, but for reportable fringe benefits purposes, the notional taxable value of these benefits (called “quasi fringe benefits”) has to be allocated to the employee. Excluded benefits are not reportable “Excluded fringe benefits” do not have to be reported for reportable fringe benefits purposes, but may still be subject to FBT. Excluded fringe benefits include the following: • entertainment by way of food and drink, and associated benefits such as travel and accommodation • pooled or shared private use of the employer’s car by employees, ie a vehicle provided for the private use of two or more employees resulting in a car fringe benefit for more than one employee (ID 2008/21) • car parking fringe benefits (other than eligible car parking expense payments) • hiring or leasing entertainment facilities (eg corporate boxes) • remote area residential fuel, housing assistance, or home ownership or repurchase schemes, where the value of the benefit is reduced • freight costs for food provided to, and costs of occasional travel to a city by, employees and their families living in a remote area (ID 2009/24: occasional travel) • emergency or essential health care provided to an employee or associate who is an Australian citizen or permanent resident, while working outside Australia, where no Medicare benefit is payable • benefits provided to address security concerns relating to an employee’s or associate’s personal safety arising from employment • certain overseas living allowance payments by the Commonwealth • certain benefits provided to Defence Force members • certain living-away-from-home allowances, expense payment benefits and residual benefits provided to Commonwealth employees (FBTAA s 5E(3); Fringe Benefits Tax Assessment Regulations 2018 s 5–12). Reportable employer superannuation contributions Reportable employer superannuation contributions (RESC) are contributions made by an employer which are additional to their mandatory superannuation guarantee contributions (9.5% in 2019/20) and are made for an individual’s benefit where the individual has, or might reasonably be expected to have, some capacity to influence the size of the contribution or the way in which the contribution was made so that the individual’s assessable income is reduced (¶4-215). Employer superannuation contributions for employees are not fringe benefits under the FBTAA (¶3-600). They also do not come within the reportable fringe benefits reporting regime, but employers must report RESC amounts to the ATO under the TAA as these amounts are included in the income tests to determine access to various tax concessions and government benefits (¶3-900).

¶3-200 What is a fringe benefit? A fringe benefit is a benefit provided by employers to employees in respect of their employment. A “benefit” includes any right (including a right or interest in real or personal property), privilege, service or facility. The term is broadly defined so that it captures most forms of benefits provided to an employee. For example, providing a car for an employee’s use or reimbursing an employee’s private expenses will fall within the definition of “benefit”. Some forms of benefits are expressly excluded as “fringe benefits” and do not give rise to any FBT liability (¶3-600). Benefits — valuation and exemption Benefits are divided into categories for valuation and exemption purposes. Any fringe benefit which is not exempt and does not fall into a specific fringe benefit category is valued as a residual fringe benefit. Categories of benefits with specific valuation and exemption rules include: • car benefits • car parking benefits • loan benefits • debt waiver benefits • expense payment benefits • housing benefits • living-away-from-home allowance benefits • property benefits • entertainment benefits • airline transport benefits • board benefits • residual benefits. Car benefits A car fringe benefit generally arises when a car which is owned or leased by an employer is either used privately by, or made available for the private use of, an employee (FBTAA s 7(1)). A car is treated as being made available for private use by an employee on any day that: • the car is not at the employer’s premises, and the employee is allowed to use it for private purposes, or • the car is garaged at the employee’s home (regardless of whether they have permission to use it for private purposes). Generally, travel to and from work is private use of a vehicle. Where the place of employment and residence are the same, the car is taken to be available for the private use of the employee. A car (which does not include a motorcycle) includes: • a sedan, four-wheel drive, station wagon, panel van or utility designed to carry a load of less than one tonne

• any other road vehicle designed to carry a load of less than one tonne or fewer than nine passengers. Private use of a motor vehicle that is not a car may be a residual fringe benefit (see below). The two methods of valuing a car fringe benefit are the statutory formula method and the operating cost method (¶3-410). Exempt car benefits An employee’s private use of a taxi, or a panel van, utility or other commercial vehicle (ie one not designed principally to carry passengers) is exempt from FBT if there was no private use of such a vehicle other than: • work-related travel (ie travel between home and work or incidental private travel in the course of performing employment-related duties), and • other private use that is minor, infrequent and irregular (eg occasional use of the car to remove domestic rubbish) (FBTAA s 8(2)(b)). Where an employee’s duties of employment are inherently itinerant in nature, the transporting of the employee’s family member by the employee on their journey from home to a particular work location is not a business journey, but a private use of the car (ID 2012/96; ID 2012/97). However, it is an excepted private use under s 8(2)(b) if the use of the car for this purpose is minor, infrequent and irregular (ID 2012/98). Travel by an employee in their employer’s car between their place of residence and the employee’s place of employment in relation to a second employer is not “work-related travel” within the meaning in FBTAA s 136(1). An employee’s place of employment for this purpose relates only to the employment relationship under which the car benefit is provided (ID 2013/34). A car benefit is an exempt benefit in relation to an FBT year if the person providing the benefit cannot deduct an amount under the ITAA97 for providing the benefit because of s 86-60 (ie the “personal services income” rules). That section limits the extent to which a personal services entity can deduct car expenses (eg a deduction will not be allowed for more than one car for private use). The use of these cars is an exempt benefit because the entity is not entitled to claim an income tax deduction for these cars. Where a car is destroyed in a natural disaster, is it not considered to be a car that is held by the employer from the date it was destroyed? That is, the calculation of the taxable value of the car fringe benefit provided will only take into account the period up to the date of the natural disaster (ID 2011/28). ATO compliance approach to determine limited private use of vehicles As noted above, a fringe benefit is an exempt benefit where the private use of eligible vehicles by current employees during an FBT year is limited to work-related travel, and other private use that is “minor, infrequent and irregular” (FBTAA s 8(2) and 47(6): car-related exemptions). Practical Compliance Guideline PCG 2018/3 sets out the ATO’s compliance approach to determining the private use of vehicles with respect to exempt car benefits and exempt residual benefits where the conditions specified in the Guideline are met (eg private travel is within specified distances). Employers do not need to rely on the Guideline, but where they do: • they do not need to keep records about an employee’s use of the vehicle to demonstrate that the private use is “minor, infrequent and irregular”, and • the Commissioner will not devote compliance resources to review that the employer can access the car-related exemptions for that employee (PCG 2018/3, para 6 and 7). Car parking benefits A car parking fringe benefit arises where an employer provides an employee with a car parking facility in certain specified circumstances (¶3-420). By contrast, a car parking expense payment benefit may arise if an employee incurs expenditure on car parking and:

• the employer reimburses the employee or pay for the car parking expenses on behalf of the employee • the car is parked at or near the employee’s primary place of employment for more than four hours between 7 am and 7 pm on the day the expenses are incurred, and • the car is used by the employee to travel between home and work on that day. In the case of car parking expense payment benefit, the proximity to a commercial parking station and the daily fee charged by it are not relevant. To calculate the taxable value of a car parking benefit, the employer has to determine the taxable value of a single car parking fringe benefit and the total number of car parking fringe benefits provided to employees using the prescribed methods discussed at ¶3-420. Exempt car parking benefits The following car parking benefits provided to employees are exempt from FBT: • residual benefit — parking provided that does not satisfy all the car parking fringe benefits conditions (¶3-420). The benefit in this case is a residual benefit that is exempt from FBT • expense payment benefit — if the employer pays or reimburses a car parking expense incurred by an employee and the expense is not a car parking expense payment fringe benefit (see above) • car parking for the disabled — car parking provided for a car used by a disabled employee. Small business employer exemption A small business employer is exempt from FBT for car parking benefits provided: • the parking is not provided in a commercial car park • the employer is not a government body, a listed public company or a subsidiary of a listed public company, and • the employer’s total income (total gross income before any deductions) for the last income year before the relevant FBT year was less than $10 million. Loan benefits A loan fringe benefit arises where an employer makes a loan to an employee and there is an obligation for the recipient to repay the loan (eg an interest-free or low-interest loan). A loan fringe benefit also arises where an employer allows a debt owed by an employee to run past the due date for payment. The benefit exists for as long as the debt remains unpaid. The taxable value of a loan fringe benefit is the difference between a statutory benchmark rate of interest and any interest actually accruing on the loan (¶3-440). Exempt loans A loan benefit may be exempt from FBT if: • the employer is engaged in the business of money lending and the loan interest rate to the employee is fixed at a rate at least equal to the rate applicable under a comparable loan made to the public in the ordinary course of business at about the time of the loan • the employer is engaged in a business of money lending and, for each income year over which the loan extends, the interest rate is variable, but never less than the arm’s length rate charged on loans made about the time the loan was made to the employee • the employer advances money to the employee solely to meet expenses to be incurred within a sixmonth period of the advance being made and the expense is incurred in carrying out employmentrelated duties. The expenses must be accounted for by the employee and any excess advance refunded or otherwise offset

• the employer makes an advance, repayable within 12 months, to an employee solely to pay a security deposit (eg a rental bond or service connection deposit) in respect of accommodation where the accommodation gives rise to an exempt benefit (as a relocation “living away from home accommodation”) or the accommodation is temporary accommodation eligible for a reduced taxable value in accordance with the relocation concessions. FBT does not apply to a loan in relation to a shareholder (or an associate of the shareholder) in a private company that causes the private company to be taken to have made a deemed dividend payment to the shareholder or associate under Div 7A of the Income Tax Assessment Act 1936 (ITAA36) (¶1-400). Debt waiver benefits If an employer releases an employee from a debt, a debt waiver benefit will arise if the waiver is connected with the employee’s employment. A debt which is not waived but remains unpaid gives rise to a loan benefit. The loan benefit will remain until the loan is repaid or repayment is waived. The taxable value of the debt waiver benefit is the amount of the debt waived. Division7A deemed dividends Where a loan benefit or a debt waiver benefit is provided by a private company to an employee (or associate) who is also a shareholder (or associate), a fringe benefit does not arise if the loan or debt waiver results in the company being taken to have paid a dividend under Div 7A of the ITAA36 to the shareholder (or associate). Expense payment benefits An expense payment benefit arises where an employer: • pays for or reimburses expenses incurred by an employee, or • pays a third party in satisfaction of expenses incurred by an employee (FBTAA s 20). A reimbursement requires the employee to be compensated exactly for an expense already incurred in contrast to an allowance paid to an employee by an employer. A payment for or reimbursement of a training course or activity for an employee who has been made redundant is an expense payment benefit (ATO ID 2015/1). It is not exempt because it is not “work-related counselling” (as defined in FBTAA s 136(1)). External expense payment fringe benefit If an employer pays an employee’s salary sacrificed amount to the trustee of a trust as repayments of principal on an interest-free loan from the trust, the employer has provided an external expense payment fringe benefit to the employee. The taxable value of the external expense payment fringe benefit is equal to the amount of the loan repayment (FBTAA s 23). This is because each repayment on the loan is a repayment of principal on an interest-free loan and the employee would not have been entitled to an income tax deduction had the employee incurred and paid these amounts. In-house exempt payment fringe benefit An in-house expense payment fringe benefit arises where the expenditure reimbursed or paid for was incurred by the employee (or family member) in purchasing goods or services that the employer (or an associate) sells to customers in the ordinary course of your business. The benefits are two types — an inhouse property expense payment fringe benefit and an in-house residual expense payment fringe benefit. Example Employer ABC is a manufacturer which markets its products through independent retailers. The employees of ABC purchase those products from the retailers at full retail price, but subsequently receive a reimbursement from ABC for part of the purchase price. The reimbursement is an in-house property expense payment fringe benefit.

The taxable value of an expense payment benefit is the amount of the expenditure incurred by the

employee which is paid or reimbursed by the employer (¶3-430). Exempt expense payment benefits The provision of an expense payment benefit (or a property benefit or residual benefit) in respect of an “eligible work-related item” will be an exempt expense payment benefit where it is provided in relation to an “exempt benefit” (¶3-600). Housing benefits A housing benefit will arise where an employer provides accommodation to or gives an employee a right to occupy a unit of accommodation as a usual place of residence for more than one day. The right to occupy may be under a lease or licence and may cover any type of accommodation, provided it is the employee’s usual place of residence. The taxable value of the housing benefit will generally be the market value of that right reduced by any contribution made by the employee. A remote area housing benefit (eg accommodation provided to employees in remote areas) is FBT-exempt (see “Remote area concessions”: ¶3-700). Living-away-from-home allowance (LAFHA) benefit A LAFHA benefit arises if an employer pays an employee an allowance to cover additional expenses incurred (and other disadvantages suffered) because the employee has to temporarily live away from their usual place of residence for employment purposes. Additional expenses do not include expenses the employee would be entitled to claim as an income tax deduction. In addition to actually living away from the usual place of residence, the employee must be required to do so. For example, an allowance paid to an employee who lived about 60 km from his place of employment, but was not required to reside in accommodation closer to his work in order to carry out his employment duties, did not constitute a LAFHA even though he was living away from his usual place of residence and was compensated by the employer for so doing (Compass Group (Vic) Pty Ltd (As Trustee For White Roche & Associates Hybrid Trust) v FC of T 2008 ATC ¶10-051). Generally, the taxable value of a LAFHA benefit is the amount of the allowance that exceeds the amount reasonably necessary to compensate the employee for the cost of the accommodation away from home and for increased expenditure on food (¶3-450). Property fringe benefits If an employer, or a third party under an arrangement with an employer, provides a property benefit to an employee either for free or at a discount, a property fringe benefit arises (FBTAA s 40). For FBT purposes, property can be tangible property (eg goods, clothing, animals, gas and electricity) or intangible property (eg real property such as land and buildings), but does not include a right arising under a contract of insurance or a lease or licence in respect of real property or tangible property. Generally, the taxable value of the benefit is the amount by which the arm’s length cost of the goods to the employer exceeds the price charged to the employee. If, however, the property provided is of a kind normally provided as part of the employer’s business, concessional rules apply (¶3-445). A property fringe benefit can also cover the payment of money, other than salary or wages, by an employer to the trustee of a trust in respect of the employment of an employee (ID 2007/204). Although money is property under the FBTAA, it is not tangible property but is intangible property (FBTAA s 136(1); ID 2010/151). The provision of bitcoin by an employer to an employee in respect of their employment is a property fringe benefit (Taxation Determination TD 2014/28). Bitcoin is not tangible property for the FBT purposes and bitcoin holding rights are not a chose in action. However, as the definition of “intangible property” includes “any other kind of property other than tangible property”, bitcoin falls within the definition. The provision of bitcoin by an employer to an employee is therefore a property benefit. As bitcoin is not money but is considered to be property for tax purposes, it satisfies the definition of a “non-cash benefit” and is excluded from PAYG withholding. Exclusion from PAYG withholding means that bitcoin is not “salary or wages” (see the definition of fringe benefit in the FBTAA). Other examples of property fringe benefits are:

• an employer’s contributions to a redundancy fund on behalf of employees. (In Caelli Constructions (Vic) Pty Ltd 2005 ATC 4938, the fund’s trust deed fixed the weekly amount of the contributions to be made by employers for each worker, determined how the contributions were to be applied, and provided that the amount standing to the credit of a particular worker’s account was available for distribution to the worker if the employment ceased.) • a payment by an employer to the trustee of a trust or a non-complying superannuation fund set up to provide benefits to employees (Taxation Ruling TR 1999/5: ¶3-100). Employee benefits trusts Where bonus units are issued to employees as part of an employee benefits trust arrangement, the bonus unit received by the employee or a transfer from the employer contribution/unallocated trust capital account to the employee’s bonus unit account is a “non-cash benefit” (under ITAA97 s 995-1(1)) and is not the employee’s “salary or wages” (¶3-600). Such a bonus unit will be a fringe benefit provided to the employee, as summarised below (TR 2010/6): • the issue by the trustee of the bonus unit is the provision of a fringe benefit to the employee • alternatively, the transfer from the employer contribution/unallocated capital trust capital account on or after the issue of a bonus unit is the provision of a fringe benefit to the employee • additionally, where there are further such transfers to the employee’s bonus unit account in relation to bonus units that were previously issued for value and/or were subject to such previous transfers, there is a provision of a fringe benefit to the employee at the time of transfer. The benefit constituting the issue of a bonus unit is a property benefit (FBTAA s 40) that is an external property fringe benefit with a taxable value determined under FBTAA s 43. The benefit constituting the transfer from the employer contribution/unallocated trust capital account is either a property benefit or a residual benefit (FBTAA s 45; John Holland Group Pty Ltd & Anor v FC of T 2014 ATC ¶20-479: provision of flights under FIFO arrangements). The issue of a bonus unit to an employee by the trustee or the transfer from the employer contribution/unallocated trust capital account to the employee’s bonus unit account under the employee benefits trust arrangement is a benefit provided by the trustee under an “arrangement” (¶3-100) in respect of the employment of the employee (TR 2010/6). Example An employer contributes $100,000 to an employee benefits trust in a financial year and the trustee of the employee benefits trust selects employee E as an employee participant. The trustee loans $100,000 to Eliza (an employee), who pays $100,000 to the trustee and receives 100,000 $1 ordinary units. Shares in the employer have a value of $20 per share at the end of the financial year. The trustee uses the $100,000 received from Eliza to purchase 5,000 shares in the employer. The trustee allocates the 5,000 employer shares to Eliza’s ordinary units. In a subsequent year, the trustee issues 1,000 bonus units to Eliza at the employer’s request. The bonus units issued to Eliza are funded out of the employer contribution to the trust, and they give Eliza a share of the income of the trust and a proportionate interest in the assets of the trust. Eliza has received a non-cash benefit which is not “salary or wages”. The benefit constituting the issue of bonus units is a property benefit under s 40, and is an external property fringe benefit with a taxable value of $100,000 under s 43. Alternatively, Eliza has received a benefit in the trust fund constituted by the monies transferred from the employer contribution/unallocated trust capital account. This benefit is a property benefit under s 40, and is an external property fringe benefit with a taxable value of $100,000 under s 43.

By contrast, employer contributions made by an employer to an industry welfare trust (Class Ruling CR 2004/76) and contributions of apprentice levies to a redundancy fund (Class Ruling CR 2004/97) do not give rise to a fringe benefit. See also Class Ruling CR 2004/113 dealing with payments for worker income protection and portable sick leave insurance policies. Exempt property benefits Goods supplied to, and consumed by, an employee on a working day and on the employer’s premises, or

on premises of a related company, are an exempt property benefit. Examples are morning and afternoon teas provided to employees and food and drinks provided on the employer’s premises through a dining card facility (FBTAA s 41). Under such “meal card” arrangements, an employer pays for an employee’s meals provided by an independent caterer located on the employer’s premises (or that the independent caterer delivers to the employer’s premises). This effectively allows an employee with a meal card to purchase food and drink out of pre-tax income, whereas most employees must purchase their meals from after-tax income The s 41 exemption for property benefits consumed on the employer’s business premises on a working day does not cover food or drink provided to an employee under a salary sacrifice arrangement. Property fringe benefits arising from contributions that an employer makes to worker entitlement funds are exempt from FBT, provided the conditions are met (¶3-600). The provision of a property benefit (or an expense payment benefit or a residual benefit) in respect of an “eligible work-related item” is an “exempt benefit” (¶3-600). Property benefits arising from providing non-entertainment meals to an employee employed in a primary production business located in a remote area are exempt benefits (¶3-700). Meal and other entertainment benefits A fringe benefit may arise in the form of a meal entertainment fringe benefit or an entertainment benefit provided by employers. Provision of “meal entertainment” is a reference to the provision of entertainment by way of food or drink, or accommodation or travel in connection with or to facilitate such entertainment, or connected reimbursements (s 37AD; ID 2014/15: expense incurred in providing the employee with travel includes reimbursements of an employee’s car parking fees). A meal entertainment benefit therefore arises if an employer provides an employee with entertainment by way of (or in connection with) food or drinks, but not entertainment by way of recreation. If a meal entertainment fringe benefit does not arise, then, depending on the circumstances, the entertainment benefit may be: • an expense payment benefit, eg reimbursement of entertainment expenditure incurred on an employee’s personal credit card to the extent that the entertainment was provided to employees or their associates • a property benefit, eg an entertainment meal provided in a restaurant to an employee • a residual benefit, eg use by an employee of sporting facilities owned by an employer • a board fringe benefit, eg an entertainment meal provided to an employee who is entitled under an industrial award to accommodation and at least two meals per day, or • a tax-exempt body entertainment benefit, eg the provision of an entertainment meal to an employee by an employer which is a tax-exempt body (see below). There are two methods for calculating the taxable value of meal entertainment fringe benefits — the 50/50 split method (ie 50% of the expenses incurred) or the 12-week register method (not applicable to salary packaged meal entertainment or entertainment facility leasing expenses, see below). The taxable value of an entertainment benefit provided by a tax-exempt employer is the expenditure incurred in providing the entertainment to the employee concerned. Where the employer elects to use the 50/50 split method, the minor benefits exemption cannot apply to reduce the taxable value of the meal entertainment fringe benefits. This is because under FBTAA s 37BA, the total taxable value of meal entertainment fringe benefits of the employer for the FBT year is 50% of the expenses incurred by the employer in providing meal entertainment for the FBT year. However, if the employer uses the 12-week register method, any minor benefits will reduce the total value of the meal entertainment fringe benefits that are used for the calculation under FBTAA s 37CB, because the minor benefits, while being meal entertainment, are not fringe benefits (TR 2007/12, para 262–265). Entertainment provided to an employee or to an associate of an employee by an income tax-exempt employer, which is provided in respect of employment, is a tax-exempt body entertainment benefit if the

expenditure would be non-deductible were the body a taxable entity (s 38; see also ATO Fact Sheet FBT and Christmas parties). Such a benefit will generally be a fringe benefit subject to FBT. Salary packaged meal entertainment and entertainment facility leasing expenses From 1 April 2016: • all salary packaged meal entertainment and entertainment facility leasing expenses are reportable and must be included on an employee’s payment summary where the reporting exclusion threshold of $2,000 is exceeded (¶3-155), and • the 50/50 split method and 12-week register method cannot be used for valuing salary packaged meal entertainment or entertainment facility leasing expenses. The above rules apply to entertainment by way of food or drink, accommodation or travel in connection with, or to facilitate the provision of, such entertainment, and entertainment facility leasing expenses. Entertainment facility leasing expenses are expenses incurred in hiring or leasing: • a corporate box • boats or planes for providing entertainment, and • other premises or facilities for providing entertainment. Leasing expenses do not include expenses attributable to providing food or beverages or expenses attributable to advertising that would be an income tax deduction (ID 2009/141: meaning of the term “facility” in the definition of “entertainment facility leasing expenses”). Airline transport fringe benefits Airline transport fringe benefits may arise when an employee of an airline or travel agent is provided with free or discounted airline travel, subject to stand-by restrictions. Free or discounted air travel that is not subject to such restrictions is a residual fringe benefit (see below). From 8 May 2012, an airline transport fringe benefit is defined as an in-house fringe benefit or an in-house residual fringe benefit to the extent that it relates to the provision of airline transport and incidental services (FBTAA s 136(1)). An airline transport benefit is taxed as an in-house residual fringe benefit to the extent that the benefit includes the provision of transport in a passenger aircraft operated by a carrier (including any related incidental services on board the aircraft) and is subject to the stand-by restrictions that customarily apply in the airline industry. The rules for calculating the taxable value of an airline transport fringe benefit (previously in FBTAA Pt III Div 8) are now aligned with the general provisions dealing with in-house property fringe benefits and inhouse residual fringe benefits (see ¶3-445). Board fringe benefits A board fringe benefit consists of any meal provided to an employee who is entitled to at least two meals a day and accommodation under an industrial award or an employment arrangement (where certain conditions are also met). The taxable value of a board benefit is $2 per meal per person ($1 where the recipient is under 12 years old). Exempt board benefits The following meals are not board fringe benefits (but may be property fringe benefits or, if provided by a tax-exempt body, tax-exempt body entertainment fringe benefits): • meals provided at a party, reception or other social function • meals provided in a dining facility open to the public, except for board meals provided to employees of a restaurant, motel, hotel, etc, and • meals provided in a facility principally used by a particular employee.

Incidental refreshments (eg morning and afternoon teas) supplied as part of board are exempt from FBT. Board meals provided to an employee who is employed in a primary production business located in a remote area are exempt benefits. Residual fringe benefits A fringe benefit which is not covered by a specific fringe benefit or valuation rule may be a residual fringe benefit. It must be possible to identify the benefit which is provided in connection with the employment relationship (FBTAA s 45). For example, a loan establishment service provided by a bank to an employee without charge, being a service for which the bank charges customers, gives rise to a residual benefit (Westpac Banking Corporation v FC of T 96 ATC 5021) (ID 2006/159: payment for the funeral expenses of a deceased employee is not a residual fringe benefit). The decision in ID 2006/159 could equally apply in circumstances where the benefit was an expense payment or property benefit that relates to funeral costs of a deceased employee, but not where an immediate member of an employee’s family has passed away (NTLG FBT minutes, February 2012). A residual fringe benefit can also arise where an employee is entitled to use a motor vehicle other than a car (eg a motorcycle), subject to certain exemptions (for the ATO compliance approach, see Practical Compliance Guideline PCG 2018/3). The exemption is subject to certain private use restrictions and excludes taxis on hire and most cars (FBTAA s 47(6); ID 2010/163: use of a tram). Where an employee only travels between home and work on a bus owned by the employer under an employment arrangement, this constitutes a residual benefit which is an exempt benefit under s 47(6) (ID 2009/140). A residual benefit that arises from the participation of an employee in a fitness class provided by an employer on the employer’s premises is not an exempt benefit under FBTAA s 47(2) if the benefit provided to the employee is the participation in a fitness class, and not the provision, or use, of a recreational facility (ID 2015/25). Where property is also provided at the same time as a residual benefit (eg spare parts are provided when a television set is repaired), the two benefits are treated as one residual benefit if the provider is in the business of supplying such goods and services. If the goods are supplied by one provider and the services by another, the two types of benefit are valued separately. A residual benefit generally arises at the time when the benefit is provided. If the benefit is provided over a period, such as where an employee has the use of property for a period of time, the benefit arises during that period. If the period straddles more than one FBT year, the benefit is taxable on a proportional basis in each year. Generally, the taxable value of a benefit is the amount by which the arm’s length cost of the benefit to the employer exceeds the price charged to the employee. If, however, the property provided is of a kind normally provided as part of the employer’s business, concessional rules apply. The provision of a residual benefit (or an expense payment benefit or a property benefit) in respect of an “eligible work-related item” is an “exempt benefit” (¶3-800). Specific exclusions from the definition of “fringe benefit” are also discussed at ¶3-600.

CALCULATING FBT ¶3-300 How is the amount of FBT calculated? FBT is levied on the “fringe benefits taxable amount” of a fringe benefit provided by an employer in respect of an employee’s employment, ie the taxable value grossed-up by the relevant factor (see “Grossing-up rates” below). The FBT grossing-up process is designed to achieve equitable tax treatment between fringe benefits and cash salary for an employee at the top marginal rate of personal income tax by converting the fringe benefits to their gross or pre-tax equivalent value. The FBT payable is then calculated by applying the FBT rate for the year to the tax-inclusive value of the fringe benefit, just as income tax is applied to gross salary or wages. FBT rate

FBT year

FBT rate

Ending 31 March 2018, 2019 and 2020 47% Grossing-up rates Under the GST regime, there are taxable supplies, GST-free supplies, input taxed supplies and GST credits (¶3-950). An employer’s cost of providing a fringe benefit will be reduced in cases where the employer is able to claim GST credits or no GST applies when purchasing the benefits provided. Therefore, to maintain tax neutrality for all types of benefits, two gross-up rates are used to determine the employer’s fringe benefit taxable amount for the 2019/20 year: • a higher (Type 1) gross-up rate of 2.0802, where the employer (provider of the benefit) is entitled to claim GST credits at the time the benefit was acquired, and • a lower (Type 2) gross-up rate of 1.8868, where the employer did not incur GST or is not entitled to claim GST credits on the purchase of the benefits. The higher gross-up factor effectively recovers the GST credits obtained by the employer in providing the fringe benefit. The supply of a fringe benefit in itself is not subject to GST. However, an employer may have to pay GST on any employee contribution to the cost of the fringe benefit provided (¶3-550). Steps to be taken in calculating FBT for an FBT year To determine the fringe benefits taxable amount for a year of tax, an employer may have to calculate two types of aggregate fringe benefits amounts. A Type 1 aggregate fringe benefits amount is the total taxable value of all fringe benefits provided to employees or their associates where GST credits are available to the employer (provider of the benefit). Any excluded fringe benefits with GST credits available to the employer are added to this amount. A Type 2 aggregate fringe benefits amount is the total taxable value of all fringe benefits provided to employees or their associates where either GST credits were not available to, or GST was not paid by, the employer. Essentially, the individual fringe benefits amount for Type 2 aggregate fringe benefits is the employer’s total individual fringe benefits amount reduced by the individual fringe benefits amount used in determining the employer’s Type 1 aggregate fringe benefits amount. The value of excluded fringe benefits can be calculated in a similar way. The steps for calculating the FBT payable on a benefit by an employer are as below: Step 1: For each employee, identify those fringe benefits that are “GST-creditable benefits”, ie benefits where the employer can claim GST credits. Work out the individual fringe benefits amount using the valuation rules applicable to the benefit. Step 2: Add all the individual fringe benefits amounts worked out in Step 1. Step 3: Identify the “excluded fringe benefits” (¶3-155) that are GST-creditable benefits and add up the taxable value of those excluded fringe benefits. Step 4: Add the totals from Steps 2 and 3. This is the Type 1 aggregate fringe benefits amount. Step 5: For each employee, identify those benefits that are not taken into account under Step 1. Work out the individual fringe benefits amount for each employee in relation to those benefits. Step 6: Add up all the individual fringe benefits amounts worked out in Step 5. Step 7: Identify the excluded fringe benefits that are not taken into account under Step 3 and add up the taxable value of those excluded fringe benefits. Step 8: Add up the totals from Steps 6 and 7. This is the Type 2 aggregate fringe benefits amount. Step 9: Calculate the fringe benefits taxable amount by grossing-up the Type 1 aggregate fringe benefits (at the 2.0802 gross-up rate) and the Type 2 aggregate fringe benefits (at the 1.8868 gross-up rate) and add them together.

Step 10: Apply the FBT rate (47%) to the fringe benefits taxable amount (the total in Step 9). This is the FBT amount payable by the employer. Example An employer provides the following benefits to a single employee: • expense payments (GST taxable supplies where input tax credits are claimed) — $7,000 • remote area residential fuel (excluded fringe benefit where input tax credits are claimed) — $1,000 • expense payments (GST-free supplies, no input tax credit available) — $6,000 • remote area rent reimbursement (excluded fringe benefit, no input tax credit available) — $3,000. Calculate employer’s Type 1 aggregate fringe benefits amount Steps 1 & 2: Type 1 individual fringe benefit amount = $7,000. Step 3: Type 1 excluded fringe benefit amount = $1,000. Step 4: Employer’s Type 1 aggregate fringe benefits amount = $8,000. Calculate employer’s Type 2 aggregate fringe benefits amount Steps 5 & 6: Type 2 individual fringe benefit amount = $6,000. Step 7: Type 2 excluded fringe benefit amount = $3,000. Step 8: Employer’s Type 2 aggregate fringe benefits amount = $9,000. Calculate fringe benefits taxable amount by grossing-up Step 9: Type 1 amount from Step 4 × 2.0802, ie $8,000 × 2.0802 = $16,641. Step 9: Type 2 amount from Step 8 × 1.8868, ie $9,000 × 1.8868 = $16,981. Step 9: Total fringe benefits taxable amount = $33,622 (ie $16,641 + $16,981). Calculate tax payable (Step 10) The FBT payable by the employer is: fringe benefits taxable amount × 47% $33,622 × 47% = $15,802

¶3-400 Calculating taxable values Each class of fringe benefits has its own specific valuation rules. Valuation rules are discussed for the following fringe benefits: • car benefits (¶3-410) • car parking benefits (¶3-420) • expense payment benefits (¶3-430) • loan benefits (¶3-440) • in-house benefits (¶3-445) • living-away-from-home allowance benefits (¶3-450). When calculating the taxable value, the value of the fringe benefit is the GST-inclusive value where applicable (¶3-950). Where the “otherwise deductible” rule applies (¶3-500), the taxable value is reduced by the hypothetical tax deduction to which the employee would have been entitled. Reduction in taxable value concession A number of fringe benefits also attract concessional treatment by way of a reduction in the taxable value of the fringe benefit that results in a reduced amount of FBT, or even no FBT, being payable. Some of the benefits to which the reduction concession applies are discussed at ¶3-700. In some instances, special conditions must be satisfied for the concession to be available, for example,

keeping certain records.

¶3-410 Car benefits A car benefit is the most common form of fringe benefit provided to employees. A car fringe benefit most commonly arises where a car that is held by an employer is made available for the private use of an employee (or an associate of the employee). A “car held by a person” refers to a car that the person owns, or leases, or that is otherwise made available to the person by another person. Private use arises if the car is actually used other than in the course of producing assessable income, or the car is garaged or kept at the employee’s residence, or the employee has custody and control of the car. Care should be taken as a car benefit can arise if, at all material times, a car is garaged or kept at or near a company taxpayer’s principal place of business, which is also the residential address of its sole director (Jetto Industrial Pty Ltd v FC of T 2009 ATC ¶10-090; [2009] AATA 374). This is the case even if the taxpayer inadvertently fails to lodge an FBT return on the mistaken belief that, because the car was 100% used for business purposes, there was no FBT liability and no requirement to lodge a return, or that no tax would have been payable in any case (whether the calculation method in FBTAA s 9 or 10 was used: see below) because the logbook and other evidence showed 100% business usage and therefore no car fringe benefit taxable value (Jetto Industrial Pty Ltd 2009 ATC ¶10-090; [2009] AATA 374). There are two ways of calculating the taxable value of car benefits — the statutory formula method and the operating cost method (FBTAA s 9, 10). Each method has its own record-keeping requirements. An employer can choose to use either method each year for each car giving rise to a car fringe benefit. The statutory formula method automatically applies if an employer does not make a choice. If an employer chooses to use the operating cost method for a particular car for any year, but the statutory formula would in fact result in a lower value for that year, the lower statutory formula value applies for the year (s 10(5)). Regardless of the method used, FBT is payable on the grossed-up taxable value of the benefit. Statutory formula method The statutory formula method applies a statutory fraction (based on kilometres travelled) to the base value of a car. Under this method, a percentage specified by law (statutory fraction) is applied to the base value of the car. The taxable value is calculated using the formula: A×B×C − E   D    where: A

is the base value of the car

B

is the statutory fraction (0.20 from 1 April 2014 onwards in all cases)

C

is the number of days in the FBT year when a car benefit was provided to an employee

D

is the number of days in the FBT year

E

is the amount of the recipients contribution (if any).

Base value The base value of a car is generally the cost price of the car (FBTAA s 9(2)(a)(i)). The cost price includes the cost of any non-business accessories fitted and delivery cost at the time of purchase, but excludes registration cost and stamp duty (FBTAA s 136(1)). Paint protection, fabric protection, rust protection and window tinting are each a “non-business accessory” (ID 2011/47). Taxation Ruling TR 2011/3 explains the meaning of “cost price” of a car in the following circumstances: • a trade-in vehicle is provided by an employee towards the purchase of a car • an up-front cash payment made by an employee towards the purchase of a car, and • arrangements involving fleet discounts, sales incentives and manufacturers’ rebates.

The base value is reduced by one-third if the employer has held the car for more than four years at the start of the FBT year. Example Assume that the car in the above example was purchased for $25,000 and was fitted with a car stereo (non-business accessory) costing $500. If 16,009 (annualised) kilometres were travelled, then the statutory fraction is 0.20. Assuming the recipient did not contribute to the provision of the vehicle, the taxable value is calculated as:

25,500 × 0.20 × 228  365 



$0

= $3,186

Operating cost method Under the operating cost method, the fringe benefits taxable value is calculated by totalling the costs of running and financing the vehicle. To use this method, adequate FBT records must be kept. The total cost is split between the business use portion and the non-business use portion. The non-business use portion becomes the taxable value of the fringe benefit, as calculated using the formula below: (C × (100% − BP)) − R where: C BP R

is the operating cost of the car during the holiday period is the business use percentage applicable to the car for the holding period, and is the amount of any recipients payment for the holding period.

The holding period refers to the period during the year in which the provider held the car for the purpose of providing the fringe benefit. The operating cost of the car includes: • where the car is owned — depreciation and imputed interest cost on the value of the car and any nonbusiness accessories fitted to the car • where the car is leased — the lease costs • expenses incurred on repairs, maintenance and fuel (ID 2014/18: car expense includes the cost of a map update of an in-built satellite navigation system that is part of the car), and • insurance and registration costs. Where the employer owns the car, depreciation and imputed interest are calculated on the car. Depreciation is calculated using the following formula: A×B×C  D    where: A

is the depreciated value of the car

B

is deemed depreciation rate (25% for cars acquired on or after 10 May 2006)

C

is the number of days during the year the provider held the car, and

D

is the number of days in the year.

Imputed interest is calculated using the following formula:

A×B×C  D    where: A is the depreciated value of the car B is the benchmark interest rate (5.37% for the 2019/20 FBT year) C is the number of days the provider held the car, and D is the number of days in the year. The imputed interest is calculated separately on non-business accessories such as CD players and fitted air conditioners. The benchmark interest rate is 5.37% for the 2019/20 FBT year (the same rate as that used to calculate the taxable value of a loan fringe benefit: ¶3-440). The business use percentage is the percentage of the total distance travelled by the car relating to business use. The business use percentage is calculated using the following formula: number of business km travelled by car during holding period   total number of km travelled by car during holding period 

×  100%

Logbook and odometer records showing the business use of the car should be maintained. The logbook must be kept for the first year in which the operating cost method is used and must be updated every five years. The logbook must be kept for a minimum of 12 weeks. An entry must be made to record each business journey. Private journeys do not have to be recorded. The details for each journey include the dates the journey began and ended, the relevant odometer readings and the journey’s purpose. A journey between home and work will generally not be a business journey. However, travel from home will be a business journey where: • it involves travel to a client’s or customer’s premises and then to work • employment actually starts prior to leaving home, eg a doctor (see also MT 2027 private use of car: home to work travel). Recipient’s payment The taxable value is reduced by contributions made by the employee towards the cost of the benefit. Example Assume a car has been leased with a yearly lease payment of $6,000. Repairs, maintenance and fuel costs for the year amount to $2,500 and insurance and registration costs amount to $1,000. The business use percentage of the car was 50%. Assuming the employee did not contribute towards the cost of the vehicle, the fringe benefits taxable value is:

($9,500 × 50%) − $0 = $4,750

Exemptions Where an employee is provided with a car expense payment fringe benefit (eg the provision of fuel), in respect of the car fringe benefit, the provision of the car expense payment fringe benefit is an exempt benefit. Statutory formula v operating cost The question of whether to use the statutory formula or operating cost method will depend on many factors, including the pattern of use of the car and the number of kilometres travelled. If the car travels relatively few kilometres in a year, the operating cost method may provide a lower fringe benefits taxable value (note that the distance travelled factor will be irrelevant under the 20% flat rate basis, see above). However, detailed records must be kept for the operating cost method. The operating cost method may also provide a lower fringe benefits taxable value if the business use percentage is relatively high, so it is

necessary to weigh up the full range of factors when deciding which valuation method to use. For guidelines, see the ATO’s “FBT — car calculator” (available at ato.gov.au/Calculators-and-tools/FBT--car) which is designed to help employers calculate the taxable value of a car fringe benefit using either the statutory formula or operating cost method. It does not calculate the grossed-up value of the benefits or the tax payable. Luxury cars lease arrangements The FBT treatment of luxury cars is the same as for other cars. However, the limits on the amount of depreciation or lease payments that may be claimed on luxury car leases for income tax purposes has made salary packaging of luxury cars less tax attractive. The treatment of luxury cars as part of a salary package is discussed at ¶10-310. Novated lease arrangements A novated lease is a tripartite arrangement between an employer, an employee and a finance company (as a lessor) under which the obligation to make the lease payments to the lessor is transferred from the employee to the employer while the employee remains with the employer. Novated leases and a related arrangement known as an associate lease are useful tools for salary packaging and are discussed in ¶10310. Full novation In full novations, the lease obligations are transferred to the employer who becomes the lessee. There are no income tax consequences for the employee during the period the employer makes the lease payments. The employer is entitled to a tax deduction for lease expenses where the vehicle is used in the business or provided to an employee as part of salary packaging. For a luxury car, the deduction is based on an accrual amount for finance charges and depreciation (subject to the car depreciation limit, see above). A car fringe benefit arises where the car is provided for the private use of the employee or employee’s associate. Partial novations For partial novations, the income and FBT consequences are as follows. The employee is assessable on the benefit received as sub-lessor at the time the lease payment obligations are transferred under a partial novation. The income or benefit is calculated by reference to the value, equivalent to the lease payments, of the consideration received. That consideration is the promise by the employer to make rental payments directly to the financier in lieu of payments to the employee under the sub-lease between the employer and the employee. A tax deduction is not available to the employee in non-luxury motor vehicle partial novations where the lease payments are contractually made by the employer directly to the finance provider. In these circumstances, the employee no longer has the contractual obligation for the lease payment liabilities and does not make the payments. For a partial novation involving a luxury motor vehicle, the employee is the notional owner as sub-lessor in the sub-lease between the employee and employer. The employee is assessed on the accrual amount of the notional loan in the luxury motor vehicle novation. The accrual amount is calculated by reference to the consideration (ie the employee granting to the employer the right to possession or use of the motor vehicle) based on the amount of the lease payment obligation transferred to the employer. A deduction is not available to the employee in a luxury motor vehicle partial novation. An employee, as sub-lessee, can claim a deduction only to the extent to which a deduction is allowable to the lessee under other provisions of ITAA97. In partial novations, a residual benefit may arise where all that occurs is the transfer to the employer of the lease payment obligations of the employee. A car benefit arises where the employer provides the car for the private use of the employee or associate of the employee. Private use of a motor vehicle other than a car Where an employee is entitled to private use of an employer’s motor vehicle other than a car (eg a

motorcycle), this gives rise to a residual benefit (FBTAA s 45: ¶3-200). A number of acceptable methods may be used to determine the taxable value of the benefit, such as the operating cost method based on the number of private kilometres travelled or other reasonably based approach (Miscellaneous Taxation Ruling MT 2034). One acceptable method is to value the net benefit of the private use of the vehicle by multiplying the number of private kilometres travelled by the employee during a year by a cents per kilometre rate (see table below). This method can only be used where there is extensive business use of the vehicle (MT 2034, para 15–16).

Motor vehicle (other than a car) — cents per kilometre rate Engine capacity/type

Rate per kilometre

Up to 2500cc

55 cents

Over 2500cc

66 cents

Motorcycles

16 cents

¶3-420 Car parking fringe benefits A car parking fringe benefit arises where an employer provides a car parking facility for an employee and all of the following conditions are satisfied: • The car is parked on business premises (which may itself be a commercial car parking station) that is within one kilometre of a commercial car parking station which is a permanent commercial parking facility open to the public for all-day parking for a fee of at least $8.95 a day for the 2019/20 FBT year (up from $8.83 a day for the 2018/19 year) (see example and explanations below). • The car is parked there for more than four hours between 7 am and 7 pm on the particular day. • The car parking is provided in respect of the employee’s employment. • The employee has parked at or near the employee’s primary place of employment. • The car is used by the employee to travel between the employee’s residence and the primary place of employment (FBTAA s 39A). Example Three commercial parking stations are located within 1 km of an employer-provided car park where the lowest fee charged by each of the operators on 1 April 2019 is $10.50, $10.00 and $9.00. The condition in the first dot point is satisfied because the lowest fee charged by one of the operators is higher than the car parking threshold.

A “commercial parking station” means a permanent commercial car parking facility where any or all of the car parking spaces are available in the ordinary course of business to members of the public for all-day parking on payment of a fee, but not a parking facility on a public street, etc, paid for by parking meters (Virgin Blue Airlines Pty Ltd v FC of T 2010 ATC ¶20-226). “All-day parking”, in relation to a particular day, means parking of a single car for a continuous period of six hours or more during the period between 7 am and 7 pm (the daylight period) on that day. A fee charged by the operator of a commercial parking station for vehicles entering the station from 1 pm is not a fee for “all-day parking” as, after 1 pm, it is not possible to park for a continuous period or six hours of more during a daylight period on that day as that period ends before 7 pm for that day (ATO ID 2014/12). In FC of T v Qantas Airways Ltd 2014 ATC ¶20-477, the Full Federal Court held that the employer (taxpayer) was liable to pay FBT in respect of car parking facilities provided to its employees at all major airports around Australia, including the Canberra airport. As part of their remuneration, Qantas employees working at various airports were provided with car parking spaces, either at the taxpayer’s own premises

at the airports or in the vicinity of the premises where the staff worked. The Qantas case examined the issue whether the car parking spaces provided constituted a car parking benefit under s 39A. That is, whether there were commercial parking stations located within a one kilometre radius of the premises where the cars were parked where the lowest fee charged for all-day parking exceeded the relevant car parking threshold (see s 39A(1)(a)(ii) and (iii)). The taxpayer argued that the parking facilities available at the airports were not “commercial parking stations”, but the court held that the requirement that there be a commercial parking station within a one kilometre radius was a trigger for liability to the tax. It was a mechanism to determine which car spaces provided to employees were sufficiently valuable such that they should be assessed with FBT. There was no ambiguity about the word “public” and the meaning of “commercial parking station” was clear. The court also rejected the AAT’s finding that the Canberra airport car parking facilities were not a “commercial parking station”. The presence of a qualifying parking station was not directed to the issue of whether employees could find alternative parking, but whether the employer-provided parking spaces had a value that was to be assessed under the FBTAA. Taxation Ruling TR 96/26 provides guidelines on the car parking provisions in FBTAA Pt III Div 10A. This ruling is currently under review and will be updated to reflect contemporary commercial car parking arrangements and legal developments including the Virgin and Qantas decisions (www.ato.gov.au/General/ATO-advice-and-guidance/Advice-under-development-program/Advice-underdevelopment---FBT-issues/). Taxable value of a car parking fringe benefit In determining the taxable value of a car parking fringe benefit, it is necessary to calculate the fringe benefits taxable value of each benefit and the number of car parking fringe benefits provided to employees (or associates). The three methods of calculating the taxable value of a single car parking fringe benefit are as follows: (1) The commercial car parking station method — under this method, the taxable value is the lowest public parking fee charged for any continuous period of six daylight hours in the ordinary course of business by any commercial car parking station within one kilometre of the business premises, reduced by any amount contributed by the employee. (2) The market value method — under this method, the taxable value is effectively the market value of the benefit provided reduced by any employee contribution. The relevant market value is to be determined by a qualified arm’s length valuer and must be reported to the employer in an approved form. (3) The average cost method — under this method, the taxable value is the average of the lowest fees charged by a commercial parking station within one kilometre of the business premises on the first and last days of the FBT year on which a car parking benefit is provided to an employee (or associate). The lowest fee must be representative, ie it cannot be substantially greater or less than the average daily fee charged for the four weeks before or after that particular day in the FBT year. In calculating the number of car parking fringe benefits provided (so as to determine the taxable value of all car parking fringe benefits for the year), an employer can keep detailed records of each car parking benefit provided or, alternatively, adopt either: • the statutory formula method, or • the 12-week record-keeping method. Statutory formula method Under this method, the taxable value is calculated according to the following formula: daily rate amount × number of days in availability period × 228  365  The daily rate amount is the value of the benefit provided as determined under the commercial car parking station method, market value method or average cost method. To calculate the number of days in

the availability period the employer must also record the number of car parking spaces available over the FBT year. Where the average number of employees covered by this method is less than the average number of spaces provided, the taxable value of the benefits is reduced proportionately. 12-week record-keeping method Under this method, the total taxable value of car parking benefits provided during the full FBT year is based on the value of benefits provided in a 12-week period. The employer must keep a register to record the details of the benefits provided during that period. The total taxable value is then determined according to the following formula: taxable value of parking benefits ×

52 ×  12 

number of days of car parking benefits  365 

The taxable value of each benefit provided during the 12-week period must be determined under the commercial car parking station method, the market value method or the average cost method. The 12week period must be representative of car parking usage over the year and a new register must be kept after four years or in the following year where the number of spaces increases by more than 10% on any day. Which valuation method to use? In calculating the taxable value of car parking fringe benefits, the commercial car parking station and average cost methods are the simplest as the market value method requires an independent valuation which makes it more complex. In calculating the number of spaces provided during the year, the statutory formula method is the simplest. However, depending on the number of spaces actually provided, the 12-week register method may provide a lower overall fringe benefits taxable value.

¶3-430 Expense payment benefits An expense payment fringe benefit arises where an employer pays or reimburses expenses incurred by an employee. A reimbursement generally requires an employee to be compensated exactly for an expense already incurred (¶3-200). The taxable value of an expense payment fringe benefit is generally the amount which is paid or reimbursed by the employer for the expenses incurred by the employee (FBTAA s 23). The valuation is different where the expense is incurred in respect of purchasing goods or services which the employer normally purchases or produces for sale to the public, or which are similar to those the employer normally supplies to the public, where concessional rules for in-house benefits may apply (¶3-445). The taxable value of the expense payment benefit may be reduced where the employee could receive an income tax deduction (¶3-500), or where it relates to certain remote area housing allowances. For example, an employer pays an employee’s home telephone bill of $1,200 for the FBT year and the employee declares that 50% of the bills are for business purposes and are therefore otherwise deductible, while the other 50% is for private calls. The expense payment would be $600 (ie 50% of $1,200). Where an employer pays amounts which have been salary sacrificed by an employee to the trustee of a trust as repayments of principal on an interest-free loan, each payment made by the employer to the trustee is taken to constitute the provision of an expense payment benefit by the employer to the employee (FBTAA s 20). The taxable value of the external expense payment fringe benefit is the amount of the loan repayment (FBTAA s 23). This value is not reduced by the deductible rule (¶3-500) as each repayment on the loan is a repayment of principal on an interest-free loan and the employee would not have been entitled to an income tax deduction had the employee incurred and paid these amounts (ID 2011/54). Employee loans and employee share trust schemes An expense payment fringe benefit may arise where an employer pays a liability owed by an employee to

a third party. However, FBT does not apply to money or property acquired by a valid employee share trust (EST), as the employee is taxed on their employee share scheme interests in the EST pursuant to Div 83A and Subdiv 130-D of the ITAA97 (ID 2010/108: what constitutes a valid EST under ITAA97 s 13085(4)). Taxpayer Alert TA 2011/5 warns about avoidance arrangements with features substantially equivalent to the following: • An employer establishes an employee benefit arrangement which operates through an employee share trust (EST), and makes a loan contribution to the trust. • The trustee of the trust uses the funds to provide interest-free loans to one or more employees and the employees use the borrowed funds to acquire units in the trust. • The trustee invests in the employer by acquiring shares and notionally allocates those shares to the units. • The employees enter into an effective salary sacrifice arrangement (SSA) with the employer. • The employer provides a benefit to employees, by paying salary sacrificed amounts to the trustee as repayments of the employee loans. In turn, the employee makes loan repayments to the employer. • The employer does not appear to include the taxable value of the benefit provided in its FBT liability (see diagram below).

The ATO considers that such an arrangement gives rise to taxation issues that include whether: • the trust can be a valid EST where it engages in activities which are not merely incidental to the activities set out in the definition of EST in s 130-85(4) (see ID 2010/108) • an effective SSA has been entered into in accordance with TR 2001/10 • repayments made by the employer to the trustee, are an expense payment fringe benefit under FBTAA s 20, and FBTAA s 24 applies to reduce the taxable value to nil under the otherwise deductible rule • the employer is required to include the taxable value of an expense payment fringe benefit in their fringe benefits taxable amount for the purpose of determining the employer’s FBT liability under

FBTAA s 66, and • the anti-avoidance provision in s 67 of the FBTAA may apply to the arrangement. Employment remuneration trust arrangements Taxation Ruling TR 2018/7 provides guidelines on how the tax laws apply to an employee remuneration trust (ERT) arrangement that operates outside of ITAA97 Div 83A (about employee share schemes: (¶3600). It applies to all Australian resident employers, employees and trustees who participate in an “ERT arrangement” involving a trust established to facilitate the provision of payments and/or other benefits to employees (for examples of ERT arrangements, see TR 2010/6 and TD 2010/10). The key points in TR 2018/7 for FBT purposes are noted below. When is a contribution a fringe benefit? A contribution made by an employer to the trustee is a fringe benefit where the trustee is an associate of an employee and the contribution is a benefit provided in respect of the employment of a particular employee, or two or more employees. “In respect of employment” requires a sufficient or material, rather than a causal, connection or relationship between the benefit and the employment (see Indooroopilly’s case: ¶3-100). A contribution is not a fringe benefit if it is a payment of salary or wages or a deemed dividend under ITAA36 Div 7A. Where a contribution is made for a particular employee (rather than employees generally), s 109ZB(3) will apply to prevent a contribution being a deemed dividend, and FBT will apply. Investing the contribution and providing benefits to employees from the ERT Where, under an arrangement with the employer, the trustee applies the contribution to make loans to employees, the employer will be taken to have provided a loan fringe benefit. The taxable value of a loan fringe benefit may be reduced by the “otherwise deductible” rule in FBTAA s 19 only where (and to the extent) there was a reasonable expectation of sufficient income had the employee used the loan for an attended purpose. There will not be a reasonable expectation of sufficient income where: the employee’s right to income of the ERT (see TD 2018/9) is at the discretion of the trustee; the entitlement to income is fixed over a finite period which, when compared to the interest expense, has no obvious commercial justification; the connection with assessable income is remote or insufficient; or no assessable income (other than capital gains) is expected to be generated (see TR 95/33). Example: No reduction in taxable value of a loan fringe benefit where there is no expectation of dividend income Tom, an employee, uses a loan from the trustee to acquire an interest in the ERT pursuant to an arrangement between the ERT trustee and Tom’s employer. The trustee in turn uses the loan funds to acquire shares in the employer (ABC Pty Ltd). However, the shares in ABC Pty Ltd are unlikely to pay dividends over the ensuing three-year period. Under the plan rules, Tom must hold the trust interest for a three-year period, after which time the interest in the ERT will be automatically redeemed and the loan repaid. The trust interest is unlikely to generate any trust income for Tom over the three-year period but will most likely deliver a sizeable capital gain to the employee on disposal of the trust interest. This is because the business is currently in a start-up phase and it is expected that the share value in ABC Pty Ltd will begin to achieve significant growth after the first two years of operations. In this situation, the otherwise deductible rule would not apply to reduce the taxable value of the loan fringe benefit because the interest in the trust is not likely to generate any trust income over the holding period. The same result would arise if, in lieu of shares, the trustee was acquiring rights to shares.

How are benefits assessed to the employee? Where a benefit received by an employee from the trustee is a fringe benefit, it is non-assessable nonexempt income of the employee (ITAA36 s 23L). Exempt expense payment benefits There are a number of exempt expense payment fringe benefits. Any expense payment fringe benefit which is covered by a no-private-use declaration is exempt. A no-private-use declaration is made by an employer who only pays for or reimburses so much of an expense that would not attract FBT. An accommodation expense payment fringe benefit will be exempt where the benefit is provided to

employees solely because they are required to live away from their usual place of residence to perform employment duties, but not where the employee is undertaking travel for employment purposes, eg overnight hotel accommodation. Where an employee is provided with a car expense payment fringe benefit, it will be exempt if the car is not leased to the employee by the provider of the benefit and the reimbursement is calculated by reference to the distance travelled by the car (¶3-410). An expense payment benefit cannot be in relation to certain types of activities such as holidays, attending medical examinations, relocating or attending an employment interview. Laptop computers — overlap with exempt benefit rule The provision of an expense payment benefit, a property benefit or a residual benefit in respect of an “eligible work-related item” is an “exempt benefit” (¶3-800). The provision of a laptop, notebook or portable computer is not an exempt benefit if, earlier in the FBT year, an expense payment benefit or a property benefit of the employee has arisen in relation to another one of these computers. Credit card use by employees Where an employer pays or reimburses an employee’s credit card account that has been used by the employee, the payment will be an expense payment fringe benefit if it is part of an effective salary sacrifice arrangement (TR 2001/10). This will be the case regardless of the items of expenditure incurred under the credit card agreement, ie purchases of goods, services or cash advances. Where the expenditure incurred by the employee is the amount outstanding as a debt to the credit provider, the payment or reimbursement would not be salary or wages. The ATO’s view is that a cash advance on a credit card does not prevent an employer making a payment or reimbursement in relation to the credit card outstanding balance. However, where there is an employer and employee agreement, arrangement or understanding in place that permit regular cash advances (eg $X weekly), the ATO would review such arrangements. If an employee uses the cash advance money to purchase a meal, the expense payment benefits relating to cash advances on the credit card is not in relation to “meal entertainment” (for the purposes of FBTAA s 37AD), but relate to the outstanding balance on the credit card account. Where an employer provides an expense payment benefit which includes some reference to cash advances on a credit card facility, the payment or reimbursement is not in relation to expenses incurred in providing entertainment by way of food or drink. Any connection as to how the cash advance funds were used by the employee is too remote to satisfy the requirements of s 37AD.

¶3-440 Loan fringe benefits A loan fringe benefit arises where an employer makes a loan to an employee (s 16, 17, 147, 148). Loans include those made by an employer’s associate, or by a third party under an arrangement with an employer, and loans to an employee’s associate or to some other person at the employee’s or associate’s request (ID 2003/315 and ID 2003/347). The loan fringe benefit exists for as long as any part of the loan remains unpaid. A loan of property is generally valued as a residual benefit (¶3-200). A loan fringe benefit also arises where an employer allows a debt owed by an employee to run past the due date for payment and exists for as long as the debt remains unpaid (s 16(2)). If any part of a loan is waived, a debt waiver fringe benefit arises (¶3-200). A loan fringe benefit also arises where a financial institution offers an arrangement which is materially different to that offered to other customers. A loan includes an advance of money, the provision of credit, or any other transaction that in substance effects a loan. Once interest has accrued for six months on such a loan, there is deemed to be a separate and additional interest-free loan of the accrued unpaid interest. A statutory benchmark interest rate of 5.37% for the 2019/20 FBT year (5.20% for the 2018/19 FBT year) is used to calculate the taxable value of a loan fringe benefit. The benchmark interest rate is the same rate as that used to calculate the taxable value of a car fringe benefit where an employer chooses to

value the benefit using the operating cost method (¶3-410). The taxable value of a loan fringe benefit is the difference between the interest accruing on the loan and the amount of interest calculated with reference to the statutory benchmark rate of interest. If the interest accruing on the loan is at least as great as the notional interest based on the benchmark rate, then the taxable value of the loan benefit is nil. The taxable value of the loan may be reduced where an employee uses all or part of the loan for incomeproducing purposes (see Example 1 below). For loans other than car loans, the starting point for determining the amount of the reduction is to calculate the amount of the notional tax deduction available to the employee. Where the loan is used to purchase a car, the deductible percentage of interest depends on the percentage of business use of the car during the year. To establish that interest would be deductible, the employee must generally complete an approved loan benefit declaration, showing the uses made of the loan and the deductible portion of the interest. A taxable benefit arises where an employer releases an employee (or associate) from a debt owed to the employer. The taxable value of the debt waiver fringe benefit is the value of the amount waived. Example 1 Assume that on 1 April 2019 John’s employer gives him a loan of $50,000 for five years at an interest rate of 5% pa. Interest is charged and paid six-monthly, and no principal is repaid until the end of the loan. The interest that is payable by the employee on the loan for the 2019/20 FBT year is $2,500 (ie $50,000 × 5%). The notional interest, using the 5.37% benchmark rate for 2019/20, is $2,685 (ie $50,000 × 5.37%). The taxable value of John’s loan fringe benefit is $185 ($2,685 − $2,500), ie

$50,000 × (5.37% − 5%) = $100

Example 2 Assume that Angela was provided with an interest-free loan of $8,000 from her employer on 1 April 2016, and no amount has been repaid since. The benchmark interest rate for the 2019/20 FBT year is 5.37% and the loan is used solely for private purposes. The taxable value of the loan fringe benefit for the 2019/20 FBT year is determined as:

$8,000 × (5.37% − 0%) = $429

Where an interest-free loan is made to an employee of a private company (who is also a shareholder), and only part of the loan is deemed to be a dividend under ITAA36 Div 7A, the remaining part of the loan is not a fringe benefit. That is because the definition of “fringe benefit” does not include anything done in relation to a shareholder (or associate of a shareholder) in a private company that causes a dividend to be taken to be paid to the shareholder or associate. If an employer mistakenly pays an amount to an employee that the employee is not legally entitled to, but is obliged to repay, and the employer subsequently allows the employee time to repay the amount, a loan fringe benefit will arise (TD 2008/10). A loan benefit can arise and continue even where the obligation to repay an amount or part of it is not enforceable by legal proceedings. It is the employer’s allowing of time to the employee to repay the mistakenly paid amount (rather than the employer’s payment under a mistake) that gives rise to a loan benefit. Accordingly, the loan benefit will not be excluded from being a loan fringe benefit as it is not a payment of salary or wages. However, in some circumstances, the loan fringe benefit may be excluded as an exempt benefit (eg a minor benefit under FBTAA s 58P). Exemptions Certain exemptions may apply to employee advances in respect of bonds or security deposits and loans by employers who carry on a business of making loans to the public (see “Exempt loans” in ¶3-200).

¶3-445 In-house benefits

An in-house fringe benefit can be an in-house expense payment fringe benefit (s 22A), an in-house property benefit (s 42) or an in-house residual fringe benefit (s 48, 49) (FBTAA s 136(1)). An in-house property fringe benefit, in relation to an employer, means a property fringe benefit in relation to the employer in respect of tangible property (¶3-200) (ID 2010/135: gift card not a property fringe benefit). An in-house property fringe benefit does not arise when a retail store employer provides an employee with a voucher/coupon entitling the employee to merchandise from a participating retail store of the employer; it arises when the employee redeems the voucher/coupon (ID 2014/17). In-house fringe benefits arise when employees receive goods or services from their employer or an associate of their employer that are identical or similar to those provided to customers by the employer or an associate of the employer in the ordinary course of business. The taxable value of in-house fringe benefits is 75% of either the lowest price at which an identical benefit is sold to the public or under an arm’s length transaction. In addition, depending on the nature of the inhouse fringe benefit, the aggregate taxable value may be reduced by a further $1,000 (¶3-700) Valuation — property produced for sale If the property is provided by an employer or associate who manufactures, produces, processes or treats the type of property concerned, the valuation rules are as follows: • If the goods are identical to goods normally sold by the employer to manufacturers, wholesalers or retailers, the taxable value of the benefit is the amount by which the employer’s lowest arm’s length selling price exceeds the amount, if any, paid by the employee. • If the goods are identical to goods normally sold by the employer to the public by retail, the taxable value of the benefit is the amount by which 75% of the lowest price charged to the public exceeds the amount, if any, paid by the employee. • Where the goods are similar, but not identical, to those sold by the employer (eg “seconds”), the taxable value of the benefit is 75% of the amount which the employee could be expected to pay for the goods at arm’s length, less the amount, if any, paid by the employee (FBTAA s 42(1)(a)). The taxable value of a “house and land package” provided by a property developer employer to an employee is not calculated as an in-house property fringe benefit in accordance with s 42(1) (ID 2004/211; Investa Properties Ltd v FC of T 2009 ATC ¶10-080). Valuation — property purchased for resale Where the property was acquired by the provider, and is of a sort that the provider would normally sell in the course of business, the taxable value of the benefit is the arm’s length price paid by that person less the amount, if any, paid by the employee (s 42(1)(b)). Valuation — in-house residual fringe benefit The taxable value of an in-house residual fringe benefit is generally 75% of the lowest price charged to the public for the same type of benefit, less any amount actually paid for the benefit (s 48, 49). There is a general exemption for the first $1,000 of the taxable value for each recipient employee each year for certain in-house benefits, including in-house property benefits valued under any of the above rules (¶3700). If the benefit is similar, but not identical, to benefits provided to the public, the taxable value is 75% of the amount that would reasonably be paid at arm’s length for the benefit, less any amount actually paid by the employee (ID 2004/487, ID 2008/30, ID 2012/85 and ID 2012/86). In determining the taxable value of an in-house residual expense payment fringe benefit (under FBTAA s 22A(2)), the lowest price at which an identical benefit is sold to a member of the public (in terms of FBTAA s 48) does not reflect any reduction in premium or rebate provided by the Commonwealth Government to an employee under the Private Health Insurance Incentives Act 2007. The reduction in premium or rebate will constitute a recipient’s contribution (see ¶3-550) (ID 2012/85; ID 2012/86). Airline transport fringe benefits

The rules for calculating the taxable value of airline transport fringe benefits are aligned with the general provisions dealing with in-house property fringe benefits and in-house residual fringe benefits, as below: • the taxable value of an airline transport fringe benefit is calculated as 75% of the stand-by airline travel value of the benefit, less the employee contribution • where the transport is on a domestic route, the stand-by airline travel value is 50% of the carrier’s lowest standard single economy airfare for that route as publicly advertised during the year of tax, and • where the transport is on an international route, the stand-by airline travel value is 50% of the lowest of any carrier’s standard single economy airfare for that route as publicly advertised during the year of tax. In-house fringe benefits under salary sacrifice arrangements The in-house fringe benefits concessions were originally included in the FBT law to reflect, among other things, the true cost of the benefits to employers, with the concessions applying by way of special valuation rules as noted above, specific exemption provisions, and reductions of aggregate taxable value (¶3-700). The concessions were not intended to allow employees to access goods and services by agreeing to reduce their salary and wages (through salary packaging arrangements) in order to buy goods and services using pre-tax income. To provide equity in cases where employees access concessionally taxed fringe benefits through salary sacrifice arrangements (and thereby receive tax-free non-cash remuneration benefits for goods and services while other employees or self-employed persons acquiring these items are required to pay for them out of after-tax income), special rules as below apply to benefits which are provided under salary packaging arrangements. The rules apply to arrangements made on or after 22 October 2012, and from 1 April 2014, to benefits provided under existing salary packaging arrangements made before 22 October 2012: • the concessions that apply to the valuation rules for in-house expense payment benefits, in-house property benefits and in-house residual benefits do not apply (FBTAA s 42(1), 48, 49). Instead, the taxable value of the in-house fringe benefit is an amount equal to its “notional value” (depending on the nature of the benefit, this is either the lowest price that an identical benefit is sold to the public, or the lowest price under an arm’s length transaction) • the specific exemption that applies to residual benefits with respect to private home to work travel using public transport (where the employer and associate are in the business of providing transport to the public) does not apply (FBTAA s 42) • the annual reduction of aggregate taxable value of $1,000 does not apply to in-house benefits (see ¶3-700).

¶3-450 Living-away-from-home allowance fringe benefit A living-away-from-home allowance (LAFHA) fringe benefit arises where an allowance or benefit is provided to an employee who is required to live away from their usual place of residence (or normal residence) in order to perform employment duties. The period that such an employee is required to live away from home is referred to the LAFHA period. Unlike most other types of fringe benefits, a LAFHA fringe benefit can only be provided by the employer to the employee. Instead of paying a LAFHA, an employer may choose to pay for an employee’s accommodation by way of an expense payment benefit or residual benefit. Similarly, the reasonable food component may be paid by way of an expense payment benefit or property benefit. LAFHA periods LAFHA benefits arise where an employee’s duties of employment require them to live away from their normal residence (or usual place of residence for offshore oil and gas rig workers).

The employee must: • either: – maintain an Australian home, with the LAFHA relating to the first 12 months an employee lives away from home, or – work on a fly-in fly-out (FIFO) or drive-in drive-out (DIDO) basis • complete a declaration confirming either of the above. A payment provided to an offshore oil and gas rig worker may still be a LAFHA benefit even if the above requirements are not satisfied (s 30(2)). Accommodation expenditure incurred must be substantiated, while food and drink expenses need only be substantiated where they exceed the amount the Commissioner considers reasonable (see below). An employee substantiates these expenses by providing a declaration or receipts to their employer. For each FBT year, the Commissioner determines what are the reasonable amounts under FBTAA s 31G for food and drink expenses incurred by employees receiving a LAFHA fringe benefit (see TD 2019/7 for the reasonable food and drink amounts within Australia and overseas for the 2019/20 FBT year). An employer can reduce the taxable value of the fringe benefit by the exempt food component if expenses are either equal to or less than the reasonable amount or are substantiated in accordance with the requirements in s 31G(2). Where the total of food and drink expenses for an employee (including eligible family members) does not exceed the amount the Commissioner considers reasonable, those expenses do not have to be substantiated. Key concepts Employment duties requirement The employment duties must be the reason for the change of normal residence rather than the employer requiring the employee to live away from home (see the Compass Group case, the facts of which took place before 1 October 2012). Employee expenses are non-deductible A LAFHA must be paid for the additional expenses of living away from home or additional expenses and compensation for other disadvantages of living away from home. The additional expenses do not include expenses for which the employee would be entitled to an income tax deduction (Roads and Traffic Authority of NSW v FC of T 93 ATC 4508; Taxation Determination TD 93/230). Also, an allowance to compensate only for “other additional disadvantages” without some clear connection with likely additional expenses will not be a LAFHA fringe benefit (Atwood Oceanics Australia Pty Ltd v Federal Commissioner of Taxation 89 ATC 4808; Taxation Determination TD 94/14). Calculating the taxable value of a LAFHA fringe benefit Employee circumstances . . .

The taxable value is . . .

Employee: • maintains a home in Australia at which they usually reside and it is available for their use at all times • receives a LAFHA fringe benefit which relates to the first 12-month period at a particular work location, and • gives the appropriate declaration about living away from home

the amount of the LAFHA paid, less • any exempt accommodation component, and • any exempt food component

Employee: • works on a FIFO or DIDO basis

the amount of the LAFHA paid, less • any exempt accommodation component, and

• has residential accommodation at or near their usual place of employment, and • gives the employer the appropriate declaration about living away from home

• any exempt food component

Employee: • does not fall into either of the above situations

the amount of the fringe benefit.

The taxable value is not reduced by any exempt food component to the extent the fringe benefit relates to a period during which the employee resumes living at their normal residence. This means that if an employer pays an allowance for food or drink during any days that the employee returns home, the allowance relating to those days is fully taxable for FBT purposes. Employees are required to provide declarations and to substantiate expenses. The “otherwise deductible” rule (¶3-500) does not apply to LAFHA benefits. Rather than paying a cash LAFHA while an employee is required to live away from home, an employer may provide accommodation and/or food for the employee or, alternatively, reimburse the employee for these expenses. In these instances, the benefits must be valued by reference to the valuation rule for the particular type of benefit and the following reduction and exemption may apply in these circumstances: • living-away-from-home — food provided (reduction is fringe benefit taxable value) • living-away-from-home — accommodation (tax-exempt benefit).

¶3-500 The “otherwise deductible” rule The taxable value of a fringe benefit provided to an employee can be reduced under the “otherwise deductible” rule (FBTAA s 19(1): loan fringe benefit, s 24(1): expense payment benefit, s 44(1): property benefit, s 52(1): residual benefit). Where an employee receives a benefit, and would have been entitled to an income tax deduction for expenditure incurred by himself/herself on the benefit, the employer can reduce the taxable value of the benefit by the amount of that notional deduction that the employee would otherwise have been able to claim. The reduction is available regardless of whether the employer would have been entitled to a deduction for the expenditure. The otherwise deductible rule does not apply to reduce the employer’s FBT liability if the fringe benefit is provided to the employee’s associate (eg a spouse) instead. That is, the taxable value of benefits provided to associates cannot be reduced by the otherwise deductible rule. The test of the otherwise deductible rule in s 52 (property benefit) requires a conclusion to be reached about whether the hypothetical expenditure of money would have been allowable as a deduction if the employee had incurred that expenditure. This hypothesis requires making the assumption that the expenditure actually incurred by the employer had been incurred by the employee; it does not require, or permit, the consideration of alternative facts or circumstances. The section does not permit, or require, the Commissioner to hypothesise about other reasonably likely alternative losses or outgoings but, rather, calls for a judgment about whether the expenditure actually incurred would have entitled the employee to obtain a deduction upon the hypothesis that it had been incurred by the employee rather than the employer (John Holland Group Pty Ltd & Anor v FC of T 2015 ATC ¶20-510: ¶3-200). The employer must obtain the relevant declaration and documentary evidence from the employee concerned before the due date for lodgment of the FBT return for each year. The declaration must generally show the nature of the expenditure to establish its relationship to the production of assessable income and the extent to which it would have been deductible to the employee. Draft Taxation Ruling TR 2017/D6 sets out general principles for determining whether an employee can deduct travel expenses under s 8-1 of the ITAA97, which is relevant to application of the otherwise deductible rule in relation to employee travel expenses. The ruling applies to travel between work locations of the same employer as well as to travel between home and a work location. Where travel is between work locations of different employers or different income-producing activities, s 25-100 of the

ITAA97 applies to specifically confer a travel expense deduction where taxpayers travel between places where they engage in separate income-producing activities, provided neither of the places is their residence. Calculation of reduction amount under otherwise deductible rule A four-step approach is used by an employer to determine the reduction amount in the taxable value of a fringe benefit provided to an employee: (1) determine the employee’s expense amount before reimbursement (2) work out the amount of the expense that the employee could normally claim as an income tax deduction (3) determine how much the employee can actually claim as a tax deduction if: (a) the employer reimburses the employee all or part of the business component of the expenses (the employee’s tax deduction is the expenses amount multiplied by the business percentage, and reduced by the reimbursement amount) (b) the business component of the expense is not taken into account (the employee’s tax deduction is the expenses amount reduced by the reimbursement amount, and multiplied by the business percentage) (4) subtract the actual deductible amount (Step 3) from the hypothetical deductible amount (Step 2). The result is the amount by which the employer can reduce the taxable value of the fringe benefit. Step 2 of the four-step approach is different where the costs of operating the employee’s own car are involved. In that case, three methods are available (the logbook record, logbook and odometer records and percentage of business use methods), with different substantiation requirements and varying results. Applying otherwise deductible to an expense payment fringe benefit An expense payment fringe benefit may arise in either of two ways — the employer reimburses an employee for expenses incurred or the employer pays a third party to satisfy expenses incurred by the employee. The expenses may be business or private expenses, or a combination of both. The taxable value of the expense payment fringe benefit is the amount of payment or reimbursement made by the employer (¶3-430). Under the otherwise deductible rule, the taxable value may be reduced by the amount which the employee would have been entitled to claim as an income tax deduction had the employee not been reimbursed by the employer. Thus, if an employee incurred an expense solely in the performance of employment-related duties, the expenditure would be wholly tax deductible. Under the otherwise deductible rule, if the employer reimbursed the employee for all or part of this expense, the taxable value of the expense payment fringe benefit would be nil. The otherwise deductible rule will therefore produce different results depending on whether the employer’s reimbursement was for the business element of the expense payment fringe benefit. This is because the employee is only entitled to a tax deduction to the extent of the expenditure incurred to derive assessable income of the employee, and no deduction is allowed for the portion of the expenditure incurred in relation to a private or domestic purpose. The following example, in relation to an expense payment fringe benefit, can similarly be applied to the other fringe benefits (see above) to which the otherwise deductible rule applies. Example Assume: (1) Betty, an employee, incurred expenditure of $500, of which 80% was employment-related (and tax deductible) and 20% was private (2) Betty was reimbursed $250 by her employer without regard to whether the expenditure was for business or private purposes

(3) without the otherwise deductible rule, the taxable value of the expense payment fringe benefit is $250. Applying the otherwise deductible rule Step 1: Amount of Betty’s gross expenditure (before any employer reimbursement) — $500. Step 2: If Betty is not reimbursed for any of the expenditure in Step 1, what would have been tax deductible for her? (This represents a hypothetical deductible amount.) — $500 × 80% = $400. Step 3: On the facts (ie with the employer reimbursement), what amount of the expenditure can Betty claim as a tax deduction? The tax-deductible amount is calculated as the amount of Betty’s expenditure (reduced by the reimbursement amount) multiplied by the business percentage — ($500 − $250) × 80% = $200. Step 4: Subtract the actual deductible amount in Step 3 from the hypothetical deductible amount in Step 2 to determine the reduction amount in the taxable value of the fringe benefit — $400 − $200 = $200. The $250 taxable value of the expense payment fringe benefit is reduced by $200 to $50.

Example Assume the same facts in the previous example except that: • the employer made a reimbursement of $350 after considering the extent to which Betty’s expenditure was employment-related and tax deductible. That is, Betty’s employer knew that under the otherwise deductible rule there would be no FBT liability for that part of the fringe benefit that was applied to an income-generating purpose and so avoided reimbursing the private or domestic part of Betty’s expenditure • the taxable value of the expense payment fringe benefit (without the otherwise deductible rule) is $350. Application of otherwise deductible rule Steps 1 and 2 are the same as in the first Example (above). Step 3: On the basis of the actual fringe benefit (ie with the employer reimbursement), what amount of the expenditure can Betty claim as a tax deduction? The tax-deductible amount is calculated as the amount of Betty’s expenditure (multiplied by the business percentage) reduced by the amount of the reimbursement — ($500 × 80%) − $350 = $400 − $350 = $50. Step 4: Subtract the deductible amount in Step 3 from the hypothetical deductible amount in Step 2 to determine the reduction amount in the taxable value of the fringe benefit — $400 − $50 = $350. The $350 taxable value of the expense payment fringe benefit is reduced by $350 to nil.

In certain cases, the employer can further reduce the taxable value of an expense payment fringe benefit that has been reduced by the otherwise deductible rule, eg with benefits such as remote area housing assistance, relocation travel or employee interviews/selection test travel by employee’s car. Adjusting the taxable value of a fringe benefit provided jointly to an employee and associate Where a fringe benefit is provided jointly to an employee and the employee’s associate, the employer’s FBT liability on the taxable value of the fringe benefit will only be reduced to the extent the employee’s share of the fringe benefit is used for income-producing purposes. To prevent the double-counting under the FBT regime, a fringe benefit provided jointly to an employee and one or more associates of the employee is deemed to be provided solely to the employee (FBTAA s 138(3)). The employer in National Australia Bank Ltd v FC of T 93 ATC 4914 provided low-interest loans jointly to the employee husband and his wife which were invested in a jointly held investment property (a loan fringe benefit). The Federal Court held that, as a result of s 138(3), the employee was the sole recipient of the loan fringe benefit. It further held that as sole recipient of the loan and sole investor of the proceeds, if the employee husband had incurred and paid unreimbursed interest on the loan, he would have been entitled to a deduction for the expense. Thus, under the otherwise deductible rule, the taxable value of the loan fringe benefit was reduced to nil so that the employer had no FBT liability arising from the loan fringe benefit provided to both the employee and his spouse. This is inconsistent with the general income tax position that income and deductions arising from jointly owned rental property should be allocated between joint owners in accordance with their interest in the property (eg joint tenants in a rental property would include 50% of the rental income in their assessable income and claim 50% of the rental property expenses). The anomaly in the NAB case had previously led to arrangements involving expense payment fringe benefits where spouses on a higher marginal tax rate could salary sacrifice their income by an amount

equivalent to the joint rental expenses, thus allowing the spouse on the higher marginal tax rate through a salary reduction to effectively claim a deduction for the entirety of the rental expenses despite owning only a share in a jointly held investment. To remedy that anomaly, an adjustment to the taxable value must now be made when applying the otherwise deductible rule where a fringe benefit is provided jointly to an employee and the employee’s associate but is deemed to be provided solely to the employee because of s 138(3). The adjustment reduces the unadjusted notional deduction by the employee’s percentage of interest in the incomeproducing asset or thing (whether tangible or intangible) to which the benefit relates, thus ensuring that the taxable value of the benefit is only reduced by the employee’s share of the benefit. Example Nellie and her husband (Jack) are jointly provided with a $100,000 low-interest loan by Nellie’s employer which they use to acquire shares. The loan fringe benefit has a taxable value of $10,000. Nellie and Jack use the loan to purchase $100,000 of shares which they will hold jointly with a 50% interest each. Nellie and Jack return 50% of the dividends derived from the shares as assessable income in each of their income tax returns. When applying the otherwise deductible rule, the notional deduction of $10,000 is reduced by Nellie’s 50% interest in the shares so that the taxable value of the loan fringe benefit of $10,000 is reduced by $5,000. The employer has an FBT liability on $5,000 which reflects the share of the loan fringe benefit that was provided to Jack.

The adjustment to the notional deduction will also apply to reduce the taxable value of a loan, expense payment, property or residual fringe benefit in circumstances where the fringe benefit is applied only partly for income-producing purposes, where more than one income-producing asset is held or where there is a change, in the FBT year, of the employee’s percentage of interest in the income-producing asset. Example Assume the facts in the above example, except that Nellie and Jack only use 50% of the $100,000 loan for acquiring shares and use the other 50% ($50,000) for a private overseas holiday. The taxable value of the loan fringe benefit that relates to that part of the loan used for private purposes ($5,000) is not deductible to either Nellie or Jack so the otherwise deductible rule does not apply to reduce that part of the loan fringe benefit. The taxable value of the loan fringe benefit that arises on that part of the loan that is used for acquiring shares can be reduced by Nellie’s share of the benefit (ie $2,500). The employer can reduce the taxable value of the loan fringe benefit ($10,000) by $2,500. The taxable value of the loan fringe benefit provided to Nellie and Jack that will be subject to FBT is $7,500 ($10,000 − $2,500).

Deferral of losses from non-commercial business activities Taxation Ruling TR 2013/6 sets out the Commissioner’s views on whether a “once-only deduction” arises in calculating the taxable value of an external expense payment fringe benefit under FBTAA s 24 where the expenditure associated with that fringe benefit would be subject to the loss deferral rule in s 35-10(2) of ITAA97 Div 35 (about the deferral of losses from non-commercial business activities). The ruling also generally applies to other FBTAA provisions expressing the same ideas as s 24. Specifically, the ruling considers: • whether the terms “deduction” and “allowable” in both the definition of “once-only deduction” in FBTAA s 136(1) and in s 24 refer to a deduction allowable under a specific provision or to a deduction taken into account in calculating taxable income under s 4-15 of the ITAA97, and • whether expenditure, which, had it been incurred by the recipient of an external expense payment fringe benefit and not reimbursed and would have been affected by the loss deferral rule in s 3510(2), can ever give rise to a once-only deduction. Taxation Determination TD 2013/20 states that when an employer reimburses an amount of expenditure incurred by an employee to a third party, under a salary sacrifice (or similar) arrangement with that employee where that expenditure is notionally subject to ITAA97 Div 35, the amount included under

ITAA97 s 35-10(2E) is increased when applying the “otherwise deductible rule” in s 24.

¶3-550 Employee contribution towards a benefit A fundamental concept of FBT is that, if an employee makes a contribution towards the provision of a benefit, the taxable value of the benefit is reduced by the amount of the contribution. This ensures that the employer is only taxed on the value of the net benefit provided to the employee. An “employee contribution” is variously referred to in the FBTAA as the “recipients contribution” (airline transport, property, residual, board and expense payment fringe benefits), the “recipients payment” (car fringe benefits) and the “recipients rent” (housing fringe benefits). While there are technical differences, each expression is defined to mean, broadly, the amount of the employee consideration (contribution) in respect of the employer providing the fringe benefit. Essentially, there needs to be a sufficient or material connection between the employee contribution or payment and the provision of the particular fringe benefit to the employee. There is no requirement that the consideration be paid by any particular time. However, except in the case of expense payment benefits, the definitions expressly require that the payment by the employee must be by way of consideration for the benefit (an implied requirement in the case of expense payment benefits). That is, the employee must be required to make the payment in return for obtaining the benefit. For example, this test is met if, at the time the benefit is provided, it was intended that the employee would make a future payment for the benefit equal to the benefit’s taxable value before deducting the employee contribution. On the other hand, the test will not be met if the benefit as originally provided was purely by way of remuneration without any intention that the employee subsequently makes a payment for the benefit. An employee will usually contribute towards the cost of the fringe benefit by way of a cash payment to the employer or the person providing the benefit. In the case of a car fringe benefit, the contribution can also be made by paying for some of the operating costs, such as fuel, if these are not reimbursed by the employer. If an employee is provided with an expense payment fringe benefit in relation to the payment of a proportion of the interest incurred on a loan granted to the employee by the employer, the employee’s payment of the remaining interest is not a recipient’s contribution (ID 2012/88). The payment of the remaining interest is made in respect of the employee’s obligation under the loan agreement and not the provision of the expense payment fringe benefit, ie there is not a sufficient or material connection between the employee’s payment of the remaining interest and the provision of the expense payment fringe benefit. For examples of a recipient’s contributions to in-house residual expense payment fringe benefits where a rebate or reduction in premium is given to an employee, see ID 2012/85 and ID 2012/86. An employee contribution must be made from the employee’s after-tax salary. A “salary sacrifice” (¶3850) of an amount of salary or a contribution of services as an employee does not constitute an employee contribution. An employee contribution may mean that a GST liability arises for the employer, with the GST attributable to the period in which the contribution was received. Any GST payable will be 1/11th of the employee’s contribution. No GST is payable on the supply of fringe benefits (including exempt benefits) that are not taxable supplies. Examples of these are where the benefit was either GST-free or input taxed, or where the provider was not registered, or required to be registered, for GST (¶3-950).

FBT EXEMPTIONS AND CONCESSIONS ¶3-600 Exemptions from FBT There are several reasons why a benefit provided to an employee may not attract FBT. The payment or benefit may be exempted from FBT (see “Exempt benefits” below) or may not be a “fringe benefit” under the FBTAA (see “Certain payments or benefits are not fringe benefits” below), or an exemption is

available for particular types of employers (see below and ¶3-650). Exempt benefits In addition to the exemptions applying to particular classes of fringe benefits (eg car parking: ¶3-420, expense payment: ¶3-430), some benefits (referred to as “exempt benefits” in the FBTAA, and sometimes inappropriately called “exempt fringe benefits” by some commentators) are specifically exempted from FBT. The term “exempt benefit” is not defined, and the FBTAA specifically provides for these benefits to be exempt from FBT (eg see FBTAA s 53 to 58ZD: “Miscellaneous exempt benefits”). These benefits are not only exempt from FBT but are also exempt from income tax in the hands of the employee (for an exception, see “Car expenses — expense payments”). International organisations, diplomatic and consular immunities Benefits provided by the following employers are exempt benefits: • certain international organisations that are exempt from income tax and other taxes by virtue of the International Organisations (Privileges and Immunities) Act 1963 • organisations established under international agreements to which Australia is a party and which oblige Australia to grant the organisation a general tax exemption. A benefit that would be exempt from tax in Australia by the operation of the Consular Privileges and Immunities Act 1972 or the Diplomatic Privileges and Immunities Act 1967 is an exempt benefit. Miscellaneous exempt benefits Some common exempt benefits are: • provision of certain work-related items (s 58X) — see below • employment interview — benefits relating to travel (eg meals, accommodation) for current and future employees to attend job interviews/selection tests (s 58A) • relocation expenses for employment reasons — expenses for travel, removal of furniture, temporary accommodation, cost of leasing furniture for temporary accommodation, relocation consultant, connection of telephone, electricity or gas services, meals and home sale and purchase costs, such as stamp duty and agent’s commission (ID 2013/8: the change of usual place of residence is not required to be compulsory; rather, the change may be one that is necessary in the circumstances for the employee to perform the duties of their employment; ID 2013/35: cost of visa application for a non-resident employee to remain in Australia not an exempt benefit as the employee was already in Australia) (s 58AA–58F, 61B, 143A) • membership fees and subscriptions — an employee’s subscription to trade/professional journal, corporate credit card membership, airport lounge membership (s 58Y) • newspapers and periodicals — provided to employees for business use (s 58H) • taxi travel — taxi travel provided by employers to employees for travel beginning or ending at the employee’s place of work, or for sick employees for travel home or to any other place to which it is necessary or appropriate for the employee to go as a result of illness or injury (eg to a doctor or a relative) (s 58Z) (see “Taxi travel exemption” below) • compassionate travel/emergency help — travel (including necessary accommodation and meals) for employees at times of death/serious illness in the family, and basic shelter, food and clothing at a time of an emergency (s 58LA, 58N) • awards for long service (subject to a limit of $1,000 for 15 years’ service, plus $100 for each additional year’s service), safety awards (s 58Q, 58R) • workers compensation (whether required under an industrial instrument or not), work site medical facilities, and occupational health and counselling (s 58J)

• remote area housing benefits (¶3-700) • minor benefits of less than $300 — small value benefits provided infrequently and/or are difficult to value (s 58P) • worker entitlement funds — payments to funds set up to protect employee entitlements on insolvency or to provide for redundancy/long service leave entitlements, as required by an industrial law/award (s 58PA, 58PB) (ID 2012/95: contribution to a fund to provide income protection insurance to its employees is not exempt benefit). Such funds must comply with the operating conditions prescribed in FBTAA. If an employer reimburses an employee for fees incurred to park the employee’s car at the local airport while the employee is working interstate at a remote location, the reimbursement constitutes an exempt benefit under FBTAA s 58G(1)(a) (ID 2012/18). Eligible work-related items The FBT exemption for “eligible work-related items” (FBTAA s 58X) is designed to reduce the cost of compliance by removing the need for employers to obtain declarations stating the percentage of employment-related use in applying the “otherwise deductible” rule (generally, the extent to which the employer could obtain a deduction in relation to the benefit, as the benefit would have been deductible to the employee: ¶3-500). Each of the following is an eligible work-related item if it is primarily for use in the employee’s employment (see ID 2008/127: factors to determine the “primary” use requirement). The s 58X exemption is limited to one item of each type that has substantially identical functions per FBT year, unless the item is a replacement of another item acquired earlier in the FBT year: • a portable electronic device, eg a mobile phone, calculator, personal digital assistant, laptop, portable printer, and portable global positioning system (GPS) navigation receiver (rather than a specific item, such as a laptop computer: see ID 2008/158 below) • an item of computer software • an item of protective clothing • a briefcase, and • a tool of trade. A combination of a tablet PC and a laptop computer or a phablet and a tablet PC will be eligible for the exemption but not a combination of a smartphone and a phablet or a tablet PC hybrid and a laptop computer because they are considered to have “substantially identical functions” and an exemption is not available for the second item provided to an employee in the same FBT year unless s 58X(3) or (4) applied (NTLG FBT Sub-committee meeting, 16 May 2013). Modifications to the application of s 58X apply to a small business entity from 2016/17, see “FBT exemption for multiple portable electronic devices — small businesses” below. In addition, employees are denied decline in value deductions for eligible work-related items that are depreciating assets, the asset is provided as an expense payment fringe benefit (¶3-430) or a property fringe benefit (¶3-200) and the benefit is exempt under s 58X. In ID 2008/158, an employee purchased a laptop computer and, at the time of purchase, also requested additional memory be included in the computer. The laptop computer and the additional memory were itemised on one invoice. The employer agreed to reimburse the employee for the cost of the laptop and additional memory (ie the total invoiced amount). The employer’s reimbursement is an expense payment benefit (FBTAA s 20(b): ¶3-430). The ATO stated that s 58X(2)(a) applies to any computer upgrades made at the time of purchase involving built-in internal components, such as additional memory, bigger hard drive, internal modem or wireless LAN module, which are ordered and itemised on the one invoice (even at a separate cost). These items are clearly not peripheral items, but form part of the laptop

computer. It is no different, in effect, from simply purchasing a laptop computer model with better specifications at an increased cost. However, where the employee requests peripheral items such as cables, modems or cradles or an extension to the warranty that is offered, these come at an additional cost and are not covered by the exemption. If an employer reimburses an employee over a period spanning two FBT years for the cost the employee incurred to purchase a laptop computer, the employer cannot provide another laptop computer to the employee in the second FBT year as an exempt benefit. Where there has been either an expense payment or property benefit in relation to a laptop computer earlier in an FBT year, the provision of another laptop computer in that same year will not be an “eligible work-related item” and therefore will not be an exempt benefit under s 58X(1) (ID 2008/159). If an employer pays an employee’s loan repayments, where the loan was taken out by the employee to purchase an eligible work-related item, the repayment of the employee’s loan is not considered to be referable to the purchase of an eligible work-related item and is therefore not an exempt benefit under s 58X(1)(a) (ID 2008/160). FBT exemption for multiple portable electronic devices — small businesses The FBT exemption in s 58X applies to eligible work-related items (see above) provided by way of an expense payment benefit, a property benefit or as a residual benefit (as defined in FBTAA s 136(1)), subject to the limitations on the exemption (ie the item is primarily for use in an employee’s employment (s 58X(2): work-related use)); one item per FBT year for items that have a substantially identical function, unless the item is a replacement (s 58X(3), (4)). For the 2016/17 and later FBT years, the substantially identical functions limitation does not apply to a “small business entity” (¶2-335) employer that provide multiples portable electronic devices to an employee in an FBT year. This means that a small business can provide a portable electronic device to an employee that has substantially identical functions to a device already provided to that employee in the same FBT year, and all of the devices will be exempt from FBT (s 58X(4)(b)). The requirement that devices are primarily for use in the employee’s employment (the work-related use test) remains unchanged. The substantially identical functions test in s 58X(3) will still apply with respect to the other eligible work-related items (see above). Taxi travel exemption The ATO has finalised its consultation on the FBTAA definition of “taxi” in light of the Federal Court decision in Uber B.V. v FC of T 2017 ATC ¶20-608. A Practical Compliance Guideline will be issued on the Commissioner’s compliance approach for the 2019 FBT year in determining whether travel undertaken by an employee in a ride-sourcing vehicle is taxi travel for the purposes of the taxi travel exemption under s 58Z (see above). The compliance approach will be reviewed ahead of the 2020 FBT year. In the interim, employers are expected to apply the ATO’s current approach to the taxi travel exemption in Chapter 20 of FBT — a guide for employers in managing their affairs for the 2019 FBT year (www.ato.gov.au/General/ATO-advice-and-guidance/Advice-under-development-program/Advice-underdevelopment---FBT-issues/). Car expenses — expense payments An exempt benefit may arise where an employer reimburses the operating expenses of an employee’s own car (eg reimbursement on an agreed number of cents per kilometre travelled in the car), with some exceptions. This is the only exempt benefit that constitutes assessable income in the hands of the employee, as other exempt benefits are both exempt from income tax and exempt from FBT. The exempt benefit does not arise where the car expenses reimbursement relates to: • holiday transport from a remote area • overseas employment holiday transport • relocation transport • transport to an employment interview or selection test

• transport to a work-related medical examination, work-related medical screening, work-related preventative health care, work-related counselling or migrant language training, or • transport was provided after the employee had ceased to perform the duties of that employment. Car expenses exempt benefit does not include road and bridge (R&B) tolls, and employers will need to obtain a declaration from employees or prepare a no-private-use declaration to reduce or exempt tolls from FBT. R&B tolls are not a separate category of fringe benefits but are either an expense payment benefit (where the employer pays or reimburses the employee expenditure) or a residual benefit (where the employee uses the employer’s electronic toll tag: ¶3-200). Certain payments or benefits are not fringe benefits A “benefit” is defined widely for FBT purposes to include any right, privilege, service or facility (¶3-200). However, many payments and benefits in respect of employment are expressly stated not to be fringe benefits (as specified in para (f) to (s) of the definition of “fringe benefit” in FBTAA s 136(1)). The main exclusions (ie non-fringe benefits) are: • salary or wages (para (f)) • an exempt benefit (para (g)) • benefits under employee share schemes or trusts, including in respect of individuals engaged in foreign service, certain stapled securities acquired under such schemes and indeterminate rights (para (h)–(hd); ID 2010/108, ID 2010/142: ESS indeterminate rights not fringe benefits) • most employer superannuation contributions (para (j), see below) • superannuation benefits and lump sum payments on termination of employment (para (k), (l)–(le)) • capital payments for enforceable restraint of trade contracts or personal injury (para (m)) • payments deemed to be dividends for income tax purposes (para (n)) • amounts that have been subject to family trust distribution tax (para (q)) • anything done in relation to a shareholder in a private company or an associate of a shareholder, that causes (or will cause) the private company to be taken under Div 7A of Pt III of the ITAA36 to pay the shareholder or associate a dividend (para (r), see below). Employee share schemes An employee share trust for an “employee share scheme” (ESS) is a trust whose sole activities are: (a) obtaining shares or rights in a company (b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the ESS to employees (or their associates) of the company or a subsidiary, and (c) other activities that are merely incidental to the activities mentioned in para (a) and (b) (ITAA97 s 130-85(4)). A disqualifying activity of an employee share trust is where the other activities are not “merely incidental” (such as the provision of financial assistance, including a loan to acquire the shares; ID 2010/108). A share provided by a company to an employee to satisfy the exercise of a right, being a right to acquire a share of the company granted under an ESS is not a fringe benefit as the shares issued in respect of the rights are not provided “in respect of” the employee’s employment (ID 2010/219). Example A company grants rights to its employees under an ESS for nil consideration which entitles the employees to acquire shares in the

company. The rights are subject to vesting conditions. When these conditions are met, the employees can exercise their rights to acquire the shares at no cost at which time the company will allocate the shares to the employees. The rights acquired by the employees under ESS are assessed under Div 83A of the ITAA97. When rights granted under the ESS are exercised, and shares are allocated by the employer, the benefit that arises comes as a consequence of the employee exercising the rights previously obtained under the scheme, and not in respect of employment. Therefore, this does not give rise to a fringe benefit, as no benefit has been provided to the employee in respect of an employment relationship.

Deemed dividends An amount lent by a private company to a shareholder during a current year is taken to be a dividend under Div 7A if the loan is not fully repaid before the private company’s lodgment day for that income year, and Div 7A Subdiv D does not otherwise prevent the private company from being taken to have paid a dividend to the shareholder (ITAA36 s 109D(1)). The amount of the deemed dividend is the amount of the loan not repaid at the relevant time, subject to s 109Y of the ITAA36 which limits the total amount of dividends taken to have been paid by the private company to the company’s distributable surplus as at the end of its year of income. The exclusion in para (r) of s 136(1) will preclude a loan from being a loan fringe benefit where the loan is taken to be a dividend, but the amount is reduced to nil in accordance with s 109Y (ID 2011/33: private company’s distributable surplus was nil). Superannuation contributions for employees Employer superannuation contributions paid in cash and in non-cash assets (eg listed shares and property) to a complying superannuation fund for employees are not fringe benefits. The employer can also claim a tax deduction for the contributions if the relevant conditions for deductibility are met. However, if an employer makes contributions to a complying superannuation fund for an associate of an employee (eg the spouse or a related person), the employer is liable to FBT for the value of the contributions. These contributions are also not deductible for tax purposes. Employer superannuation contributions, being non-fringe benefits, are also not reportable fringe benefits. Employer superannuation contributions to a non-complying superannuation fund (eg a foreign fund) are subject to FBT. The contributions are also not tax deductible (¶4-210). Some employers pay expenses on behalf of a superannuation fund and later make journal entries that reclassify the expense payment as superannuation contributions for employees. Although there is no payment of money directly to a fund, the ATO accepts that payments made directly to a creditor of the fund of this nature that are accepted as deductible contributions by the superannuation fund are treated as superannuation contributions and, therefore, are not fringe benefits. The ATO has warned about arrangements that use offshore trust structures (purported to be superannuation funds) in an attempt to shift funds into Australia in a concessionally taxed manner, or substantially defer the time at which such amounts are subject to tax in Australia. Such arrangements may give rise to various tax issues (and regulatory issues under the Superannuation Industry (Supervision) Act 1993), including whether the offshore trust funds may be superannuation funds and whether the contributions to the offshore trust funds may be excluded from being fringe benefits (Taxpayer Alert TA 2009/19). Diagram of typical arrangement

¶3-650 Exempt employers and rebatable employers The FBT concessions which specifically apply where an employer is a non-profit organisation are: • the FBT exemption or FBT rebate • exemption for certain benefits provided by registered religious institutions and non-profit companies • concessions for car parking and remote area benefits. A non-profit entity that is a charity must be registered with the Australian Charities and Not-for-profits Commission (ACNC) and endorsed by the ATO. The ACNC also registers each registered charity in a sub-type according to its charitable purposes. For FBT purposes, the sub-types are: • registered health promotion charity (HPC) (charitable institution whose principal activity is to promote the prevention or the control of diseases in human beings) • registered public benevolent institution (PBI) (charitable institution that is a public benevolent institution) • registered religious institution (charitable institution that is a religious institution). ATO endorsement of a registered charity is also required to access the following: • the FBT exemption for PBIs • the FBT exemption for HPCs • the FBT rebate for registered charities. FBT exemption — subject to capping Organisations that are exempt from FBT for benefits provided to their employees up to a prescribed annual cap per employee include the following (FBTAA s 57, 57A): • registered PBIs (other than hospitals) and registered HPCs endorsed by the ATO • public and non-profit hospitals and public ambulance services. The exemption applies where the total grossed-up value of certain benefits (which are benefits not otherwise exempt: see “Benefits excluded from capping thresholds” below) provided to each employee during the FBT year is equal to or less than the capping threshold. If the total grossed-up value of fringe benefits provided to an employee is more than that of capping threshold, FBT is payable by the

organisation on the excess. Organisation

Capping threshold

Registered PBIs and HPCs

$30,000 per employee

Public and non-profit hospitals and public ambulance services

$17,000 per employee

The full capping threshold applies even if the employer did not employ the employee for the full FBT year. For example, if a registered PBI employed an employee between October and March and the total grossed-up value of benefits provided was $25,000, FBT will not be payable. Certain entertainment benefits under salary packing arrangements may be eligible for a separate exemption cap (see below). Hospital work — what duties are covered? The duties of the employment of an employee of a government body are exclusively performed in, or in connection with, a public hospital or a non-profit hospital for the purposes of the term “exclusively” in FBTAA s 57A(2)(b) when the duties are performed: • “in” the hospital such that the employee performs their duties in the physical location of the hospital facility and within that facility at a place where activities are conducted that enable the hospital to carry out its functions, or • “in connection with” the hospital such that the employee is engaged in activities that enable the hospital to carry out its functions. These duties may be performed at places other than “in” the hospital. Where an employee engages in separate job positions during a year, each job position must be considered separately for the purpose of determining whether the criteria in s 57A(2) are satisfied. Where an employee has more than one job position during the year, it is possible for s 57A(2) to apply to the benefits provided in respect of one of the positions even if the requirements of s 57A(2) are not met in relation to the other position. Also, that requirement will be met if an employee performs some of their duties “in” a hospital and undertakes the balance of the duties “in connection with” a hospital (Taxation Determination TD 2015/12). Rebatable employers An employer pays FBT on the grossed-up taxable value of fringe benefits and is entitled to claim an offsetting tax deduction (see ¶3-150). To ensure that certain non-government, non-profit employers that are unable to claim a tax deduction are not disadvantaged, these employers (commonly called “rebatable employers”) are eligible for a rebate of 47% of the amount of FBT payable, subject to a capping threshold. FBT year ending

Rebate %

31 March 2018 and later years 47%

Capping threshold $30,000

If the total grossed-up taxable value of fringe benefits provided to an employee is more than the capping threshold, a rebate cannot be claimed for the FBT liability on the excess amount. The capping threshold applies even if the rebatable employer did not employ the employee for the full FBT year. For example, if the total grossed-up value of benefits provided to an employee between October and March was $15,000, a rebate applies to all of the FBT payable for providing these benefits. Rebatable employers (non-government, non-profit organisations) include: • registered charities (other than PBIs or HPCs, or government institution charities) that are an institution (see further below) • religious, educational, scientific or public educational institutions • trade unions and employer associations

• non-profit organisations established: – to encourage music, art, literature or science – to encourage or promote a game, sport or animal races – for community service purposes – to promote the development of aviation or tourism – to promote the development of Australian information and communications technology resources – to promote the development of the agricultural, pastoral, horticultural, viticultural, manufacturing or industrial resources of Australia. The FBT rebate is not available to: • charities that are not institutions (eg the charity is a fund) • charities that are institutions established by a law of the Australian Government, a state or a territory (eg public universities, public museums and public art galleries) • registered PBIs and HPCs — these organisations are eligible for the FBT exemption. Certain entertainment benefits under salary packaging arrangements may access a separate capping threshold (see below). Registered religious institutions A “registered religious institution” is determined by the entity being established as an institution and its registration with the ACNC. Religious institutions are eligible for the FBT rebate when they are a registered charity with the ACNC and endorsed by the ATO as a charitable institution (see above). Registered religious institutions may also be eligible for FBT concessions for benefits they provide to religious practitioners, live-in carers and domestic employees. No ATO endorsement is required, but the institution must be registered with the ACNC as a charity with a sub-type “advancing religion”. A benefit provided by a registered religious institution to an employee religious practitioner, or their spouse or child in respect of the practitioner’s pastoral duties or directly related religious activities is an exempt benefit (FBTAA s 57). “Religious practitioners” are, in essence, ordained ministers of religion and lay persons commissioned to perform the ministry, members of religious orders and students undertaking certain religious studies or training (for examples, see TR 2019/3). Separate cap for salary packaged entertainment benefits A separate single grossed-up cap of $5,000 applies to fringe benefits that are salary packaged meal entertainments and entertainment facility leasing expenses, that is: • entertainment by way of food or drink • accommodation or travel in connection with, or to facilitate the provision of, such entertainment • entertainment facility leasing expenses. Salary packaged entertainment provided is included in the capping threshold for the FBT exemption and FBT rebate (see above). However, if the capping threshold is exceeded in a particular year, it is raised by the lesser of: • $5,000, and • the total grossed-up taxable value of salary packaged entertainment benefits.

This means employers are provided with a single grossed-up cap of $5,000 per employee each FBT year for salary packaged entertainment benefits which remain eligible for concessional FBT treatment. The $5,000 cap is available even if the employer did not employ the employee for the full FBT year. The $5,000 separate cap is the grossed-up amount (see GST Ruling GSTR 2001/3). Other concessions A car parking fringe benefit and car parking expense payment fringe benefit are exempt from FBT when provided by registered charities, scientific institutions (other than an institution run for the purposes of profit or gain to its shareholders or members) and public educational institutions. For remote area concessions, an extended definition of remote applies to housing benefits provided for employees of a public hospital, a government body where the duties of the employee are exclusively performed in, or in connection with, a public hospital or a non-profit hospital, a hospital carried on by a non-profit society or a non-profit association that is a rebatable employer, a registered charity, a public ambulance service or a police service. Benefits excluded from capping thresholds The following fringe benefits, which are excluded benefits for reporting purposes (¶3-155), are specifically excluded from an employee’s individual fringe benefits amount and, as such, are not included in the calculation of the capping thresholds where they are provided by registered PBIs and HPCs, public hospitals, non-profit hospitals, public ambulance services and rebatable employers: • car parking fringe benefits • meal entertainment (not salary packaged) and entertainment facility leasing expenses (not salary packaged).

¶3-700 Other FBT concessions and caps In-house fringe benefits — tax free threshold Broadly, these are benefits of a kind that are supplied to the public (or certain classes of the public, eg the police force) in the ordinary course of the employer’s business. The first $1,000 of the aggregate of the taxable values of the following “in-house” benefits (¶3-445) provided to an employee in a year is exempt from FBT (FBTAA s 62). Some types of in-house fringe benefits include the following: • in-house property fringe benefits — generally, goods and other property provided to employees which are of a kind that the employer sells in the ordinary course of business (those valued as outlined at ¶3-445) • in-house residual fringe benefits — generally, services and other residual benefits provided to an employee which are of a kind that the employer provides in the ordinary course of business (those valued as outlined at ¶3-445) • in-house expense payment benefits — where the expenditure to which the benefit relates was incurred by an employee in acquiring property or other benefits of a kind that the employer provides in the ordinary course of business (those valued as outlined at ¶3-430). The exemption includes benefits provided to an associate of the employee (Miscellaneous Tax Ruling MT 2044). An employer who provides one or more of the above in-house fringe benefits to an employee during the FBT year may reduce the aggregate of the taxable values of the in-house fringe benefits by $1,000. If a particular fringe benefit is also eligible for another concession, the taxable value is first reduced by the other concession, and then by this concession. For example, the taxable value of an in-house residual benefit is generally 75% of the lowest price charged to the public for the same type of benefit, less any amount actually paid for the benefit. This means that anywhere up to 25% of the value of the benefit plus

an additional $1,000 per employee could be exempt from FBT each year. The annual $1,000 reduction of aggregate taxable value is not available in respect of in-house fringe benefits which are provided under a salary packaging arrangement (¶3-850). Consistent with the principles outlined in Miscellaneous Taxation Ruling MT 2025 (guidelines for valuation of housing fringe benefits), a retirement village operator can apply a valuation discount of 10% on the statutory annual value of housing fringe benefits provided to live-in-managers in a retirement village (PCG 2016/14). Entertainment expense payments A reduction in the taxable value of an expense payment fringe benefit is available where the expense payment fringe benefit arises from expenditure an employee incurs in entertaining people other than the employee or associates (eg expenditure incurred by the employee on entertaining your clients). An employer may reduce the taxable value of the expense payment fringe benefit by the percentage of the expenditure incurred in entertaining the other people. No reduction in the taxable value applies under this concession if the otherwise deductible rule applies. Remote area concessions A location is considered remote if it is not in, or adjacent to, an eligible urban area. For guidelines and the ATO classifications on whether an area is remote for FBT purposes, see “Fringe benefits tax — remote areas”: www.ato.gov.au/general/fringe-benefits-tax-(fbt)/in-detail/exemptions-and-concessions/fbt--remote-areas. The principal remote area concessions in the FBTAA are: • remote area housing benefit exemption (s 58ZC; ID 2005/156) • residential fuel reduction (s 59) • remote area loan and interest (s 60(1), (2)) • remote area rent (s 60(2A)) • remote area property benefit and (s 60(3)) • remote area residential property expense payment benefit, residential option fees, residential property repurchase consideration (s 60(4)–(6)) • remote area holiday transport (s 60A, 61; ID 2014/9: calculation of taxable value) • remote area home ownership schemes (s 65CA–65CC). Care must be given to the effectiveness of lease agreements between an employer and employee relating to a residential property either owned or leased by the employee in a remote area (Taxpayer Alert TA 2002/9). For instance, where an employee in a remote area leases a residence to the employer and then salary sacrifices rent to the employer, the employer is not entitled to the remote area housing exemption. The taxable value of housing fringe benefits arising from assistance provided to an employee in a remote area is reduced by 50%. Housing assistance includes where the employer: • pays or reimburses interest on a housing loan, or pays an option for the right to purchase a home • reimburses an employee for expenses connected with a home, or pays or reimburses rent, or • supplies or reimburses the cost of gas, electricity and other residential fuel for an employee in a remote area. The provision of transport to and from an employee’s home base and a remote area worksite is an exempt benefit and the value of certain travel benefits provided to an employee under an award or industry custom is reduced by 50% (up to a limit).

Remote area home ownership schemes This concession permits the amortisation of fringe benefits provided in connection with remote area home ownership schemes. The period of amortisation is generally five to seven years. The benefits may consist of: • a discount on the purchase of a home or of land on which to build a home • a reimbursement of the cost of buying land and/or building a home, or • an option fee entitling you to first choice in repurchasing the home. There must be a restriction on the employee’s freedom to sell the house during the amortisation period. If the employer repurchases the home during the amortisation period, the unamortised balance is brought to account in that FBT year. Where an employee is forced by a contractual buy-back arrangement to suffer a loss in selling the home back to the employer, the employer may deduct 50% of that loss from the aggregate taxable values in that FBT year. (The rationale for this reduction is that any fringe benefit given to the employee to facilitate the original purchase of the house is being offset by the loss on its resale.) Employees posted overseas Where an employee is posted overseas and is provided with travel for a holiday, the taxable value of the benefit is reduced by 50%. The reduction also applies to expatriate employees who are posted to Australia. Fringe benefits relating to the education costs of the employee’s children are exempt to the extent that the costs relate to a school term while the employee is overseas. Issues paper — remote area tax concessions and payments The Productivity Commission has released an issues paper relating to its review to determine the appropriate ongoing form and function of the zone tax offset, FBT remote area concessions and remote area allowance (www.pc.gov.au/inquiries/current/remote-tax/issues/remote-tax-issues.pdf: submissions closed on 29 April 2019).

FBT PLANNING ¶3-800 Reducing your FBT liability When recruiting employees or at employee salary reviews, an employer may, by negotiation and planning with the employees, adopt strategies so as to reduce its FBT liability or, in certain cases, have no FBT liability at all. Some strategies invariably have a tax impact on the employees affected and therefore would need to be looked at in an overall total remuneration context (ie total employment costs) with the employees. These strategies include: • replacing fringe benefits with cash salary • having employees make a contribution • providing benefits that are exempt from FBT or benefits that are not fringe benefits • providing tax-deductible benefits to employees. Appropriate declarations must also be obtained in respect of fringe benefits (see checklist below). Replacing fringe benefits with cash salary The most obvious strategy for employers is to replace employee fringe benefits with the cash equivalent in the form of salary or wages. In that case, the employer will have no FBT liability and none of the administration and time costs associated with providing fringe benefits. In addition, this will also considerably reduce some of the accounting and record-keeping requirements on the part of the employers for the impact of the GST and

its interaction with FBT. However, the employer’s cost benefits should be examined with the employees concerned as they will have to pay income tax on any increased salary or wages. Cash payments are generally more tax effective for employees with a tax rate below 47% (ie the top marginal rate of 45% plus Medicare levy of 2%), except where concessional FBT treatment applies. Using employee contributions As a general rule, an employer will be able to reduce its FBT liability by obtaining a contribution from the employee, as the taxable value of a fringe benefit is reduced by the amount of the employee contribution towards the cost of the benefit. Note, however, that an employee contribution towards the cost of a particular fringe benefit can be used only to reduce the taxable value of that benefit and not the taxable value of any other fringe benefit. Example Anna receives a car fringe benefit and a loan benefit from her employer. She contributes $25 a week for the use of the vehicle provided to her. The taxable value of that vehicle would be reduced by $1,300 ($25 × 52 weeks) and the loan benefit is unaffected.

The provision of a fringe benefit or exempt benefit can be a taxable supply for GST purposes. Accordingly, where an employee, or associate, makes a contribution for that taxable supply, GST is payable on the provision of the fringe benefit or exempt benefit. The amount of GST payable is 1/11th of the contribution (¶3-550, ¶3-950). Providing benefits that are exempt from FBT An employer who provides only exempt benefits, or benefits that are not fringe benefits, will not have an FBT liability. For example, an employer would not be liable for FBT for providing the following items to employees (limited to one item of each type per employee, per FBT year, unless it is a replacement item): • a mobile phone or car phone (used mainly in employment) • protective clothing • office tools (eg brief case, calculator) • computer software for use in employment • laptop computer (notebook), limited to one purchase or reimbursement per employee per year (¶3600). Minor benefits are generally exempt from FBT. This is the case where the value of the benefit is less than $300 and it would be unreasonable to treat it as a fringe benefit, eg it is provided infrequently. Providing benefits that are deductible An employer may not have an FBT liability if it pays for or reimburses an expense that its employees would otherwise have been able to claim as a tax deduction under the income tax law (¶3-500). Preparing for FBT year end Issues that employers should bear in mind when preparing for each FBT year end include the following: • identifying and collating all the possible benefits provided to employees and their associates (eg expense payments, gifts, entertainment) via a review of staff remuneration and salary packages • ensuring that all invoices and receipts have obtained receipts for an unreimbursed expenditure relating to any fringe benefits provided, including those for car expenses incurred such as petrol, insurance and registration, and • obtaining declarations from employees (see below).

Ensure declarations are obtained In each FBT year, the employer must obtain all employee declarations no later than the day on which the FBT return for the year is due (see below), such as: • airline transport benefit declaration • employee’s car declaration • employment interview or selection test declaration — transport in employee’s car • expense payment benefit declaration • fuel expenses declaration • living-away-from-home declaration • loan fringe benefit declaration • no private use — expense payments declaration • no private use — residual benefits declaration • declaration of car travel to work-related medical examination, medical screening, preventative health care, counselling or migrant language training • property benefit declaration • recurring benefits declaration — recurring expense payment fringe benefit, property fringe benefit, residual fringe benefit • relocation transport declaration • remote area holiday transport declaration • residual benefit declaration • residual benefit declaration — vehicles other than cars • temporary accommodation declaration • declarations regarding the otherwise deductible rule. Lodging an FBT return An employer is required to lodge an FBT return with the ATO by 21 May each year (or 28 May if covered by a tax agent lodgment program) if the employer has an FBT liability for the FBT year. No FBT return is required if the fringe benefits taxable amount is nil, but the employer must lodge a Notice of non-lodgment with the ATO. Record-keeping exemption Employers must put in place a reliable and comprehensive record-keeping system which ensures that all relevant documentation and records are obtained and held on file at the time the FBT return is due for lodgment. Employers may elect not to keep records for an FBT year, but to have their FBT liability for that FBT year determined using the total taxable value of fringe benefits provided in an earlier base year in which FBT records were kept (FBTAA s 135C). To be eligible for the record-keeping exemption, a base year needs to be established and, during the FBT year immediately before the current year, the employer has not received an ATO notice requiring the employer to resume record-keeping.

An employer that is not a government body or an income tax-exempt organisation can elect to apply the record-keeping exemption if: • FBT records have been kept for the base year • the employer’s aggregate fringe benefits amount provided in the current year is not 20% more than that in the base year • the employer’s aggregate fringe benefits amount in the base year does not exceed the exemption threshold for the FBT year ($8,714 for the 2019/20 FBT year, $8,393 for the 2017/18 FBT year). FBT matters which attract the ATO’s attention The matters below will likely attract attention when the ATO is determining compliance with the FBT obligations: • failing to report car fringe benefits, incorrectly applying exemptions for vehicles or incorrectly claiming reductions for these benefits • mismatches between the amount reported as an employee contribution on an FBT return and the income amount on an employer’s tax return • claiming entertainment expenses as a deduction but incorrectly reporting them as a fringe benefit or incorrectly classifying such expenses as sponsorship or advertising • incorrectly calculating car parking fringe benefits due to significantly discounted market valuations, or using non-commercial parking rates or not having adequate evidence to support the calculated rates • not applying FBT to the personal use of an organisation’s assets provided for the personal enjoyment of employees or associates • not lodging FBT returns (or lodging them late) to delay or avoid payment of tax (www.ato.gov.au/Business/Privately-owned-and-wealthy-groups/What-attracts-our-attention). The 2019 FBT return instructions are available at www.ato.gov.au/Forms/2019-Fringe-benefits-tax-returninstructions/.

¶3-850 Salary packaging or sacrifice Salary packaging and salary sacrifice arrangements are discussed in detail in Chapter 10. A “salary packaging arrangement” is defined to mean an arrangement where the employee receives a benefit: • in return for a reduction in salary or wages that would not have happened apart from the arrangement, or • as part of the employee’s remuneration package, and the benefit is provided in circumstances where it is reasonable to conclude that the employee’s salary or wages would be greater if the benefit were not provided (FBTAA s 136(1)). A salary packaging arrangement is also commonly referred to as salary sacrifice or total remuneration packaging arrangement. A “salary sacrifice arrangement” (SSA) arises where an employee agrees contractually with an employer to give up part of the remuneration that the employee would otherwise receive as salary or wages in return for the employer (or an associate of the employer) providing benefits of a similar value. The main assumption made by the parties is that the employee is then taxed on the reduced salary or wages and the employer is liable to pay FBT, if any, on the benefits provided. It should be noted that SSAs may also have other income tax implications as well as PAYG withholding and superannuation guarantee

contributions consequences for employees and employers. The ATO’s approach is to treat SSAs as “ineffective SSAs” or “effective SSAs” (Taxation Ruling TR 2001/10). This is to distinguish between arrangements where the employee is considered to have derived the salary sacrifice amount as assessable income and where there is no derivation of the cash salary. An “effective SSA” arises where an employee agrees to receive part of their remuneration as benefits before the employee has earned the entitlement to receive that amount as salary or wages. In contrast, an “ineffective SSA” arises where an employee directs that an existing entitlement to receive salary or wages that has been earned is paid in the form of non-cash benefits. The test, therefore, is whether entitlement to the amount sacrificed has been earned. Generally, an entitlement arises when services are performed, and not when payment for the services is received. The period to which the payment relates is, therefore, critical. Under an “ineffective SSA”, the benefits provided to an employee are considered to be payments of salary or wages and remain part of the employee’s assessable income, while benefits provided under an “effective SSA” are treated according to the type of benefit provided (eg fringe benefit, superannuation contribution, employee share plan shares) with the appropriate FBT rules applying. It may be possible for employees to reduce their salary and wages below the minimum entitlement under an industrial award in certain circumstances. An SSA under an employee share trust arrangement was held to be a mere redirection of assessable income (Yip v FC of T 2011 ATC ¶10-214). In that case, the taxpayer was an employee of a private company which provided a long term equity incentive structure to deliver equity based benefits to its employees, including the taxpayer. Contributions settled by company and made to the trustee were attributable to prospective salary or bonus remuneration of the employees. The trustee had invited the taxpayer to apply for the issue of units and to apply for a loan to fund her subscription, with the loan to be repayable in full by her. The net effect was that the taxpayer would forgo receipt of either fixed dollar amounts deducted from her gross salary or bonuses for what was described as a “benefit”. The trust deed gave the taxpayer “cancellation entitlements” whereby the trustee would make payments that the employee had previously sacrificed to the employee in the event of certain specific events. The AAT held that the SSA amounts were ordinary income of the employee under constructive receipt rules, ie the “salary sacrifice” request merely meant the employer had dealt with the amounts in accordance with the employee’s direction. The SSA provided no tangible benefit to the employee other than the deferral of income tax. Although the AAT did accept the taxpayer’s right to flexibility in receiving remuneration partly as cash and as benefits, there was no “benefit” in this situation and, therefore, the SSA amounts remained the employee’s income. What type of benefits can be included? All non-cash benefits can be covered by an SSA. The more common types of benefits include: • employer superannuation — employer superannuation contributions to a complying superannuation fund for the benefit of an employee are not fringe benefits (and not subject to FBT), except those made for an associate of an employee • fringe benefits — such as car fringe benefits and expense payment fringe benefits (eg payment of an employee’s loan repayments, school fees, child care costs and home telephone costs) • exempt benefits — such as expense payment, property or residual benefits arising for the following items commonly provided: a notebook computer, laptop computer or similar portable computer (exemption is limited to one a year), or a mobile phone or car phone (exemption if primarily for use in employee’s employment) (¶3-600). Donations made to deductible gift recipients by an employee under an SSA do not result in an employer incurring an FBT liability. No concessions for certain benefits accessed through an SSA Certain tax concessions are lost where the fringe benefits below are accessed through an SSA on or after 22 October 2012:

• the concessional taxable value calculation method for in-house expense payment benefits, in-house property benefits or in-house residual benefits. Instead, the taxable value of the benefit is based on the “notional value” of the benefit • the residual benefits exemption for employee transport from home to work (for employers in the transport business), and • the annual $1,000 reduction of aggregate taxable value in respect of in-house fringe benefits (see ¶3700). Caps on FBT salary sacrificed meal entertainment benefits and entertainment facility leasing expenses Salary packaged meal entertainment benefits from 1 April 2016 are: • subject to a separate single grossed-up cap of $5,000, and benefits exceeding the $5,000 cap will count towards an existing FBT exemption or rebate cap • reportable fringe benefits and must be included on a payment summary where the reporting threshold is exceeded (these benefits cannot have their taxable value calculated using the elective valuation rules).

¶3-900 Impact on employees of reportable fringe benefits If the total taxable value of certain fringe benefits provided to an employee exceeds $2,000 in an FBT year, the employer is required under the reportable fringe benefits arrangements (¶3-155) to report the grossed-up taxable value of the fringe benefits on the payment summary given to the employee. These reporting arrangements are designed to ensure that employees with salary packaging cannot avoid surcharges and child support obligations or have access to certain tax concessions. Benefits provided to the employee’s associates (eg the spouse or children) in respect of the employee’s employment are also included as the employee’s fringe benefits. In addition, if the employee shares a fringe benefit with other employees, the employer will need to work out the portion of the taxable value that reasonably reflects the amount of the benefit provided to each employee, based on the employee’s usage of the benefit. Reportable fringe benefits are not included in an employee’s assessable (or taxable) income and do not affect the amount of standard Medicare levy payable. However, the employee’s reportable fringe benefits total (ie the sum of the reportable fringe benefits amounts in respect of all employment) is taken into account for various purposes under the tax laws. For example, to determine the employee’s: • eligibility to claim a deduction for personal superannuation contributions, a tax rebate for spouse superannuation contributions, or entitlement to government co-contributions (¶4-220 to ¶4-265) • liability for the Medicare levy surcharge (¶3-950, ¶20-020) • Higher Education Loan Program (HELP) repayments (¶20-080) • child support obligations (¶18-705) • entitlement to certain income-tested government benefits and concessions (see “Family Assistance payments” in ¶6-350). Working out the reportable amount If the reportable fringe benefits amount of an employee in an FBT year (1 April to 31 March) exceeds $2,000 (grossed-up at 1.8868, ie $3,773), the taxable value of the benefits is reported on the employee’s payment summary for the corresponding income year. The grossing-up ensures the value of fringe benefits is consistent with other forms of income on the payment summary. As income tax is not paid on fringe benefits, the grossed-up taxable value of a benefit

includes the amount of income tax that the employee would have paid if cash salary, rather than the fringe benefit, had been received. For grossing-up purposes, the FBT rate used is equal to the highest marginal rate of income tax plus Medicare levy, ie grossing-up is calculated using the lower gross rate of 1.8868 (¶3-155, ¶3-300). Example In the 2019/20 FBT year, Michael’s employer provides him with a car where the taxable value of the car fringe benefit is $2,500. Michael and his wife also stay in employer-provided accommodation, with a taxable value of $800, several times during the year. The total taxable value of the fringe benefits provided to Michael is $3,300. An amount of $6,226 ($3,300 grossed-up by 1.8868) is the reportable fringe benefits amount for Michael and this amount will be reported in the payment summary given to him for the relevant income tax year.

Reducing impact of reportable fringe benefits An employee may consider the following options to reduce the amount of reportable fringe benefits: • substitute or modify fringe benefits for cash salary • make a contribution that reduces the taxable value of the fringe benefit • receive only fringe benefits that are not reportable (eg car parking benefits other than car parking expense payment benefits, entertainment by way of food or drink, and benefits associated with that entertainment such as travel and accommodation) (¶3-155) • receive only benefits which are exempt from FBT (eg exempt benefits used primarily for work and minor benefits: ¶3-600).

¶3-950 Fringe benefits — interaction with other taxes The general scheme of the FBT and income tax laws is that monetary remuneration, including most allowances, is subject to income tax in the employee’s hands, while non-cash benefits are generally subject to FBT but not income tax. Therefore, a fringe benefit that is taxable under the FBTAA, or is specifically exempted from FBT (except for certain car expense payment benefits), is free from income tax. An employer’s fringe benefits taxable amount is calculated by classifying fringe benefits into two types of aggregate fringe benefits amounts — Type 1 aggregate fringe benefits amount, being those fringe benefits where there is an entitlement to a GST input tax credit to the provider, and Type 2 aggregate fringe benefits amount, being those fringe benefits where there are no entitlements to GST input tax credits to the provider (¶3-300). Guidelines on the operation of the FBT gross-up formula to take into account the effect of input tax credits (where applicable) in respect of GST paid on some fringe benefits are set out in Taxation Ruling TR 2001/2. Income tax and FBT Employers can claim an income tax deduction for the cost of providing fringe benefits. The amount deductible is the GST-exclusive value if GST input tax credit is available on the acquisition of the fringe benefit (see below), or the full amount paid or incurred if GST input tax credit is not available. If either a recipient’s payment or a recipient’s contribution (as consideration for a taxable supply) is added to an employer’s assessable income, such a payment or contribution will be added for income tax purposes at the GST-exclusive value. Where the otherwise deductible rule (¶3-500) applies, the calculation of the taxable value of a fringe benefit is reduced by the hypothetical deduction to which the employee would have been entitled had the employee incurred the expense. In this case, the employer takes into account the GST-inclusive value, as applicable (TR 2001/2, para 24–26). The deduction is available even though no deduction would have been allowed had the employee incurred the expenditure (eg entertainment, club fees, expenditure on leisure facilities and boats, travel expenses of accompanying relatives). Further, an employer is assessable for income tax on amounts of FBT reimbursed or amounts received to reduce

the taxable value of fringe benefits provided. Employers can claim an income tax deduction for its FBT payment (¶3-050). Medicare levy surcharge Medicare levy is payable by resident individual taxpayers based on their taxable income or combined family taxable income above a threshold amount. A Medicare levy surcharge applies to high-income taxpayers who do not have appropriate private patient hospital cover (¶1-075). Income for surcharge purposes includes a taxpayer’s reportable fringe benefits total (¶3-155). GST For the 2019/20 FBT year (where the GST rate is 10% and the FBT rate is 47%), if an employer (benefit provider) is entitled to claim an input tax credit in respect of GST paid on goods or services acquired in order to provide fringe benefits (a Type 1 benefit), the gross-up rate of 2.0802 applies when calculating the FBT liability. If there is no entitlement to claim an input tax credit (a Type 2 benefit), the gross-up rate of 1.8868 applies (¶3-300). The classification of a fringe benefit (including an excluded fringe benefit) as a Type 1 benefit does not depend on the extent of the GST input tax credit entitlement to the provider or whether input tax credit is subsequently claimed. The test is whether there is any entitlement to a GST input tax credit. A fringe benefit (including an excluded fringe benefit) that is either wholly GST-free or input taxed cannot be classified as a Type 1 benefit; consequently, it must be a Type 2 benefit. Some fringe benefits may be supplied that do not entitle the provider to GST input tax credits (ie fringe benefits where the acquisition does not meet the requirements of a creditable acquisition under A New Tax System (Goods and Services Tax) Act 1999 (GST Act) s 11-5). Such a benefit cannot be classified as a Type 1 benefit; consequently, it must be a Type 2 benefit (TR 2001/2 para 17–18). If an employee makes a contribution or payment towards the cost of the fringe benefit provided, this is consideration for a taxable supply for GST purposes and the employer is liable to pay GST based on 1/11th of the contribution. A GST-creditable benefit arises where either the employer or provider of the fringe benefit (or another member of the same GST group) is entitled to an input tax credit under the GST Act because of the provision of the benefit. A benefit provided in respect of an employee’s employment is also a GST-creditable benefit if: • the benefit consists of a “thing”, as defined in the GST Act (or an interest in or a right over such a thing, a personal right to call for or be granted any interest in or right over such a thing, a licence to use or any other contractual right exercisable over such a thing) • the thing was acquired or imported and either the employer or provider of the fringe benefit is entitled to an input tax credit under the GST Act because of the acquisition or importation. Employee contributions Where an employee or associate is a recipient of a fringe benefit or exempt benefit (ie a taxable supply for GST purposes) and makes a “contribution” or payment (other than a contribution of services as an employee) to the employer for the supply of the benefit (¶3-550), GST is payable on that supply by the employer. The contribution or payment is the price for that supply; therefore, 1/11th of that amount is the GST payable by the employer. For FBT purposes, the taxable value of a fringe benefit is reduced by the full amount of the contribution the employee makes in relation to the benefit, regardless of whether the employer has to remit any GST for that contribution. Where the employee makes a contribution by paying to a third party (eg the purchase of fuel or oil in respect of a car fringe benefit), no further GST is payable by the employer for that type of employee contribution. This is because GST has already been paid at the time of the supply to the employee, or

associate, from the third party. Contributions in respect of GST-free or input taxed supplies are not taxable supplies and no GST would be payable for any contribution towards these supplies. An employer that is not registered (or not required to be registered) for GST does not have to pay GST on an employee’s contribution. Example Janet’s employer (Beauty Pty Ltd) provides her with a car that she uses wholly for private purposes. Beauty Pty Ltd is registered for GST. In the FBT year, Janet contributed $3,300 (as an employee’s payment) directly to her employer towards the running costs of the car. Beauty Pty Ltd will have to remit $300 (1/11th of $3,300) of that contribution for GST and will deduct the full $3,300 of the contribution when calculating the taxable value of the car fringe benefit. Janet also pays some of the car’s running costs (fuel, oil and servicing) amounting to $2,200 that FBT year. Although the $2,200 is a recipient’s payment for FBT purposes, it is not a contribution for the supply of the benefit for GST purposes. Beauty Pty Ltd is not liable to GST for that payment, but is required to deduct the full $2,200 when calculating the taxable value of the car fringe benefit. Therefore, when calculating the taxable value of the car fringe benefit provided to Janet, Beauty Pty Ltd will deduct $5,500, being the total of Janet’s payments ($3,300 + $2,200).

Interaction with personal services income rules The taxable value of fringe benefits provided to an employee is reduced by the amount of a payment that is non-deductible because of the personal services income (PSI) rules so as to avoid double taxation. Under the PSI rules in the ITAA97, a payment to an associate of a service provider for performing ancillary work is not deductible. However, if FBT is payable on the value of the benefit, this will result in double taxation (ie income tax and FBT). In such a case, FBT will only be payable on the value of the benefit that is deductible to the provider.

SUPERANNUATION The big picture

¶4-000

Superannuation in Australia Objective of superannuation

¶4-100

Superannuation funds

¶4-110

Other superannuation entities

¶4-120

Regulation of superannuation entities

¶4-150

Superannuation and bankruptcy laws

¶4-160

Contributions to superannuation funds Superannuation contributions

¶4-200

Contributions made to a fund

¶4-203

Acceptance of contributions

¶4-205

Employer superannuation contributions

¶4-210

Employer contributions following salary sacrifice

¶4-215

Personal superannuation contributions

¶4-220

First Home Super Saver scheme

¶4-222

Downsizer contributions by individuals aged 65 and over

¶4-223

Tax on concessional contributions of high-income earners

¶4-225

Transfer balance cap rules from 1 July 2017

¶4-227

Transfer balance account

¶4-228

Transfer balance cap

¶4-229

Excess transfer balance determinations

¶4-230

Excess transfer balance tax

¶4-231

Modified transfer balance cap rules for capped defined benefit income streams ¶4-232 Total superannuation balance

¶4-233

Excess concessional contributions

¶4-234

Penalties imposed on excess concessional contributions

¶4-235

Excess non-concessional contributions

¶4-240

Tax treatment of excess non-concessional contributions

¶4-245

Excess contributions may be disregarded or reallocated to another year

¶4-250

Splitting superannuation contributions with a spouse

¶4-260

Government co-contribution for low-income earners

¶4-265

Low-income superannuation tax offset

¶4-270

Tax offset for spouse contributions

¶4-275

Taxation of contributions in the hands of the fund

¶4-280

Taxation of funds and RSA providers Taxation of funds and RSA providers

¶4-300

Complying or non-complying?

¶4-310

Taxation of complying superannuation funds

¶4-320

Taxation of non-complying funds

¶4-340

Taxation of PSTs and RSA providers

¶4-360

Tax on “no-TFN contributions income”

¶4-390

Withdrawal of superannuation benefits Withdrawal of superannuation benefits

¶4-400

Superannuation benefits paid to a member

¶4-420

Superannuation death benefits

¶4-425

Roll-over superannuation benefits

¶4-430

Superannuation benefits paid to former temporary residents

¶4-435

Transfer of superannuation between Australia and New Zealand

¶4-440

Superannuation income streams which commenced before 1 July 2007

¶4-450

Superannuation split on relationship breakdown

¶4-480

Superannuation guarantee scheme Superannuation guarantee scheme

¶4-500

Quarterly payment of SG amounts

¶4-510

Employees covered by SG scheme

¶4-520

How much does an employer have to contribute?

¶4-540

Liability to SG charge if insufficient contributions

¶4-560

Choice of fund rules

¶4-580

Foreign superannuation funds Australian or foreign superannuation funds

¶4-600

Superannuation benefits from foreign superannuation funds

¶4-650

¶4-000 Superannuation

The big picture Superannuation funds Superannuation is all about individuals saving for their retirement, and superannuation funds are the most common entity used for this purpose. • The objective of superannuation, proposed to be “to provide income in retirement to substitute or supplement the Age Pension”, is to be enshrined in legislation as a stand-alone Act ....................................¶4-100 • A superannuation fund is a fund set up to provide benefits to its members on retirement or death benefits to dependants on the member’s death ....................................¶4-110

• Retirement savings accounts (RSAs), pooled superannuation trusts (PSTs) and approved deposit funds (ADFs) are other superannuation vehicles ....................................¶4-120 • Superannuation funds, other than self managed superannuation funds (SMSFs), are primarily regulated by the Australian Prudential Regulation Authority (APRA), but the Australian Securities and Investments Commission (ASIC) and the Australian Tax Office (ATO) are also involved in regulating their operations. SMSFs are primarily regulated by the ATO ....................................¶4150 • From 1 November 2018 the new Australian Financial Complaints Authority took over the Superannuation Complaints Tribunal’s role in settling complaints about superannuation....................................¶4-150 Superannuation contributions • There are two types of contributions: concessional (deductible) contributions and nonconcessional (non-deductible) contributions ....................................¶4-200 • Contributions can be made to a superannuation fund if the fund is allowed to accept the contributions. Subject to age restrictions and a work test, a superannuation fund can generally accept contributions from employers on behalf of employees or from members for themselves or for someone else such as a spouse ....................................¶4-205 • From 1 July 2019, individuals aged 65–74 with a total superannuation balance below $300,000 may be able to make voluntary contributions for 12 months from the end of the financial year in which they last met the work test ....................................¶4-205 • A fund may not accept contributions from a member if the member’s Tax File Number (TFN) is not quoted to the fund ....................................¶4-205 • An employer is allowed a tax deduction for contributions on behalf of an employee to a complying superannuation fund, provided certain conditions are satisfied ....................................¶4-210 • An employer is entitled to a deduction for SG contributions for an employee regardless of the employee’s age ....................................¶4-210 • Employer superannuation contributions resulting from a salary sacrifice arrangement must be reported on the employee’s payment summary and may reduce the superannuation concessions otherwise available to the employee ....................................¶4-215 • Members, including employees, are generally entitled to a tax deduction for personal contributions if certain conditions are satisfied ....................................¶4-220 • Individuals saving for their first home may be able to contribute up to $30,000 into superannuation and withdraw the contributions to use as a deposit on a home ....................................¶4-222 • Individuals aged at least 65 may be able to make a non-concessional contribution to a complying superannuation fund of up to $300,000 from the proceeds of selling their home ....................................¶4-222 • Concessional contributions are generally taxed at 15% but may also be liable to an additional 15% Division 293 tax if the contributor’s income exceeds $250,000 ....................................¶4225 • A transfer balance cap ($1.6m for 2019/20) limits the amount of capital an individual can transfer to the retirement phase to support a superannuation income stream that benefits from the earnings tax exemption ....................................¶4-227

• An individual may be liable to excess transfer balance tax if their transfer balance exceeds the $1.6m cap ....................................¶4-227 • An individual whose transfer balance exceeds their transfer balance cap may be required to remove amounts from superannuation or transfer them to the accumulation phase ....................................¶4-227 • Modified transfer balance cap rules apply for certain capped defined benefit income streams ....................................¶4-232 • An individual’s “total superannuation balance” is used to value their superannuation interests and determine their entitlement to various superannuation concessions ....................................¶4233 • A Bill proposing that the outstanding balance of a limited recourse borrowing arrangement be included in a member’s total superannuation balance in an SMSF or small APRA fund lapsed when Parliament was prorogued for the 2019 federal election ¶4-233 • The basic concessional contributions cap is $25,000 for 2019/20 ....................................¶4-234 • Individuals who do not fully use their concessional contributions cap from 2018/19 may be able to make catch-up contributions in later years ....................................¶4-234 • An individual’s excess concessional contributions are included in their assessable income and taxed at their marginal rate. The individual is also liable to excess concessional contributions charge ....................................¶4-235 • An individual may apply to have excess concessional contributions released from superannuation ....................................¶4-235 • An individual is not allowed to make non-concessional contributions if their total superannuation balance for the year exceeds the transfer balance cap ($1.6m for 2019/20) ....................................¶4-240 • The non-concessional contributions cap is $100,000 for 2019/20 ....................................¶4-240 • An individual who is aged under 65 may be able to bring forward non-concessional contributions for the next two years if their total superannuation balance is less than the transfer balance cap ($1.6m for 2019/20) ....................................¶4-240 • Excess non-concessional contributions tax may be payable by a member whose nonconcessional contributions exceed the non-concessional contributions cap ....................................¶4-245 • To avoid liability to excess non-concessional contributions tax, a member may elect to withdraw excess non-concessional contributions ....................................¶4-245 • Penalties imposed on an individual who has excess contributions in a year may be reduced if the Commissioner makes a determination to disregard contributions or reallocate them to another year ....................................¶4-250 • Concessional contributions made by an employer for a member or made by the member personally may be split with the member’s spouse ....................................¶4-260 • Low-income taxpayers may be entitled to a government co-contribution to match their undeducted personal contributions if their non-concessional contributions for the year do not exceed $100,000 and their total superannuation balance is less than $1.6m ....................................¶4-265

• Low-income taxpayers may be entitled to a low-income superannuation tax offset ....................................¶4-270 • Persons who contribute on behalf of a low-income or non-working spouse may be entitled to a tax offset for their contributions ....................................¶4-275 Taxation of superannuation funds • APRA, or the ATO in the case of an SMSF, issues a notice that a superannuation fund is a complying superannuation fund if it satisfies certain requirements. It remains a complying fund until a notice is issued that it is non-complying ....................................¶4-310 • For 2019/20, complying superannuation funds are subject to the concessional tax rate of 15% on most of their income whereas non-complying funds are taxed at 45% ....................................¶4320 and ¶4-340 • The taxable income of superannuation funds includes taxable contributions, investment income, dividends and capital gains, but does not generally include roll-overs from other superannuation funds or income on assets out of which pensions are paid ....................................¶4-320 • Superannuation funds are taxed at the rate of 47% for 2019/20 on their “no-TFN contributions income”, but a tax offset may be allowed if the individual’s TFN is later quoted to the fund ....................................¶4-390 Superannuation benefits • Contributions (and earnings on contributions) are generally required to be preserved in a superannuation fund until the member retires after reaching preservation age, dies, becomes permanently incapacitated, suffers from a terminal illness, reaches 65 years of age or qualifies on hardship or compassionate grounds ....................................¶4-400 • Superannuation benefits paid to a member, whether in the form of a lump sum or an income stream, from a source that has been taxed in the fund are generally tax-free for members aged 60 and over. Tax is payable (but at concessional rates) if a superannuation benefit is paid to a member aged under 60 or if it is paid from a source that has not been taxed in the fund ....................................¶4-420 • An individual may be liable to additional tax if they receive a pension in excess of $100,000 from a defined benefit income stream that has commutation restrictions ....................................¶4-420 • Superannuation death benefits paid to a dependant are tax-free if paid as a lump sum. A benefit that is paid as an income stream is tax-free if either the deceased or the dependant is aged at least 60 at the time of death. Superannuation death benefits paid to non-dependants are taxed and must generally be paid as a lump sum ....................................¶4-425 • Superannuation benefits rolled over into a superannuation fund or to purchase a superannuation annuity are generally tax-free at the time of the roll-over. For 2019/20, if the roll-over benefit includes an untaxed roll-over amount in excess of $1.515m, 47% tax is payable on the excess amount ....................................¶4-430 • Special withholding tax rates apply to superannuation benefits paid to former temporary residents who have left Australia ....................................¶4-435 • Superannuation may be transferred between Australian complying superannuation funds and New Zealand KiwiSaver schemes ....................................¶4-440 • Spouses whose relationship has broken down may split their superannuation entitlements, either by agreement or by court order ....................................¶4-480

Superannuation guarantee scheme • Single Touch Payroll reporting applies to all employers from 1 July 2019 regardless of the number of their employees ....................................¶4-510 • Each quarter, employers must make superannuation contributions to a complying superannuation fund on behalf of their employees, other than those who are excluded employees ....................................¶4-520 • A Bill proposing that individuals whose income exceeds $263,157 for a financial year from multiple employers could nominate that income from certain of the employers would be exempt from SG lapsed when Parliament was prorogued for the 2019 federal election .................................... ¶4-520 • The minimum level of SG support for 2019/20 is 9.5% of an employee’s ordinary time earnings ....................................¶4-540 • Employers who fail to make the required superannuation contributions are liable to an SG charge ....................................¶4-560 • Directors of companies with unpaid SG charge liabilities may be personally liable ....................................¶4-560 • A Bill for a 12-month amnesty for employers who have underpaid their SG contributions lapsed when Parliament was prorogued for the 2019 federal election ....................................¶4-560 • Employers must, in many cases, give employees a choice of fund into which their SG contributions are paid and are penalised if they fail to do so ....................................¶4-580 • A Productivity Commission report recommends major changes to the way SG contributions for members who do not choose a fund are allocated to a default superannuation fund ....................................¶4-580 Foreign superannuation funds • A foreign superannuation fund is generally not entitled to taxation concessions in respect of fund income and deductions ....................................¶4-600 • The tax treatment of payments received from foreign superannuation funds depends on when and how the payment is made and the amount of the payment ....................................¶4-650

SUPERANNUATION IN AUSTRALIA ¶4-100 Objective of superannuation The government announced in the 2016 Federal Budget that the objective of the superannuation system would be enshrined in legislation. A Bill to achieve this — the Superannuation (Objective) Bill 2016 — was introduced into parliament in November 2016. The Bill had not been passed by the time parliament was prorogued for the 2019 federal election and will need to be reintroduced. The Bill proposes that the primary objective of the superannuation system is “to provide income in retirement to substitute or supplement the age pension”. This objective clarifies that superannuation is intended to assist individuals to support themselves by providing income to meet their expenditure needs in retirement. Subsidiary objectives will provide a framework for assessing whether particular superannuation legislation

is compatible with the primary objective. Various subsidiary objectives of the superannuation system have been proposed, including: • to facilitate consumption smoothing over the course of an individual’s life • to manage risks in retirement, and • to alleviate fiscal pressures on the Australian Government from the retirement income system.

¶4-110 Superannuation funds Various superannuation entities hold funds intended to be used in a person’s retirement. The most common is a superannuation fund, but there are also retirement savings accounts, approved deposit funds, pooled superannuation trusts and eligible roll-over funds (¶4-120). A “superannuation fund” can broadly be described as an “indefinitely continuing fund” set up to provide retirement benefits to members or death benefits to dependants on the death of a member. An offshore trust (called the “Samoan superannuation fund”) was held not to be a superannuation fund in LLUN v FC of T 2018 ATC ¶1-095 because, although it was an indefinitely continuing fund, it could not be said that its sole purpose was the provision of retirement benefits. This was because the trust deed allowed benefits to be paid to a member before their retirement and the entity described in the trust deed as the “principal employer” did not actually have employees. A superannuation fund is established by governing rules (a trust deed for a private sector fund and legislation for a public sector fund) and is administered by trustees appointed under the deed or legislation. The governing rules specify who may make contributions to the fund, who can receive benefits and when, and how benefits are calculated. Benefits may be paid as a lump sum or an income stream or as a combination of the two. There are generally two types of superannuation fund: • an “accumulation fund” (sometimes called a “defined contribution fund”), where the superannuation benefit is based on contributions and earnings on contributions, minus taxes and fees, and the member bears the risk, and • a “defined benefit fund”, where the superannuation benefit is based on a formula tied to factors such as age and salary at retirement and period of membership, and the employer bears the risk. Complying superannuation funds Concessional tax treatment (¶4-300) applies to a complying superannuation fund. To be a complying superannuation fund, a fund must: • be a “resident regulated superannuation fund”, that is a fund whose trustees have elected that the fund will be regulated under the Superannuation Industry (Supervision) Act 1993 (SISA) and that is an Australian superannuation fund (¶4-600), and • satisfy certain conditions relating, for example, to trustee duties, acceptance of contributions and payment of benefits, investment of funds and compliance with regulatory standards. In order to be a regulated fund, a fund must have either: • a corporate trustee, or • individual trustees and a trust deed which specifies that the sole or primary purpose of the fund is to provide pensions (although this does not prevent members from being given the option to commute benefits to a lump sum). An election to be a regulated superannuation fund cannot be revoked. Complying funds receive notification of their complying status from APRA (or, in the case of an SMSF,

from the ATO), and this entitles them to concessional tax treatment (¶4-300). Complying superannuation funds (which include RSA providers) may accept superannuation guarantee (SG) contributions for their employees (¶4-500) and, together with ADFs, may accept roll-over superannuation benefits (¶4-430). ADFs and RSAs are discussed at ¶4-120. Small superannuation funds A small superannuation fund (one with fewer than five members) is exempted from some of the prudential requirements imposed on other funds by SISA. Small superannuation funds are sometimes referred to as do-it-yourself (DIY) funds because decision making rests with individuals who wish to maintain control over their family’s superannuation savings. A small superannuation fund may be: • a self managed superannuation fund (SMSF) which is regulated by the ATO (see below), or • a small APRA fund which has fewer than five members but does not satisfy the definition of an SMSF and is regulated by APRA. Self managed superannuation funds Broadly, an SMSF is a superannuation fund: • with fewer than five members • where each member is a trustee (or director of the trustee company) and there are no other trustees, and • where no member is an employee of another member (or of an associated person), unless they are related. These rules are varied where a fund has only one member. A fund with only one member may be an SMSF if: • it has a corporate trustee and the member is either: – the sole director, or – one of two directors and not an employee of the other director unless they are related, or • it has two individual trustees and the member is: – one of the trustees, and – not an employee of the other trustee (unless they are related). Regardless of the number of members, a fund can generally only be an SMSF if no trustee receives remuneration for services performed in relation to the fund. The member/trustee relationship needs to be monitored to ensure it continues to satisfy the legislative requirements. If the member/trustee link is broken, or the fund otherwise fails to meet the SMSF conditions, a trustee must notify the ATO within 21 days. Failure to comply with the SMSF rules may cause a trustee to be penalised. SMSFs are regulated by the ATO. The ATO has the same investigative powers in respect of SMSFs as APRA has in respect of other regulated superannuation funds and administers largely similar rules. The primary aim of the ATO in relation to SMSFs is to ensure that they: • comply with the relevant provisions of SISA • are administered in a manner consistent with retirement income policy, and • use superannuation money for appropriate retirement purposes.

Superannuation funds with fewer than five members that do not meet the SMSF definition (“small APRA funds”) are regulated by APRA rather than the ATO. The government introduced legislation into Parliament in February 2019 — the Treasury Laws Amendment (2019 Measures No 1) Bill 2019 — that proposed the maximum number of allowable members of an SMSF be increased from four to six. This proposal was removed from the Bill before the Bill was passed by Parliament in April 2019. SMSFs are discussed in detail in Chapter 5. Defined benefit funds Some superannuation funds operated by large employers and some public sector funds provide defined benefits, at least on retirement or death. Technically, a “defined benefit fund” is a superannuation fund that has at least one defined benefit member. A defined benefit member is a person whose benefit is calculated, wholly or in part, by reference to: • the amount of the member’s salary at a particular date, being the date of the member’s termination of employment or retirement or an earlier date, or the member’s salary averaged over a period before retirement, and/or • a specified amount. Example Examples of defined benefits are: – a benefit on death equal to five times salary at the date of death, and – a lump sum retirement benefit equal to 15% of final average salary (salary averaged over the three years immediately preceding the date of retirement) for each year of service with the company.

With a defined benefit fund, the employer’s contributions vary periodically, depending on actuarial advice, to ensure that there will be sufficient money in the fund to meet expected liabilities for benefits. In some cases, an employer may take a “contributions holiday” because contributions are not, at that time, needed to meet expected liabilities. Employer contributions to a defined benefit fund are not allocated to individual member accounts, but are held as an unallocated reserve. Members may, or may not, be required to contribute and members’ entitlements are determined by the provisions of the trust deed and rules. Accumulation funds An “accumulation fund” is a superannuation fund where the final benefit payable to a member is the amount accumulated in the member’s account in the fund at that time. The member’s account is credited with contributions made for the member by the member, spouse or employer together with investment earnings. The account may be debited with fees, taxes and premiums for death or disablement insurance. Public sector funds A “public sector fund” is a superannuation fund that is part of a scheme for the payment of superannuation, retirement or death benefits, which is established: • under a Commonwealth, state or territory law, or • under the authority of the Commonwealth, state or territory government, a municipal corporation or a public authority constituted by or under a Commonwealth, state or territory law. A public sector fund may be unfunded, funded, or partly funded (such as the Commonwealth government superannuation fund for public servants). Constitutionally protected funds A “constitutionally protected fund” is a fund that is protected from tax liability by s 114 of the Constitution.

Such a fund, eg one operated by a state government for its employees, cannot be liable to Commonwealth taxation as any imposition of tax would be a tax on the property of a state, which is prohibited by s 114. Funds that are constitutionally protected funds are prescribed in reg 995-1.04 and Sch 4 of the Income Tax Assessment Regulations 1997. Public offer superannuation funds A “public offer superannuation fund” is a superannuation fund regulated by APRA that offers or intends to offer superannuation interests to the public on a commercial basis, generally by issuing a Product Disclosure Statement. Such funds are offered by banks, life offices and investment companies. Industry funds are also generally operated as public offer funds. The trustee of a public offer fund must be a registrable superannuation entity (RSE) licensee (¶4-150) and must comply with rules relating to the issuing, offering or making of invitations of superannuation interests set out in SISA and in the Corporations Act 2001. Retail funds Retail funds are generally provided by financial institutions and insurance companies to cater for people who are interested in investing and saving for their retirement. Investment and administrative services are offered to clients. Retail funds are intended to generate revenue and profit for the provider. Industry funds Industry funds were developed by trade union and industry bodies to provide retirement income for their members. Although originally confined to workers within the relevant industry, industry funds have, in recent years, been opened to the general public and are now often public offer funds. Industry funds are not-for-profit bodies and generally charge lower fees than other funds. Master funds or trusts Employer-sponsored funds or public offer superannuation funds may come under a master fund or trust arrangement that is offered by a finance institution. Such an arrangement groups a number of funds under a single master trust deed and provides professional administration for all the funds under the deed. Each fund has access to a wide range of investment, benefit design and insurance options according to its needs.

¶4-120 Other superannuation entities Retirement savings account providers Retirement savings accounts (RSAs) may be provided by banks, building societies, credit unions, life insurance companies and financial institutions approved by APRA as RSA institutions. RSAs are intended to be a simple, low-cost and low-risk savings product, which employers may use as an alternative to superannuation funds for their employees, and which individuals may use for personal superannuation contributions. RSAs are primarily intended for people with low amounts of superannuation benefits or with transient working patterns. RSAs take the form of a “capital guaranteed” account or policy offered by RSA providers. There is no limit to the amount that can be held in an RSA, but RSA providers must provide prescribed information to account holders when their account balance reaches $10,000. This includes information about the lowerrisk/lower-return nature of RSAs and about alternative products offering potentially higher returns over the longer term. RSAs are essentially invested in cash. They are convenient for investing small amounts; however, they are not suitable for long-term investment. Approved deposit fund (ADF) An ADF is an indefinitely continuing fund maintained by a corporate trustee approved by APRA, which receives, holds and invests certain types of roll-over funds until such funds are withdrawn. ADFs are principally roll-over vehicles. They cannot directly accept contributions or pay a pension and they must

pay out a member’s benefits when the member reaches age 65 or dies. Pooled superannuation trust (PST) A PST is a unit trust maintained by a corporate trustee approved by APRA, which is used only for investing assets of regulated superannuation funds, ADFs, life offices and registered organisations. A PST pays tax at 15% and credits after-tax earnings to the superannuation funds which invest in it. Individual investors cannot invest in PSTs. Eligible roll-over fund (ERF) An ERF is a regulated superannuation fund or ADF which must treat all members as protected members and each member’s benefits as minimum benefits. These protection measures limit the expenses that a superannuation fund may deduct where a member’s account balance is less than $1,000. The account balance cannot be reduced by the deduction of expenses and, in effect, expenses cannot exceed investment earnings. Superannuation funds and ADFs which do not wish to comply with the member protection standards that apply to members with small account balances may transfer the benefit entitlements of affected members to ERFs.

¶4-150 Regulation of superannuation entities General administration of SISA and its regulations is primarily shared by the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investment Commission (ASIC) and the Commissioner of Taxation (ATO). As part of the superannuation regulatory regime: • superannuation funds, other than SMSFs, are principally regulated by APRA, which is responsible for the prudential regulation of all deposit-taking institutions • SMSFs are regulated by the ATO • the ATO (formerly the Chief Executive Medicare) administers the early release of superannuation benefits on compassionate grounds • the Fair Work Ombudsman has general administration of employer notifications about superannuation contributions for employees • APRA and ASIC have joint responsibility for the regulation of RSA providers and RSA business, and • the ATO is responsible for the administration of the SG scheme. A superannuation fund must elect to be regulated (whether by APRA or the ATO) within 60 days of its establishment. A fund which elects to be a regulated fund will, subject to it being a complying fund, be entitled to concessional taxation treatment (¶4-320). To be a complying superannuation fund, a fund must have complied with the various requirements of SISA and SISR during the course of the year. These impose obligations on fund trustees relating to, for example, the sole purpose test, acceptance of contributions and payment of benefits, investment strategy and licensing rules. If a fund does not comply, it may lose its concessional tax status and penalties may be imposed on those who are responsible for the non-compliance, eg the trustees. Licensing and registration requirements Superannuation entities that are registrable superannuation entities (RSEs) must hold an RSE licence and must register with APRA. A “registrable superannuation entity” means a regulated superannuation fund, an ADF or a PST (but not an SMSF). To obtain an RSE licence and to register a fund, the trustees must have a risk management plan for the

fund that sets out reasonable procedures that the RSE licensee will apply to identify, monitor and manage risks that arise in operating the entity. The RSE licence is in addition to the Australian Financial Services Licence (AFSL) issued by ASIC to providers of financial services under the Corporations Act. Holding an AFSL licence is a requirement for undertaking certain types of business activities under an RSE licence, eg where the trustee is dealing in a financial product or providing advice about financial products. Resolution of complaints about superannuation matters ASIC is responsible for the administration of the resolution of complaints scheme. Disputes regarding superannuation, including those relating to the conduct and decisions of superannuation fund trustees, are dealt with by the Australian Financial Complaints Authority (AFCA). Before 1 November 2018, superannuation complaints were dealt with by the Superannuation Complaints Tribunal (SCT). AFCA deals with all financial system complaints, replacing the SCT, Financial Ombudsman Service and the Credit and Investments Ombudsman (¶8-615). The SCT will continue operations until 1 July 2020 to resolve the current backlog of complaints. Levies Superannuation entities are required to pay a supervisory levy to the ATO in the case of SMSFs or to APRA in the case of other superannuation entities. The supervisory levies are tax deductible. Funds that are regulated by APRA are also liable to pay a levy to provide financial assistance where the fund or its beneficiaries suffer loss from fraudulent conduct or theft. The levy does not apply to SMSFs. The financial assistance levy is deductible and a grant of financial assistance is exempt from income tax.

¶4-160 Superannuation and bankruptcy laws Generally, the interest of a member in benefits in a superannuation fund is protected from creditors in the event of the member’s bankruptcy. The protection is subject to provisions in the Bankruptcy Act 1966, which allow bankruptcy trustees to recover any superannuation contributions made prior to bankruptcy with the intention of defeating creditors. Superannuation contributions made before bankruptcy The bankruptcy trustee may recover the value of contributions made by the bankrupt member, or by another person for the benefit of the bankrupt member, if the purpose of the contributions was to defeat creditors. Any consideration given by the superannuation trustee for the contribution will be ignored in determining whether the contribution is recoverable by the bankruptcy trustee. This overcomes the 2003 High Court decision in Cook v Benson that cast doubt on a bankruptcy trustee’s power to recover contributions where a trustee had provided consideration for the contributions. The pattern of a bankrupt’s past contributions and whether any contributions are uncharacteristic will be considered by a court in determining whether they are made to defeat creditors. The Official Receiver has power to issue a notice to the fund to freeze the contributions to prevent the bankrupt from rolling them into another fund or otherwise dealing with them in a way that would prevent recovery by the bankruptcy trustee. The overall effect is that contributions to superannuation funds to defeat creditors may be recoverable in the same way as other payments or transfers to defeat creditors.

CONTRIBUTIONS TO SUPERANNUATION FUNDS ¶4-200 Superannuation contributions Tax concessions may be available to people who make superannuation contributions. The contributions may be made by employers on behalf of employees (sometimes after the employee sacrifices salary) or

by members on their own behalf or on behalf of someone else, such as their spouse. The concession may be a tax deduction, a government co-contribution, a low-income superannuation contribution or a tax offset. A contribution is essentially anything of value that increases the capital of a fund and that is provided for the purpose of providing superannuation benefits. The meaning of “contributions” and when they are made is discussed at ¶4-203. Fund must be able to accept the contributions Contributions can only be made for a person (whether by an employer, a member or another person) if the fund is allowed to accept the contributions. The rules on when a fund can accept contributions are discussed at ¶4-205. Importance of quoting a tax file number It is important that a member’s tax file number is quoted to the superannuation fund when a contribution is made, because otherwise the following adverse consequences may arise: • the fund cannot accept personal contributions (¶4-220) from the member or, if it accepts the contributions, would have to return them to the member • a government co-contribution (¶4-265) or low-income superannuation tax offset (¶4-270) is not payable for the member, and • additional tax may be payable by the fund on the contributions (¶4-390). Concessional contributions Contributions are classified as either “concessional” or “non-concessional” contributions. Concessional contributions are contributions made by an employer for a member or by a member personally, where a deduction has been allowed and the contributions are included in the assessable income of a superannuation fund. Concessional contributions are generally taxed at 15%, although concessional contributions for high-income individuals may be taxed at 30% (¶4-225). A deduction is allowed for contributions made by employers on behalf of their employees provided certain conditions are met (¶4-210). A deduction is also allowed for personal contributions made by members if certain conditions are met (¶4234). If a deduction is not allowed for a personal contribution, a government co-contribution (¶4-265) or low-income superannuation tax offset (¶4-270) may be allowed. Even though employer or member contributions may be deductible, there are limits on the amount of concessional contributions that can benefit from concessional treatment (eg being taxed at 15% when paid to the fund). If the concessional contributions made for a member in a year exceed the member’s concessional contributions cap for the year ($25,000 for 2019/20), the excess amount is included in their assessable income and taxed at marginal rates. An individual may elect to have 85% of their excess concessional contributions for a year released from superannuation. The individual is also liable to excess concessional contributions charge. The treatment of excess concessional contributions is discussed at ¶4-234 and ¶4-235. Non-concessional contributions Non-concessional contributions are generally contributions made by a member where a deduction has not been allowed and the amount is not included in the assessable income of the fund. Non-concessional contributions are taxed at 0% when paid into the fund and at 0% when paid from the fund as a superannuation benefit. If a member has non-concessional contributions in excess of their non-concessional contributions cap ($100,000 for 2019/20) (¶4-240), the member may elect to withdraw excess contributions plus 85% of the associated earnings on the contributions. No tax is imposed on the excess contributions that are withdrawn, but all of the associated earnings are included in the member’s assessable income and taxed

at ordinary rates (¶4-245). The member may be liable to excess non-concessional contributions tax on any excess amount that is not withdrawn from the fund. Commissioner may disregard or reallocate contributions In limited circumstances, liability to penalties on excess contributions can be avoided if the Commissioner makes a determination that certain contributions should be disregarded or reallocated to another year (¶4250). The Commissioner can only make such a determination if there are special circumstances and the making of the determination would be consistent with the objects of the legislation. Issues relating to contributions The following matters affecting contributions to superannuation funds are of relevance to financial planning: • the meaning of “contributions” and when they are made (¶4-203) • when contributions can be accepted (¶4-205) • deductions for employer contributions (¶4-210) • the consequences of sacrificing salary into employer superannuation contributions (¶4-215) • the deductibility of personal contributions (¶4-220) • the use of superannuation contributions by first home buyers (¶4-222) • contributions made by people over 65 years from the proceeds of selling their home (¶4-223) • the imposition of Division 293 tax on the concessional contributions of high-income earners (¶4-225) • the transfer balance cap rules that limit the amount of capital a member can transfer to the retirement phase to support a superannuation income stream (¶4-227 to ¶4-232) • a member’s total superannuation balance (¶4-233) • the treatment of a member’s excess concessional contributions or excess non-concessional contributions for a year (¶4-234 to ¶4-245) • whether excess contributions may be disregarded or reallocated to another year (¶4-250) • the splitting of a member’s contributions with the member’s spouse (¶4-260) • a low-income member’s entitlement to a government co-contribution to match their personal contributions (¶4-265) • entitlement to a low-income superannuation tax offset to compensate for the 15% tax imposed on deductible contributions (¶4-270) • eligibility for a tax offset for contributions made for a spouse (¶4-275), and • how contributions are taxed in the fund (¶4-280).

¶4-203 Contributions made to a fund When “contributions” are made to a fund, there may be tax consequences for the contributor, for the member for whom the contributions are made and for the fund itself.

The ATO’s view is that a contribution to a fund is anything of value that both: • increases the capital of the fund, and • is provided by a person with the intention of providing superannuation benefits for one or more members of the fund (Taxation Ruling TR 2010/1). A contribution would usually be money, but it can also be the transfer of an asset such as business property (an in specie contribution), in which case the amount of the contribution is the market value of the asset. A contribution can also be an addition to the value of an existing asset by, for example, making an improvement, or when a creditor forgives a debt owed by the fund. The roll-over of a member’s superannuation interest from one fund to another and the transfer of a benefit from an overseas fund to an Australian superannuation fund would be contributions as they both increase the capital of the receiving fund. A contribution may also be made: • when an employer pays expenses on behalf of a fund • when an employer makes contributions after an employee enters into a salary sacrifice arrangement, and • subject to conditions being satisfied, when money is transferred, at the employer’s direction, from an accumulation fund’s reserve account or surplus to a member’s account in the fund. The timing of a contribution The timing of a contribution determines the year in which a deduction (or other tax concession) is allowed, whether there are excess contributions for a member for the year and also the period for which the contribution is counted for SG purposes (¶4-500). For both deduction and SG purposes, a contribution is generally “made” to a fund when it is received by the fund. A contribution by electronic funds transfer is made when the amount is credited to the fund’s bank account, and an in specie contribution is made when ownership in the property passes (Taxation Ruling TR 2010/1). If an employer contributes to the Small Business Superannuation Clearing House (as is permitted for SG purposes for employers of fewer than 20 employees or who have an annual aggregated turnover of no more than $10m) (¶4-500), rather than directly to an employee’s superannuation fund, and the clearing house pays the contribution to the employee’s fund, the contribution is taken to be made to the fund: • for deduction purposes, when it is actually received by the fund, and • for the purpose of determining if an employer has satisfied its SG obligations, when it is made to the clearing house.

¶4-205 Acceptance of contributions A superannuation fund can only accept contributions for a member in the circumstances set out in the Superannuation Industry (Supervision) Regulations 1994 (SISR). Mandated employer contributions A superannuation fund may accept “mandated employer contributions” in respect of a person without restrictions, ie regardless of the person’s age or the number of hours that the person works. Mandated employer contributions may be any of the following contributions that an employer is required to make: • SG contributions made on behalf of an employee for whom the employer is required to contribute and where the contributions reduce the employer’s potential liability for the SG charge (¶4-500) • SG shortfall components, ie payments that an employer must make when their SG contributions fall short of what is required (¶4-560) • award contributions made in satisfaction of the employer’s obligations under an industrial agreement or award, or • payments to an individual’s account in a superannuation fund from the Superannuation Holding Accounts Special Account (SHASA) (SISR reg 5.01(1) and (2)). Employers are required to make SG contributions regardless of the age of the employee for whom the contributions are made (¶4-520). There is no maximum age for the making of SG contributions. Before 1 July 2013, the SG obligation to contribute for an employee ceased when the employee reached 70, and employer contributions for a person aged at least 70 were only mandated employer contributions if they were made under an award. SG contributions do not need to be made for an employee who is aged under 18 and is working only parttime, so employer contributions for such an employee would not be mandated employer contributions unless an award requires the employer to contribute. An award or other industrial law may require an employer to make contributions for employees in circumstances where SG contributions would not be required, eg if the employee is aged under 18 and working part-time. Where members have an effective arrangement with their employer to sacrifice salary to superannuation, the contributions are treated as employer contributions (¶4-215). However, only contributions up to the required SG level (9.5% of ordinary time earnings for 2019/20 — see ¶4-540) or the industrial law level (if higher than 9.5%) are mandated employer contributions. Acceptance of other contributions Apart from mandated employer contributions, the general rule is that a fund may accept contributions as follows (SISR reg 7.04): (1) Person aged under 65 A fund may accept contributions made for a person who is aged under 65 with no restrictions. The contributions may be made by an employer (including under a salary sacrifice arrangement) or by the member. Contributions may also be accepted for a spouse who is aged under 65. (2) Person aged 65–70 A fund may accept contributions made for a person who has reached age 65 but not age 70 if the person satisfies the “work test”, ie they have been “gainfully employed at least on a part-time basis” during the income year in which the contributions are made. The contributions may be made by the employer (including under a salary sacrifice arrangement) or by the member.

Contributions may also be accepted for a spouse as long as the spouse has been gainfully employed at least on a part-time basis during the year. (3) Person aged 70–75 Apart from mandated employer contributions, a fund may accept contributions only for a person who has reached age 70 but not age 75 if: (i) the member satisfies the “work test” during the income year in which the contributions are made, and (ii) the contributions are received on or before the 28th day after the end of the month in which the individual turns 75. The contributions may be made by the employer or by the member. A fund cannot accept contributions on behalf of a spouse once the spouse has reached age 70. (4) Person aged 75 or over A fund can accept contributions only on behalf of a person who has reached age 75 if they are mandated employer contributions. These could be contributions in compliance with SG or award obligations. Work test — gainfully employed on a part-time basis A person satisfies the work test if they are “gainfully employed”, ie they are employed or self-employed for “gain or reward” in any business, trade, profession, vocation, calling, occupation or employment (SISR reg 1.03(1)). The APRA view is that “gain or reward” involves remuneration such as salary or wages, business income, bonuses, commissions, fees or gratuities, in return for personal exertion. This would not generally include income that comes only from passive investments such as dividends, interest and capital gains. Example Ming turned 65 on 13 May 2019 and retired from employment on 30 June 2019. After her retirement, she continued to receive income from her investments and dividends from her shareholdings and also volunteered at the local community centre 12 hours a week. Ming is not entitled to make contributions for the 2019/20 tax year because she is not gainfully employed.

A person is gainfully employed “on a part-time basis” during an income year if the person has worked at least 40 hours in a period of not more than 30 consecutive days in that financial year. Example Sandra, aged 66, works full-time from 1 July 2019 to 15 July 2019. She then retires and does not perform any paid work during the remainder of the 2019/20 income year. Although she works only for the first two weeks of the 2019/20 tax year, Sandra is gainfully employed on a part-time basis during 2019/20 and a fund may accept contributions from her.

Contributions by a person aged 65 and over from the proceeds of selling their home A fund may accept contributions from a person aged 65 and over where the contributions come from the sale of the person’s home (¶4-223). This is an exception to the general rules that apply when an individual has reached 65. One-year exemption from the work test from 1 July 2019 From 1 July 2019, individuals aged 65–74 may be able to make personal contributions for 12 months from the end of the financial year in which they last met the work test. To be eligible for the exemption for a financial year, a member’s total superannuation balance (¶4-233) must be less than $300,000 at the end of the previous financial year (reg 7.04(1)) but is not required to remain at less than $300,000 during the year the contribution is made. The member must have met the work test in the previous financial year and

must not previously have made use of the work test exemption. Summary of contribution rules The following table summarises the general circumstances (subject to the exceptions noted above) under which a fund can accept contributions for the 2019/20 income year: Member under 65 years

– a fund can accept all contributions made for a person who is under 65 years of age, irrespective of employment or other income earning status.

Member 65 to under 70

– a fund can accept all contributions (personal, employer, spouse) if the person for whom the contribution is made has been gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in that financial year (work test). – a fund can accept mandated employer contributions.

Member 70 to under 75

– a fund can accept personal contributions or non-mandated employer contributions for a member if the member has been gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in that financial year (work test) and the contributions are received on or before 28 days after the end of the month in which the member turns 75. – a fund can accept mandated employer contributions.

Member 75 or over

– a fund can only accept mandated employer contributions.

Member contributions may not be accepted in certain cases A regulated superannuation fund may not accept personal contributions where the member’s TFN has not been quoted to the fund. The TFN may be quoted to the fund by the member or by the member’s employer, or may be given to the fund by the ATO. A fund that accepts member contributions in breach of this rule must return the contributions, generally within 30 days of becoming aware of the breach. Before 1 July 2017, a fund could not accept a “fund-capped contribution” (broadly, a non-concessional contribution made by a member) in an income year that exceeded their non-concessional contributions cap for the year. This rule was intended to prevent members inadvertently breaching the non-concessional contributions cap rules. A fund that accepted a contribution in excess of a member’s allowable amount was required to return the excess amount. The fund-capped contribution limit was replaced from 1 July 2017 by eligibility conditions based on a member’s total superannuation balance (¶4-233). Amounts transferred from KiwiSaver schemes A fund may be able to accept the transfer of a member’s superannuation from a New Zealand KiwiSaver scheme (¶4-440). The transferred amount is treated as a non-deductible personal contribution. Accrual of benefits — defined benefit funds The general rules for making contributions cannot apply to defined benefit funds as contributions are not specifically allocated to individual members. For these funds, rules apply to the accrual of benefits rather than the acceptance of contributions. Budget proposals for changes to the contribution rules The government proposed in the 2019 Federal Budget that from 1 July 2020: (1) individuals aged 65 and 66 would be able to make personal contributions without needing to meet the work test, and (2) the age limit for spouse contributions would be increased from 69 to 74 (although a fund would only be able to accept a contribution for a spouse aged over 66 if the spouse satisfies the work test).

Legislation to implement these proposals has not yet been introduced into Parliament.

¶4-210 Employer superannuation contributions An employer is allowed a tax deduction for all contributions paid to a superannuation fund as long as a number of conditions are satisfied. Although the amount of the employer’s deduction is generally not limited, the employee may be penalised if contributions by the employer on behalf of the employee exceed the concessional contributions cap (¶4-245). An employer contribution is taxed at 15% when it is paid to a complying superannuation fund (¶4-280). Concessional contributions made for high-income taxpayers may be subject to an additional 15% Division 293 tax (¶4-225). This affects both employer and personal contributions for which a deduction has been claimed. To compensate for the imposition of the 15% contributions tax, a low-income superannuation tax offset may be payable for a low-income earner (¶4-270). Conditions to be satisfied for a contribution to be deductible For an employer contribution to be deductible, the following conditions must be satisfied (s 290-80 of the Income Tax Assessment Act 1997 (ITAA97)). (1) Contribution is for the purpose of providing superannuation benefits for an employee of the employer To be entitled to a deduction, an employer must make a contribution “for the purpose” of providing superannuation benefits for an employee. The Commissioner considers that this must be the contributor’s sole purpose (Taxation Ruling TR 2010/1). A deduction would not be allowed if contributions were specifically intended to provide superannuation benefits for a dependant of an employee, although a dependant may benefit if an employee dies. “Superannuation benefits” means “individual personal benefits, pensions or retiring allowances” (ITAA36 s 6(1)). A contribution will be made for the purpose of providing superannuation benefits for an employee if it is intended to benefit a particular employee who is a member of the fund or an identifiable class of employee. The employer is not required to formally allocate the contribution to a particular employee, but an employee for whom a contribution is made must have fully secured rights to the superannuation benefit. The contribution must be made to provide superannuation benefits for a person who is an “employee” of the employer when the contribution is made, even if the benefits are payable to a dependant of the employee because of the employee’s death. “Employee” means: • an employee within the ordinary meaning, generally a person who is paid wages or salary in return for their services, or • a person who is deemed to be an employee for the purposes of the SG rules (¶4-520). This would most commonly be a person who works under a contract that is wholly or principally for the person’s labour. In the case of persons who are only employees because of the expanded SG definition, employer contributions may be deductible even if the employer is not required to contribute on their behalf but does so voluntarily. SG contributions are not, for example, required to be made for employees aged under 18 and working part-time, but if an employer chooses to make such contributions, the contributions may be deductible. In France 2010 ATC ¶10-158, the Administrative Appeals Tribunal found that there was not an employment relationship between a husband and a wife who owned an investment property and that contributions made by the husband on behalf of the wife were not deductible as they were made under a merely domestic arrangement.

In certain cases a contribution for a former employee may be deductible, eg if the contribution reduces the employer’s SG charge percentage for the employee. Example Milo’s employment with Argus is terminated on 30 September 2019. The SG liability of Argus in respect of Milo for the September 2019 quarter is $2,500. To avoid incurring liability to SG charge, Argus is required to contribute this amount to a complying superannuation fund by 28 October 2019. If Argus makes this contribution, it will be deductible, even though Milo is at this time a former employee.

(2) Employment activity condition An employer is only entitled to a tax deduction if the individual for whom the contributions are made satisfies the employment activity condition. This means the individual must be: • an employee within the expanded meaning for SG purposes (¶4-520), or • engaged in producing the assessable income of the employer, or • an Australian resident who is engaged in the employer’s business. Directors satisfy the employment activity condition if they are “entitled to payment” for the work they do for the company. A director is generally only treated as entitled to payment if the entitlement is specifically provided for in the company’s constitution or approved by resolution of the shareholders. In Kelly v FC of T (No 2) 2012 ATC ¶20-329 (upheld by the Full Federal Court in Kelly 2013 ATC ¶20-408), a director was found not entitled to payment, and not therefore deemed to be an employee for whom the company was entitled to deductions for superannuation contributions. Although the director was paid a superannuation benefit by the company, there was no evidence of a company resolution giving him the entitlement to the payment. The fact of payment did not, by itself, prove the entitlement. Contributions for a director of a company that derives its assessable income from passive investments may be deductible as long as the director is entitled to payment for their services (ATO ID 2007/144). Example Melissa is a director of a company that derives its income from passive investments such as shares and bonds. As a director, Melissa is an employee for SG purposes (SGAA s 12(2)) and satisfies the employment activity condition as long as she is entitled to payment for the performance of her duties as a director.

(3) Contribution to a complying superannuation fund For the contribution to be deductible, one of the following conditions must apply: (a) the fund receiving the contribution is a complying superannuation fund (¶4-310) (b) it is reasonable for the employer to believe the fund is a complying fund, or (c) the employer has obtained a written statement that the fund is a resident regulated superannuation fund that can accept employer contributions. (4) Age conditions To be deductible, an employer contribution for an employee must come within at least one of the following three situations: (a) it is made no later than the 28th day after the end of the month in which the employee turns 75 (b) the employer is required to make the contribution by an industrial award, agreement or law, or (c) the contribution counts as an SG contribution for the employee.

Since 1 July 2013, there has not been a maximum age limit for SG contributions and employers may be able to claim deductions for such contributions for employees regardless of their age. In earlier years, the SG scheme only required an employer to make contributions for an employee until the employee reached 70 years. Although there is no longer a maximum age limit for SG contributions, an employee’s age may affect the amount of an employer’s deduction: • if the contribution is made by the 28th day after the end of the month in which the employee turns 75, all of the contribution may be deductible • if the employee is older than 75 and the contribution is only counted for SG purposes, the employer can deduct only the minimum amount required for SG purposes, that is, 9.5% of the employee’s ordinary time earnings for 2019/20 (¶4-540), and • if the employee is older than 75 and the employer is required to make the contribution by an industrial award and also under SG law, the employer can deduct only the greater of the amount that is required to be contributed by the industrial award and the amount that is required to be contributed under SG law. A voluntary contribution by an employer for an employee who is aged at least 75 would not be deductible if it is made later than 28 days after the end of the month in which the employee turned 75. Example During 2019/20, an employer contributes $2,000 to a superannuation fund on behalf of an employee who is aged 76. Because the employee works as a casual store man and is only paid $420 per month, the employer is not liable to make SG contributions on his behalf (¶4-520). Neither is the employer required by an industrial law to make the contributions. As the employer’s contributions are voluntary contributions, not covered by either SG or industrial law requirements, and the employee is aged over 75, the contributions are not deductible. If the employee earned at least $450 in any month, the employer would be required to make SG contributions and they would be deductible.

Salary sacrifice contributions Salary sacrifice contributions to a complying superannuation fund are treated as employer contributions. Salary sacrifice arrangements and their consequences for employees and employers are discussed at ¶4215. Employer contribution to a non-complying superannuation fund An employer contribution for an employee to a non-complying superannuation fund that the employer does not reasonably believe to be a complying fund is not deductible and is subject to fringe benefits tax. An employer is also liable to fringe benefits tax where a contribution is made for a person who is not an employee of the employer, eg a spouse. Splitting contributions with a spouse Contributions made by an employer on behalf of an employee may generally be split with the employee’s spouse. Contributions splitting is discussed at ¶4-260.

¶4-215 Employer contributions following salary sacrifice Salary sacrifice involves an employee entering into an agreement with their employer for some of their salary to be sacrificed in return for fringe benefits or increased employer superannuation contributions. Salary sacrifice is attractive if it results in a lower income tax liability for an employee. This would be the case if the benefits received by the employee are taxed at a lower rate than the income would have been if it had not been sacrificed. Although the FBT rate is generally the same as the highest individual income tax rate plus Medicare levy (47% for the FBT year from 1 April 2019 to 31 March 2020), many fringe

benefits such as child care or cars may be taxed at a lower rate or be exempt from FBT. Employer contributions for an employee to a complying superannuation fund are not a fringe benefit, and therefore there may be tax savings if salary is sacrificed into superannuation. These tax savings can only be achieved if salary is sacrificed under an “effective” salary sacrifice arrangement. This involves an employee giving up a future entitlement to salary, rather than salary that has already been earned (Taxation Ruling TR 2001/10). The attraction of sacrificing salary for employer superannuation contributions is reduced for some employees because “reportable employer superannuation contributions”, which includes salary sacrifice contributions, are taken into account in determining if an individual: • is eligible for a government co-contribution when they make contributions (¶4-265) • is eligible for a low-income superannuation tax offset (¶4-270) • is entitled to a tax offset when they make contributions for a spouse (¶4-275) • has exceeded their concessional contributions cap for the year (¶4-234), or • is liable to pay an additional 15% Division 293 tax on their concessional contributions (¶4-225). For years before 2017/18, reportable employer superannuation contributions were also taken into account in determining if an individual was entitled to a deduction for their personal superannuation contributions (¶4-220). Reportable employer superannuation contributions Reportable employer superannuation contributions (RESCs) are contributions made by an employer (or an associate of the employer) for an employee to the extent that the employee could influence the size or the manner of the contribution (s 16-182 in Sch 1 of the Taxation Administration Act 1953 (TAA)). This will most commonly catch employer contributions resulting from a salary sacrifice arrangement. It is not intended to catch contributions that an employer is already obliged to make, eg SG contributions by an employer or contributions under an industrial agreement (unless the employee can influence the terms of the agreement). If the employee is an associate of the employer (eg related by family), there is a rebuttable presumption that the employee had the capacity to influence the contribution amount. An RESC does not include additional superannuation contributions for an employee as a result of some action by the employee if the contributions are required by an “industrial instrument” or rules of a superannuation fund and the employee has no capacity and cannot reasonably be expected to have the capacity to influence the content of that requirement. An “industrial instrument” means an Australian law or an award, order, determination or industrial agreement in force under an Australian law and includes a modern award or enterprise agreement (as defined in the Fair Work Act 2009). Example Ralph’s employer is required to make an employer contribution for him under the deed of the superannuation fund to which Ralph’s employer contributes. This deed is subordinate legislation under a state law. The contribution amount prescribed in the deed is based on Ralph’s personal contribution — if, for example, Ralph contributes 0%, 5% or 8%, his employer must contribute 9%, 11.5% or 13% respectively. If Ralph contributes 8% of his salary as a personal after-tax contribution and, as required under the deed, his employer contributes 13%, none of the amount the employer contributes is an RESC as the additional employer contributions are required by an Australian law. Neither Ralph nor his employer has capacity to influence the requirement for the additional contribution to be made or its size as the contribution and its amount are determined by the deed. Ralph’s personal contributions are also not RESCs as they are made from his assessable income. Examples of RESCs are as follows: • additional employer contributions made under an employment contract whose terms and conditions the employee has influenced, or additional employer contributions made for an employee as part of a negotiated remuneration package, and • employer contributions that the employee has influenced to be made in such a way that the employee’s assessable income is reduced, even if the requirement to make the contribution, or the contribution size, is prescribed by an industrial instrument or by fund rules.

An employer is obliged to report on an employee’s payment summary the amount of RESCs made for the employee during the income year. The amount to be reported is the amount that both: • exceeds the amount the employer would otherwise have been required to make, and • is contributed because of the influence of the employee. If an employer makes additional superannuation contributions to cover the cost of premiums for insurance cover for an employee due to the choice of superannuation fund made by the employee (¶4-580), the additional contributions are RESCs (ATO ID 2010/112). RESCs counted in income tests As well as counting for superannuation purposes, an employee’s RESC is counted in the income tests for: (i) eligibility for dependant tax offsets (ii) liability to Medicare levy surcharge and repayments of higher education loan program (HELP) debts (iii) entitlement to certain Centrelink benefits, and (iv) obligations to make child support payments to the Department of Human Services. Consequences for an employer The consequences for an employer of an effective salary sacrifice into superannuation include: • the employer may be entitled to a deduction for the contributions (¶4-210), and • the employer’s liability to make SG contributions may be reduced because the liability is based on an employee’s ordinary time earnings after reduction for the sacrificed salary. The Treasury Laws Amendment (Improving Accountability and Member Outcomes in Superannuation Measures No 2) Bill 2017 proposed that, from 1 July 2018, salary sacrifice contributions would not count in calculating an employer’s compliance with their SG obligations or reduce the earnings based upon which SG is calculated. The Bill lapsed when Parliament was prorogued for the 2019 federal election, and at the time of writing, had not been reintroduced into Parliament.

¶4-220 Personal superannuation contributions Individuals who make superannuation contributions in order to obtain superannuation benefits for themselves, or for their dependants in the event of their own death, may be entitled to tax concessions for those contributions as follows: • a deduction — if the deduction conditions are satisfied • a government co-contribution for low-income earners — individual contributors who receive income from employment or business may be entitled to a government co-contribution if their income is low and they have not received a deduction for the contributions (¶4-265) • a low-income superannuation tax offset — a low-income earner for whom deductible contributions are made may be entitled to a low-income superannuation tax offset to compensate them for the 15% tax imposed on the contributions (¶4-270), and • a tax offset for spouse contributions — contributions on behalf of a low-income spouse may entitle the contributor to a tax offset (¶4-275). A member can only make personal contributions to a superannuation fund if the fund is allowed to accept contributions from that member. As explained at ¶4-205, this depends on the member’s age, whether the member satisfies the work test (if required) and whether the member provides their tax file number. Deduction for personal contributions

If the deduction conditions are satisfied when a member makes a personal contribution and the member claims a deduction, the member’s contribution is a concessional contribution. If the member does not claim a deduction, the contribution is a non-concessional contribution. Although there is generally not a specific limit on the amount of concessional contributions that may be made by a member for a year or on the deduction allowable, tax consequences arise for a member if their concessional contributions for a year exceed their concessional contributions cap for the year. These tax consequences may indirectly create a limit. The concessional contributions cap is $25,000 for 2019/20, the same as for the previous two years. The consequences that arise for a member with excess concessional contributions (¶4-234 and ¶4-235) are intended to discourage the making of contributions in excess of the contributions cap. As with employer contributions, deducted personal contributions are generally taxed at 15% when paid to the fund. Concessional contributions made by or for high-income earners may also be liable to an additional 15% Division 293 tax (¶4-225). Conditions to be satisfied for a contribution to be deductible Personal contributions by a member are deductible for 2019/20 (and the previous two years) if the following conditions are satisfied (ITAA97 s 290-150 to 290-180). 1. The contribution is made for the purpose of providing superannuation benefits for the member, although the benefits may ultimately be paid to dependants if the member dies. 2. If the contribution is to a superannuation fund, it is a complying superannuation fund. Personal contributions to the following superannuation funds are not deductible: (a) contributions to Commonwealth public sector superannuation schemes by members with defined benefit interests (b) untaxed funds that do not include an amount in their assessable income as a result of receiving superannuation contributions, and (c) certain funds that are prescribed in the regulations and in which a member holds a defined benefit interest — the fund may choose for either all contributions to the fund, or contributions to defined benefit interests in the fund, to be non-deductible. 3. Age-related conditions require: (i) a contributor aged under 18 at the end of the income year to have earned income from carrying on a business or from employment during the year, and (ii) in any other case, a contribution to be made by the 28th day after the month in which a contributor turns 75. 4. The contribution must not be a downsizer contribution made from the proceeds of the sale of the main residence owned by the contributor for at least 10 years (¶4-223). 5. The contributor must notify the trustee in writing that they intend to claim the deduction and they receive acknowledgment of the notice from the trustee (see “Notice requirements” below). Even if these conditions are satisfied, a member’s deduction for a contribution may be limited in other ways. These include: • a deduction cannot create or increase a loss for the year and so is limited to the amount that reduces the member’s taxable income to zero (ITAA97 s 26-55) • a contribution is not deductible to the extent that it is attributable to a capital gain from the disposal of small business assets where a member who is aged under 55 years elects for an amount up to $500,000 to be disregarded for CGT purposes and to be used for retirement (ITAA97 s 152-305) — only the amount of a contribution that exceeds the $500,000 exempt amount could be deductible • a contribution for a member who is a partner in a partnership cannot be taken into account in calculating the net income or loss of the partnership (ITAA36 s 90), and

• a member who borrows money to make a contribution is not entitled to a deduction for interest on the loan (ITAA97 s 26-80). Notice requirements A deduction for personal superannuation contributions is only allowable if: • the member has given a notice to the trustee of the fund stating the intention to claim a deduction for all or part of the contribution covered by the notice, and • the member receives an acknowledgment of the notice. A notice of an intended deduction claim cannot be given to a superannuation fund if: • the person has ceased to be a member of the fund (eg the member has rolled all their benefits into another fund) • the trustee no longer holds the relevant contributions, or • the trustee has begun to pay a superannuation income stream based in whole or part on the contributions. In any case, the notice must be given by the earlier of: (i) the day the person lodges their income tax return for the year the contribution is made, and (ii) the end of the next income year. Once made, a notice cannot be revoked or withdrawn, but it can be varied to reduce (including to nil) the amount the member wishes to deduct. A variation is only effective if the person is still a member of the fund, the trustee still holds the contribution and the trustee has not commenced to pay a superannuation income stream based on the contribution. A notice generally cannot be varied after the earlier of: (i) the day the person lodges their income tax return for the year in which the contribution is made, and (ii) the end of the financial year following the year the contribution is made. Pre-2017/18 deduction condition — the 10% rule For years before 2017/18, the “10% rule” was important in determining eligibility for a deduction for member contributions. The rule had the effect that it was only in rare cases that an employee could claim a deduction for personal contributions, and a deduction was generally restricted to the self-employed and the substantially self-employed. Under the 10% rule, a member’s contribution was only deductible if less than 10% of the total of the following amounts came from employment-related activities in the year: • the member’s assessable income — this could include salary, termination payments, superannuation benefits, net capital gains, dividends, interest or rent • the member’s reportable fringe benefits total — these are fringe benefits that are reported on an employee’s payment summary because the employer has provided the employee with fringe benefits with a taxable value exceeding $2,000 in a year (see ¶3-155), and • the member’s reportable employer superannuation contributions (RESCs) — basically contributions made by an employer for an employee where the employee could influence the size or the manner of the contribution (¶4-215). Employer contributions for an employee after the employee entered into a salary sacrifice arrangement (¶4-215) were counted as income in determining if the employee was entitled to a deduction. Excess concessional contributions (¶4-234) were not included.

“Employment-related activities” means activities which result in the individual being treated as an employee for SG purposes. This includes not only employees within the ordinary meaning but also individuals who are deemed to be employees for SG purposes, eg persons who work under a contract that is principally for their labour (¶4-520). Example In the 2016/17 year, Stefan earned $85,000 from his landscape gardening business. He also earned $18,000 from teaching at TAFE and had a reportable fringe benefits total of $3,925. TAFE withheld PAYG amounts from Stefan’s earnings and made $1,500 SG contributions, but no other contributions, for him. The total of Stefan’s assessable income, reportable fringe benefits total and RESCs for 2016/17 was $106,925, of which 20.5% (ie the $18,000 + $3,925 relating to his work for the TAFE) was derived from employment-related activities. The $1,500 SG contributions were not taken into account as they were not RESCs. Because the proportion of the total of Stefan’s assessable income, reportable fringe benefits total and RESCs that came from employment-related activities was more than 10%, he failed the 10% rule and was not entitled to a deduction for contributions he made in 2016/17.

Employment income of an Australian resident employed overseas by a foreign employer could be counted in the 10% rule (Taxation Ruling TR 2010/1). For a foreign resident, income from employment outside Australia was not assessable in Australia and so was not counted.

¶4-222 First Home Super Saver scheme Under the First Home Super Saver (FHSS) scheme, individuals can contribute up to $30,000 into superannuation and withdraw the contributions to use as a deposit on a first home. The withdrawn contributions and deemed earnings on the contributions are taxed at the contributor’s marginal tax rates less a 30% offset. Contributions have been able to be made into superannuation for this purpose on or after 1 July 2017 and to be withdrawn on or after 1 July 2018. Allowing contributions to be withdrawn and used to acquire a first home is an exception to the general rule that contributions must be made for the purpose of providing superannuation benefits (¶4-220). Eligible individuals To be eligible to participate in the FHSS scheme, an individual must: (i) be aged at least 18 years (ii) have not previously owned a home or, if they have previously owned a home, the Commissioner determines they are allowed to participate because of financial hardship they have suffered, and (iii) have not previously requested the release of superannuation contributions under the FHSS scheme. Eligible contributions Contributions are eligible for the purposes of the FHSS scheme if they were made: (i) as voluntary employer contributions such as salary sacrifice contributions or voluntary personal contributions, and (ii) as concessional contributions within the concessional contributions cap for the year ($25,000 for 2019/20, 2018/19 and 2017/18) or as non-concessional contributions within the non-concessional contributions cap for the year ($100,000 for 2019/20, 2018/19 and 2017/18). Up to $15,000 of contributions can be eligible for one financial year and total FHSS contributions cannot exceed $30,000. Withdrawn contributions On or after 1 July 2018, individuals can apply to withdraw up to their “FHSS maximum release amount”,

which is the total of: (i) the sum of their FHSS non-concessional contributions and 85% of their FHSS concessional contributions, and (ii) associated earnings on the FHSS releasable contributions calculated on a compounding daily basis based on the shortfall interest charge rate. Concessional contributions and associated earnings that are withdrawn are included in the contributor’s assessable income and taxed at marginal rates with the benefit of a non-refundable offset equal to 30% of the assessable amount. For released amounts of non-concessional contributions, only the associated earnings are taxed, with a 30% tax offset. An individual is not required to wait until they receive their released amount before entering into a contract to purchase or construct premises. Such a contract can be entered into in the period beginning 14 days before and ending 12 months after they made the withdrawal request. The premises must be occupied by the individual as soon as practicable after it is purchased or constructed and for at least six months of the first year. An individual who does not enter into a contract within the required period to purchase or construct a home may re-contribute the released amount into superannuation as a non-concessional contribution. The contribution must be made by the time they would have been required to enter into a contract, and the Commissioner must be notified of the action taken by the individual. Liability to FHSS tax An individual is liable to pay First Home Super Saver tax (FHSS tax) if they do not, within the required time: (i) enter into a contract to purchase or construct residential premises, or (ii) re-contribute the released amount into superannuation. The FHSS tax is equal to 20% of an individual’s assessable FHSS released amounts. ATO guidance on the FHSS scheme Super Guidance Note SPR GN 2018/1 contains general information about the FHSS scheme and examples for individuals. Law Companion Ruling LCR 2018/5 lists various contributions that are not eligible for release, including amounts that reduce an employer’s potential superannuation charge liability or that are required to be made under an industrial agreement, government co-contributions and amounts paid due to a contributions splitting arrangement.

¶4-223 Downsizer contributions by individuals aged 65 and over On or after 1 July 2018, individuals aged 65 and over may be able to make superannuation contributions of up to $300,000 from the proceeds of selling their home. This is intended to make it easier for older individuals to “downsize” from homes that no longer meet their needs. Under the general rules about when a fund can accept contributions (¶4-205), individuals cannot make personal contributions if they are aged 65 or over unless they satisfy the work test. The work test rules have been amended to enable superannuation funds to accept downsizer contributions from individuals who have reached 65 regardless of their connection to the work force. A contribution is a downsizer contribution is it satisfies the following conditions: 1. An individual who is aged 65 years or over makes a contribution to a complying superannuation fund from the capital proceeds received when they dispose of their home located in Australia. 2. The contract for the sale of the home is entered into on or after 1 July 2018.

3. Either the individual or their spouse has owned the home at all times during the 10 years ending when it is sold. 4. Both the individual and their spouse can make a contribution from the disposal of the same home, but the maximum contribution each can make is $300,000. 5. The contribution is made within 90 days, or a longer time allowed by the Commissioner, after the home is disposed of. 6. At or before the contribution is made, the individual notifies to the superannuation provider their choice for the contribution to be treated as a downsizer contribution. A downsizer contribution is also excluded from being a non-concessional contribution and does not therefore count towards an individual’s non-concessional contributions cap (¶4-245). A deduction is not allowed for the contribution. The rule that an individual with a total superannuation balance (¶4-233) above $1.6m cannot make nonconcessional contributions does not apply to a downsizer contribution. However, once the downsizer contribution is made it would count towards the individual’s total superannuation balance in later years, potentially limiting the ability to make non-concessional contributions in those later years. ATO guidance Law Companion Ruling LCR 2018/9 and Super Guidance Note SPR GN 2018/2 provide ATO guidance for people aged 65 and over who are considering selling their home and making downsizer contributions.

¶4-225 Tax on concessional contributions of high-income earners Concessional contributions (¶4-234) are generally taxed at 15% when they are paid to a complying superannuation fund. Concessional contributions include employer contributions, such as SG contributions and salary sacrifice contributions for an employee, and a member’s personal contributions for which a deduction has been allowed. Concessional contributions made on or after 1 July 2017 for individuals with income greater than $250,000 may also be liable for an additional 15% Division 293 tax. For the years 2012/13 to 2016/17, Division 293 tax could apply where an individual’s income was greater than $300,000. Division 293 tax applies to concessional contributions to accumulation interests and to defined benefit contributions. It does not apply to: • non-concessional contributions (¶4-240) • concessional contributions that exceed the individual’s concessional contributions cap for the year (¶4-234) or excess contributions that are disregarded by the Commissioner (¶4-250) • state higher level office holders in respect of contributions to constitutionally protected funds (unless the contributions are salary packaged contributions), or • Commonwealth judges and justices in respect of contributions for a defined benefits interest in a superannuation fund established under the Judges Pensions Act 1968. Division 293 tax is assessed by the Commissioner and is generally due and payable within 21 days of the Commissioner giving a notice of assessment to the individual. For defined benefit interests, Division 293 tax is generally deferred for payment until 21 days after the first benefit is paid from the individual’s superannuation interest. Individuals are authorised to have amounts released from certain superannuation interests to facilitate payment of the tax. Liability to Division 293 tax An individual is liable for Division 293 tax for an income year if they have “taxable contributions” for the year (ITAA97 s 293-15). From 2017/18, an individual has taxable contributions for an income year if the

sum of: • their “income for surcharge purposes” (less “reportable superannuation contributions”), and • their “low tax contributions”, exceeds $250,000. If the $250,000 threshold is exceeded, the individual’s taxable contributions amount is the lesser of the low tax contributions and the amount of the excess over $250,000 (ITAA97 s 293-20). Division 293 tax is imposed at the rate of 15% on the amount of the taxable contributions. “Income for surcharge purposes” means the sum of the individual’s: • taxable income • reportable fringe benefits total (¶3-900) • reportable superannuation contributions, and • total net investment losses, eg from negative gearing (ITAA97 s 995-1(1)). The taxable component of a lump sum superannuation benefit (¶4-420) is not included if an offset reduces the tax on the taxable component to nil. “Reportable superannuation contributions” is the sum of the deductible contributions made for the individual personally and RESCs (¶4-215) made for the individual (ITAA97 s 995-1(1)). An individual’s “low tax contributions” are broadly concessional contributions such as employer contributions made on behalf of the individual and deductible personal contributions made by the individual, but not including the amount of concessional contributions that exceeds the concessional contributions cap (¶4-234) for the year (ITAA97 s 293-25 and 293-30). If an individual’s income, excluding their concessional contributions, is less than $250,000, but the inclusion of their concessional contributions pushes them over the $250,000 threshold, Division 293 tax only applies to the amount of the contributions that is in excess of the threshold. Because Division 293 tax does not apply to concessional contributions that exceed an individual’s concessional contributions cap, the maximum amount of Division 293 tax that can be payable in a year is 15% of the concessional contributions cap, ie for 2019/20 $3,750 ($25,000 × 15%), the same as for 2018/19 and 2017/18. Example For 2019/20, Romi has taxable income of $200,000, a reportable fringe benefits total of $35,000 and concessional contributions (not including salary sacrifice contributions) of $28,000. The concessional contributions cap for the year is $25,000. Without the concessional contributions, Romi’s income would be $235,000 and therefore below the $250,000 threshold. When the concessional contributions (not including the $3,000 in excess of the $25,000 cap) are added, the threshold is exceeded. Romi has $10,000 taxable contributions (the amount that, when the concessional contributions are added, is in excess of the $250,000 threshold). Division 293 tax ($10,000 × 15% = $1,500) is imposed on that $10,000.

Division 293 tax may be paid from an individual’s own money or from superannuation using a release authority issued by the Commissioner. Defined benefit members ITAA97 Subdiv 293-D (s 293-100 to 293-115) provides that an individual’s low tax contributions include notional contributions in respect of defined benefit interests (defined benefit contributions). This ensures that individuals with defined benefit interests are treated in a similar way to individuals with accumulation interests. An individual’s defined benefit contributions for a financial year in respect of a defined benefit interest has the meaning given by the regulations, ie by ITAR reg 293-115.01 to 293-115.20 and Sch 1AA. As the

actual value of benefits received by an individual from a defined benefit interest can only be known when the benefit is paid, the regulations provide that an individual’s defined benefit contributions is an estimate of the amount of employer contributions that would be made if contributions to fund all the employerprovided benefits expected to be paid were made annually. Generally, this is the sum of the actuarial value of the employer-provided benefits attributed to the individual for a financial year, the administrative expenses and the risk benefits attributable to the interest. The method for determining defined benefit contributions averages the cost of employer-provided benefits across all defined benefit members and all years of service. There are special rules for accruing members with interests other than funded benefit interests. Generally, these interests are in superannuation funds for Commonwealth, state and territory employees including constitutionally protected funds and certain public sector superannuation schemes. For members with a defined benefit interest, Division 293 tax is included in a debt account and is generally not payable until 21 days after the first benefit is payable from the superannuation interest (Div 133 and 134 of Sch 1 of the TAA). Interest is applied to the outstanding balance of a debt account at the long-term bond rate. The debt amount is capped at 15% of the employer-financed component of the value of the superannuation interest that accrues after 1 July 2012. Members may voluntarily pay their Division 293 tax liability from other sources at an earlier time. Certain “state higher level office holders” do not pay Division 293 tax in respect of contributions to constitutionally protected funds unless the contributions are made as part of a salary package. These office holders include state ministers, judges and magistrates, state governors and state public service departmental heads. Division 293 tax is also not payable by Commonwealth justices and judges in respect of contributions to a defined benefit interest established under the Judges Pensions Act 1968. Former temporary residents Former temporary residents who receive a departing Australia superannuation payment (¶4-435) are entitled to a refund of any Division 293 tax that they have paid (ITAA97 s 293-230). This reflects the fact that any concessional tax treatment of their superannuation contributions is removed by a final withholding tax on the superannuation benefit.

¶4-227 Transfer balance cap rules from 1 July 2017 From 1 July 2017, a transfer balance cap limits the amount of capital an individual can transfer to the “retirement phase” to support a superannuation income stream. The transfer balance cap is intended to limit the extent to which the superannuation interests of certain individuals attract an earnings tax exemption when they are receiving superannuation income stream benefits. The transfer balance cap is $1.6m for 2019/20, the same as for 2018/19 and 2017/18. The transfer balance cap rules are primarily in ITAA97 Div 294, 303 and 307 and TAA Sch 1 Div 136, with transitional provisions in ITTPA Div 294. Background to the introduction of the transfer balance cap — the pre-1 July 2017 rules An individual’s investments in superannuation are generally subject to a 15% earnings tax imposed on the individual’s superannuation fund. When an individual accesses their superannuation, they may choose to receive a superannuation lump sum or a superannuation income stream. If the individual commences a superannuation income stream, income earned from the investment of the capital that supports the income stream may be exempt from tax (the earnings tax exemption) (¶4-320). Before 1 July 2017, there was no limit on the amount an individual could transfer into a superannuation income stream to benefit from the exemption. This provided a tax advantage to high wealth individuals with significant superannuation balances. Summary of the transfer balance cap rules The transfer balance cap rules that apply from 1 July 2017 can be summarised as follows.

• An individual has a transfer balance account if they are, or have at any time been, the “retirement phase recipient” of a superannuation income stream. • An individual is generally a retirement phase recipient of a superannuation income stream if a superannuation income stream benefit is payable to them at that time, or a deferred superannuation income stream will be payable to them after that time, from a superannuation income stream, that is “in the retirement phase” (¶4-228). • A superannuation income stream is only entitled to the earnings tax exemption (¶4-320) if it is “in the retirement phase”. • Credits and debits are made to an individual’s transfer balance account at various times (¶4-228). • When an individual first commences a superannuation income stream that is in the retirement phase, their personal transfer balance cap equals the general transfer balance cap for that financial year, ie $1.6m for 2019/20 (¶4-229). • An individual has an excess transfer balance when the balance of their transfer balance account exceeds their personal transfer balance cap, and the Commissioner may make an excess transfer balance determination requiring the individual to take action to remove the excess amount (¶4-230). • The Commissioner must issue a commutation authority to one or more superannuation providers if an individual has not acted on an excess transfer balance determination by the due date (¶4-230). The commutation authority authorises the commutation in full or in part of an individual’s superannuation income stream. • An individual whose transfer balance exceeds their transfer balance cap may be liable to excess transfer balance tax on excess transfer balance earnings accrued while the cap was exceeded (¶4231). • Transitional rules provided CGT relief for complying superannuation funds that held assets for individuals in the retirement phase and needed to reallocate the assets to the accumulation phase before 1 July 2017 in order to comply with the $1.6m transfer balance cap from that date (¶4-231). • The transfer balance cap rules are modified for certain defined benefit income streams that are subject to commutation restrictions which make some general transfer balance cap rules unworkable, eg the requirement to commute an excess balance and transfer it to the accumulation phase or take it in cash (¶4-232).

¶4-228 Transfer balance account An individual has a transfer balance account if they are, or have at any time been, the “retirement phase recipient” of a superannuation income stream. An individual starts to have a transfer balance account on the later of: (i) 1 July 2017, where they were receiving superannuation income streams on that day; and (ii) the day they first start a superannuation income stream and superannuation income stream benefits are payable to them. “Retirement phase recipient” of a superannuation income stream An individual is a retirement phase recipient of a superannuation income stream at a time if a superannuation income stream benefit: • is payable to the individual at that time from a superannuation income stream that is “in the retirement phase” at that time, or • will be payable to the individual after that time from a superannuation income stream that is in the retirement phase at that time and is a “deferred superannuation income stream”.

A deferred superannuation income stream is basically where the rules for the provision of the benefit provide for payments to start more than 12 months after the superannuation interest is acquired and to be made at least annually afterwards (SISR reg 1.03(1)). “In the retirement phase” From 1 July 2017, the earnings tax exemption (¶4-320) applies when a superannuation income stream is “in the retirement phase”. A superannuation income stream is in the retirement phase if: • a superannuation income stream benefit is currently payable from it • it is a deferred superannuation income stream that has not yet become payable but the member has satisfied a condition of release for retirement, terminal medical condition, permanent incapacity or attaining age 65, or • it is a transition to retirement income stream and the person to whom the benefit is payable has satisfied a condition of release for retirement, terminal medical condition, permanent incapacity or attaining age 65, and, except in the case of attaining age 65 where notification is not required, has notified the superannuation income stream provider that the condition has been satisfied. A transition to retirement income stream is automatically in the retirement phase if it starts to be paid to a reversionary beneficiary after the member’s death. A reversionary transition to retirement income stream can automatically transfer to a dependant on the death of the original pension recipient without a condition of release having to be satisfied. The original transition to retirement income stream does not cease on the original pensioner’s death or a new pension commence when it transfers to the dependant. When the entitlement to a transition to retirement income stream transfers to a reversionary beneficiary, the reversionary beneficiary receives a credit to their transfer balance account (see below). The amount of the credit and when it arises depend on the date of death of the member. Superannuation income streams that are not in the retirement phase The following superannuation income streams are excluded from being in the retirement phase and therefore cannot benefit from the earnings tax exemption: • a deferred superannuation income stream that has not become payable and the member has not met a relevant condition of release • a superannuation income stream that fails to comply with the pension or annuity standards under which it is provided • a transition to retirement income stream where the member has not satisfied a relevant condition of release or has failed to notify the superannuation provider of having done so, and • a superannuation income stream that stops being in the retirement phase because the superannuation provider fails to pay a superannuation lump sum as required by a commutation authority (¶4-230). Changes to a transfer balance account A transfer balance account operates like a bank account, with the value of an individual’s account changing as credit or debit entries are recorded. A credit reduces the amount of available cap space an individual has, and a debit increases the available cap space. Example Ilsa started a pension on 1 July 2017 from a superannuation income stream valued at $950,000. At 1 July 2019, the value of the superannuation interest that supports the pension is $990,000 because of investment earnings. By 1 July 2022, Ilsa has drawn down $250,000 of the superannuation interest that supports the pension. Ilsa started to have a transfer balance account on 1 July 2017, and the balance of the account at all times is $950,000. This reflects the credit that arose on 1 July 2017 when she started the pension.

Credits to a transfer balance account The following amounts are credited towards an individual’s transfer balance account: 1. the value of superannuation interests that support superannuation income streams in the retirement phase the individual was receiving on 30 June 2017 2. the commencement value of new superannuation income streams in the retirement phase the individual starts to receive on or after 1 July 2017, and 3. excess transfer balance earnings on excess transfer balance amounts. An individual has an excess transfer balance when the balance of their account exceeds their personal transfer balance cap on a particular day. The earnings compound daily until the breach of the transfer balance cap is rectified or the Commissioner issues a determination (¶4-230). An excess transfer balance is disregarded if: (i) it is less than $100,000 (ii) is caused by existing superannuation income streams on 30 June 2017, and (iii) the individual rectifies the breach within six months (¶4-231). Once a superannuation income stream has commenced, changes in the value of its supporting interest are not counted as credits. This means that increases in value due to investment earnings do not have the growth counted towards the cap. Law Companion Ruling LCR 2016/9 provides guidance on transfer balance credits. Credit where a payment is made in respect of a limited recourse borrowing arrangement There may also be a credit to an individual’s transfer balance account where an SMSF or a small APRA fund makes a payment in respect of a limited recourse borrowing arrangement (¶5-360) that increases the value of a superannuation interest supporting a retirement phase superannuation income stream. The credit arises at the time of the payment and the amount of the credit is the amount by which the individual’s superannuation income stream increases in value because of the payment. This means the credit can only arise where the payments are sourced from assets that do not support the same income stream, eg from assets that support accumulation interests in the fund. Generally, a credit only arises from payments relating to limited recourse borrowing arrangements where the contract for the borrowing is entered into on or after 1 July 2017, and not to contracts entered into before 1 July 2017 but completed after that date. A credit does not arise where there is a refinancing of the outstanding balance of borrowings arising under contracts entered into before 1 July 2017, although this exemption is only available if the refinancing arrangement applies to the same asset and the refinanced amount is not greater than the outstanding balance on the limited recourse borrowing arrangement just before the refinancing. Credit arising from death benefit income streams A superannuation death benefit (¶4-425) may be paid either as a superannuation income stream or as a lump sum if the beneficiary is a dependant of the deceased member. This means the benefit is paid to a person who is (i) a spouse, (ii) a child of the deceased less than 18 years, (iii) financially dependent or with a disability, or (iv) a person who was in an interdependency relationship with the deceased. Payments to non-dependants must be made as a lump sum. In the case of a non-reversionary death benefit income stream, the value of the supporting superannuation interest is credited to the beneficiary’s transfer balance account on the later of 1 July 2017 and the day the benefit is payable to the beneficiary. In the case of a reversionary death benefit income stream, a credit for the value of the supporting superannuation interest does not arise in the beneficiary’s transfer balance account until 12 months after

the superannuation income stream benefit first becomes payable to the beneficiary. This deferral gives the beneficiary time to adjust their affairs following the death of the member before consequences such as a breach of their transfer balance cap arise. The amount that is credited may include investment gains that accrued to the deceased’s superannuation interest between the time the person died and the income stream became payable to the beneficiary. If a death benefit income stream, in combination with an individual’s own superannuation income stream, results in a beneficiary exceeding their transfer balance cap, they will need to decide which superannuation income stream to commute. A superannuation death benefit cannot be held in an accumulation interest as this contravenes the regulatory requirement to cash the benefit as soon as practicable. The ATO’s views on reversionary and non-reversionary income streams and the timing of transfer balance credits are set out in Law Companion Ruling LCR 2017/3. As a general rule: • a reversionary death benefit income stream is a superannuation income stream that reverts to the reversionary beneficiary automatically upon the member’s death; the superannuation income stream continues with the entitlement to it passing from one person (the member) to another (the dependant beneficiary), and • a non-reversionary death benefit income stream is a new superannuation income stream where the superannuation provider has the power or discretion to determine the recipient, the form in which the death benefit will be paid, eg as a superannuation lump sum or a superannuation income stream, or the amount of the death benefit. Debits to a transfer balance account An individual’s transfer balance account is debited when superannuation income streams that were previously credited (because they receive the earnings tax exemption) are reduced by capital being commuted or because the earnings tax exemption is lost. This ensures that an individual’s transfer balance reflects the net amount of capital the individual has transferred to the retirement phase of superannuation. Pension draw downs are not debited from an individual’s transfer balance. This reflects the expectation that, once an individual has used their transfer balance cap, the value of their retirement phase assets will decline as they use this income to support themselves in their retirement. A debit arises in the transfer balance account in the following cases: • full or partial commutation of a superannuation income stream in the retirement phase to a superannuation lump sum • a structured settlement amount an individual receives for personal injury is contributed towards their superannuation interests • an individual loses some or all of the value in their superannuation interest because of family law payment splits, fraud or void transactions under the Bankruptcy Act 1966 • where a superannuation income stream provider does not comply with a commutation authority (¶4230), a debit equal to the value of the superannuation income stream arises to reflect that the income stream is no longer in the retirement phase, and • where an individual has insufficient superannuation interests available to rectify an excess transfer balance (¶4-230), a debit arises to write off the excess transfer balance. Once a superannuation income stream has commenced, a superannuation interest that supports a superannuation income stream that loses value because of investment losses does not have the reduction reflected in the individual’s transfer balance account. Law Companion Ruling LCR 2016/9 provides guidance on transfer balance debits.

¶4-229 Transfer balance cap When an individual first commences a retirement phase (¶4-228) superannuation income stream, their personal transfer balance cap equals the general transfer balance cap for that financial year. The general transfer balance cap is $1.6m for the 2019/20 financial year, the same as it was for 2018/19 and 2017/18. The general transfer balance cap is subject to indexation in $100,000 increments on an annual basis in line with the CPI. Proportional indexation of the personal transfer balance cap Where an individual starts to have a transfer balance account and has not used the full amount of their cap, their personal transfer balance cap is subject to proportional indexation in line with increases in the general transfer balance cap. Proportional indexation is intended to keep constant the proportion of an individual’s used and unused cap space as the general transfer balance cap increases. Indexation is only applied to an individual’s unused cap percentage. This is worked out by finding the individual’s highest transfer balance at the end of a day at an earlier point in time, comparing it to their personal transfer balance cap on that day and expressing the unused cap space as a percentage. Once a proportion of cap space is used, it is not subject to indexation, even if the individual subsequently removes capital from their retirement phase. Example Singh first commences a $960,000 retirement phase superannuation income stream on 1 July 2017 and there are no further credits to his transfer balance account. Singh’s highest transfer balance is $960,000 which means that, at that time, he has used 60% of his $1.6m personal transfer balance cap. Assuming the general transfer balance cap is indexed to $1.7m in 2022/23, Singh’s personal transfer balance cap is increased proportionally to $1.02m. Singh’s personal transfer balance cap is increased by 60% of the corresponding increase to the general transfer balance cap.

Law Companion Ruling LCR 2016/9 provides guidance on how the transfer balance cap operates for account-based superannuation income streams. Modified transfer balance cap for death benefit income streams payable to a child Death benefit reversionary pensions paid to a child from income streams payable to the deceased prior to death come within the child’s transfer balance cap. Other amounts payable as death benefits to the child must be cashed as lump sums. The transfer balance cap that applies to child dependants in receipt of a reversionary pension is modified so that the child can generally receive their share of the deceased’s retirement phase interest without prejudice to the child’s future retirement. This recognises that child dependants are generally required to commute a death benefit income stream by age 25, at which time their transfer balance account and modified transfer balance cap cease. An exception applies where the child recipient has a permanent disability and is not required to cash the pension. The personal transfer balance cap of a child who is only receiving death benefit income streams as a child recipient is not set to the indexed value of the general transfer balance cap, but is generally determined by reference to the value of the deceased’s retirement phase interests that they receive.

¶4-230 Excess transfer balance determinations An individual has an excess transfer balance if the balance of their transfer balance account (¶4-228) exceeds their personal transfer balance cap (¶4-229) on a particular day. If an individual has more than one superannuation pension account in the retirement phase, the transfer balance cap applies to the combined amount in the accounts. This could include, for example, a pension from a deceased spouse’s superannuation account or pension income from a former spouse’s superannuation pension as part of a Family Court settlement. Guidance Note GN 2017/1 provides ATO guidance on the transfer balance cap for retirement phase

accounts that commence on or after 1 July 2017. The ATO emphasises that members should keep track of their transfer balance account to make sure they do not exceed the cap and that transfers into the retirement phase need to be managed. Example When Wally retired on 1 June 2019, he had an accumulated superannuation balance of $1.85m. He can transfer $1.6m into a retirement phase account to support a pension income stream without exceeding his transfer balance cap. The remaining $250,000 can be kept in an accumulation account or can be withdrawn from superannuation as a cash lump sum. Once he has transferred $1.6m into the retirement income account, Wally cannot make any additional contributions to that account, even if there are fluctuations to the account from investment earnings or the draw down of pension payments.

If an individual has excess transfer balance, the Commissioner may require the superannuation income stream to be fully or partly commuted so that the amount of the individual’s income streams that are in the retirement phase is reduced. Individuals already in retirement before 1 July 2017 with transfer balances in excess of the cap at 30 June 2017 were required to either withdraw the excess amounts from superannuation or transfer the excess amounts into an accumulation account. Transitional arrangements applied for balances that exceeded the cap by no more than $100,000 (¶4231). Transitional relief was also available to ameliorate the CGT consequences where superannuation funds needed to transfer assets from the retirement phase to the accumulation phase before 1 July 2017 (¶4231). Certain defined benefit income streams are not required to be reduced if their value exceeds the transfer balance cap, but defined benefit pension payments are subject to additional taxation consequences (¶4232). Commutation requests made before 1 July 2017 by a member of an SMSF to avoid exceeding the transfer balance cap may have faced the problem that the member did not, at that time, know precisely the value of the superannuation interests that supported their superannuation income streams. The ATO states in Practical Compliance Guideline PCG 2017/5 that an acceptable approach in these circumstances was for the member to make an irrevocable request to commute their income stream by the amount that exceeded $1.6m at 30 June 2017. The commutation request and acceptance by the fund trustee had to be made in writing before 1 July 2017 and to specify the superannuation income stream and a methodology for calculating the precise amount to be commuted. Individual advised of their excess transfer balance When an individual has an excess transfer balance, the Commissioner may make a written excess transfer balance determination stating the amount of the excess (the “crystallised reduction amount”). The Commissioner’s determination must include a “default commutation notice” stating that, if the individual does not make an election by the specified date to commute a superannuation income stream, the Commissioner will issue a commutation authority (see “Commutation authorities” below). An individual may make an election for the commutation of an income stream, and the irrevocable election must generally be made within 60 days from the date the determination was issued. The total amount elected to be commuted must equal the crystallised reduction amount. An individual does not need to make an election if the superannuation income stream they wish to be commuted is the superannuation income stream included in the Commissioner’s default commutation notice. Where an individual has already taken steps to rectify their breach and has removed their excess transfer balance, the Commissioner is not required to issue a determination but the individual may still be liable for excess transfer balance tax (¶4-231). An individual who is dissatisfied with an excess transfer balance determination issued to them may object

within 60 days from the date the determination is served on them. From January 2018, the ATO started sending excess transfer balance determinations to individuals who have exceeded their transfer balance cap and not rectified the excess. The ATO reminds SMSF members on its website that: • the sooner a member removes the amount set out in the determination out of retirement phase, the less excess transfer balance tax they will pay • if the SMSF trustee has not already reported information to the ATO for the member, they must do so as soon as possible. If additional time is needed, the member can request an extension of time • the member must commute the amount set out in the determination from retirement phase. Removing it by making a large pension payment will not result in a debit in their transfer balance account, so they will still be in excess of their transfer balance cap • unless the member is commuting a death benefit income stream, they do not need to remove the amount set out in the determination from the super system. The excess may be kept in an accumulation phase account, and • the trustee must ensure that the minimum pension payment standards are met at the time they commute the income stream. Commutation authorities The Commissioner may issue a commutation authority when an individual has an excess transfer balance. The purpose is for the amount of the individual’s excess to be removed and the transfer balance brought back to the individual’s transfer balance cap. The Commissioner must issue a commutation authority if: (i) an excess transfer balance determination has been issued to an individual and has not been revoked, (ii) the period within which an election may be made by the individual, generally 60 days, has ended, and (iii) an amount remains after the crystallised reduction amount has been reduced by any debits to the transfer balance account arising from a commutation since the determination was issued and notified to the Commissioner. A commutation authority must specify the superannuation income stream to be commuted in full or in part and the amount by which the superannuation income stream is to be reduced. A superannuation income stream provider issued with a commutation authority must, within 60 days, pay by way of commutation a superannuation lump sum equal to the lesser of: • the amount stated in the commutation authority, and • the “maximum available release amount”, ie the total amount of all superannuation lump sums that could be paid from the superannuation interest at that time. The superannuation income stream provider should consult the individual on whether they wish the commutation amount to remain within superannuation in an accumulation account or, if the individual meets a relevant condition of release, to be paid as a superannuation lump sum. A superannuation income stream provider must, within 60 days, notify the Commissioner and the individual of the commuted amount or that the commutation authority will not be complied with because the superannuation income stream is a capped defined benefit income stream (¶4-232). If an individual has an excess transfer balance but no remaining superannuation income streams from which the excess can be commuted, the Commissioner must notify the individual that they have a noncommutable excess transfer balance and a debit for the excess is applied to the individual’s transfer balance account (¶4-228). This effectively writes off the remainder of the excess so that excess transfer balance earnings do not continue to accrue. Consequences of not complying with a commutation authority Where a superannuation income stream provider fails to comply with a commutation authority:

• the relevant superannuation income stream is no longer in the retirement phase and does not qualify for the earnings tax exemption from the start of the financial year in which the non-compliance occurred • a debit arises in the individual’s transfer balance account for the value of the superannuation interest that supports the superannuation income stream that has ceased to be in the retirement phase, which generally will mean the individual no longer has an excess transfer balance, and • if the individual wishes to again have a superannuation income stream that qualifies for the earnings tax exemption, they would need to commute the superannuation income stream in full and start a new superannuation income stream.

¶4-231 Excess transfer balance tax An individual who has an excess transfer balance is liable to excess transfer balance tax on the excess transfer balance earnings accrued while the cap was exceeded. Excess transfer balance tax is not deductible (ITAA97 s 26-99). For first breaches of the transfer balance cap (whether in 2017/18 or in a later year), the tax rate is set at 15%, which broadly replicates the outcome if the excess capital had been in the accumulation phase. For subsequent breaches, the tax rate is 30%. The tax is imposed by the Superannuation (Excess Transfer Balance Tax) Imposition Act 2016. Excess transfer balance tax is applied to the accrued amount of an individual’s excess transfer balance earnings over a period the individual had an excess transfer balance. The earnings are calculated from the date the individual’s transfer balance first exceeds their transfer balance cap to the date when the transfer balance is no longer in excess. Excess transfer balance earnings accrue daily on excess transfer balances at a rate based on the general interest charge. Excess transfer balance tax is due and payable at the end of 21 days after the Commissioner gives an individual notice of the assessment of the amount of the tax. If the tax is not paid by the due date, general interest charge starts accruing on the unpaid amount. Transitional relief for small excess transfer balances at 30 June 2017 Transitional rules apply to excess transfer balances where: (a) the only transfer balance credits in the individual’s transfer balance account (¶4-228) in the sixmonth period beginning on 1 July 2017 related to superannuation income streams the individual had just before 1 July 2017 (b) the sum of those transfer balance credits exceeded the individual’s transfer balance cap, but was less than or equal to $1,700,000, and (c) at the end of the six-month period from 1 July 2017, the sum of all the transfer balance debits arising in the transfer balance account equalled or exceeded the amount of the excess from para (b). The purpose of this transitional rule was to ensure that transfer balance cap breaches of less than $100,000 that occurred on 30 June 2017 were not penalised as long as they were rectified within six months. The assumption was that such small breaches were likely to be unintentional, because it may have been difficult for individuals with existing superannuation income streams to predict their retirement phase balances at 30 June 2017 and ensure they were not in breach of their $1.6m transfer balance cap. Transitional CGT relief when assets transferred from retirement phase Under the pre-1 July 2017 law, capital gains on the disposal of assets that supported a superannuation income stream could be exempt from tax (the earnings tax exemption: ¶4-320). From 1 July 2017, an individual with a transfer balance over the transfer balance cap ($1.6m for 2019/20, 2018/19 and 2017/18) is required to commute or roll back the excess amount to the accumulation phase, with earnings on the transferred amount subject to 15% tax. This could make a fund liable to CGT on capital gains accumulated before 1 July 2017 where the gains would, in the absence of the new law, have been

exempt income. Transitional CGT relief was introduced to ameliorate this potential consequence. Under the transitional provisions, complying superannuation funds were able to reset the cost base of assets to their market value where those assets were reallocated or reapportioned from the retirement phase to the accumulation phase before 1 July 2017 in order to comply with the transfer balance cap rules. CGT relief was available if: • the reallocation or reapportionment from the retirement phase took place during the period 9 November 2016 to 30 June 2017 in relation to assets held by a complying superannuation fund through that period, and • the superannuation fund made an irrevocable choice to apply the relief and notified the choice to the Commissioner by the day the trustee is required to lodge the fund’s 2016/17 income tax return. The CGT relief operated on an asset-by-asset basis and had the effect that: (a) the fund was deemed to have sold and reacquired the relevant asset for market value at the following times: (i) if the asset was a segregated pension asset for the purposes of the earnings tax exemption on 9 November 2016 and stopped being a segregated pension asset before 1 July 2017 — on the day it stopped being a segregated pension asset, or (ii) if the fund obtained an actuarial certificate to claim an exemption based on a proportion of its assets — immediately before 1 July 2017 (b) the deemed sale triggered CGT event A1 and resulted in the reacquired asset having its cost base set at its current market value (c) when the asset is sold after 1 July 2017, a capital gain only arises in relation to capital growth that accrued to the asset after the CGT relief was applied, ie once the asset is no longer supporting superannuation interests in the retirement phase (d) the 12-month eligibility period for the CGT discount commences on the date the asset is deemed to be sold and reacquired, and (e) any subsequent events that could affect the asset’s cost base apply to the reset cost base amount. Law Companion Ruling LCR 2016/8 sets out the Commissioner’s approach to the transitional CGT relief. The Commissioner warns in the ruling that the anti-avoidance provisions in ITAA36 Pt IVA (¶1-610) could apply if a superannuation trustee entered into a scheme for the main purpose of placing the trustee in a position to be able to choose the CGT relief so as to obtain a tax benefit. If a scheme goes further than is necessary to comply with the transfer balance cap reforms, and involves additional steps unnecessary for that purpose but necessary to obtain a tax benefit, the Commissioner will generally infer that the scheme was entered into for the purpose of obtaining a tax benefit. Merely commencing a pension during the period 9 November 2016 to 30 June 2017 was not of concern from a Pt IVA perspective, but a commutation of the pension shortly after its commencement might suggest the purpose of obtaining a tax benefit.

¶4-232 Modified transfer balance cap rules for capped defined benefit income streams Many defined benefit superannuation income streams are subject to commutation restrictions which make some of the transfer balance cap rules unworkable, eg the requirement to commute an excess balance and transfer it to the accumulation phase or take it in cash. As a result, the transfer balance cap rules have been modified so that they apply appropriately to those defined benefit income streams. The purpose of the modifications is to accord taxation treatment to certain non-commutable

superannuation income streams that is commensurate with the treatment accorded to other income streams under the transfer balance cap rules. The modifications: (i) change the valuation rules (ii) prevent an individual from having an excess transfer balance in certain circumstances, and (iii) change the tax treatment of a superannuation income stream benefit. Capped defined benefit income streams The modifications apply to “capped defined benefit income streams”, basically superannuation income streams that are subject to commutation restrictions. Two categories of superannuation income streams are affected: (1) lifetime pensions, which are often provided to Commonwealth, state and territory public office holders and military and civilian employees and meet the standards in SISR reg 1.06(2) — this means they are paid at least annually throughout the life of the primary beneficiary with the size of the pension payments in a given year fixed, the amount paid as a benefit in each year cannot be reduced except if the CPI falls, and the income stream can only be commuted to a lump sum amount in very limited circumstances including within six months of the pension commencing, and (2) other superannuation income streams that already existed at 30 June 2017 — this covers certain lifetime annuities, life expectancy pensions and annuities and market-linked annuities and pensions. A superannuation income stream may also be a capped defined benefit income stream if it is prescribed as such by the following regulations: • SISR reg 1.06A prescribes certain innovative superannuation income streams where the benefit cannot commence before the primary beneficiary has retired, has a terminal medical condition, is permanently incapacitated or has reached age 65, the benefits are payable throughout the life of the beneficiary, the payments are not unreasonably deferred after they start, and there are commutation restrictions on access to capital, and • ITAR reg 294-130.01(2) prescribes lifetime pensions where commutation is permitted outside of six months of the commencement day, reversionary pensions that allow a child beneficiary to commute at any time, public sector scheme invalidity pensions that can be varied, suspended or terminated in certain circumstances and certain partial invalidity pensions provided by public service schemes Special value of capped defined benefit income streams An individual may determine the “special value” of a capped defined benefit income stream for the purposes of their transfer balance account. The special value of a superannuation interest that supports a lifetime pension or a lifetime annuity is worked out by multiplying the annual entitlement by a factor of 16. An individual’s annual entitlement is worked out by annualising the first income stream benefit payable from the income stream across an income year. Subsequent increases to the income stream benefit due to indexation are not relevant to the calculation of the annual entitlement. The use of a factor of 16 means that a pension that pays $100,000 per annum would fully exhaust the $1.6m transfer balance cap. The special value of life expectancy pensions and annuities and market-linked pensions and annuities is worked out by multiplying the annual entitlement by the number of years remaining on the term of the product. Example Bron purchases a market-linked pension in January 2018 with a term of five years. At 30 June 2018, the pension has an annual entitlement of $70,000. The remaining term is rounded up to five years, giving the pension a special value of $350,000.

The special value rules are used to determine the amount of credits and debits that arise in relation to capped defined benefit income streams. Where an individual receives a capped defined benefit income stream, a credit arises in their transfer balance account equal to the special value of the superannuation interest that supports the income stream. Where a life expectancy or market-linked pension or annuity being paid before 1 July 2017 becomes payable to a reversionary beneficiary on or after 1 July 2017, the credit that arises in the beneficiary’s transfer balance account is equal to the special value of the superannuation interest that supports that income stream on the date it first becomes payable to the beneficiary. The credit arises in the transfer balance account 12 months later. A transfer balance debit arises: (i) for a full commutation of a superannuation income stream — equal to the income stream’s debit value at that time; (ii) for a partial commutation — equal to a proportion of the income stream’s debit value, worked out by subtracting from 1 the special value of the income stream immediately after the commutation divided by the special value of the income stream immediately before that time; and (iii) where an income stream ceases to be in the retirement phase — equal to the income stream’s debit value. The debit amount that arises is worked out by reference to the superannuation income stream’s “debit value” which is generally: (i) for a lifetime pension or annuity, the residual of its starting special value taking into account previous associated debit amounts, and (ii) for a life expectancy or market-linked pension or annuity, its special value at the relevant time. Excess transfer balance If an individual only has a capped defined benefit income stream, the transfer balance in their transfer balance account can never exceed their capped defined benefit balance, which means there is not an excess transfer balance. An individual may have an excess transfer balance if they have both a capped defined benefit income stream and another superannuation income stream. The individual may choose to fully or partly commute the other superannuation income stream to reduce the balance of their transfer balance account below their transfer balance cap. If the value of the superannuation interest supporting the other superannuation income stream is reduced to nil, so that the individual only has the capped defined benefit income stream, the Commissioner will issue a notice to the individual. A debit arises in the individual’s transfer balance account at that time equal to the amount of the excess transfer balance stated in the notice. As a consequence, the individual will have to cease an excess transfer balance in their transfer balance account (Law Companion Ruling LCR 2016/10). Income tax consequences Capped defined benefit income streams do not, of themselves, result in an excess transfer balance (¶4230) for an individual. Income tax consequences may, however, arise for an individual with defined benefit pension or annuity income that exceeds the defined benefit income cap for a financial year. The defined benefit income cap is $100,000 per annum. These consequences are that: (a) for benefits paid from a taxed element, 50% of the excess may be included in the individual’s assessable income and taxed at marginal rates, or (b) for benefits paid from an untaxed element, the 10% tax offset may be limited to the first $100,000 of defined benefit income the individual receives (¶4-420). ATO guidance Law Companion Ruling LCR 2016/10 provides commentary and examples on lifetime pensions and annuities that are capped defined benefit income streams. Law Companion Ruling LCR 2017/1 clarifies how the defined benefit income cap applies to

superannuation income stream pensions or annuities that are paid from non-commutable life expectancy or market-linked products.

¶4-233 Total superannuation balance The concept of a “total superannuation balance” is used from 1 July 2017 to value an individual’s total superannuation interests. It is broadly the amount the individual has in superannuation at a particular time, including amounts in pension and accumulation phase. An individual’s total superannuation balance is used to determine their superannuation rights and entitlements for an income year and is generally tested at 30 June of the prior income year. Significance of the total superannuation balance To be eligible for the following concessions from 2017/18, an individual’s total superannuation balance must be less than the general transfer balance cap (¶4-229), ie $1.6m for 2019/20, 2018/19 and 2017/18, at 30 June in the previous financial year: 1. to be eligible to make non-concessional contributions or to bring forward non-concessional contributions for the next two years (¶4-240) 2. to receive a government co-contribution (¶4-265) 3. to receive a tax offset for spouse contributions (¶4-275) — in this case, it is the spouse’s total superannuation balance that is tested against the general transfer balance cap, and 4. to increase the basic concessional contributions cap by catch-up contributions (¶4-234) — the total superannuation balance in this case must be under $500,000 at 30 June of the previous financial year. The total superannuation balance is also used to determine if an SMSF or a small APRA fund is able to use the segregated assets method for determining exempt current pension income in a financial year (¶4320). These funds must use the proportionate method for the full year, if (i) the fund has at least one member who has a superannuation interest in the fund that is in the retirement phase, and (ii) at the end of 30 June of the previous financial year, the individual has a total superannuation balance that exceeds the general transfer balance cap (¶4-229) ($1.6m for 2019/20, 2018/19 and 2017/18) and is a retirement phase recipient (¶4-228) of a superannuation income stream. Calculation of the total superannuation balance An individual’s total superannuation balance at a particular time is calculated as the sum of: 1. the accumulation phase value of their superannuation interests that are not in the retirement phase (¶4-227), ie generally the total amount of superannuation benefits that would become payable if the individual voluntarily caused the superannuation interest to cease at that time, or an amount as calculated according to the regulations. Transition to retirement income streams, non-commutable allocated pensions or annuities, and deferred superannuation income streams that are not yet payable may be included in the accumulation phase value 2. the retirement phase value of their superannuation interests, which is the balance of their transfer balance account (generally, the commencement value of a superannuation pension). An individual’s transfer balance is adjusted: (i) to reflect the current value of account-based superannuation interests in the retirement phase; and (ii) to disregard any debits that have arisen in respect of structured settlements, and 3. any roll-over superannuation benefits paid at or before that time and received by the fund after that time, and not reflected in the individual’s accumulation phase value or balance of their transfer balance account (the amount may, for example, be in transit because it is rolled over at the end of a financial year), reduced by structured settlement contributions. Structured settlement contributions are excluded from the

total superannuation balance calculations to recognise that these are usually large payments that can provide the funds for ongoing medical and care expenses resulting from serious injury and income loss. Where an individual’s total superannuation balance was calculated on 30 June 2017, the calculation of their transfer balance was based on the credits to their transfer balance account that arose at the start of 1 July 2017 (because of existing superannuation income streams) less payment split debits that might apply to those income streams on 1 July 2017. Law Companion Ruling LCR 2016/12 provides guidance on how an individual’s total superannuation balance is calculated from 1 July 2017. The Ruling includes examples relating to: (i) an account-based pension and defined benefit lifetime pension; (ii) partial commutation of an account-based annuity; (iii) excess transfer balance credit; (iv) a roll-over superannuation benefit; (v) a structured settlement contribution; (vi) structured settlement contribution split between an account-based pension and a lifetime pension; (vii) transitional arrangements at 30 June 2017 for an account-based pension; and (viii) transitional arrangement at 30 June 2017 for a structured settlement contribution and payment split. In Guidance Note GN 2017/8, the ATO recommends a member take the following steps to work out their total superannuation balance at the end of 30 June of a financial year: 1. Ensure they know the balances of all their interests in accumulation phase and the value of any superannuation income streams at the end of 30 June of the relevant year. 2. If necessary, contact their fund to obtain the most up-to-date information, or it may be on their annual statement. 3. A member who has a defined benefit interest and has not retired may need to contact their fund to determine the accumulation phase value of their interest. 4. If necessary, find out the value of any concessional and non-concessional contributions made to their fund in the financial year and whether any roll-over benefits are in transit between their funds at 30 June. 5. Make relevant adjustments if they have contributed a structured settlement payment or there has been a payment split. Proposal to take limited recourse borrowing arrangements into account The Treasury Laws Amendment (2018 Superannuation Measures No 1) Bill 2018 proposed that the outstanding balance of a limited recourse borrowing arrangement may be included in a member’s total superannuation balance. A member’s total superannuation balance would only be increased where the member had either satisfied a condition of release with a nil cashing restriction, eg reaching 65 years or being over 60 and ceasing gainful employment, or it was a related-party arrangement in the sense that the arrangement is between the fund and one of its associates. ’The proposal only affected superannuation assets in an SMSF or in other funds with fewer than five members, and borrowings arising under contracts entered into on or after 1 July 2018. The Bill lapsed when Parliament was prorogued for the 2019 federal election.

¶4-234 Excess concessional contributions Penalties may be imposed on a superannuation fund member for whom concessional contributions are made in a year in excess of the concessional contributions cap. There are two types of penalties: (1) from 2013/14, excess concessional contributions are included in the member’s assessable income and taxed at marginal rates, and an excess concessional contributions charge may also be imposed, and (2) before 2013/14, excess concessional contributions tax of 31.5% was imposed on the excess concessional contributions. The imposition of penalties on excess concessional contributions is discussed at ¶4-235.

The tax treatment of excess non-concessional contributions is discussed at ¶4-240. Concessional contributions cap An individual has excess concessional contributions if the amount of their concessional contributions for an income year exceeds their concessional contributions cap for the year. For 2019/20 (and also 2018/19 and 2017/18), the basic concessional contributions cap is $25,000, and this cap applies to all individuals. For earlier years, a higher cap applied for older individuals. The concessional contributions cap may be indexed from year to year, but only if indexation would increase the cap by at least $2,500. For years before 2017/18, the concessional contributions cap was increased if indexation would increase the cap by at least $5,000. Individuals with a total superannuation balance (¶4-233) below $500,000 who do not fully use their concessional contributions cap may be allowed to make additional concessional contributions for unused cap amounts. See “Basic concessional contributions cap may be increased by catch-up contributions” below. Concessional contributions Concessional contributions are contributions that are included in the assessable income of the recipient superannuation fund. Most commonly, concessional contributions are: • employer contributions, whether SG contributions, additional voluntary employer contributions or employer contributions made after an employee enters into a salary sacrifice arrangement, and • personal contributions for which the member has claimed a deduction. Amounts allocated from a reserve for a member according to conditions set out in the regulations are treated as concessional contributions. These conditions generally require a trustee who receives a contribution in a month to allocate the contribution to a member within 28 days after the end of the month or, if this is not reasonably practicable, within a reasonable time. Concessional contributions that are split by a member with their spouse (¶4-260) are counted in determining whether the member (not the spouse) has exceeded the concessional contributions cap, because those contributions will have been taxed when originally paid to the fund for the member. Concessional contributions do not include contributions made for a spouse or for a child aged under 18 unless the spouse or child is an employee of the contributor, but they do include contributions made for other family members even if not deductible. Concessional contributions also do not include: • an amount transferred to a complying superannuation fund from a foreign superannuation fund where the former member of the foreign fund chooses that the amount be included in the assessable income of the receiving fund rather than the member being taxed on the amount (¶4-650), or • a roll-over superannuation benefit that an individual is taken to receive, to the extent that it consists of an element untaxed in the fund and is not an excess untaxed roll-over amount (¶4-430). Defined benefit interests Concessional contributions are defined differently where the member has a defined benefit interest, ie where the benefit payable to the person is defined by reference to the person’s salary, a specified amount or specified conversion factors. Where a member has a defined benefit interest, employer contributions may not be attributable to each individual member and, in such a case, the calculation of a member’s concessional contributions is based on their “notional taxed contributions” as calculated according to the regulations. Before 1 July 2017, the concessional contributions amount for a defined benefit interest was basically an individual’s notional taxed contributions.

From 1 July 2017, an additional amount is included in an individual’s concessional contributions to ensure the concessional contributions amount better reflects the full amount of accrued benefits for the defined benefit interest for the financial year. The additional amount is the amount by which the defined benefit contributions for the defined benefit interest exceed the notional taxed contributions for the interest. For schemes that are unfunded or partially unfunded, the individual’s defined benefit contributions will typically be greater than their notional taxed contributions and they will therefore have an additional amount to include in their concessional contributions. Because the amount of notional taxed contributions for a member of a defined benefit scheme is largely beyond the member’s control, grandfathering arrangements apply to some members with notional taxed contributions in excess of the concessional contributions cap. These arrangements have the effect that the notional taxed contributions for the member’s defined benefit interest may be taken to be at, and not in excess of, the concessional contributions cap. To be eligible for the grandfathering provisions, an individual must: • for 2009/10 onwards, have been a member of an eligible defined benefit fund on 12 May 2009 • not have had a substantial change to the rules of their benefit since that date, and • not have had a non-arm’s length change to their salary of more than 50% in a year or 75% in three years since that date. Constitutionally protected funds and unfunded defined benefit schemes From 1 July 2017, contributions to constitutionally protected funds and certain other amounts relating to constitutionally protected funds and unfunded defined benefit schemes are included in a taxpayer’s concessional contributions and count towards their concessional contributions cap in the same way as they would for other superannuation funds. Concessional contributions included as a result are not treated as excess concessional contributions and taxed as such, but the fact that they are counted towards an individual’s concessional contributions cap limits the individual’s ability to make further concessional contributions. Members would have excess concessional contributions if they have other concessional contributions and, as a result, their total concessional contributions exceed the cap. Before 1 July 2017, these amounts did not count towards a member’s concessional contributions cap and members of constitutionally protected funds and unfunded defined benefit schemes were able to make additional concessional contributions to other superannuation funds. Law Companion Ruling LCR 2016/11 explains how concessional contributions are calculated for defined benefit interests and constitutionally protected funds from 1 July 2017. The amount included in an individual’s concessional contributions from 1 July 2017 will reflect the full amount of funded and unfunded accrued benefits for defined benefit interests. According to the ATO, this will be the amount by which the “defined benefit contributions” for the interest (generally, as calculated for the purposes of Division 293 tax: ¶4-225) exceed the “notional taxed contributions” for the interest. Law Companion Ruling LCR 2016/11 contains seven examples to illustrate the ATO’s view. Basic concessional contributions cap may be increased by catch-up contributions Individuals who do not fully use their concessional contributions cap from the 2018/19 financial year may be able to make catch-up contributions in later years. The purpose of allowing catch-up contributions is to benefit people whose ability to make regular superannuation contributions is limited by interrupted work patterns or irregular income. Individuals with a total superannuation balance (¶4-233) of less than $500,000 just before the start of a financial year may be able to increase their concessional contributions cap in the financial year by applying unused concessional contributions cap amounts from one or more of the previous five financial years. The $500,000 threshold amount is not indexed. An individual would have unused concessional cap amounts for a financial year if they did not fully use their basic concessional contributions cap for that year. Only unused amounts accrued from the 2018/19 financial year onwards may be carried forward. This means the 2019/20 financial year is the first year in which unused concessional contributions cap

amounts can be applied. Unused amounts not utilised after five years cannot be carried forward. An individual’s concessional contributions cap cannot be increased by more than the amount by which they would otherwise exceed the concessional contributions cap. Only the exact amount of unused concessional contributions cap that is necessary is used, and any remaining unapplied unused concessional contributions cap is preserved to be carried forward for another year. Example In the 2023/24 financial year, Saul has $45,000 concessional contributions, comprising a deductible personal contribution of $28,000 and his employer’s contribution of $17,000 on his behalf. At 30 June 2023, Saul’s total superannuation balance is less than $500,000. Assuming that the basic concessional contributions cap is $25,000 for 2023/24, Saul will have exceeded the cap by $20,000 in that year. For the previous five years, he has unused concessional contributions cap amounts of $15,000. Saul will be able to increase his concessional contributions cap for 2023/24 by using $15,000 of unused concessional contributions cap from the previous five years. The remaining $5,000 of unapplied concessional contributions cap is carried forward for a later year.

Amounts of unused concessional contributions cap are applied in order from the earliest to the most recent year. Amounts not used after five financial years can no longer be carried forward. The government has indicated its intention to allow individuals with unused concessional cap space to contribute more than $25,000 under the concessional cap carry forward rules during the work test exemption year (¶4-205). Legislation to enact this measure has not yet been introduced into Parliament.

¶4-235 Penalties imposed on excess concessional contributions Excess concessional contributions (¶4-234) are included in a member’s assessable income and are taxed at marginal rates. Excess concessional contributions charge is also imposed on the excess contributions. In the absence of the penalties, concessional contributions would be taxed at 15% when paid into a complying superannuation fund and the benefit attributable to those contributions would be tax-free if later paid as a superannuation benefit to a member aged at least 60. Penalties on excess concessional contributions may be avoided if, on application by the member, the Commissioner makes a determination to disregard contributions or to reallocate them to another year (¶4250). Treatment of excess concessional contributions From 2013/14, excess concessional contributions are treated as follows. 1. Included in assessable income and taxed at ordinary tax rates Excess concessional contributions, ie concessional contributions in excess of the relevant concessional contributions cap (¶4-234) for the year, are included in an individual’s assessable income and taxed at ordinary tax rates (¶1-055). The Commissioner retains discretion to disregard or reallocate excess concessional contributions to another year upon the application of an individual (¶4-250). 2. Offset of 15% of the excess contributions An individual is entitled to a non-refundable offset equal to 15% of their excess concessional contributions. This offset reduces the individual’s tax liabilities to account for the tax payable on the contributions when they are paid to the superannuation fund. If the amount of the offset is greater than the tax liability, the excess amount of the offset is lost. Example For the 2019/20 financial year, Chris, who is aged 43 and runs his own business, claims a $40,000 deduction for the contributions he makes to his superannuation fund. Because Chris’ concessional contributions cap is $25,000, he has excess concessional contributions of $15,000. The tax consequences for Chris are as follows: – the $15,000 excess concessional contributions are included in Chris’ assessable income and taxed at his marginal tax rate

– he is entitled to a tax offset equal to 15% of the excess concessional contributions, ie a tax offset of $2,250 ($15,000 × 15%), and – the offset is applied to reduce the income tax liability on Chris’ income for the year.

3. Imposition of excess concessional contributions charge Excess concessional contributions charge is payable on the amount of an individual’s income tax liability for an income year that is attributable to the individual having excess concessional contributions. The calculation of the charge takes into account both the increase in the individual’s income tax liability due to the inclusion of their excess concessional contributions and the reduction in their tax liability due to the tax offset. The charge is payable from the first day of the income year in which the excess concessional contributions are made to the day before the tax is due to be paid under the individual’s first income tax assessment for the year that includes the excess concessional contributions. The excess concessional contributions charge for a day is worked out by multiplying the rate worked out under s 4 of the Superannuation (Excess Concessional Contributions Charge) Act 2013 for that day by the sum of: (i) the amount of tax on which the individual is liable to pay the charge, and (ii) the excess concessional contributions charge on that amount from previous days. The formula for calculating the charge uses a base interest rate for the day plus an uplift factor of 3%. The base interest rate is the monthly average yield of 90-day Bank Accepted Bills published by the Reserve Bank of Australia. Excess concessional contributions charge is calculated daily and compounds daily. The charge is not deductible (ITAA97 s 26-74) and the Commissioner does not have discretion to remit it. Example In 2019/20, Sanjay has excess concessional contributions of $5,000 and, when this amount is included in his assessable income, his taxable income is $70,000. Sanjay’s marginal tax rate is 32.5% and he is also liable for Medicare levy of 2%. As a result of the excess concessional contributions, Sanjay’s taxable income has increased by $5,000, and his additional tax liability is $1,725 ($5,000 × 34.5%). Sanjay is entitled to a tax offset equal to 15% of his excess concessional contributions, decreasing his tax liability by $750. The amount of Sanjay’s income tax liability that is attributable to his excess concessional contributions is $975 ($1,725 − $750). The calculation of the charge is based on this amount.

4. Release of excess contributions An individual may elect to have up to 85% of their excess concessional contributions for a financial year released from superannuation. There is an 85% cap because the remaining 15% represents the income tax liability that the fund incurred when it received the contributions. The choice of how much to release, up to the 85% limit, is at the discretion of the individual. No tax is payable on the released amount. Once the Commissioner receives an individual’s election to release an amount, the Commissioner must provide a release authority for the specified amount to the relevant superannuation fund. A superannuation fund may choose not to comply with the release authority if the individual has a defined benefit interest, an interest in a non-complying fund or an interest that supports a superannuation income stream. 5. Impact on the amount of an individual’s non-concessional contributions An individual’s excess concessional contributions are included in the calculation of their non-concessional contributions, which is significant in determining whether the individual has excess non-concessional contributions (¶4-240). If an individual elects to release an amount of their excess concessional contributions, the amount of their excess concessional contributions that is counted is reduced for the

purpose of determining their non-concessional contributions. The amount of the reduction is equal to 100/85 of the amount released. As a result, if an individual chooses to release the full 85% of their excess concessional contributions, their excess concessional contributions will have no impact on their nonconcessional contributions. Excess concessional contributions tax before 2013/14 For 2012/13 and earlier years, excess concessional contributions tax was payable by an individual on their excess concessional contributions. If the Commissioner determined that an individual had excess concessional contributions, the Commissioner sent to the individual: (i) an excess concessional contributions tax assessment, and (ii) a release authority to enable the individual to withdraw the amount of the excess concessional contributions tax from their superannuation fund. The release authority allowed the individual to withdraw excess contributions and use them to satisfy the tax liability. Excess concessional contributions were also included in an individual’s non-concessional contributions (¶4-240), which could have the effect of the individual being liable to excess non-concessional contributions tax (¶4-245).

¶4-240 Excess non-concessional contributions An individual has excess non-concessional contributions for a year if the amount of their nonconcessional contributions for the year exceeds their non-concessional contributions cap. For an individual with excess non-concessional contributions, the consequence may be either: • an election by the individual to withdraw the excess contributions and earnings on those contributions, and to pay tax on those earnings, or • a liability to excess non-concessional contributions tax. The tax treatment of excess non-concessional contributions is discussed at ¶4-245. Non-concessional contributions cap As a general rule, the non-concessional contributions cap is $100,000 for 2019/20, the same as for 2018/19 and 2017/18. The cap was $180,000 for the years 2014/15 to 2016/17. The non-concessional contributions cap is indexed in increments of $2,500 in line with average weekly ordinary time earnings. From 2017/18, the non-concessional contributions cap is nil for an individual who, immediately before the start of the year, had a total superannuation balance (¶4-233) that equals or exceeds the general transfer balance cap (¶4-229) for the year ($1.6m for 2019/20, 2018/19 and 2017/18). Such individuals are not allowed to make non-concessional contributions for the year. Bringing forward non-concessional contributions Despite the actual amount of the non-concessional contributions cap for a year, an individual aged under 65 may be able to use three years’ worth of non-concessional contributions in one year. Individuals who are aged 63 or 64 in a particular year and who fully take advantage of the bringing forward of contributions for the next two years are not required to meet the work test (¶4-205) in either of those two following years. From 2017/18, an individual is eligible to bring forward contributions in a particular financial year if: • their non-concessional contributions for that year exceed their general non-concessional contributions cap • their total superannuation balance (¶4-233) is less than the general transfer balance cap (¶4-227)

($1.6m for 2019/20, 2018/19 and 2017/18) • the difference between the general transfer balance cap and their total superannuation balance is greater than the general non-concessional contributions cap • they are under 65 years at any time in the year, and • a bring-forward period is not currently in operation for them in respect of the year. In the 2019/20, 2018/19 and 2017/18 financial years, the amount of the cap an individual may bring forward is: (a) three times the annual cap, ie $300,000, over three years if their total superannuation balance is less than $1.4m (b) two times the annual cap, ie $200,000, over two years if their total superannuation balance is above $1.4m and less than $1.5m, and (c) nil if their total superannuation balance is $1.5m or above, ie there is no bring-forward period and the general non-concessional contributions cap applies. An individual cannot make a non-concessional contribution at all in 2019/20, 2018/19 or 2017/18 if their total superannuation balance at 30 June before the year commences is $1.6m or more. Transitional arrangements apply to individuals who brought forward their non-concessional contributions cap in the 2015/16 or 2016/17 financial years. These rules ensure the benefit of the $180,000 pre2017/18 cap is not retained for any part of the bring-forward period that occurs in 2017/18 or later years. Example If an individual triggered their bring-forward period in the 2015/16 financial year, their non-concessional contributions cap for the first (2015/16) and second (2016/17) years are set by the rules that applied to those years, ie based on $180,000. Their cap for the 2017/18 year is applied as if the first year cap had been $460,000 (ie $180,000 for 2015/16, $180,000 for 2016/17 and $100,000 for 2017/18). The individual is entitled to contribute $460,000 over the bring forward period. If, however, an individual triggered their bring forward period in the 2016/17 financial year, their non-concessional contributions cap for the first (2016/17) year is set by the rules that applied to that year, ie based on $180,000. Their cap for the second (2017/18) and third (2018/19) years is applied as if the first year cap had been $380,000 (ie $180,000 for 2016/17, $100,000 for 2017/18 and $100,000 for 2018/19).

The government has indicated its intention to allow individuals whose non-concessional contributions, excluding contributions made under the work test exemption (¶4-205), exceed $100,000 to access the bring forward arrangements. At the time of writing, legislation to enact this measure had not yet been introduced into Parliament. Non-concessional contributions Non-concessional contributions are generally contributions made in a year by an individual that are not included in the assessable income of a superannuation fund. In most cases, these are undeducted contributions from after-tax income. Contributions made directly by an individual into their spouse’s account (¶4-250) are counted against the receiving spouse’s non-concessional contributions cap, and not against that of the contributor. Excess concessional contributions (¶4-234) may also be counted as non-concessional contributions. From 2013/14, where an individual elects to have excess concessional contributions released from superannuation (¶4-235), the released amount is not counted as non-concessional contributions. Amounts that are not included in non-concessional contributions Non-concessional contributions generally do not include: • a government co-contribution

• a payment relating to a structured settlement or orders for personal injuries • contributions to a constitutionally protected fund (usually for state government employees), or • an amount rolled over from one complying superannuation fund to another or paid from a complying superannuation fund to an entity to purchase a superannuation annuity. Contributions of amounts that come from the disposal of small business assets may also not be included in a person’s non-concessional contributions. The amount that is not included is contributions up to the “CGT cap amount”. This is a lifetime, not annual, cap. The CGT cap amount, which is $1.515m for 2019/20 ($1.480m for 2018/19 and $1.445m for 2017/18), may include: • capital gains on assets that the taxpayer has held for at least 15 years • capital proceeds from the disposal of assets that would otherwise have qualified for the CGT exemption except that the disposal of the assets resulted in no capital gain, the asset was a pre-CGT asset, or the asset was disposed of within 15 years because of the permanent incapacity of the person, and • up to $500,000 of capital gains arising from the sale of a small business and placed in a complying superannuation fund so it can be used for retirement.

¶4-245 Tax treatment of excess non-concessional contributions For 2019/20 (and the previous six years), two possible tax treatments apply where an individual has excess non-concessional contributions (¶4-240) for a year: • the individual can elect to withdraw excess non-concessional contributions plus 85% of the associated earnings on the excess contributions and tax is payable on the associated earnings, or • the individual is liable to pay excess non-concessional contributions tax on the excess contributions. Election to withdraw excess non-concessional contributions In order to avoid liability to excess non-concessional contributions tax, an individual can elect to withdraw excess non-concessional contributions made on or after 1 July 2013 plus 85% of the associated earnings on the excess contributions. The full amount of the associated earnings are taxed at the individual’s marginal tax rate, but the individual is entitled to a non-refundable tax offset equal to 15% of the associated earnings that are included in their assessable income. Excess non-concessional contributions tax is not imposed on excess non-concessional contributions if they are withdrawn from the superannuation fund, but may be imposed on any excess contributions that remain in the fund. The “associated earnings” amount is intended to approximate the amount earned from the excess contributions while they were held in superannuation. The amount is calculated for the period that: • starts on the first day of the year the excess contributions were made, and • ends on the day the Commissioner makes a determination that the individual has excess nonconcessional contributions for the year. The amount is calculated using an average of the general interest charge rate for each of the quarters of the contributions year and compounds on a daily basis. If an individual elects to release their excess non-concessional contributions plus 85% of the associated earnings, the Commissioner must issue a release authority to a superannuation fund identified in the election. The superannuation fund that receives the release authority has 21 days to pay to the individual the lesser of the amount stated in the release authority and the maximum amount that can be released

from interests it holds for the individual. The tax consequences of the individual’s election are: • the excess non-concessional contributions that are paid to the individual are received as a tax-free superannuation lump sum benefit • the associated earnings amount is included in the individual’s assessable income and taxed at the individual’s marginal tax rate for the year the excess contributions were made, and • the individual is entitled to a non-refundable tax offset equal to 15% of the associated earnings amount included in their assessable income. The ATO is monitoring (search: Super Scheme Smart: Individuals) schemes where individuals (including SMSF members) seek refunds of deliberately excess non-concessional contributions with a view to manipulating the taxable and non-taxable components of their superannuation account balances. Liability to excess non-concessional contributions tax Excess non-concessional contributions tax may be payable by an individual who has excess nonconcessional contributions in a year. The tax is payable on the excess contributions at the rate of 47% for 2019/20, 2018/19 and 2017/18 (49% for 2016/17, 2015/16 and 2014/15). If the excess non-concessional contributions were made on or after 1 July 2013, excess non-concessional contributions tax is not imposed to the extent that the individual chooses to withdraw the excess contributions plus 85% of associated earnings from superannuation (see “Election to withdraw excess non-concessional contributions” above). If, based on superannuation fund and tax return information, the Commissioner determines that an individual has excess non-concessional contributions for a year, the Commissioner will: • make an assessment of the individual’s excess non-concessional contributions tax liability, and • send to the individual an excess non-concessional contributions tax assessment and a release authority. The release authority authorises the fund, according to the individual’s direction, to pay either the individual or the ATO an amount up to the amount stated in the authority. The authority allows an individual to withdraw superannuation money which would otherwise be preserved in the fund until the individual has reached preservation age or has retired (¶4-400). The individual must, within 21 days, give the release authority to a fund that holds a superannuation interest for the person (other than a defined benefit interest). As long as the release authority is given to the superannuation fund as required, the fund must comply with the request for the release of funds within 30 days. If payment is made to the ATO, it is taken to satisfy the individual’s liability for excess nonconcessional contributions tax. If payment is made to the individual, it is tax-free to the extent that it does not exceed the amount authorised for release, with any excess amounts being assessed at marginal rates. In some circumstances, the ATO may send the release authority directly to the superannuation fund.

¶4-250 Excess contributions may be disregarded or reallocated to another year In limited circumstances, the Commissioner may make a determination that excess concessional contributions (¶4-234) or excess non-concessional contributions (¶4-240) are to be disregarded or reallocated to another year. Such a determination would reduce the adverse consequences that follow from excess contributions being made for an individual (¶4-235 and ¶4-245). The Commissioner may only make a determination to disregard contributions or to allocate them to another year if it is considered that: • to make the determination would be consistent with the object of the legislation, which is stated to be to ensure that the amount of concessionally taxed superannuation benefits an individual receives

results from contributions that have been made gradually over the course of the individual’s life, and • there are “special circumstances”. In making the determination, the Commissioner may have regard to: • whether a contribution would more appropriately be allocated to another year, eg if the employer should have made the contribution in a different year but failed to do so, and • whether it was reasonably foreseeable, when the contribution was made, that the member would have excess contributions for the relevant year. Special circumstances Circumstances would be “special” if their existence would make it unjust, unreasonable or inappropriate for excess contributions tax to be imposed, and if they are different from the ordinary or usual. Example George is aged 45. His employer contributes $20,000 each year to his superannuation fund under the terms of an effective salary sacrifice arrangement. However, his employer’s contribution for Year 1 is made on 3 July of Year 2 and the contribution for Year 2 is made on 29 June of Year 2. This results in George having no concessional contributions for Year 1 but $40,000 concessional contributions in Year 2. The Commissioner may exercise his discretion to allocate $20,000 to Year 1. This reallocation would fairly match the employer’s contributions to the financial year in which they should have been made.

Special circumstances would not include: • financial hardship • ignorance of the law • incorrect professional advice, or • retrospectivity of the law or an adverse effect from legislative changes (Practice Statement Law Administration PS LA 2008/1). If the Commissioner refuses to make a determination to disregard or reallocate contributions, the affected taxpayer may apply to the Administrative Appeals Tribunal (AAT) for review of the Commissioner’s decision. It has been difficult for taxpayers to prove that there are sufficiently special circumstances for the Commissioner to exercise the discretion to disregard or allocate a contribution to another year. For example, taxpayers were unsuccessful in: • Schuurmans-Stekhoven v FC of T 12 ESL 03, where an employer made contributions for an employee in early July 2007 and the employee unsuccessfully argued that the contributions should be allocated to the 2006/07 income year • Tran v FC of T 2012 ATC ¶10-236, where a taxpayer who made excess non-concessional contributions alleged that the error resulted from incorrect information issued by the ATO • Peaker v FC of T 2012 ATC ¶10-238, where a cheque mailed to a superannuation fund on 28 June 2007 by the taxpayer’s employer was received by the fund on 5 July 2007 and was counted towards the taxpayer’s concessional contributions cap for 2007/08 (rather than, as the taxpayer expected, for 2006/07), and • Paget 2012 ATC ¶10-251, where an employer initiated an electronic funds transfer to the taxpayer’s superannuation fund on 30 June 2009, but the contribution was not received into the fund’s bank account until 1 July 2009, resulting in the taxpayer being liable to excess contributions tax for 2009/10.

Hamad 2012 ATC ¶10-280 is one of the few cases where a taxpayer has successfully argued that special circumstances meant the Commissioner should have made a determination in the taxpayer’s favour. The employer usually made contributions in the month following the sacrifice of salary. However, for April, May and June 2009 a single contribution was made in July 2009. This meant that the taxpayer had 15 months of contributions made for him in 2009/10, and became liable to excess contributions tax. The AAT said the employer contributions received in July 2009 should be allocated to 2008/09 because there were special circumstances in that the taxpayer had been misled by his employer who retained superannuation amounts and made late payments.

¶4-260 Splitting superannuation contributions with a spouse Contributions to a superannuation fund may be split with the member’s spouse. Splitting is available whether the contribution is made by the member personally or by the member’s employer on behalf of the member. Contributions splitting can be used with other planning strategies such as spouse contributions, salary sacrifice and government co-contributions. This particularly assists couples where there is a significant disparity between the incomes of the two spouses. The low-income or non-working spouse gains superannuation assets, receives tax concessions and has their own income in retirement. Moving superannuation into the account of the older spouse can be beneficial because that spouse may be able to satisfy a condition of release sooner and, if they are 60 or older, will be taxed on the benefit at a lower rate than the younger spouse would be. Placing the superannuation assets in the account of one spouse rather than the other may also be beneficial when the assets test or income test is being applied for social security purposes (

¶6-500). Contributions splitting does not, however, enable a member with excess concessional contributions to avoid penalties on the excess contributions (¶4-235) because the contributions have already been included in the assessable income of the fund before they are split by the member. Members of a superannuation fund can split their contributions with their spouse if they are members of an accumulation fund or members of a defined benefit fund and hold an accumulation interest in the fund. Married or de facto couples (including a same-sex couple) can apply. What contributions can be split? Contributions that can be split are called “splittable contributions”. Most commonly, these are as follows: • contributions to a superannuation fund by an employer for a member • deducted contributions by a member • SG amounts transferred to a member’s superannuation account by the ATO, and • amounts allocated from a fund surplus by a trustee to meet the employer’s liability to contribute. Amounts that cannot be split include: • existing superannuation benefits in the fund • undeducted contributions by a member • amounts rolled over or transferred into the fund, and • capital gains tax exempt amounts arising from the disposal of a small business and used for retirement. How does contributions splitting work? Contributions splitting allows a member to make a request to the trustee of their fund after the end of a financial year relating to splittable contributions made in the previous financial year. Example Adonis Imports makes four quarterly SG contributions on behalf of Jess during 2019/20. After 30 June 2020, Jess can apply to the fund trustee for the contributions to be split with her spouse.

A member can also apply to have splittable contributions made in the current financial year split if the member’s entire superannuation benefit is to be rolled over or transferred in that year. Limit on contributions that can be split A member can only split contributions up to the maximum limit for the year. The maximum amount that can be split is 85% of the taxed splittable contributions, ie employer contributions and deductible personal contributions. The 85% limit ensures that it is the amount of the taxed splittable contributions, net of 15% contributions tax, that can be split. Application to split contributions A member with an accumulation interest in a fund may apply to the trustee to roll-over, transfer or allot an amount for the benefit of the member’s spouse. A trustee does not have to accept a member’s application, but if it is accepted the trustee must act on it within 90 days. A trustee cannot act on an invalid application. An application is invalid if: • in the financial year in which it is made, the member has already made an application that the trustee has acted on or is still processing

• the application relates to benefits exceeding the maximum splittable amount, or • the member’s spouse is too old — generally, this means that the spouse is aged 65 years or more, or is aged between the relevant preservation age (¶4-400) and 65 years and is permanently retired from the workforce. Although trustees are not required to accept a splitting application, they may do so if they are satisfied that all conditions for a valid application have been met. In addition to those conditions, trustees may impose additional restrictions before accepting a splitting application. Consequences of contributions splitting The splitting of a member’s contributions has the following consequences: • a new superannuation benefit is created for the spouse — this benefit is treated as a roll-over if rolled over to another fund or if transferred to an account in the existing fund in the spouse’s name, and is not treated as a contribution to the spouse’s fund • the new superannuation benefit consists entirely of a taxable component, and there is no tax-free component • the taxable component consists of an element taxed in the fund if paid from a member’s account in a taxed superannuation fund; the amount of the taxed element cannot exceed the amount of the taxed splittable contributions specified in the member’s contributions splitting application, and the taxable component otherwise consists of an element untaxed in the fund, and • amounts credited to the spouse’s account are preserved benefits until the trustee is satisfied that they are no longer preserved benefits, eg on the member reaching preservation age and permanently retiring, reaching age 65 or becoming permanently incapacitated.

¶4-265 Government co-contribution for low-income earners An individual may be entitled to a government co-contribution to match their undeducted personal contributions. To be eligible for the co-contribution, a taxpayer must satisfy the following conditions. 1. The taxpayer makes personal contributions to a complying superannuation fund for the purpose of obtaining superannuation benefits. 2. At least 10% of the taxpayer’s total income for the year comes from employment-related activities (ie work as an employee, including being deemed to be an employee for SG purposes (¶4-520)) or from carrying on business. A person’s “total income” is the sum of their assessable income, reportable fringe benefits (fringe benefits reported on the person’s payment summary) and reportable employer superannuation contributions (RESCs), most commonly, salary sacrificed into superannuation. RESCs are discussed at ¶4-215. 3. The taxpayer’s total income for the year is less than the higher income threshold which, for 2019/20 is $53,564 ($52,697 for 2018/19). For a person deriving income from carrying on business, business deductions (but not deductions for personal superannuation contributions) are taken into account in calculating their total income. Excess contributions that are included in a taxpayer’s assessable income (¶4-235 and ¶4-245) are not included in the taxpayer’s total income for this purpose. 4. The taxpayer lodges an income tax return for the year. 5. The taxpayer’s non-concessional contributions (¶4-240) for the year do not exceed their nonconcessional contributions cap ($100,000 for 2019/20 and 2018/19) for the year. 6. Immediately before the start of the financial year, the taxpayer’s total superannuation balance (¶4233) is less than the general transfer balance cap (¶4-227) for the year, ie $1.6m for 2019/20 and

2018/19. 7. The taxpayer is aged less than 71 years at the end of the year. 8. The taxpayer does not hold an eligible temporary resident visa at any time during the year. No co-contribution for deducted contributions A contribution is only eligible to be matched by a government co-contribution to the extent that the Commissioner has not allowed a deduction for the contribution. Example Rohit carries on a freelance sign writing business and is entitled to claim deductions for contributions he makes to a complying superannuation fund. During 2019/20, his total income (after taking account of business-related expenses) is $31,000. If he contributes $10,000 to a superannuation fund and claims a deduction for only $9,000, he would be entitled to a government cocontribution for the $1,000 undeducted contribution, which would be of more value to him than if he claimed a deduction for the $10,000.

Where deductible contributions have been made by a taxpayer, or are made on the taxpayer’s behalf by an employer, a low-income superannuation tax offset (¶4-270) may be allowable. Calculation of co-contribution The maximum government co-contribution for 2019/20 is 50% of the eligible contributions the person makes during the income year, up to a maximum co-contribution of $500. This is the same as it was for 2018/19. The actual amount of co-contribution to which an employee is entitled varies according to the income of the employee for the year. For 2019/20, for a personal contribution of $1,000, the maximum co-contribution is: • if the sum of the person’s total income for the year is $38,564 or less — $500 • if the person’s total income for the year exceeds $38,564 — $500 reduced by 3.333 cents for each dollar by which the person’s total income for the year exceeds $38,564. A person’s entitlement to a co-contribution is phased-out completely when their total income reaches $53,564. If a person contributes less than $1,000 in the year, a proportion of the maximum co-contribution may be payable. Where the contributor earns income from business rather than from employment, for the purpose of calculating the amount of the co-contribution entitlement (but not in calculating eligibility), the person’s total income is reduced by amounts for which business deductions are allowed. Example Lucy, an employee with assessable income of $40,000 and reportable employer superannuation contributions of $4,000, contributes $3,000 to a complying superannuation fund in 2019/20. As $44,000 exceeds $38,564 by $5,436, the amount of co-contribution that may be payable to Lucy for the year is calculated as the lesser of: • $500 − [$5,436 × 0.0333 = $181] = $319, and • $3,000 × 50% = $1,500 Lucy is therefore eligible for a co-contribution of $319.

Statement by superannuation fund The superannuation fund is required to make a statement to the ATO (generally by 31 October following the end of the year) indicating the amount of contributions made during the year by or on behalf of the

employee. Once the ATO has received all necessary information (ie the tax return and the fund statement), the cocontribution should be paid within 60 days, generally into the fund that received the personal contributions. Interest is payable by the ATO if payment is not made by the due date. Example Mitch earns $19,000 assessable income during an income year and also has $6,000 reported on his payment summary as a reportable fringe benefit. Mitch’s employer contributes $1,500 to an industry superannuation fund on behalf of Mitch. Mitch also makes a personal contribution of $750. Mitch lodges his income tax return, and the superannuation fund makes a statement to the ATO that Mitch has received employer superannuation support and has also contributed $750. The ATO will make a determination that Mitch is entitled to receive a co-contribution, and this will be paid into Mitch’s superannuation fund.

¶4-270 Low-income superannuation tax offset Individuals with an adjusted taxable income below $37,000 may be entitled to a low-income superannuation tax offset. The offset is capped at $500 per annum, and is intended to compensate lowincome individuals for the 15% tax on concessional contributions made on their behalf by their employer or by themselves. The low-income superannuation tax offset replaced the low-income superannuation contribution from 1 July 2017. The eligibility conditions and the amounts payable are the same for the tax offset and the contribution. Eligibility conditions An individual is only entitled to the low-income superannuation tax offset if they satisfy the following conditions. • A concessional contribution (¶4-234), including an allocation from reserves and notional taxed contributions, is made for the individual. This would most commonly be an employer SG or award contribution, an employer contribution made after an employee enters into a salary sacrifice arrangement, or a personal contribution for which the individual claims a deduction. • The individual’s adjusted taxable income does not exceed $37,000. Adjusted taxable income is the sum of the individual’s: – taxable income – total adjusted fringe benefits (ie the taxable value of fringe benefits provided to the individual during the FBT year) – foreign income that is not taxable in Australia – total net investment losses (ie the amount by which deductions attributable to financial investments and rental property exceed the gross income from financial investments and rental property) – tax-free pensions and benefits (not including superannuation income stream benefits that are tax-free for an individual aged at least 60), and – reportable superannuation contributions (ie deductible superannuation contributions made for the individual in the year by an employer or by the individual, including salary sacrifice contributions), less the child support or child maintenance expenditure for the year. • At least 10% of the individual’s total income for the year is derived from employment-related activities or from carrying on a business. Excess concessional contributions that are included in the individual’s assessable income (¶4-235) are disregarded in calculating an individual’s total income.

• The individual is not a holder of a temporary resident visa. Amount of the low-income superannuation tax offset The maximum amount of low-income superannuation tax offset for an individual for a year is calculated generally as 15% of the individual’s concessional contributions up to a maximum of $500. Example A self-employed individual with adjusted taxable income of $32,000 makes deductible superannuation contributions of $15,000 in 2019/20. The low-income superannuation tax offset is calculated as:

$15,000 × 15% = $2,250. As this amount exceeds $500, the allowable tax offset is $500.

A low-income superannuation tax offset is not included in the assessable income of the superannuation fund to which it is paid, and forms part of the tax-free component when it is included in a superannuation benefit paid to the individual. The Commissioner generally determines entitlement to the low-income superannuation tax offset based on the member’s income tax return and other information such as the member’s payment summary or Centrelink reports. The Commissioner may estimate a member’s eligibility if, after 12 months following the relevant income year, the Commissioner reasonably believes there is insufficient information to decide whether to make a determination that a tax offset is payable. This could be, for example, because the member’s taxable income is below $18,200 and the member is not required to lodge an income tax return.

¶4-275 Tax offset for spouse contributions A taxpayer may be entitled to a tax offset for superannuation contributions made for the benefit of a lowincome or non-working spouse. Conditions that must be satisfied A taxpayer is only entitled to a tax offset for spouse contributions if the following conditions are satisfied. • The taxpayer makes a contribution to a complying superannuation fund on behalf of their spouse. “Spouse” means a legal or de facto spouse, including a same-sex spouse. A de facto spouse is one who lives with the taxpayer on a genuine domestic basis as a couple. • The taxpayer and the spouse are Australian residents when the contributions are made. • The total of the spouse’s assessable income, reportable fringe benefits and reportable employer superannuation contributions (RESCs) (¶4-215) is, for 2019/20, 2018/19 and 2017/18, less than $40,000. • The taxpayer’s contribution is not deductible. Calculation of the offset The maximum offset in a year of income is $540, based on 18% of maximum contributions of $3,000 paid to a complying superannuation fund. For 2019/20, 2018/19 and 2017/18, the $3,000 contributions limit is reduced by $1 for each $1 by which the total of the spouse’s assessable income, reportable fringe benefits and RESCs exceeds $37,000, so that the offset is fully phased-out when the total is $40,000 or more. Example

Todd contributes to a complying superannuation fund for Sam, his spouse. During 2019/20, he contributes $4,000 and the total of Sam’s assessable income, reportable fringe benefits total and reportable employer superannuation contributions is $39,500. The offset to which Todd is entitled is calculated as follows: (1) determine the difference between the total of Sam’s assessable income, reportable fringe benefits total and reportable employer superannuation contributions and $37,000, ie $39,500 − $37,000 = $2,500 (2) reduce the maximum contribution amount of $3,000 by the excess at (1), ie $3,000 − $2,500 = $500 (3) the offset is 18% of the (2) amount, ie 18% × $500 = $90.

Spouses for whom contributions can be made There are no limitations on a fund accepting contributions on behalf of a spouse who is aged less than 65 years. Contributions can only be made on behalf of a spouse who is aged from 65 to 70 if the spouse is gainfully employed on at least a part-time basis (¶4-205). A fund cannot accept contributions on behalf of a spouse who has reached age 70. The following table summarises the rules for spouse contributions. Age of receiving spouse Under 65

A fund can accept contributions for a spouse under age 65, irrespective of employment status

65–70

A fund can accept contributions for a spouse if that spouse was gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in the year that the superannuation contribution was made

Over 70

A fund cannot accept contributions for a spouse aged 70 or over

Spouse contributions which qualify for the offset are not taxable contributions when received by the fund or RSA. They form part of the tax-free component when paid by the fund as part of a superannuation benefit (¶4-420). The government announced in the 2019 Federal Budget that the age limit for making spouse contributions would be increased from 69 to 74 from 1 July 2020. At the time of writing, legislation for this proposal had not yet been introduced to Parliament.

¶4-280 Taxation of contributions in the hands of the fund Personal contributions for which a tax deduction has been claimed and all employer contributions are included in the taxable income of the fund. Taxable income of a complying superannuation fund is generally taxed at 15% (¶4-320). Personal contributions for which no deduction has been claimed are not included in the taxable income of the fund. This includes contributions made on behalf of a spouse (¶4-275). For 2019/20 and 2018/19, a fund must pay tax at the rate of 47% on “no-TFN contributions income”, ie contributions paid to the fund where a TFN has not been quoted (¶4-390).

TAXATION OF FUNDS AND RSA PROVIDERS ¶4-300 Taxation of funds and RSA providers A concessional tax regime applies to superannuation funds, ADFs, PSTs and RSA providers. There are three aspects to this concessional tax treatment. These relate to: • contributions paid to such entities (¶4-200 and following) • benefits paid from such entities (¶4-400 and following), and

• the taxation of the entity itself. Complying superannuation funds are subject to tax on a concessional basis, with assessable income, including taxable contributions, being subject to tax at 15%. In contrast, non-complying funds are subject to a 45% tax rate. Whether or not a fund is a complying superannuation fund is determined by whether it complies with the conditions specified in SISA and SISR. The SIS regime also prescribes the conditions which other superannuation entities such as ADFs and PSTs must satisfy in order to qualify for tax concessions. Constitutionally protected funds (ie state superannuation funds) are generally exempt from tax, although some of these funds may become taxed funds. The circumstances in which a superannuation fund or ADF is complying or non-complying are discussed at ¶4-310. The tax treatment of the various superannuation entities is considered in the following paragraphs: • complying superannuation funds — ¶4-320 • non-complying superannuation funds — ¶4-340 • PSTs — ¶4-360 • RSA providers — ¶4-380. Where contributions are made to a fund and no TFN has been quoted for the individual for whom the contributions are made, the contributions are “no-TFN contributions income”, which is liable to an additional tax (¶4-390).

¶4-310 Complying or non-complying? The tax treatment of a superannuation fund depends on whether the fund is a complying or a noncomplying fund. Only a complying superannuation fund is eligible for concessional tax treatment under the income tax regime. Funds other than self managed superannuation funds A superannuation fund is a complying superannuation fund if APRA (or the ATO in the case of an SMSF) has given the fund a notice stating that it is a complying fund and has not subsequently given it a notice stating that it is not a complying fund. A fund other than an SMSF is a complying superannuation fund for a year of income if it satisfies two conditions: (1) it is a “resident regulated superannuation fund” at all times during the year of income that it is in existence (¶4-110), and (2) it does not contravene the SIS legislation, or it contravenes the SIS legislation but does not fail the “culpability test” in relation to the contravention. For a fund not to contravene the SIS legislation, the trustee must have complied with all the duties and obligations imposed on the trustees of superannuation entities, and the fund must have complied with all the conditions relevant to a resident regulated superannuation fund. An APRA-regulated fund which contravenes the SIS legislation may still qualify as a complying superannuation fund if it does not fail the culpability test in relation to the contravention. A fund fails the culpability test if: • all members of the fund were directly or indirectly knowingly concerned in, or party to, the contravention, or some (but not all) members were involved and the “innocent members” would not suffer “any substantial financial detriment” if the fund became non-complying, and • after considering the taxation consequences if the fund became non-complying, the seriousness of the

contravention and all other relevant matters, APRA believes that a notice should be given to the fund stating that it is not a complying superannuation fund. Self managed superannuation funds For an SMSF (¶4-110) to be a complying fund: • the trustee must not have contravened the SIS legislation in that year, or • the trustee contravened the SIS legislation but the ATO has nonetheless decided that it should receive a compliance notice after taking into account taxation consequences, the seriousness of the contravention and any other relevant circumstances. The culpability test is not relevant for SMSFs. Non-complying funds A non-complying superannuation fund is a fund that is not a complying superannuation fund during a particular year and includes: • foreign superannuation funds • regulated superannuation funds which contravene the SIS legislation and fail the culpability test and are not “pardoned” by the regulator, and • superannuation funds (other than exempt public sector superannuation schemes) which do not elect to become regulated superannuation funds.

¶4-320 Taxation of complying superannuation funds The taxable income of a superannuation fund (including an SMSF) is potentially made up of three components: • low tax component • non-arm’s length component, and • no-TFN contributions income. In the case of a complying superannuation fund: • the low tax component is taxed at the concessional rate of 15% • the non-arm’s length component is taxed at 45%, and • an additional tax of 32% may be imposed on the “non-TFN contributions income” (¶4-390). Assessable income The calculation of a complying superannuation fund’s assessable income takes into account that it is a resident taxpayer and includes therefore income from Australian and foreign sources. The fund’s assessable income for a year of income includes taxable contributions made to the fund for that income year, as well as taxable investment income. A fund’s taxable contributions may comprise any of the following: • employer contributions on behalf of an employee — this includes: (i) mandated and voluntary employer contributions (¶4-210), and (ii) salary sacrifice contributions (¶4-215) • deductible personal superannuation contributions (¶4-220) • amounts transferred from a foreign fund to an Australian superannuation fund (¶4-650).

A complying superannuation fund which has investments in the form of superannuation policies taken out with a life assurance company or registered organisation, or in the form of units in a PST, may transfer liability to tax on taxable contributions to that entity by written agreement between the superannuation fund and the transferee entity. The effect of the transfer is that the relevant contributions are excluded from the fund’s assessable income for the year concerned, and are included in the assessable income of the transferee for the same year. Capital gains Complying superannuation funds are liable for tax on capital gains realised on the disposal of assets. Since 21 September 1999 complying superannuation funds have been entitled to a one-third discount in calculating tax on capital gains if the asset was held for at least 12 months, giving an effective tax rate of 10% for capital gains in a complying superannuation fund. If the asset was purchased prior to 11.45 am EST on 21 September 1999, the taxable gain can be calculated as the capital proceeds from the asset’s disposal reduced by the asset’s (indexed) cost base, if this gives a lower amount of tax. Tax on capital gains applies to all assets, including assets acquired before 20 September 1985 (when CGT commenced), as any asset owned by a complying superannuation fund at 30 June 1988 is, for CGT purposes, taken to have been acquired by the fund on 30 June 1988. A specific exemption from CGT applies in respect of the disposal of life assurance policies, or rights under life assurance policies, whether or not the fund is the original beneficial owner of the policy. With a few specific modifications for assets which were held at 30 June 1988, gains or losses are calculated in accordance with the normal CGT provisions (see Chapter 2). The main modification is that the cost base used is either: • the asset’s cost base as of 30 June 1988, as calculated under the normal CGT rules, or • the asset’s market value as of 30 June 1988, whichever provides the lower gain or loss. If the cost base is used, the consideration is deemed to have been given on 30 June 1988, so that indexation (if applicable) only applies from that date. Trading stock Superannuation funds cannot treat shares, units in a unit trust or land as trading stock from 11 May 2011. They must calculate any gain or loss under the CGT provisions. Investments in PSTs If a complying superannuation fund invests in PSTs, the PSTs will have paid tax at 15% so the following special tax treatment applies: • income derived and capital gains realised by the PST are not taxable to the investing fund, and • on disposal or redemption of units in a PST, any resulting gains are not taxable under the CGT provisions, and realised losses may not be offset against capital gains. Exemption for income attributable to liability to pay income stream benefits A complying superannuation fund may be entitled to an exemption (the “earnings tax exemption”) for so much of its income as is attributable to its liability to pay certain superannuation income stream benefits, eg life pensions, allocated pensions and market-linked pensions. The earnings tax exemption does not extend to assessable contributions or to non-arm’s length income of the fund, but may be available for the capital gain on the disposal of assets. From 1 July 2017, the earnings tax exemption applies when a superannuation income stream is “in the retirement phase” (¶4-228) at the time. A superannuation income stream is in the retirement phase at a time if: (a) a superannuation income stream benefit is payable from it at that time

(b) it is a deferred superannuation income stream: (i) where the rules for the provision of the benefit provide for payments to start more than 12 months after the superannuation interest is acquired and to be made at least annually afterwards, and (ii) the person who will receive the benefit has satisfied a condition of release for retirement, terminal medical condition, permanent incapacity or attaining age 65, or (c) it is a transition to retirement income stream (¶16-585) and the person to whom the benefit is payable has satisfied a condition of release for retirement, terminal medical condition, permanent incapacity or attaining age 65, and, except in the case of attaining age 65 where notification is not required, has notified the superannuation income stream provider that the condition has been satisfied. Before 1 July 2017, a complying superannuation fund was entitled to the earnings tax exemption relating to its liability to pay superannuation income stream benefits that were “payable at that time”. To determine the exempt amount, the trustee may: • segregate some of the fund’s assets as specifically relating to such current pension liabilities — the exempt income is then the part of the fund’s income that is derived from the segregated current pension assets, or • base the exemption on the proportion of average value of current pension liabilities of the fund to the average value of the fund’s total superannuation liabilities. From 1 July 2017, SMSFs and small APRA funds are not able to use the segregated method to determine their earnings tax exemption for an income year if: • at a time during the income year, there is at least one superannuation interest in the fund that is in the retirement phase • just before the start of the income year, a person has a total superannuation balance (¶4-233) that exceeds $1.6m and the person is the retirement phase recipient (¶4-228) of a superannuation income stream, and • at a time during the income year, the person has a superannuation interest in the fund. According to Law Companion Ruling LCR 2016/8, this means an SMSF or a small APRA fund cannot use the segregated method from the 2017/18 income year if it has a member who has a transfer balance under the $1.6m transfer balance cap but who also has a total superannuation balance exceeding $1.6m. The assets of such funds — called “disregarded small fund assets” in the legislation — cannot be segregated assets, and the funds are required to use the proportionate method to determine their earnings tax exemption. A superannuation fund paying a pension may be required to obtain an actuarial certificate each year to claim the earnings tax exemption. Although the earnings tax exemption is generally only available if a fund has liabilities in respect of superannuation income stream benefits, the exemption may also be available if a fund would have such liabilities except that the member has died. If a member who was receiving a superannuation income stream dies, the earnings tax exemption continues until: • the member’s benefits are cashed as a lump sum, and/or • a new superannuation income stream commences (the benefits must be cashed as soon as practicable). In such a case, the exemption amount cannot be greater than it was before the member’s death although investment earnings since that date may be added. The government proposed in the 2019 Federal Budget that from 1 July 2020 funds with interests in both the accumulation and retirement phases during an income year would be allowed to choose their

preferred method of calculating exempt current pension income. At the time of writing, legislation for this proposal had not yet been introduced into Parliament. General and specific deductions As a general rule, the deductibility of expenditure incurred by a complying fund is determined under the general income tax deduction rules (¶1-305), unless a specific provision applies. In Taxation Ruling TR 93/17, the ATO states that the expenses of a superannuation fund (or of an ADF or PST) which are ordinarily deductible include: • administration fees • actuarial costs • accountancy and audit fees • costs of complying with APRA guidelines (unless the cost is a capital expense) • trustee fees and premiums under an indemnity insurance policy • costs in connection with the calculation and payment of benefits to members (but not the cost of the benefit itself) • investment adviser fees • subscriptions for membership of professional associations, and • other administrative costs incurred in managing the fund. Expenses that are incurred partly in producing assessable income and partly in gaining exempt income (eg amounts accrued before 1 July 1988 and exempt current pension income) must be apportioned. Two apportionment methods are set out in Taxation Ruling TR 93/17, with the correct method for apportioning an expense generally depending on the particular circumstances: • if an expense has a distinct and severable part that relates to producing assessable or nonassessable income, it can be apportioned according to the ratio of those parts, and • if expenditure serves both objects indifferently, any method of apportionment is acceptable if it gives a fair and reasonable assessment of the extent the expenditure relates to producing assessable income. In relation to other types of expenditure incurred by a superannuation fund: • an expense that is deductible under ITAA97 s 25-5 for managing a fund’s tax affairs does not need to be apportioned on account of producing any non-assessable income • although costs incurred by a trustee in establishing a superannuation fund are not deductible under ITAA97 s 8-1 because they are expenses of a capital nature, they may be deductible over five years under ITAA97 s 40-880, and • costs associated with amending a trust deed are deductible revenue outgoings if the amendments simply make the administration of the fund more efficient and do not amount to a restructuring of the fund. Deduction for disability insurance premiums A fund which provides death or disability benefits may claim a deduction for the cost of providing those benefits. Premiums are only deductible to the extent the fund has a current or contingent liability to provide a “disability superannuation benefit” (ITAA97 s 295-465). For these purposes, a superannuation benefit is a

disability superannuation benefit if: • it is paid to a person because he or she suffers from either physical or mental ill-health, and • two legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training. This means that premiums may be only partially deductible if the total and permanent disability (TPD) definition in a particular policy is broader than the ITAA97 definition of disability superannuation benefit, or if it is the same but the insurance policy includes other (non-deductible) types of cover and the TPD component of the premium is not specified. To overcome the potential difficulty in calculating the deduction in these cases, regulations may prescribe the proportion of a specified insurance policy premium to be treated as being attributable to a fund’s liability to provide disability superannuation benefits. Superannuation funds have the option of using the simpler method provided in reg 295-465.01 of the Income Tax Assessment Regulations 1997 for determining the deductible portion of TPD insurance premiums or can obtain an actuary’s certificate to apportion the premium differently. Superannuation funds that self-insure their liability to provide disability benefits may deduct the amount the fund could reasonably be expected to pay in an arm’s length transaction to obtain insurance to cover the liability, or may determine the deductible amount by using the percentages specified in the regulations. The Commissioner’s views on the deductibility of premiums paid by complying superannuation funds for insurance policies that provide TPD cover for members are set out in Taxation Ruling TR 2012/6. Anti-detriment deduction when death benefit paid When a member of a superannuation fund dies and a death benefit is paid to the deceased member’s dependants or to the trustee of the deceased member’s estate in lump sum form, the superannuation fund may increase the death benefit payment to the amount that would have been available if the 15% contributions tax had not been imposed on taxable contributions to the fund. Before 1 July 2017, a fund that paid the increased amount was allowed an “anti-detriment deduction” for the amount of the increase. To claim the deduction, the fund was required to satisfy the ATO that the benefit of the deduction was passed on to the dependants of the deceased member through the increased death benefit. The anti-detriment deduction has been removed for lump sums paid in relation to a death on or after 1 July 2017. From 1 July 2019, the removal of the deduction will extend to all benefits paid from that date, regardless of whether the death was before or after 1 July 2017. The purpose of the removal is to avoid inconsistencies and to better align the treatment of lump sum death benefits across all superannuation funds with the treatment of bequests outside of superannuation. Treatment of dividends Where a complying superannuation fund receives Australian company dividends, its income will be grossed up by any franking credit attaching to those dividends in the same manner as applies to other taxpayers (¶1-405). The fund is entitled to an offset for the full amount of the franking credits, even though its rate of tax is only 15%. The offset may be offset against tax on any income of the fund, including capital gains and taxable contributions. Any excess franking credits will be refunded. Foreign income tax offsets A superannuation fund is entitled to an offset for tax paid on foreign income up to the amount of Australian tax payable in respect of that income (¶1-575). Non-arm’s length income The non-arm’s length component of a complying superannuation fund’s taxable income for an income year is the amount of the fund’s non-arm’s length income less any deductions to the extent that they are attributable to that income. The non-arm’s length component is taxed at 45% for 2018/19 and 2017/18 (47% for the years 2014/15 to 2016/17).

Three types of income make up a fund’s non-arm’s length income: • income derived from a scheme where the parties are not dealing at arm’s length and the amount is greater than it would have been from an arm’s length transaction • private company dividends, unless the amount is consistent with an arm’s length dealing, and • discretionary trust distributions and distributions where the fund has a fixed entitlement to trust income.

¶4-340 Taxation of non-complying funds A non-complying superannuation fund (eg a foreign superannuation fund or a superannuation fund that has received a notice from APRA stating that it is a non-complying fund) is taxed at the rate of 45% for 2019/20, 2018/19 and 2017/18 (47% for the years 2014/15 to 2016/17). A non-complying fund is not eligible for certain tax concessions available to a complying fund (¶4-320), such as tax at the 15% rate, special CGT rules (although a non-complying fund is entitled to a 50% CGT discount as a trust), death and disablement insurance deductions, exemption of income related to pension liabilities, ability to transfer contributions tax liability, ability to exclude “last minute” employer contributions from fund income, and the ability to invest with PSTs. A non-complying fund is also not entitled to a refund of excess franking credits. Other tax-related matters applying specifically to non-complying funds include the following: • neither employer nor member contributions are tax deductible • member contributions are not entitled to the government co-contribution • contributions on behalf of a spouse are not entitled to a tax offset • employer contributions cannot satisfy the employer’s obligations to make contributions for employees under the SG scheme • a liability to tax may arise for transfers of amounts from certain superannuation funds, and • account holders in the SHASA cannot transfer their entitlements to a non-complying fund. Consequences of becoming non-complying If a complying superannuation fund becomes non-complying, the fund is subject to tax at 45% on the excess of the market value of its total assets over total undeducted contributions. This could occur, for example, if an Australian superannuation fund ceases to satisfy the conditions for being an Australian superannuation fund (¶4-600).

¶4-360 Taxation of PSTs and RSA providers Unit trusts which qualify as PSTs under the SIS legislation (¶4-120) are generally subject to tax at the rate of 15% on their taxable income. The non-arm’s length component of the taxable income of a PST is subject to tax at the rate of 45% for 2019/20, 2018/19 and 2017/18 (47% for the years 2014/15 to 2016/17). RSA providers (¶4-120) are subject to tax at the rate of 15% on the RSA component of their taxable income.

¶4-390 Tax on “no-TFN contributions income” Superannuation funds and RSA providers are taxed at the rate of 47% for 2019/20, 2018/19 and 2017/18 (49% for the years 2014/15 to 2016/17) on their “no-TFN contributions income”. This is the amount of superannuation contributions included in the entity’s assessable income where no TFN is “quoted (for

superannuation purposes)” by the individual. A TFN is “quoted (for superannuation purposes)” if the individual quotes their TFN to