Australian Tax 2018 9780409346893, 0409346896

Table of contents :
Full Title
Copyright
Preface
Why study tax law?
Text features
Acknowledgments
Table of Cases
Table of Statutes
Table of Contents
Chapter 1 The taxpayers and introduction
Chapter overview
Constitutional taxation powers
Sources of Australian taxation law
Rules developed by Parliament
Summary
Further problems
Chapter 2 Who we don’t tax, free riders and policy
Chapter overview
Policy
The great debate: ‘tax expenditures analysis’ v ‘optimal tax theory’
Optimal tax theory
Who doesn’t pay tax — the free riders
Summary
Tax evasion
Ethics
History of Australian taxation
How does real tax reform happen?
The future
Summary
Further problems
Chapter 3 Income tax basics
Chapter overview
Income tax pyramid
Level 1: The income tax equation
Level 2: Income tax legislation overview
Level 3: Analysis
The legal reasoning model
Summary
Further problems
Chapter 4 International tax
Chapter overview
International tax norms and problems
Step 1: Residence rules
Step 2: Source rules
Step 3: Taxation of foreign income of residents
Step 4: Taxation of foreign residents
Double tax agreements — overview
Step 5: Transfer pricing — ITAA 1936 Pt III Div 13
Step 6: International loans and capital raising
Step 7: Consolidations — international tax
Step 8: Corporate concessions
Summary
Further problems
Chapter 5 Income tax accounting
Chapter overview
Tax period
Timing of income
Timing of deductions
Trading stock: ITAA 1997 Div 70
Trading stock exemption for small business entities
Consolidated groups — an overview
Summary
Further problems
Chapter 6 Ordinary income
Chapter overview
Derivation — timing of income
Convertible into money
The principle of mutuality
Periodical gains have the character of income
Windfall gains
Receipts from illegal activities
Gains from the use of property
Income from personal services has the character of income
Receipts from carrying on a business
Capital receipts are generally not ordinary income
Summary
Further problems
Chapter 7 Statutory income
Chapter overview
ITAA 1997 — statutory income provisions
ITAA 1936 — statutory income provisions
Summary
Further problems
Chapter 8 Non-assessable income
Chapter overview
Exempt entities: ss 11-5 and 50-1
Principle of mutuality
ITAA 1997 — ordinary or statutory income exempt from income tax
ITAA 1936 — exempt income provisions
Non-assessable and non-exempt income
Payments not exempt from income tax
Summary
Further problems
Chapter 9 Capital gains and losses
Chapter overview
CGT general rules: ITAA 1997 Div 103
Step 1: Residence
Step 2: Must have a CGT event
Step 3: Identify the CGT asset
Step 4: Is the CGT event/CGT asset exempt?
Step 5: Do the special CGT rules apply?
Step 6: Calculating the capital gain/loss
Step 7: Netting capital gains/losses
Foreign resident CGT withholding regime
Summary
Further problems
Chapter 10 General deductions
Chapter overview
Words and phrases analysis of ITAA 1997 s 8-1
Words and phrases analysis step 1: the positive limbs of s 8-1
Words and phrases analysis step 2: the negative limbs of s 8-1
Capital or capital nature
Categories of expenditure in s 8-1: employees and investors
Categories of expenditure s 8-1: business
GST and deductions: ss 27-1–27-5
Summary
Further problems
Chapter 11 Specific deductions
Chapter overview
Specific deductions: ITAA 1997
Specific deductions: ITAA 1936
Summary
Further problems
Chapter 12 Deduction limitations
Chapter overview
Limitations: ITAA 1997
Limitations: ITAA 1936
Summary
Further problems
Chapter 13 Capital allowances
Chapter overview
Capital allowances: Div 40
Depreciating assets: Subdivs 40-A–40-F
Step 1: Understand s 40-25
Step 2: Must have a taxable purpose
Step 3: Must have a depreciating asset
Step 4: Must have a holder of a depreciating asset
Step 5: Calculate depreciation
Step 6: Calculate balancing adjustments
Step 7: Do the special rules apply?
Step 8: Complete the depreciation schedule
Other listed capital allowances: Subdivs 40-G–40-J
Capital works: Div 43
Capital allowances: ITAA 1936
Summary
Further problems
Chapter 14 Entities
Chapter overview
Individuals
Partnerships
Trusts
Companies
Summary
Further problems
Chapter 15 Superannuation and eligible termination payments
Chapter overview
Step 1: Understand the superannuation basics
Step 2: Taxation of superannuation contributions by employers, self-employed and employees
Step 3: Taxation of superannuation entities
Step 4: Taxation of superannuation benefits
Step 5: Taxation of employment termination payments
Step 6: Other issues
Summary
Further problems
Chapter 16 Special taxpayers
Chapter overview
Mining
Primary production
Averaging tax offset: ITAA 1997 Div 392
Applying averaging
Artists, authors, inventors, sportspersons, production associates
Australian film
Summary
Further problems
Chapter 17 Anti-avoidance
Chapter overview
General anti-avoidance: ITAA 1936 Pt IVA
Application of ITAA 1936 Pt IVA
Specific anti-avoidance provisions
Alienation of personal services income: ITAA 1997 Pt 2-42, Divs 84–87
Summary
Further problems
Chapter 18 Fringe benefits tax
Chapter overview
FBT pyramid
Level 1: The FBT equation
Level 2: Legislation overview of FBTAA
Level 3: Analysis of components of FBT equation
Summary
Further problems
Chapter 19 Goods and services
Chapter overview
GST pyramid
Level 1: The GST equation
Level 2: Legislation overview of GST
Level 3: Analysis of components of GST equation
Step 2: What are your GST-free supplies?
Step 3: What are your input-taxed supplies?
Step 4: Do the special GST rules apply?
Step 5: What are your input tax credits?
Step 6: What are your adjustments?
Step 7: GST instalments
Step 8: Calculating your GST
Administration
GST and other taxes
GST and contractual disputes
Summary
Further problems
Chapter 20 Tax planning
Chapter overview
Minimise assessable income
Maximise deductions
Use of tax offsets
Use of entities
Use of averaging
Use of withholding tax provisions
Use of international tax concessions
Compliance with anti-avoidance provisions
Case in point
Current and proposed tax changes
Interactions with GST, FBT and superannuation rules
Record keeping and documentation
Lobbying and media
Summary
Further problems
Chapter 21 Tax administration
Chapter overview
Self-assessment and income tax returns
Assessment
Audits
Power to amend assessments
Penalties, interest and offences
Review rights
Public and private rulings
Taxpayers’ charter
Australian business number (ABN)
Pay-as-you-go (PAYG): TAA 1953 Sch 1 Pts 2-5, 2-10
Inspector-General of Taxation
Australian Taxation Office and the internet
Summary
Chapter 22 Taxation in practice
Chapter overview
Income tax returns
Individuals
Partnerships
Trusts
Company
Fringe benefits tax returns
GST tax returns
Summary
Further problems
Chapter 23 Solving complexity
Chapter overview
Routine transactions
Complex transactions
Summary
Further problems
Appendix 1
Appendix 2
Index

Citation preview

Australian Tax 2018

Australian Tax 2018 Dr Paul Kenny BEc (Adelaide), M Tax Law, SJD (Deakin) CTA

Michael Blissenden LLM (USyd), GDip TaxLaw, LLB, BA (UNSW)

Dr Sylvia Villios PhD (Law), MTax, CTA, GDLP, LLB, (Hons), BCom (Acc)

LexisNexis Butterworths Australia 2018

AUSTRALIA

ARGENTINA AUSTRIA BRAZIL CANADA CHILE CHINA CZECH REPUBLIC FRANCE GERMANY HONG KONG HUNGARY INDIA ITALY JAPAN KOREA MALAYSIA NEW ZEALAND POLAND SINGAPORE SOUTH AFRICA SWITZERLAND TAIWAN UNITED KINGDOM USA

LexisNexis LexisNexis Butterworths 475–495 Victoria Avenue, Chatswood NSW 2067 On the internet at: www.lexisnexis.com.au LexisNexis Argentina, BUENOS AIRES LexisNexis Verlag ARD Orac GmbH & Co KG, VIENNA LexisNexis Latin America, SAO PAULO LexisNexis Canada, Markham, ONTARIO LexisNexis Chile, SANTIAGO LexisNexis China, Beijing, SHANGHAI Nakladatelství Orac sro, PRAGUE LexisNexis SA, PARIS LexisNexis Germany, FRANKFURT LexisNexis Hong Kong, HONG KONG HVG-Orac, BUDAPEST LexisNexis, NEW DELHI Dott A Giuffrè Editore SpA, MILAN LexisNexis Japan KK, TOKYO LexisNexis, SEOUL LexisNexis Malaysia Sdn Bhd, PETALING JAYA, SELANGOR LexisNexis, WELLINGTON Wydawnictwo Prawnicze LexisNexis, WARSAW LexisNexis, SINGAPORE LexisNexis Butterworths, DURBAN Staempfli Verlag AG, BERNE LexisNexis, TAIWAN LexisNexis UK, London, EDINBURGH LexisNexis Group, New York, NEW YORK LexisNexis, Miamisburg, OHIO

ISBN: ISSN:

9780409346893 (pbk). 9780409346916 (ebk). 1833-2382.

© 2018 Reed International Books Australia Pty Limited trading as LexisNexis. This book is copyright. Except as permitted under the Copyright Act 1968 (Cth), no part of this publication may be reproduced by any process, electronic or otherwise, without the specific written permission of the copyright owner. Neither may information be stored electronically in any form whatsoever without such permission. Inquiries should be addressed to the publishers. Typeset in Bembo and Gill Sans. Printed by Griffin Press PMP Print Pty Ltd Visit LexisNexis Butterworths at www.lexisnexis.com.au

Preface Since 2004 this text has chronicled Australia’s tax system and two central themes have emerged (as discussed in Chapters 1 and 2). First, as a low taxing OECD country, Australia’s tax system is challenged to provide funds to meet the needs and wants of its citizens as seen by the mediocre performance of important social indicators and the rising inequality. Secondly, the tax exemptions for free riders has given rise to a two class tax system.1 There is an over reliance on income tax and regressive indirect taxes rather than taxes on the many free riders (wealth taxes and a broader income tax / capital gains tax are needed). Additional tax is also needed to combat the negative externalities (free riders are not adequately taxed on harmful activities such as: illegal drugs, tobacco, junk food consumption, gambling and activities that damage the environment). There is also a need for taxes on the use of scarce community resources (free riders are not adequately taxed for mining our minerals, oil and gas; and for insolvency guarantees to major banks). This text is designed to fast track the attainment of both routine and complex tax technical skills through the use of a modern step-by-step approach to explaining Australia’s difficult taxation laws. The reason for doing this is simple: there is no other way to properly explain tax law! The aim of this book is to equip you with powerful tax skills that will open doors to rewarding careers in both the business and government sectors. To help you obtain core tax skills, in its first 20 chapters, this book: uses the unique tax pyramid to explain as clearly and as simply as possible the operation of Australia’s key taxation laws; and provides you with over a thousand examples of how to apply these laws to solve real-world problems. Chapter 22 links the legal analysis of Chapters 1–21 to the real world by analysing income tax, fringe benefits tax (FBT), and goods and services tax (GST) returns and schedules. Finally, Chapter 23 develops advanced tax skills by using a unique and

comprehensive research framework to solve complex tax problems, and then provides wide-ranging business problems for you to solve.

Tax pyramid: three levels of Australia’s taxation laws This book adopts a unique three-level tax pyramid approach to explain as clearly and as simply as possible the operation of Australia’s complex tax laws. The tax pyramid is designed for both domestic and international business and law students studying in Australia. The tax pyramid has the following structure:

At the top of the pyramid rest the key tax equations for income tax, GST and FBT that are used to calculate tax payable/refundable. The second level provides an overview of the legislation. The bottom layer of the pyramid consists of the step-by-step processes that provide a detailed analysis of the components of the tax equation.

Over 1000 examples and problems: ranging from simple to complex The tax pyramid approach is supported by the simplest possible examples and problems that explain how the step-by-step processes apply in the real world. These examples and problems build to more complex issues. The problems are designed for tutorials, lectures, workshops, self-learning, web-based learning and team-based learning.

Comprehensive research framework Finally, the book builds up to Chapter 23, which provides a comprehensive research framework for solving complex tax problems. This is the essential tax skill that is in high demand in lucrative careers in business and government. You can fast track your tax career if you are able to master this framework. Paul Kenny Michael Blissenden Sylvia Villios 4 October 2017

1.

P Coorey and B Potter, ‘Labor sets its sights on trusts’ Australian Financial Review, 20 July 2017, leader of the Labor opposition, Bill Shorten said “there were two classes of Australian taxpayer, the vast bulk of pay as you earn workers which could be called economy class, and then business class beyond the curtain a different tax menu is served. ..People with sufficient wealth to utilise every loophole and tax advantage of every tax subsidy.”

Why study tax law? In our fast-moving world, highly trained tax professionals are in demand and are well paid. Jobs are available in the big accounting firms, as well as the many small to medium-sized accounting/law firms and also corporates. There are numerous government positions and many tax professionals choose to run their own tax businesses. Not only are these careers available in every Australian state, but also work is available in the leading business centres such as London and New York. Studying tax law is a stimulating prospect, as well as an intimidating one — stimulating in the sense that tax is a battleground of the mind. Studying tax will develop your mind and your mental strength. It is akin to Scrabble, Rubik’s Cube, chess and poker. It is addictive. If you like writing and reading, if you like numbers and if you like policy, it will appeal. You will develop your legal reasoning and writing skills and your tax accounting skills, and you will gain confidence and mental resolve. As you meet the challenges offered up in this text, you will also feel a great sense of accomplishment. This will culminate in Chapter 23, which poses the ultimate challenge. Tax poses a fearful symmetry of legal, accounting and information technology challenges. It can also be intimidating. Both the tax profession and the Australian Taxation Office are challenged by the exceedingly high levels of complexity associated with the 125 tax laws, and the community expectations for the efficient and effective use of modern information technology. The tax labyrinth has become a maelstrom of fear. Tax law reform, information technology improvements and leadership are badly needed. For the ignorant, the misinformed, the greedy, the bankrupt and the jailed, the tax labyrinth is a nightmare. Catastrophic errors of judgment are made by over-confident taxpayers and their advisers. Beware! Tax scheme promoters continue to prey on the ignorance of taxpayers and their advisers.1

The current frequency of jail sentences for tax fraud suggests that it is now a golden age for ethics and a bronze age for tax evasion. For some dead-eyed, shell-shocked tax veterans, the brain implosions and mental battering of the tax labyrinth can prove to be disastrous. ‘A Brisbane accountant was sentenced to 3 years and 6 months’ jail by the District Court Brisbane for submitting $174,293 in false GST claims.’2 ‘An Adelaide accountant was sentenced to 3 years and 3 months’ jail by the District Court of South Australia for $4,560,007 in attempted GST fraud and forgery.’3 Another was jailed for 3 years for tax fraud4 and yet another sentenced to 7 years’ jail for a $700,000 tax fraud.5 To prepare you for these challenges, this text is built around gaining an understanding of tax policy and a step-by-step approach to applying tax law using the tax pyramid shown above. The text also uses a four-step legal reasoning model. This framework is the key to unlocking the mysteries of the tax labyrinth. Be sure, the tax labyrinth will test your mettle and reveal your mental chinks.

Aims of the text Australia has one of the most complex tax systems in the world; thus, the study of tax poses significant challenges. This text aims to provide you with a clear understanding of the basics of the Australian tax system through a stepby-step approach to unravelling complex law. Specifically, the text aims to provide: 1. an understanding of taxation policy; 2. an understanding of income tax and the application of the income tax equation; 3. an understanding of FBT and the application of the FBT tax equation; and 4. an understanding of GST and the application of the GST equation. The initial questions to ask are — what is tax and why is tax important?

What is tax? Tax can be defined as ‘a compulsory exaction of money by a public authority for public purposes enforceable by law’.6 For example, taxes include income tax and GST. However, when a government-owned body, such as Australia Post, charges money for a service (postage), this does not constitute a tax.

Why is tax important? Taxation is critically important for the effective functioning of a society. It enables a government to provide public goods (such as roads, schools, hospitals, defence, courts) to support the disadvantaged and to correct market imperfections (such as monopolies). As stated by Isaacs J:7 It is one of the empirical certainties of history that no structural society has ever arisen without taxation. However, the power of taxation is one which is particularly liable to abuse, either in the hands of an individual autocrat or of a sectional oligarchy such as may wield the sceptre of authority even under the forms of a modern Parliamentary system; but without that power no Government, as we understand the term, is possible. The power to tax is the one great power upon which the whole national fabric is based. It is as necessary to the existence and prosperity of a nation as is the air he breathes to a natural man. It is not only the power to destroy, but the power to keep alive.

About the authors Dr Paul Kenny is an Associate Professor in Taxation Law at Flinders University, a past President of the Australasian Tax Teachers Association and a Chartered Accountant. His academic interests include taxation policy, small business taxation, wine taxation and the internet. Dr Sylvia Villios is a Senior Lecturer at the Adelaide Law School, University of Adelaide. Sylvia researches and teaches in taxation law, particularly focussing on questions about the operation of the Australian tax system, taxation policy, corporate taxation and the role, powers and accountability of the Commissioner of Taxation. Prior to her appointment at the University of Adelaide, Sylvia was engaged in legal practice for 6 years at two of Adelaide’s

leading law firms, specialising in advising clients on taxation, trust law, superannuation and general corporate and commercial matters. Michael Blissenden is a Professor in the School of Law at the Western Sydney University who has also been a tax writer with CCH Australia and Butterworths.

About the contributing authors Gordon Mackenzie is a Lecturer in superannuation taxation at the Australian School of Taxation at UNSW. He is also Convener of the Master of Tax and Financial Planning and has over 30 years’ experience in superannuation. He was responsible for updating Chapter 15. Lidia Xynas is an Associate Professor the College of Law and Justice at Victoria University, Melbourne. Prior to teaching, Lidia was a corporate accountant and an Australian lawyer. Her research and teaching interests are in taxation law and succession law. She was responsible for updating Chapter 14.

1.

2. 3.

Australian Taxation Office, ‘Promoter penalty practice statements released’, Media Release 2008/19: Tax Commissioner Michael D Ascenzo notes that, often, the ‘brains’ of tax avoidance schemes are located offshore but rely on local advisers with a client base to sell the schemes. His advice is to avoid these schemes at all costs. Australian Taxation Office, ‘Accountant jailed for GST fraud’, Media Release 2008/37.

4.

Australian Taxation Office, ‘Accountant jailed for attempting GST fraud of over $4.5 million’, Media Release 2008/15. Australian Taxation Office Media Release, 14 December 2007.

5. 6.

Australian Taxation Office Media Release, 14 September 2007. Mathews v The Chicory Marketing Board (Vic) (1938) 60 CLR 263 at 276 per Latham CJ.

7.

R v Barger (1908) 6 CLR 41.

Text features Practice problem These enable readers to check their understanding of the material. The answers to each chapter’s problems are found on the web at: . This symbol indicates a practical example demonstrating the operation of tax law in commercial practice.

XvY Facts: This is a case summary relevant to the topic. Court held: Case summaries provide students with a brief outline of the facts of the case, the decision of the court and the reasons for that decision.

Further problems Found at the end of each chapter, these questions enable students to consolidate their understanding of the topic. They are designed for interactive class discussion and team-based learning or for use in assessment. The answers to these questions are available only to lecturers who use this text as compulsory course reading.

Attempt the Web Quiz for each

chapter A distance learning Web Quiz is provided to students whose lecturer adopts the text. The Web Quiz enables students to check their understanding of key concepts and provides immediate feedback on both correct and incorrect answers.

Acknowledgments The authors and publishers are grateful to the holders of copyright in material from which extracts appear in this work, particularly the Commonwealth of Australia. All legislative material herein is reproduced by permission but does not purport to be the official or authorised version. It is subject to Commonwealth of Australia copyright. While every care has been taken to establish and acknowledge copyright, the publishers tender their apologies for any accidental infringement. They would be pleased to come to a suitable arrangement with the rightful owners in each case.

Publishers’ note The publishers and authors both exclude liability for loss suffered by any person resulting in any way from the use of, or reliance on, this publication.

Table of cases References are to paragraph numbers

A AAT Case [2006] …. 10.45 AAT Case 2/2015 [2015] …. 17.10 AAT Case 3/99 (1999) …. 17.16 AAT Case 13/99 (1999) …. 5.6 AAT Case 42/95 (1995) …. 5.26 AAT Case 63 (1987) …. 10.45 AAT Case 87 (1987) …. 10.45 AAT Case 519 …. 4.21, 4.23, 4.29 AAT Case 3304 (1987) …. 10.38 AAT Case 4309 (1988) …. 10.38 AAT Case 7752; Case Z9 (1992) …. 7.5 AAT Case 8892 (1993) …. 4.21 AAT Case 9254 (1994) …. 10.45 AAT Case 9679 (1994) …. 10.45 AAT Case 10079 (1995) …. 14.18 AAT Case 10363 (1995) …. 10.50 AAT Case 10666 (1996) …. 10.50 AAT Case 11455 (1996) …. 10.45 AAT Case 12821 …. 10.51 AAT Case 12860 …. 6.23 AAT Case Re AGR Joint Venture and FCT [2007] …. 19.59 AAT Case Re Bayconnection Property Developments Pty Ltd and FCT ….

19.22 AAT Case Re Brookdale Investments Pty Ltd and FCT [2013] …. 19.50 AAT Case Re Caller and FCT [2009] …. 9.50 AAT Case Re Carlaw and FCT (1995) …. 10.50 AAT Case Re Chaudri and FCT (1999) …. 10.50 AAT Case Re Clothing Importer and FCT [2011] …. 19.27 AAT Case Re Confidential and FCT [2013] …. 9.10 AAT Case Re Crown Insurance Services and FCT [2011] …. 4.38 AAT Case Re Drysdale and FCT [2008] …. 19.73 AAT Case Re Farnan v FCT [2005] …. 17.44 AAT Case Re Food Supplier and FCT [2007] …. 19.38 AAT Case Re Geekie and FCT (1998) …. 10.38, 10.45 AAT Case Re Groves and FCT [2011] …. 4.29 AAT Case Re Heaney and FCT [2013] …. 17.44 AAT Case Re Hinch and FCT (1997) …. 10.38 AAT Case Re Hornsby Shire Council and FCT [2008] …. 19.24 AAT Case Re Iyengar and FCT [2011] …. 4.12, 4.21 AAT Case Re Jakjoy Pty Ltd and FCT [2013] …. 9.102 AAT Case Re Karapanagiotidis and FCT (2007) …. 9.102 AAT Case Re Karmela Co Pty Ltd and FCT [2004] …. 19.58 AAT Case Re Keenhilt Pty Ltd (as Trustee for the CHC Services Trust) and FCT [2007] …. 19.24 AAT Case Re Keep and FCT [2013] …. 9.50 AAT Case Re Lyons and FCT (1999) …. 10.38 AAT Case Re Mayhew and FCT [2013] …. 4.21 AAT Case Re Murphy and FCT [2014] …. 9.10 AAT Case Re Murray and FCT [2013] …. 4.12 AAT Case Re Nordern and FCT [2013] …. 4.21 AAT Case Re Ohl and FCT [2012] …. 21.8

AAT Case Re Park and FCT [2011] …. 17.46 AAT Case Re Private Tutor and FCT [2013] …. 19.22, 19.72 AAT Case Re Touram Pty Ltd and FCT [2008] …. 19.27 AAT Case Re Qantas Airways Ltd and FCT [2014] …. 18.42 AAT Case Re Rod Mathiesen Truck Hire Pty Ltd (as trustee for the Mathiesen Family Trust) and FCT [2013] …. 19.26 AAT Case Re Rossitto and FCT (1998) …. 10.51 AAT Case Re Slade Bloodstock Pty Ltd and FCT [2006] …. 18.22 AAT Case Re Snugfit Australia Pty Ltd and FCT [2013] …. 19.43 AAT Case Re Summers and FCT [2008] …. 9.50 AAT Case Re Syttadel Holdings Pty Limited and FCT [2011] …. 9.99 AAT Case Re Tabone and FCT [2006] …. 10.40, 17.17 AAT Case Re Tingari Village North Pty Ltd and FCT [2010] …. 9.101 AAT Case Re The Engineering Manager and FCT [2014] …. 4.21 AAT Case Re Vaughan and FCT [2011] …. 9.99, 9.102 AAT Case Re VBI and FCT [2005] …. 10.51 AAT Case Re Westcott and FCT (1997) …. 10.45 AG of British Columbia v Ostrum [1904] …. 6.18, 6.19 AGC (Advances) Ltd v FCT (1975) …. 5.28, 10.15 AGR Joint Venture and FCT, Re [2007] …. 19.59 Aid/Watch Inc v FCT (2010) …. 8.4 Alcoa of Australia Ltd v FCT [2008] …. 11.9 All Sports Ltd v FCT [2011] …. 1.30 All States Frozen Foods Pty Ltd v FCT (1990) …. 5.39 Allied Mills Industries Pty Ltd v FCT (1989) …. 6.43 Allsop v FCT (1964) …. 6.44 Amalgamated Zinc (De Bavay’s) Ltd v FCT (1935) …. 5.28, 10.5, 10.7, 10.49, 10.53 Ambulance Service of New South Wales v DCT (2003) …. 18.25

Applicant and FCT, Re [2004] …. 17.15 Archibald Thomson, Black & Co Ltd v Batty (1919) …. 10.62 Arthur Murray (NSW) Pty Ltd v FCT (1965) …. 5.15 Atlas Tiles Ltd v Briers (1978) …. 6.38 Ausnet Transmission Group Pty Ltd v FCT [2015]…. 10.20 Australian National Hotels Ltd v FCT (1988) …. 10.58 Australasian Jam Co Pty Ltd v FCT (1953) …. 5.53

B Batchelor v FCT [2013] …. 7.24 Bayconnection Property Developments Pty Ltd and FCT, Re …. 19.22 Bell v Kennedy (1868) …. 4.20 Berghofer and FCT, Re (2008) …. 7.8 BHP Billiton v FCT [2002] …. 5.13 Blank v FCT [2014] …. 5.6, 6.19 Bohemians Club v Acting FCT (1918) …. 6.8 BP Australia Ltd v FCT (1965) …. 10.24 — v — [1966] …. 10.15 Brent v FCT (1971) …. 5.4, 5.6, 5.16 Briar Holdings Pty Ltd v Capolingua (1997) …. 9.1 British American Tobacco Australia Services Ltd FCT (2010) …. 17.15 British Insulated & Helsby Cables v Atherton (1926) …. 10.22 Broken Hill Proprietary Company Ltd v FCT (1999) …. 10.58 Broken Hill Theatres Pty Ltd v FCT (1952) …. 10.24, 10.62 Brookdale Investments Pty Ltd and FCT, Re [2013] …. 19.50 Burmah Steamship Co Ltd v IRC (1930) …. 6.39 Bywater Investments Ltd & Ors v FCT [2016] …. 4.39

C

C of T v Meeks (1915) …. 4.51 Californian Copper Syndicate v Harris (1904) …. 6.24, 6.25, 23.2 Californian Oil Products Ltd (in liq) v FCT (1934) …. 6.41, 6.43 Caller and FCT, Re [2009] …. 9.50 Cameron v Deputy Federal Commissioner of Taxation (Tas) (1923) …. 1.17 — v FCT [2011] …., 17.58 Carberry v FCT [2011] …. 9.13 Carlaw and FCT, Re (1995) …. 10.50 Carlisle Silloth Golf Club v Smith (1912) …. 6.8 Case 2 CTBR (1967) …. 10.45 Case 2/98 (1998) …. 4.21 Case 19 CTBR (1974) …. 10.38 Case 26 CTBR (1981) …. 10.51 Case 40 (1968) …. 11.12 Case 47 CTBR (1986) …. 10.38 Case 51/93 (1993) …. 10.51 Case 58 (1962) …. 11.12 Case 64 (1944) …. 11.12 Case 78 CTBR (1944) …. 4.23 Case 82 (1953) …. 11.12 Case 519 (1985) …. 4.21, 4.22, 4.29 Case D62 (1972) …. 5.6 Case J47 (1958) …. 11.7 Case N43 (1991) …. 19.25 Case N56 (1981) …. 14.10 Case Q68 (1983) …. 4.21 Case S75 (1985) …. 14.20 Case T73 (1986) …. 10.35 Case T75 (1968) …. 11.12

Case T78 (1986) …. 10.35 Case U52 (1987) …. 5.16 Case U80 (1987) …. 10.45 Case U95 (1987) …. 10.45 Case W58 (1989) …. 17.15 Case Z1 (1992) …. 10.35 Case Z9; AAT Case 7752 (1992) …. 7.5 Case Z35 (1992) …. 16.26 Casimaty v FCT (1997) …. 6.32 Cecil Bros Pty Ltd v FCT (1964) …. 10.14, 10.15 Channel Pastoral Holdings Pty Ltd v FCT [2015] …. 17.16 Charles Moore & Co (WA) Pty Ltd v FCT (1956) …. 10.5, 10.15, 10.24, 10.53, 10.55 Chaudri and FCT, Re (1999) …. 10.50 CIR (NZ) v National Bank of New Zealand (1977) …. 5.7 Cliffs International Inc v FCT (1979) …. 10.24 Clothing Importer and FCT, Re [2011] …. 19.27 Coal Developments (German Creek) Pty Ltd v FCT (2007) …. 14.85 Coleambally Irrigitation Mutual Co-operative Ltd v FCT [2004] …. 6.8 Coles Myer Finance Ltd v FCT (1993) …. 5.18, 5.27 Colonial Mutual Life Assurance Society Ltd v FCT (1953) …. 10.24 Commercial & Accounting Services (Camden) Pty Ltd v Cummins [2011] …. 2.39 Commercial Union Assurance Co of Australia Ltd v FCT (1977) …. 5.18, 5.25 Commissioner for Inland Revenue v Lever Bros and Unilever Ltd (1946) …. 4.55 Confidential and FCT, Re [2013] …. 9.10 Cook, Re [1948] …. 14.37

Cooper Brookes (Wollongong) Pty Ltd v FCT (1981) …. 1.27, 1.30, 1.47, 17.20 Cooperative Bulk Handling Ltd v FCT (2010) …. 8.4 Couch and FCT, Re [2009] …. 9.50 Coward and FCT, Re (1999) …. 6.38 Crown Insurance Services and FCT, Re [2011] …. 4.38 CT (NSW) v Cam & Sons Ltd (1936) …. 4.58 Curran v FCT (1974) …. 1.30

D DAFF and FCT, Re (1998) …. 6.23 DCT v PM Developments Pty Ltd (2008) …. 1.30, 1.48 Dean v FCT (1997) …. 6.19, 6.36 Deputy Commissioner of Taxes (SA) v Executor, Trustee and Agency Company of South Australia Ltd (Carden’s case) (1938) …. 5.4, 5.10, 5.12 Dickenson v FCT (1958) …. 6.35, 6.36 Drysdale and FCT, Re [2008] …. 19.73

E Eastern Nitrogen v FCT [2001] …. 17.15 Eisner v Macomber (1920) …. 6.3, 6.29, 6.30 Elberg v FCT (1998) …. 10.62 Esquire Nominees v FCT (1972) …. 4.38, 4.56 Evans v FCT (1989) …. 6.23 Evenden v FCT [1999] …. 5.28

F Falcetta v FCT; FCT v Bartlett (2004) …. 11.2 Farnan v FCT [2005] …. 17.44

FCT v Angliss & Co Pty Ltd (1931) …. 4.51 — v Anovoy Pty Ltd [2001] …. 10.58 — v Applegate (1979) …. 4.12, 4.21, 4.28 — v Australian Gas Light Co (1983) …. 5.13 — v Bamford; Bamford v FCT (2010) …. 14.45, 14.62 — v Beville (1953) …. 14.21 — v Blake (1984) …. 6.21 — v Brand (1995) …. 5.26 — v Brown (1999) …. 10.59 — v Citylink Melbourne Ltd [2006] …. 5.18, 10.24 — v Cooke and Sherden (1980) …. 6.5, 6.24, 7.44 — v Cooling (1990) …. 6.28, 6.29, 9.1 — v Cooper (1991) …. 10.30, 10.49–10.51 — v CSR Ltd (2000) …. 6.44 — v Cyclone Scaffolding Pty Ltd (1987) …. 6.26 — v Day [2008] …. 10.7, 10.30, 10.49, 10.53 — v Dixon (1952) …. 6.9, 6.18, 6.21, 6.30, 7.4 — v Dixon Consulting Pty Ltd [2006] …. 17.60 — v DP Smith (1981) …. 6.38, 10.44 — v Dunn (1989) …. 5.10 — v Duro (1953) …. 10.62 — v Edwards (1993) …. 10.45 — v — (1994) …. 10.45 — v Faichney (1972) …. 10.38 — v Finn (1961) …. 10.32, 10.34, 10.35 — v Firstenberg (1976) …. 5.10 — v Firth (2002) …. 12.29 — v Forsyth (1981) …. 10.38, 10.63 — v Foxwood (Tolga) Pty Ltd (1981) …. 10.15

— v French (1957) …. 4.50 — v Futuris Corporation Limited [2012] …. 17.7, 17.10 — v Harris (1980) …. 6.18, 6.21 — v Hart [2004] …. 17.15 — v Hatchett (1971) …. 10.13, 10.33–10.35 — v Highfield (1982) …. 10.35 — v Holmes (1995) …. 7.4 — v Hunger Project Australia [2014] …. 11.40 — v Ilbery (1981) …. 10.5 — v Indooroopilly Children Services (Qld) Pty Ltd (2007) …. 18.22 — v James Flood Pty Ltd (1953) …. 5.18, 5.20, 5.22, 5.23, 5.25 — v Janmor Nominees Pty Ltd (1987) …. 10.40, 17.17 — v Jenkins (1982) …. 4.21 — v Lewis Berger & Sons (Aust) Ltd (1927) …. 4.51 — v Maddalena (1971) …. 5.26, 10.34, 10.35, 10.39, 10.49, 10.54 — v McDonald (1987) …. 14.11 — v McNeil (2005) …. 6.16 — v — (2007) …. 6.16 — v McPhail (1968) …. 11.42 — v Miller (1946) …. 4.12, 4.28 — v Mitchum (1965) …. 4.50 — v Montgomery (1999) …. 6.16, 6.28, 6.29 — v Munro (1926) …. 10.8 — v Murray (1998) …. 1.30, 1.31 — v Myer Emporium Ltd (1987) …. 6.10, 6.24, 6.27–6.30, 6.34, 7.9, 7.45, 10.24, 17.6 — v Payne (2001) …. 10.37, 10.49, 11.29 — v Peabody (1994) …. 17.10, 17.15 — v Pechey (1975) …. 4.12, 4.15, 4.28

— v Phillips (1978) …. 10.14 — v Reliance Carpet Co Pty Ltd [2008] …. 19.64 — v Reynolds (1981) …. 6.24, 6.26, 6.27 — v Riverside Road Lodge Pty Ltd (in liq) (1990) …. 10.15 — v Roberts and Smith (1992) …. 10.60, 12.18 — v Rowe (1995) …. 10.49 — v — (1997) …. 7.23, 10.18 — v Shields (1999) …. 6.23 — v Slade Bloodstock Pty Ltd [2007] …. 18.22 — v Slater Holdings Ltd (1984) …. 14.81 — v Sleight [2004] …. 6.23, 17.15, 17.18 — v Snowden & Willson Pty Ltd (1958) …. 10.16, 10.24, 10.62 — v South Australian Battery Makers Pty Ltd (1978) …. 10.14, 10.24 — v Spedley Securities Ltd (1988) …. 6.24, 6.28 — v Spotless Services Ltd (1993) …. 4.55 — v — (1995) …. 4.55 — v — (1996) …. 17.10, 17.15 — v St Hubert’s Island Pty Ltd (1978) …. 6.23 — v Stone (2005) …. 6.23 — v Studdert (1991) …. 10.35 — v Students World (Australia) Pty Ltd (1978) …. 1.30 — v Sutton Motors (Chullora) Wholesale Pty Ltd (1985) …. 5.39 — v Swansea Services Pty Ltd [2009] …. 19.22 — v Sydney Refractive Surgery Centre Pty Ltd (2008) …. 6.38 — v Total Holdings (Australia) Pty Ltd (1979) …. 10.61 — v Triton Foundation (2005) …. 8.4 — v United Aircraft (1943) …. 4.57 — v Walker (1985) …. 6.23

— v Western Suburbs Cinemas Ltd (1952) …. 11.9, 11.11 — v Westraders Pty Ltd (1980) …. 1.25, 1.27, 1.47 — v Whitfords Beach Pty Ltd (1982) …. 6.28, 6.33 — v Whiting (1943) …. 14.52, 14.58 — v Woite (1982) …. 6.36 — v Word Investments Ltd [2006] …. 8.4 Federal Wharf Co Ltd v DCT (1930) …. 6.16 Ferguson v FCT (1979) …. 6.23 First Provincial Building Society Ltd v FCT (1995) …. 7.8 FKYL, Re and FCT [2016] …. 19.58 Fletcher v FCT (1991) …. 10.15, 17.3, 17.6, 17.26 — v FCT (1992) …. 17.6, 17.26 — v Income Tax Commr (Jamaica) (1971) …. 6.8 Foley Bros Pty Ltd v FCT (1965) …. 10.62 Food Supplier and FCT, Re [2007] …. 19.38 Fowler v FCT [2008] …. 17.46

G G E Crane Sales Pty Ltd v FCT (1971) …. 11.18 Garforth v Newsmith Stainless Ltd (1979) …. 5.6 Gashi v FCT [2012] …. 6.47 Geekie and FCT, Re (1998) …. 10.38, 10.45 Glenboig Union Fireclay Co Ltd v IRC (1922) …. 6.39 Gloxinia Investments Limited as Trustee for Gloxinia Unit Trust v FCT (2009) …. 1.30 GP International Pipecoaters Pty Ltd v FCT (1990) …. 6.25, 10.18 Groves and FCT, Re [2011] …. 4.29 Gulland v FCT, Watson v FCT, Pincus v FCT (1985) …. 17.16

H Hallstroms Pty Ltd v FCT (1946) …. 10.15, 10.24 Hance v FCT [2008] …. 10.43 Handley v FCT (1981) …. 10.38 Harmer v FCT (1991) …. 14.37, 14.52 Hart v FCT [2002] …. 10.40 Hayes v FCT (1956) …. 6.12, 6.18, 6.21 Hayley v FCT (1958) …. 10.56 Healey v FCT [2012] …. 9.64, 9.131 Heaney and FCT, Re [2013] …. 17.44 Heavy Minerals Pty Ltd v FCT (1966) …. 6.41 Henderson v FCT (1970) …. 5.11 Henry Jones (IXL) Ltd v FCT (1991) …. 6.10, 6.30 Hepples v FCT (1990) …. 9.28 — v — (1992) …. 9.14 Herald & Weekly Times v FCT (1932) …. 10.49, 10.53, 10.62 Hinch and FCT, Re (1997) …. 10.38 Hornsby Shire Council and FCT, Re [2008] …. 19.24 Horton v Young (Insp of Taxes) [1972] …. 10.63 Howland-Rose v FCT (2002) …. 17.3, 17.18 Hua Wang Bank Berhad v FCT [2014] …. 4.36

I Igloo Homes Pty Ltd v Sammut Constructions Pty Ltd [2004] …. 19.98 Integrated Insurance Planning Pty Ltd v FCT (2004) …. 6.27, 9.13 IR Commrs v Carron Company (1968) …. 10.62 — v Fleming & Co (Machinery) Ltd (1951) …. 6.43 IR Commrs (Ceylon) v Appuhamy [1963] …. 10.62 Iyengar and FCT, Re [2011] …. 4.12, 4.21

J J & G Knowles & Associates Pty Ltd v FCT (2000) …. 18.22 J Rowe & Son Pty Ltd v FCT (1971) …. 5.12 Jakjoy Pty Ltd and FCT, Re [2013] …. 9.102 Jayatilake v FCT (1990) …. 10.35 JMB Beverages Pty Ltd v FCT [2010] …. 19.38 John Fairfax & Sons Pty Ltd v FCT (1959) …. 10.24, 10.55, 10.62 John v FCT (1989) …. 1.30, 10.15 John Holland Group Pty Ltd v FCT [2015] …. 18.50 Jolley v FCT (1989) …. 14.10 Jones v FCT [2002] …. 10.59

K Karapanagiotidis and FCT, Re (2007) …. 9.102 Karmela Co Pty Ltd and FCT, Re [2004] …. 19.58 Keenhilt Pty Ltd (as Trustee for the CHC Services Trust) and FCT, Re [2007] …. 19.24 Keep and FCT, Re [2013] …. 9.50 Kelly v CIR (NZ) [1970] …. 14.33 — v FCT (1985) …. 6.18, 6.20 Koitaki Para Rubber Estates Ltd v FCT (1941) …. 4.36 Kratzmann v FCT (1970) …. 10.62

L Law Shipping Co v IR Commrs (1924) …. 11.11 Leigh v IRC (1927) …. 5.7 Leonard v FCT (1919) …. 14.22 Levene v IRC [1928] …. 4.12, 4.14, 4.16, 4.28 Liftronic v FCT (1996) …. 6.38

Lincolnshire Sugar Co Ltd (in liq) v Smart (1937) …. 7.8 Lindsay v FCT (1961) …. 11.9 Lloyd v Sulley (1884) …. 4.10, 4.11 Lodge v FCT (1972) …. 10.36 London Australia Investment Co Ltd v FCT (1977) …. 6.23 Lopez v FCT (2005) …. 4.61 Lunney v FCT; Hayley v FCT (1958) …. 10.12, 10.37, 10.49, 10.63, 10.64 Lyons and FCT, Re (1999) …. 10.38 Lyons v FCT (1999) …. 10.38 Lysaght v IR Commrs (1928) …. 4.15

M Macarthur v FCT (2002) …. 17.16 McCauley v FCT (1944) …. 6.16 McLaurin v FCT (1961) …. 6.44 Magna Alloys & Research Pty Ltd v FCT (1980) …. 10.15, 10.16, 10.49, 10.53, 10.62, 11.3, 11.25 Malayan Shipping Co Ltd v FCT (1946) …. 4.34 Mallalieu v Drummond [1981] …. 10.45 Mansfield v FCT (1996) …. 10.45, 10.46 Marreco v Richardson [1908] …. 5.6 Martin v FCT (1953) …. 6.13, 6.23 Mayhew and FCT, Re [2013] …. 4.21 Memorex Pty Ltd v FCT (1987) …. 6.26 Metal Manufacturers v FCT (1999) …. 17.15 — v — [2001] …. 17.15 Moana Sands Pty Ltd v FCT (1988) …. 6.28 Montgomery v FCT (1998) …. 6.28 Mount Isa Mines Ltd v FCT (1992) …. 10.24

Municipal Mutual Insurance Ltd v Hills (1932) …. 6.8 Murphy and FCT, Re [2014] …. 9.10 Murray and FCT, Re [2013] …. 4.12

N Naglost v FCT [2002] …. 10.35 Nathan v FCT (1918) …. 4.48 Naval, Military & Airforce Club of South Australia (Inc) v FCT (1994) …. 9.14 Nelson v FCT [2014] …. 16.14 New Zealand Flax Investments Ltd v FCT (1938) …. 5.18, 5.23, 5.25 Newsom v Robertson [1952] …. 10.63 Nicks Ltd v Taylors Ltd [1962] …. 5.6 Nilsen Development Laboratories Pty Ltd v FCT (1981) …. 5.18, 5.23, 5.24 No Worries Management Pty Ltd v Dolman [2004] …. 19.111 Nordern and FCT, Re [2013] …. 4.21 North Australian Pastoral Co Ltd v FCT (1946) …. 4.37 North Ryde RSL Community Club Ltd v FCT [2002] …. 6.8 Northumberland Development Co Pty Ltd v FCT (1994) …. 6.16 Nullaga Pastoral Co Pty Ltd v FCT (1978) …. 6.16

O Odeon Associated Theatres Ltd v Jones [1972] …. 11.11 Ohl and FCT, Re [2012] …. 21.8

P P & N Beverages Australia v FCT [2007] …. 19.38 Partridge v Mallandaine (1886) …. 6.15 Payne v FCT (1996) …. 6.6, 6.7, 6.18 PBL Marketing Pty Ltd v FCT (1985) …. 10.62

Petroulias v R (Cth) [2006] …. 2.35, 2.40 Petrovic v FCT [2005] …. 10.35 Peyton v FCT (1963) …. 5.28 Philip Morris v FCT (1979) …. 5.42 Pincus v FCT (1985) see Gulland v FCT, Watson v FCT, Pincus v FCT (1985) Pine Creek Goldfields Ltd v FCT (1999) …. 10.24 Placer Pacific Management Pty Ltd v FCT (1995) …. 5.28 Planche v Fletcher (1779) …. 4.7 Point v FCT (1970) …. 11.20 Primary Health Care Ltd v FCT [2010] …. 13.41 Private Tutor and FCT, Re [2013] …. 19.22, 19.73 Professional Admin Service Centres Pty Ltd v FCT [2013] …. 19.73 Putnin v FCT (1991) …. 10.49, 10.62 Puzey v FCT [2002] …. 6.23, 17.18

Q Qantas Airways Ltd and FCT, Re [2014] …. 18.42 Quality Publications Australia Pty Limited v FCT [2012] …. 9.123 Queensland Meat Export Co Ltd v Deputy FCT (1939) …. 5.28

R R v Jones; R v Hili [2010] …. 17.2 — v Meares (1997) …. 17.1 RACV Insurance Pty Ltd v FCT (1974) …. 5.18, 5.25 Rafferty v FC of T [2017] …. 10.64 Raftland Pty Ltd as trustee of the Raftland Trust v FCT [2008] …. 14.65 Reckitt & Colman Pty Ltd v FCT (1974) …. 7.8 Reliance Carpet Co Pty Ltd v FCT (2006) …. 19.64 Reo Motors Ltd v CT (NSW) (1931) …. 10.62

Resch v FCT (1942) …. 1.16 Reuter v FCT (1993) …. 6.19 Rhodesia Metals Ltd (in liq) v C of T [1940] …. 4.54 Richard James Pye v FCT (1959) …. 10.62 Richard Walter Pty Ltd v FCT (1997) …. 17.6 Rio Tinto Services Ltd v FCT [2015] …. 19.57 Robert G Nall Ltd v FCT (1937) …. 10.15 Roche Products Pty Ltd and FCT, Re (2008) …. 4.85 Rod Mathiesen Truck Hire Pty Ltd (as trustee for the Mathiesen Family Trust) and FCT, Re [2013] …. 19.26 Rogers v IRC (1879) …. 4.12, 4.28 Ronpibon Tin NL v FCT; Tongkah Compound NL v FCT (1949) …. 10.4, 10.7, 10.9, 10.111, 10.15, 10.16, 10.30, 10.49 Rossitto and FCT, Re (1998) …. 10.51 Rotherwood Pty Ltd v FCT (1996) …. 6.16 Ryan and FCT, Re (2004) …. 17.10

S Sacca v Adam (1983) …. 20.1 Saeed v Minister for Immigration and Citizenship (2010) …. 1.30, 1.47 Scammell (G) & Nephew Ltd v Rowles [1939] …. 10.62 Scott v C of T (NSW) (1935) …. 1.31, 6.3 — v FCT (1966) …. 6.12, 6.18, 6.21 Scott (No 3) v FCT [2002] …. 10.37, 10.64 Scott (No 5) v FCT [2002] …. 10.37 Scottish Australian Mining Co Ltd v FCT (1950) …. 6.16, 6.28, 6.32 Shaw v FCT (1920) …. 5.10 Slade Bloodstock Pty Ltd v FCT (2007) …. 18.22 Slater v CT (NZ) (1949) …. 4.12, 4.28

Smith v FCT (1987) …. 7.4 SNF (Australia) Pty Ltd v FCT [2011] …. 4.85 Snook v London & West Riding Investments Ltd [1967] …. 17.6 Snugfit Australia Pty Ltd and FCT, Re [2013] …. 19.43 Softwood Pulp & Paper Ltd v FCT (1976) …. 10.54 South Australia v Commonwealth of Australia (1992) …. 1.19 South Sydney Junior Rugby League Club Ltd and FCT, Re (2006) …. 8.4 Southwell v Savill Bros Ltd (1901) …. 10.62 Spassked Pty Ltd v FCT [2003] …. 10.15 Spriggs v FCT; Riddell v FCT [2009] …. 10.39, 10.54 Squatting Investments Company v FCT (1953) …. 7.8 Stanton v FCT (1955) …. 6.16 State Chamber of Commerce and Industry v Commonwealth of Australia (1987) …. 1.14 Steele v FCT (1999) …. 10.57–10.59 Stockvis v FCT (1930) …. 10.62 Stoneleigh Finance Ltd v Phillips [1965] …. 17.6 Studebaker Corp of Australia v C of T (NSW) (1921) …. 4.55 Summers and FCT, Re [2008] …. 9.50 Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) …. 10.24, 10.58, 10.62 Sydney Ferries Ltd v C of T (NSW) (1922) …. 10.62 Sydney Water Board Employees’ Credit Union Ltd v FCT (1973) …. 6.8 Symond v Gadens Lawyers Sydney Pty Ltd (No 2) [2013] …. 20.1 Syttadel Holdings Pty Limited and FCT, Re [2011] …. 9.99

T Tabone and FCT, Re [2006] …. 10.40, 17.17 Tam v Mannall [2010] …. 19.111

Taras Nominees Pty Ltd as Trustee for the Burnley Street Trust v FCT [2014] …. 9.10 Taylor v FCT (1970) …. 14.52 Tennant v Smith [1892] …. 6.5 Thomas v FCT [1972-1973] …. 10.38 Ting v FCT [2015] …. 10.32 Tingari Village North Pty Ltd and FCT, Re [2010] …. 9.101 Touram Pty Ltd and FCT, Re [2008] …. 19.27 Tyco Australia Pty Ltd v FCT [2007] …. 10.24

U Uber B.V FCT [2017] …. 19.22 Union Trustee Co of Australia Ltd v FCT (1935) …. 11.25 Unit Construction Ltd v Bullock (1959) …. 4.39 Ure v FCT (1981) …. 10.9, 10.15, 10.61

V Vallumbrosa Rubber Co Ltd v Farmer (1910) …. 10.21 Van Den Berghs Ltd v Clark (1935) …. 6.42 Vaughan and FCT, Re (2011) …. 9.99, 9.102 VBI and FCT, Re [2005] …. 10.51 Vegners v FCT (1999) …. 14.52 Vendardos, Re [1964] …. 6.16 Vidler v FCT [2009] …. 19.58 Virgin Blue Airlines Pty Ltd v FCT [2010] …. 18.42

W W Nevill & Co Ltd v FCT (1937) …. 10.16, 10.53 W Thomas & Co Pty Ltd v FCT (1965) …. 11.6, 11.9, 10.12 Wangaratta Woollen Mills Ltd v FCT (1969) …. 13.9

Ward & Co Ltd v C of T (NZ) [1923] …. 10.62 Warner Music Australia v FCT (1996) …. 7.23 Watson v DCT [2008] …. 6.23 — v — [2010] …. 17.31 WD & HO Wills (Australia) Pty Ltd v FCT (1996) …. 10.16, 17.15 Westcott and FCT, Re (1997) …. 10.45 Westfield Ltd v FCT (1991) …. 6.34 Westpac Banking Corporation v FCT (1996) …. 18.34 Whitaker v FCT (1998) …. 6.16 White v FCT (2012) …. 9.99 Wickman Machine Tool Sales Ltd v L Schuler AG [1974] …. 19.111 Wilkie v IRC (1952) …. 4.24 Woods v DCT (1999) …. 6.23

Y Yarmouth v France (1887) …. 13.9 Yorkshire Railway Wagon Co v Maclure (1882) …. 17.6

Table of statutes References are to paragraph numbers

COMMONWEALTH A New Tax System (Family Assistance) (Administration) Act 1999 …. 8.27 A New Tax System (Goods and Services Tax) Act 1999 (GSTA 1999) …. 1.23, 1.46, 5.61, 19.1 Ch 1 …. 19.4, 19.5 Ch 2 …. 19.4, 19.6, 19.8, 19.10 Ch 2 Pt 2-6 …. 19.87 Ch 3 …. 19.4, 19.6, 19.7 Ch 4 …. 19.4, 19.6, 19.8 Ch 5 …. 19.4, 19.9 Ch 6 …. 19.4, 19.10 Div 1 …. 19.14 Div 2 …. 19.14 Div 5 …. 19.14 Div 7 …. 19.86 Div 9 …. 19.15 Subdiv 9-C …. 19.98 Div 13 …. 19.62, 19.74 Div 17 …. 19.86 Div 19 …. 19.75, 19.76, 19.82 Div 21 …. 19.75, 19.83 Div 23 …. 19.17 Subdiv 25-A …. 19.23

Div 27 …. 19.88 Div 29 …. 19.97 Div 37 …. 19.64 Div 38 …. 19.7, 19.30 Subdiv 38-A …. 19.31 Subdiv 38-B …. 19.31, 19.40, 19.46 Subdiv 38-C …. 19.31, 19.46, 19.47 Subdiv 38-D …. 19.31, 19.47 Subdiv 38-E …. 19.31, 19.48 Subdiv 38-F …. 19.31, 19.49 Subdiv 38-G …. 19.31, 19.51 Subdiv 38-I …. 19.31, 19.54 Subdiv 38-J …. 19.31, 19.50, 19.54 Subdiv 38-K …. 19.31, 19.52 Subdiv 38-L …. 19.31, 19.54 Subdiv 38-M …. 19.31, 19.54 Subdiv 38-N …. 19.31, 19.54 Subdiv 38-O …. 19.31, 19.54 Subdiv 38-P …. 19.31, 19.54 Subdiv 38-Q …. 19.31, 19.54 Subdiv 38-R …. 19.31, 19.54 Subdiv 38-S …. 19.31, 19.53 Div 40 …. 19.7, 19.30, 19.55, 19.60 Subdiv 40-A …. 19.56 Subdiv 40-B …. 19.57 Subdiv 40-C …. 19.58 Subdiv 40-D …. 19.59 Div 42 …. 19.7, 19.62, 19.74 Divs 48–51 …. 19.63

Div 54 …. 19.63 Div 57 …. 19.18 Div 66 …. 19.63 Div 69 …. 19.63 Div 72 …. 19.63 Div 75 …. 19.63 Div 78 …. 19.63 Div 81 …. 19.63 Div 87 …. 19.63 Div 90 …. 19.63 Div 93 …. 19.63 Div 96 …. 19.63 Div 99 …. 19.63, 19.64 Div 102 …. 19.63 Div 105 …. 19.63 Div 108 …. 19.63 Div 114 …. 19.63 Div 117 …. 19.63 Div 123 …. 19.63, 19.102 Div 126 …. 19.63 Div 129 …. 19.63, 19.75 Div 132 …. 19.63 Div 135 …. 19.63 Div 138 …. 19.63 Div 144 …. 19.18, 19.63 Div 147 …. 1.48, 19.18, 19.63 Div 153 …. 19.63 Div 156 …. 19.63

Div 157 …. 19.63 Div 159 …. 19.63 Div 165 …. 19.63 Div 176 …. 19.9 Div 177 …. 19.9 Div 188 …. 19.18, 19.20 s 5-5 …. 19.6 s 7-1(2) …. 19.65, 19.74 s 7-5 …. 19.86 s 9-5 …. 19.15, 19.27, 19.64, 19.69 s 9-10 …. 19.24, 19.64 s 9-10(1) …. 19.24 s 9-10(2) …. 19.24 s 9-10(2)(d) …. 19.24 s 9-10(2)(g) …. 19.24 s 9-15 …. 19.24, 19.26, 19.64 s 9-15(3) …. 19.26 s 9-15(3)(b) …. 19.26 s 9-15(3)(c) …. 19.26 s 9-20 …. 19.18, 19.22 s 9-20(2)(b) …. 19.22 s 9-25 …. 19.27 s 9-30 …. 19.59 s 9-70 …. 19.98 s 9-75 …. 19.98 s 9-75(3) …. 18.29 s 9-80 …. 19.38, 19.100 s 11-5 …. 19.66 s 11-10 …. 19.67

s 11-10(1) …. 19.67 s 11-10(2) …. 19.67 s 11-15 …. 19.67 s 11-20 …. 19.64 s 11-25 …. 19.72, 19.84, 19.99 s 11-30 …. 19.72, 19.99 s 11-30(3) …. 19.72 s 13-10 …. 19.74 s 15-5 …. 19.74 s 15-15 …. 19.74 s 17-5 …. 19.2, 19.3, 19.86, 19.112 s 21-5(1) …. 19.83 s 21-10 …. 19.83 s 21-15(1) …. 19.84 s 21-20 …. 19.84 s 23-5 …. 19.17, 19.18 s 23-10 …. 19.17, 19.18 s 23-15 …. 19.17, 19.18 s 27-5 …. 19.88 s 27-10 …. 19.88 s 27-15 …. 19.88 s 27-30 …. 19.88 s 27-35 …. 19.88 s 29-5 …. 19.91, 19.94 s 29-10 …. 19.92, 19.95 s 29-20 …. 19.95 s 29-20(1) …. 19.96, 19.97 s 29-40 …. 5.55, 19.90

s 29-45 …. 19.90 s 29-70(1) …. 19.104 s 29-70(2) …. 19.104 s 29-80(1) …. 19.104 s 33-5 …. 19.94 s 35-5(1) …. 19.100 s 38-1 …. 1.36, s 38-2 …. 19.33 s 38-3 …. 2.11, 19.34, 23.2 s 38-3(1) …. 19.34 s 38-3(2) …. 19.34 s 38-4 …. 1.34, 19.33 s 38-6 …. 19.39 s 38-7 …. 19.41 s 38-10 …. 19.41 ss 38-20–38-40 …. 19.42 s 38-45 …. 19.43 s 38-45(1) …. 19.43 s 38-47 …. 19.44 s 38-50 …. 19.44 s 38-55 …. 19.45 ss 38-90–38-97 …. 19.46 s 38-110 …. 19.46 s 38-185 …. 19.48 s 38-220 …. 19.49 s 38-250 …. 19.51 s 38-270 …. 19.51 s 38-325 …. 19.50 s 38-325(1)(c) …. 19.50

s 38-385 …. 19.59 s 40-5 …. 19.55 s 40-35 …. 19.57 s 40-65 …. 19.58 s 40-65(1) …. 19.58 s 40-70 …. 19.57 s 40-75 …. 19.58 s 40-100 …. 19.59 s 40-130 …. 19.60 s 99-5 …. 19.64 s 99-10 …. 19.64 s 131-5 …. 5.55 s 162-5 …. 5.55 s 144-5 …. 19.22 s 144-5(1) …. 19.22 s 184-1 …. 19.21 s 188-10 …. 19.20 s 188-10(1)(a) …. 19.18, 19.90 s 188-15 …. 19.19 s 188-15(1) …. 19.19 s 188-20 …. 19.20 s 188-20(1) …. 19.20 s 188-22 …. 19.19, 19.20 s 188-25 …. 19.19, 19.20 s 195-1 …. 1.32, , 19.10, 19.22, 19.50, 19.59 Sch 1 …. 19.4, 19.11, 19.34 Sch 1 cl 1 …. 19.34 Sch 2 …. 19.4, 19.12, 19.34, 19.38

Sch 2 cl 1 …. 19.34, 19.38 Sch 3 …. 19.4, 19.13, 19.43 A New Tax System (Goods and Services Tax) Regulations 1999 …. 19.14 Acts Interpretation Act 1901 (AIA) …. 1.38, 1.39, 1.41, 1.42, , s 15AA …. 1.38, 1.40, 1.42, 1.48, s 15AB …. 1.39, 1.40 s 15AB(2) …. 1.42 s 15AC …. 1.40 s 17(a) …. 4.11 Australian Business Number Act 1999 …. 21.16 s 3 …. 21.17 Australian Participants in British Nuclear Tests (Treatment) Act 2006 …. 8.27 Banking Act 1959 …. 8.23 Bankruptcy Act 1966 …. 15.53 s 74 …. 9.135 Commonwealth of Australia Constitution Act 1901 s 51 …. 1.14, 1.20 s 51(ii) …. 1.13, 1.14, 1.17 s 53 …. 1.21, 1.22 s 55 …. 1.15, 1.16 s 99 …. 1.18, 1.19 s 114 …. 1.19, 1.20 Corporations Act 2001 …. 8.23, 14.69, 15.1 Criminal Code Act 1995 Div 136 …. 21.9 Div 137 …. 21.9 Customs Tariff Act 1995 Sch 4 …. 19.28 Diverted Profits Tax Act 2017 …. 4.91

Domicile Act 1982 s 7 …. 4.20 s 10 …. 4.20 First Home Saver Accounts (Further Provisions) Amendment Act 2008 …. 7.22 Freedom of Information Act 1982 …. 21.13 Fringe Benefits Tax Act 1986 s 6 …. 18.2, 18.3, 18.4, 18.68 Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) …. 1.14, 1.23, 1.46, 2.46, 5.7, 6.7, 8.36, 18.1, 18.4, 18.36 Pt I …. 18.4, 18.5 Pt II …. 18.4, 18.6 Pt IIA …. 18.4, 18.7 Pt IIA Div 1 …. 18.7, 18.71 Pt IIA Div 2 …. 18.7 Pt IIA Div 3 …. 18.7 Pt III …. 18.4, 18.8 Pt III Divs 2–12 …. 18.31 Pt III Div 2 …. 18.32 Pt III Div 3 …. 18.33 Pt III Div 4 …. 18.34 Pt III Div 5 …. 18.35, 18.46 Pt III Div 6 …. 18.36 Pt III Div 7 …. 18.37 Pt III Div 8 …. 18.38 Pt III Div 9 …. 18.39 Pt III Div 9A …. 18.40 Pt III Div 10 …. 18.41 Pt III Div 10A …. 18.42

Pt III Div 11 …. 18.43 Pt III Div 12 …. 18.44, 18.47 Pt III Div 13 …. 18.21, 18.25, 18.48 Pt III Div 14 …. 18.51 Pt IIIA …. 18.4, 18.9 Pt IV …. 18.4, 18.10 Pt V …. 18.4, 18.11 Pt V Div 1 …. 18.11 Pt V Div 2 …. 18.11 Pt VII …. 18.4, 18.12 Pt X …. 18.4, 18.13 Pt XA …. 18.4, 18.14 Pt XI …. 18.4, 18.15 Pt XIA …. 18.4, 18.16 Pt XIB …. 18.4 Pt XIC …. 18.4, 18.18 Pt XII …. 18.4, 18.19 s 5 …. 18.68 s 5B …. 18.2, 18.3 s 5B(1A) …. 18.69, 18.71 s 5B(1B) …. 18.69 s 5B(1C) …. 18.69 s 5B(1E) …. 18.73 ss 5B(1E)–5B(1L) …. 18.73 s 5C(3) …. 18.70 s 5C(4) …. 18.70 s 5E(3) …. 18.72 s 7 …. 18.32 s 8 …. 18.21, 18.45

s 9 …. 18.57 s 9(2)(c) …. 18.57 s 10 …. 18.64 s 10(2) …. 18.58 s 14 …. 18.33 s 16 …. 18.34, 18.65 s 17 …. 18.21, 18.45 s 18 …. 18.65 s 19 …. 18.65 s 20 …. 18.35 s 20A …. 18.21, 18.46 s 21 …. 18.21, 18.46 s 22 …. 7.20, 18.21, 18.46 s 22A …. 18.46 s 23 …. 18.46 s 24 …. 18.46 s 25 …. 18.36 s 30 …. 18.37 ss 31–31B …. 18.37 s 31(b) …. 18.37 ss 31C–31E …. 18.37 s 32 …. 18.38 s 35 …. 18.39 ss 37A–37AG …. 18.40 s 37B …. 18.40 s 37BA …. 18.40 ss 37C–37CA …. 18.40 s 38 …. 18.41

s 39A …. 18.42 s 39A(1)(a)(i) …. 18.42 s 39A(1)(f) …. 18.42 s 40 …. 18.43 s 41 …. 18.45 s 45 …. 18.44 s 47 …. 18.21 s 47(2) …. 18.47 s 47A …. 18.21, 18.47 s 52(1) …. 18.50 s 58GA …. 5.55 s 58P …. 18.48 s 58X …. 13.13, 18.48 s 58ZC …. 18.46 s 61G …. 18.30 s 62 …. 18.38, 18.51 s 65J …. 18.9, 18.75 s 66 …. 18.10 s 67 …. 18.10 s 132(1) …. 18.16 s 135M …. 18.72 s 135P …. 18.72 s 135Q …. 18.72 s 136(1) …. 18.20, 18.21, 18.22, 18.23, 18.24, 18.38, 18.42, 18.47 s 149A …. 18.69 s 154 …. 18.22 Fringe Benefits Tax Regulations 1992 …. 18.4 Fuel Tax Act 2006 …. 5.61 Higher Education Support Act 2003 …. 18.17, 18.72

Income Tax Act 1922 …. 10.5 s 23(1)(a) …. 10.2 s 25(b) …. 10.2 s 25(e) …. 10.2 Income Tax Act 1986 …. 3.28 Income Tax Assessment Act 1936 (ITAA 1936) …. 1.23, 1.46, 3.4, 3.5, 3.6, 3.12, 3.14, 3.15, 3.20, 3.21, 3.25, 3.26, 3.27, 3.29, 3.66, 4.11, 4.70, 5.4, 6.1, 8.3, 8.31, 8.38, 11.1, 12.1, 13.1, 13.71, 13.73, 14.10, 14.60, 14.68, 15.1, 15.2, 15.29, 15.47, 17.21, Pt I …. 3.5, 3.15 Pt II …. 3.5, 3.16 Pt III …. 3.5, 3.17 Pt III, Div 5A …. 14.34 Pt III, Div 6 …. 4.59, 14.36 Pt III, Div 6AA …. 14.4, 14.26, 14.55 Pt III, Div 6AAA …. 4.68 Pt III, Div 6B …. 14.67 Pt III, Div 6C …. 14.67 Div 6 …. 9.65 Div 6D …. 14.64 Div 6E …. 9.65 Pt III, Div 7A …. 4.61, 14.71, 14.83 Pt III, Div 9 …. 6.8 Div 10 …. 10.24 Pt III Div 13 …. 4.3, 4.85 Pt III, Div 13A …. 4.30, 4.67, 7.32, 15.58 Pt III, Div 16D …. 12.30 Pt III, Div 16K …. 14.91 Pt IIIB …. 3.5, 3.18, , 4.80, 4.90

Pt IV …. 3.5, 3.19 Pt IVA …. 3.5, 3.20, 4.55, 10.15, 10.40, 14.5, 14.45, 14.62, 14.65, 17.1, 17.4, 17.5, 17.6, 17.7, 17.8, 17.10, 17.11, 17.13, 17.14, 17.15, 17.16, 17.17, 17.18, 17.19, 17.20, 17.65, 20.14 Pt VA …. 3.5, 3.21 Pt VIIB …. 3.5 Pt VIII …. 3.5, 3.23 Pt X …. 3.5, 3.23, 4.68 Pt XI …. 4.68 Div 19A …. 17.10 s 6(1) …. 1.32, 3.15, 3.29, 4.11, 4.18, 4.22, 4.26, 4.30, 4.31, 4.42, 4.57, 4.67, 4.93, 6.16, 7.52, 14.18, 14.58, 14.72, 14.81 s 6(1AA)–(6) …. 3.15 s 6BA …. 14.92 s 6C …. 4.57, 4.58 s 6CA …. 4.52 s 7A(1) …. 4.11 s 18 …. 5.2 s 19 …. 6.1, 14.52 s 21 …. 7.44, 12.46 s 21A …. 6.7, 6.24, 7.44, 13.38, 17.23 s 23(q) …. 4.50, 4.59, 17.15 s 23AA …. 8.31 s 23AB …. 8.31 s 23AD …. 8.31 s 23AF …. 3.58, 3.60, 4.59, 4.61, 4.93 ss 23AF–23AG …. 4.61, 8.34 s 23AG …. 4.59, 4.61 s 23AG(1AA) …. 4.61

s 23AH …. 4.59, 4.62, 4.65, 8.42 s 23AH(3) …. 4.59, 4.62, 4.65 s 23AI …. 8.42, s 23AJ …. 4.59, 4.63 s 23AK …. 8.42 s 23CD …. 4.61 s 23E …. 8.42 s 23G …. 8.35 s 23J …. 8.42 s 23L …. 8.36, 8.37 s 23L(1) …. 8.42 ss 24AK–24AZ …. 8.5 s 25(1) …. 6.1 s 25A …. 7.45, 14.45 s 26 …. 7.3 s 26(e) …. 6.27, 7.4, 7.5, 18.1 s 26AAA …. 17.15 s 26AB …. 7.46, 17.23 s 26AF(1) …. 15.53 s 26AFA(1) …. 15.53 s 26AG …. 7.47, 9.46 s 26AH …. 7.48 s 26AJ …. 7.49 s 26BB …. 7.50 s 26C …. 7.51 s 27H …. 6.21 s 36 …. 1.27 s 36A …. 1.27 s 44 …. 6.16, 7.52, 14.80

s 44(1) …. 14.78, 14.79, 14.81 s 44(4) …. 8.42 s 45-45D …. 14.84 s 46FA …. 22.55 s 47 …. 14.82 s 47(1) …. 14.82 s 51 …. 10.15 s 51(1) …. 5.18, 5.28, 10.2, 10.15, 10.24, 10.36, 10.58 s 51AAA …. 10.45 s 51AD …. 12.30 ss 51AEA–51AEC …. 11.49 s 51AF …. 13.33 s 51AGA …. 12.34 s 51AH …. 12.35 s 51AJ …. 12.36 s 51AK …. 12.37 s 52A …. 12.46 ss 54–62AAV …. 13.3 s 63E …. 11.49 s 63F …. 11.49 s 65(1B) …. 12.46 s 65(1C) …. 12.46 s 67AAA …. 10.42 s 70B …. 11.49 s 73A …. 11.49, 13.71 ss 73B–73G …. 11.49, 13.71 s 73B …. 12.39, 12.40 s 73B(27A) …. 9.47

s 73BA …. 9.43, 12.39, 12.40 s 73BF(4) …. 9.47 s 73BH …. 12.39, 12.40 s 73BM(4) …. 9.47 ss 73P–73Z …. 11.49 s 73Y …. 12.39, 12.40 s 79A …. 3.44 s 79B …. 3.45 s 80G …. 10.15 s 82A …. 3.28, 10.35, 12.38 ss 82C–82CE …. 4.90, 11.49 ss 82KL–82KZO …. 5.29, 17.22 s 82KZL …. 12.40 s 82KZL(1) …. 5.29, 12.40 s 82KZM …. 3.12, 5.30, 5.55, 10.42, 12.39, 12.41 s 82KZM(1) …. 12.39 s 82KZM(1)(aa)(ii) …. 12.41 s 82KZM(1)(b) …. 12.39 ss 82KZMA–82KZMD …. 5.31 s 82KZMA …. 12.40 s 82KZMA(1)(a) …. 12.40 s 82KZMA(2)(a)(ii) …. 12.41 s 82KZMA(5) …. 12.40 s 82KZMD …. 5.31, 5.55 s 82KZME …. 5.32, 12.39 s 82KZMF …. 5.32 s 82KZMG …. 5.33, 12.39, 15.24, 16.24 ss 82L–82T …. 11.49 s 90 …. 11.49, 14.15, 14.17, 14.18, 14.19, 14.20, 14.23

s 91 …. 14.8, 14.13 s 92 …. 7.53, 11.49, 14.19, 14.20 s 92(1) …. 7.53 s 92(2) …. 14.16 s 94 …. 14.25 s 94K …. 14.9 ss 95–102 …. 11.49 s 95 …. 14.45 s 95(1) …. 4.42, 14.45 s 95(2) …. 4.41 s 95A …. 14.49, 14.52 s 95A(2) …. 14.53 s 95B …. 14.54 s 96B …. 14.53 s 97 …. 7.54, 14.45, 14.47, 14.48, 14.49, 14.51, 14.55, 14.58 s 97(1) …. 7.54, 14.48 s 97(2) …. 14.49 s 98 …. 14.47, 14.50, 14.51, 14.55, 14.58 s 98(1) …. 14.50 s 98(2) …. 14.49 s 98(3) …. 14.39 s 98(4) …. 14.49 s 98A …. 14.49 s 99 …. 14.45, 14.47, 14.51, 14.58 s 99A …. 14.45, 14.47, 14.51, 14.55, 14.58, 14.65 s 99A(2) …. 14.51 s 99B(2A) …. 8.42 s 100A …. 14.65

s 100A(1) …. 14.65 s 100AA …. 14.62 s 100AB …. 14.62 s 101 …. 14.53 s 101A …. 14.58 s 102 …. 14.66 ss 102AA–102AGA …. 14.4 s 102AAM …. 22.67 s 102AC(1) …. 14.55 s 102AC(2) …. 14.4 s 102AC(2)(b) …. 14.28 s 102AE(2) …. 14.26 s 102AE(3) …. 14.26 s 102AG(2)(c) …. 14.51 ss 102D–102L …. 11.49 ss 102M–102T …. 11.49 s 103A(1) …. 14.72 s 103A(2) …. 14.72 s 103A(4)–(4E) …. 14.72 s 103A(5) …. 14.72 s 108 …. 14.83 s 109 …. 12.46, 14.71, 14.83 s 109D …. 14.83 s 109E …. 14.83 s 109G …. 14.83 s 109J …. 14.83 s 109K …. 14.83 s 109L …. 14.83 s 109M …. 14.83

s 109Y …. 14.83 s 109ZC(3) …. 8.42 s 109ZCA(4) …. 8.42 s 117 …. 14.72 ss 121A–121IEL …. 11.49 ss 124ZM–124ZZD …. 11.49 s 128B(3)(jb) …. 8.42 s 128D …. 8.42 s 128F …. 4.90, 22.56 s 128FA …. 22.56 s 128GB(2) …. 4.90 ss 128TG–128TL …. 11.49 s 135A …. 11.49 s 136AD …. 4.85 s 136AD(3) …. 4.85 s 136AD(4) …. 4.85 ss 141–148 …. 11.49 s 156 …. 3.50 ss 159GE–159GO …. 11.49, 12.42 ss 159GP–159GZ …. 7.55, 11.49 s 159GZZZZE …. 12.43 s 159GZZZZG …. 8.37 ss 159GZZZJ–159GZZZS …. 11.49 ss 159GZZZZD–159GZZZZH …. 11.49 s 159H …. 3.39 s 159N …. 3.39 s 159P …. 3.42, 10.51 s 159Q …. 2.42, 3.42

ss 159ZR–159ZRD …. 3.46 s 160AAA(1) …. 3.41 s 160AAA(3) …. 3.41 s 160AAAA …. 3.40 s 160AD …. 3.36 s 160M(6) …. 9.1, 9.14 s 160M(7) …. 9.1, 9.14, 9.20 ss 160ZZVA–160ZZZJ …. 11.49 s 166 …. 21.3 s 167 …. 21.3 s 170 …. 21.3, 21.6 s 170(1) …. 21.6 ss 177A–177G …. 12.46 s 177A …. 17.9 s 177A(3) …. 17.9 s 177C …. 17.5, 17.10, 17.11 s 177C(1) …. 17.7 s 177C(1)(a) …. 17.10 s 177C(2)–(3) …. 17.11 s 177C(2A) …. 17.15 s 177C(2A)(a) …. 17.15 s 177C(4) …. 17.10 s 177C(4)–(5) …. 17.10 s 177CB(1)–(4) …. 17.12 s 177D …. 17.5, 17.7, 17.13 s 177DA …. 17.14 s 251R …. 3.56 s 251S …. 3.56 s 252 …. 13.70, 14.70

s 260 …. 3.20, 17.17 s 262A …. 12.44 s 263 …. 21.5, 21.12 s 264 …. 21.5, 21.12 s 271-105(3) …. 8.42 ss 316–468 …. 11.49 s 318 …. 17.48, 18.24 s 404 …. 22.23, 22.35, 22.56 Sch 2D …. 11.49 Sch 2F …. 14.56 Sch 2F …. 8.42 Sch 25A …. 22.21, 22.31, 22.32 Sch 25A, Pt B …. 22.46 Income Tax Assessment Act 1997 (ITAA 1997) …. 1.15, 1.22, 1.23, 1.31, 1.35, 1.45, 1.46, 1.48, 3.4, 3.5, 3.6, 3.12, 3.13, 3.14, 3.20, 3.21, 3.29, 3.30, 3.31, 3.34, 3.66, 5.4, 6.23, 7.3, 8.3, 8.4, 8.8, 8.30, 8.38, 9.135, 13.9, 13.53, 13.68, 13.73, 14.10, 14.68, 15.1, 15.2, 15.29, 15.30, 15.47, 17.21, 21.2, 21.5 Ch 1 …. 3.4, 3.5 Ch 2 …. 3.4, 3.5, 3.7 Ch 3 …. 3.4, 3.5, 3.8 Ch 4 …. 3.4, 3.5, 3.9 Ch 5 …. 3.4, 3.5, 3.10 Ch 6 …. 3.4, 3.5, 3.10 Pt 1-1 …. 3.6 Pt 1-2 …. 1.45, 3.6 Pt 1-3 …. 3.6, 3.17 Pt 1-4 …. 3.6 Pt 2-1 …. 3.7, 3.17

Pt 2-5 …. 3.7 Pt 2-10 …. 3.7 Pt 2-15 …. 3.7 Pt 2-20 …. 3.7 Pt 2-25 …. 3.7 Pt 2-40 …. 3.7 Pt 2-42 …. 3.7, 14.5, 14.63, 17.45, 17.46 Pt 3-1 …. 3.8 Pt 3-3 …. 3.8, 9.66 Pts 3-5–3-95 …. 9.115 Pt 3-5 …. 3.8, 9.115 Pt 3-6 …. 3.8, 9.115 Pt 3-10 …. 3.8, 9.115 Pt 3-25 …. 3.8, 9.115 Pt 3-30 …. 3.8, 9.115, 15.16 Pt 3-32 …. 3.8, 9.115 Pt 3-35 …. 3.8, 9.115 Pt 3-45 …. 3.8, 9.115 Pt 3-50 …. 3.8 Pt 3-80 …. 3.8 Pt 3-90 …. 3.8, 9.115, 13.95, 14.95, 17.17 Pt 3-95 …. 3.8, 9.115 Pt 4-5 …. 3.9 Pt 5-30 …. 3.10 Pt 5-35 …. 3.10 Pt 6-1 …. 3.11 Pt 6-5 …. 3.11 Div 2 …. 3.4 Div 3 …. 3.34

Div 6 …. 3.59, 5.16, 6.2, 14.45, 23.6 Div 8 …. 3.59, 23.6 Div 9 …. 1.45 Div 10 …. 1.45, 7.1 Div 11 …. 1.45 Subdiv 11-B …. 8.41 Div 12 …. 1.45 Div 13 …. 1.45, 3.36 Div 17 …. 8.39 Subdiv 20-A …. 7.23, 17.23 Subdiv 20-B …. 7.26, 17.23 Div 26 …. 10.2, 10.27, 12.23 Div 27 …. 13.44 Subdiv 27-B …. 13.37 Div 28 …. 11.37, 12.31, 13.5 Div 30 …. 11.38, 11.41, 11.46 Subdiv 30-DA …. 11.9, 11.43 Subdiv 30-DB …. 11.43, 11.44, 11.46 Div 31 …. 11.44, 11.46 Div 32 …. 12.24 Div 34 …. 10.45, 12.25 Div 35 …. 12.26, 13.68, 17.29, 17.31, 17.37, 17.44 Div 36 …. 11.45, 11.46 Div 40 …. 7.24, 9.43, 11.48, 13.2, 13.9, 13.11, 13.14, 13.16, 13.23, 13.41, 13.44, 13.45, 13.63, 13.68, 13.72, 16.7 Subdivs 40-A–40-E …. 13.68 Subdivs 40-A–40-F …. 13.1, 13.2, 13.3 Subdiv 40-D …. 7.28 Subdiv 40-E …. 13.58

Subdiv 40-F …. 13.16, 13.59 Subdivs 40-G–40-J …. 13.1, 13.2, 13.64, 13.73 Subdiv 40-G …. 13.16, 13.64 Subdiv 40-H …. 13.65 Subdiv 40-I …. 13.66, 16.8, 16.12 Subdiv 40-J …. 13.16, 13.67 Div 41 …. 13.1, 13.73 Div 42 …. 13.3 Div 43 …. 13.1, 13.9, 13.11, 13.14, 13.68, 13.69, 13.73, 23.5 Div 45 …. 7.29 Div 50 …. 8.5, 8.7, 8.22, 8.44 Div 51 …. 8.21, 8.44 Div 52 …. 8.24, 8.27, 8.44 Subdiv 52-CA …. 8.27 Subdiv 52-CB …. 8.27 Subdiv 52-E …. 8.27 Div 53 …. 8.28, 8.44 Div 54 …. 8.29, 8.44 Div 55 …. 8.43, 8.44 Div 59 …. 6.2, 8.40, 8.44 Subdiv 61-A …. 3.37 Subdiv 61-G …. 3.43 Div 67 …. 3.36, 14.6, 14.78 Div 70 …. 1.31, 5.35, 5.54, 5.69, 7.30, 9.44, 11.48, 14.44, 14.74 Subdiv 70-B …. 5.37 Subdiv 70-C …. 5.38 Subdiv 70-D …. 5.47 Subdiv 70-E …. 5.53, 16.23

Div 80 …. 7.31, 15.65 Div 82 …. 15.65 Div 83 …. 15.61, 15.65 Subdiv 83-D …. 15.65 Div 83A …. 7.32 Subdiv 83A-B …. 7.4 Subdiv 83A-C …. 7.4 Divs 84–87 …. 17.45, 17.46 Div 84 …. 14.5, 17.46 Div 85 …. 8.41, 11.48, 12.32, 17.47, 17.50, 17.51 Div 86 …. 7.33, 8.41, , 11.48, 12.32, 14.5, 17.62 Subdiv 86-A …. 17.52 Subdiv 86-B …. 17.47, 17.55 Div 87 …. 14.5, 17.58, 17.60 Subdiv 87-A …. 17.56 Subdiv 87-B …. 17.61 Div 100 …. 1.36, 9.1 Div 102 …. 7.34, 9.2 Div 103 …. 9.3 Div 104 …. 9.9, 9.133, 9.135 Subdiv 104-E …. 9.16 Subdiv 104-F …. 9.17 Subdiv 104-G …. 9.18 Subdiv 104-I …. 9.21 Subdiv 104-J …. 9.23 Subdiv 104-K …. 9.24, 9.25 Div 108 …. 9.133 Subdiv 108-D …. 9.31 Div 109 …. 9.32, 9.133

Div 110 …. 9.128, 9.130, 9.133 Subdiv 110-B …. 9.133 Div 112 …. 9.131, 9.133 Subdiv 112-C …. 9.131 Subdiv 112-D …. 9.131 Div 114 …. 9.132 Div 115 …. 9.135 Subdiv 115-A …. 9.60, 9.64 Subdiv 115-C …. 9.65 Div 116 …. 9.120, 9.133 Div 118 …. 9.135 Subdiv 118-B …. 8.1, 9.50, 9.53 Subdiv 118-D …. 9.54 Subdiv 118-E …. 9.55 Subdiv 118-F …. 9.56 Subdiv 118-G …. 9.56 Subdiv 118-H …. 9.57 Subdiv 118-I …. 9.58 Div 122 …. 9.67, 14.74 Div 124 …. 9.68 Subdiv 124-B …. 9.102 Subdiv 124-O …. 9.102 Div 125 …. 9.69 Div 126 …. 9.70 Subdiv 126-A …. 9.102 Subdiv 126-B …. 17.15 Div 128 …. 9.71, 9.72 Div 130 …. 9.73

Subdiv 130-A …. 14.92 Div 132 …. 9.74 Div 134 …. 9.75 Div 138 …. 9.116 Div 139 …. 9.116 Div 140 …. 9.116 Div 149 …. 9.76 Div 152 …. 9.77, 9.105, 9.137 Subdiv 152-A …. 9.77, 9.109, 9.110, 9.112, 9.113, 9.135 Subdiv 152-B …. 5.57, 9.77, 9.110 Subdiv 152-C …. 5.57, 9.77, 9.111, 9.135 Subdiv 152-D …. 5.57, 9.77, 9.112, 9.135 Subdiv 152-E …. 5.57, 9.77, 9.113, 9.135 Div 160 …. 14.89 Div 165 …. 14.85 Subdiv 165-B …. 14.85 Subdiv 165-C …. 12.32, 14.90 Subdiv 165-CA …. 14.88 Subdiv 165-CC …. 14.85 Subdiv 165-CD …. 14.85 Div 166 …. 14.86 Subdiv 166-C …. 12.32 Div 175 …. 12.32, 14.85 Subdiv 175-A …. 14.85 Subdiv 175-B …. 14.85 Subdiv 175-C …. 12.32 Subdiv 175-CA …. 14.88 Subdiv 175-CB …. 14.88 Divs 200–215 …. 14.78

Div 207 …. 3.48, 7.35, 14.6 Div 230 …. 5.17, 5.34, 5.36, 7.36, 9.45 Div 240 …. 7.37 Div 242 …. 7.38 Div 243 …. 7.39 Subdiv 243-C …. 12.28 Div 247 …. 12.29 Div 250 …. 12.30, 13.70, 13.73, 14.6 Subdivs 280–293 …. 15.16 Div 290 …. 15.28 Div 295 …. 15.16, 15.29, 15.45 Subdiv 295-B …. 15.30 Subdiv 295-C …. 15.29, 15.31 Subdiv 295-D …. 15.35 Subdiv 295-E …. 15.36 Subdiv 295-F …. 15.37 Subdiv 295-G …. 15.29, 15.38 Subdiv 295-H …. 15.39 Subdiv 295-I …. 15.44 Subdiv 295-J …. 15.45 Divs 301–307 …. 15.16 Divs 301–306 …. 8.41 Div 301 …. 15.48, 15.50 Subdiv 301-C …. 15.48 Div 302 …. 15.51 Div 307 …. 15.56 Div 320 …. 7.40 Div 321 …. 7.40

Div 328 …. 13.43, 17.22 Subdiv 328-C …. 19.90 Subdiv 328-D …. 5.55, 13.60, 14.29 Subdiv 328-E …. 5.54, 5.55 Subdiv 328-F …. 5.56 Subdiv 328-G …. 5.55, 9.114, 13.61 Div 355 …. 3.49 Div 375 …. 16.36 Subdiv 375-G …. 16.36 Subdiv 375-H …. 16.36 Div 376 …. 16.37 Div 384 …. 7.42 Subdiv 385-E …. 16.16 Subdiv 385-F …. 16.19 Subdiv 385-G …. 16.18 Div 392 …. 14.3, 16.26 Div 393 …. 11.48, 16.25 Div 394 …. 11.48, 16.34 Div 405 …. 14.3, 16.35 Div 415 …. 11.50 Div 420 …. 4.83, 13.72 Divs 700–721 …. 14.95 Div 723 …. 9.116 Div 725 …. 9.116 Div 727 …. 9.116 Div 768 …. 3.9, 4.30, 4.66, 4.67 Div 768-915 …. 4.30, 4.66, 4.67 Subdiv 768-R …. 8.6, 8.44, 9.8 Div 770 …. 3.9, 4.69

Div 775 …. 3.9, 7.43 Div 802 …. 3.9, 4.64 Div 815 …. 3.9 Subdiv 815 …. 12.32 Div 820 …. 3.9, 4.88, 12.32 Div 830 …. 3.9, 14.9 Div 840 …. 3.9 Div 842 …. 3.9 Div 855 …. 3.9, 9.8 Div 900 …. 12.31 Div 974 …. 4.87 s 1-3 …. 3.4 s 2-5 …. 3.4 s 2-40 …. 3.31 s 2-45 …. 3.32 s 4-1 …. 15.29 s 4-10 …. 3.60 s 4-10(3) …. 3.36 s 4-15 …. 3.2, 3.6, 3.59, 6.1, 10.1, 14.15, 14.75 s 5-1 …. 1.45 s 6-1 …. 1.45, 3.31 s 6-5 …. 3.33, 4.10, 4.47, 4.59, 4.71, 4.80, 4.81, 4.93, 5.4, 5.6, 5.52, 5.61, 5.69, 6.1, 6.2, 6.3, 6.8, 6.16, 6.22, 6.27, 6.45, 6.48, 7.1, 7.2, 7.4, 7.8, 7.10, 7.11, 7.12, 7.14, 7.16, 7.17, 7.24, 9.13, 9.14, 9.40, 13.68, 17.6, 17.23, 18.35, 23.2, 23.5, 23.6 s 6-5(1) …. 2.11 s 6-5(2) …. 4.9, 5.3, 6.4 s 6-5(3) …. 4.93, 5.3, 6.4 s 6-5(4) …. 5.3, 5.16, 6.4, 17.22

s 6-10 …. 4.10, 4.47, 4.48, 4.59, 4.66, 4.71, 4.80, 4.81, 5.4, 5.69, 6.2, 7.1 s 6-10(2) …. 7.1 s 6-10(3) …. 5.3, 5.16, 6.4 s 6-10(4) …. 4.9, 17.22 s 6-15 …. 8.2 s 6-15(1) …. 6.2, 8.1 s 6-15(2) …. 8.1 s 6-15(3) …. 8.1 s 6-20 …. 8.2 s 6-20(1) …. 8.1 s 6-23 …. 8.1, 8.2, 8.39 s 6-25 …. 3.32, 6.16, 7.2 s 6-25(2) …. 7.2, 7.56 s 8-1 …. 3.12, 3.28, 4.80, 5.18, 5.26, 5.37, 5.49, 5.69, 6.23, 8.3, 8.38, 9.129, 10.1, 10.2, 10.3, 10.4, 10.5, 10.7, 10.10, 10.15, 10.18, 10.19, 10.24, 10.28, 10.35, 10.38, 10.39, 10.40, 10.41, 10.42, 10.43, 10.45, 10.49, 10.50, 10.51, 10.52, 10.53, 10.62, 10.65, 10.66, 11.1, 11.3, 11.15, 11.26, 11.38, 11.39, 11.40, 11.45, 11.51, 12.1, 12.36, 12.38, 12.39, 12.40, 13.1, 13.68, 13.72, 17.3, 17.6, 17.17, 17.26, 17.47, 18.50, 22.5, 22.6, 23.5, 23.6 s 8-1(1) …. 4.71, 5.28, 10.2, 10.9 s 8-1(1)(a)-(b) …. 10.4 s 8-1(1)(a) …. 10.2, 10.7, 10.29, 10.39, 10.49 s 8-1(1)(b) …. 10.2, 10.39, 18.71 s 8-1(2) …. 10.2, 10.19 s 8-1(2)(a)-(d) …. 10.2 s 8-1(2)(a) …. 10.2 s 8-1(2)(b) …. 10.25, 10.29, 18.44 s 8-1(2)(c) …. 4.71, 10.27 s 8-1(2)(d) …. 10.27, 12.1

s 8-5 …. 11.1 s 8-5(3) …. 12.1 s 8-10 …. 11.1 s 10-5 …. 7.56 s 11-1 …. 8.3 s 11-5 …. 8.4, 8.44 s 11-10 …. 8.44 s 11-15 …. 8.44 s 11-50 …. 8.41 s 11-55 …. 8.41, 8.44 s 12-5 …. 11.49 s 13-1 …. 3.51 s 15-1 …. 1.45 s 15-2 …. 7.4, 17.23 s 15-3 …. 7.6 s 15-5 …. 7.2, 7.7 s 15-10 …. 7.2, 7.8, 9.13 s 15-15 …. 7.9, 11.22, 13.68 s 15-20 …. 6.16, 7.2, 7.10 s 15-25 …. 7.11 s 15-30 …. 7.12 s 15-35 …. 7.13 s 15-40 …. 7.14 s 15-45 …. 7.14, 16.24 s 15-46 …. 7.16 s 15-50 …. 7.17, 14.32 s 15-55 …. 7.18 s 15-60 …. 7.19 s 15-70 …. 7.20

s 15-75 …. 7.21 s 15-80 …. 7.22 s 17-1 …. 1.45 s 17-5 …. 5.61, 8.39 s 17-10 …. 8.39 s 20-10 …. 3.64 s 20-20 …. 7.23, 11.19 s 20-20(2) …. 7.24 s 20-20(3) …. 7.25 s 20-30 …. 7.23, 7.25 s 25-1 …. 3.31 s 25-5 …. 3.64, 11.2, 11.3, 10.62, 11.2, 15.69 s 25-5(1) …. 10.42 s 25-5(2) …. 10.42 s 25-10 …. 11.4, 11.9, 11.12 s 25-10(1) …. 11.4 s 25-10(2) …. 11.12 s 25-10(3) …. 11.11 s 25-15 …. 11.13 s 25-20 …. 11.14 s 25-25 …. 11.15 s 25-25(6) …. 11.15 s 25-30 …. 11.16 s 25-30(4) …. 11.16 s 25-35 …. 11.17, 14.90 s 25-40 …. 11.22, 13.68 s 25-45 …. 11.23 s 25-47 …. 11.24

s 25-50 …. 11.25, 11.40, 12.20 s 25-50(3) …. 11.25 s 25-55 …. 11.26 s 25-60 …. 11.27 s 25-65 …. 11.27 s 25-70 …. 11.27 s 25-95 …. 11.28, 14.32 s 25-100 …. 10.37, 11.29, 11.34 s 25-100(2) …. 11.30 s 25-100(3) …. 11.32 s 25-100(4) …. 11.33 s 25-100(5) …. 11.34 s 25-105 …. 11.35 s 25-110 …. 11.36 s 26-5 …. 9.129, 12.3 s 26-10 …. 12.4 s 26-15 …. 12.5 s 26-17 …. 12.6 s 26-19 …. 10.35, 12.7 s 26-20 …. 12.8 s 26-22 …. 11.43, 12.9 s 26-25 …. 12.10 s 26-26 …. 12.11 s 26-30 …. 12.12 s 26-35 …. 12.13, 14.23, 14.31 s 26-35(4) …. 8.41 s 26-40 …. 12.14 s 26-45 …. 12.15 s 26-47 …. 9.129, 12.16

s 26-50 …. 12.17 s 26-52 …. 12.18 s 26-53 …. 12.18 s 26-54 …. 9.129, 12.19 s 26-55 …. 11.41, 11.46, 12.20 s 26-60 …. 12.21 s 26-65 …. 12.22 s 26-68 …. 12.23 s 26-70 …. 12.23 s 26-75 …. 12.23 s 26-80 …. 12.23 s 26-85 …. 12.23 s 26-90 …. 12.23 s 26-95 …. 12.23 ss 27-1–27-5 …. 10.65 ss 27-80–27-110 …. 13.44 s 27-95 …. 13.54 s 30-15 …. 11.38, 11.39, 11.40, 19.22 s 32-20 …. 12.24 s 32-70 …. 7.27 s 35-10 …. 17.35, 17.36 s 35-10(2)(b) …. 17.29 s 35-10(3) …. 17.31 s 35-10(4) …. 17.38, 17.44 s 35-15 …. 17.29 s 35-20 …. 17.29 s 35-30 …. 17.33, 17.43 s 35-35 …. 17.34, 17.43

s 35-40 …. 17.43 s 35-45 …. 17.36, 17.43 s 35-55 …. 17.41, 17.44 s 35-55(1) …. 17.39 s 35-55(1)(a) …. 17.40, 17.44 s 35-55(1)(b)(ii) …. 17.44 s 35-55(1)(c) …. 17.44 s 36-10 …. 8.3, 11.46, 14.84 s 36-15(1) …. 11.46 s 36-15(5) …. 11.46 s 36-15(6) …. 11.46 s 36-15(7) …. 11.46 ss 36-35–36-40 …. 11.46 s 40-10 …. 13.2 s 40-25 …. 13.3, 13.4, 13.6, 13.48, 13.73 s 40-25(1) …. 13.4, 13.7, 13.19, 13.21 s 40-25(2) …. 13.6, 13.48 s 40-25(3)–(6) …. 13.5 s 40-25(7) …. 13.6, 13.48 s 40-25(8) …. 13.6 s 40-30 …. 13.7, 16.6 s 40-30(1) …. 13.7, 13.11, 13.15 s 40-30(2) …. 13.8, 13.11 s 40-30(3) …. 13.10 s 40-30(4) …. 13.11 s 40-30(5)–(6) …. 13.11 s 40-40 …. 13.19 s 40-45 …. 13.15 s 40-45(1) …. 13.13, 17.28

s 40-45(2) …. 13.14 s 40-45(6) …. 13.15 s 40-50 …. 13.16 s 40-50(1) …. 13.16 s 40-50(2) …. 13.16 s 40-53 …. 13.17 s 40-55 …. 13.18 s 40-60 …. 13.21, 13.29 s 40-65 …. 13.24 s 40-65(1) …. 13.22 s 40-65(2) …. 13.23 s 40-65(3) …. 13.24 s 40-65(4) …. 13.24 s 40-65(5) …. 13.24 s 40-65(6) …. 13.24 s 40-70 …. 13.22, 13.25, 13.48 s 40-70(1) …. 13.21, 13.25, 13.26 s 40-72 …. 13.22, 13.25 s 40-75 …. 13.22, 13.26, 13.48 s 40-80 …. 13.22, 13.28, 13.29, 16.6, 16.7 s 40-85 …. 13.47 s 40-85(1) …. 13.46 s 40-85(2) …. 13.47 s 40-90 …. 13.62 s 40-90(2) …. 13.37 s 40-95(1) …. 13.29 s 40-95(2) …. 13.29 s 40-95(3) …. 13.29

ss 40-95(4)–(6) …. 13.29 s 40-95(4) …. 13.35 s 40-95(4B) …. 13.35 s 40-95(4C) …. 13.35 s 40-95(5) …. 13.35 s 40-95(5B) …. 13.35 s 40-95(5C) …. 13.35 s 40-95(7) …. 13.30, 13.35 s 40-100 …. 13.35 s 40-100(1) …. 13.31 s 40-100(2) …. 13.31 s 40-100(3) …. 13.31 s 40-100(4) …. 13.31 s 40-102 …. 13.29, 13.32, 13.35 s 40-102(4) …. 13.32 s 40-105 …. 13.34 s 40-105(1) …. 13.33 s 40-105(2) …. 13.33 s 40-105(3) …. 13.33 s 40-105(4) …. 13.34 s 40-110(1) …. 13.35 s 40-110(3) …. 13.35 s 40-110(3A)–(4) …. 13.35 s 40-110(5) …. 13.35 s 40-130 …. 13.22, 13.29 s 40-140 …. 13.22 s 40-180 …. 13.38 s 40-180(2) …. 13.38, 13.39 s 40-180(3) …. 13.38

s 40-180(4) …. 13.38 s 40-185 …. 13.38, 13.40 s 40-190 …. 13.40, 13.41 s 40-190(1) …. 13.40 s 40-190(2) …. 13.40 s 40-190(3) …. 13.41 s 40-195 …. 13.42 s 40-200 …. 13.43 s 40-202 …. 17.28 ss 40-205–40-210 …. 13.43 s 40-215 …. 13.43 s 40-220 …. 13.43 ss 40-225–40-230 …. 13.43 s 40-285 …. 7.28, 13.52, 13.55 s 40-285(1) …. 13.49, 13.50 s 40-285(2) …. 13.49, 13.51 s 40-285(3) …. 13.49 s 40-290 …. 13.50, 13.51 s 40-295 …. 14.14, 13.52 s 40-295(1) …. 13.52 s 40-295(2) …. 13.52 s 40-300(2) …. 14.29 s 40-300(3) …. 13.53 s 40-305 …. 13.53 s 40-305(1) …. 13.53 s 40-310 …. 13.53 ss 40-320–40-335 …. 13.60 s 40-340 …. 13.56, 14.14

s 40-340(3) …. 14.29 s 40-340(4) …. 14.29 s 40-365 …. 13.57 s 40-365(5)(a) …. 13.37 s 40-445 …. 13.58 ss 40-515–40-575 …. 16.19, 16.20 s 40-515 …. 16.20 s 40-545(3) …. 16.20 ss 40-630–40-675 …. 16.21 s 40-630 …. 16.21 s 40-645 …. 16.22 s 40-730 …. 15.8 s 40-730(1) …. 16.8 s 40-730(5) …. 15.6 s 40-730(7) …. 15.7 s 40-735 …. 16.9 s 40-750 …. 16.10 ss 40-755–40-765 …. 16.11 s 40-755 …. 16.11 s 40-755(1) …. 16.11 ss 40-830–40-875 …. 16.12 s 40-860(1) …. 16.12 s 40-865(2) …. 16.12 s 40-880 …. 10.39, 10.62, 13.1, 13.68, 13.73, 17.28, 22.15, 22.27, 22.39, 22.55, 23.25 s 40-880(5)–(9) …. 13.68 s 43-20 …. 13.69 s 43-70(2)(e) …. 13.9 s 45-1 …. 7.29

s 45-40 …. 13.9 s 49-50(1) …. 17.28 s 50-1 …. 8.4 s 50-5 …. 8.4 s 50-10 …. 8.4 s 50-15 …. 8.4 s 50-25 …. 8.4, 15.29 s 50-30 …. 8.4 s 50-35 …. 8.4 s 50-40 …. 8.4 s 50-45 …. 8.4 s 50-50(a) …. 8.4 s 50-50(c) …. 4.61 s 50-50(d) …. 4.61 s 50-52 …. 8.4 s 50-70 …. 8.4 s 51-5 …. 8.8 s 51-10 …. 8.9 s 51-30 …. 8.10 s 51-32 …. 8.11 s 51-33 …. 8.12 s 51-35 …. 8.13 s 51-40 …. 8.14 s 51-42 …. 8.15 s 51-43 …. 8.16 s 51-45 …. 8.17 s 51-50 …. 7.18 s 51-52 …. 8.19 s 51-54 …. 8.19

s 51-55 …. 8.19 s 51-57 …. 8.20 s 51-60 …. 8.21 ss 51-110–51-115 …. 8.22 s 51-120 …. 8.23 s 52-10 …. 8.25 s 52-65 …. 8.26 s 52-140 …. 8.27 s 52-150 …. 8.27 s 52-160 …. 8.27 s 52-162 …. 8.27 s 52-165 …. 8.27 s 52-170 …. 8.27 s 52-172 …. 8.27 s 52-175 …. 8.27 s 52-180 …. 8.27 s 55-5 …. 8.43 s 55-10 …. 8.43 s 59-10 …. 8.40 s 59-15 …. 8.40, 16.5 s 59-20 …. 8.40 s 59-25 …. 8.40 s 59-30 …. 8.40 s 59-35 …. 6.8, 8.40 s 59-40 …. 8.40 s 59-50 …. 8.40 s 59-65 …. 8.40 ss 61-580–61-590 …. 3.47

s 63-10 …. 14.6 s 63-10(1) …. 3.36 s 67-25 …. 14.6 s 70-5 …. 5.36 s 70-10 …. 1.35 s 70-10(1) …. 5.36 s 70-10(2) …. 5.36 s 70-15 …. 12.27 s 70-20 …. 5.37 s 70-25 …. 5.37 s 70-30 …. 5.37, 5.69 s 70-30(5) …. 5.69 s 70-35 …. 5.38, 5.39, 5.69 s 70-40 …. 5.40 ss 70-40–70-50 …. 5.46 s 70-45 …. 5.40, 5.46 s 70-45(1A) …. 5.45 s 70-50 …. 5.46 ss 70-90–70-115 …. 5.52 s 70-90 …. 5.48, 17.22 s 70-90(2) …. 8.41 s 70-95 …. 5.48 s 70-100 …. 5.49, 14.14, 17.22 s 70-100(2) …. 14.28 s 70-100(4) …. 14.28 s 70-105 …. 5.50 s 70-110 …. 5.51, 5.69, 17.22 s 70-115 …. 5.52 s 70-120 …. 11.48, 16.23

s 82-A …. 3.28 s 82-10 …. 8.41 s 82-10(4) …. 15.59 ss 82-65–82-75 …. 15.60 s 82-65 …. 8.41 s 82-70 …. 8.41 s 82-130 …. 15.64 s 82-130(1) …. 15.57 s 82-130(1)(a)(i) …. 15.57 s 82-130(1)(a)(ii) …. 15.57 s 82-130(1)(c) …. 15.58 s 82-130(2) …. 15.57 s 82-130(3) …. 15.57 s 82-135 …. 15.58 ss 82-140–82-160 …. 15.59 s 83-10(1) …. 15.62 s 83-10(2) …. 15.62 s 83-10(3) …. 15.62 ss 83-75–83-115 …. 15.63 s 83-80 …. 8.41 s 83-170 …. 8.41 s 83-170(2) …. 15.64 s 83-170(3) …. 15.64 s 83-175(4) …. 15.64 s 83-235 …. 8.41, 15.65 s 83-240 …. 8.41, 15.65 s 84-5 …. 14.5, 17.46 s 84-5(3) …. 17.46

s 84-5(4) …. 17.46 s 84-10 …. 17.46 s 85-10(1) …. 17.47, 17.48 s 85-10(2)(e) …. 17.48 s 85-10(2)(f) …. 17.48 s 85-10(2)(g) …. 17.48 s 85-10(2)(h) …. 17.48 s 85-15 …. 17.49 s 85-20(1) …. 17.49 s 85-25(1) …. 17.49 s 85-30 …. 17.48, 17.50 s 85-35 …. 17.51 s 86-5 …. 7.33 s 86-15 …. 17.52 s 86-15(1) …. 17.52, 17.53, 17.54, 17.62 s 86-15(3) …. 17.53 s 86-15(4) …. 17.53 s 86-15(5) …. 17.52 s 86-20 …. 17.54 s 86-60 …. 17.55 s 86-60(b) …. 17.55 s 87-15(1) …. 17.56 s 87-18 …. 17.57 s 87-20(1) …. 17.58 s 87-20(1)(b) …. 17.58 s 87-25(1) …. 17.59 s 87-25(3) …. 17.59 s 87-30(1) …. 17.60 s 87-30(1)(b) …. 17.60

s 87-60 …. 17.61 s 87-65 …. 17.61 s 95(2) …. 4.41 s 102-5 …. 9.2, 9.65, 9.135 s 102-5(1) …. 7.34 s 102-10 …. 9.2, 9.133, 9.135, 12.32 s 102-15 …. 9.135 s 102-20 …. 9.2 s 102-22 …. 9.2 s 102-25 …. 9.2 s 102-30 …. 9.135 s 102-30(2) …. 9.135 s 103-5 …. 9.3, 9.14, 9.19, 9.20, 9.128 s 103-10 …. 9.4 s 103-15 …. 9.5 s 103-25 …. 9.6 s 103-30 …. 9.7 s 104-5 …. 9.9 s 104-10 …. 9.10, 9.27, 9.133, 9.137 s 104-10(4) …. 9.134 s 104-10(5) …. 9.35 s 104-15 …. 9.11 s 104-20 …. 9.12 s 104-25 …. 13 s 104-25(1) …. 14.82 s 104-25(3) …. 14.93 s 104-35 …. 9.14 s 104-135(1) …. 14.93

s 104-150 …. 9.19 s 104-155 …. 6.16, 9.20 s 104-165 …. 9.21 s 104-170 …. 9.22 s 104-197 …. 9.113 s 104-198 …. 9.113 s 104-235 …. 13.55 s 104-240 …. 13.55 s 106-5 …. 14.30 s 108-5 …. 9.28 s 108-5(1)(a) …. 9.133 s 108-5(2)(a) …. 14.14 s 108-10 …. 9.29 s 108-10(1) …. 9.30 s 108-17 …. 9.129 ss 108-20–108-30 …. 9.30 s 108-20 …. 9.30 s 108-20(1) …. 9.30 s 108-25 …. 9.30 s 108-30 …. 9.129 s 108-55 …. 9.31 ss 108-60–108-85 …. 9.31 s 108-60 …. 9.31 s 108-65 …. 9.31 s 109-5(2) …. 9.133 s 109-10 …. 9.32 s 109-15 …. 9.32 s 110-10 …. 9.128, 9.132 s 110-25 …. 9.129

s 110-25(2) …. 9.130 s 110-25(2)–(6) …. 9.128 s 110-25(3) …. 9.130 s 110-25(4) …. 9.130 s 110-25(4)(d) …. 9.102 s 110-25(5) …. 9.113, 9.130, 23.8 s 110-25(6) …. 9.130 s 110-35 …. 9.130 s 110-35(1)(b) …. 9.128 s 110-35(2) …. 9.133 s 110-38 …. 9.129 s 110-38(2) …. 12.18 s 110-40 …. 9.129 s 110-40(3) …. 9.12 s 110-43 …. 9.129 s 110-43(3) …. 9.12 s 110-45 …. 9.129 s 110-45(3) …. 9.12 s 110-50 …. 9.129 s 110-55 …. 9.133 s 110-55(3) …. 9.133 s 112-1 …. 9.67 ss 112-40–112-97 …. 9.131 s 112-45 …. 9.131 s 114-1 …. 9.132 ss 115-5–115-20 …. 15.29 s 115-228 …. 14.48 s 116-20 …. 89.120, 9.133

s 116-20(1)(a) …. 9.123 s 116-25 …. 9.120 s 116-30 …. 9.13, 9.121 s 116-40 …. 9.122 s 116-45 …. 9.123 s 116-50 …. 9.124 s 116-55 …. 9.125 s 116-60 …. 9.126 ss 116-65–116-105 …. 9.126 ss 118-5–118-37 …. 9.48 s 118-5 …. 9.34 s 118-10 …. 9.36 s 118-10(1) …. 9.30 s 118-10(3) …. 9.30 s 118-12 …. 8.3, 9.37 s 118-13 …. 9.38 s 118-15 …. 9.39 s 118-20 …. 9.40 s 118-21 …. 9.41, 12.32 s 118-22 …. 9.42 s 118-24 …. 9.43, 13.55 s 118-25 …. 1.31, 9.44 s 118-27 …. 9.45 s 118-30 …. 9.46 s 118-35 …. 9.47, 9.51 s 118-37 …. 9.48 s 118-40 …. 9.49 s 118-42 …. 9.49 s 118-45 …. 9.49

s 118-55 …. 9.49 s 118-60 …. 9.49 s 118-65 …. 9.49 s 118-70 …. 9.49 s 118-75 …. 9.49 s 118-80 …. 9.49 s 118-110 …. 9.50 s 118-110(1) …. 9.50 s 118-135 …. 9.50 s 118-140 …. 9.51 s 118-145 …. 9.50, 9.51 s 118-150 …. 9.50 s 118-150(3) …. 9.50 s 118-170 …. 9.51 s 118-185 …. 9.52 s 118-185(2) …. 9.50 s 118-190(2) …. 9.52 s 118-195 …. 9.53 ss 118-560–118-565 …. 9.127 s 124-1 …. 9.68 s 152-10(1)(a)–(b) …. 9.78 s 152-10(1)(c)(i) …. 9.81 s 152-10(1)(c)(iii) …. 9.83 s 152-10(1)(c)(iv) …. 9.84 s 152-10(1A) …. 9.84, 9.85 s 152-10(1B) …. 9.84, 9.87 s 152-10(2) …. 9.103 s 152-10(4) …. 9.78

s 152-12 …. 9.79 s 152-15 …. 9.97, 9.99 s 152-20 …. 9.97, 9.99 s 152-20(2)(a) …. 9.98 s 152-20(2)(b) …. 9.98 s 152-20(3) …. 9.98, 9.99 s 152-20(4) …. 9.99 s 152-35 …. 9.102 s 152-35(1) …. 9.100 s 152-35(1)(b) …. 9.102 s 152-35(2) …. 9.100 s 152-40(4) …. 9.102 s 152-40(4)(e) …. 9.101, 9.102 s 152-42 …. 9.102 s 152-42(2) …. 9.102 s 152-45 …. 9.102 s 152-47 …. 9.85 s 152-47(1) …. 9.93 s 152-48 …. 9.88, 9.91 s 152-55 …. 9.105 s 152-60 …. 9.104 s 152-65 …. 9.106 s 152-70 …. 9.107, 9.108 s 152-70(2) …. 9.107 s 152-75(1) …. 9.108 s 152-75(1)(a) …. 9.108 s 152-75(1)(b) …. 9.108 s 152-75(2) …. 9.108 s 152-78 …. 9.85

s 152-80 …. 9.80, 9.109 ss 152-105–152-110 …. 9.110 s 152-105(d) …. 9.110 s 152-110(2) …. 8.41 s 152-115 …. 9.110 s 152-205 …. 9.111 s 152-215 …. 9.111 s 152-220 …. 9.111 s 152-305 …. 9.112 s 152-305(1) …. 9.112 s 152-305(2) …. 9.112 s 152-310 …. 8.41 s 152-310(2) …. 15.58 s 152-315(4) …. 9.112 s 152-325 …. 9.112 s 152-325(1) …. 9.112 s 152-330 …. 9.112 ss 152-410–152-415 …. 9.113 s 152-420 …. 9.113 s 152-430 …. 9.113 s 165-12(1) …. 14.86 s 165-13 …. 14.87 s 165-210 …. 14.85, 14.87 s 166-175 …. 14.86 s 170-25(1) …. 8.41 s 170-125(1) …. 8.41 s 207-20 …. 14.78 s 207-20(1) …. 7.35, 7.52

s 207-35(3)(b) …. 14.60 s 207-50 …. 14.60 s 230-30 …. 8.41 s 240-40 …. 8.41 s 240-50 …. 11.48 s 240-55 …. 11.48 s 240-85 …. 11.48 s 240-105 …. 11.48 s 240-110 …. 11.48 s 242-40 …. 8.41 s 247-5 …. 12.29 s 250-5 …. 13.70 s 250-160 …. 8.41 s 275-105 …. 5.36 s 280-5 …. 15.12, 15.13 ss 290-60–290-80 …. 11.47, 15.18 s 290-150 …. 11.46, 11.47, 12.20, 15.19 ss 290-230–290-240 …. 15.21 s 292-25 …. 15.25 s 292-85 …. 15.28 s 295-5(1) …. 15.29 s 295-5(2) …. 15.29 s 295-5(3) …. 15.29 s 295-10 …. 15.29 s 295-95 …. 15.42 s 295-160 …. 15.32 s 295-165 …. 15.32 s 295-170 …. 15.32 s 295-171 …. 15.32

s 295-175 …. 15.32 s 295-185 …. 15.32 s 295-190 …. 15.33 s 295-190(1) …. 15.33 s 295-190(4) …. 15.33 s 295-195 …. 15.43 s 295-200 …. 15.34 s 295-320 …. 15.36 s 295-335 …. 15.36 ss 295-385–295-400 …. 15.37 s 295-385 …. 15.29 s 295-390 …. 15.29 ss 295-460–295-475 …. 15.38 s 295-545 …. 15.29 s 295-545(1) …. 15.40 s 295-545(2) …. 15.40 s 295-545(3) …. 15.40 s 295-550 …. 15.40 s 295-555 …. 15.41 s 301-10 …. 15.48 s 301-15 …. 15.48 s 301-20 …. 3.57, 15.48, 15.56 s 301-175(1) …. 15.49 s 301-175(2) …. 15.49 s 301-225 …. 15.50 s 306-5 …. 15.52 s 306-10 …. 15.52 s 307-5 …. 15.53

s 307-5(1) …. 115.53 s 307-10 …. 15.53 s 307-120 …. 15.54 s 307-210 …. 15.55 s 307-215 …. 15.56 s 307-220(1) …. 15.55 s 307-225 …. 15.55 s 307-275 …. 15.56 s 307-280 …. 15.56 s 307-295 …. 15.56 s 315-310 …. 8.41 s 316-255 …. 8.41 s 322-10 …. 8.4 s 328-110 …. 5.56 s 328-110(3) …. 5.59 s 328-115 …. 5.60 s 328-115(1) …. 5.61 s 328-115(2) …. 5.60, 5.61 s 328-115(3) …. 5.60, 5.61 s 328-115(3)(a) …. 5.61 s 328-115(3)(b) …. 5.61 s 328-115(3)(c) …. 5.61 s 328-119 …. 5.58 s 328-120(1) …. 5.61 s 328-120(2) …. 5.61 s 328-120(3) …. 5.61 s 328-120(4) …. 5.61 s 328-120(5) …. 5.61 s 328-125 …. 2.11, 9.97, 9.102

s 328-125(2)(a) …. 5.64 s 328-125(2)(b) …. 5.64 s 328-125(3) …. 5.65 s 328-125(4) …. 5.65 s 328-125(4)(a) …. 5.65 s 328-125(4)(b) …. 5.65 s 328-125(7) …. 5.66 s 328-130 …. 9.92, 9.97 s 328-130(1) …. 5.62 s 328-285(1)(b) …. 5.54 ss 360-60–360-65 …. 9.118 s 376-2 …. 16.37 s 380-35 …. 8.41 s 385-130 …. 16.17 s 385-150 …. 16.18 ss 392-1–392-95 …. 3.50, 14.3, 16.26 s 392-5 …. 16.26 s 392-20(2) …. 16.26 s 392-75 …. 16.33 s 392-95 …. 16.27 s 402-85 …. 14.14 ss 405-1–405-50 …. 14.3 s 703-15(2) …. 14.95 s 703-50 …. 14.95 s 768-910(3) …. 4.30, 4.67 s 768-915 …. 4.30, 4.67 s 775-25 …. 8.41 s 775-27 …. 8.41

s 775-30 …. 11.48 s 775-70 …. 13.37 s 775-75 …. 13.37 s 802-20 …. 8.41 s 840-915 …. 8.41 s 855-10 …. 9.8 s 855-15 …. 9.8 s 855-20 …. 9.8 s 900-220(3) …. 11.31 s 950-150 …. 3.31 s 960-115 …. 14.34 s 960-275(1) …. 9.132 s 960-275(2) …. 9.132 s 995-1 …. 1.31, 1.32, 3.29, 4.30, 4.41, 5.63, 6.23, 14.9, 14.69 s 995-1(1) …. 5.58, 5.62, 5.69, 13.54, 16.14 Income Tax Assessment Regulations 1936 …. 3.5 Income Tax Assessment Regulations 1997 …. 3.5 Pt 2 Div 26 …. 3.13 Pt 2 Div 30 …. 3.13 Pt 2 Div 31 …. 3.13 Pt 2 Div 50 …. 3.13 Pt 2 Div 51 …. 3.13 Pt 2 Div 61 …. 3.13 Pt 2 Div 70 …. 3.13 Pt 2 Div 83A …. 3.13 Pt 2A …. 3.13 Pt 3 …. 3.13 Pt 4 …. 3.13 Pt 5 ….3.13

Pt 6 …. 3.13 Income Tax Rates Act 1986 …. 1.15, 3.28 s 3(1) …. 14.72 Income Tax Regulations 1936 …. 15.29 reg 20 …. 21.6 Sch 10 …. 4.65, 4.68 Life Insurance Act 1995 …. 8.23 Medical Indemnity Act 2002 s 5 …. 9.68 Medicare Levy Act 1986 …. 3.28 Military Rehabilitation and Compensation Act 2004 …. 8.27 New Business Tax System (Alienation of Personal Services Income) Act 2000 …. 17.48 New Business Tax System (Capital Allowances) Act 2001 …. 16.19, 16.20 New Business Tax System (Imputation) Act 2002 …. 14.78 Privacy Act 1988 …. 21.13 Public Service Act 1922 …. 10.49, Public Service Act 1999 …. 20.19 Retirement Savings Accounts Act 1997 …. 18.20 Social Security Act 1991 …. 12.7 Superannuation (Departing Australia Superannuation Payments Tax) Act 2006 …. 15.49 Superannuation (Excess Non-concessional Contributions Tax) Act 2007 s 292-80 …. 15.27 s 292-90 …. 15.27 Superannuation (Excess Untaxed Roll-over Amounts Tax) Act 2007 s 4 …. 15.66 s 5 …. 15.66 Superannuation (Government Co-contribution for Law Income Earners) Act

2003 s 6 …. 15.22 Superannuation Guarantee (Administration) Act 1992 …. 15.17 Superannuation Guarantee Charge Act 1992 s 5 …. 15.68 Superannuation Industry (Supervision) Act 1993 …. 15.1, 15.2 s 10 …. 15.2 Superannuation (Self-managed Superannuation Funds) Supervisory Levy Imposition Act 1991 …. 15.69 Superannuation Supervisory Levy Imposition Act 1998 …. 15.69 Superannuation (Unclaimed Money and Lost Members) Act 1999 …. 8.23 Tax Laws Amendment (2006 Measures No 1) Act 2006 …. 2.39, 23.8 Tax Laws Amendment (2011 Measures No 5) Act 2011 …. 14.45, 14.62 Tax Laws Amendment (Combating Multinational Tax Avoidance) Act 2015 …. 17.19 Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013 …. 17.7 Tax Laws Amendment (Small Business) Act 2007 …. 5.59 Tax Agreements Act 1953 …. 4.93 Taxation Administration Act 1953 (TAA 1953) Pt IVC …. 2.39, 21.10, 21.22 ss 8A–13C …. 21.9 s 14ZW(1) …. 21.10 s 14ZZK …. 4.28 s 14ZZK(b) …. 21.10 s 14ZZK(b)(i) …. 12.45 s 14ZZO …. 6.47 s 14ZZO(b) …. 21.10 s 14ZZO(b)(i) …. 12.45

s 45-30 …. 3.52 s 370-5 …. 21.27 Sch 1 Subdiv 12-F …. 4.82, 12.10 Sch 1, Subdiv 14-D …. 21.21 Sch 1 Div 13 …. 17.62 Sch 1 Div 290 …. 2.39, 17.63, 20.14 Sch 1 Div 298 …. 17.63, 20.14 Subdiv 298-B …. 2.39 Sch 1 Div 358 …. 21.11 Sch 1 Div 359 …. 21.11 Sch 1 Div 390 …. 15.16, 15.46 Sch 1 Divs 284–288 …. 21.8 Sch 1 Pt 2-5 …. 21.18, 21.19 Sch 1 Pt 2-10 …. 21.18, 21.20 Sch 1 s 13-5(1) …. 17.62 Sch 1 s 14-200(1) …. 9.136 Sch 1 s 45-30 …. 3.52 Sch 1 s 45-130 …. 5.55 Sch 1 s 45-400 …. 5.55 Trust Recoupment Tax Assessment Act 1985 …. 14.65

NEW SOUTH WALES Water Management Act 2000 …. 9.13

VICTORIA Partnership Act 1958 s 5 …. 14.9

UNITED KINGDOM

Income Tax Act 1842 Sch D …. 6.25

INTERNATIONAL Australia–Switzerland Double Taxation Agreement art 9 …. 3.85

TAXATION RULINGS AND DETERMINATIONS Determinations TD 93/22 …. 10.51 TD 93/26 …. 10.50 TD 93/111 …. 10.45 TD 93/232 …. 10.45 TD 93/242 …. 5.6 TD 94/45 …. 10.45 TD 94/48 …. 10.45 TD 96/41 …. 16.19 TD 1999/38 …. 6.8 TD 1999/62 …. 10.45 TD 2008/27 …. 10.40 TD 2012/1 …. 17.17 TD 2012/7 …. 18.63 TD 2014/26 …. 9.28 TD 2017/10 …. 9.128 Interpretative Decisions ID 2001/225 …. 10.35 ID 2002/45 …. 3.84 ID 2003/359 …. 14.3 ID 2004/391 …. 9.79

ID 2004/650 …. 9.79 ID 2006/218 …. 12.39 Rulings GSTR 2000/19 …. 19.82 GSTR 2001/8 …. 19.38 GSTR 2014/3 …. 19.24 IT 252 …. 16.19 IT 2193 …. 6.38 IT 2360 …. 5.2 IT 2479 …. 4.87 IT 2540 …. 14.30 IT 2582 …. 10.60 IT 2607 …. 4.11, 4.25 IT 2622 …. 14.58 IT 2641 …. 10.45 IT 2650 …. 4.11, 4.22, 4.25, 4.21 IT 2670 …. 5.39 MT 2006/1 …. 19.21 MT 2016 …. 18.22 TR 92/1 …. 21.11 TR 92/3 …. 6.28 TR 92/8 …. 10.35 TR 93/1 …. 21.11 TR 93/2 …. 6.7 TR 93/11 …. 5.12 TR 93/30 …. 10.38 TR 94/8 …. 14.10 TR 94/22 …. 10.45 TR 94/25 …. 5.27

TR 94/26 …. 5.18 TR 95/8 …. 10.45, 10.51 TR 95/9 …. 10.45 TR 95/10 …. 10.45 TR 95/11 …. 10.45 TR 95/12 …. 10.45 TR 95/13 …. 10.45 TR 95/14 …. 10.45 TR 95/16 …. 10.45 TR 95/17 …. 10.45 TR 95/18 …. 10.45, 10.50 TR 95/19 …. 10.45, 10.51 TR 95/20 …. 10.45 TR 95/21 …. 10.45 TR 95/22 …. 10.45 TR 95/25 …. 10.40, 10.60, 14.18 TR 95/33 …. 10.15 TR 95/34 …. 10.37 TR 95/35 …. 9.12 TR 95/36 …. 10.24 TR 96/15 …. 4.60 TR 96/17 …. 10.46 TR 96/18 …. 10.46 TR 97/7 …. 5.26 TR 97/11 …. 6.23 TR 97/12 …. 10.45 TR 97/20 …. 4.85 TR 97/23 …. 11.11

TR 98/1 …. 5.12 TR 98/6 …. 10.45 TR 98/9 …. 10.32, 10.33, 10.34, 10.35, 10.50 TR 98/14 …. 10.45 TR 98/17 …. 4.12 TR 99/10 …. 10.45, 10.50 TR 2000/18 …. 16.20 TR 2001/6 …. 10.24 TR 2001/8 …. 17.16 TR 2001/14 …. 17.31, 17.40, 17.42, 17.44 TR 2002/5 …. 4.80 TR 2002/18 …. 10.40, 17.17 TR 2003/4 …. 6.23 TR 2003/5 …. 18.25 TR 2003/16 …. 10.45 TR 2004/4 …. 10.59 TR 2004/15 …. 4.40 TR 2005/13 …. 11.40 TR 2006/3 …. 7.8 TR 2011/6 …. 13.68 TR 2016/D1 …. 13.68 TR 2017/1 …. 13.65 TR 2017/2 …. 13.31 TR 2017/D1 …. 13.11

Contents Preface Why study tax law? Text features Acknowledgments Table of cases Table of statutes

CHAPTER 1

The taxpayers and introduction

Chapter overview Constitutional taxation powers Sources of Australian taxation law Rules developed by Parliament Summary Further problems

CHAPTER 2

Who we don’t tax, free riders and policy

Chapter overview Policy The great debate: ‘tax expenditures analysis’ v ‘optimal tax theory’ Optimal tax theory Who doesn’t pay tax — the free riders Summary

Tax evasion Ethics History of Australian taxation How does real tax reform happen? The future Summary Further problems

CHAPTER 3

Income tax basics

Chapter overview Income tax pyramid Level 1: The income tax equation Level 2: Income tax legislation overview Level 3: Analysis The legal reasoning model Summary Further problems

CHAPTER 4

International tax

Chapter overview International tax norms and problems Step 1: Residence rules Step 2: Source rules Step 3: Taxation of foreign income of residents Step 4: Taxation of foreign residents Double tax agreements — overview Step 5: Transfer pricing — ITAA 1936 Pt III Div 13 Step 6: International loans and capital raising

Step 7: Consolidations — international tax Step 8: Corporate concessions Summary Further problems

CHAPTER 5

Income tax accounting

Chapter overview Tax period Timing of income Timing of deductions Trading stock: ITAA 1997 Div 70 Trading stock exemption for small business entities Consolidated groups — an overview Summary Further problems

CHAPTER 6

Ordinary income

Chapter overview Derivation — timing of income Convertible into money The principle of mutuality Periodical gains have the character of income Windfall gains Receipts from illegal activities Gains from the use of property Income from personal services has the character of income Receipts from carrying on a business Capital receipts are generally not ordinary income

Summary Further problems

CHAPTER 7

Statutory income

Chapter overview ITAA 1997 — statutory income provisions ITAA 1936 — statutory income provisions Summary Further problems

CHAPTER 8

Non-assessable income

Chapter overview Exempt entities: ss 11-5 and 50-1 Principle of mutuality ITAA 1997 — ordinary or statutory income exempt from income tax ITAA 1936 — exempt income provisions Non-assessable and non-exempt income Payments not exempt from income tax Summary Further problems

CHAPTER 9

Capital gains and losses

Chapter overview CGT general rules: ITAA 1997 Div 103 Step 1: Residence Step 2: Must have a CGT event Step 3: Identify the CGT asset Step 4: Is the CGT event/CGT asset exempt?

Step 5: Do the special CGT rules apply? Step 6: Calculating the capital gain/loss Step 7: Netting capital gains/losses Foreign resident CGT withholding regime Summary Further problems

CHAPTER 10 General deductions Chapter overview Words and phrases analysis of ITAA 1997 s 8-1 Words and phrases analysis step 1: the positive limbs of s 8-1 Words and phrases analysis step 2: the negative limbs of s 8-1 Capital or capital nature Categories of expenditure in s 8-1: employees and investors Categories of expenditure s 8-1: business GST and deductions: ss 27-1–27-5 Summary Further problems

CHAPTER 11 Specific deductions Chapter overview Specific deductions: ITAA 1997 Specific deductions: ITAA 1936 Summary Further problems

CHAPTER 12 Deduction limitations Chapter overview

Limitations: ITAA 1997 Limitations: ITAA 1936 Summary Further problems

CHAPTER 13 Capital allowances Chapter overview Capital allowances: Div 40 Depreciating assets: Subdivs 40-A–40-F Step 1: Understand s 40-25 Step 2: Must have a taxable purpose Step 3: Must have a depreciating asset Step 4: Must have a holder of a depreciating asset Step 5: Calculate depreciation Step 6: Calculate balancing adjustments Step 7: Do the special rules apply? Step 8: Complete the depreciation schedule Other listed capital allowances: Subdivs 40-G–40-J Capital works: Div 43 Capital allowances: ITAA 1936 Summary Further problems

CHAPTER 14 Entities Chapter overview Individuals Partnerships Trusts

Companies Summary Further problems

CHAPTER 15 Superannuation and eligible termination payments Chapter overview Step 1: Understand the superannuation basics Step 2: Taxation of superannuation contributions by employers, selfemployed and employees Step 3: Taxation of superannuation entities Step 4: Taxation of superannuation benefits Step 5: Taxation of employment termination payments Step 6: Other issues Summary Further problems

CHAPTER 16 Special taxpayers Chapter overview Mining Primary production Averaging tax offset: ITAA 1997 Div 392 Applying averaging Artists, authors, inventors, sportspersons, production associates Australian film Summary Further problems

CHAPTER 17 Anti-avoidance Chapter overview General anti-avoidance: ITAA 1936 Pt IVA Application of ITAA 1936 Pt IVA Specific anti-avoidance provisions Alienation of personal services income: ITAA 1997 Pt 2-42, Divs 84–87 Summary Further problems

CHAPTER 18 Fringe benefits tax Chapter overview FBT pyramid Level 1: The FBT equation Level 2: Legislation overview of FBTAA Level 3: Analysis of components of FBT equation Summary Further problems

CHAPTER 19 Goods and services Chapter overview GST pyramid Level 1: The GST equation Level 2: Legislation overview of GST Level 3: Analysis of components of GST equation Step 2: What are your GST-free supplies? Step 3: What are your input-taxed supplies? Step 4: Do the special GST rules apply? Step 5: What are your input tax credits?

Step 6: What are your adjustments? Step 7: GST instalments Step 8: Calculating your GST Administration GST and other taxes GST and contractual disputes Summary Further problems

CHAPTER 20 Tax planning Chapter overview Minimise assessable income Maximise deductions Use of tax offsets Use of entities Use of averaging Use of withholding tax provisions Use of international tax concessions Compliance with anti-avoidance provisions Case in point Current and proposed tax changes Interactions with GST, FBT and superannuation rules Record keeping and documentation Lobbying and media Summary Further problems

CHAPTER 21 Tax administration

Chapter overview Self-assessment and income tax returns Assessment Audits Power to amend assessments Penalties, interest and offences Review rights Public and private rulings Taxpayers’ charter Australian business number (ABN) Pay-as-you-go (PAYG): TAA 1953 Sch 1 Pts 2-5, 2-10 Inspector-General of Taxation Australian Taxation Office and the internet Summary

CHAPTER 22 Taxation in practice Chapter overview Income tax returns Individuals Partnerships Trusts Company Fringe benefits tax returns GST tax returns Summary Further problems

CHAPTER 23 Solving complexity

Chapter overview Routine transactions Complex transactions Summary Further problems

Appendix 1 Appendix 2 Index

[page 1]

1 The taxpayers and introduction Learning Objectives After you have studied this chapter, you should be able to: identify the major Australian taxes; consider the extent of Australia’s taxation level compared with that of other countries; identify the Commonwealth of Australia’s constitutional power to tax; explain the sources of Australian Commonwealth taxation law; explain the doctrine of precedent; explain the various approaches to statutory interpretation; outline the relevant Sections of the Acts Interpretation Act for the interpretation of a statute; be aware of legal citation guides; and explain how to use extrinsic material in the interpretation of a statute.

[page 2]

Key Legislative Provisions Acts Interpretation Act 1901 s 15AA Constitution ss 51, 53, 55, 99, 114 Income Tax Assessment Act 1936 (ITAA 1936) s 6(1) Income Tax Assessment Act 1997 (ITAA 1997) s 995-1

Key Cases Cooper Brookes (Wollongong) Pty Ltd v FCT (1981) 147 CLR 297; 81 ATC 4292 FCT v Westraders Pty Ltd (1980) 11 ATR 24

Chapter overview 1.1 This chapter examines introductory tax issues such as Australia’s tax system, ethics, the taxation powers in the Constitution, the sources of tax laws, statutory interpretation principles and rules, the doctrine of precedent and the history of Australian taxation.

Part 1: Australia’s tax system compared with others in the OECD 1.2 The Australian Treasury provides the following analysis of Australian taxation.1 The analysis in this section combines the tax systems of all levels of government — national, state and local — and compares Australia’s tax system

with the tax systems of other OECD economies, using the accrual accounting framework. Tax burden 1.3 Australia’s tax-to-GDP ratio is low by international standards. In 2010 (Australia’s 2010–11 financial year), the latest year for which comparable international data is available, Australia had the sixth-lowest tax burden of the OECD countries (Chart 1.1) and has typically ranked in the bottom third of countries since 1965 (when comparable data was first available). In 2010, Australia’s tax-to-GDP ratio was 25.6 per cent — below the OECD average of 33.8 per cent. [page 3] Chart 1.1:

Tax-to-GDP ratio for OECD countries, 2010(a)

(a) The OECD’s measure of the tax burden in the total taxation revenue of national, state and local governments expressed as a percentage of gross domestic product. For Australia, the data is for the 2010–11 financial year, the latest year where comparable numbers are available. Source: OECD Revenue Statistics, 2012.

Chart 1.2 shows Australia’s taxes by level of government over time. The

Australian Government’s total taxation revenue as a percentage of GDP averaged 22.5 per cent over the period from 1980–81 to 2010–11. Chart 1.2:

Australia’s tax-to-GDP ratio by level of government

Source: ABS Catalogue 5506.0, Taxation Revenue, Australia; and OECD Revenue Statistics, 2012.

The Australian Government raised 80.3 per cent of Australia’s total tax revenue in 2010 (Chart 1.3). The proportion of total taxation revenue attributed to the central government in Australia is the sixth highest among the OECD countries. [page 4] Chart 1.3: Australian Government taxation revenue as a proportion of total taxation revenue for OECD countries, 2010

Source: OECD Revenue Statistics, 2012.

Tax mix 1.4 The Australian tax mix is broadly similar to that in most OECD countries (Chart 1.4), although there are a few distinguishing features. Like most countries, Australia raises the majority of its taxation revenue (62.3 per cent in 2010) from direct taxation that is levied on incomes — wages, salaries, payrolls and profits. This is close to the OECD average of 61.6 per cent. Countries with a higher reliance than Australia on direct taxation include Japan (71.3 per cent) and Switzerland (70 per cent). The remaining 37.7 per cent of Australia’s taxation revenue is derived from indirect taxation, including the goods and services tax (GST), excise and customs duties, and property taxes. The OECD average is 38.4 per cent. Chart 1.4: Direct and indirect taxation revenue as a proportion of total taxation revenue for OECD countries, 2010

Source: OECD Revenue Statistics, 2012.

[page 5] Australia’s composition of direct taxes differs from that of most OECD countries. Australia is one of two OECD countries (the other being New Zealand) that do not levy social security taxes. In contrast, social security taxes are a large source of direct taxation revenue for a significant number of OECD countries (Chart 1.5). Chart 1.5: Australia’s taxation composition compared with the OECD average, 2010

Source: OECD Revenue Statistics, 2012.

Relative to GDP, Australia has the third-lowest level of total taxation on personal income, which includes taxes on personal income, social security taxes and taxes on payroll, in the OECD (Chart 1.6). Australia’s tax burden relating to these items (11.2 per cent of GDP) is lower than the OECD average (18.4 per cent). Chart 1.6: Components of direct taxation in respect of individuals and payrolls, 2010(a)

(a) Chile and Mexico have not been included, due to incomplete data. This affects the average OECD figure. Source: OECD Revenue Statistics, 2012.

Most indirect taxation in OECD countries is generated through various taxes on goods and services. Australia has the fourth-lowest level for goods and services taxes and total [page 6] indirect taxation in the OECD (Chart 1.7). Australia’s indirect tax burden relating to these items is 9.7 per cent of GDP, which is significantly lower than the OECD average of 12.9 per cent.

Chart 1.7:

Components of indirect taxation, 2010

Source: OECD Revenue Statistics, 2012.

Note: The OECD Revenue Statistics publication bundles other indirect taxes, such as excise, customs and sales taxes, into its label for ‘goods and services taxes’ — this terminology should not be confused with the ‘goods and services tax’ as reported in the Australian Government Budget papers, which does not incorporate any additional indirect taxes. Petrol taxation 1.5 The rate of excise duty on unleaded petrol in Australia is 38.1 cents per litre. This rate has been maintained since the indexation of petrol excise rates to the Consumer Price Index (CPI) ceased in March 2001. The impact of excise duty on unleaded petrol, combined with the impact of general consumption taxes (value-added tax (VAT), GST and sales taxes), is shown in Chart 1.8 for most OECD countries. Under this combined measure, which illustrates the total tax imposed on consumers, the average level of tax included in petrol prices for the OECD countries was A$0.95 per litre in the second quarter of 2012. In comparison, the level of tax included in unleaded petrol prices in Australia for the second quarter of 2011 was about half this amount, at A$0.54 per litre — the fourth lowest of the OECD countries for which comparable data is available.

[page 7] Chart 1.8:

Regular unleaded petrol prices(a)

(a) Iceland and Israel have not been included, due to incomplete data. Source: IEA Statistics, Energy Prices and Taxes, Third Quarter 2012.

Part 2:

Australian Government taxes

1.6 The analysis in Part 1 combined the tax systems of all levels of government and used the accrual accounting framework. This section focuses on Australian Government taxes — that is, it excludes taxes imposed by state and local governments — and uses the cash accounting framework. Tax mix 1.7 The Australian Government’s main source of taxation revenue is the taxation of various forms of income. These taxes are estimated to represent around 74.4 per cent of total taxation receipts in 2012–13 (Chart 1.9). Personal income tax, which is made up of gross income tax withholding, gross other individuals’ income tax and individuals’ refunds, accounts for 47.1 per cent of total taxation receipts.

A further 2.4 per cent is from taxes levied on superannuation funds, and 1.2 per cent is from fringe benefits tax (FBT). Company income and resource rent taxation accounts for 22.6 per cent of total taxation receipts. The carbon pricing mechanism, introduced on 1 July 2012, accounts for 1.2 per cent of total taxation receipts. Sales taxes, inclusive of the GST, contribute 14.6 per cent. The remaining 11 per cent of taxation receipts are mostly accounted for by excise and customs duties. [page 8] Chart 1.9:

Australian Government tax mix, 2012–13

Source: 2012–13 MYEFO.

Tax receipts as a proportion of GDP have moved in a relatively small range over the last two decades (Chart 1.10). Sales taxes have expanded with the introduction of GST in 1999–2000, while total individuals’ income taxes fell. Taxes as a proportion of GDP steadily increased from the early 1990s, peaking in 2004–05 at 24.2 per cent. The tax-to-GDP ratio declined as the

global financial crisis reduced receipts sharply. Tax receipts are expected to rebound steadily relative to GDP to average 22.8 per cent over the estimates period. Chart 1.10: Major categories of tax receipts as a proportion of gross domestic product

(a) Sales taxes include the GST, the luxury car tax, the wine equalisation tax and the wholesale sales tax. (b) Other taxes include other indirect taxes, fringe benefits tax and the carbon pricing mechanism. Source: 2012–13 MYEFO.

[page 9] Personal income tax distribution 1.8 The personal income tax system is progressive — the tax share increases for those who earn more, while those individuals who have limited means bear relatively little or no tax liability (Chart 1.11). For the 2009–10 income year), 57.5 per cent of personal income tax was collected from the 17.4 per cent of taxpayers earning more than $80,000 per year (with around 24 per cent of personal income tax coming from the 2.3 per cent of taxpayers earning over $180,000 per year). In comparison, the 30.5 per cent of taxpayers who earned less than $35,000

in taxable income per year paid only 4 per cent of the total net tax payable on income. The 52.1 per cent of taxpayers in the $35,001 to $80,000 income range paid 38.6 per cent of total net tax payable on income. Chart 1.11:

Net tax payable by income level, 2009–10

Source: ATO, Taxation Statistics 2009–10.

Company income tax distribution 1.9 Most company income tax is paid by a relatively small group of large companies (Chart 1.12). For the 2009–10 income year, 63.9 per cent of company income tax was collected from the 0.5 per cent of incorporated taxpayers who earned more than $100 million in total income. [page 10]

Chart 1.12:

Net tax payable by company income size, 2009–10

Source: ATO, Taxation Statistics 2009–10.

Indirect taxes 1.10 The share of indirect taxes in total receipts exhibits a long-term declining trend (Chart 1.13), as some of the indirect tax bases do not grow as quickly as the income tax bases. Policy decisions taken by governments, such as trade liberalisation and removal of indexation on petroleum excises, have accelerated this trend. However, with the introduction of the GST in July 2000, the share of indirect taxes in total tax receipts increased from 22.9 per cent in 1999–2000 to 29.9 per cent in 2000–01. In addition, decisions to increase the luxury car tax and to remove the crude oil excise exemption on condensate production increased indirect tax receipts from 2008 to 2009. [page 11]

Chart 1.13:

Australian Government indirect taxes

(a) Sales taxes comprise the GST, the luxury car tax, the wine equalisation tax and the wholesale sales tax. Source: 2012–13 MYEFO.

2013–14 tax revenue 1.11 More recently, the total taxation revenue collected in Australia increased $18.77 billon (5 per cent) from $415.12 billion in 2012–13 to $433.89 billion in 2013–14.2 Taxes on income increased $6.71 billion (3 per cent); the GST and other taxes on goods and services increased $6.61 billion (7 per cent), and taxes on property increased $4.52 billion (13 per cent) over the same period. In 2013–14, taxes on income comprised 57 per cent of total taxation revenue for all levels of government, and the GST and other taxes on goods and services comprised 24 per cent. Tax expenditures 1.12 Tax expenditures provide a benefit to a specified activity or class of taxpayer. They can be delivered as a tax exemption, tax deduction, tax offset, concessional tax rate or deferral of a tax liability. The government can use tax expenditures to allocate resources to different activities or taxpayers in much the same way that it can use direct expenditure programs. The data on tax expenditures reported below includes tax expenditures related to the GST. The data incorporates the impact on tax expenditures of

policy decisions up to and including those reported in the 2012–13 MYEFO. Care needs to be taken when analysing tax expenditure data. For a detailed discussion, see Chapter 2 of the TES. Chart 1.14 contains estimates of total tax expenditures for the period 2007–08 to 2015–16. Total tax expenditure as a proportion of GDP is expected to rise slightly to 7.8 per cent in 2012–13; the average across the period shown is 8.5 per cent. [page 12] Chart 1.14:

Aggregate tax expenditures 2007–08 to 2012–13

Source: TES 2011 and 2012–13 MYEFO.

The largest measured tax expenditures for 2014–15 were:3 capital gains tax (CGT) main residence exemption — discount component ($25.5 billion); CGT main residence exemption ($20.5 billion); concessional taxation of employer super contributions ($16.3 billion); and concessional taxation of super entity earnings ($13.4 billion).

Constitutional taxation powers The Commonwealth’s power to tax 1.13 The Constitution provides the power for the Commonwealth Parliament to enact tax legislation, but this power has certain limitations. Section 51(ii) provides Parliament with the power to make laws for the peace, order and good government of the Commonwealth in respect of taxation, but not so as to discriminate between states or parts of states. [page 13]

Read Constitution s 514 Limitations on the Commonwealth’s taxing power Must be in respect of taxation 1.14 Section 51(ii) of the Constitution requires that tax legislation be in respect of taxation. The High Court of Australia, however, has not set out any concrete test of what constitutes taxation under s 51(ii). A number of taxpayers have challenged the constitutional validity of tax laws on the basis that the relevant law is not in respect of taxation. For example, in State Chamber of Commerce and Industry v Commonwealth of Australia (1987) 163 CLR 329, the High Court found that the Fringe Benefits Tax Assessment Act constituted a valid law being in respect of taxation, even though the law had another effect in discouraging the uptake of fringe benefits by employees and employers. Taxation laws shall deal only with the imposition of taxation 1.15 Section 55 provides that laws imposing taxation shall deal only with the imposition of taxation, and any provision therein dealing with any other matter shall be of no effect. Thus, the various tax Acts contain separate Acts

dealing with imposing rates and Acts that detail the incidence, assessment and collection of the tax. For example, the Income Tax Rates Act 1986 imposes the income tax rates, while the Income Tax Assessment Act 1997 deals with the incidence, assessment and collection of income tax.

Read Constitution s 55 Taxation laws shall deal with one subject of taxation only 1.16 Further, s 55 requires that legislation imposing taxation shall deal with one subject of taxation only. The validity of the CGT provisions (written into the income tax laws) were thus under scrutiny in Resch v FCT (1942) 66 CLR 198; 6 ATD 203. However, the High Court found that both income and capital gains taxation fell within the one subject of taxation. Federal tax cannot discriminate between the states 1.17 Section 51(ii) prohibits any federal tax from discriminating between states or parts of states. Thus, in Cameron v Deputy Federal Commissioner of Taxation (Tas) (1923) 32 CLR 68, the High Court found that a rule that provided different valuations for livestock in different states contravened s 51(ii). Federal revenue laws shall not give preference to any one state or any part of it over another state or any part of it 1.18 Section 99 provides that the Commonwealth shall not by any law or regulation of trade, commerce or revenue give preference to any one state or any part of it over another state or any part of it. [page 14]

Read Constitution s 99 The Commonwealth is prohibited from imposing any tax on

property, of any kind, belonging to a state 1.19 Section 114 prohibits the Commonwealth from imposing any tax on property, of any kind, belonging to a state. The High Court has considered a number of cases questioning what is a tax on property and what constitutes a state. For example, South Australia was successful before the High Court in South Australia v Commonwealth of Australia 92 ATC 4066 in arguing that its state superannuation fund was exempt from CGT under s 114, as CGT is a tax on property.

Read Constitution s 114 Territorial limitations 1.20 Section 51 restricts Parliament’s taxing power to legislation for the peace, order and good government of the Commonwealth. This seemingly limits Australian taxation to activities or taxpayers with an Australian connection. For example, the income tax laws and goods and services tax laws both set Australian-connected jurisdictional limits. Laws imposing taxation shall not originate in the Senate 1.21 Section 53 also provides that proposed laws imposing taxation shall not originate in the Senate, and the Senate may not amend proposed laws imposing taxation. Thus, all tax Bills must stem from the House of Representatives, and any Senate amendment must be agreed by the House of Representatives.

Read Constitution s 53 Sources of Australian taxation law 1.22 There are three sources of taxation law: statute law (eg, ITAA 1997), case law (eg, High Court, Federal Court, Administrative Appeals Tribunal) and the practice of the ATO (eg, public rulings).

Statute law 1.23 This text focuses on the tax laws made by the Commonwealth Parliament (known as Acts of Parliament, statutes or legislation). These laws help govern how our society operates and how people behave with one another. The most important legislation dealt with in this book includes: the Income Tax Assessment Act 1997 (ITAA 1997); the Income Tax Assessment Act 1936 (ITAA 1936); the A New Tax System (Goods and Services Tax) Act 1999 (GSTA 1999); and the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986). [page 15]

Case law 1.24 There are two main roles for case law: to create law to fill a legislative vacuum (eg, what is income) — this is becoming rarer, given the detail of modern legislation — and to interpret legislation (eg, determining the meaning of ‘income’). Most of the case law referred to in this textbook is provided by the High Court, the Federal Court, the Administrative Appeals Tribunal and its predecessor, the Boards of Review. Some references are also made to international tax cases.

Australian Taxation Office rulings 1.25 The ATO issues public rulings. These rulings are binding, so a taxpayer following these rulings will be protected from penalty or any other adverse consequences from the ATO. Prior to the public rulings system, ATO rulings were only administratively binding on the ATO. A taxpayer can apply to the ATO for a private ruling if they are unsure of how the income tax laws affect them. These rulings are important in practice, as they provide certainty as to the Commissioner’s attitude to the application of the ITAA. However,

ATO rulings do not constitute law, and they carry far less weight than the legislation and case law.5

Principles of statutory interpretation 1.26 It is vital that legislation is consistently interpreted so that the same rules apply to everyone. However, tax is complex, and words or phrases in a taxing provision may have more than one meaning, may involve technical terms or may be unclear. Thus, principles have been developed both by courts and by Parliament to aid in the reading of legislation. Over the centuries, the courts have developed these principles to guide their decision making. By understanding these, you may predict how a court will interpret a provision. The courts have tended to view tax laws with the same judicial intolerance as is accorded to penal statutes. Thus, the traditional approach has been to tax only where there are clear words for that purpose; that is, a taxing Act is to be given its literal meaning, and any ambiguities are resolved in favour of the taxpayer. Likewise, provisions exempting tax are to be construed in favour of the taxpayer where there is doubt. There are many principles that the courts have developed. Some of these are discussed below. Literal rule 1.27 This was originally regarded as the most important rule. It operates to give words their ordinary and natural meaning when used in the Act, allowing them to be understood in context. Thus, this meaning will be followed even if it leads to absurd results, as the courts prefer to leave any interpretation difficulties to Parliament to resolve.6 The problem with such an approach is that it does not consider the taxation policy goals or legislative purpose, and thus facilitates manipulation of the taxation laws. For example, in the 1970s, Barwick CJ in the High Court frequently adopted a very strict formal and literal approach to interpreting taxation statutes. Consequently, a number of [page 16]

artificial tax avoidance schemes that were challenged by the Commissioner of Taxation were not struck down by the High Court. In FCT v Westraders Pty Ltd (1980) 11 ATR 24, the taxpayer was able to claim a $6 million loss in respect of a tax avoidance scheme involving ITAA 1936 ss 36 and 36A. Barwick CJ, in taking a literal approach, stated at 59–60: The function of the court is to interpret and apply the language in which the Parliament has specified those circumstances … It is not for the court to mould or attempt to mould the language of the statute so as to produce some result which it might be thought the Parliament may have intended to achieve, though not expressed in the actual language employed.

Golden rule 1.28 The courts apply the literal meaning unless some absurdity arises, so the literal meaning is modified to avoid the absurdity.7 But different judges will have different views of what is absurd. Mischief rule 1.29 Where the legislative meaning is unclear, the mischief rule directs the court to ascertain the provision’s meaning by reference to the state of the law before the passing of the Act, the mischief or problem that the pre-existing law created and the legislative remedy that Parliament introduced. The court then construes the legislation so as to ensure that the legislation deals with the mischief.

Flexibility of principles — move to a purposive approach 1.30 Obviously, there exists considerable tension between these rules; for example, a literal interpretation may encourage tax avoidance (see Curran v FCT 74 ATC 4296), while a purposive approach will make tax avoidance harder (see John v FCT 89 ATC 4101). Thus, given this flexibility, the matter of statutory interpretation is ultimately driven by judicial philosophies or attitudes. For example, in the 1970s, the literal rule was dominant, and this encouraged large-scale tax avoidance through ‘bottom of the harbour’ and other schemes. However, the 1980s and 1990s have seen the Federal Court

and the High Court adopt a purposive approach (and thereby close down such blatant schemes). FCT v Students World (Australia) Pty Ltd 78 ATC 4040, an anti-avoidance case, marked the move to a purposive approach, where the court stated that a wide interpretation should be given to anti-avoidance provisions. These sentiments were echoed in Cooper Brookes (Wollongong) Pty Ltd v FCT (1981) 147 CLR 297; 81 ATC 4292: The fundamental object of statutory construction in every case is to ascertain the legislative intention by reference to the language of the statute as a whole. But in performing that task the courts look to the operation of the statute according to its terms and to legitimate aids to construction.8

There are, though, restrictions to the use of a purposive approach. The High Court in Saeed v Minister for Immigration and Citizenship (2010) 84 ALJR 507 at 515 warned of the [page 17] limits of an approach that relies on policy arguments and extrinsic materials to achieve a desired outcome, stating: ‘it is erroneous to look at extrinsic materials before exhausting the application of the ordinary rules of statutory interpretation’.9

Other judicial rules 1.31 The ejusdem generis (of the same kind or nature) rule: Legislation may not list all the kinds of things or types of conduct to which the Act may apply. This legal presumption provides that the general word will be limited to include only things or conduct within the same category as the preceding listed words. The noscitur a sociis (meaning can be gathered from the context) rule: This legal presumption provides that if a word can have more than one meaning, then the meaning of other words with which that word is associated in the provision can be used to interpret its meaning. There must be a group of words with similar meaning and a word that is ambiguous. Thus, the meaning

of the ambiguous word can be obtained having regard to the context of the similar words. (Unlike ejusdem generis, it does not require the word to be a general word following a group of specific words.) General words are to be given their ordinary and popular meaning; for example, ‘income’ is given its ordinary meaning: see Scott v C of T (NSW) (1935) 35 SR (NSW) 215. Technical words are generally given their technical meaning; for example, in FCT v Murray (1998) 193 CLR 605,10 the High Court gave the term ‘goodwill’ its technical meaning. The Act should be read as a whole: You need to take into account that the purpose of the ITAA is to calculate taxable income; that is, assessable income less deductions. Words are assumed to be used consistently throughout the Act: This is made clear in the ITAA 1997, which has a dictionary at s 995-1 and relies on common meanings for words throughout; for example, ‘trading stock’ means the same where it is referred to in Div 70 (about trading stock) as it does in s 118-25 (exempting trading stock from CGT).

Rules developed by Parliament Definitions 1.32 Legislation may define the meaning of a particular word in a dictionary or a definitions Section. For example, the definitions can be found in: ITAA 1997 s 99–1; ITAA 1936 s 6(1); and GSTA 1999 s 195–1. Definitions are expressed in a number of ways. [page 18]

Means definitions 1.33 A definition phrased this way suggests that the defined word has a conclusive meaning (entirely determined by the definition provided).

Read GSTA 1999 s 38-4 Includes definitions 1.34 A definition phrased this way suggests that the word takes on its ordinary meaning as well as the meaning added by the definition (ie, it extends the meaning of the word).

Read ITAA 1997 s 70-10 Intrinsic materials 1.35 Intrinsic materials consist of the materials contained within the legislation. For example, to help interpret an Act, the court could use the long title or the short title of the Act, the preamble (the preamble gives the reasons why the Act was enacted), statement of objects clauses, the Division or Chapter headings of the statute, Schedules, guides, notes and examples. The court cannot use the marginal notes and footnotes, though.

Read GSTA 1999 s 38-1; ITAA 1997 Div 100 Past court decisions 1.36 If a term is not defined in the statute, past court decisions can be used for determining the meaning of words. The following legal publications can assist in the interpretation of words in a statute: Halsbury’s Laws of Australia (LexisNexis Butterworths Australia); The Key and Research Guide contains the Words, Phrases and Maxims segment;

Australian Legal Words and Phrases (LexisNexis Butterworths Australia); Words and Phrases Legally Defined (Butterworths UK); The Australian Digest (The Law Book Co Ltd); and The Laws of Australia (The Law Book Co Ltd).

Dictionaries 1.37 If a term has not been examined by a court, then the ordinary meaning of a word can be determined by a dictionary. While the Australian courts have used both the Macquarie Dictionary and the Oxford English Dictionary, the Macquarie Dictionary is preferred.

Statutory approaches to interpreting legislation 1.38 The Acts Interpretation Act 1901 (AIA) provides both general and specific rules for the interpretation of Commonwealth legislation. The goal is to prevent the need to include [page 19] general interpretation provisions in all Acts. The AIA provides, though, that its rules apply unless the contrary intention applies. Under the AIA, statutory interpretation is based on reading the statute as a whole and in its context. The interpretation of each provision must be made within the context of the Act. Thus, intrinsic materials (noted above) are an important part of the context of a law. In addition to intrinsic materials, other materials may include the history of the need for the legislation, the deficiencies of the previous legislation or judge-made law, the Australian Constitution, Law Reform Commission reports, reports of other advisory bodies and any material that could assist with the understanding of meaning. The AIA s 15AA provides: In the interpretation of a provision of an Act, a construction that would promote the purpose or

object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.

Note: A court can still skirt around s 15AA by taking a narrow view of the purpose of a law. Section 15AA does not permit the courts to ignore the words of a statute. Where the legislation fails to reflect the intent of government but its meaning is clear, the court must follow the words of the statute.

Use of extrinsic aids 1.39 Traditionally, courts have not taken into account materials outside the Act in determining purpose. This has been relaxed by the introduction of s 15AB of the AIA, so that courts may now refer to explanatory memoranda, second reading speeches and parliamentary committee reports in ascertaining the meaning of a provision. While this is designed to encourage a purposive interpretation rather than a literal one, the courts still have the discretion not to follow this approach. Section 15AB permits such extrinsic material to be used when interpreting an Act: to confirm that the meaning of the provision is the ordinary meaning conveyed by the text; to resolve ambiguity or obscurity; or because the ordinary meaning, if applied, would lead to a result that is manifestly absurd or unreasonable.

Read Acts Interpretation Act 1901 ss 15AA, 15AB Changes in drafting style 1.40 The AIA s 15AC provides that if a provision is re-enacted and different words are used in respect of the same subject matter, there is usually a presumption that a different meaning was intended by the re-enactment. [page 20]

Further rules 1.41 The AIA sets out further rules about the operation of Commonwealth statutes in relation to: the commencement of Acts; public holidays and weekends; the measurement of time; service by post; plural and singular; grammatical forms; gender; and reasons for a decision.

Summary: steps in interpreting legislation 1.42 The following are the steps to be used in interpreting legislation: 1. Examine the operation of the Act: What date does the Act commence? Does the relevant issue happen within the time frame of the statute? 2. Determine the relevant Section(s): Examine the table of contents, headings, notes etc that show the Section(s) that apply. 3. Read the Section(s): Find the significant words in the Section. 4. Ascertain the meaning of significant words in the Section: Is the word defined in the legislation? If not, has a court defined it previously? If not, use a dictionary to determine the meaning. If the meaning of the word is not clear, consider the purpose that Parliament had when enacting the Section or statute (see the extrinsic material). 5. Read the Section in a way that promotes the object of the Act (s 15AA): See the extrinsic material listed at s 15AB(2) of the Act. 6. Build a step-by-step process/decision tree: For example, this textbook frequently uses these to guide the operation of tax laws (eg, see the stepby-step processes at the beginning of Chapter 5 for understanding the income tax rules).

Doctrine of precedent

1.43 The doctrine of precedent requires a court lower in the judicial hierarchy (illustrated above) to follow and apply a legal principle established by a higher court. [page 21]

Practice Problem 1 What rules do the courts use to interpret the ITAAs?

Citing tax legislation and cases 1.44 There are a number of approaches to legal citation. The popular Australian Guide to Legal Citation is available free on the internet.11 The ATO has its own legal citation guidelines. You will need to ask your lecturer for guidance on what legal citation system you require for your study. Some basic guidelines are detailed below.

Guides and legislation 1.45 Note that guides are not legislation, so, generally, do not cite these in your legal arguments. Guides are usually the first Section (or few Sections) in a Division (sometimes, a Division or Part is a guide). In the complete consolidated legislation (available at ), the guide finishes before the heading ‘Operative provisions’, and the legislation then follows. For example, guides in ITAA 1997 include: Sections: 5-1, 6-1, 15-1, 17-1; Divisions: 9, 10, 11, 12, 13; and Part 1-2.

Abbreviations — legislation 1.46 Quote the legislation in full and in italics when cited the first time in a paper. Use abbreviations thereafter: Income Tax Assessment Act 1997 — ITAA 1997; Income Tax Assessment Act 1936 — ITAA 1936; A New Tax System Tax (Goods and Services Tax) Act 1999 — GST Act 1999; and Fringe Benefits Tax Assessment Act 1986 — FBTA 1986. SINGULAR

PLURAL

Chapter

Ch

Chs

Part

Pt

Pts

Division

Div

Divs

Subdivision

Subdiv

Subdivs

Section

s

ss

[page 22]

SINGULAR

PLURAL

Subsection

subs

subss

Paragraph

para

paras

Subparagraph

subpara

subparas

Case citations 1.47

Case name in italics and year in brackets; for example: Cooper Brookes (Wollongong) Pty Ltd v FCT (1981) 147 CLR 297; 81 ATC 4292; FCT v Westraders Pty Ltd (1980) 11 ATR 24; and Saeed v Minister for Immigration and Citizenship (2010) 84 ALJR 507.

Attempt the Web Quiz for Chapter 1

Summary 1.48

This chapter covers the following: The Constitution provides the power for the Commonwealth Parliament to enact tax legislation, but this power has certain limitations. There are three sources of taxation law: statute law (eg, ITAA 1997), case law (eg, High Court, Federal Court, Administrative Appeals Tribunal) and the practice of the ATO (eg, public rulings). Principles of statutory interpretation have been developed to guide the decision making of courts. The following steps should be used to interpret a statute: 1. Examine the operation of the Act. 2. Determine the relevant Section(s).

3. 4. 5.

Read the Section(s). Ascertain the meaning of significant words in the Section. Read the Section in a way that promotes the object of the Act: AIA 1901 s 15AA. 6. Build a step-by-step process/decision tree. Doctrine of precedent requires a court lower in the judicial hierarchy to follow and apply a legal principle established by a higher court.

Further problems 1 2

Have the courts changed the way they interpret taxation statutes? Decisions from which of the following take precedence: the Administrative Appeals Tribunal, the Full Federal Court or the High Court? [page 23]

3

4

5

1.

What common approaches to statutory interpretation should be used: a where a word has several meanings; b to interpret legislation that has a clear meaning? Did the Federal Court in DCT v PM Developments Pty Ltd (2008) ATC 20-078; [2008] FCA 1886 rely on intrinsic materials to assist in the interpretation of the GSTA 1999 (A New Tax System (Goods and Services Tax) Act 1999) Div 147? Why or why not? When did the Income Tax Assessment Act 1997 (ITAA 1997) and the A New Tax System (Goods and Services Tax) Act 1999 (GSTA 1999) commence?

Australian Treasury at , Pocket Guide to the Australian Tax System, reproduced with permission, copyright Commonwealth of Australia.

2.

Australian Bureau of Statistics (ABS), Taxation Revenue, Australia, 2013–14.

3. 4.

Treasury, Tax Expenditures Statement 2014. Available at AustLII .

5. 6.

The rulings are archived at . See FCT v Westraders Pty Ltd (1980) 80 ATC 4357.

7. 8.

See Cooper Brookes (Wollongong) Pty Ltd v FCT (1981) 147 CLR 297; 81 ATC 4292. Above n 6, at 4305.

9.

See Gloxinia Investments Limited as Trustee for Gloxinia Unit Trust v FCT (2009) 72 ATR 975; DCT v PM Developments Pty Ltd (2008) 70 ATR 741; All Sports Ltd v FCT [2011] FCA 824. 10. See (1998) 98 ATC 4585. 11. .

[page 25]

2 Who we don’t tax, free riders and policy Learning Objectives After you have studied this chapter, you should be able to: explain the tax policy criteria; identify a tax expenditures analysis; identify an optimal tax policy analysis; and critique the current tax system.

[page 26] Diagram 2.1:

Stages of tax policy

Chapter overview 2.1 This chapter examines tax policy. The study of policy is useful, in that it will provide a framework in which to critically appraise the current tax system and future tax reform proposals. This will help you understand the tax system and assist you in predicting likely interpretations by the courts and sense future directions of tax law reforms.

Policy 2.2

Taxation policy focuses on two essential issues:

how much tax to collect; and who pays.

How much tax should be collected? 2.3 How much tax is to be collected (known as fiscal adequacy) is the vital question of public policy1 that directly determines the level of services that the citizens of a country receive. Some countries (such as Sweden, Belgium, Finland and Denmark) have taxes that are almost equal to 50 per cent of gross domestic product (GDP). As discussed in Chapter 1, Australia (as well as other countries, the United States, Japan and Ireland) have taxes that are about or less than 30 per cent of GDP. Of course, there are marked differences in government services between these countries. [page 27]

How much tax? Low-taxing v high-taxing countries: the great impact of taxation 2.4 Whether a country decides to be a low-taxing or a high-taxing country strikes at the very heart of the social contract that we write for one another in a democratic country (via the ballot box). If you have been lucky enough to have travelled and spent time in a number of countries, you will be well aware of the stark differences between the level of community services that are provided in Australia and other OECD countries compared with the nonOECD countries. This is generally evident in the levels of poverty, the poor state of the roads, levels of personal insecurity, public buildings, infrastructure and public services in many non-OECD countries. So which model should Australia prefer (Australia is currently a low-taxing OECD country)? First, to be a low- or high-taxing country raises the question, what do the people in a particular society view as their important common community goals? Relevantly, Professor Neil Brooks examined a broad range of societies and found that different countries, cultures and

political systems had broadly similar social and economic goals.2 The social goals included abolition of poverty, support for the vulnerable, an egalitarian society, social equality, personal freedom and security.3 The economic goals included high rates of GDP growth and high standards of living.4 So, then, what should be preferred — a low- or a high-taxing country? In Australia, many interest groups strongly oppose increased levels of taxation on economic grounds. They argue that such taxes impose dead weight costs and cripple economic growth. They further assert that governments only waste taxes by their inefficient spending programs. Are these views justified? Professor Neil Brooks undertook this groundbreaking research by examining 180 social and economic performance indicators between lowtaxing (Japan, the United States, Switzerland, Australia, Ireland) and hightaxing (Nordic countries, France, Belgium) OECD countries. He found that the economic performance of low- and high-taxing OECD countries was very similar.5 However, rather disturbingly, the social data showed that there were relatively high social costs associated with low-taxing countries (high child poverty rates, low incomes of disabled persons, extreme levels of inequality, lower social solidarity, high gender (female) inequality, high infant mortality rates, higher murder rates and a higher perception of government corruption). What sort of society and tax system do you want? All social indicators, with the exception of suicide (which is explained by the cold and dark climatic conditions of Nordic countries), showed that hightaxing countries provide far superior social outcomes to low-taxing countries. As set out in the Commonwealth tax expenditures and noted throughout this textbook, the Australian taxation laws are riddled with thousands of tax preferences and loopholes. There are, however, high social costs associated with these tax breaks in the forgone tax revenue. Politicians often appear eager to [page 28] trumpet the introduction of new tax concessions in order to gain votes or to

gain the favour of powerful interest groups, but how often do they promote the virtues of increasing taxes and improving the social fabric of the community?

Who pays? The tax policy criteria 2.5 Having established some desired level of taxation, the next question is, who should pay? Over 200 years ago, Adam Smith produced four functional criteria for assessing a tax system:6 1.

Equality: when ability to pay is taken into consideration, a good tax should distribute the burden of supporting more or less equally among those who benefit from government.

2.

Convenience: the time and manner of payment should be as convenient as possible for the taxpayer. Certainty: the amount of tax that is due, the method of payment, and the deadline for payment should be clear so that each taxpayer can be certain about his or her obligations.

3. 4.

Efficiency: the cost of administering the tax should be as low as possible so that a large fraction of what is taken from the taxpayer’s pocket is not used up in collecting taxes.

Today, a similar set of functional criteria for designing a tax system of fiscal adequacy,7 economic efficiency, equity and simplicity is well accepted in Australia and internationally.8 While other objectives do exist for tax policy,9 the central focus involves these four functional criteria.

Who pays? Impact on economic efficiency 2.6 The central concern of economics is how to generate economic growth.10 It is clear that economic growth is important — after 30 years, an economy growing at 3 per cent [page 29] is 150 per cent wealthier than one growing at 2 per cent. This huge difference is due to compounding.11 Taxes obviously influence behaviour; thus, some economists think that taxation could be used to encourage certain types of behaviour that generate

economic growth. For example, taxing a particular activity or good will discourage that activity or the purchase of that good; conversely, a tax exemption will encourage certain behaviour. That begs the questions, what are the contributors to economic growth and what are the effects of taxation policy? Also, a related issue is how well economists can measure or predict the effects of tax changes on economic growth. There are many economic theories,12 although the market approach clearly takes precedence in the modern taxation debate. Under the market view, economists prefer a neutral tax system because such a system does not favour nor discourage similarly placed activities or classes of taxpayer (as described by A Smith in An Inquiry into the Nature and Causes of the Wealth of Nations), so as not to distort the market forces for consumption, production, trading, investment and financing.13 Under a neutral income tax system, all types of income (economic income)14 would be equally subject to income tax. As Broke aptly stated:15 Politicians and the public still believe that fiscal change can achieve social purposes. That tax breaks work. That accelerated depreciation encourages investment which no doubt explains our non-existent shipping industry. That the tax system is a good way of keeping our film industry going. As a general proposition, it doesn’t hold water and it needs to be punctured as often and as brutally as possible.

Practice Problem 1 Which tax base provides greater economic efficiency: 1 one solely based on taxing all types of income (a comprehensive income tax); or 2 one based solely on consumption; or 3 Australia’s current mix of taxes?

Who pays? Impact on equity 2.7 From a justice perspective, tax laws that are fairer and more equitable will be preferred, although there are a number of views as to what constitutes

fairness and justice. There are many concepts of justice, such as utilitarianism (John S Mill), social or distributive justice (Rawls), [page 30] justice and rights (Robert Nozick), justice and equality (Kai Niuelsen, Ronald Dworkin), mixed theories of justice (David Miller), Marxism and communitarianism. However, it is generally accepted in the modern tax debate that equity should be considered in terms of horizontal and vertical equity. Horizontal equity 2.8 A generally accepted and fundamental principle of social justice demands equal treatment for people in similar circumstances.16 In a tax sense, this requires the determination of a tax base to measure similar circumstances so that an appropriate amount of tax is imposed on a taxpayer. Accordingly, most commentators have defined the tax base by a taxpayer’s ‘ability to pay’.17 Thus, the classic definition of horizontal equity requires that those with an equal ability to pay bear equal burdens of tax.18 Ability to pay could be based on income or wealth, or a combination thereof. However, to ensure equity, the tax base should be defined as comprehensively as possible so as to include both income and wealth. Thus, the Haig-Simons formulation of economic income has become a widely accepted19 means of defining ability to pay, as this approach includes both income and wealth gains. For example, Eric and Sally both earn $40,000 and both pay $10,000 income tax; thus, horizontal equity is satisfied. Vertical equity 2.9 Horizontal equity concerns only the equal treatment of equals, so, as a corollary, vertical equity is required to ensure that the tax imposed on people in different circumstances is also fair. While there are different notions of what constitutes vertical equity, it is clearly not fair that a person with a lower ability to pay should pay more tax than a person with a greater ability to pay.

Indeed, most countries have progressive rates of income tax20 to try to ensure that a person with a greater ability to pay not only pays more tax but also pays at a higher income tax rate. For example, Eric earns $40,000 and pays $10,000 income tax (at a 25 per cent tax rate) and Sally earns $100,000 and pays $30,000 income tax (at a 30 per cent tax rate); thus, vertical equity is satisfied. Politicians have great problems in selling tax reforms that are very regressive (ie, they create more losers than winners). For example, the 2014 proposal to increase fuel excise brought this rationale from the Treasurer: ‘Well, change to the fuel excise does exactly that, the poorest people either don’t have cars or actually don’t drive very far in many cases. But, they are opposing what is meant to be, according to the Treasury, a progressive tax.’21 Fuel excises are very regressive, and this incident illustrates the need for an independent body to take over tax reform. [page 31]

Practice Problem 2 Do the following persons satisfy horizontal equity and vertical equity? 1 A and B both earn $50,000 and both pay $15,000 income tax. 2 A earns $50,000 and pays $10,000 income tax, and B earns $100,000 and pays $10,000 income tax. 3 A earns $50,000 and pays $10,000 income tax, and B earns $100,000 and pays $30,000 income tax.

Practice Problem 3 Are the principles of horizontal and vertical equity breached, given the

amounts of income tax paid by A, B and C? TAXABLE INCOME

INCOME TAX

TAX RATE

A

$10,000

$1000

10%

B

$50,000

$10,000

20%

C

$100,000

$10,000

10%

Practice Problem 4 What are the equity implications for: 1 exemptions provided for capital gains on a main residence; 2 100 per cent superannuation deductions; and 3 imposing GST on food? Measuring equity 2.10 The Gini coefficient is one of the most common ways of measuring income inequality. A country with a Gini coefficient of 0 has complete equality in incomes, while a country with a Gini coefficient of 1 has complete inequality. In Australia, the Gini coefficient in disposable household income was in 1980 was 0.2., in 1995 0.309 and up to 0.334 in 2010!22 In 2011, the OECD found that the average income of the top 10 per cent of Australians was nearly 10 times higher than that of the bottom 10 per cent, more unequal than the OECD average.23 [page 32]

Who pays? Impact on simplicity 2.11

Has taxation law ever achieved simplicity? In 1853, the UK

Chancellor of the Exchequer Gladstone said:24 … the Honourable Gentleman said that laws of this kind ought to be made intelligible to all persons who has [sic] not received a legal education. To bring the construction of these laws within the reach of such persons, was no doubt extremely desirable, but very far from being easy … The nature of property in this country, and its very complicated forms, rendered it almost impossible to deal with it for the purpose of the income tax in a very simple manner.

The Chief Justice of the High Court of Australia, French CJ, asserted: ‘The area of taxation law is a wonderful laboratory for excursions in purposeless interpretation.’25 Simplicity and tax seem to be two different matters. Commentators26 have noted that simplicity cannot be easily defined. Cooper27 found that simplicity has elements of predictability, proportionality, consistency, compliance, administration, coordination and expression. Tran-Nam28 defined simplicity in terms of the degree of difficulty of establishing the amount of tax liability and collecting and enforcing tax. Simplicity can also be measured in a number of ways, for example:29 the writing style of the tax legislation; the degree of difficulty of the content of the tax legislation; by the behaviour of taxpayers and tax administrators of the tax law; and the costs of operating the tax. The first three methods of measurement are very difficult to quantify. For example, a tax law may be written simply, such as the definition of ordinary income in ITAA 1997 s 6-5(1),30 yet defining ordinary income is a highly complex task, as seen by the hundreds of court cases involving ordinary income (see Chapter 6). Similarly, simple content in the legislation can give a misleading impression of its simplicity. Also, a complex piece of legislation that replaces myriad judicial principles may be simpler than the judicial principles. Additionally, behaviour is undoubtedly an important aspect to be taken into account in designing a tax law. Whether taxpayers comply with a law is an indicator of whether it is understood, but, again, this is difficult to measure. The same applies to measuring the responses of tax administrators. Of course, the proliferation of tax exemptions and concessions in the income tax laws has added considerable volume and complexity to the law. For example, have a look at the following concessions:

[page 33]

Read Income tax concessions Small Business Entities ITAA 1997 s 328-125 GST food exemption GSTA 1999 s 38-3 The most rigorous and generally accepted measure of simplicity seeks to identify the operating costs of a tax law. Operating costs consist of compliance costs of taxpayers and the administration costs of the Government. Simplicity can, theoretically at least, be measured by estimating these operating costs and dividing this amount over the amount of tax revenue. It follows that simplicity will improve where the operating costs of this ratio falls. Compliance costs can be defined as the costs ‘incurred by taxpayers, or third parties, such as businesses, in meeting the requirements laid upon them in complying with a given structure and level of tax’.31 Taxes, though, can provide a number of benefits to taxpayers that may offset these costs. First, compiling accounts for tax purposes can provide useful information to management for the conduct of business. Second, the compliance costs are tax-deductible expenses. Third, various tax concessions offer the temporary or permanent deferral of tax. Compliance costs = costs of taxpayers complying with tax laws — managerial benefits to taxpayers — tax deductibility benefits — cashflow savings of tax preferences Taxation administration can be categorised into four types of government activities:32 1. tax policy, design and planning; 2. tax law drafting and enactment; 3. ATO; and 4. tax dispute resolution. Administration costs can thus be represented by the following equation:

Administration costs = tax policy, design and planning costs + tax law drafting and enactment + Australian Taxation Office costs + tax dispute resolution With its 125 different and ever changing taxes, Australia has one of the most complex tax systems in the world. Whilst the ATO has invested heavily in computers, software and use of the internet, the change process has been problematic.33 There is a trade-off between [page 34] voluminous complex law and modern computerisation. Fewer and broader taxes would greatly improve simplicity and facilitate workable technology.

Practice Problem 5 1 2

Do the exemptions in the GST help simplify this tax? Do the exemptions in the income tax help simplify this tax?

The great debate: ‘tax expenditures analysis’ v ‘optimal tax theory’ 2.12 There are two schools of thought. A tax expenditure analysis focuses on the merits of a comprehensive income tax and the costs of any departures from it, while optimal tax theory justifies distortions from a comprehensive income tax. The recent Australian tax inquiry the Henry Review34 and past

inquiries (the Asprey Report,35 the Draft White Paper36 and the Ralph Report),37 as well as the recent United Kingdom Mirrlees Review,38 have generally aspired towards a comprehensive tax, and thus appear in some ways to favour a tax expenditure analysis. However, such tax inquiries often employ optimal tax theory to justify departures from a comprehensive tax.

Tax expenditures analysis 2.13 Income tax exemptions or concessions39 are also known as tax expenditures. A tax expenditure budget recognises departures from economic income and asserts that such incentives through the tax system are the same as a direct grant program.40 In other words, the effectiveness [page 35] of a tax expenditure can be gauged by comparing its costs with its benefits. Surrey41 considered that ‘without a tax expenditure budget there could be no real understanding of spending and who is advantaged’. Tax expenditures, though, appear to be costly when seen in the light of a tax based on economic income.

Costs 2.14 Calculating the revenue cost of a tax expenditure first requires the definition of an income tax base. The cost of the tax preference can then be estimated by its departure from that base. For example, using a Haig-Simons definition of income that includes accrued capital gains, it is apparent that the cost of exempting capital gains from tax runs into many billions of dollars.42

Benefits 2.15 The benefits of a tax preference, or tax expenditure, can be analysed with regard to its impact on economic efficiency, equity and simplicity. For

example, it is commonly argued that a tax preference encourages economic growth, since it increases savings and investment, risk-taking, entrepreneurial activity, new ventures, equity financing and foreign investment, and improves international competitiveness. Although optimal tax theorists argue that the economic gains from certain tax preferences are significant, other literature shows that these benefits are questionable and/or small and are offset by serious costs as follows. First, it means significantly higher levels of other taxes, given the massive revenue leakage. Second, this provides serious inequities, as the benefits are available only to taxpayers, not to the poor, loss-making businesses or tax-exempt bodies. Third, such preferences have an upside-down effect, providing a greater benefit to those in higher income tax brackets. Given that the wealthy own the vast majority of the nation’s assets, there appears to be no justification for providing such an enormous outlay to such a small percentage of the population that is in the least need. Fourth, preferences impose unfair administrative burdens on the tax office and add to complexity. Fifth, this tax expenditure is open-ended; it cannot be controlled by a government and concealed from the public and not costed. Finally, it distorts the market allocation of resources, and its overall effect is to damage the integrity of the tax system. It is apparent that the costs outweigh the benefits in many, if not all, tax expenditures. Tax preferences appear to be a blunt instrument in achieving economic goals, and they impose serious inequities and costs. [page 36]

Optimal tax theory 2.16 An optimal tax is ‘the one that maximises social welfare, in which the choice between equity and efficiency best reflects society’s attitudes toward these competing goals’.43 Optimal tax theorists will trade off equity, simplicity and fiscal adequacy for economic efficiency (eg, the proposed savings income tax exemptions in the Henry Review or the Mirrlees Review).

Unfortunately, the implementation of modern tax reform appears to be undertaken without sufficient quantification or detailed analysis of the impacts on economic efficiency, equity or simplicity. This, of course, creates many problems, as evident in the Review of Business Taxation’s CGT discount,44 the former simplified tax system45 and the non-commercial loss reforms.46 Without quantification of tax policy impacts, dubious claims are made about [page 37] tax reforms. The Review of Business Taxation47 underplayed the massive inequity and tax revenue losses created by the CGT discount. The extra complexity resulting from the former simplified tax system was portrayed by the Review of Business Taxation48 as ‘simplification’. The Review of Business Taxation49 asserted that the non-commercial loss reforms would affect only hobby businesses, yet they have also had a harsh impact on genuine micro businesses. In recent tax reviews (the Henry and Mirrlees Reviews), optimal tax theorists have a major influence by introducing distortions to the comprehensive tax base (eg, income tax concessions for savings) trading off equity, simplicity and fiscal adequacy for hoped gains to economic efficiency Tax reviews can be very divided about the application of optimal tax theory. For example, the UK Mirrlees Review used optimal tax theory to propose that effective income tax rates be adjusted to reflect evidence on behavioural responses.50 Mothers of school age children and people near retirement are very responsive to work incentives, so lower income tax rates were warranted for these people.51 The Mirrlees Review estimated that these changes would result in a large increase in employment.52 While the Australian Henry Review found that ‘effective tax rates can be high for some people, including for those likely to reduce their level of work as a result’53 (implying agreement with optimal tax theory), it made no recommendations to adjust effective tax rates to reflect evidence on behavioural responses. In New Zealand, the Buckle Review also made no such recommendations, and asserted that a broad income tax base with lower income tax rates would limit such behavioural impacts54 (favouring a tax expenditures approach).

Optimal tax theory appears more politically popular than a tax expenditures analysis, since it supports the use of tax concessions and thus enables politicians to justify concessions targeted to specific voter groups. The central difficulty with optimal tax theory is the limitations of economic modelling to substantiate the mooted gains. Assumptions used in the modelling do not reflect the real world. For example, optimal tax theorists recognise the limits of modelling in respect of labour supply and concessional taxes and the issue of taxable and total income elasticities.55 [page 38] Perhaps the key difficulty that prevents a structural economic modelling of these important dimensions is that we do not observe effort. If we cannot measure effort, we cannot measure the price of effort (termed the effective wage rate). As this is likely to differ across the various skill groups of workers, the unobservability of effort and its effective wage rate can become a very important confounding factor when measuring incentives. This does pose a challenge for policy analysis and evaluation. The losses to equity, simplicity and fiscal adequacy from departures from comprehensive income are all too real and clear (as tax expenditure analysis points out).

Who doesn’t pay tax — the free riders 2.17 There are two sets of free riders in the tax system. First, there are free riders who enjoy government approved tax exemptions. Second, others are involved in tax evasion in the cash economy and fraudulent tax schemes. The first category of free riders is considered first. Comparing Australia’s current tax system with a sensible tax system allows a comparison to be made between the taxpayers and those who don’t pay tax. Drawing upon the key tax policy criteria, the available research, past Australian income tax inquiries (the Asprey Report,56 the Draft White Paper57

and the Ralph Report)58 and the findings of the recent United Kingdom Mirrlees Review59 and Australia’s Henry Review,60 the general outline of a sensible tax structure and competing arguments become apparent. Such a sensible tax system allows the Government to raise revenue and redistribute in the most efficient, fair and simple way. It is necessary to spread the revenue base over a number of taxes, because the higher the tax rate on a particular tax, the higher the incentive to get around the tax rules. Also, there are limited ways you can redistribute if there is only one tax (eg, only a GST), so income and wealth taxes are needed. However, having 125 different government taxes produces excessive complexity and costs to the community. It is apparent from the above reviews that a sensible tax structure consists of far fewer and broader taxes that need to work in harmony together (as well as integrate with the social security benefit). Given the lack of economic evidence to support optimal tax theory, it is submitted that a sensible tax structure should be generally aligned with comprehensive tax bases and the following package of seven taxes. [page 39]

1.

A broad progressive income tax

2.18 There are a plethora of complex tax concessions in the current progressive income tax system that allow excessive tax minimisation and tax avoidance and appear to encourage tax evasion. This is unfair; paying tax should not be optional. Also, this favours certain types of economic activity, and this is inefficient. Such concessions undermine fiscal adequacy. As Justice Richard Edmonds noted, the trade-off for Australia’s high tax-free threshold and the steep increase in rates after the tax-free threshold is that Australia’s effective marginal tax rates are comparatively high vis-à-vis other countries with similar tax systems.61 The judge considers that the calls for broadening the base of the GST without base broadening of the income tax and reduction of its high marginal tax rates ‘is not only politically flawed and unlikely to

succeed, but is inconsistent with the generally accepted criteria or design principles which should drive the structure of the tax system’. A broad-based income tax is preferred. Such a tax system treats similar economic activities in similar ways for tax purposes, is simpler and helps to minimise economic distortions. All expenses incurred in producing the income would be deductible. Taxable income from all sources would be taxed according to the same tax rate structure. A fair tax system should also feature a progressive tax rate structure. Progressivity carries out a vital redistribution role but also involves a loss of efficiency, as the behaviour of both poor and rich is affected. It is important to design a progressive tax rate structure to minimise the loss of efficiency A single rate of company income tax should be employed. There should be equal treatment of income derived from employment and self-employment and from operating a small company. However, there is an international shift away from dividend imputation,62 with Australia and New Zealand being the only two OECD economies using imputation. As the Australian economy has become more open, the benefits of dividend imputation have declined. Consequently, alternatives to dividend imputation should be considered. Exceptions 2.19

There are only a few exceptions from a broad income tax base.63

Superannuation concessions 2.20 People tend not to save adequately for their retirement, and the population is ageing. Thus, it is important to offer limited encouragement for individuals to provide for their retirement so as to prevent reliance on expensive government age pensions.64 [page 40]

2.

A broad single rate GST

2.21 The current GST system of GST-free rates, input taxes supplies and exemptions to large amounts of consumption promotes complexity, distorts consumption decisions and unfairly impacts on consumers with different patterns of consumption. Exemptions prevent businesses from claiming GST paid on their inputs; this distorts production decisions. As the Henry Review notes: ‘the GST is an efficient tax relative to most other taxes levied in Australia, it is less efficient than it could be because of its failure to tax consumption on a truly comprehensive basis’.65 A value-added tax (GST) should be applied to all final consumption expenditure by households. Expenditure on business inputs, though, should be untaxed, with businesses able to be refunded GST charged on their inputs. This involves a single GST rate with minimal exemptions (a GST on financial services is unpractical). However, an economically equivalent tax to the GST should be applied to financial services.66 Removing the exemptions on basic necessities of life would greatly increase tax revenue but be very regressive on low income earners. This impact must be offset by a combination of income tax cuts and permanent increases in means-tested social security benefits that are indexed for inflation to ensure a revenue-neutral outcome.

3. Additional taxes on illegal drugs, tobacco, carbon and gambling 2.22 Additional taxes are economically justifiable on certain harmful activities such as illegal drugs, tobacco and junk food consumption, and gambling and activities that damage the environment. The regressive impact of such taxes must be recognised through adjustments to the means-tested social security benefits that are adjusted for inflation and income tax rates. Gambling taxes should recoup the economic rent generated by government restrictions on the supply of gambling services or be used efficiently to impose such restrictions.67

4.

Land tax

2.23 There are great efficiency benefits of a broad land tax, and thus such a tax should replace all existing stamp duties and other transactional taxes on land and buildings.68 To aid equity, an increasing marginal rate schedule should be applied according to the per-square-metre value. [page 41] The Henry Review found:69 Stamp duties on conveyances are inconsistent with the needs of a modern tax system. While a significant source of State tax revenue, they are volatile and highly inefficient and should be replaced with a more efficient means of raising revenue. Conveyance stamp duty is highly inefficient and inequitable. It discourages transactions of commercial and residential property and, through this, its allocation to its most valuable use. Conveyance stamp duty can also discourage people from changing their place of residence as their personal circumstances change or discourage people from making lifestyle changes that involve a change in residence. It is also inequitable, as people who need to move more frequently bear more tax, irrespective of their income or wealth.

5.

Transfer of wealth tax

2.24 Taxing the transfer of wealth from one generation to the next has the potential to lessen the inequality of life chances between children, due to the accident of their birth. Efficiency and equity are enhanced through a tax on such transfers.70 Thus, all assets transferred on death or during the donor’s lifetime should be subject to tax.

6.

Uniform resource rent tax

2.25 The resource taxes on royalties distort investment and production decisions, and this reduces the community’s return from its abundant resources.71 Additionally, they do not collect an adequate return for the community, because they are unresponsive to changes in profits. Such taxes collected a declining share of the return to resources over the recent period of increasing profitability in the resource sector.

The Henry Review recommended a uniform resource rent tax that should be applied on taxable profit associated with a resource project equal to net income less an allowance for undeducted expenses or unused losses.72 The allowance rate would be set by the long-term government bond rate, as the Government would share in the risks of projects by providing a loss refund if the tax value of expenditure is otherwise unable to be used.73

7.

Road congestion tax

2.26 The heavily congested parts of the road network impose high costs on the community.74 As the Henry Review recommended, transparent congestion charges should [page 42] apply to all registered vehicles using congested roads.75 The regressive impact of such taxes must be recognised through adjustments to the means-tested social security benefits that are adjusted for inflation and income tax rates.

Setting tax rates 2.27 The current income tax rate structure appears to reduce employment and earnings more than necessary. Political judgment that has regard to fiscal adequacy needs and economic research is needed in determining the appropriate tax rates for the above taxes and the degrees of income tax, wealth tax and land tax progressivity.

Interaction with the social security benefit 2.28 This package of seven taxes is recommended, as diversified funding sources are needed to ensure fiscal adequacy. A progressive income tax and social security benefit are required for effective redistribution. A single social security benefit should be provided to those with a low income and/or who have high needs.

It is not always possible (ie, it is impractical) to apply income taxes or GST comprehensively, so some exceptions will occur. These require other taxes to act as a proxy for the exemption (ie, for GST exemption, a proxy tax on financial transactions is warranted). Where governments are unwilling to guarantee indexed compensation to low income or special needs people, the retention of exemptions for indirect taxes on the basic necessities of life is warranted. Tax policy case study: The Australian wine industry 2.29 The Australian wine industry makes a significant contribution to the economy: it is a regional business and drives regional communities and it is a significant tourism industry. However, the wine equalisation tax (wine tax) and its accompanying rebate are outdated and distorting this industry. The tax is encouraging the production of cheap wines and oversupply at a time when the industry is struggling to compete internationally. While Australian wine drinkers might not care too much about drinking non-premium wine, this comes at the expense of Australia’s reputation as a premium wine producer to overseas markets. The wine tax, an indirect tax on wine, was originally established in 1930 as a wholesales tax, at a rate of 2.5 per cent. over time it was repealed and then reintroduced, steadily increasing to 41 per cent by 1997. With the advent of the 10 per cent GST in 2000, the wine tax was reduced to 29 per cent (and renamed as the Wine Equalisation Tax) so as not to alter the overall tax burden. Australian producers (and New Zealanders) can claim an annual rebate off the wine tax of A$500,000. [page 43] From the 1980s to 2007, the Australian wine industry experienced

explosive growth on the back of a low Australian dollar, exports, innovation and differentiation. This came at the expense of ‘old-world’ wine countries (such as France and Italy). However, since 2007 the growth changed to a contraction. Domestic wine sales have remained flat and exports declined by 38 per cent between 2007–12.76 In the wake of the oversupply of grapes and low profitability, the high wine tax has stymied the industry’s ability to compete internationally. It differs to the policies of old-world wine countries and emerging competitors who impose zero or low amounts of wine tax. This decline coincides with a higher exchange rate, emerging new competitors from New Zealand, Chile, Argentina and South Africa, and a more competitive old-world wine industry. Wine drinkers in traditional and new wine-consuming countries, such as the United Kingdom, United States and China, tend to prefer premium wines. As a result, these wines have a considerable market share. However, the wine tax punishes premium winemakers and favours voluminous cheap wine, as the Treasury’s 2015 Tax White Paper reform process noted.77 The Australian wine tax has different impacts on consumers and producers, and this creates different distortions. It raises consumption and tax revenue but incentivises winemakers to reduce prices, downgrade product quality, reduce advertising and marketing costs. The cost of complying with the tax dissuades winemakers from investing in the quality of their wine and encourages winemakers to lower the cost of their wines due to competition. The annual rebate of A$500,000 that goes with the wine tax also helps inefficient producers stay afloat and is subject to widespread rorting. A Senate committee found this damages the profitability of the industry overall because of distortions it creates and the widespread rorting. It also provides a competitive advantage to the New Zealand wine industry that increasingly accesses the rebate. New Zealand wine producers are not subject to the same tax compliance checks as

Australian businesses, as they do not lodge an Australian income tax return or business activity statement (BAS), but are still able to claim the rebate. The amount NZ wine producers are claiming has grown quickly from A$5 million in 2006–07 to A$25 million 2013–14.78 The health sector frequently calls for higher taxes on alcohol given the external costs of alcohol to hospitals and health services for alcohol abuse and other government expenditures such as police. However, the wine tax is not effective in targeting those who abuse alcohol. The vast majority of wine drinkers drink in moderation. Also, the external costs associated with wine consumption appear to be significantly lower than other forms of alcohol. While governments have previously cited revenue-raising as the rationale for significant increases in the wine tax, only comparatively small amounts of revenue are raised by wine taxation (0.2 per cent of total tax revenue).79 Wine should be taxed using a broadly based tax, such as a comprehensive GST set at a uniform rate. This is a fairer tax for the wine industry and aligns with the tax policies of competitor countries. This is less distortionary, far simpler, and provides a more continual revenue source for governments.

[page 44]

Estimating the revenue costs of tax-free riders 2.30 In the absence of any known estimates of the tax revenue shortfall as a result of the exemptions and concessions in the current tax system compared to a sensible tax system, the following estimate is made. First, the Commonwealth acknowledges some of the tax exemptions in its annual tax expenditures as follows:80 COMMONWEALTH TAX EXPENDITURES 2014–15

$ BILLION

Taxing all capital gains of residents Concession of non superannuation termination benefits Capping the superannuation concession to $5 billion

61 2 25

Research and development tax offset

1

Capital works deductions

1

Family tax benefit exemptions

2.3

Child care assistance

1.4

Interest withholding tax exemption

1.7

Broaden GST to include food, education, health, financial supplies, child care and water Total

21.4 116.8

As set out above, the Commonwealth finds that this broader definition of income tax and GST could raise an additional $117 billion. A sensible tax system, however, would further extend the tax base to include other free riders as follows: ADDITIONAL REVENUE FROM A BROADER SENSIBLE TAX SYSTEM 2014–15

$ BILLION

Income and wealth taxes Estimated capital gains tax on realisations on a total of $3 billion of foreign investment in Australia81

14

Capping negative gearing at $10,00082

1.5

Broader company tax on multinationals83

6

[page 45]

ADDITIONAL REVENUE FROM A BROADER SENSIBLE TAX SYSTEM 2014–15 Wealth tax at 2.5 per cent of tax base84

$ BILLION 11

Tax on externalities GST of 30 per cent on sugary drinks and fast food85 Carbon tax set at former 2014 tax rate of $24.15 per tonne of carbon86 Road transport congestion tax

4 12 2

Doubling gambling taxes87

7.6

100 per cent GST on illegal drugs88

17

Taxes on use of community resources Alberta Canada style royalty scheme on oil and gas89

11

Resource super profits tax on minerals90

9

Bank liability taxes91

2

Total

97.1

Including the Government’s stated tax expenditures of $117 billion, it is estimated that taxing free riders in 2014-15 could have raised an estimated $214 billion in 2014-15, or about 50 per cent of the total revenue raised by all Australian, state and territory governments. This begs the question, who gains and loses in the current tax system? Winners 2.31 Wealthy and high income taxpayers gain most benefit from the tax advantaged status accruing from CGT exemptions, excessive superannuation – retirement concessions, use of negative gearing, capital allowance write-offs, land tax exemptions, and the absence of wealth [page 46] taxes.92 These taxpayers include the influential 1 per cent of Australian residents who own as much wealth as the bottom 70 per cent. Unusually, foreign residents all benefit from the lack of taxation on their Australian based

assets and operations, which also provides them with a competitive advantage. Foreign multinationals in particular gain from the limited taxation on their Australian based operations. Also, businesses that involve negative externalities such as gambling, fast food and sugary drinks, road transport, illegal drugs and carbon tax producing industries, all benefit under the current tax system. The health sector, public transport, and the criminal justice system also appear to gain from the medical, transportation and criminal problems associated with this lack of taxation. Additionally, the deficiency in mining taxes means that miners are major beneficiaries from the limited taxation on the community’s natural resources.93 Banks also enjoy free or low costs community guarantees (although the 2017 budget provided a bank tax). The excessive levels of tax complexity produced by the 125 Commonwealth, state and local taxes assists employment in the accounting and law professions, the courts and the ATO. Losers 2.32 The large impact of the tax free riders means that that low and middle income earners are subject to relatively high personal income tax rates, with a 39 per cent income tax rate (including Medicare levy) cutting in at the level of average salaries. Low and middle income earners are also unable to gain much benefit from the tax concessions that are skewed towards wealth holders and successful businesses. The rising inequality makes it harder to increase tax and redistribute income. In the past, on average, inequality has reduced the amount of income tax governments can collect as a share of GDP.94 The deficiencies in taxes on externalities means that the community suffers higher rates of: gambling and illegal drug addictions; obesity from fast food and sugary drinks;95 pollution; risk of climate change and road congestion. Businesses other than those engaged in mining or banking in Australia are at a disadvantage given the absence of such government assistance. Internationally, relatively low tax revenues (as produced by our current tax system) is associated with a rising inequality,96 worse health, more obesity, more violent crime, more political instability and more institutional corruption.97

In Australia, it is seen in our social fabric. Aboriginals, women, children, the aged and the disabled are the worst affected. There is great gender inequality (with a high average 18 per cent [page 47] gender pay difference)98 and 36 per cent more women report high levels of psychological distress than men.99 Children face a higher mortality rate than in many other OECD countries100 and 731,300 or 17.4 per cent of children are living in poverty.101 Low income workers are priced out of affordable housing.102 Public social protection expenditure for older persons at 5 per cent of GDP constitutes half of the support provided in Sweden.103 There is a lack of protection for the disabled, with 45 per cent of people with disabilities living in poverty or near poverty (and women are less likely to be in the workforce, with a participation rate of 49 per cent).104 Australian workers not only face a very high marginal income tax; they work an average of 1695 hours, much higher than Sweden.105 The low level of tax collections is also symptomatic with: relatively high murder rates (1.7 per 100,000 persons),106 relatively high infant mortality (24th worst in OECD),107 average rating in the corruptions perceptions index (13th worst in OECD),108 low confidence in political parties109 (only 31 per cent of respondents expressed quite a lot of confidence),110 and relatively low foreign aid contributions.111 Small business in particular suffer from high levels of tax complexity. Additionally, deficiencies in the taxation of externalities are evident in the way we lead the world in both gambling112 and recreational drug use.113 We also have very high levels of obesity, [page 48] with almost one in three being obese (25th worst in world)114 and have failed to tax carbon and road congestion. This all imposes very high community

costs that run into many billions of dollars, but both these costs and the significant tax expenditures in exempting these activities, all appear to be ignored in the budget. There is no need for such a wealthy country to have such poor social indicators across the board. At the heart of the problem is an opaque system of tax design, low levels of tax, excessive complexity, as well as a lack of transparency about the true level of tax expenditures and the identification of free riders. Governments need to establish a sensible tax system as set out in recent tax reviews noted above. As in some other countries, the Commonwealth should also publish all taxable incomes and list all political donations. Women, children, the aged, the disabled, Aboriginals and salary and wage earners deserve better.

Summary 2.33 Whether you agree with the tax expenditures analysis or the optimal tax theorists, the current tax system is a long way from a sensible tax structure. The ATO’s computer systems struggle to cope with the many and ever changing taxes.115 Too often our tax laws are an outcome of political processes, special interest groups and lobbyists rather than being policy driven. As the Oxford University Centre for Business Taxation found (in a survey of 10 countries, including Australia, New Zealand, the United Kingdom, Germany, France, Ireland and the United States), the importance of tax policy making is undervalued and largely under-resourced. As seen by recent former Prime Ministers’ problematic leadership in implementing major tax reforms (Kevin Rudd — mining tax, and Julia Gillard — carbon tax) and the current Government’s comments on tax reform, implementing reform is politically difficult.116 An independent body is needed to design, implement and maintain Australia’s tax laws.117

Tax evasion

2.34 Tax evasion happens in the black economy, where people operate entirely outside the tax and regulatory system or are known to the authorities but do not correctly report their tax obligations. The Australian Bureau of Statistics (ABS) estimated in 2012 that the [page 49] black economy had grown to 1.5 per cent of GDP ($25 billion per year in today’s dollars) in Australia. The Board of Taxation has established a Black Economy Taskforce to develop an innovative, forward-looking whole-of-government policy response to combat the black economy in Australia, recognising that these issues cannot be tackled by traditional tax enforcement measures alone.118 The Taskforce is chaired by Mr Michael Andrew AO. The Taskforce notes the black economy ‘could be growing, entailing higher costs for the community. Low wages growth, pressure on business margins, regulatory burdens, and the expanding (and unevenly regulated) sharing economy are likely to strengthen incentives for black economy participation.’119 The Taskforce makes the following key initial recommendations:120 1. Access to Australian Government procurement opportunities should be limited to firms which have a good tax record and do not engage in bribery or corruption. By taking a lead on this, the Government will send a clear signal to private sector supply chain managers. Responsible supply chain management must become the new norm and should be consistent with parallel initiatives across different levels of government. 2. The Taskforce should consult on the idea of providing tax and other incentives for small businesses who adopt a non-cash business model. A proposal will be developed in time for consideration by the Government for MYEFO later this year. 3. The Taxable Payment Reporting System (TPRS), which currently only applies to the building and construction industry, should be expanded to the cleaning and courier sectors. The Taskforce will consider whether the TPRS should be applied more broadly in its Final Report.

4.

5. 6.

7.

Businesses should not be able to claim deductions on cash wage payments where they did not make or report Pay As You Go (PAYG) payments, issue payment summaries or statements of earnings, or make applicable superannuation contributions. Similarly, businesses should not be able to claim deductions for payments to contractors where a valid Australian Business Number (ABN) is not quoted and the payer has not withheld part of the payment under the ‘no-ABN withholding’ requirements. These payments should not be included in cost bases for capital gains tax or depreciation purposes. The Taskforce will consult on this proposal before finalising its position. A ban on sales suppression technology. This technology allows businesses to hide cash takings to avoid paying income tax. Australia needs a robust, real-time business identification and verification system in order to reduce red tape, generate valuable data for government and businesses (eg, simple verification of their counterparts) and improve delivery of relevant services. The Taskforce will work with relevant agencies on ways to rationalise business registries and strengthen business registration and verification arrangements (eg, to address the misuse of ABNs). The Government should work cooperatively with state, territory and local governments, given their common interest in countering the black economy. [page 50]

8.

9.

The Government should consult with the states and territories on the idea of including tax literacy modules in vocational education training (VET), small business courses and in new migrant communities. The Taskforce will work with the Department of Education and Training on this. The provision of funding to the Australian Taxation Office audit and compliance programs to better target black economy activities, including by strengthening its use of technology, and to buttress its ABN

monitoring and public education activities.

Ethics 2.35 ‘Ethical behaviour can be described as acting with integrity which in turn means telling the truth, avoiding shady and illicit dealings, refusing to take or give bribes … it means being true to oneself.’121 Tax preferences damage tax integrity, as they provide taxpayers and tax advisers with both the rationale and the opportunity for tax avoidance and tax evasion. Additionally, such preferences may affect tax administration, as administrators may be tempted to provide favourable interpretations of the law so as to satisfy the requirements of an income tax preference.122 Taxing comprehensive income limits tax avoidance and evasion activities that take advantage of income tax preferences.123 This prevents resources from being wasted on low-yielding investments and tax planning. Such tax avoidance means that income tax rates and other taxes must be higher.124 The net effect of tax avoidance has almost certainly been a shift from taxes on income to other forms of taxation, usually indirect taxes.125 Consequently, a comprehensive income tax appears to lead to both a reduced reliance on indirect taxes and reduced levels of tax avoidance.

Breaches of comprehensive income and ethics 2.36 Given the significant breaches of horizontal equity and vertical equity in the Australian tax system, one may surmise that this would impact heavily on the ethics of the players in the tax system. As Pederick observed:126 If the tax system and its administration are seen as to press heavily on some but lightly on other taxpayers in essentially the same circumstances, with essentially the same tax paying capability, then the confidence of the citizenry in the fairness and justness of the system, of their government, erodes. Cynicism grows apace and a race not to be left out of the tax minimisation

[page 51]

derby, by hook or by crook, infects the body politic. Since government in our societies truly is of the people, by the people and for the people, to escape collection of one’s share of the costs of our joint enterprises is to rifle the common treasury, to take from one’s neighbour. A society that breeds an attitude that one’s duty is wholly to one’s self and not to the community, not to one’s country, when it comes to taxes, is a society with a cancer at work. It is, moreover, a cancer that threatens the quality of life on a wider front and, indeed, perhaps the long term stability of the society it infects.

Feld and Frey127 similarly argue that taxpayers’ compliance is achieved where they perceive the political process as being fair and legitimate in terms of both horizontal and vertical equity. Indeed, there exists broad evidence of ethical deficiencies across the spectrum of players in the taxation system, as set out below.

Governments 2.37 A number of commentators have highlighted the difficulty of tax reform and the weaknesses of governments. In 1928, Adams asserted that:128 Modern taxation or tax making in its most characteristic aspect is a group contest in which powerful interests vigorously endeavor to rid themselves of present or proposed tax burdens. It is, first of all, a hard game in which he who trusts wholly to economics, reason, and justice, will in the end retire beaten and disillusioned. Class politics is the essence of taxation.

Stigler129 similarly found that, in the real world, income tends to be redistributed from those who have income and wealth to those who have political power. Hayek stated that:130 Corrupt and at the same time weak the governing majority must do what it can do to gratify the wishes of the groups from which it needs support, however harmful to the rest such measures may be it is wholly incapable of pursuing a consistent course of action, lurching like a steamroller driven by one who is drunk.

Certainly, the 1999 Review of Business Taxation and the Australian Federal Government made numerous departures from the comprehensive tax policy principles set out in the review’s first paper, A Strong Foundation. For example, the growth of tax preferences in the CGT rules, the small business income tax accounting concessions and the introduction of NCL exemptions for primary producers and professional artists all depart from the review’s core tax design principles. This shows the strong influence that certain groups such as corporates, investors, small business, primary producers and artists have on the Federal Government’s tax policy. Where a government favours particular

taxpayers over others, this negatively impacts on taxpayer attitudes and undermines the integrity of the tax system. [page 52]

Tax committee inquiries 2.38 While tax inquiries131 generally agree on the high ideals of a comprehensive income tax base and horizontal equity, these aspirations are usually not sought in their final recommendations or in subsequent tax reforms. All of the major recent reports into income taxation have placed great emphasis on comprehensive reform to achieve their equity and economic efficiency objectives. These reports generally found equity to be very important. The Draft White Paper132 considered equity to be crucial, while economic efficiency was necessary. As noted above, A Tax System Redesigned133 found that equity was a basic criterion for community acceptance of the tax system. The Asprey Report134 considered that simplicity was subordinate to equity. Yet numerous tax concessions that breach equity emanated from the 1999 review’s recommendations.

Tax professionals 2.39 Tax professionals play an important role in the Australian tax system, as 73 per cent of individuals and 94 per cent of companies choose to use tax agents.135 However, it is apparent that tax exemptions and tax minimisation strategies are eagerly exploited by certain tax professionals.136 While this could be due to interpretational problems, Ayres et al137 found that advisers adopt an aggressive stance in ambiguous tax deduction cases. Similarly, Porcano138 found that tax returns prepared with tax assistance (especially those prepared by CPAs and lawyers) had much higher levels of non-compliance than returns that were self-prepared. A review of recent ATO media releases provides a number of examples of tax professionals being unethical and committing fraud. For example, the NSW Supreme Court (Gzell J) awarded over $100,000 in damages against an

accountant for using client lists of a former employer to gain business.139 A Tamworth accountant was jailed for 2 years and 3 months for GST and income tax fraud totalling $114,248.140 An accountant created three business entities and registered them for GST. However, the businesses never traded, yet she lodged eight activity statements.141 She further claimed false tax deductions in her 2002 and [page 53] 2003 personal income tax returns.142 A former Victorian accountant was sentenced in the Melbourne County Court to 2 years in jail for GST fraud totalling $861,741.143 The recent Australian experience with mass-marketed tax schemes illustrates the lack of ethical conduct of certain tax professionals. The Australian Senate Economics Reference Committee144 investigation into the operation of the ATO found that mass-marketed schemes posed a major risk to revenue. The ATO disallowed deductions from these schemes worth $1.5 billion, claimed by 22,000 taxpayers.145 The inquiry noted estimates of tax avoidance by highwealth individuals of $800 million per annum.146 More recently, the ATO and other government agencies have been engaged in Project Wickenby.147 This is a multi-agency taskforce investigating internationally promoted tax arrangements allegedly involving significant tax avoidance or evasion and, in some cases, large-scale money laundering.148 As a consequence of such conduct, the Federal Government introduced harsh new penalties in Div 290 and Subdiv 298-B of the Taxation Administration Act 1953 (TAA 1953) to deter the promotion of tax exploitation schemes.149 Previously, there were no civil or administrative penalties for the promoters of these schemes.150 Such promoters were able to make substantial profits, while investors were at risk of penalties under the TAA 1953.151

Tax administrators

2.40 Under-resourced in an increasingly complex tax system, tax administrators come under intense pressure as taxpayers and tax planners seek to maximise tax preferences.152 This can lead to poor tax administration. Grbich153 found that tax planners use time-honoured legalistic games to exploit the language of rulings. Tax officers are mesmerised by the legalistic arguments and occasionally by superficial economic rhetoric.154 Further, tax preferences can lead to unethical behaviour.155 [page 54]

Taxpayers 2.41 The prevalence of tax preferences appears to have had a profound impact on taxpayers. Tanzi found that tax avoidance and evasion are likely to occur where evasion opportunities exist.156 A number of studies have found that the belief that the tax laws are unfair may encourage the acceptability of tax avoidance.157 Murphy surveyed 2040 taxpayers who entered into tax avoidance schemes (29 per cent responded) and found that the taxpayers perceived the tax system to be unfair to them compared with other taxpayers.158 Interestingly, in a survey posted out to 7743 individuals (with a 29 per cent response rate) and consisting of 500 tax-related questions, Taylor found that the most common complaint asserted that the tax system was inequitable.159 The ATO surveyed taxpayers’ attitudes to income tax.160 The ATO declined to release the results, claiming that it would not be in the public interest to do so, implying a very negative public attitude to income taxation. In contrast, Richardson surveyed 105 postgraduate business students at an Australian university on the impact of tax fairness perception on tax compliance behaviour.161 He found that tax fairness had varying effects on tax compliance behaviour.162 Relevantly, tax audit activity by the ATO in 2005–06 raised $3798 million of income tax, penalties and interest.163 Sometimes, the tax avoidance activities (such as the mass-marketed schemes)164 have been carried out on a massive scale. Mathews165 concluded that the essential problem is not making

the rich pay higher rates of tax, or even pay more tax, than the poor; it is making the rich pay any tax at all. [page 55]

History of Australian taxation 2.42 Australia’s infant taxes had simple requirements, administrative simplicity and invisibility; thus, Australia relied on customs and excise duties. This enabled minimal taxation of the wealthy, propertied classes. The impetus for direct taxation (income) arose not from equitable notions of distributive justice but from economic depression and low tax revenues. This was assisted by the rise of the labour movement, which demanded a reversal of regressive taxation and the decline in power of the landowners. South Australia introduced the first income tax; it had low tax revenues and the lack of a dominant rural opposition to such a tax. Queensland resisted the introduction of income tax until after federation, largely because of its dominant rural sector.166 The progressive income tax rates were designed to provide equity to an otherwise regressive indirect tax system, as well as to raise revenue. This trend, however, was weakened by a subsequent increased reliance on indirect taxation and by the structural deficiencies in the income tax base. Some of the more important Australian taxation events are outlined below.

Pre-World War II 2.43

The ATO website includes a brief history of Australian tax:

When Governor Phillip arrived in New South Wales in 1788, he had a Royal Instruction that gave the Governor power to impose taxation if the colony needed it. However, he did not impose any taxes during his term of office. The first taxes in Australia were raised to help pay for the completion of Sydney’s first gaol and provide for the orphans of the colony. Import duties were put on spirits, wine and beer and later on luxury goods. After 1824 the Government of New South Wales raised extra revenue from customs and excise duties. These were the most important sources of money for the colony’s

government throughout the nineteenth century. Taxes were raised on spirits, beer, tobacco, cigars and cigarettes. Colonial governments also raised money from fees on wills and from stamp duty, which is a tax imposed on certain kinds of documents. In 1880 the Colony of Tasmania imposed a tax on income received from the profits of public companies. Four years later, a general tax on income was introduced in South Australia and in 1895 income tax was introduced in New South Wales at the rate of six pence in the pound. By 1900 all colonies were collecting income tax. With Federation in 1901, the power to impose customs and excise duties was transferred to the new Commonwealth Government. The Commonwealth Government only kept one quarter of the money it raised, giving the rest to the States. The Commonwealth Government had the power to impose direct taxation, a power it did not use until 1910. In 1910 a land tax was introduced by the Commonwealth Government to provide for the defence of the nation and to prepare for a major increase in migration. At the outbreak of World War One land tax rates were increased to help pay for the war effort.

[page 56] Commonwealth income tax was introduced in 1915 in response to the massive increase in Commonwealth spending on the War. Different rates of tax applied to different incomes. During this period income tax was imposed by both the State and Commonwealth Governments. Entertainment tax was imposed in 1917, taxing the price of admission into a place of entertainment. This tax was also imposed from 1942 to 1953. By 1918 income tax amounted to one third of Commonwealth tax revenue and a half of state tax revenue. Sales tax was introduced in 1930 on certain goods which are produced or imported into Australia. At the request of the Australian Wool Growers Council, a wool tax was originally imposed in 1936 to raise money to help improve the production of wool and extend the use of wool throughout the world. In 1942, the Commonwealth Government arranged to collect all income tax on a uniform basis throughout Australia. Part of the arrangement was handing back some of the tax collected for the States to use. A pay-as-you-go (PAYG) system of income tax for salary and wage earners and a provisional tax system for income (other than salary and wages) were introduced in 1944.167

The 1960s 2.44 However, by the 1960s, the income tax base was in dire need of reform. The many exemptions (such as the absence of capital gains taxation, FBT and international tax measures) set the scene for an upturn in tax avoidance and the encouragement of tax evasion.

The era of tax avoidance: 1970s to early 1980s 2.45 The 1970s heralded an era of unprecedented tax avoidance resulting from a loophole-ridden income tax base and the High Court’s failure to strike down blatant tax avoidance schemes. Such was the extent of the rorting that the Government eventually introduced retrospective anti-avoidance legislation to strike down bottom of the harbour schemes, and rewrote the general antiavoidance provisions and other protective measures, fuelling the start of a prolific growth in the size of the ITAA.

Labor Government reforms: the 1980s–1990s 2.46 In the face of declining income tax collection, the Labor Government introduced the following reforms in an attempt to shore up the income tax base. The Prescribed Payments System (PPS) was introduced in 1983; this required tax payments to be deducted from taxpayers contracted to certain industries. This reform sought to attack the tax evasion that was rife in certain industries where contractors received undeclared cash income. CGT was the major tax reform undertaken by the Labor Government in the 1980s; it significantly shored up the income tax base by taxing many types of capital gains. Previously, only short-term capital gains were generally subject to income tax. CGT applied to all assets acquired after 19 September 1985, although many exemptions were retained. [page 57] Another major tax reform, the Fringe Benefits Tax Assessment Act 1986 (FBT), was introduced to stem the rorting of the income tax base from the payment of fringe benefits by employers to employees, resulting from the fact that these benefits were not previously subject to income tax. Note that FBT is imposed on employers rather than on employees on all non-cash fringe benefits provided (cash benefits would, of course, be subject to income tax).

The Medicare levy was also introduced in 1986 as a small measure to help defray the costs of running the national health system. The major administrative reform occurred in 1985–86 with the ATO’s move to self-assessment. This meant that the army of ATO personnel who formerly manually checked each and every income tax return were released into advising functions and field audit activity. The ATO has since relied on computer analysis of income tax return information to target its audit resources (ie, using variances from industry/occupation standards). Also, the international tax laws were revamped and strengthened. In 1991, controlled foreign companies legislation was introduced in order to tax Australian shareholders on their share of certain foreign income. In 1991, foreign investment fund measures were brought in to complement these other changes. Also, transferor trust measures were introduced in 1992 to apply accruals taxation to the income of certain non-resident trusts. In an attempt to improve the income tax laws, the Taxation Law Improvement Project was born. This involved the rewrite of the ITAA 1936 into the ITAA 1997. However, this project was fundamentally flawed, as it could not alter the content of the laws; it could only rewrite tax law. Thus, only a superficial improvement was gained in a better-worded, but still complex, Act. This project needs to continue, because having two income tax assessment Acts is not a very satisfactory outcome. By the mid-1990s, the ITAA had grown considerably in size, and the provision of tax advice had become a far more complex business.

Liberal Government reforms: 1990s–2007 2.47 Notwithstanding the reforms of the 1980s, the Liberal Government was concerned about the declining income tax base and a perceived overreliance on income taxation. In an ambitious reform agenda, the Government reduced the scope of the income taxation base, reduced income tax rates and broadened the consumption tax base by replacing sales tax with a goods and services tax (GST). The GST commenced on 1 July 2000 and is now the second-largest revenue earner, next to income tax. Also, significant changes were made to business and investment taxation with the Ralph business tax reforms, many of which were introduced from 1999 onwards.

Overall, this period witnessed a remarkable change in the Australian taxation system, with a massive surge in the volume of tax legislation. Consequently, tax law has become likened by tax practitioners to a supernova that threatens to collapse in on itself. This, of course, has generated considerable employment for accountants, lawyers, ATO staff and business activity statement preparers. These changes included: GST; consolidations regime; CGT discount; CGT small business concessions; [page 58] personal service income rules; company income tax rate reduced to 30 per cent; value-shifting rules; new trust loss rules; a simplified tax system for small business taxpayers (now small business entities); uniform capital allowance rules; a new PAYG withholding and instalment tax payments system; a new penalty and self-assessment regime; taxation of financial arrangements rules; new simplified superannuation measures; a choice of superannuation fund measures; the new Tax Practitioners Board; large reductions in individual tax rates and tax brackets; and the promoter penalty regime.

The Henry Review 2.48 In 2008, the Labor Government called for a review of the tax system, and consequently the Head of Treasury Ken Henry led the review (known as the Henry Review). 2.49 The Henry Review of taxation had an ambitious set of objectives and scope as follows:168 1.

The tax system serves an important role in funding the quality public services that benefit individual members of the community as well as the economy more broadly. Through its design it can have an important impact on the growth rate and allocation of resources in the economy.

2.

Raising revenue should be done so as to do least harm to economic efficiency, provide equity (horizontal, vertical and inter-generational), and minimise complexity for taxpayers and the community. The comprehensive review of Australia’s tax system will examine and make recommendations to create a tax structure that will position Australia to deal with the demographic, social, economic and environmental challenges of the 21st century and enhance Australia’s economic and social outcomes. The review will consider:

3.

3.1. The appropriate balance between taxation of the returns from work, investment and savings, consumption (excluding the GST) and the role to be played by environmental taxes; 3.2. Improvements to the tax and transfer payment system for individuals and working families, including those for retirees; 3.3. Enhancing the taxation of savings, assets and investments, including the role and structure of company taxation; 3.4. Enhancing the taxation arrangements on consumption (including excise taxes), property (including housing), and other forms of taxation collected primarily by the States;

[page 59] 3.5. Simplifying the tax system, including consideration of appropriate administrative arrangements across the Australian Federation; and

4.

3.6. The interrelationships between these systems as well as the proposed emissions trading system (ETS). The review should make coherent recommendations to enhance overall economic, social and environmental wellbeing, with a particular focus on ensuring there are appropriate incentives for: 4.1. workforce participation and skill formation;

4.2. individuals to save and provide for their future, including access to affordable housing; 4.3. investment and the promotion of efficient resource allocation to enhance productivity and international competitiveness; and 4.4. reducing tax system complexity and compliance costs. 5.

6. 7.

8.

9.

The review will reflect the government’s policy not to increase the rate or broaden the base of the goods and services tax (GST); preserve tax-free superannuation payments for the over 60s; and the announced aspirational personal income tax goals; The review’s recommendations should not presume a smaller general government sector and should be consistent with the Government’s tax to GDP commitments; The review should take into account the relationships of the tax system with the transfer payments system and other social support payments, rules and concessions, with a view to improving incentives to work, reducing complexity and maintaining cohesion; The review should take into account recent international trends to lower headline rates of tax and apply them across a broader base, as well as domestic and global economic and social developments and their impact on the Australian economy; The review will also incorporate consideration of all relevant tax expenditures.

The Henry Review produced a discussion paper, two consultation papers and two reports. The tax review was relatively short-lived, given the breadth of its tax reform agenda. The Henry Review report consists of three volumes (about 1300 pages) and contains 138 recommendations. The 2010 Labor Government’s initial response dealt with fewer than 50 of the recommendations. The Government enacted reforms to environment, resource, company and small business taxes and superannuation.

Liberal Coalition Government 2013–17 2.50 The Liberal Coalition Government has repealed the carbon tax and the mining tax, effective from 1 July 2014. Also, the tax loss carry-back measure and instant asset write-off and accelerated depreciation for motor vehicles for small business were discontinued. However, in 2015, small business tax concessions were reinstated and increased. 2.51 Also, a Budget deficit levy (income tax) of 2 per cent is to apply for 3 years from 1 July 2014 for incomes over $180,000, and the FBT rate increased. 2.52 The re-elected 2016 Liberal Coalition Government has a focus on innovation, introducing a number of tax incentives. Preventing tax avoidance

is also a priority, improving transparency, and anti-avoidance measures have been instigated. The Board of Taxation has also developed a sounding board for suggestions on how to improve the tax system. It is available at: . [page 60] In 2017, the Government focused on achieving its 10-year enterprise tax plan. This plan comprises: better targeting the deductible liabilities measure by addressing double counting of deductible liabilities under the consolidation regime; business simplification for taxation of financial arrangements and regulation reform; enhancing access to asset-backed financing; excise refund scheme for distillers, extending the brewery refund scheme to domestic distillers and producers of low strength beverages; implementing a new suite of collective investment vehicles; increasing the small business entity turnover threshold to $10 million from 1 July 2016; increasing the unincorporated small business tax incrementally over 10 years from 5 per cent to 16 per cent; reducing the company tax rate to 25 per cent over 10 years; targeting amendments to Division 7A; targeting personal income tax relief — increase the 32.5 per cent tax threshold from $80,000 to $87,000 from 1 July 2016; and wine equalisation tax rebate integrity to reduce the WET rebate cap and tighten eligibility criteria. GST The application of the GST to low value goods imported by consumers.

Income tax With regards to the National Innovation and Science Agenda: expanding tax incentives for early stage investors; expanding the new arrangements for venture capital limited partnerships; and increasing the Medicare levy low-income thresholds. Superannuation reform package The measures examined include: allowing catch-up concessional superannuation contributions; harmonising contribution rules for those aged 65 to 74; improving superannuation balances of low income spouses; introducing a superannuation transfer balance cap; introducing a lifetime cap for non-concessional superannuation contributions; introducing a Low Income Superannuation Tax Offset (LISTO); reforming the taxation of concessional superannuation contributions; removing the anti-detriment provision in respect of death benefits from superannuation; strengthening integrity of income streams; and tax deductions for personal superannuation contributions. Tax integrity package Measures in this category include: a new diverted profits tax; better protection of tax whistleblowers; broadening the securitised asset measure; [page 61]

deferred tax liabilities; establishing the Tax Avoidance Taskforce; implementing the OECD hybrid mismatch arrangement rules; increasing administrative penalties for significant global entities; and strengthening transfer pricing rules. Crackdown on the black economy 2.53 The Government established a taskforce to tackle the black economy (those who operate entirely outside the tax system or who are known to tax authorities but deliberately misreport their tax obligations, including organised crime). The Australian Bureau of Statistics estimated the black economy at 1.5 per cent of Australia’s GDP or around $24 billion. The new Black Economy Taskforce is being chaired by Mr Michael Andrew AO.

How does real tax reform happen? 2.54 Rational policy making does not appear to be possible; rather, reform is generally an incremental approach, with reforms frequently being made in response to the policy environment, pressure groups and political processes.169 Occasionally, real and significant tax reform processes are implemented when the right supply and demand factors are present. Supply factors such as a political champion and good tax policy, and demand factors such as public and government demand for reform and an economic crisis, are needed.170 Significant tax reform has also succeeded where politicians have taken the electorate by way of surprise. Economic depression, crisis or war 2.55 In Australia, World War I inspired the introduction of the personal income tax and corporate tax. The economic depression also provided for the introduction of the Wholesale Sales Tax in 1930. World War II facilitated the introduction of the widespread Commonwealth income tax. In 1972, the Asprey Inquiry (1972–75) on tax resulted from rising inflation and income tax

bracket creep. In 1984, major tax reform was the main focus in an economic recession and a period of high tax avoidance and evasion. The Hawke Labor Government successfully implemented tax reform, broadened the tax base and introduced a CGT and an FBT. Surprise tax policy 2.56 Individual leaders such as John Howard, in positions of power and influence, provide a model for successful tax reform. Howard led the Liberal Coalition Government to victory at the 1996 federal election with a no GST policy. Howard stated: ‘there’s no way the GST will be part of our policy. It’s dead. Never ever. It’s dead.’171 However, in 1998–99, the Howard Liberal Government’s surprise ‘tax reform: not a new tax, a new tax system’ (ANTS) package included a new 10 per cent GST. Howard was re-elected and the GST subsequently introduced, even [page 62] in the absence of any crisis. The economic growth was strong and the budget was in surplus. The approach taken generally followed the modern approaches suggested for reform in the tax politics literature;172 that is: taking the electorate by surprise (a brief and unexpected new GST proposal was released shortly before the election campaign); show how losses will be offset by overall gains (an interdependent tax package that included compensating losers was used); an appearance of public consultation; and marketing by political leaders and intensive media campaigns.

The future 2.57 Two central themes have emerged in Australian taxation. First, as a low-taxing OECD country, Australia’s tax system is challenged to provide

funds to meet the needs and wants of its citizens as seen by the mediocre performance of important social indicators and the rising inequality. Second, the tax exemptions for free riders have given rise to a two-class tax system. There is an over-reliance on high income tax rates and regressive indirect taxes rather than taxes on the many free riders (eg wealth taxes and a broader income tax/capital gains tax are needed). Additional tax is also needed to combat the negative externalities (free riders are not adequately taxed on harmful activities such as: illegal drugs, tobacco, junk food consumption, gambling and activities that damage the environment). There is also a need for taxes on the use of scarce community resources (free riders are not adequately taxed for mining our minerals, oil and gas; and for insolvency guarantees to major banks). Tax reform has proven to be problematic. Sensible taxes such as carbon taxes and mining taxes have been introduced and then abandoned, further taxes on gambling, fast food and sugary drinks, land tax, road congestion, income and wealth are needed. Recently, the Commonwealth has taken positive steps towards a more sensible tax system by placing extra taxes on the major banks and strengthening income and GST taxation on foreign multinationals operating in Australia. However, inexplicably, other free riders appear ignored. At a minimum, the Commonwealth should identify all free riders in its annual tax expenditure statements. How else will we address the inequality and increasing social problems? Will we move back towards or further away from a sensible tax system? Given that politicians continue to ignore tax inquiry recommendations for a more sensible tax system, the current system appears broken. Will we see the emergence of an independent body for tax design, implementation and maintenance?173 Will someone from Treasury, the ATO or the private sector emerge to play a leadership role? [page 63]

Attempt the Web Quiz for Chapter 2

Summary 2.58

This chapter covers the following: The first tax policy question relates to fiscal adequacy. Has the Government sufficient funds to run the country? Second, who pays the taxes? There are three relevant key tax policy criteria: economic efficiency requires that the base upon which the tax is levied should be economically neutral; equity requires that the tax base adhere to horizontal and vertical equity; and simplicity is another very desirable goal. It is important to appreciate that tax policy design usually involves a trade-off between conflicting policy goals. Taxes that attempt to achieve equity (eg, exempting capital gains from income tax or food from GST) add to the complexity. Alternatively, taxes that are simple, such as indirect taxes and excises, impede equity. Australian federal governments and taxation systems have proven to be very effective in raising sufficient taxation revenue to run a workable (albeit modest) level of government goods and services. While tax reform continues to be implemented without any accurate quantification or transparent detailed analysis of economic efficiency, equity and simplicity effects, the quest for improved tax reform remains. A tax expenditure budget recognises departures from economic income and asserts that such incentives through the tax system are the same as a direct grant program. Ethics plays a critical role in the taxation system. Ethical behaviour means acting with integrity, which, in turn, means telling the truth, avoiding shady and illicit dealings, and refusing to take or give bribes. It means being true to oneself. Tax preferences damage tax integrity, as they provide taxpayers and tax advisers with both the rationale and the opportunity for tax avoidance

and tax evasion. World governments’ prefer value added taxes and high taxes on salary and wage earners (almost 40% for marginal income tax rates for average wages in Australia); other types of gains are exempted leading to an extreme concentration of wealth; just 8 lightly taxed billionaires own as much as 50% (3.5 billion people) on the planet.174 [page 64]

Further problems 1

2 3 4 5 6 7

8 9 10

Some people say that Australia should have just one tax, a GST (say at a 50 per cent tax rate), and remove all other taxes. This would be simpler and more efficient. Evaluate this proposal. Is the current GST (which exempts certain goods and services) efficient? Is the current income tax (which exempts certain types of income and offers many special tax deductions) simple? Is the Ralph income tax reform that reduced the tax on capital gains by 50 per cent for individuals fair? Is the Ralph income tax reform that introduced uniform capital allowance provisions for business economically efficient? Does the CGT exemption for the residential home enhance economic efficiency? John earns $100,000 and pays $20,000 income tax while Simone earns $200,000 and pays $50,000 income tax. Simone argues that it is unfair for her to pay more tax than John. Discuss. Design an optimal tax system for Australia. What is a tax expenditure? What are Australia’s two largest tax expenditures?

1.

This is also known as fiscal adequacy.

2.

3.

N Brooks, ‘The Social Benefits and Economic Costs of Taxes: A Comparison of High and Low Tax Countries’, 18th Australasian Tax Teachers Association National Conference, University of Melbourne, 30 January 2006, 9. Above n 2, 10.

4. 5.

Above n 2, 11. Above n 2, 36, 40.

6.

E West, Adam Smith and Economics: From Market Behaviour to Public Choice, Edward Elgar Pub, Aldershot, 1990, 15. Fiscal adequacy was dealt with above at 2.3 (ie, what level of tax revenue should a government collect).

7. 8.

Review of Business Taxation, A Tax System Redesigned, More Certain, Equitable and Durable, Report, July 1999, (Ralph Report) AGPS, Canberra, 9, 13; Taxation Review Committee (Chair: K W Asprey), Full Report, 1975 (Asprey Report), para 3.6; J Waincymer, Australian Income Tax Principles and Policy, 2nd ed, Butterworths, Sydney, 1993, 26; J Alm, ‘What is an “Optimal Tax”?’ (1996) XLIX National Tax Journal 117. Alm stated: A central issue in public economics is the appropriate design of a tax system. Such a system is usually viewed as balancing the various desirable attributes of taxation: taxes must be raised (revenue-yield) in a way that treats individuals fairly (equity), that minimises interference in economic decisions (efficiency), and that does not impose undue costs on taxpayers or tax administrators (simplicity).

Asprey Report, above n 8, para 3.27. The Asprey Report observes that other objectives for tax policy include tax law flexibility for economic management. Governments may need to raise or lower rates quickly to stabilise the economy, or rates may need to be changed to influence consumer or business behaviour. Also, for political acceptability reasons, a change in a tax rate should have the maximum impact on the level of economic activity per dollar of revenue raised. Another important objective for tax policy is economic growth. This may justify lower levels of overall taxation and lower taxes on investment and saving. 10. R Goode, ‘The National Tax Journal in 1948–50 and 1994–96’ (1997) Vol L NTJ 707. Academics have now given economic efficiency a higher priority than equity, according to Goode’s review of the contents of the NTJ from 1948–50 to 1994–96. 9.

11. C I Plosser, ‘Is a Balanced Budget the Key to Our Economic Future?’, paper presented at William E Simon Graduate School of Business Administration, University of Rochester, Rochester, New York, 4 December 1995. 12. J Waincymer, Australian Income Tax Principles and Policy, 2nd ed, Butterworths, Sydney, 1993, 7. 13. A Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, R Campbell and A Skinner (eds), Liberty Press, Indianapolis, 1981, 825–7. 14. Economic income (also known as comprehensive income) is the total of an entity’s net receipts during the year plus the changes in the value of assets over the year. For example, John received a salary of $50,000 and dividends and rent of $10,000, and the value of his real estate and shares increased $20,000 over the year. His economic income would therefore be $80,000 ($50,000 + $10,000 + $20,000). 15. A Broke, ‘Simplification of Tax or I Wouldn’t Start From Here’ (2000) 1 British Tax Review 18.

16. R Krever and N Brooks, A Capital Gains Tax for New Zealand Victoria University Press, Wellington, 1990, 43. 17. D F Bradford, Untangling the Income Tax, Harvard University Press, Cambridge, Mass, 1986, 150–1; P Kenny, ‘Australian Taxation, Ethics and Social Capital’ (2003) Vol 21 Nos 3 and 4, Business and Professional Ethics Journal (Florida) 109, 110. 18. N B Cunningham and D H Schenk, ‘The Case for a Capital Gains Preference’ (1993) 48 TLR 319, 365. 19. Above n 18, at 364. 20. J Norregaard, ‘The Progressivity of Personal Income Tax Systems’ in International Monetary Fund, Tax Policy Handbook, Shome P (ed), Washington DC, 1995, 130. 21. News.com.au, ‘Treasurer Joe Hockey tells low income households they would not be bothered by petrol excise rises because rich will pay them’, 13 August 2014, (accessed 16 July 2015). 22. M Fletcher and B Guttmann, ‘Income Inequality in Australia’, (2013) Economic Roundup, Issue 2,

23. OECD (2011), ‘Divided We Stand: Why Inequality Keeps Rising, COUNTRY NOTE: AUSTRALIA’, . 24. United Kingdom Parliament Hansard, 27 May 1853: col 722. 25. French CJ, High Court Chief Justice address to the Law and Justice Foundation, Sydney, 21 October 2013. 26. B L Bittker, ‘Tax Reform and Simplification’ (1974) 29 University of Miami Law Review 1, 1; B Tran-Nam, ‘Tax Reform and Tax Simplicity: A New and “Simpler” Tax System?’ (2000) 23 University of New South Wales Law Journal 241, 242. 27. G S Cooper, ‘Themes and Issues in Tax Simplification’ (1993) 10 Australian Tax Forum 417, 424. 28. B Tran-Nam, ‘Assessing the Revenue and Simplification Impacts of the Government’s Tax Reform’ (1999) Journal of Australian Taxation 329, 332. 29. B Tran-Nam, ‘Tax Reform and Tax Simplicity: A New and “Simpler” Tax System?’ (2000) 23 University of New South Wales Law Journal 241, 244. 30. Section 6-5(1)) of the ITAA 1997 states: ‘Your assessable income includes income according to ordinary concepts, which is called ordinary income.’ 31. C Sandford, M Godwin and P Hardwick, Administrative and Compliance Costs of Taxation, Fiscal Publications, Bath, 1989, 10. 32. B Tran-Nam, ‘Assessing the Revenue and Simplification Impacts of the Government’s Tax Reform’ [1999] JAT 329, 332–33. 33. P Durkin, ‘Technology Crisis Engulfs Tax Office’, Australian Financial Review, 17 July 2017, 6; finds that the ‘Tax Office is facing calls for government intervention, compensation and an independent review after a hacking breach and more computer outages’. 34. Australia’s Future Tax System: Final Report, 2009 (Henry Report) . 35. Asprey Report, above n 8, 414.

36. Australian Government, Reform of the Australian Taxation System, RATS; Draft White Paper Reform of the Australian Taxation System (1985) AGPS, Canberra, 78. 37. Ralph Report, above n 8, 112. 38. J Mirrlees, S Adam, T Besley, R Blundell, S Bond, R Chote, M Gammie, P Johnson, G Myles and J Poterba, Tax by Design: The Mirrlees Review (2010), Oxford University Press, Oxford. The Institute for Fiscal Studies’ (which financed the Mirrlees Review) goal is to promote effective economic and social policies by understanding better their impact on individuals, families, businesses and the Government’s finances. Our findings are based on rigorous analysis, detailed empirical evidence and in-depth institutional knowledge. It is Britain’s leading independent microeconomic research institute and an authoritative commentator on the public finances, tax and welfare policy, tax law, education, inequality and poverty, pensions, productivity and innovation, consumer behaviour and the evaluation of policies designed to promote development in poorer countries. See 478, Table 20.1 . 39. An income tax concession or exemption provides certain taxpayers with a reduced tax liability. For example, the CGT exemption on the main residence provides a large tax benefit for homeowners. 40. R Hamilton, ‘The Concept of a Tax Expenditure Budget’ (1982) 17 TIA 30. 41. S S Surrey, ‘Tax Expenditure Analysis: the Concept and its Uses’ (1979) Vol 1, No 2, Canadian Taxation 3, 7. 42. Ralph Report, above n 8, Chs 24, 25, modelled the revenue impacts and industry effects of its tax reform proposals. No quantification was provided, though, on the equity and simplicity impacts! 43. J Stiglitz, Economics of the Public Sector, 2nd ed, W W Norton & Company, New York, 1988, 478– 9. 44. P Kenny, ‘Australia’s Capital Gains Tax Discount: More Certain, Equitable and Durable?’ (2005) 1 Journal of Australasian Tax Teachers Association 38; C Evans, ‘Taxing Personal Capital Gains in Australia: Causes of Complexity and Proposals for Reform’, paper presented at the Australasian Tax Teachers Association National Conference, Flinders University, Adelaide, 29–30 January 2004; P Kenny, ‘Australian Taxation, Ethics and Social Capital’ (2003) 21 Business and Professional Ethics Journal (Florida) 109; C Evans, ‘Taxing Capital Gains: One Step Forwards or Two Steps Back?’ (2002) 5(1) Journal of Australian Taxation 114; C Evans, ‘The New Regime: CGT After Ralph’ (2000) 3(6) The Tax Specialist 313; C Evans, ‘Curing Affluenza?: A Critique of Recent Changes to the Taxation of Capital Gains in Australia’ (2000) 23 University of New South Wales Law Journal 299; G Cooper, ‘The Ralph Review of Business Taxation: The Government Response to the Ralph Report: An Initial Overview’ (1999) 34(5) Taxation in Australia 232; M Dirkis, ‘The Ralph Report: A Step Closer, a Step Farther Away’ (1999) 34(5) Taxation in Australia 241. 45. K Bain ‘Exemptions and Concessions in the Australian Tax System: Equity at the Expense of Simplicity’ (2010) 5(1) Journal of Australasian Tax Teachers Association 66; M Burton, ‘Small Business Tax Advantages — Towards Holism With A Suggested Definition, Typology and Critical Review’ (2006) 2(1) Journal of the Australasian Tax Teachers Association 78; L Samarkovski and B Freudenberg, ‘TLIP: Lip Service or in Service? A Review of the Non-Commercial Loss and STS Measures Against the TLIP Principles’ (2006) 21 Australian Tax Forum 387; J Tretola, ‘The Simplified Tax System — Has it Simplified Tax at all and if so Should it be Extended’ (2007), published in the proceedings of the 19th Australasian Tax Teachers Association National Conference, Queensland, 22 January 2007; M McKerchar, ‘Is the Simplified Tax System Simple?’ (2007) 10 The Tax Specialist 140; G Shaw, ‘Changing to the Simplified Tax System’ (2005) Taxpayers Australia, 7 November 2005, 154; P Kenny, ‘Accounting Principles and Taxation Rules for Small Business:

The Impact of Ralph’ (2005) 1 Journal of Australasian Tax Teachers Association 79; G Walker, ‘The Simplified Tax System — the Good, the Bad and the Ugly’ (2003) 7, 20 CCH Tax Week 95; B Bondfield, ‘If there is an Art to Taxation the Simplified Tax System is a Dark Art’ (2002) 17 Australian Tax Forum 313; M Hine, ‘Small Business Tax System (STS)’, Taxation Institute of Australia, Western Australian State Convention, May 2001, 24, 29; I Snook, ‘Simplified Tax System: A Favourable Current, a Riptide or Just Plain Dead Calm?’, Taxation Institute of Australia, South Australian State Convention, May 2001, 75; L Wolfers and J Miller, ‘The Simplified Tax System: Is this Government Speak for “Complex”?’ (2001) 35 Taxation in Australia 374; F Martin, ‘STS Implications’ (2001) 36 Taxation in Australia 245; R Douglas, ‘Tax Simplification for Small to Medium Business’ (2000) Taxation Institute of Australia, New South Wales State Convention, May 2000, 8; G Cooper, ‘The Government Response to the Ralph Report: An Initial Overview’ (1999) 34 Taxation in Australia 232. 46. J Cassidy, ‘Devil’s in the Detail: Non-Commercial Business Losses’ 2008 Journal of the Australasian Tax Teachers Association Vol. 3 No. 2; L Samarkovski and B Freudenberg, ‘TLIP: Lip Service or in Service? A Review of the Non-Commercial Loss and STS Measures Against the TLIP Principles’ (2006) 21 Australian Tax Forum 387; P Kenny, ‘The Non-Commercial Loss Restrictions: A Very Blunt Instrument for Micro Business’ (2006) 21 Australian Tax Forum 573; L Greenleaf, ‘The NonCommercial Loss Provisions: A Lesson in Collateral Damage?’ (2006) 21 Australian Tax Forum 669; Rural Industries Research and Development Corporation (RIRDC), Economic Effects of Income Tax Law on Investments in Australian Agriculture, With Particular Reference to New and Emerging Industries, January 2006; Board of Taxation, Post-Implementation Review of the Quality and Effectiveness of the Non-Commercial Losses Provisions in Division 35 of the Income Tax Assessment Act 1997, A Report to the Treasurer, June 2004, ; Submissions to the Board of Taxation’s ‘Postimplementation Review of the Quality and Effectiveness of the Non-Commercial Losses Provisions in Division 35 of the Income Tax Assessment Act 1997, A Report to the Treasurer’, June 2004, ; R Douglas, ‘Farmers Nil, Commissioner Nil. Thanks, Ralph, Great Result’ (2001) 35 Taxation in Australia 387; G Cooper, ‘Tax Reform: Non Commercial Losses’ (2000) 35 Taxation in Australia 160. 47. Ralph Report, above n 8, 595–607. 48. Above n 8, 576, ‘small business are calling … for a simpler and more certain system to be introduced’. 49. Above n 8, 296, ‘… not to disadvantage genuine business activities’. 50. Mirrlees Review, above n 38, 474. 51. Ibid 478. 52. Ibid. 53. Henry Review, above n 34, 21. 54. Victoria University of Wellington, A Tax System for New Zealand’s Future, Report (2010). Report of the Tax Working Group, Centre for Accounting, Governance and Taxation Research, Chaired by Professor Bob Buckle. Available at (accessed 16 July 2015), 15–16. 55. C Meghir and D Phillips, ‘Labour Supply and Taxes’, Dimensions of Tax Design (2010) Mirrlees Review, Institute of Fiscal Studies, Oxford University Press, 222. 56. Asprey Review, above n 8, 414. 57. Reform of the Australian Taxation System, above n 36, 78.

58. Ralph Report, above n 8, 112. 59. Mirrlees Review, above n 38, goal is to promote effective economic and social policies by understanding better their impact on individuals, families, businesses and the Government’s finances. Our findings are based on rigorous analysis, detailed empirical evidence and in-depth institutional knowledge. It is Britain’s leading independent microeconomic research institute and an authoritative commentator on the public finances, tax and welfare policy, tax law, education, inequality and poverty, pensions, productivity and innovation, consumer behaviour and the evaluation of policies designed to promote development in poorer countries. See 478, Table 20.1 . 60. Henry Review, above n 34. 61. Justice Richard Edmonds, ‘Structural Tax Reform: What Should be Brought to the Table?’ Australasian Tax Teachers Association Conference, Adelaide, 20 January 2015. 62. Dividend imputation provides a tax offset called a franking credit to company members who receive dividends. 63. Notably, the Henry Review and Mirrlees Review were influenced by optimal tax theory, and both sought income tax concessions for savings and investment in addition to superannuation concessions. However, insufficient economic or other evidence was provided to warrant such departures from a comprehensive income tax base. The theory does not accord to the real world. 64. Mirrlees Review, above n 38, Ch 4. 65. Henry Review, above n 34, Ch 7, 51. 66. Mirrlees Review, above n 38, 486. 67. Henry Review, above n 34, Recommendation 76. 68. Henry Review, above n 34, Ch 6, Recommendation 52 stated: ‘Given the efficiency benefits of a broad land tax, it should be levied on as broad a base as possible. In order to tax more valuable land at higher rates, consideration should be given to levying land tax using an increasing marginal rate schedule, with the lowest rate being zero, with thresholds determined by the per-square-metre value.’ 69. Henry Review, above n 34, para 6.2. 70. Mirrlees Review, above n 38, 486. 71. Henry Review, above n 34, Ch 6. 72. Henry Review, above n 34, Ch 6. 73. Henry Review, above n 34, Ch 6. 74. Mirrlees Review, above n 38. In respect of the UK, note: ‘The economic costs of not having a coherent system of motoring taxation are large. The government estimates that annual welfare benefits of up to 1 per cent of national income are available from a road pricing scheme that varies charges by place and time of day to accurately reflect actual congestion levels and costs.’ 75. Henry Review, above n 34, Ch 8, ‘Recommendation 61: Governments should analyse the potential network-wide benefits and costs of introducing variable congestion pricing on existing tolled roads (or lanes), and consider extending existing technology across heavily congested parts of the road network. Beyond that, new technologies may further enable wider application of road pricing if proven cost-effective.’ 76. See . 77. .

78. indexed cost base

Capital proceeds > indexed cost base but no capital gain if collectable is acquired for $500 or less: s 118-10(1)

Capital proceeds > indexed cost base but no capital gain if PUA is acquired for $10,000 or less: s 118-10(3)

Capital loss

Capital proceeds < reduced cost base

Capital proceeds < reduced cost base Losses can only offset gains from collectables: s 108-10(1)

Losses are disregarded: s 10820(1)

Practice Problem 9 Calculate the capital gain/loss for the following assets (ignore indexing and CGT discounts). [page 275]

COLLECTABLE I

PUA I

CONTRACT RIGHTS

Cost base

400

1000

500

Capital proceeds

200

8000

700

Capital gain/loss

Practice Problem 10 Ignore indexing and CGT discounts and calculate the capital gain/loss for the following assets.

Cost base

COLLECTABLE 2

PUA 2

LAND

1000

21,000

11,000

Capital proceeds

1100

23,000

5000

Capital gain/loss

Separate CGT assets: Subdiv 108-D 9.31 Under CGT, there are exceptions to the common law principle that what is attached to the land is part of the land. A building or structure acquired after 19 August 1985 is treated as a separate CGT asset: s 108-55.

Example Sonia bought a block of land with a building on it on 10 August 1985. On 1 December 2005, she constructed another building on the land. The other building is taken to be a separate CGT asset from the land. Also, a depreciating asset that is part of a building is a separate asset: s 10860.

Example Ken owns an office building from which he carries on a business. He installs rest rooms for his staff. The plumbing fixtures and fittings are depreciating assets. These are separate CGT assets from the office building. Land acquired on or after 20 September 1985 that is adjacent to land (the original land) acquired before that day is taken to be a separate CGT asset from the original land if it and the original land are amalgamated into one title: s 108-65.

Example On 10 April 1983, Grant bought a block of land. On 11 June 2008, he bought another block of land adjacent to the first block. He amalgamated the titles to the two blocks into one title. The second block is treated as a separate CGT asset. He can make a capital gain or loss from it if he sells the whole area of land. Further, certain capital improvements to a CGT asset are treated as being a separate CGT asset: ss 108-60–108-85.

[page 276]

Time of acquisition of CGT assets 9.32 This is vitally important, given that CGT applies only to assets acquired after 19 September 1985 for indexation purposes and CGT discounts etc. While timing varies according to the CGT event, the general rule is that you acquire an asset when you become the owner. Division 109 provides specific rules for each CGT event; some of these are listed below. EVENT

IN THESE CIRCUMSTANCES

YOU ACQUIRE THE ASSET AT THIS TIME

A1

An entity disposes of a CGT asset to you (except where you compulsorily acquire it)

When the disposal contract is entered into or, if none, when the entity stops being the asset’s owner

A1, case 2

You compulsorily acquire a CGT asset from another entity

The earliest of: a when you paid compensation to the entity; b when you became the asset’s owner; c when you entered the asset under the power of compulsory acquisition; or d when you took possession of it under that power

D1

An entity creates contractual or other rights in you

When the contract is entered into or the right created

When you acquire a CGT asset without a CGT event, s 109-10 provides the following. If you construct/create a CGT asset — when the construction/creation started. If a company allots/issues shares — when the contract is entered into; if none, when the shares are issued/allotted. If a trustee of a unit trust issues units — when the contract is entered into; if none, when the units are issued.

Note: You do not acquire a CGT asset if the asset was disposed of to you to provide or redeem a security, and in a few other situations: see s 109-15.

Read ITAA 1997 Div 109 Step 4: Is the CGT event/CGT asset exempt? 9.33 The CGT provisions do not apply to the following exempt assets, transactions and events.

Exempt assets 9.34 You disregard the capital gains and losses arising from cars, motorcycles and valour decorations: s 118-5. [page 277] Pre-CGT assets 9.35 Assets acquired prior to 20 September 1985 are generally excluded from CGT; for example, see s 104-10(5). Collectables and personal use assets: s 118-10 9.36

Certain collectables and PUAs are exempt. Capital gain/loss from a collectable is disregarded if you acquired it for a market value of $500 or less. Capital gain/loss from a PUA or part of the asset is disregarded if you acquired it for $10,000 or less.

Assets used to produce exempt income: s 118-12 9.37

Assets used to produce exempt income are exempt.

Shares in a pooled development fund: s 118-13 9.38

Shares in a pooled development fund are exempt.

Registered emissions unit or from the right to a free carbon unit: s 118-15 9.39 Any capital gain or capital loss that a taxpayer makes from a registered emissions unit or from the right to a free carbon unit is disregarded: s 118-15.

Anti-overlap provisions Reducing capital gains if amount is otherwise assessable: s 118-20 9.40 A capital gain is reduced where another provision of the ITAA includes an amount as assessable income. The reduction is the amount that is included as assessable income. Thus, you disregard capital gains that constitute ordinary income under s 65. You are a property developer and buy land to resell at a profit. You make a profit of $40,000 and a capital gain of $30,000 from selling this land. The capital gain is reduced to zero because $40,000 is included in assessable income: see s 6-5. Carried interests: s 118-21 9.41

CGT events relating to carried interests are not treated as income.

Eligible termination payments and superannuation lump sums: s 118-22 9.42 Eligible termination payments and superannuation lump sums are exempt from CGT. Note: They are dealt with elsewhere in the income tax provisions: see

Chapter 15. [page 278] Depreciating assets: s 118-24 9.43 Any capital gain or loss from a CGT event (that is also a balancing adjustment event) that happens to a depreciating asset or a research and development allowances depreciating asset (ITAA 1936 s 73BA) is disregarded. Division 40 deals with the capital allowance provisions: see Chapter 13. Trading stock: s 118-25 9.44 Trading stock is exempt from CGT, since it is dealt with in Div 70: see Chapter 5. Division 230 financial arrangements: s 118-27 9.45 A capital gain or capital loss you make from a CGT asset or in creating a CGT asset or from the discharge or a liability is generally disregarded if it is part of a Div 230 financial arrangement. Film copyright: s 118-30 9.46 Film or copyright capital gains or capital losses included as assessable income under ITAA 1936 s 26AG are disregarded. Research and development: s 118-35 9.47 Research and development capital gains or capital losses included as assessable income under ITAA 1936 ss 73B(27A), 73BF(4) or 73BM(4) are disregarded.

Exempt or loss-denying transactions Compensation, damages: s 118-37

9.48 Disregard the following capital gains or losses from a CGT event happening in respect of: compensation or damages you receive for any wrong or injury you suffer in your occupation; compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally; winnings or prizes from gambling, a game or a competition with prizes; a re-establishment grant; and a dairy exit payment. Also, a capital gain from a reimbursement or payment is disregarded for: the General Practice Rural Incentives Program or Rural and Remote General Practice Program; Sydney aircraft noise insulation; M4/M5 cash back; and a sugar industry exit grant. [page 279]

Read ITAA 1997 ss 118-5-118-37 Other exemptions 9.49

Additionally, there are exemptions for the following: expiry of a lease: s 118-40; transfer of stratum units: s 118-42; sale of rights to mine: s 118-45; foreign currency hedging gains and losses: s 118-55; gifts under a cultural bequests program: s 118-60; later distributions of personal services income: s 118-65; transactions by exempt entities: s 118-70;

marriage breakdown settlements: s 118-75; and boat capital gains: s 118-80.

Main residence exemption: Subdiv 118-B 9.50 In accordance with s 118-110(1), you disregard a capital gain or loss from a CGT event in relation to a CGT asset that is a dwelling if you are an individual and the dwelling was your main residence throughout your ownership period and the interest did not pass to you as a beneficiary or was acquired as trustee of a deceased estate. A dwelling includes any building, caravan, houseboat or mobile home and any land immediately under it. The maximum area of adjacent land to the dwelling is 2 hectares. Re Summers and FCT AAT Case (2008) 71 ATR 61; 2008 ATC 10-007; [2008] AATA 152 Facts: The taxpayer lived in a shed on her land for 4 months following the collapse of a contract to build a house on the land. She moved her only bed into the shed and had mains water and a toilet connected. Originally, the shed was built by the builder to carry out his work. The taxpayer sought the main residence exemption. AAT held: The shed was her home, given her history of occupying rented premises in a similar manner and her working and social habits. But she could not apply the concession in ITAA 1997 s 118-150, since she did not occupy the shed as soon as practicable after its completion. A partial exemption was available under s 118-145 from the time she moved out of the shed until its sale.

Re Couch and FCT AAT Case [2009] AATA 41 Facts: The husband and wife taxpayers acquired an Adelaide unit in June 2000 with the intention of it being their main residence. Being in

the defence forces and posted away from Adelaide, they did not have any opportunity to live there, so they leased the property out. When they returned to Adelaide, they decided that the unit would not be suitable as a family home and they sold it without having lived in it. At issue was whether the capital gain made on the disposal should be disregarded pursuant to ITAA 1997 s 118-110.

[page 280]

AAT held: CGT event A1 applied. The taxpayers did not move into the unit at the time it was first practicable to do so after acquisition. The unit was leased out. The main residence exemption in s 118-110 was not available.

Re Caller and FCT AAT Case [2009] AATA 890 Facts: The taxpayers acquired the property in December 200I but the husband was required to remain in another location for work for 3 years. After acquisition, the taxpayers leased the property to a tenant during this 3-year absence. They moved into the property after 3 years. They sold the property in September 2006 for a capital gain and claimed the full main residence exemption per ITAA 1997 s 118-110. The Commissioner disputed this, allowing only a partial exemption in accordance with the reducing formula in s 118-185(2) for non-main residence days. AAT held: only a partial exemption was allowed. Whether the capital gain from the sale of the property was wholly or only partially exempt turned on the meaning of ‘first practicable’ as stated in s 118-

135. A period when the property is let out and during which rental is being derived cannot qualify for the exemption.

Re Keep and FCT AAT Case [2013] AATA 709 AAT held: The taxpayer failed to discharge the burden of proof. The house did not become the taxpayer’s main residence as soon as practicable after the completion of its construction, and the house did not continue to be the taxpayer’s main residence for at least 3 months after that, per s 118-150(3) ITAA 1997. His relationship with his former partner ended in September 2004. In May to June 2005, he and his then ex-partner moved into the house in order to meet the requirements to sell the property without CGT. By September 2005, the taxpayer moved out, and in November 2005, the house was sold. Rules that may extend the exemption 9.51 The exemption is extended from the time of acquisition to the time it was first practicable for the taxpayer to move in: see s 118-35. The exemption will cover two residences for a maximum period of 6 months where a taxpayer acquires a second residence before the first was disposed of: see s 118-140. The exemption is extended indefinitely provided that the dwelling is not used for the purpose of producing assessable income. If it is used for such a purpose, the exemption will apply for only a maximum of 6 years: see s 118145. You can own only one main residence per family. If there are two residences, a choice must be made: see s 118-170. The main residence CGT exemption extends to a compulsory acquisition or other involuntary realisation of adjacent land or structures where the dwelling itself is not also compulsorily acquired. It is extended to the compulsory creation of an easement over adjacent land and the compulsory variation of the taxpayer’s rights in relation to adjacent land.

The Commissioner has a discretion to extend the 2-year period for applying the main residence exemption on the disposal of a residence after the deceased holder’s resident’s death. [page 281] Partial exemption 9.52 A partial exemption applies where the dwelling is the taxpayer’s residence for only part of the ownership period: see s 118-185. Thus, the capital gain/loss will be:

You purchase a house in July 1990 and move in immediately. In July 1993 you move out and rent it, then sell it in July 1998 for a capital gain of $10,000.

Where the dwelling is used for income-producing purposes during the ownership period (see s 118-190(2)), the capital gain is increased by an amount that is reasonable, having regard to the extent to which you would have been able to deduct any interest on borrowing for the dwelling. You purchase a home used as a main residence (75 per cent) and surgery (25 per cent) and make a capital gain on disposal of $20,000. The capital gain is 25 per cent of $20,000 = $5000. Dwellings acquired from deceased estates 9.53

Be aware that in certain circumstances a capital gain is ignored where

a dwelling passes to a beneficiary or a trustee in a deceased estate: see s 118195.

Read ITAA 1997 Subdiv 118-B Insurance and superannuation exemptions: Subdiv 118-D 9.54 Capital gains and losses from CGT events in relation to certain general insurance policies, life insurance policies and annuities are exempt. Certain amounts payable out of superannuation funds and approved deposit funds are also exempt. Capital gains and losses from CGT events in relation to retirement savings accounts (RSAs) are disregarded.

Units in pooled superannuation trusts: Subdiv 118-E 9.55 A capital gain or capital loss from a CGT event in respect of certain units in pooled superannuation trusts is disregarded. [page 282]

Venture capital exemption: Subdivs 118-F, 118-G 9.56 A non-resident tax-exempt pension fund that invests in venture capital in an Australian company or trust can disregard certain capital gains and losses.

Demutualisation of Tower Corporation: Subdiv 118-H 9.57 You disregard certain capital gains or losses from certain membership rights in Tower Corporation.

Look-through earnout rights Subdivision 118-1

9.58 Capital gains and losses arising in respect of look-through earnout rights are disregarded. Payments received or paid under the earnout arrangements will affect the capital proceeds and cost base of the underlying asset or assets to which the earnout arrangement relates.

CGT discounts 9.59 Additionally to the above exemptions, a CGT discount may apply to reduce the amount of the capital gain as follows. CGT discount: Subdiv 115-A 9.60

The requirements for a discount capital gain are that: the gain must be made by an individual, trust or complying superannuation fund; it must result from a CGT event happening after 11.45am (EST), 21 September 1999; no indexation applies to the cost base; and the asset must be owned by the taxpayer for at least 12 months. The CGT events that do not qualify for a discount are D1-D3, E9, F1, F2, F5, H2, J2, J3 and K10. Exceptions to the discount capital gains 9.61 Note that certain exceptions apply to the availability of the CGT discount to prevent manipulation of the rules. These exceptions are: an agreement entered into within 12 months of the CGT event so as to artificially extend the 12-month period; and changes to equity interests in a company or trust where more than half the cost base of the CGT assets was acquired within the 12-month period before the sale of equity interests. Also, the CGT discount does not apply to capital gains made by a foreign resident or a temporary resident. However, the CGT discount will still apply to the portion of the discount capital gain of a foreign resident individual that accrued up until 8 May 2012.

Discount percentage 9.62 Individuals and trusts 50 per cent; complying superannuation funds 33 1/3 per cent. [page 283] Application for assets acquired after 11.45 am (EST), 21 September 1999 9.63 The CGT discount applies for such assets held for 12 months, but there is no indexation if the discount is taken. Application for assets acquired before 11.45 am (EST), 21 September 1999 9.64 If the asset was held for at least 12 months, there is a choice between: 1. 50 per cent CGT discount but no indexation; or 2. 100 per cent of the capital gain, but indexation applies up until 30 September 1999 (where it is frozen). Healey v FCT (2012) 208 FCR 300; [2012] FCA 269 Facts: A beneficiary of a trust was made presently entitled to a capital gain of $14 million made by the trust from the disposal of shares. The trust acquired the shares for $3 million from a related entity under a sale agreement. However, the shares were not transferred to the trust until 18 months later. When the transfer happened, the shares were sold by the trust to a third party for $18 million. The Commissioner argued that the trust acquired the shares within 12 months, so the CGT 50 per cent discount did not apply. Full Federal Court held: CGT event E2 was the more specific CGT event to apply because the transaction involved the transfer of property to a trust. Thus, the shares had been sold by the trust within 12 months of their acquisition, and therefore the beneficiary was not

entitled to the 50 per cent CGT discount. The court also rejected the taxpayer’s alternative argument that the trust and the entity from which it acquired the shares were not dealing with each other at arm’s length. Thus, the market value substitution rules did not apply to impose a market value cost base for the shares of $17 million (and not $3 million) to remove the capital gain.

Read ITAA 1997 Subdiv 115-A Practice Problem 11 Should Shirley take a CGT discount for the following pre-21 September 1999 assets that were sold in the current tax year? SHARES

HOUSE

Cost base

10,000

10,000

Indexed cost base

12,000

13,000

Capital proceeds

13,000

20,000

[page 284]

Practice Problem 12 Provide examples of the following: 1 CGT-exempt assets 2 CGT-exempt transactions 3 CGT discounts.

Practice Problem 13 What exemptions are available to a taxpayer selling a small business?

Practice Problem 14 What CGT exemptions apply to the following transactions? 1 A camera retailer sells a camera to a customer for $500. 2 A fireman sells his sole residence in Manly, Sydney, for $700,000. 3 A surfer sells his t-shirt and thongs for $20 to a UK backpacker. 4 A plumber receives bank interest of $100. 5 A student receives $30,000 compensation for a car accident that injured her neck. 6 A teacher wins $100,000 in the Queensland lottery. 7 An Australian investment company sells an airport in India for $400 million.

Trusts with a net capital gain: Subdiv 115-C 9.65 From the 2010-11 income year, capital gains and franked distributions can be streamed to specific beneficiaries. Thus, ITAA 1997 Subdiv 115-C works to tax capital gains to which a beneficiary is specifically entitled, rather than the general trust rules in ITAA 1936 Div 6. ITAA 1936 Div 6E removes

capital gains from being assessed under both ITAA 1936 Div 6 and Subdiv 115-C. Normally, the amount of trust net income that constitutes the net capital gain is dealt with as being a capital gain made by the beneficiary that is entitled to it. Thus, the beneficiary applies any capital losses against the capital gain. Under Subdiv 115-C, where the trust’s capital gain is reduced by the 50 per cent CGT discount or the small business CGT 50 per cent reduction, the capital gain to the beneficiary is doubled. In this way, the beneficiary applies capital losses to the gain and then the CGT discount or the small business reduction as per s 102-5. The capital gain to the beneficiary is multiplied by four if the trust’s capital gain is reduced by both the 50 per cent CGT discount and the small business CGT 50 per cent reduction. [page 285]

Step 5: Do the special CGT rules apply? 9.66 ITAA 1997 Pt 3-3 contains the special CGT rules. These can be summarised as follows.

Transfer of assets to a wholly owned company: Div 122 9.67 Optional rollover relief is available where an individual, trustee or partners in a partnership transfer an asset/net assets in a company wholly owned by the individual, trustee or partners.

Read ITAA 1997 s 112-1 Replacement asset rollovers: Div 124 9.68

Rollover relief is provided to the following replacement CGT assets:

asset compulsorily acquired, lost or destroyed; statutory licences; strata title conversion; exchange of shares or units; exchange of rights or options; exchange of shares in one company for shares in another company; exchange of units in a unit trust for shares in a company; conversion of a body to an incorporated company; Crown leases; depreciating assets; prospecting and mining entitlements; scrip for scrip rollover; disposal of assets by a trust to a company; financial services reform (FSR) transitions; exchange of a membership interest in a medical defence organisation (MDO) for a membership interest in another MDO (‘MDO’ is defined in s 5 of the Medical Indemnity Act 2002); exchange of stapled ownership interests for ownership interests in a unit trust; and water entitlements.

Read The guide to ITAA 1997 s 124-1 Demerger relief: Div 125 9.69

Division 125 provides CGT relief for demergers. [page 286]

Same asset rollover relief: Div 126 9.70

Rollover relief is available: where a CGT asset is transferred to a spouse in a marriage breakdown; where a company disposes of a CGT asset to another company that is a member of the same wholly owned group (due to consolidated group laws, this does not apply from 1 July 2003); where a CGT asset is transferred because of changes to a trust deed; where superannuation entities merge; and where there are certain transfers of assets between trusts.

Effect of death: Div 128 Impact on the deceased 9.71 Any notional capital gain/loss on assets held by the deceased are generally disregarded on death. A final income tax return must be completed, which must include any capital gains and losses realised prior to death. Impact on the beneficiary or legal personal representative 9.72 A capital gain/loss on death is also generally disregarded on the passing of the asset from the deceased estate to the beneficiary. Nevertheless, a capital gain or loss may arise if CGT event K3 applies. This occurs where an asset passes to a non-resident beneficiary or exempt entity or the trustee of a complying superannuation fund.

Read ITAA 1997 Div 128 Investments: Div 130 9.73

Cost base modifications are made for certain investments.

Leases: Div 132

9.74

Cost base modifications are made for certain leases.

Options: Div 134 9.75 The cost base of an asset is modified where an option that relates to it is exercised.

When an asset stops being a pre-CGT asset: Div 149 9.76 This division deals with certain situations in which a pre-CGT asset stops being a pre-CGT asset. [page 287]

Small business CGT concessions: Div 152 9.77 The small business CGT concessions (SBCGTCs) are extraordinarily complex, and explaining them is like unscrambling an egg. Having said that, the following basic explanation is provided. See Chapter 23 for links for further analysis. In determining SBCGTCs for the 2012-13 income year, this analysis consists of two stages and seven steps as follows: Stage 1 — Meet the basic requirements, Subdiv 152-A

Step 1: A CGT event resulting in a capital gain happens in relation to an asset owned by the taxpayer Step 2: Meet the small business entity (SBE) condition or the maximum net asset value test is met Step 3: Must be an active asset

Stage 2 — The four small business CGT concessions

Step 4: Fifteen-year business asset exemption: Subdiv 152-B Step 5: Fifty per cent active asset reduction: Subdiv 152-C Step 6: CGT retirement exemption: Subdiv 152-D Step 7: CGT rollover: Subdiv 152-E

A CGT event resulting in a capital gain happens in relation to an asset owned by the taxpayer CGT events 9.78 A CGT event (other than CGT event K7) must happen that results in a capital gain in relation to an asset owned by the taxpayer.7 Certain other CGT events do not meet the basic conditions. The 15-year exemption and 50 per cent reduction exemption are not available for capital gains rolled over under CGT events J2, J5 and J6.8 Small business CGT rollover relief is also not available under CGT events J5 and J6. In relation to an asset owned by the taxpayer 9.79 Also, the capital gain must happen in relation to an asset owned by the taxpayer. This means that CGT D1 would normally not be available for the concessions.9 However, relief may be provided for CGT event D1 where the CGT event is inherently connected with a CGT asset.10 Further, CGT event F1 applies because the relevant event happens to the underlying land and thus is in relation to a CGT asset.11 The Australian Taxation Office (ATO) advised that this asset nexus requirement would also apply to CGT event H1 (forfeiture of a deposit), D2 (grant of an option) and D3 (grant of a right to income from mining).12 [page 288] Death 9.80 Death does not automatically lead to the failure of the active asset test (as discussed below in step 3). Access to the small business concessions can generally still be obtained within 2 years of the death of an individual.13

Meet SBE condition or maximum net asset value test The SBE condition

9.81 This basic condition is met if the taxpayer is an SBE in the income year in which the capital gain arises14 (or meets the maximum net asset value test). There are four substeps in applying the SBE test: Substep 1: SBE under the usual definition; Substep 2: SBE and partners in partnerships; Substep 3: SBE and passively held assets; and Substep 4: Special rules. Substep 1: SBE under the usual definition 9.82 A taxpayer will be an SBE if the aggregated turnover of it, its affiliates and connected entities is less than $2 million (as explained in Chapter 5). Substep 2: SBE and partners in partnerships 9.83 A partner in a partnership carries on the partnership business collectively with the other partners under the CGT regime. A partner cannot be an SBE; rather, the partnership must qualify as an SBE. A partner is eligible for the SBCGTCs if the partnership is an SBE in the income year and the CGT asset is an interest in an asset of the partnership.15 An asset is a partnership asset if the partners own the asset in proportion to their interests in the partnership as per the partnership agreement. Partners may also be eligible for the CGT concessions for a CGT asset the partner owns where the CGT asset is not their interest in an asset of the partnership asset: see passively held assets at 9.84 below. Note: Special rules apply for businesses being wound up: see 9.90 below. Substep 3: SBE and passively held assets 9.84 Taxpayers satisfy this basic condition for a CGT asset they own in the income year where they are not carrying on a business (ie, passively held assets) but that CGT asset is either:16 a passive asset used in the business of the taxpayer’s affiliate or entity connected held assets;17 or

[page 289] a passive asset of a partner used in partnership.18 Further, special rules may apply to the SBE test for working out an entity’s aggregated turnover for passively held assets: see 9.85 below. Passive asset — business of affiliate or connected entity 9.85 In summary, a taxpayer that is not in business can access the CGT concessions through the SBE test where their asset is used in a business of an affiliate or connected entity. For affiliates or entities connected to the taxpayer, the requirements for passively held CGT assets in the income year are as follows.19 The taxpayer’s affiliate or entity connected with the taxpayer must be an SBE for the income year (ie, the income year in which the CGT event happens to the taxpayer’s CGT asset). The taxpayer does not carry on a business in the income year (other than in partnership). If the taxpayer carries on a business in partnership, the CGT asset is not an interest in an asset of the partnership. In any case where the SBE referred to above is the entity that at a time in the income year carries on the business where: the SBE owns the asset (whether tangible or intangible) and it is used, or held ready for use, in the business carried on by the SBE or the SBE’s affiliate or an entity connected with the SBE; and if the asset is an intangible asset, the SBE owns it and it is inherently connected with a business that is carried on (whether alone or in partnership by the SBE, the SBE’s affiliate or another entity connected with the SBE). The terms ‘affiliate’ and ‘connected entity’ were discussed in Chapter 5. Special rules apply for spouses and children taken to be affiliates (s 152-47) and connected entities (trustee of discretionary trust may nominate beneficiaries to be controllers of trust, s 152-78 — see 9.102).

Passive asset of partner used in partnership 9.86 In summary, a partner can obtain the concessions through the SBE test where their asset is used in a business of the partnership(s). Thus, assets fully owned by the partner (rather than the partnership) that are used in the partnership can obtain the concessions through the SBE test. 9.87 For partnerships, the requirements for passively held CGT assets in the income year are that:20 the taxpayer is a partner in a partnership; the partnership is an SBE for the income year; the taxpayer does not carry on a business in the income year (other than in partnership); the CGT asset is not an interest in an asset of the partnership; and the business the taxpayer carries on as a partner in the partnership (referred to above) is the business that the taxpayer, at a time in the income year, carries on and the CGT asset [page 290] is used in the business of the taxpayer’s affiliate or an entity connected with the taxpayer; or the CGT is an intangible asset the taxpayer owns and is inherently connected with a business that is carried on (whether alone or in partnership by the taxpayer, the taxpayer’s affiliate or another entity connected with the taxpayer). 9.88 Another special rule for calculating aggregated turnover applies if a taxpayer is a partner in more than one partnership and the asset is used in more than one partnership business.21 The rule treats each partnership that the taxpayer is a partner in and that uses the asset as being connected with the partnership that is trying to work out whether it is an SBE. Thus, in the aggregated turnover of the taxpayer partnership accessing the concessions, the turnover of any other partnerships that are deemed to be connected must be included.

Substep 4: Special rules 9.89

Special rules apply to the SBE test for: winding up businesses; working out aggregated turnover for passively held assets; spouses and children taken to be affiliates; and connected entities: trustee of discretionary trust may nominate beneficiaries to be controllers of trust (see 9.102).

Winding up businesses 9.90 If an entity is not using the asset in the business in the year the CGT event occurs because the business the entity previously carried on is winding up, there is a special rule that applies provided that the entity used the asset in the business in the year the business ceased. Working out aggregated turnover for passively held assets 9.91 A special rule for calculating aggregated turnover applies if a taxpayer is a partner in more than one partnership and the asset is used in more than one partnership business.22 The rule treats each partnership that the taxpayer is a partner in and that uses the asset as being connected with the partnership that is trying to work out whether it is an SBE. Thus, in the aggregated turnover of the taxpayer partnership accessing the concessions, the turnover of any other partnerships that are deemed to be connected must be included. Spouse and child taken to be affiliates 9.92 The taxpayer’s spouse or child (under 18 years of age) is not automatically an affiliate under s 328-13023 (they must act according to the taxpayer’s directions or wishes or in concert with the taxpayer in relation to the spouse’s or child’s business), as discussed in Chapter 5. However, the taxpayer’s spouse or child may be taken to be the taxpayer’s affiliate for the purposes of the basic conditions set out at 9.93–9.96 below. 9.93 A taxpayer’s spouse or child is taken to be an affiliate for the purposes of determining whether the taxpayer is eligible for the SBCGTCs where one entity owns a CGT asset and:24

[page 291] that asset is used, or held ready for use, in the course of carrying on a business by another entity; or that asset is inherently connected with a business carried on by another entity. The taxpayer’s spouse or child may be taken to be an affiliate in the following situations. 1.

Taxpayer’s asset used by an entity that spouse or child owns

9.94 The taxpayer’s spouse or child may be taken to be an affiliate where a CGT asset is owned by the taxpayer and that asset is used in a business carried on by an entity that the taxpayer’s spouse or child owns or has an interest in.25 The spouse or child will be taken to be your affiliate for the purposes of the $6 million maximum net asset value test, $2 million aggregated turnover test and active asset test. 2.

Taxpayer’s entity has interest in an asset used by spouse or child in their business or an entity they have an interest in

9.95 The taxpayer’s spouse or child may be taken to be an affiliate where a CGT asset is owned by an entity that the taxpayer owns or has an interest in and that asset is used in a business carried on by your spouse or child or an entity that your spouse or child has an interest in.26 The spouse or child will be treated as an affiliate of the individual for the purposes of the SBCGTCs in relation to net asset value, calculating aggregated turnover and all the basic conditions for eligibility. 3.

Taxpayer’s asset their spouse or child uses in their business

9.96 Where a taxpayer owns an asset that their spouse or child uses in their business that they carry on as an individual, their spouse or child will be taken to be an affiliate for the $6 million maximum net asset value test (as well as the $2 million aggregated turnover test and active asset test).27 The spouse or child will be treated as an affiliate of the individual for the purposes of the

SBCGTCs in relation to net asset value, calculating aggregated turnover and all the basic conditions for eligibility. Maximum net asset value test 9.97 Taxpayers satisfy this basic condition if the maximum net asset test is met. This test is met if, just before the CGT event, the sum of the net value of the CGT assets owned by the taxpayer28, any entities connected with the taxpayer and any affiliates of the taxpayer or entities connected with such affiliates does not exceed $6 million.29 This test treats the taxpayer and its related entities as one economic entity. For example, if the net value of the economic entity’s assets is greater than $6 million, the SBCGTs do not apply. [page 292]

Elvis has net assets of $3 million and controls three family trusts that are connected to him. The trusts have a net value of assets of $4 million. Elvis is not eligible for the SBCGTs, as the net assets exceed $6 million. The net value of the CGT assets of a taxpayer is the sum of the market value of the entity’s CGT assets less the following items:30 liabilities of the taxpayer related to the assets; provisions for annual leave; provisions for long service leave; provisions for unearned income; and provisions for tax liabilities. Disregarded assets from the maximum net asset test 9.98 To prevent double counting, the net asset value for a taxpayer, shares, units or other interests (apart from debt) held in an entity connected with the taxpayer are disregarded.31

Also, assets of a private or personal nature are also excluded for an individual taxpayer. Assets excluded include those that are:32 solely for the personal use and enjoyment of the individual or a small business CGT affiliate; rights to capital amounts payable out of a superannuation fund or an approved deposit fund; rights to an asset of a superannuation fund or an approved deposit fund; and life insurance policies. In the case of a house or dwelling, an individual includes only the current market value of a dwelling in their net assets, to the extent that it is reasonable, having regard to the amount that the dwelling has been used to produce assessable income that gives rise to deductions for interest payments or would give rise to deductions for interest if interest had been paid.

Example Hooksy owns his house, which has a market value of $1,000,000 just before applying the net assets test. He has owned the house for 10 years. For the first 3 years, 20 per cent of it was used for producing assessable income; for the following 2 years, 40 per cent of it was used for producing assessable income; for 2 years, it was used solely as a main residence; and for the last 3 years, it was used 10 per cent for producing assessable income. His dwelling has had 17 per cent income-producing use: (3/10 × 20%) + (2/10 × 40%) + (2/10 × 0%) + (3/10 × 10%). He will include $170,000 in his net assets ($1,000,000 × 17%). He has a liability of $500,000 attached to the house. Therefore, 17 per cent ($8500) of the liability is also included in the calculation of the net assets. Additionally, the assets of a small business CGT affiliate are excluded if those assets are not used, or not held ready for use, in a business carried on by the taxpayer, either alone or [page 293]

together with others, or in a business carried on by an entity connected with the taxpayer, either alone or together with others.33 Complying superannuation funds 9.99 The concessions will not be available for any capital gain a complying superannuation fund makes on the sale of an asset used in a related entity’s business. As the members or trustees of the fund do not control the fund in the manner needed, the related entity is not a connected entity, and therefore the business’s real property is not an active asset. Bert has CGT assets with a value of $6 million and liabilities relating to the assets of $1 million and he has made provisions for $200,000 of annual leave for his employees, $100,000 for unearned income and $100,000 for tax liabilities for the financial year. He has a net asset value of $4.6 million ($6 million – $1.4 million). For partnership assets, the maximum net asset value test includes only the assets of each partner and not the assets of the entire partnership. Griswald is a partner in a law firm. The firm has net assets of $20 million and Griswald has a 10 per cent share in the partnership. The partnership sells its office building and makes a capital gain. For the net asset test, Griswald includes only $2 million in net assets in relation to his interest in the partnership.

Re Vaughan and FCT AAT Case [2011] AATA 758 Facts: The taxpayer, a beneficiary of a family trust and sole shareholder and director of the trust’s trustee company, received a capital gain of $6 million from the trust’s sale of units in the 2007 financial year. The taxpayer claimed CGT small business concessions.

Under the former maximum net asset value test of $5 million, the Commissioner claimed that the net assets were above $5 million. The taxpayer argued that the value of the relevant assets totalled $4.1 million. AAT held: The net assets for the purposes of the net asset value test totalled just over $8 million, and the test was therefore not met. A debt of $2 million that was owed by the family trust to one of the unit trusts did not relate to any specific assets of the family trust under the requirements of being a liability related to an asset in ITAA 1997 s 152-20. Also, an amount of $1.2 million held in the bank account of the taxpayer could not be reduced by a debit balance in a linked account that reflected borrowed funds used to purchase a residence that was owned by his spouse. This was because the liability attached to an asset that was not owned by the taxpayer, a connected entity or an affiliate. The AAT also said that the fact that the liability arose from the use of multiple linked accounts with the one institution did not alter this outcome. Guarantees given by the family trust and the taxpayer in respect of loans made by one of the unit trusts could not be taken into account, as they were excluded contingent liabilities and not a presently existing legal obligation.

[page 294]

White v FCT (2012) 200 FCR 594; [2012] FCA 109 Facts: A husband and wife held 30 per cent and 28.2 per cent, respectively, of the shares in a company that they sold for a capital gain of $3.6 million (ie, $1.8 million each). Both claimed the 15-year retirement exemption. The Commissioner argued that they did not pass the then $5 million maximum net asset value test. The Commissioner contended that the net value of the assets of the company had to be taken into account for each taxpayer because of

the (then) requirement in s 152-15 and s 152-20(3) that included the net value of assets of any CGT small business affiliates or entities connected with such small business affiliates used in carrying on a business. Federal Court held: They satisfied the former maximum net asset value test in the 2007 income year on the sale of their combined 58 per cent shareholding in a company. Only the value of their respective individual shareholdings, and not the assets of the company, had to be included in the test, in view of the exception for disregarding assets used in carrying on a business by an entity (the company) that is connected with you only because of your small business CGT affiliate. The exception in the then s 152-20(4) applied to prevent the taxpayers from being CGT small business affiliates of each other, and, as a result, they passed the assets test.

Re Syttadel Holdings Pty Ltd and FCT AAT Case [2011] AATA 589 Facts: The taxpayer acquired a marina in June 1996 for $1.675 million and sold the marina as a going concern for $8.9 million on 4 July 2006. The taxpayer requested a private ruling from the Commissioner to determine the market value of the marina to be between $4 million and $4.5 million so as to access the CGT exemption. The Commissioner disagreed, as the value should be the sale price of the marina. AAT held: The taxpayer was not entitled to the CGT small business concession, as the former net asset value test was not satisfied. The taxpayer’s valuer came up with a market value for the marina of $4.5 million, but this value used an unusual practice to adopt a market value by references to offers made and the sum at which a vendor was prepared to sell. The taxpayer failed to discharge the onus of proof. The Commissioner’s valuer used conventional approaches of capitalisation of operating profit and direct comparison.

Active asset test 9.100 A CGT asset generally satisfies the active asset test if the following two requirements are met:34 1. the asset was an active asset for at least half of the ownership period or at least 7 years if the ownership period is greater than 15 years;35 and 2. the taxpayer, the taxpayer’s affiliate or another entity connected with the taxpayer owns it and uses it, or holds it ready for use, in the course of carrying on a business.36 [page 295] Other active assets 9.101 Also, an intangible asset owned by the taxpayer that is inherently connected with a business carried on by the taxpayer, an affiliate or another entity connected with the taxpayer (eg, goodwill or the benefit of a restrictive covenant) is an active asset. Further, active assets include a share in an Australian resident company or an interest in a resident trust and the total of the market values of the active assets of the company or trust is 80 per cent or more of the market values of all of the assets of the company or trust for at least 50 per cent of the time that the SBE owned the shares or interests. Doug ran a footy jumper manufacturing operation. He acquired a clothing machine, which he used to produce jumpers. He sold the machine during the year. The machine was used solely for the business for the entire period of ownership and it meets the active asset test. Cynthia ran a beauty business from a shop that she had owned for 9 years. She ran the business for 6 years and then rented the shop out for 3 years before selling it. The shop satisfies the active asset test, as it was actively used in her business for more than half the period of

ownership. The property did not have to be used in the business just before it was sold. Edmund ran a vineyard on a property that he had owned for 20 years. He ran the vineyard for 4 years and then leased it to an unrelated party for 6 years. He then ran the farm for another 6 years before retiring and leasing the property for another 4 years before selling it. The vineyard satisfies the active asset test because it was actively used in his business for at least 7.5 years. The period did not have to be continuous and the property does not have to be used in the business just before it is sold.

Re Tingari Village North Pty Ltd and FCT (2010) 78 ATR 693; AAT Case [2010] AATA 233 Facts: The taxpayer company sold a mobile home park business and the land on which it was situated for a capital gain of $2.1 million in November 2005. The taxpayer disclosed a net capital gain of only $70,646 from the sale of the park in its 2006 return (after applying the CGT small business retirement concession and the 50 per cent reduction concession). The Commissioner issued an amended assessment to deny the concessions on the basis that the park was excluded from being an active asset under ITAA 1997 s 152-40(4)(e), as it was used in the course of carrying on a business of deriving rent. The taxpayer also failed the former $5 million maximum net asset value test. AAT held: CGT small business concessions did not apply. The park was not an active asset and various assets and liabilities of connected entities were not properly taken into account, so it failed the former $5 million maximum net asset value test. CGT assets that cannot be active assets

9.102 (a)

The following CGT assets cannot be active assets, per s 152-40(4): interests in an entity that is *connected with you, other than *shares and interests covered by subsection (3);

[page 296] (b) shares in a company, other than: (i)

shares in a *widely held company that are covered by subsection (3), (3A) or (3B) and held by a *CGT concession stakeholder of the company; and (ii) shares in any other company that are covered by subsection (3), (3A) or (3B); (c) interests in a trust, other than: (i) interests in a trust to which subsection (5) applies that are covered by subsection (3), (3A) or (3B) and held by a CGT concession stakeholder of the trust; and (ii) interests in any other trust that are covered by subsection (3), (3A) or (3B); (d) financial instruments (such as loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts and a right or option in respect of a share, security, loan or contract); (e) an asset whose main use in the course of carrying on the *business mentioned in subsection (1) is to *derive interest, an annuity, rent, royalties or foreign exchange gains unless: (i) the asset is an intangible asset and has been substantially developed, altered or improved by you so that its *market value has been substantially enhanced; or (ii) its main use for deriving rent was only temporary. *Refers to defined terms in the ITAA 1997.

Doug has a warehouse, which he rents out. The warehouse is not an active asset, as Doug is not using it in the course of carrying on his business. If Doug operated his business from the warehouse, then it would be an active asset. Under s 152-42, a trustee of a discretionary trust may nominate not more than four beneficiaries as being controllers of the trust for an income year for which the trustee did not make a distribution of income or capital if the trust had a tax loss or no taxable income for that year: s 152-42(2). This means that each nominated beneficiary controlled the trust for that income year, as required per s 328-125. Thus, these nominated beneficiaries are connected with the trust.

Section 152-45 alters the active asset test in s 152-35 if there is an involuntary disposal of an asset. In this situation, the active asset test requires that the asset owned must have been an active asset during at least half of a specified period. Relief is provided for compulsory acquisition under Subdiv 124-B and assets subject to rollover relief under FSR assets, Subdiv 124-O, or assets subject to Subdiv 126-A, marriage or relationship breakdown rollover relief. Re Karapanagiotidis and FCT (2007) 68 ATR 348; 2007 ATC 2746; [2007] AATA 1961 Facts: The husband and wife acquired a vacant block of land in November 1995, the time of settlement of a contract when they made the final payment due under the original vendor finance. The date of the contract was November 1989. The taxpayers included the interest on the loan in the cost base under ITAA 1997 s 110-25(4)(d). They also claimed CGT small business rollover relief.

[page 297]

AAT held: The property was acquired at the date of the contract for CGT; thus, the interest was excluded from the cost base. The taxpayer was not entitled to the CGT small business rollover relief, since the land was not an ‘active asset’. The storage of their hire car business records in two containers placed on the land did not amount to the carrying on of a business.

Re Vaughan and FCT (2011) 85 ATR 608; [2011] AATA 758 Facts: Husband and wife taxpayers operated a child care business for

6 years on premises they owned. They then leased the premises to a young couple for 6 years and then to ABC Learning for 5 years before selling the premises. AAT held: The asset did not qualify for the CGT small business concessions, since it did not qualify as an active asset for at least 7.5 years of the 17-year period that it was owned by the taxpayers, as required by ITAA 1997 s 152-35(1)(b).

Re Jakjoy Pty Ltd and FCT [2013] AATA 526 Facts: The taxpayer owned a range of commercial properties used in carrying on a business of deriving rent. The taxpayer sought exemption from the capital gain under the CGT small business concessions being active assets; thus, s 152-40(4)(e) applied. The Commissioner disagreed. AAT held: The exemption does not apply. The assets were used mainly to derive rent, even if the assets were used in carrying on a business of deriving rent. Thus, the commercial properties did not qualify as active assets for the purpose of qualifying for the small business concessions. Further tests if the CGT asset is a share in a company or interest in a trust 9.103 To be eligible for the SBCGTCs, if the CGT asset is a share in a company or an interest in a trust (known as the object company or trust), then one of the following two additional requirements must be met just before the CGT event:37 1. the entity claiming the concession is a CGT concession stakeholder in the object company or trust; or 2. CGT concession stakeholders in the object company or trust together have a small business participation percentage in the entity claiming the concession of at least 90 per cent.

CGT concession stakeholder 9.104 An individual is a CGT concession stakeholder of the object company or trust if they are:38 (a) a significant individual in the company or trust; or (b) a spouse of a significant individual in the company or trust if the spouse has a small business participation percentage in the company or trust at that time that is greater than zero. [page 298] Significant individual 9.105 An individual is a significant individual in a company or a trust at a time if at that time the individual has a small business participation percentage in the company or trust of at least 20 per cent.39 Thus, up to eight taxpayers can obtain the Div 152 concessions; that is, taxpayers and their spouses. Small business participation 9.106 The small business participation percentage in another entity at a time is the sum of the entity’s:40 direct small business participation percentage in the other entity at that time; and indirect small business participation percentage in the other entity at that time. Direct small business participation percentage 9.107 An entity’s direct small business participation percentage in a company is: the percentage that the entity has because of holding the legal and equitable interests in shares in the company;41 the percentage of the voting power in the company; the percentage of any dividend that the company may pay; and

the percentage of any distribution of capital that the company may make. If these amounts are different, use the smaller or smallest amount. Note: Redeemable shares are ignored per s 152-70(2). Jake’s shares do not carry any voting rights but they carry an entitlement to 20 per cent of any dividends and capital distributions of TeaPot Pty Ltd. His direct small business participation percentage in TeaPot Pty Ltd is nil. For trusts, two situations apply.42 First, if the entities have entitlements to all the income and capital of the trust, then an entity’s direct small business participation percentage is the percentage of any distribution of income or of capital that the trustee may make to which the entity would be beneficially entitled. If these amounts are different, use the smaller amount. Second, if the entities do not have entitlements to all the income and capital of the trust, then an entity’s direct small business participation percentage in a trust is the percentage of the distributions of income or of capital made by the trustee to which the entity was beneficially entitled. If these amounts are different, use the smaller amount. Where the trust did not make a distribution of income or capital during the year, then there will be no significant individual during that year (see 9.105). [page 299] Indirect small business participation percentage 9.108 To calculate the indirect small business participation percentage, first it is necessary to calculate the direct small business participation percentage that the entity (known as the holding entity) has in another entity (known as the intermediate entity) at that time.43 Second, multiply the above amount by the sum of:44 (i)

the intermediate entity’s direct small business participation percentage (if any) in the test entity at that time; and

(ii) the intermediate entity’s indirect small business participation percentage (if any) in the test

entity at that time (as worked out under one or more other applications of this section).

If there is more than one intermediate entity to which s 152-75(1)(a) applies at that time, the holding entity’s indirect small business participation percentage is the sum of the percentages worked out under s 152-75(1) in relation to each of those intermediate entities.45

Example Emily has an indirect small business participation percentage in the unit trust as follows:

Multiplying the percentages above produces a small business participation percentage of 43.2 per cent. Emily also owns 20 per cent of the unit trust; that is, her direct small business participation percentage is 20 per cent in the unit trust. This is added to the individual’s indirect small business participation percentage to produce a small business participation percentage in the trust of 63.2 per cent. [page 300]

Death of the individual 9.109 Under s 152-80, access to the small business concessions can still be obtained within 2 years of the death of an individual. In this situation, the relief is obtained by the deceased person’s legal personal representative or beneficiary.

Read ITAA 1997 Subdiv 152-A Fifteen-year business asset exemption: Subdiv 152-B 9.110 An individual, company or trust can disregard a capital gain arising from a CGT asset where they owned the CGT asset for at least 15 years.46 To gain this exemption, the following three requirements must all be met:47 the basic conditions for relief in Subdiv 152-A are satisfied (steps 1–3 above); the asset is an active asset; and the entity continuously owned the asset for the 15-year period leading up to the CGT event. If the entity is an individual, there is an additional requirement. He or she must be over 55 years of age and retired or permanently incapacitated.48 If the entity is a company or trust, it had a significant individual for a total of at least 15 years during which the entity owned the asset, and the individual who was the significant individual just before the CGT event retires or is permanently incapacitated. Further time extensions apply if there is rollover due to marriage breakdown or compulsory acquisition or an asset is replaced as a result of FSR measures.49

Example Sid operated a car repair business for 30 years and for the whole of this time he operated the business out of a building he owned. He sold the building for a large capital gain and reduced his working hours by 10 per cent to 40 hours per week. He cannot access the 15-year concession, because he did not retire.

Read ITAA 1997 Subdiv 152-B Fifty per cent active asset reduction: Subdiv 152-C 9.111 A capital gain can be reduced by 50 per cent if the basic conditions are met in respect of the gain (steps 1–3 above).50 However, the 50 per cent reduction does not apply where the 15-year exemption applies.51 Section 152220 allows an entity to choose not to use the 50 per cent reduction amount in the capital gain. [page 301] For individuals, since the small business 50 per cent reduction applies after the 50 per cent CGT discount, this results in an effective 75 per cent reduction in the capital gain. A company, however, can receive only the 50 per cent active asset reduction. Also, an individual who elects indexation will receive only the 50 per cent active asset reduction.

Example Randolph is a small business taxpayer and sells an active asset for a $100,000 capital gain. He elects to use a 50 per cent discount rather than indexation. He can thus use the 50 per cent discount percentage and the 50 per cent active asset reduction. This provides an effective reduction of 75 per cent in the capital gain as follows. Capital gain

$100,000

Less current year capital losses

0

Less prior year capital losses

0

Less 50% CGT discount

$50,000

Subtotal

$50,000

Less 50% reduction

$25,000

Net capital gain

$25,000

Read ITAA 1997 Subdiv 152-C CGT retirement exemption: Subdiv 152-D 9.112 An individual can choose to disregard all or part of a capital gain from a CGT event to the extent of the lifetime limit of $500,000 if the following requirements are met:52 the basic conditions in Subdiv 152-A are satisfied (steps 1–3 above); if the individual is under 55 just before making the choice, the individual contributes an amount equal to the asset’s CGT-exempt amount to a complying superannuation fund or an RSA; and the contribution is made at the later of making the choice and receiving the proceeds. However, if the CGT event is CGT event J2, J5 or J6, the contribution must be made when the individual made the choice. Under this concession, individuals aged 55 or over can access a CGTexempt amount and, if eligible, can claim a tax deduction for this amount as a personal contribution to superannuation. Such deductible contributions must be included in the concessional contributions cap. A company or a trust (except a public entity) can choose to disregard a CGT-exempt amount if:53 the basic conditions in Subdiv 152-A are satisfied (steps 1–3 above); the entity satisfies the significant individual test; and the company or trust conditions in s 152-325 are satisfied. [page 302] Where an entity makes the choice in s 152-305 for any part of the capital gain from the CGT asset, that part of the capital gain equal to its CGTexempt amount is disregarded. An individual must ensure that his or her CGT retirement exemption

lifetime limit of $500,000 is not exceeded. A company or trust must also ensure that the CGT retirement exemption limit of individuals is not exceeded. The CGT-exempt amount must be set out in writing.54 Botticelli sells an active asset for $200,000, making a $100,000 capital gain, and does not make any other CGT exemption elections. He elects a CGT exempt amount of $100,000 under the retirement exemption. His capital gain is therefore zero. if Botticelli had made a retirement exemption election for $490,000 in a prior year, his CGT retirement exemption limit would be $10,000. Thus, the capital gain would be reduced to $90,000. There are further conditions that a company or trust must satisfy before being entitled to choose to apply the small business retirement exemption.55 The company or trust, as the employer of the CGT concession stakeholders, must make a payment to the CGT concession stakeholders. The payment must be made in the two situations specified in s 152-325(1). Also, Subdiv 152-D does not apply to a capital gain to which the 15-year exemption applies.56

Read ITAA 1997 Subdiv 152-D SBCGT rollover: Subdiv 152-E 9.113 A taxpayer can choose to obtain a rollover if the basic conditions in Subdiv 152-A are satisfied (steps 1–3 above) for all or part of the capital gain from an active asset.57 Rollover can be applied even where the replacement asset has not yet been acquired, or where the taxpayer has not yet incurred fourth element58 expenditure to improve the asset. CGT event J5, however, happens to reinstate the rolled over capital gain if, by the end of the replacement asset period, the taxpayer has not acquired the

asset or incurred the expenditure: s 104-197. Also, CGT event J6 happens to reinstate the rolled over capital gain if, by the end of the replacement asset period, the cost of the replacement asset or the amount of fourth element expenditure incurred is less than the amount of the capital gain that was disregarded: s 104-198. The replacement asset period commences 1 year before and ends 2 years after the last CGT event in the income year for which a rollover was elected. Also, CGT event J2 will reinstate a rolled over capital gain where, after the replacement asset period, there is a change in the use/status of the replacement asset; for example, where [page 303] it is no longer an active asset. However, the reinstated capital gain under J2 may be eligible for further rollover relief under Subdiv 152-E. In 2006, Ken makes a capital gain of $100,000 on an active asset and meets the maximum net asset value test. Ken disregards the whole capital gain under the small business rollover. In 2008, Jennifer does not have any replacement assets by the end of the 2-year period. CGT event J5 happens and Jennifer makes a capital gain of $100,000. In 2006, Barbie makes a capital gain of $200,000 on an active asset and meets the maximum net asset value test. She disregards the whole capital gain under the small business rollover. In 2007, she spends $50,000 on improving an asset. However, the asset is not active at the end of 2 years from the CGT event. In 2008, she does not have any other replacement assets. CGT event J5 happens and she makes a capital gain of $50,000. In 2004, Graham makes a capital gain of $600,000 on an active asset and meets the maximum net asset value test.

He chooses to disregard the whole capital gain. In 2006, he purchases new business premises for $200,000 and spends $150,000 on improving some other assets. The replacement assets meet all of the relevant conditions. The amount of expenditure on the replacement assets is only $350,000 and the capital gain that was rolled over was $600,000. Thus, in 2006, 2 years after the original CGT event, CGT event J6 happens because there has been insufficient expenditure and he makes a capital gain of $250,000. The rollover of $350,000 of the original capital gain continues. Special rules apply in s 152-420 if an individual who has obtained a rollover under Subdiv 152-E dies. Subdivision 152-E does not apply to a capital gain to which the 15-year exemption applies.59

Read ITAA 1997 Subdiv 152-E59 Restructures of small businesses 9.114 Subdivision 328-G also provides tax neutral consequences for a small business entity that restructures the ownership of the assets of the business, without changing the ultimate economic ownership of the assets. The amendments apply to transfers of transfers of CGT assets, where the CGT event arising from the transfer occurs on or after 1 July 2016. 9.115 Parts 3-5–3-95 provide further special rules as follows. Part 3-5 — Corporate taxpayers and corporate distributions Part 3-6 — The imputation system Part 3-10 — Financial transactions Part 3-25 — Particular kinds of trusts Part 3-30 — Superannuation Part 3-32 — Co-operatives and mutual entities Part 3-35 — Insurance business

[page 304] Part 3-45 — Rules for particular industries and occupations Part 3-90 — Consolidated groups Part 3-95 — Value shifting

Value shifting rules: ITAA 1997 Divs 723, 725, 727 9.116 The general value shifting regime commenced from 1 July 2002 and replaced the former value shifting provisions (ITAA 1997 Divs 138, 139, 140).60 The Explanatory Memorandum sets out its purpose:61 Value shifting rules are needed to prevent: distortion of gains and losses when interests are sold, rendered worthless or otherwise come to an end; and opportunities for inappropriate deferral or avoidance of tax liabilities where the value shift results in an interest decreasing in value, or inappropriate taxation where the value shift results in an interest increasing in value; value shifting makes it possible for a taxpayer to bring forward losses and defer gains by shifting value out of assets which are due to be realised in the short term and into assets which are not due to be realised until some time later; and value shifting arrangements distort the relationship between an asset’s market value and its adjustable value (eg, cost base), thereby bringing inappropriate gains and losses to account upon realisation.

The rules prevent related entities from avoiding tax by shifting asset values (including CGT values) between associated entities. The regime applies mainly to interests in companies and trusts that are not consolidated but meet control or common ownership tests. Also, for entities that deal at arm’s length or on market value terms, the rules will not generally apply. These rules apply to both tax losses and capital losses.

CGT treatment of the sale and purchase of businesses and earnout rights 9.117 Special rules apply for the CGT treatment of the sale and purchase of businesses involving earnout rights (rights to future payments based on the

performance of an asset or assets after sale). Capital gains and losses arising in respect of look-through earnout rights are disregarded. The payments received or paid under the earnout arrangements will affect the capital proceeds and cost base of the underlying asset or assets in respect of the earnout arrangements. [page 305] Tax incentives for early stage investors in innovation companies 9.118 A modified CGT treatment may apply if you are, or a trust or partnership of which you are a member is, issued with certain kinds of equity interests in a small Australian company with high-growth potential that is engaging in innovative activities: ITAA 1997 ss 360-60–360-65.

Step 6: Calculating the capital gain/loss 9.119 As previously discussed, the formulas for calculating a capital gain/loss are set out in each particular CGT event, although the following equations are typically used. Capital gain = Capital proceeds — Assets cost base62 Capital loss = Reduced cost base — Capital proceeds Thus, we need to work out what constitutes capital proceeds, cost base and reduced cost base.

Capital proceeds 9.120 Section 116-20 provides generally that 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.

Read ITAA 1997 Div 116 Practice Problem 15 1 2

Pete sells land for $74,000. What are the capital proceeds? Pete sells a building and receives $50,000 cash, and included in the sale s a boat with a market value of $15,000. What are the capital proceeds?

However, there are six modifications that potentially apply to this rule. See s 116-25 for the table of modification rules that apply to the various CGT events. The modifications are as follows. Market substitution rule: s 116-30 9.121 If you receive no capital proceeds, you are taken to have received the market value. Also, if there are capital proceeds, they can be replaced with a market value where: [page 306] the proceeds cannot be valued; or the proceeds do not equal market value and it is a non-arm’s-length transaction or it is CGT event C2.

Practice Problem 16

Jane transfers land worth $10,000 to a friend for no consideration. What are the capital proceeds?

Practice Problem 17 Debbie sells land to a relative for $30,000. Its market value is $130,000. What are the capital proceeds? Apportionment rule: s 116-40 9.122 If you receive a payment that relates to more than one CGT event, the capital proceeds are so much of the payment that is reasonably attributable to that event.

Practice Problem 18 Steve sells land and a boat for $100,000. The land is worth $80,000 and the boat $20,000. What are the capital proceeds? If you receive a payment in a transaction that relates to one CGT event and something else, the capital proceeds are so much of the payment that is reasonably attributable to that event.

Practice Problem 19

Tony, a financial planner, provides advice worth $5000 and sells a block of land to Joe for a total of $70,000, including the advice. What are the capital proceeds?

[page 307] Non-receipt rule: s 116-45 9.123 The capital proceeds are reduced by the unpaid amount if you are not likely to receive some or all of the proceeds and it is not as a result of anything you have done or omitted and you took reasonable steps to get the unpaid amount. However, if you reduce by the unpaid amount and later receive part of this amount, the capital proceeds are increased by that part. Quality Publications Australia Pty Ltd v FCT (2012) 202 FCR 574; [2012] FCA 256 Facts: The Commissioner assessed the taxpayer for $4.1 million capital proceeds received from the sale of its publishing business, pursuant to ITAA 1997 s 116-20(1)(a). The taxpayer argued that a payment direction mechanism meant that a related trust of the taxpayer had subscribed for shares in the purchaser and was required to pay the capital proceeds to the taxpayer at the purchaser’s direction. Thus, the capital proceeds were not received. Federal Court held: The capital proceeds the taxpayer was entitled to receive was the amount of $4.1 million, as set out in the sale agreement with the purchaser. The asset sale agreement provided for the payment by the Quality Group direct to the vendor, on the purchaser’s behalf, in satisfaction of the consideration. The court also found that there were no grounds for further reducing the shortfall penalty imposed for recklessness for failing to properly calculate the net capital gain.

Practice Problem 20 1

2

Amanda sells a house for $65,000 and receives only $50,000 before the purchaser goes missing. What are the capital proceeds? If subsequently the purchaser comes back and pays her the $15,000, what are the capital proceeds?

Repaid rule: s 116-50 9.124 The capital proceeds are reduced by any part you repay and compensation you pay that can be reasonably regarded as a repayment of part of them. You cannot reduce the capital proceeds for any part that you can deduct.

Practice Problem 21 1

2

You sell a house for $50,000, but you misled the buyer on the house’s condition and you are sued and have to pay $10,000 damages. What are the capital proceeds? if the $10,000 costs were deductible, what are the capital proceeds?

Assumption of liability: s 116-55 9.125 The capital proceeds are increased if another entity acquires the CGT asset subject to a secured liability by the amount of the liability assumed by the other entity. [page 308]

Practice Problem 22 Cynthia sells land and receives $50,000 and the buyer assumes the $100,000 mortgage over the land. What are the capital proceeds? Misappropriation rule: s 116-60 9.126 The capital proceeds from a CGT event are reduced if a taxpayer’s employee or agent misappropriates (whether by theft, embezzlement, larceny or otherwise) all or part of those proceeds. The capital proceeds are reduced by the amount misappropriated. Note: Further special rules apply for capital proceeds for certain options, leases, shares or interests in a trust etc: see ss 116-65–116-105.

Practice Problem 23 What modifications potentially apply if: 1 2 3

a house is sold; a fire burns down a hotel; and $1 million is received for a restrictive covenant not to compete in the Western Australian electrical retail market?

Earnout rights 9.127 The CGT treatment of the sale and purchase of businesses involving certain earnout rights — rights to future payments linked to the performance of an asset or assets after sale — will be disregarded: ss 118-560-118-565. Payments received or paid under the earnout arrangements will affect the

capital proceeds and cost base of the underlying asset or assets to which the earnout arrangement relates.

Cost base 9.128 Division 110 defines the cost base. However, certain CGT events do not require a cost base: see s 110-10. For all other CGT events (such as A1), the cost bases include five elements, of which indexation (where applicable) is calculated for elements 1, 2, 4 and 5. These five elements are set out in s 110-25(2)–(6). They are as follows. 1. The total of: the money you paid, or are required to pay, in respect of acquiring it; and the market value of any property you gave, or were required to give, in respect of acquiring it (worked out as at the time of acquisition). 2. Incidental costs you incurred. These costs can include giving property: see s 103-5. 3. The costs of owning the CGT asset you incurred (but only if you acquired the asset after 20 August 1991). These costs include: [page 309] interest on money you borrowed to acquire the asset; costs of maintaining, repairing or insuring it; rates of land tax, if the asset is land; interest on money you borrowed to refinance the money you borrowed to acquire the asset; and interest on money you borrowed to finance the capital expenditure you incurred to increase the asset’s value. These costs can include giving property: see s 103-5.

4.

The capital expenditure you incurred: the purpose or the expected effect of which is to increase or preserve the asset’s value; or that relates to installing or moving the asset. The expenditure can include giving property: see s 103-5. 5. Capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. These costs can include giving property: see s 103-5. Tax Determination 2017/10 provides that for CGT purposes, costs that a taxpayer incurs after a CGT event happens can be related to that CGT event for the purpose of working out incidental costs under s 110-35(1)(b). What is not part of the cost base? 9.129 The main exclusions from the cost base are: expenditure to the extent that you can deduct it: ss 110-40, 110-43, 11045, 110-50; expenditure to the extent that you have received a recoupment and it is not included in your assessable income; and expenditure in the third element for PUAs and collectables: ss 108-17, 108-30. Section 110-38 also provides that the following expenditure does not form part of any element of the cost base to the extent: of expenditures on illegal activities: s 26-54; that it is a bribe to a foreign public official or a bribe to a public official; that it is in respect of providing entertainment; that s 26-5 prevents it from being deducted (even if some other provision also prevents it from being deducted); and of non-business boat expenses: s 26-47.

The most common example of exclusions from cost

base would be deductible depreciation, interest and maintenance expenses on business assets.

When you sell a business or rental property, the insurance, interest, council rates and maintenance costs do not form part of the cost base, as these expenses are deductible under s 8-1.

[page 310]

You sell a holiday home acquired in 1992. The insurance, interest, council rates and maintenance costs form part of the cost base per s 110-25, as these expenses are not deductible. You sell a building that includes $14,000 worth of improvements, which were half paid for by a tenant and were not included in your assessable income. Only $7000 of improvements are included in your cost base. Incidental costs 9.130 There are a number of incidental costs you might have incurred. Except for the ninth example, they are costs that you might have incurred to acquire a CGT asset or that relate to a CGT event (s 110-35): 1. remuneration for a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser; 2. costs of transfer; 3. stamp duty or other similar duty; 4. costs of advertising or marketing for a buyer/seller;

5. 6. 7. 8. 9.

valuation costs for apportionment for the purposes of the CGT provisions; search fees relating to a CGT asset; the cost of a conveyancing kit (or a similar cost); borrowing expenses (such as loan application fees and mortgage discharge fees); and expenditure that: a is incurred by the head company of a consolidated group to an entity that is not a member of the group; b reasonably relates to a CGT asset held by the head company; and c is incurred because of a transaction that is between members of the group.

Read ITAA 1997 Div 110 Calculate the cost base: On 1 July 1986, you acquired land at a contract price of $500,000, the stamp duty was $20,000 and the conveyancing and legal costs to purchase were $3000. The contract was dated 1 July 1986, from which time you became liable for payment. On 1 July 1986, you paid $10,000 in legal costs incurred in enforcing your right to take up an option to acquire the land. From 1 July 1986 to 30 June 2000, you incurred the following costs in keeping this property: Interest Maintenance costs Rates and taxes Cost of improvements to the land incurred on 23 May 1990

$50,000 $3000 $30,000 $20,000

The interest, repairs, and rates and taxes were not

claimed as business deductions (as vacant land).

[page 311]

At the time of sale, 31 August of the current tax year, advertising costs of $2000 and real estate commissions of $11,000 were paid. COST BASE

SECTION

$

1st element

s 110-25(2)

2nd element

s 110-25(3), s 110-35

20,000 + 3000 + 11,000 + 2000

3rd element

s 110-25(4) does not apply, as the land was acquired before 21/08/91

0

COST BASE

s 110-25(5)

5th element

s 110-25(6)

Cost base

500,000

SECTION

4th element

$

$

36,000

$

20,000 10,000 566,000

Practice Problem 24 What are the elements of the cost base in the following CGT event? A holiday house was purchased for $500,000, with stamp duty of $20,000. The selling costs are $15,000 and the interest and rates and taxes cost $73,000.

Modifications to cost base and reduced cost base: Div 112 9.131 Generally, a cost base will be modified where any of the following apply: market value substitution rule (eg, non-arm’s-length transactions); split, changed or merged assets; apportionment rules on acquisition or disposal of part; and assumption of liability rule. Healey v FCT (2012) 208 FCR 300; [2012] FCA 269 Facts: A beneficiary of a trust was made presently entitled to a capital gain of $14 million made by the trust from the disposal of shares. The trust acquired the shares for $3 million from a related entity under a sale agreement. However, the shares were not transferred to the trust until 18 months later. When the transfer happened, the shares were then sold by the trust to a third party for $18 million. The Commissioner argued that the trust acquired the shares within 12 months, so the CGT 50 per cent discount did not apply. The taxpayer claimed that the trust and the entity from which it acquired the shares were not dealing with each other at arm’s length; thus, the market value substitution rules should apply to provide an $18 million cost base.

[page 312]

Federal Court held: The market value substitution rules do not apply. The taxpayer had not discharged the onus of proving this, and

there was no commonality of controllers between the relevant parties. Also, there are special rules that will modify the cost base where the CGT event involves an acquisition that is listed in the table at s 112-45. Other special rules apply for the situations set out at ss 112-40–112-97, for replacement asset rollover events (Subdiv 112-C applies) and for same asset rollover events: Subdiv 112-D.

Read ITAA 1997 Div 112 Indexation of cost base: Div 114 9.132 The cost base also includes indexation if Div 114 is satisfied. Generally, expenditure is indexed from when it is incurred63 (see s 114-1), except for the third element of the cost base, as indexing does not apply. Indexing applies only to CGT assets held for more than 12 months. It does not apply to the reduced cost base and to assets acquired after 21 September 1999, since indexation is frozen as at 30 September 1999.

Read ITAA 1997 Div 114 Each element of the cost base (except the third element) is multiplied by the indexation factor for the quarter of the year when the CGT event happened, divided by the indexation factor when the expenditure was incurred: s 960-275(1). The note in s 960-275(2) makes clear that you index the cost base from the time you incur the expenditure (examine the contract to find out when this occurred). This is so even if you pay for the asset over a number of instalments. The indexation factors are set out in Concise Tax legislation text, Lexis Nexis. Example

Sarg buys land for $1,000,000 pursuant to a contract dated 1 June 1996. He pays $100,000 deposit upon signing the contract and is liable to pay the $900,000 balance also at this time, but the contract stipulates that it is payable on 1 July 1996. Sarg can index the cost base from 1 June 1996, indexation factor is 64.7. Example Calculate the cost base for shares purchased for $1 million incurred on 31 December 1985 and sold on 1 July of the current tax year. The indexed cost base is frozen to 30 September 1999: $1 million × 68.7/40.5=1.696 = $1,696,000.

[page 313]

Reduced cost base: Subdiv 110-B 9.133 The reduced cost base is relevant in ascertaining whether a capital loss from a CGT event has occurred. The reduced cost base consists of five elements, although indexation does not apply: see s 110-55. All of the elements of the reduced cost base except the third are the same as those of the cost base: s 110-35(2). The third element is any amount worked out in accordance with s 110-55(3). Note: The reduced cost base does not get indexed! This is a common error by first-time students of taxation law. From the time of acquisition, 1 July 1986, to the date of sale in the current income tax year, you incurred the following costs in keeping a property: interest $80,000, repairs $50,000, rates and taxes $150,000. The building was not eligible for any capital allowance deductions. Cost of improvements to the building: $20,000 incurred

on 23 May 1990. The interest, repairs, and rates and taxes were claimed as business deductions. At the time of sale, 31 August of the current tax year, advertising costs of $2000 and real estate commissions of $11,000 were paid. Calculate the cost base using the CPI index numbers up to 30 September 1999 (when indexation is frozen). ELEMENTS — COST

MULTIPLIED BY CPI FACTORS

INDEXED COST BASE $

Money paid to acquire 01/07/86–30/09/99

500,000 × 68.7/43.2 (1.590)

795,000

incidental costs on acquisition 01/07/86– 30/09/99 Stamp duty $20,000 Conveyancing and legal costs $3000

23,000 × 68.7/43.2 (1.590) =

36,570

incidental costs on sale $2000 advertising $11,000 commission

13,000

Non-capital costs of ownership

As the land was pre21/08/91

Improvements $20,000 23/05/90–30/09/99

20,000 × 68.7/57.1 (1.203) =

Total indexed cost base

0 24,060

868,630

The following examples illustrate how the cost base, capital proceeds and capital gains/losses are calculated. [page 314]

Practice Problem 25 Calculate the capital gain/loss for each of the following assets of a resident individual. LAND

SHARES

HOTEL

Cost base

10,000

50,000

100,000

Reduced cost base

10,000

50,000

100,000

Indexed cost base

11,000

62,000

120,000

Capital proceeds

14,000

48,000

250,000

Practice Problem 26 Calculating a capital gain Sam, a resident, sells a modern Australian painting for $320,000 on a contract dated 1 July of the current income tax year. The only costs of sale were auction expenses of $9600. The painting cost $250,000 and was purchased at an auction and incurred on 5 September 1993. Calculate the capital gain or loss. Calculating a capital loss Jack sells land for $17,000 pursuant to a contract dated 11 September of the current income tax year. The only costs of sale were expenses of $550. The land cost $25,000, incurred on 5 October 1992. Calculate the capital gain or loss. Details CGT event Div 104 CGT asset Div 108

Indexation

$

Acquisition Div 109 Reduced cost base Div 110/112

Capital proceeds Div 116 Reduced cost base Capital loss s 102-10

[page 315]

Practice Problem 27 Robin acquired the following assets, which were all sold on 30 June of the current tax year. Provide details of the cost base amounts and section references. INDEXATION FACTOR

1. On 1/7/89, acquired vacant land for $20,000 paid for by a loan. The interest on the loan was $100 2. On 23/5/94, acquired a holiday house for $200,000, including stamp duty of $8000, paid for by a loan The interest on the loan was $20,000

INDEXED AMOUNT

COST BASE AND INDEXED COST BASE AMOUNTS

3. On 1/7/88, acquired a suit for $600 4. On 1/7/2000, acquired shares for $15,000 5. On 1/12/83, acquired shares for $3000

Not all CGT events produce capital gains or losses 9.134 Note: Not all CGT events will result in a capital gain or a capital loss. If the capital proceeds are less than the indexed cost base but greater than the reduced cost base, there will be no capital gain or loss. There will also be no capital gain or loss where the capital proceeds equal the indexed (or unindexed) cost base or the reduced cost base. See the key equations in s 10410(4). You sell land for $20,000 that was acquired at a reduced cost based of $18,000. The indexed cost base at the time of CGT event A1 is $21,000. Thus there is no capital gain or loss.

[page 316]

Step 7: Netting capital gains/losses 9.135 A separate calculation of a capital gain or loss is required for each asset, with the net capital gain included in assessable income. Section 102-5 sets out the following five-step process: Working out your net capital gain Step 1. Reduce the capital gains you made during the income year by the capital losses (if any) you made during the income year.

Note 1: You choose the order in which you reduce your capital gains. You have a net capital loss for the income year if your capital losses exceed your capital gains: see section 102-10. Note 2: Some provisions of this Act (such as Divisions 104 and 118) permit or require you to disregard certain capital gains or losses when working out your net capital gain. Subdivision 152-B permits you, in some circumstances, to disregard a capital gain on an asset you held for at least 15 years. Step 2. Apply any previously unapplied net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of capital gains under step 1 (including any capital gains not reduced under that step because the capital losses were less than the total of your capital gains). Note 1: Section 102-15 explains how to apply net capital losses. Note 2: You choose the order in which you reduce the amounts. Step 3. Reduce by the discount percentage each amount of a discount capital gain remaining after step 2 (if any). Note: Only some entities can have discount capital gains, and only if they have capital gains from CGT assets acquired at least a year before making the gains. See Division 115. Step 4. If any of your capital gains (whether or not they are discount capital gains) qualify for any of the small business concessions in Subdivisions 152-C, 152-D and 152-E, apply those concessions to each capital gain as provided for in those Subdivisions. Note 1: The basic conditions for getting these concessions are in Subdivision 152-A. Note 2: Subdivision 152-C does not apply to CGT events J2, J5 and J6. In addition, Subdivision 152-E does not apply to CGT events J5 and J6. Step 5. Add up the amounts of capital gains (if any) remaining after step 4. The sum is your net capital gain for the income year. Note: For exceptions and modifications to these rules: see section 102-30. (2) However, if during the income year: (a) you became bankrupt; or (b) you were released from debts under a law relating to bankruptcy; any net capital loss you made for an earlier income year must be disregarded in working out whether you made a net capital gain for the income year or a later one. (3) Subsection (2) applies even though your bankruptcy is annulled if: (a) the annulment happens under section 74 of the Bankruptcy Act 1966; and (b) under the composition or scheme of arrangement concerned, you were, will be or may be released from debts from which you would have been released if instead you had been discharged from the bankruptcy.

[page 317] Under s 102-10 a net capital loss is calculated:

Working out your net capital loss Step 1. Add up the *capital losses you made during the income year. Also add up the *capital gains you made. Step 2. Subtract your *capital gains from your *capital losses. Step 3. If the Step 2 amount is more than zero, it is your net capital loss for the income year.64 * Refers to defined terms in the ITAA 1997 If there is a capital loss, this cannot be offset against assessable income but can be carried forward indefinitely to be set off against other capital gains. Also, note that special rules apply to gains and losses arising from collectables and PFUs (as outlined previously), per s 102-10.

Practice Problem 28 Calculate the net capital gain/loss. (Follow the seven steps.) Alex, a resident, bought a house for $100,000 in 1995, which he rented out. In January of the current year, he sold the house for $200,000. He chooses the CGT discount. He has prior year net capital losses of $10,000 and current losses of $15,000, and he chooses the CGT discount. The house is not eligible for capital allowance deductions. Also, there were no depreciable assets included in the sales price.

Practice Problem 29 Penny, a resident, acquires shares in BHP in 1996 and sells the shares in October of the current tax year for an undiscounted capital gain of $22,000. She chooses the CGT discount. She also makes a capital gain of $15,000 (after indexing) in January of the current tax year from land acquired on March 1990. She chose indexing. She

has a capital loss of $5000 from the prior tax year and also has a capital loss of $15,000 in the current year. Calculate the net capital gain/loss. (Follow the seven steps.)

[page 318]

Practice Problem 30 1

2

3

Calculate the net capital gain or loss (follow the seven steps) for Pamela, a resident, who is a lawyer based in Darwin. On 1 May of the current year ended 30 June, she sold an antique painting for $20,000. The sales contract was dated 30 June of the current income tax year. The painting cost $5000 and was acquired on 29 June 1985 and the costs were incurred on that date. She sold shares for $10,000 on 30 June of the current income tax year. The shares cost $20,000, which were incurred on 23 July 1988. She acquired a holiday house in Sydney for $100,000, paid on the date of the contract. The purchase contract was dated 30 June 1986. Other costs were stamp duty of $5000 and the legal costs to purchase of $500, which were paid on 16 July 1986. Her costs of running the house included interest $30,000, repairs $3000.

On 24 June 2000, she spent $10,000 on legal costs in defending her right to the ownership of the property in opposing the bank’s action to foreclose on the mortgage. On 31 December of the current income tax year, she sold the house for a contract price of $500,000. However, she received only $450,000 of the amount in cash. The balance owing was to be paid by April of the current income tax year. This $50,000, though, remained unpaid as at 30 June, and she could not be bothered pursuing this debt. Her advertising costs on sale were $3000 and the sales commission was $8000.

Practice Problem 31 Calculate the net capital gain or loss (follow the seven steps) for Murry, a resident, who: 1 purchases a second house for $250,000 incurred on 23 June 1988 and sells it for $380,000 on 30 January of the current income tax year; 2 purchases a rare stamp album for $12,000 incurred on 23 July 1989 and sells it for $130,000 on 30 January of the current income tax year; 3 purchases a car for $25,000 incurred on 12 June 1998 and sells it for $13,000 on 30 January of the current income tax year; 4 purchases a guitar for $25,000 incurred on 23 January 1995 and sells it for $9000 on 30 January of the current income tax year; 5 purchases a house in London for $1,250,000 incurred on 23 June 1993 and sells it for $1,680,000

6

7

on 30 January of the current income tax year — the house is not eligible for any capital allowance deductions; purchases a taxi licence for $150,000 incurred on 23 October 1996 and sells it for $80,000 on 30 January of the current income tax year; and purchases a holiday home for $230,000 incurred on 23 June 1985 and sells it for $480,000 on 30 January of the current income tax year.

[page 319]

Practice Problem 32 On 1 July 1988, Wilma acquired a pleasure craft at a contract price of $500,000 for her private use. The stamp duty was $20,000 and the legal costs to purchase were $1000. All of these costs were incurred on 1 July 1988. From 1 July 1988 to 31 December of the current income tax year, she incurs the following costs in keeping the boat: interest $50,000, repairs $100,000. Also, costs of improvements to the boat of $40,000 were incurred on 23 May 1999. At the time of sale, 31 December of the current tax year, advertising costs of $2000 and sales commission of $11,000 were paid. she sold the boat for $700,000. Calculate the capital gain/loss. (Follow the seven steps.)

Attempt the Web Quiz for

Chapter 9

Foreign resident CGT withholding regime 9.136 From 1 July 2016 a new regime came into operation that imposes withholding obligations on the purchasers of certain Australian assets, s 14200(1) in Sch 1 to the TAA 1953. The purpose of the regime is to assist in the collection of foreign residents’ CGT liabilities.

Summary 9.137 Given that appreciation of assets is a major source of Australian wealth, you need to have a good understanding of how CGT works and its exemptions. CGT event A1, ITAA 1997 s 104-10, is the main CGT event, and you need to understand its interaction with capital proceeds rules, cost base rules, exemptions etc. You must go through the seven steps as follows. Step 1: Consider residence Step 2: Must have a CGT event Step 3: Identify the CGT asset Step 4: Is the CGT event/CGT asset exempt? Step 5: Do the special rules apply? Step 6: Calculate the capital gain or capital loss Step 7: Netting the capital gains/losses CGT is generally optional, as a taxpayer must realise an asset to trigger CGT. The 50 per cent individual discount will not always produce the best result; sometimes, you are better off with indexing.

To minimise CGT, deduct capital losses from a non-discount capital gain if there are both non-discount capital gains and discount capital gains. [page 320] Defer capital gains to years of low income. Plan for the CGT implications of buying assets (ie, what holding entity), restructuring businesses and selling businesses. Ensure that assets are kept for 12 months to obtain CGT discounts. Take advantage of the generous main residence exemption and the Div 152 concessions for small business.

Further problems

1 2 3 4

Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. Why is residence important for CGT? a What is a CGT event? b Why is this important? When does, and how does, CGT event A1 apply? What CGT events apply to the following (if any)? If ascertainable, what are the capital proceeds, if any? What types of CGT assets are relevant to the CGT events? a Doug sells shares in Telstra for $500. b Zara immigrates to Australia on 1 October 1994 and becomes a citizen on 1 December 1996. Then, in May of the current income

5

6

7

tax year, she leaves permanently to go to India. She owns a rental house in Bondi. c Eddie receives an antique watch valued at $50,000 from his father for his Christmas present in the current tax year. His father bought the watch in 1992 for $20,000. Classify the following as CGT assets, collectables or PUAs and identify any exemptions that may apply. What CGT events apply (if any)? a A mobile phone in a phone retailer’s shop is sold to a customer. b A mobile phone is used by a plumber — 50 per cent for work use only. c A storm destroys a farmer’s storage shed. d A private (non-business) art collector drops an antique Chinese vase worth $200,000. Classify the following as CGT assets, collectables or PUAs and identify any exemptions that may apply. All assets were acquired after 1985. What CGT events apply (if any)? a A building is sold. b A Holden sedan motor vehicle is stolen. c A radio station licence is purchased. d A 100-year-old bed is exchanged for a new bed. Eric, a resident, acquired the following assets: An antique vase bought on 2 November 1989 for cash $5500 Vacant land purchase contract signed and incurred on 1 August 1989 $100,000 A city car park was acquired as a rental property and the acquisition costs were incurred on 1 October 1999 $250,000 [page 321] The following occurred during the current taxation year.

The antique vase purchased in November 1989 was stolen in June of the last tax year. He received a $2000 insurance payout on 1 April in the current tax year. b He sold the land for $45,000 on 20 June of the current tax year. c He sold the city car park for $300,000 on 30 June of the current tax year. He incurred $10,000 interest, $3000 rates and $4000 in repairs on the property. The old property was not eligible for capital allowance deductions. d On 31 December of the current tax year, he received $12,000 from his neighbour for withdrawing his objection to the council for the building of a second storey onto the neighbour’s residence. No legal costs were involved in the written agreement. Advise Eric of the CGT implications for each of the transactions that occurred in the 30 June tax year. Also, calculate the amount of net capital gain or loss to be included in his assessable income. In answering this question, follow the seven steps and provide all legislative references. Barnie, a resident, acquired the following assets: a

8

Jewellery incurred on 15 November 1989

$18,000

A rental house in Sydney, purchase contract signed and incurred on 1 August 1989

$250,000

2000 shares in BHP for $7 per share incurred on 5 November 1989

$14,000

The following occurred during the current taxation year: a On 1 July of the current tax year, he sold the Sydney rental property for $400,000. He incurred $20,000 interest, $8000 rates and taxes, and repairs of $3000 on the property. In addition, he built an extension costing $40,000 on 23 March 2001. b On 7 September of the current tax year, he sold the jewellery for $40,000. c On 18 August of the current income tax year, he sold all his BHP shares for $9.25 per share less $0.25 per share brokerage. Advise Barnie of the capital gain or loss on each of the above transactions

9 10

11

in the 30 June income tax year. Also, calculate the amount of the net capital gain/loss in the 30 June tax year. In answering this question, follow the seven steps and provide all legislative references. Using the facts in 8 above, what difference would it make if Barnie had a $10,000 prior year capital loss and a $5000 current year capital loss? What modification rules may potentially apply for capital proceeds and cost base to the following. a Shares are sold. b A rare stamp is destroyed in a fire. c A wine business gives up its rights under its exclusive agency agreement to sell ‘Barossa black beast’ wine for $400,000. The business subsequently ceases trading. Sandy acquired the following assets, which were all sold on 30 June of the current tax year. Provide details of the cost base amounts and Section references. [page 322]

INDEXATION FACTOR 1. On I/7/96, acquired rental house for $300,000, including stamp duty of $10,000, all paid for by a loan. The interest on the loan was $30,000 2. On 24/6/91, acquired jewellery for $600 paid for by a loan. The interest on the loan was $100 3. On 4/11/95, acquired a gold-plated dining table for

COST BASE AMOUNTS

COST BASE AND INDEXED COST BASES

$11,000 paid for by a loan. The interest on the loan was $1000 4. On 2/9/96, acquired artwork for $490 paid for by a loan. The interest on the loan was $100

12 13

14

15

16

17

18

Wu, a non-resident, disposes of a residential property located in Sydney. Can she make a capital gain or loss? Brown Pty Ltd made a $69,000 capital gain from the disposal of a house acquired in 1987. The directors of the company lived in the property during this ownership period of the dwelling. Is the main residence CGT exemption available to a company that owns this dwelling? White Pty Ltd has no money and issues shares to the controlling shareholder in return for $1 million cash. However, the market value of the issued shares is $100,000. The shareholder and the company are not dealing at arm’s length. Does the CGT cost base market value substitution rule apply? Mani engaged a consultant to find a suitable rental property and incurred consultancy fees of $500, then, on advice received, purchased a rental property a few months later. Will the fees paid form part of the cost base of the property? Paul hunts for gold nuggets as a hobby (not a business) and finds some nuggets worth $11,000. Are the gold nuggets PUAs for CGT purposes? Nellie owns a rental property. She hired furniture and ornaments as part of her marketing strategy to sell the property. The hire costs total $2000. Can she include the costs of hiring furniture and ornaments used in marketing the property as part of the cost base of the property? Ken has net assets of $2 million and controls three family companies that are connected to him. The companies have a net value of assets of $3.5 million.

Is he eligible for the CGT concessions? [page 323] 19

20

21

22 23

24

25

26

A and B are both partners of A-B Partnership. They do not communicate socially or otherwise talk outside the partnership. Are they small business CGT affiliates under ITAA 1997 Div 152? Sarah has a horse riding business based on land that she has owned for 8 years. She ran the business for 5 years and then agisted the land for 3 years before selling it. Does the land satisfy the active asset test under ITAA 1997 Div 152? Ulma, a resident, has CGT assets with a value of $8 million and liabilities relating to the assets of $2 million and has made provisions for $100,000 of annual leave for her employees, $100,000 for unearned income and $100,000 for tax liabilities for the financial year. Is she eligible for the CGT concessions under ITAA 1997 Div 152? Brad has an advertising business. He also owns an office building, which he rents out. Is the building an active asset under ITAA 1997 Div 152? Mr and Mrs Chen carry on business through a company in which Mr Chen owns 70 per cent of the shares and Mrs Chen the other 30 per cent. Mrs Chen sells her shares. Can she claim ITAA 1997 Div 152 relief? Dan is a dentist and sells a building acquired in 2000, which he has used as his workplace for the last 7 years, for a $600,000 capital gain. Calculate his net capital gain (ie, apply exemptions). Bella purchases a rental property and engages a licensed builder to prepare a building inspection report on the property. The report cost $500. Are costs incurred by Bella for the building inspection report deductible under ITAA 1997 s 8-1 or do they form part of the CGT cost base? Terri owns a rental property acquired in 1999. The electricity supply to

the property was converted from overhead mains to underground power. She contributed to this work by paying the local council a levy. The property was sold in the current income year with its underground power. Does the underground power levy paid by Terri form part of the cost base of the taxpayer’s property under ITAA 1997 s 110-25(5)? 27

28

29

Ben acquired a rental property in 2001 but, as a result of a court judgment with the local council, the property was forfeited under a state law. The property vested absolutely in the state on the making of the forfeiture order. Is the forfeiture of a property a disposal of a CGT asset? Henry is a resident of Australia for tax purposes and he served in the US spy corps during World War II. He received an ex gratia lump sum payment of $100,000 from the US Government. The lump sum payment is tax free in the US. The lump sum was paid in recognition of the fact that he was not entitled to war benefits that were generally paid to the armed forces. The amount of the payment also depended on the length of the taxpayer’s service in the merchant navy. Will Henry make a capital gain or capital loss on receipt of this ex gratia lump sum payment? Shelly purchased a dwelling in 1986 and then demolished the dwelling and subdivided the land into two blocks. Prior to the demolition, she obtained a valuation of the land and dwelling by a registered valuer. In 2001, she constructed two new dwellings on [page 324]

30

the land and lived in one and rented out the other. The rental property was sold in the current income year. Do the costs of demolition form part of the cost base of the CGT asset? Blue Pty Ltd acquired shares in a company in 1995 and sold them for $2 million in the current income year. In 1995, Blue was invoiced by its

31

legal advisers for services to acquire the shares. The invoices were paid by BIG Ltd on behalf of its subsidiary, Blue. Blue reimbursed BIG in 2001 for this payment by way of a journal entry. Can Blue Pty Ltd index these incidental costs relating to the acquisition of shares during 1995? Lilly entered into an oral supply agreement with Baz to supply sand. The agreement represented the whole business carried on by Lilly. The agreement was terminated and an amount of $30,000 was paid for the cancellation of the agreement after a few years. Lilly accepted the payment, signed a Deed of Release (not to sue) and thus lost her rights under the agreement. She was also put out of business by the cancellation of the agreement. Does CGT apply?

1.

Justice Graham Hill commenting on the former CGT provisions: ITAA 1936 s 160M(6) and (7) in FCT v Cooling 90 ATC 4472 at 4488: ‘While both subsections present difficulties of construction, the former is drafted with such obscurity that even those used to interpreting the utterances of the Delphic oracle might falter in seeking to elicit a sensible meaning from its terms.’

2.

3.

Institute of Chartered Accountants Australia, Connect with your peers (), citing Professional Indemnity Underwriting Manager for Vero Insurance. ss 855-15, 855-20.

4. 5.

ss 110-40(3), 110-43(3), 110-45(3). These provisions replaced ITAA 1936 s 160M(6) and (7), commonly known as the ‘terrible twins’.

6. 7.

ATO, Tax Determination TD 2014/26. s 152-10(1)(a)–(b).

8. 9.

s 152-10(4). The active asset requirement (see step 3 below) also would not normally be met with CGT event D1.

10. s 152-12. In ATO ID 2004/391, the CGT concessions applied to a capital gain from granting a carbon sequestration right. 11. ATO ID 2004/650. 12. ATO NTLG CGT Sub-committee minutes August 2002. 13. s 152-80. 14. s 152-10(1)(c)(i). This SBE test applies only to CGT events happening after 30 June 2007. 15. s 152-10(1)(c)(iii).

16. s 152-10(1)(c)(iv). A transitional rule prevents taxpayers from becoming ineligible for the concessions for CGT events occurring prior to 19 March 2009, as a result of the June 2009 amendments to the affiliate rule and its retrospective application. 17. s 152-10(1A). 18. s 152-10(1B). 19. s 152-10(1A). 20. s 152-10(1B). 21. s 152-48. 22. s 152-48. 23. For 2006-07 and prior years, a ‘small business CGT affiliate’ included a spouse or child. From 2007–08, a spouse and child are no longer automatic affiliates. 24. s 152-47(1). 25. ATO, ‘Advanced Guide to Capital Gains Tax Concessions for Small Business 2010–11’ , 22. 26. Above n 25. 27. See n 25. 28. s 152-15. 29. See s 152-20 for the net value of the CGT assets; see s 328-125 for when an entity is connected with another entity; see s 328-130 for what constitutes an affiliate. 30. s 152-20. 31. s 152-20(2)(a). 32. s 152-20(2)(b). 33. s 152-20(3). 34. s 152-35(1). 35. The relevant period begins when the asset is acquired and ends the earlier of the CGT event and, if the cessation of the business is 12 months prior to that time, any longer period that the Commissioner allows: s 152-35(2). 36. The meaning of ‘affiliate’ and ‘connected taxpayer’ was explained in Chapter 5. 37. s 152-10(2). 38. s 152-60. 39. s 152-55 40. s 152-65 41. s 152-70 42. Above n 25. 43. ss 152-75(1)(a), 152-70. 44. s 152-75(1)(b). 45. s 152-75(2). 46. ss 152-105–152-110. 47. Above n 25. 48. s 152-105(d).

49. s 152-115. 50. s 152-205. 51. s 152-215. 52. s 152-305(1). 53. s 152-305(2). 54. s 152-315(4). 55. s 152-325. 56. s 152-330. 57. ss 152-410–152-415. 58. ITAA 1997 s 110-25(5). 59. s 152-430. 60. Division 138 applied where CGT assets were transferred or created at less than market value. Division 139 applied to value shifting through debt forgiveness. Division 140 basically applied where value was shifted between share and similar interests in a company. However, these measures provided only limited coverage of value shifts. 61. Explanatory Memorandum, New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002, para 7.9. 62. Note that indexing applies only to assets acquired before 21 September 1999 and is frozen to 30 September 1999. 63. Although indexation is not relevant for certain CGT events listed at s 110-10. 64. For exceptions and modifications to these rules, see s 102-30.

[page 325]

10 General deductions Learning Objectives After you have studied this chapter, you should be able to: outline the operation of s 8-1; understand the words and phrases analysis of s 8-1 — the positive limbs; explain the role of sufficient connection in respect of the positive limbs of s 8-1; outline the incidental and relevant test involved in the application of the positive limbs of s 8-1; outline the perceived connection test involved in the application of the positive limbs of s 8-1; outline the essential character test involved in the application of the positive limbs of s 8-1; outline the legal rights approach in respect of the application of the positive limbs of s 8-1; outline the purpose test involved in the application of the positive limbs of s 8-1; identify the leading business cases involving the positive limbs of s 8-1;

understand the words and phrases analysis of s 8-1 — the negative limbs; identify the elements of the negative limbs of s 8-1; identify the leading business cases involving the four negative limbs of s 8-1; distinguish between a deductible and a capital expense; distinguish between a deductible and a private expense; outline the leading employee and investor categories of expenditure and cases involving the first positive limb of s 81; outline the leading business categories of expenditure and cases involving the positive limbs of s 8-1; [page 326] determine whether a particular expense is deductible under s 8-1 (provide full legal reasoning); and understand the interaction of goods and services tax (GST) and income tax deductions.

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Key Legislative Provisions Income Tax Assessment Act 1997 (ITAA 1997) s 4-15 Div 8 Div 26 Div 27

Key Cases AAT Case [2006] AATA 100; (2006) 61 ATR 1192; 2006 ATC 119 Cecil Bros Pty Ltd v FCT (1964) 111 CLR 430 Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344; 11 ATD 147 FCT v Anstis [2009] FCAFC 154 FCT v Brown 99 ATC 4852 FCT v Cooper (1991) FCR 177; 91 ATC 4396 FCT v D P Smith (1981) 147 CLR 578; 11 ATR 538; 81 ATC 4114 FCT v Day [2008] HCA 53 FCT v Edwards (1994) 49 FCR 318; 94 ATC 4255 FCT v Faichney (1972) 129 CLR 38; 72 ATC 4245 FCT v Finn (1961) 106 CLR 60; 12 ATD 348 FCT v Forsyth (1981) 148 CLR 203; 81 ATC 4157 FCT v Hatchett (1971) 125 CLR 494; 71 ATC 4184 FCT v Janmor Nominees Pty Ltd (1987) 19 ATR 254; 87 ATC 4813 FCT v Maddalena 71 ATC 4161; (1971) 2 ATR 541; 45 ALJR 426

FCT v Munro (1926) 38 CLR 153 FCT v Payne (2001) 202 CLR 93; 2001 ATC 4027 FCT v Phillips (1978) 8 ATR 783; 78 ATC 4361 FCT v Roberts and Smith (1992) 37 FCR 246; 92 ATC 4380 FCT v Snowden & Willson Pty Ltd (1958) 99 CLR 431; 11 ATD 463 FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 FCT v Total Holdings (Australia) Pty Ltd (1979) 9 ATR 885; 79 ATC 4279 Fletcher v FCT (1991) 173 CLR 1 Hance v FCT [2008] FCAFC 196 Hayley v FCT (1958) 100 CLR 478; 11 ATD 404 Herald & Weekly Times v FCT (1932) 48 CLR 113; 2 ATD 169 John Fairfax & Sons Pty Ltd v FCT (1959) 101 CLR 30; 11 ATD 510 La Rosa v FCT 53 ATR 1; [2003] FCAFC 125 Lodge v FCT (1972) 128 CLR 171; 72 ATC 4174 Lunney v FCT; Hayley v FCT (1958) 100 CLR 478 [page 328] Lyons v FCT 99 ATC 2258 Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276; 80 ATC 4542 Mansfield v FCT 96 ATC 4001 Ronpibon Tin NL v FCT; Tongkah Compound NL v FCT (1949) 78 CLR 47 Softwood Pulp & Paper Ltd v FCT (1976) 7 ATR 101; 76 ATC 4439 Spassked Pty Ltd v FCT (2003) 52 ATR 337; 2003 ATC 4184; [2003] FCAFC 282 Spriggs v FCT; Riddell v FCT 2009 ATC 20-109; [2009] HCA 22 Steele v FCT (1999) CLR 459; 99 ATC 4242 Tabone and FCT, Re AAT Case 2006 ATC 2211; (2006) 62 ATR 1210; [2006] AATA 466

Ure v FCT 81 ATC 4100 W Nevill & Co Ltd v FCT (1937) 56 CLR 290; 4 ATD 187 W D & H O Wills (Australia) Pty Ltd v FCT (1996) 65 FCR 298; 96 ATC 4223 Revenue v capital Anovoy Pty Ltd v FCT 2001 ATC 4197 FCT v Anovoy Pty Ltd [2001] FCA 447 Austnet Transmission Group Pty Ltd v FCT [2015] HCA 25 BP Australia v FCT (1965) 112 CLR 386 British Insulated & Helsby Cables v Atherton (1926) 10 TC 155 Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423 Case 51/93 93 ATC 542 Cliffs International Inc v FCT (1979) 142 CLR 140 Colonial Mutual Life Assurance Society Ltd v FCT (1953) 73 CLR 604 FCT v Citylink Melbourne Ltd [2006] HCA 35 Hallstroms Pty Ltd v FCT (1946) 72 CLR 634; 8 ATD 190 Mount Isa Mines Ltd v FCT (1992) 176 CLR 141; 92 ATC 4755 Pine Creek Goldfields Ltd v FCT (1999) 42 ATR 758; 99 ATC 4904 Sun Newspapers Ltd v FCT (1938) 61 CLR 337 The Broken Hill Pty Co Ltd v FCT [1999] FCA 1628; 99 ATC 5193 Tyco Australia Pty Ltd v FCT [2007] FCA 1055 VBI and FTC, Re AAT Case [2005] AATA 683; (2005) 59 ATR 1197; 2005 ATC 193

Key ATO Publications TR 92/8 Income tax: deductibility of self education expenses TR 93/30 Income tax: deductions for home office expenses TR 94/22 Income tax: implications of the Edwards case for the deductibility

of expenditure on conventional clothing by employees TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith TR 95/33 Income tax: subsection 51(1) — relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings [page 329] TR 98/9 Income tax: deductibility of self-education expenses incurred by an employee or a person in business TR 2002/18 Income tax: home loan unit trust arrangement Deductions essentials

Diagram 10.1:

Deductions general

Chapter overview 10.1 Deductions form the second half of the equation used to calculate taxable income; that is, Taxable income = Assessable income – Deductions: see ITAA 1997 s 4-15. There are two types of deductions: general deductions and specific deductions. General deductions are [page 330]

basically expenses that have sufficient connection with the earning of assessable income and are not of a capital or private nature, do not relate to exempt income and are not otherwise specifically denied as deductions. The general deductions provision, ITAA 1997 s 8-1 (along with s 6-5), is one of the central provisions of the ITAA 97. However, parliaments have progressively amended the scope of the general deductions framework via a plethora of specific deductions and limiting provisions. This chapter adopts a twopronged analysis of s 8-1: first analysing the words and phrases of the section and then categorising expenses as non-business/business expenses. This chapter examines the second stage in determining deductions: see Chapter 5 for the accounting rules that apply. DEDUCTIONS METHOD Chapter 5

What tax accounting rules apply?

This chapter — Is the loss or outgoing a general deduction? Chapter 11

Is the loss or outgoing a specific deduction (excluding capital allowances)?

Chapter 12

Do any of the deduction limitations apply?

Chapter 13

Is the loss or outgoing a capital allowance?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the expense is deductible

Words and phrases analysis of ITAA 1997 s 81 10.2 ITAA 1997 s 8-1 (like its predecessor ITAA 1936 s 51(1)) is drafted in general terms so as to deal with the myriad situations in which expenses arise in the economy. However, the apparent simplicity of the words and phrases in

the section belies its complexity, as can be seen in the enormous amount of case law that tests the limits of the meaning of both the individual words and the phrases. Section 8-1 consists of two positive limbs, Subs (1)(a) and (b), and four negative limbs, Subs (2)(a)–(d). POSITIVE LIMBS Section 8-1(1): You can deduct any loss or outgoing that: a b

is incurred in gaining or producing your assessable income; and is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

[page 331]

NEGATIVE LIMBS Section 8-1(2): Exclusions to the extent that: a b

it is a loss or outgoing of capital or of a capital nature; it is a loss or outgoing of a private or domestic nature;

c

it is incurred in relation to gaining or producing your exempt income or non-assessable non-exempt income; and a provision of this Act prevents you from deducting it.

d

Read ITAA 1997 s 8-1 Thus, working out whether an expense is deductible under s 8-1 requires a two-step process. First, does the expense satisfy the positive limbs? Second, do any of the negative limbs deny the expense? This chapter seeks to analyse the following words and phrases that make up s 8-1. In both positive limbs in s 8-1(1): ‘any loss or outgoing’; ‘to the extent that’;

‘incurred’; ‘in gaining or producing’; ‘your assessable income’; and sufficient connection between the ‘loss or outgoing’ and ‘the assessable income’. In the second positive limb in Subs (1)(b): ‘necessarily incurred’; ‘carrying on a business’; and ‘purpose’ — although this appears only in the second positive limb in Subs (1)(b), the courts have used this test in both positive limbs in s 81(1). In the negative limbs in s 8-1(2): ‘to the extent that’; ‘of capital, or of a capital nature’; ‘private or domestic nature’; ‘incurred in earning exempt income’; and ‘a provision of this Act prevents you from deducting it’ (see, in particular, Div 26).

Words and phrases analysis step 1: the positive limbs of s 8-1 10.3 While this analysis focuses on the words and phrases of s 8-1, it is emphasised that the main area of concern usually involves whether there is sufficient connection between the loss or outgoing and the assessable income. [page 332]

Relationship between the first and second limbs: s 8-

1(1)(a)–(b) 10.4 The first and second positive limbs are not mutually exclusive, as they are linked by the conjunction ‘or’. Thus, they are alternatives. The first positive limb is available to all taxpayers, while the second limb is available only to business taxpayers. Ronpibon Tin NL v FCT; Tongkah Compound NL v FCT (1949) 78 CLR 47, a leading High Court case on s 8-1, viewed both limbs as covering similar ground. However, some commentators consider that the second limb has a wider operation. This chapter will first deal with the common elements of both limbs; then it will examine the operation of the first and second limbs.

Common elements of the two positive limbs of s 8-1 ‘any loss or outgoing’ 10.5 The meaning of ‘any loss or outgoing’ was examined in Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295, where (in respect of the 1922 Tax Assessment Act) Latham CJ said at 303: ‘losses and outgoings … be read as meaning that the outgoings must be an expenditure which has an effect in gaining or producing income’. Also, in FCT v Ilbery (1981) 12 ATR 563, Toohey J at 569 stated: ‘“outgoings”… it suggests something paid out, something that has left the hands of the taxpayer’. On the other hand, a loss can be different from an outgoing. See Charles Moore and Co v FCT (1956) 95 CLR 344. ‘incurred’ 10.6 Timing of an expense is an important issue, since it governs the tax year when a deduction can be claimed. The issue is not that the expense is deductible but rather when it is deductible. Thus, this is a very important matter for tax planning. Timing of deductions is examined in Chapter 5. ‘in gaining or producing’ 10.7 The meaning of these words was considered in Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295, where Dixon J said that ‘in gaining

or producing’ is to be read as ‘in the course of gaining or producing’ and that this ‘looks rather to the scope of the operations or activities and the relevance thereto of the expenditure than to the purpose in itself’. In Ronpibon Tin NL v FCT; Tongkah Compound NL v FCT (1949) 4 AITR 236 at 245, the High Court observed: In brief substance, to come within the initial part of the subsection it is both necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.

The majority of the High Court in FCT v Day [2008] HCA 53 appears to have employed a broad scope for deductions under s 8-1; that is, what is ‘in the course of income production’ may be widened. Expenses that are not the result of the day-to-day business activities or work may have sufficient nexus to the production of assessable income to be allowable deductions. As discussed below, in Day (see 10.30), legal expenses incurred by a public [page 333] servant in defending improper conduct charges in respect of his private life were deductible. The High Court found that the words ‘in the course of’ in ITAA 1997 s 8-1(1)(a) did not require a direct nexus between an expenditure and the activity that produced the assessable income. An indirect nexus was sufficient, as long as it was not too remote. ‘your assessable income’ 10.8 No deduction is allowable for expenditure incurred by one taxpayer to generate income for another taxpayer. FCT v Munro (1926) 38 CLR 153 Facts: The taxpayer owned a rental property that was leased to tenants. He borrowed money to acquire shares in a company for his family members and also to make an interest-free loan to the

company. The loan was secured by a mortgage over the rental property. He claimed a deduction for interest on the loan on the basis that the security on the loan was the rental property and it was necessary to pay interest on the loan to retain that rental property to continue to generate assessable income. High Court held: Expenses were not deductible, because he did not borrow money for the purpose of producing assessable income but to produce assessable income for family members by way of the shares and the company with the interest-free loan. The security given for the loan is irrelevant in determining whether interest on the loan is deductible.

Practice Problem 1 Can Orange Pty Ltd deduct the following expense? An employee of Orange Pty Ltd pays the fuel expenses for his business work vehicle and forgets to claim reimbursement. Are the fuel expenses deductible to Orange Pty Ltd? ‘to the extent that’ (apportionment) 10.9 It is clear that s 8-1(1) contemplates apportionment. In Ronpibon Tin, the High Court found that management expenses must be apportioned in determining deductions. Ronpibon Tin NL v FCT; Tongkah Compound NL v FCT (1949) 78 CLR 47 Facts: The taxpayer was a mining company with operations in Malaysia but could not operate the mine during the war. During this

time, its income consisted of investments, but it still claimed all management and office expenses in respect of the mine. The Commissioner viewed that only 2.5 per cent of the expenses were deductible. High Court held: The court returned the case to the trial judge to determine what proportion of the expenses was deductible but found that 2.5 per cent was inappropriate. Thus, expenses must be apportioned in a fair and reasonable way. In Ronpibon Tin, Latham CJ, Rich, Dixon, McTiernan and Webb JJ stated: For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end … (56, 57)

[page 334] The question of fact is therefore to make a fair apportionment to each object of the company’s actual expenditure where items are not in themselves referable to one object or the other (at 60).

See also Ure, another leading case on apportionment. Ure v FCT 81 ATC 4100 Facts: The taxpayer lawyer borrowed funds from a bank at 12 per cent and on-lent to a family trust at 1 per cent. The Commissioner argued that only 1 per cent was deductible; the taxpayer needed to apportion expenses. Federal Court held: Interest was deductible up to 1 per cent only. There was an ‘air of unreality about the situation’. The predominant purpose was of a private or domestic nature. A taxpayer’s indirect objects or motives can be relevant to characterise the nature of the expense. The courts have used various methods to apportion a deduction. For

example: according to various types of income earned (ie, part assessable and exempt); distance — kilometres (car expenses); time spent (legal fees charged on an hourly basis); floor area (ie, home business); interest expense (business and non-business loan); and travel expenses (part business, part private).

Sufficient connection of losses and outgoings and assessable income 10.10 The central issue in s 8-1 usually involves whether there is sufficient connection between the loss or outgoing and the production of assessable income. The courts have attempted to paraphrase the words of the positive limbs to determine the degree of connection required, although you must be careful in applying such tests without due regard to the words of s 8-1. The following tests have been adopted by the courts. Incidental and relevant test 10.11 The loss or outgoing must be ‘incidental and relevant’ to incomeproducing activities, as seen in Ronpibon Tin, where the court held that an expense will be deductible only if it is incidental and relevant to gaining or producing assessable income. While this phrase ‘incidental and relevant’ is often repeated in case law, it raises the question, what is ‘incidental and relevant’? Thus, this test appears to be of little assistance in determining whether there is sufficient connection. Essential character test 10.12 The ‘essential character’ of the loss or outgoing must be of a work or business nature, as demonstrated in Lunney v FCT.

[page 335]

Lunney v FCT; Hayley v FCT (1958) 100 CLR 478 Facts: A shipping employee claimed a deduction for travelling 14 miles from home to work. Court held: Not deductible, because it was not business expenditure, just a consequence of living in one place and working in another. The court considered that whether expenditure is deductible depends on the essential character of the expenditure. The expenditure has no attribute capable of giving it the colour of a business expense; it is a necessary consequence of living in one place and working in another. Once again, the words ‘essential character’ are often cited in case law, which then raises the question, what is ‘essential character’? The perceived connection test 10.13 FCT v Hatchett 71 ATC 4184 asserted that there must be a perceived connection between the outgoing and the assessable income. However, a taxpayer and the Commissioner may well perceive this connection somewhat differently. What precisely is a ‘perceived connection’? Legal rights view 10.14 In the past, Australian courts have enforced a taxpayer’s legal rights;1 that is, they have focused on whether a taxpayer is entitled to a deduction if the expense is incurred (form), rather than on the substance of the transaction (ie, whether the expenses are commercially realistic or reasonable). Cecil Bros Pty Ltd v FCT (1964) 111 CLR 430 Facts:

A

shoe

retailer

purchased

stock

from

independent

wholesalers. Then it introduced an associated company, B, to purchase stock from the wholesaler and on-sell to the taxpayer with a mark-up of 10 per cent. The aim was to provide for family members who were shareholders of B. Court held: Deductible, as the expenditures were made for the purpose of acquiring trading stock.

FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 Facts: The taxpayer paid annual rent of 10 per cent of the capital cost of a factory to a housing trust. The housing trust had a deal with the taxpayer’s parent that it would erect a factory and the parent or its nominee would rent back the factory for 16 years at 10 per cent of the cost of the factory with an option to purchase the factory at the value of the housing trust’s unrecouped costs in building the factory. The taxpayer claimed the rent deductions until an associate of the parent took up the option to purchase the factory. High Court held: Expenses deductible, as the only legal rights obtained by the taxpayer as a result of the payments were rights as a lessee.

[page 336] Cecil Bros essentially involved the transferring of profits to other family members. In substance, the payments in South Australian Battery Makers were instalments of a capital asset. Thus, this test is not appropriate, as it will lead to artificial deductions. While it is doubtful that the courts would now take such a legal rights stance, Phillips still provides authority for professional tax planning and thus supports the legal rights view. Consequently, service trusts are very popular today among professional firms.

FCT v Phillips (1978) 8 ATR 783; 78 ATC 4361 Facts: The taxpayer was a partner of an accounting partnership. The partnership established a service trust, which held the office furniture and equipment and managed the office employees for the partnership. The mark-up on the staff costs and the leasing fees was commercially realistic. The Commissioner viewed this as tax evasion. Federal Court held: Expenses deductible: see Cecil Bros above. The rates charged were commercially realistic and services provided were essential to the conduct of the business. If payments were not realistic, there would be a dual purpose and deductions limited accordingly. The purpose test 10.15 While ‘purpose’ appears only in the second positive limb, the courts’ interpretation has implied a role for purpose in both positive limbs. This test looks at the substance (rather than the form) of the transaction to see whether there is sufficient connection between the expense and the income. Hallstroms Pty Ltd and Magna Alloys are leading cases. Hallstroms Pty Ltd v FCT (1946) 72 CLR 634; 8 ATD 190 Facts: A manufacturer of fridges incurred legal expenses in opposing the extension of a patent. That patent was for a model of fridge that was far superior to those made by the taxpayer and was owned by a competitor. High Court held: The legal costs were deductible, not capital, in nature. The majority held that the expenses were incurred to enable the taxpayer to carry on business in the same way it had always done in the past. Also, the court found that the expenses were not incurred in obtaining anything that the taxpayer did not otherwise have or could otherwise get; they were incurred with the taxpayer staying in the same position.

In a dissenting judgment, Dixon J found that unless the taxpayer was able to manufacture a superior fridge, it would have had to cease business or get involved in manufacturing a different product altogether. The expenses were incurred in relation to the taxpayer’s profit-yielding structure, thus were capital.

Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276; 80 ATC 4542 Facts: The taxpayer claimed legal expenses paid on behalf of directors in defending criminal charges. The charges related to the company’s practice of making gifts to customers, including gifts to employees of government departments. Federal Court held: Deductible under the second limb. There are two tests: (1) the outgoing being reasonably seen as desirable or appropriate to pursue the business ends of the [page 337] business (determined objectively) and (2) if so, whether the person carrying on the business so saw it (subjective): The controlling factor is that, viewed objectively, the outgoing must, in the circumstances, be reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income. Provided it comes within that wide ambit, it will, for the purposes of sec 51(1), be necessarily incurred in carrying on that business if those responsible for carrying on the business so saw it: at 4559, per Deane and Fisher JJ.

In accordance with Ure (where a taxpayer’s indirect objectives or motives were relevant to characterise the nature of the expense), and in Fletcher and Spassked, the courts have taken a harder line on tax avoidance and adopted a purposive approach to s 8-1.

Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276; 80 ATC 4542 Facts: The taxpayer claimed legal expenses paid on behalf of directors in defending criminal charges. The charges related to the company’s practice of making gifts to customers, including gifts to employees of government departments. Federal Court held: Deductible under the second limb. There are two tests: (1) the outgoing being reasonably seen as desirable or appropriate to pursue the business ends of the business (determined objectively) and (2) if so, whether the person carrying on the business so saw it (subjective): The controlling factor is that, viewed objectively, the outgoing must, in the circumstances, be reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income. Provided it comes within that wide ambit, it will, for the purposes of sec 51(1), be necessarily incurred in carrying on that business if those responsible for carrying on the business so saw it: at 4559, per Deane and Fisher JJ.

In Fletcher, Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ stated at 4957: Two introductory points should be made about s 51(1). The first is that, as the words ‘to the extent to which’ make plain, the subsection contemplates apportionment. In their joint judgment in Ronpibon Tin NL v FCT; Tongkah Compound NL v FCT (1949) 78 CLR 47 at 59; 4 AITR 236, Latham CJ, Rich, Dixon, McTiernan and Webb JJ pointed out that there are at least two kinds of outgoings which require apportionment for the purposes of the subsection: One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. As their Honours also pointed out, supra, what represents the appropriate apportionment in the case of such items of expenditure is essentially a question of fact. The second introductory point to be made about s 51(1) is that the reference in it to the assessable income is not to be read as confined to ‘assessable income’ actually derived in the particular tax year. It is to

[page 338]

be construed as an abstract phrase which refers not only to assessable income derived in that or in some other tax year but also to ‘assessable income’ which the relevant outgoing ‘would be expected to produce’, supra, at 57; see also AGC (Advances) Ltd v FCT (1975) 132 CLR 175 at 196–7; 5 ATR 243; 5 ALR 108; FCT v Riverside Road Lodge Pty Ltd (in liq) (1990) 23 FCR 305 at 311–12; 21 ATR 499; John v FCT (1989) 166 CLR 417 at 426; 20 ATR 1. It is commonly possible to characterise an outgoing as being wholly of the kind referred to in the first limb of s 51(1) without any need to refer to the taxpayer’s subjective thought processes. That is ordinarily so in a case where the outgoing gives rise to the receipt of a larger amount of assessable income. In such a case, the characterisation of the particular outgoing as wholly of a kind referred to in s 51(1) will ordinarily not be affected by considerations of the taxpayers’ subjective motivation. If, for example, a particular item of assessable income can be earned by making a lesser outgoing in one of two possible ways, one of which is a loss or outgoing of the kind described in s 51(1) and the other of which is not, it will ordinarily be irrelevant that the taxpayer’s choice of the method which was tax deductible was motivated by taxation considerations or that the non-deductible outgoing would have been less than the deductible one. In such a case, the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterise the whole outgoing as one which was incurred in gaining or producing assessable income. If the outgoing can properly be wholly so characterised, it is not for the court or the Commissioner to say, how much a taxpayer ought to spend in obtaining his income, but only how much he has spent: see eg, Ronpibon Tin, supra, at (CLR) 60; Cecil Bros Pty Ltd v FCT (1964) 111 CLR 430 at 434; 8 AITR 523; 9 AITR 246. The position may, however, be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterisation of the outgoing for the purposes of the subsection by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing: see eg, Robert G Nall Ltd v FCT (1937) 57 CLR 695 at 699–700, 706, 708–9, 712–13; 1 AITR 169. Where that is so, it is a ‘commonsense’ or ‘practical’ weighing of all the factors which must provide the ultimate answer: see eg, BP Australia Ltd v FCT [1966] AC 224 at 264; 112 CLR 386; 9 AITR 615; Hallstroms Pty Ltd v FCT (1946) 72 CLR 634 at 648; 3 AITR 436; FCT v Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278 at 285, 293; 11 ATR 859; 35 ALR 1. If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterised as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51(1) unless it is either somehow excluded by the exception of ‘outgoings of capital, or of a capital, private or domestic nature’ or incurred in relation to the gaining or production of exempt income. If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterised by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary.

[page 339]

Spassked Pty Ltd v FCT (2003) 52 ATR 337; 2003 ATC 4184; [2003] FCAFC 282 Facts: The taxpayer claimed an interest deduction from a loan from IEF, a finance company. IEF and the taxpayer were part of the company group. The funds were used to subscribe to shares in a subsidiary, GIH. As a result of the loan, the taxpayer incurred losses, which it transferred to other companies under s 80G. The Commissioner disallowed the deduction for $932 million as not allowable under ITAA 1936 s 51 (now ITAA 1997 s 8-1) or ITAA 1936 Pt IVA. The taxpayer argued that the amounts were deductible, as it received a $43 million dividend in respect of the restructuring. Federal Court held: The interest was not deductible under s 51(1), as the subjective purpose of the arrangement was not to incur interest expense to gain assessable income, as seen by the minimal amount of dividends, per Fletcher v FCT (1991) 22 ATR 613. The dividends were paid to create an appearance, as following the arrangement the taxpayer’s income growth did not meet the directors’ projections. Spassked and Fletcher provide authority that if expenses are less than income, then there is no need to consider a taxpayer’s purpose; otherwise, purpose will need to be considered. Also, Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344 provides authority that a taxpayer’s purpose is irrelevant if expenses are involuntary (this case involved the deductibility of losses incurred from the theft of takings — finding that the stolen takings were deductible). Overall, though, the purpose test is very important (for voluntary expenses), given that it is widely applied and since it complies with sound tax policy principles for deductible expenses. Taxation Ruling TR 95/33 provides guidance for using objective and subjective purpose tests to characterise expenditure under s 8-1. Determining

the objective purpose of expenditure is generally used in any of the following situations: where the outgoing is involuntary (ie, it is commercially necessary); where there is a clear connection between the nature and scope of the taxpayer’s income-producing activities and the outgoing; where the level of the outgoing is commercially realistic; and where the assessable income derived from the outgoing exceeds the amount of the outgoing. Determining the subjective purpose of expenditure is generally used in any of the following situations: where the outgoing produces no assessable income; where the outgoing produces an amount of assessable income that is less than the outgoing; and where there is no clear connection between the nature and scope of the taxpayer’s income-producing activities and the outgoing. [page 340]

Practice Problem 2 Parkside Café incurs the below expenses. The café makes a $200,000 profit. In establishing the purpose of the expenditure, should an objective or subjective purpose be used? 1 $300,000 in award wages for kitchen staff and $100,000 above-award wages paid to a relative for some part-time bookkeeping work 2 rent for shop 3 interest on a business loan to purchase a pizza oven 4 interest on a loan to purchase an interest in a forest

plantation — the plantation produces no income in the year

Read TR 95/33 Practice Problem 3 In determining whether there is sufficient connection between the loss or outgoing and the production of assessable income, what approaches are courts likely to take?

Necessarily incurred 10.16 The initial question is, whether the word ‘necessarily’ restricts the operation of the second positive limb? There must be sufficient connection between the loss or outgoing and the production of assessable income, but the word ‘necessarily’ does not really limit the operation of the second limb, as found in Ronpibon Tin NL v FCT (1949) 8 ATD 431 at 435. The word ‘necessarily’ no doubt limits the operation of the alternative, but it is probably intended to mean no more than ‘clearly appropriate’ or ‘adapted for’. The word ‘necessarily’ has not narrowed the operation of the second limb; it only looks to commercial necessity. Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276; 80 ATC 4542 Full Federal Court held: The controlling factors for business deductions are: 1 the outgoing must be reasonably seen as desirable or appropriate to pursue the business ends of the business (determined objectively);

if so, whether the person carrying on the business so saw it (subjective). (This case provides authority that the courts will take a broad approach to ‘necessarily incurred’, given the two purpose tests that were developed.) 2

[page 341]

W Nevill & Co Ltd v FCT (1937) 56 CLR 290; 4 ATD 187 Facts: The taxpayer instituted a system of joint management, but the two-manager system was not successful and the company paid a lump sum of £2500 to one of the managers for agreeing to cancel his contract. This resulted in a salary saving, lower costs and improved efficiency, thereby increasing assessable income. Were the expenses necessary? High Court held: Expenses were deductible under the first limb. The character can be determined only by the purpose of the expenditure, which is to improve the business and to increase the income-producing capacity of the taxpayer.

FCT v Snowden & Willson Pty Ltd (1958) 99 CLR 431; 11 ATD 463 Facts: The taxpayer builder incurred expenses in responding to adverse publicity that it had received. This involved placing newspaper advertisements and legal costs for representation at a Royal Commission that had been appointed to inquire into the taxpayer’s activities. Was it necessary? High Court held: Expenses were deductible under the second limb,

as it was reasonable for the taxpayer to counter adverse publicity so it could sustain its business and continue to carry it on in the same way.

W D & H O Wills (Australia) Pty Ltd v FCT (1996) 65 FCR 298; 96 ATC 4223 Facts: The taxpayer carried on the business of manufacturing and marketing tobacco products. It was unable to obtain insurance cover against the health risks arising from the consumption of its products, and so it decided to set up a wholly owned subsidiary to provide such cover. The subsidiary was incorporated in Singapore and was managed by a third-party management company. Singapore was selected, as it offered good communication and other facilities, a choice of firms to provide management, reasonable cost levels, concessional tax rates, freedom from exchange controls and other investment opportunities. The subsidiary made substantial profits because no claims were made by the taxpayer under the insurance policies. The taxpayer claimed a deduction for premiums paid to the Singaporean subsidiary (about $4 million per annum for 4 years). Were the expenses necessary? Federal Court held: Insurance was deductible under the second limb. The insurance was intended and did provide cover against major risks arising out of the taxpayer’s business, and the risks insured against went to the very heart of that business. The absence of cover through the open market created a need and therefore a clear connection between premiums and the taxpayer’s business. Although the premiums were substantial and paid to a related company, they were not unreasonable for the cover obtained. The taxpayer had valid commercial reasons for establishing a subsidiary to provide that cover. Thus, the court concluded that, viewed objectively, the premiums were seen to be desirable or appropriate and were seen to be that way by the taxpayer.

[page 342] ‘carrying on a business’ 10.17 The second limb mandates that a taxpayer must be carrying on a business. The question of whether a business is being carried on is discussed in Chapter 6.

No symmetry between deriving income and incurring a deduction 10.18 An important aspect of s 8-1 is that it provides no symmetry between deriving income and incurring a deduction. In other words, a receipt could be income in the hands of a payee regardless of whether it is a capital expense of the payer: see FCT v Rowe (1997) 35 ATR 432 at 446; GP International Pipecoaters Pty Ltd v FCT (1990) 21 ATR 1 at 6.

Words and phrases analysis step 2: the negative limbs of s 8-1 10.19 (a) (b) (c)

Subsection 8-1(2) excludes expenses to the extent that: it is a loss or outgoing of capital, or of a capital nature; or it is a loss or outgoing of a private or domestic nature; or it is incurred in relation to gaining or producing your exempt income …; or (d) a provision of this Act prevents you from deducting it.

Capital or capital nature 10.20

Expenses of capital or of a capital nature are not deductible, as

opposed to expenses of a revenue nature. The issue is a constant one for the courts: Ausnet Transmission Group Pty Ltd v FCT [2015] HCA 25. The High Court held that licence fees paid to the State Government were designed to ensure that the taxpayer would achieve an acquisition of a transmission licence. On that basis, the expenditure was of a capital nature. The courts have had substantial difficulties in determining what constitutes capital, but they have formulated the following guidelines.

Once and for all test 10.21 In Vallumbrosa Rubber Co Ltd v Farmer (1910) 5 TC 529 at 536, Lord Dunedin asserted that ‘capital expenditure is a thing that is going to be spent once and for all, and income expenditure is a thing that is going to recur every year’. In that case, the taxpayer was allowed deductions of the annual maintenance expenses on a rubber tree plantation, even though only oneseventh of the trees were producing rubber at any one time.

Enduring benefit test 10.22 This important test has prevailed since the leading UK case, British Insulated & Helsby Cables v Atherton. [page 343]

British Insulated & Helsby Cables v Atherton (1926) 10 TC 155 Facts: The taxpayer contributed £30,000 for a staff pension fund. House of Lords held: Not deductible but capital, as it brought into existence an asset with enduring benefit.

Fixed v circulating capital

10.23 Expenditure that produces fixed capital is of a capital nature (eg, machinery) and expenditure producing circulating capital is of a revenue nature (eg, wages) and is thus deductible.

Business entity test 10.24

The leading Australian test was formulated in Sun Newspapers. Sun Newspapers Ltd v FCT (1938) 61 CLR 337

Facts: The taxpayer paid a lump sum in instalments over a 3-year period to a competitor, in consideration for the competitor not being associated with the production of a daily paper within 300 miles of Sydney. High Court held: The lump sum was not deductible; it was capital in nature. Dixon J provided three tests (at 363): a

the character of the advantage sought, and in this its lasting qualities may play a part

b

the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

c

The High Court has confirmed the approach adopted in Sun Newspapers numerous times, including in Hallstroms; South Australian Battery Makers; Snowden & Willson; John Fairfax & Sons; Broken Hill Theatres; and Charles Moore & Co. Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423 Facts: Legal expenses incurred by the taxpayer in successfully opposing the grant of a cinema licence to a potential competitor. High Court held: Legal expenses were not deductible; they were

capital in nature because the expenses related to the profit-yielding structure of the business. In Broken Hill Theatres, Dixon CJ, McTiernan, Fullagar and Kitto JJ stated: On the strength of these facts it was argued that the business of the taxpayer company at Broken Hill was of a special character and that the opposing of such applications ought to be regarded as an ordinary incident of the carrying on of such a business from year to year. The recurrent character of expenditure has been said more than once to be an element which may throw light on the question whether that expenditure is or is not an outgoing of a

[page 344] capital nature. But, in our opinion, the expenditure in the present case cannot be regarded as ‘recurrent’ in the relevant sense. At the time when it was made, nobody could say whether Boulus or anybody else would or would not make another application in two or five or ten years’ time. The expenditure in connection with each application between 1938 and 1948 was made on a particular and isolated occasion. Similar occasions might or might not arise in the future. Experience might suggest a probability that similar occasions would arise, but no such consideration could affect the essential nature of the expenditure, which was incurred in each case for the purpose of preserving and protecting the company’s business.

Colonial Mutual Life Assurance Society Ltd v FCT (1953) 73 CLR 604 Facts: The taxpayer purchased land and, as consideration for purchase, it agreed to pay the vendor an amount equal to 90 per cent of all rents received from shops to be built on the land. High Court held: The payment was not deductible; it was capital. Even though the payments were recurrent, the true effect was that they were instalments of the purchase price and thus were an outgoing of capital.

BP Australia v FCT (1965) 112 CLR 386

Facts: An oil company entered into an exclusive trade tie agreement for 3–15 years to supply petrol in response to threats from a competitor that was making similar arrangements. Under the agreements, the taxpayer paid the retailers according to the petrol sold. High Court held: Costs were deductible on revenue account. The first and second tests of Sun Newspapers were satisfied — expenses were recurrent in nature, part of marketing operations and produced no enduring benefit to the taxpayer’s profit-making structure.

Mount Isa Mines Ltd v FCT (1992) 176 CLR 141 Facts: A mining company claimed a deduction for the costs of demolishing cooling and roasting plant towers. The taxpayer argued that the towers were demolished to protect the safety of employees and that the expenditure did not result in the acquisition of a tangible asset. Rather, it argued that the demolition was of a nature of maintenance. It was a recurrent nature of the taxpayer’s mining business. It further argued that the courts had broadened the scope of income per Myer Emporium, so deductions should also be broadened. High Court held: The costs were not deductible; they were capital. The fact that no tangible asset was acquired and that the expenditure may have been recurrent was outweighed by the fact that demolition eliminated a disadvantageous asset of the business. It therefore had an enduring benefit to the business. The High Court held that the taxpayer did not succeed in establishing that the income concept had been expanded. In Mount Isa Mines at 4759–60, Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ stated: [There] is nothing in the evidence, let alone the findings of fact, to suggest that structures such as the Old Roaster and the Marley Tower have a very short life and that their demolition is a

frequent occurrence in the mining operations conducted at Mt Isa. Each structure played a part in the operations conducted there over a long period of time until it became obsolete

[page 345] and redundant. Each item was demolished, following a review, because it was obsolete and dangerous. In some situations, the demolition of structures and plant which have a very short life may well be capable of being treated as a matter of maintenance or upkeep or as an incident in the day-to-day conduct of a business. However, in the light of the evidence and the findings of fact, the established purpose of the demolition was to eliminate a disadvantageous asset and to confer a positive and enduring advantage on the premises on which the taxpayer’s business was carried on.

FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 Facts: The taxpayer claimed instalments of a capital amount. High Court held: The instalments were deductible, not of a capital nature (the court took a legal rights approach, rather than looking at the substance).

Cliffs International Inc v FCT (1979) 142 CLR 140 Facts: The taxpayer acquired the right to mine an area of land, and the consideration included the payment of a royalty based on each unit of ore sold. Was the royalty deductible? High Court held: The royalty was deductible; the majority held that the payments were not capital in nature.

Pine Creek Goldfields Ltd v FCT 99 ATC 4904; (1999) 42 ATR 758 Facts: A goldminer operated an open-cut mine near the Stuart

Highway in the Northern Territory. The mine straddled a highway, substantially reducing the mineral reserves available for mining and shortening the life of the mine by 1 year. Thus, the taxpayer constructed a diversion around the highway and claimed a deduction for this expenditure under either the former s 51(1) or the former Div 10. Full Federal Court held (majority): The expenditure incurred by a goldminer in diverting a road to enable mining operations to continue was deductible under ITAA 1936 Div 10 but not under s 51(1). The expenditure was of a capital nature and therefore not deductible under s 51(1). Relocation of the highway was ‘the key that unlocked the ability to mine’. The expenditure was a once and for all payment for a substantial advantage of an enduring nature; namely, making resources available for exploitation. The majority also said that there was no proper evidentiary basis for concluding that the expenditure was an outlay of a kind that an open-cut miner could be expected to incur from time to time.

FCT v Citylink Melbourne Ltd 62 ATR 648; 2006 ATC 4404; [2006] HCA 35 Facts: The taxpayer operated the Melbourne Citylink Road Project and claimed a deduction for over $220 million in concession fees liable to be paid to the Victorian State Government. The concession fees were payable by the taxpayer to the State of Victoria for the right to construct and operate the Citylink Project. The state was required to provide services and entitlements over land. Under the agreement, the taxpayer elected to defer its liability to actually pay the fees until 2034 but claimed deductions for the accrued liabilities as they arose. The Commissioner disallowed the taxpayer’s claim for over $220 million in concession fees incurred. [page 346]

Full High Court held: The amounts had been incurred and the fees were not capital costs. The fees were payable only during the term of the concession period. The taxpayer did not acquire any permanent ownership rights over the roads or land used. The fees were periodic licence fees for use of the infrastructure assets, which ultimately would be surrendered back to the Victorian State Government.

Tyco Australia Pty Ltd v FCT [2007] FCA 1055 Facts: Tyco acquired a commercial security alarm monitoring business and then expanded into the residential market. To help its expansion, it implemented an Authorised Dealer Programme and paid $132 million over three income years to dealers for the assignment of their service agreements for security alarm monitoring. The Commissioner regarded the fees as capital payments incurred to create a business structure. Federal Court held: Deductible under ITAA 1997 s 8-1. In acquiring the service agreements, the taxpayer was building its profityielding structure by the incremental winning of customers via the arrangements the taxpayer entered into with independent dealers that originated the service agreements. Each assignment and novation and each passing of a customer to the taxpayer was an incremental accretion to its customer base.

Read TR 2001/6; TR 95/36 Practice Problem 4 List business expenses that are of a capital nature.

Practice Problem 5 Pink Pty Ltd conducts a forestry business. Two items of expenditure were incurred during the year: 1 clearing land ready for cultivation; and 2 weeding around newly sown trees. Are these capital expenses?

[page 347]

Practice Problem 6 Are these capital expenses or deductible under s 8-1? 1 Legal expenses of a footballer in the course of successfully appealing against a 2-month disqualification for punching a fellow player. 2 The cost of moving machinery to a new site as a result of the acquisition of new business premises. 3 The costs incurred by a butcher in defending a prosecution for selling possum meat. If the prosecution is successful, the owner will lose his licence to operate as a butcher. 4 White Pty Ltd is an Australian subsidiary of a Japanese car manufacturer; it imports cars that it sells in Australia. The Government introduces a quota system to protect the local industry. In response, White spends $1 million on advertising attacking the quota system, stressing the cost and quality advantages of its cars.

Private or domestic nature 10.25 It would seem to be a rare situation where an expense of a private or domestic nature would satisfy the requirements of the positive limbs. Nevertheless, the courts have held that private living expenses are not deductible under s 8-1(2)(b).

Incurred in gaining exempt income 10.26 It would seem difficult to find an expense that would satisfy the positive limbs if it is incurred in gaining exempt income, so s 8-1(2)(c) has little application.

Deduction limitations 10.27 Section 8-1(2)(d) denies a deduction where a provision in the ITAA prevents a deduction. Many of these limiting provisions can be found in Div 26. They are considered in Chapter 12.

Categories of expenditure in s 8-1: employees and investors 10.28 The second method of understanding s 8-1 involves categorising the case law. In this Section, the following non-business categories of employee and investor expenses are considered: living expenses; employee work-related expenses; self-education; childminding expenses; travel expenses;

[page 348] home office expenses; preliminary expenses; interest; managed investment scheme expenses; insurance; clothing; cosmetics and personal grooming; bank fees; technical/professional publications; legal expenses; food; and medical expenses.

Living expenses 10.29 Living expenses are not deductible, as they do not have sufficient connection to the production of assessable income under the positive limb, s 8-1(1)(a), and they are excluded by the negative limb, s 8-1(2)(b). This is evident in the private expenses discussed at 10.45 and 10.46 below.

Employee work-related expenses 10.30 Certain work-related expenses of employees are deductible. The expenses that can be claimed vary from occupation to occupation. The ATO provides guidelines to deductions for specific occupations. Full details are available at . These expenses are typically claimed on page 3 of the individual’s income tax return under the categories listed at D1–D5, work-related car, travel, uniform and other expenses. In FCT v Day [2008] HCA 53, the majority of the High Court relevantly

commented on the relationship between deductible expenditure and assessable income of employees at [33] (emphasis added): That no narrow approach should be taken to the question of what is productive of a taxpayer’s income is confirmed by cases which acknowledge that account should be taken of the whole of the operations of the business concerned in determining questions of deductibility … A similar approach should be taken to what is productive of a salary earner’s income, whether it be described as employment or by reference to a bundle of tasks to be performed and duties to be observed. In some cases those duties to be observed may extend beyond what is contained in a contract of employment. In Cooper, Hill J, referring to the statement in Ronpibon Tin, observed that it will often be necessary to analyse with some care the operations or activities regularly carried on by the taxpayer [(1991) 29 FCR 177 at 198; 91 ATC 4396], and Lockhart J referred to the need to have regard to the terms and conditions of a taxpayer’s employment [(1991) 29 FCR 177 at 182; 91 ATC 4396]. A reference to the ‘day-to-day’ activities undertaken by a taxpayer may not be a sufficient description of what their position involves.

[page 349]

Self-education 10.31 Generally, self-education expenses, which can include formal and informal self-education expenses, are deductible if they are sufficiently related to earning assessable income. The self-education cases have focused on three central issues to determine sufficient connection. Maintains or improves employment skill or knowledge 10.32 If the taxpayer’s income-earning activities are based on the exercise of a skill or some specific knowledge, and self-education maintains or improves that skill or knowledge, then it is deductible: FCT v Finn (1961) 106 CLR 60; 12 ATD 348; TR 98/9. On the other hand, see Ting v FCT 2015 ATC, where the self-education expenses by a school teacher in undertaking postgraduate studies in business management were not deductible. Leads to, or is likely to lead to, an increase in income 10.33

If the self-education leads to, or is likely to lead to, an increase in the

taxpayer’s assessable income from their present activities, then it is deductible: FCT v Hatchett (1971) 125 CLR 494; 2 ATR 557; 71 ATC 4184; TR 98/9. To get employment, to obtain new employment or to open up a new income-earning activity 10.34 However, self-education to enable the taxpayer to get employment, to obtain new employment or to open up a new income-earning activity is not deductible: FCT v Maddalena (1971) 2 ATR 541; 71 ATC 4161; TR 98/9. The expenses are incurred at a point too soon to have sufficient connection to gaining or producing assessable income. The leading cases on self-education are Finn and Hatchett. In addition, there will be no deduction for self-education expenses where the expenses are incurred after being made redundant. Self-education costs in respect of Youth Allowance 10.35 Self-education costs in respect of Youth Allowance were held to be deductible in Anstis. In response to this case, s 26-19 was enacted and now denies deductibility for this type of expenditure. Deductible employee self-education expenses: s 8-1 CIRCUMSTANCES

AUTHORITY

Overseas travel and living costs of a senior government architect who voluntarily studied architectural developments. The taxpayer sought to increase his chances of gaining a particular promotion and to keep up to date

FCT v Finn (1961) 106 CLR 60; 12 ATD 348

Flying lessons for a flight engineer employed by Qantas that improved the taxpayer’s proficiency as a flight engineer

FCT v Studdert (1991) 33 FCR 75; 22 ATR 762; 91 ATC 5006

[page 350]

CIRCUMSTANCES

AUTHORITY

Teacher’s higher certificate in teaching

FCT v Hatchett (1971) 125 CLR 494; 2 ATR 557; 45 ALJR 565; 71 ATC 4184

A dentist in general practice (20 per cent of his work involved periodontic work) went to London and completed a Master of Science degree in Periodontics in 12 months over 1975–76. While he was away, he leased his practice to a locum. Shortly after returning to Australia, the taxpayer sold his practice to the locum and took up a full-time position as a Senior Lecturer in Periodontics at Sydney University. In January 1979, he commenced practice in that speciality

FCT v Highfield 82 ATC 4463

A law clerk employed by solicitors who had been admitted to the bar travelled to the UK to attend a postgraduate course in international law. This would help him in earning his future income as a barrister. The airfares, course fees and living expenses were deductible

Case T78 86 ATC 1094

Professional and trade journals, textbooks and stationery

TR 98/9

Airfares, meals and accommodation on overseas study tours or sabbatical, on work-related conferences or seminars, or attending an educational institution

TR 98/9

Interest incurred on borrowed moneys where the funds are used to pay for self-education expenses

TR 98/9

Certain motor vehicle expenses and fares for travel to or from the place of education

TR 92/8

Extended warranty on a computer used for selfeducation

ATO ID 2001/225

Non-deductible employee self-education expenses: s 8-1 CIRCUMSTANCES

AUTHORITY

A primary school teacher’s costs of studying an arts degree

FCT v Hatchett 71 ATC 4184

Self-education to get employment, to obtain new employment or to start a new income-earning activity

FCT v Maddalena (1971) 2 ATR 541; 45 ALJR 426; 71 ATC 4161

Child care fees incurred by a taxpayer undertaking studies relevant to employment

Jayatilake v FCT (1990) 21 ATR 736; 91 ATC 4516

[page 351]

CIRCUMSTANCES

AUTHORITY

Medical registrar who resigned from his position and travelled to the UK to undertake specialised research. He commenced practice on his own account as a consultant physician when he returned home

Case T73 86 ATC 1060

A legal officer with the Public Service incurred costs of a 6-month pre-admission course at the College of Law and the costs of being admitted as a solicitor

Case Z1 92 ATC 101

Expenditure on meals while attending an educational institution, conference or seminar where the taxpayer is not required to sleep away from home

TR 98/9

Dentist in general practice on a postgraduate degree. The dentist will carry on a different income-earning activity or business and be in no different position from a person who undertakes study to obtain a job

TR 98/9

Henry Kaye investment seminars in respect of the taxpayer’s property investments

Petrovic v FCT 2005 ATC 2169

In Naglost v FCT 2002 ATC 2008, the taxpayer, an Air Force manager, was allowed a deduction for expenses incurred in a masters university course for management but was not allowed the cost of courses for personal financial planning. Note: Section 82A restricts the first $250 of self-education expenses leading to a formal qualification from being deductible, although ITAA 1936 s 82A permits a wider range of expenses to be taken into account than ITAA 1997 s 8-1. As TR 98/9 notes, such costs as child care and the capital costs of study equipment can be taken into account for that $250 amount.

Childminding expenses

10.36

Childminding expenses are not deductible for employees. Lodge v FCT (1972) 128 CLR 171; 72 ATC 4174

Facts: A law cost clerk worked for solicitors mainly from home and claimed a deduction for nursery expenses in having her child minded because she was unable to work with the child at home. High Court held: Not deductible. Although the expenses were incurred in gaining assessable income and were an essential prerequisite to gaining her income, the court found that the character of the nursery fees was not relevant or incidental to the incomeproducing activities of preparing bills of cost.

[page 352] In Lodge, Mason J stated at 175–6: The expenditure was incurred for the purpose of earning assessable income and it was an essential prerequisite of the derivation of that income. Nevertheless its character as nursery fees for the appellant’s child was neither relevant nor incidental to the preparation of bills of cost, the activities or operations by which the appellant gained or produced assessable income. The expenditure was not incurred in, or in the course of, preparing bills of cost. If the appellant’s case is approached on the footing that she was carrying on a business, because she was not an employee of Law Cost, the result in my opinion is no different. If it be correct to say, as I have held, that the expenditure was not incurred in preparing bills of cost, it follows in this case that it was not incurred in carrying on the business of preparing such bills of cost. To this point I have not considered the question whether the expenditure was of a ‘private or domestic’ nature. The relationship between the operative parts of s 51(1) and this exception has not been discussed at length. In this case the arguments were directed to the operative provisions rather than to the exception. However, I should express my view that the expenditure in question was of a ‘private or domestic’ nature and for that reason is excluded by s 51(1).

Travel expenses 10.37

Home-to-work expenses are generally not deductible: see Lunney.

Lunney v FCT; Hayley v FCT (1958) 100 CLR 478 Facts: A shipping employee claimed a deduction for travelling 14 miles from home to work. High Court held: Costs were not deductible, because it was not business expenditure, just a consequence of living in one place and working in another. Although travel expenses between two places of the same business or same employment are generally deductible, the High Court in Payne considered the connection to assessable income too remote where the travel involved two unrelated places of work. FCT v Payne (2001) 202 CLR 93 Facts: The taxpayer had two sources of assessable income: one as a pilot and the other from deer farming activities at his property near Tamworth (where he also lived). The taxpayer claimed the cost of travel and accommodation expenses between the property and the Mascot airport. High Court held: Expenses were not deductible. The travel was not part of the taxpayer’s operations as a pilot or as a deer farmer. It related to intervals between these two types of income-earning activity, thus was not sufficiently connected with any incomeproducing activity. Note: Section 25-100, a specific deduction, has been introduced to overcome the decision in Payne to provide a deduction for travel directly between two different workplaces (see Chapter 11). [page 353]

Travel expenses incurred by itinerant employees (ie, travelling salespeople) are deductible.2 Relocation expenses, however, are generally not deductible, as such travel is a prerequisite to earning income. Travel expenses are deductible, however, when a taxpayer needs to transport bulky, particularly valuable or confidential equipment: see Scott (No 3) v FCT 2002 AAT 2243. In Scott (No 5) v FCT 2002 AAT 280, the costs of travelling to meet a new employer after a job had been obtained were held to be deductible. In the 2017 Federal Budget it was announced that deductions for travel expenses related to inspecting, maintaining or collecting rent for a residential property will be disallowed from 1 July 2017: see Treasury Laws Amendment (Housing Integrity) Bill 2017.

Home office expenses3 10.38 Generally, only limited deductions are available for home-related expenses unless they relate to the carrying on of a business at home: Faichney. The exception is Lyons. FCT v Faichney (1972) 129 CLR 38; 72 ATC 4245 Facts: An employee claimed a deduction for expenses for a home study that was used for work purposes. The expenses included a proportion of the interest paid on the loan used to build the home and a proportion of electricity charges. High Court held: The interest was not deductible, as it was an outgoing of a private or domestic nature (negative limb of s 8-1). However, the court did not have to decide whether the expense satisfied the first limb. The electricity was deductible, even though expenses in lighting and heating a home are normally private and domestic in nature and not connected to gaining or producing assessable income. The electricity expenses had an employment characteristic to the extent to which the taxpayer was exclusively engaged in work from which the taxpayer would derive assessable income.

Lyons v FCT 99 ATC 2258 Facts: An employee actuarial analyst undertook studies at the UK Institute of Actuaries to become an actuary. No lectures or tutorials for Part 1 of the course were held in Australia. There was no room available for the taxpayer to conduct her study at any institution associated with her course in Australia, nor were study facilities available at her place of work. Thus, the taxpayer set up the spare bedroom in her home as a home study and claimed, based on floor space, 15 per cent of the total outlay for rent. The Commissioner considered that the taxpayer was entitled to claim only a deduction for the difference between what was actually paid for heating/cooling and lighting and what would have been payable had the taxpayer not worked from home. AAT held: Expenses were deductible. The room set aside by the taxpayer was a home study, as the taxpayer was not provided with any alternative venue and the method of apportioning the expense as a percentage of total floor area was a well-recognised method of apportioning expenses. There was a direct connection between the self-education expenses and the taxpayer’s income.

[page 354] Deductible employee home office expenses: s 8-1 CIRCUMSTANCES Interest, rent, heating, lighting, depreciation, insurance and repairs on equipment, cleaning, maintenance and decorating, and telephone for a home office that is clearly identifiable as a place of business and that constitutes a place of business in the ordinary and common sense

AUTHORITY TR 93/30

meaning of the term A territory manager who was not provided with an office and who had a separate home office to carry out work duties

(1986) CTBR(NS) Case 47

A sales representative required by the employer to maintain a home office to do work duties

AAT Case 3304 (1987) 18 ATR 3319

An employee architect who ran a small practice from his home office

(1974) 19 CTBR(NS) Case 65

Proportion of rent for an actuarial student who used a room to study through a UK university. There was no alternative place to study

AAT Case [1999] AATA 445; Re Lyons and FCT (1999) 42 ATR 1106

Proportion of the mortgage interest for a taxpayer who used a room in his ex-wife’s home for work purposes and who made the mortgage payments

AAT Case 4309 (1988) 19 ATR 3461

The extra heating/cooling/lighting costs and depreciation on furniture, equipment etc for a home office that is used solely for specific work by a self-employed person or employee

TR 93/30; Practice Statement PS 99/4

Non-deductible employee home office expenses: s 8-1 CIRCUMSTANCES

AUTHORITY

A proportion of mortgage interest payable on a home loan claimed by a barrister who had city chambers

Thomas v FCT [1972–73] ALR 368; (1972) 3 ATR 365; 46 ALJR 397

A proportion of mortgage interest relating to a room converted to a study claimed by a research scientist

FCT v Faichney (1972) 129 CLR 38; 3 ATR 435

A barrister with city chambers claimed rent paid to a trust (the owner of the family residence) for the right to use a room in the house as an office

FCT v Forsyth (1981) 148 CLR 203; 34 ALR 263; 11 ATR 657; 55 ALJR 340

A proportion of mortgage interest payable on a home loan claimed by a barrister who had city chambers

Handley v FCT (1981) 148 CLR 182; 34 ALR 274; 11 ATR 644; 55 ALJR 345

[page 355]

A proportion of rent on an interstate family home where one room was used solely as a home office. The taxpayer worked for the whole period he was interstate

AAT Case [1999] AATA 161; 41 ATR 1195

A proportion of home expenses claimed by a restaurant manager

AAT Case 12352, Re Hinch and FCT (1997) 37 ATR 1128

A proportion of mortgage interest payable on a home loan claimed by a clinical nurse specialist in a hospital who prepared reports and lectures at home

AAT Case 12851, Re Geekie and FCT (1998) 39 ATR 1028

Preliminary expenses 10.39 Preliminary employee expenses (expenses prior to the commencement of the earning of assessable income) are not deductible under s 8-1 (but see Chapter 13, s 40-880). FCT v Maddalena (1971) 2 ATR 541; 71 ATC 4161; 45 ALJR 426 Facts: A footballer employed by a club claimed expenses in seeking employment for a different club. Court held: Travel was not deductible, as the expenses were incurred in getting to work and not in doing work. Therefore, they came at a point too soon in gaining assessable income. However, if the preliminary expenses are recurring and relate to a short period of work, then the expenses are deductible, per Spriggs and Riddell. Spriggs v FCT; Riddell v FCT 2009 ATC 20-109; [2009] HCA 22

Facts: Spriggs and Riddell were professional sportsmen (Australian football and rugby). Spriggs’s total income was $106,869, including non-playing income of $641 licensing fees for the use of his image on playing cards. Riddell received $220,174 from playing rugby and $11,394 from promotional work. They claimed deductions for management fees of $2310 and $21,175, respectively, per ITAA 1997 s 8-1. The Commissioner denied these claims. The management fees were not incurred in the course of earning income as employees, as they were incurred to obtain new employment contracts, as in FCT v Maddalena (above). High Court held: Management fees were deductible: s 8-1. The taxpayers obtained and performed an employment contract as part of, and during the course of, running a business. The taxpayers’ promotional activities and their celebrity status were closely tied to their employment of playing football. As a whole, the taxpayers were in the business of commercially exploiting their sporting skills and celebrity status for a short period of time. Their business activity involved entering into contracts with third parties in order to exploit their celebrity status. There was a sufficient connection between the management fees and the gaining or producing of assessable income from the business of exploiting sporting prowess and celebrity status for the management fees to be deductible per s 8-1(1)(a). The expenses were incurred in the course of gaining or producing income from the taxpayers’ businesses. The expenses [page 356] were also necessarily incurred in carrying on those businesses and thus were deductible under s 8-1(1)(b). The management fees were not capital amounts, as the advantages sought from the playing contracts were relatively short term in nature and recurrent as being subject to continual renewal.

Interest 10.40 Interest expenses are generally deductible if the borrowed funds are used for an income-producing purpose. If part of the purpose is for private use, then apportionment is necessary. The Commissioner has issued a determination stating that the deductibility of compound interest is determined according to the same principles as the deductibility of ordinary interest: see Hart v FCT 2002 ATC 4608, Taxation Determination TD 2008/27. FCT v Janmor Nominees Pty Ltd (1987) 19 ATR 254; 87 ATC 4813 Facts: A family trust borrowed to purchase a property that it rented to the head of the family as a commercial rental. Court held: Interest was deductible. However, it is clear that the Commissioner will oppose such home loan interest deduction arrangements. In Taxation Ruling TR 2002/18, the Commissioner denied interest deductions for such home loan arrangements. This approach was supported in Tabone. Re Tabone and FCT AAT Case 2006 ATC 2211; 62 ATR 1210; [2006] AATA 466 Facts: In the income tax years 1999–2003, the taxpayer claimed interest expenses in relation to borrowings to invest in the Tabone Unit Trust to construct his family home. The taxpayer transferred land that he owned to the unit trust and then obtained a loan (guaranteed by the trustee of the unit trust that mortgaged the property as security to Westpac) to build the house. At the same time, units in the unit trust were issued to the taxpayer. After construction, he and his family moved into the new house. The

taxpayer argued that he paid $130 per week rent to the unit trust. However, no records were kept of any regular payments. The taxpayer did not obtain any income from the unit trust in the income tax years 1999–2003. AAT held: The interest expense was not deductible under ITAA 1997 s 8-1. There was insufficient nexus between the interest expenses and the likelihood of assessable income from the unit trust. The main purpose of the borrowing was to provide a family residence. There was only a minor or possible purpose of deriving income from the unit trust. The interest was of a private or domestic nature. Also, the AAT found that the unit trust arrangement amounted to a scheme entered into for the dominant purpose of obtaining a tax benefit, and thus the general anti-avoidance rules in ITAA 1936 Pt IVA applied.

[page 357]

Read TR 95/25 Negative gearing 10.41 The fact that income derived from the use of borrowed funds is less than the interest expense does not prevent the interest from being deductible. Section 8-1 does not set a limit to the amount deductible. The following illustrates the effect of negative gearing. Amy borrows $200,000 at 7 per cent interest to acquire shares yielding 5 per cent net. The interest of $14,000 is deductible under s 8-1 and the $4000 loss ($14,000 − $10,000) is an allowable deduction against other income.

Practice Problem 7 Ted borrows $100,000 secured against a rental property to purchase his residence. Are the interest expenses deductible? Capital-protected loans 10.42 Under a capital-protected loan, the lender guarantees that the underlying investment (eg, shares) will not fall below the amount of the loan. Under Div 247, deductions are deferred for capital-protection costs until the realisation of the asset. Note: There are numerous specific provisions that may affect s 8-1 interest deductions, such as: s 25-5(1): a deduction is provided for the general interest charge incurred by a taxpayer; s 25-5(2) prevents a deduction for interest expenditure incurred on borrowings taken out to pay tax; ITAA 1936 s 51AAA limits a deduction for interest where the sole reason relates to the derivation of a capital gain under ITAA 1997 s 102-5; ITAA 1936 s 67AAA denies a deduction for financing costs incurred to make personal superannuation contributions or to pay most life insurance premiums; and ITAA 1936 s 82KZM impacts on the timing of a deduction for prepaid expenditure such as interest, rent etc in return for services that are not wholly provided within 12 months of the date the expenditure is incurred.

Managed investment scheme expenses 10.43 Expenses incurred in connection with an agricultural managed investment scheme may be deductible.

[page 358]

Hance v FCT [2008] FCAFC 196 Facts: The investment scheme involved a participant (grower) who subleased 1 hectare of land and grew almonds on it. The promoter managed the almond lots and harvested and sold the almonds. These almonds were also pooled for sale with those of other growers and the net proceeds of sale after costs. The sales were expected to start in 2012 and end in 2031. For an almond lot, the participant would pay rent, management fees and responsible entity fees. After that, participants were liable for annual rental, management fees, farm operating costs, performance fees and other costs. The taxpayer (grower) requested a private ruling from the Commissioner on whether the various outgoings were allowable deductions under ITAA 1997 s 8-1. The Commissioner found that the grower’s interest in the scheme would be a right to share in the profits generated from it either contractually or as beneficiary of a trust. The outgoings should be characterised as the price paid for the acquisition of the interest and thus capital. The Full Federal Court held: Deductible. The growers in the scheme were each carrying on an individual business on his or her lot with the purpose of producing almonds for sale at a profit. The long duration of the operations, the nature of the work involved in farming and the almond crops to be received from year to year pointed to a business. The costs were incurred as operating expenses in carrying on a business and were deductible per s 8-1.

Insurance 10.44 Sickness and accident and disability insurance related to employment is deductible.

FCT v D P Smith (1981) 147 CLR 578; 11 ATR 538; 81 ATC 4114 Facts: An employee doctor claimed a deduction for a disability insurance policy premium. The policy provided a monthly payment to the taxpayer for loss of income. High Court held: Deductible, as the expense related to assessable income. Investors can claim deductions for their insurance costs in respect of their investment properties.

Clothing 10.45 Conventional clothing is generally not deductible. This was seen in cases involving shop assistants seeking deductions for black conventional clothing that they were required to wear. These expenses were not deductible: see Case U80, 87 ATC 470; Case U95, 87 ATC 575. However, if the clothing is not conventional and is specifically related to the taxpayer’s occupation, it may be deductible (eg, uniforms that are not conventional clothing). Also, where expenditure on clothing is at abnormal levels or where there is excessive wear and tear, a deduction may be available (eg, protective clothing — boots, aprons, helmets, overalls). Where the cost of clothing is deductible, cleaning and maintenance costs will also be deductible. Compulsory uniforms are generally deductible under s 8-1, as the essential character of an employee’s expenditure on clothing is directly connected to the employment income. Thus, [page 359] stockings, shoes, socks etc that are part of a compulsory uniform are

deductible. A compulsory uniform is one that the employee is expressly required to wear by the employer: Taxation Ruling TR 97/12. Note: ITAA 1997 Div 34 restricts deductions for non-compulsory uniforms unless the design of uniform is entered on the Register. See Approved Occupational Clothing Guidelines 2017, effective from 1 October 2017. Excessive expenditure on conventional items required by the taxpayer’s job may also be deductible, but this would be an unusual situation. FCT v Edwards (1994) 49 FCR 318; 94 ATC 4255 Facts: The taxpayer claimed two-thirds deduction for conventional clothing expenses as a private secretary to the Governor. The clothes were worn in carrying out her duties. The taxpayer claimed twothirds of the expenses, which represented her additional expenditure over and above normal clothing expenditure. Federal Court held: Clothing deductible, as (1) additional expenditure fell within the first limb and (2) the expenditure was not private in nature. This is a special case, as she was expected to dress in a manner compatible with the Governor’s wife and was required to maintain an extensive wardrobe and make additional changes of clothing during a given day and rarely had the opportunity to wear the clothing for private use. It was held that the apportionment was reasonable. However, Edwards would appear to have a limited application as seen by AAT Case [2006] AATA 100: AAT Case [2006] AATA 100; (2006) 61 ATR 1192; 2006 ATC 119 Facts: The taxpayer, a chief executive of a private company, made presentations at conferences, seminars etc. Thus, she claimed a deduction of $38,797 in her 30 June 2003 tax return for the clothing.

She asserted that this was necessary for the image of the company, per Edwards (above). AAT held: Not deductible, as the clothing was a private expense. Edwards did not establish a general proposition that clothing was deductible. The taxpayer in this case was distinguished from Edwards. Further, she admitted that she wore the abnormal clothing in her normal working life.

Mansfield v FCT 96 ATC 4001 Facts: A flight attendant claimed moisturisers, pantyhose and shoes. Federal Court held: Costs were deductible, given the working conditions in the aircraft: dehydration required high use of moisturiser, cabin pressure required bigger shoes and the cramped conditions caused the laddering of pantyhose. In Mansfield, Hill J found that the shoes for a flight attendant were deductible. Hill J relevantly noted the excessive wear and tear on the shoes in reaching his conclusion, stating at 4008: [page 360] The shoes in the present case were required to be worn as part of the uniform … There is the additional feature that the cabin pressure requires the shoes to be a half-size too large for ordinary use. Further, of course, there is the fact that the taxpayer’s employment brings about regular scuffing of the shoes. It is these features that lead, in my view, to the conclusion that the occasion of the outgoing on shoes, that is to say cabin shoes, should be seen as being found in the duties which Mrs Mansfield performed as a flight attendant in the year of income.

Deductible employee clothing expenses: s 8-1 CIRCUMSTANCES A flight attendant’s moisturisers to prevent

AUTHORITY Mansfield v FCT (1996) 31 ATR 367; 1996 ATC

dehydration, shoes that needed to be larger than her normal size due to aircraft pressurisation and pantyhose that laddered due to the confined space of aircraft

4001

A naval officer’s tropical uniform

(1957) 7 CTBR(NS) Case 54

A funeral director’s dark suit (but not black trousers) — only funeral directors wear black suits in tropical Queensland

(1983) 26 CTBR(NS) Case 136

Clothing of the secretary to the Queensland Governor’s wife, on the basis that the dress obligations of her position were abnormal and thus deductible to the extent that the expenditure exceeded her normal expenditure

FCT v Edwards (1993) 27 ATR 293; 93 ATC 5162

Conventional clothing worn by police officers when on undercover duty if of a kind not normally worn

TR 94/22

Compulsory uniforms if the entire uniform is worn

TD 1999/62; TR 97/12

Protective clothing

TD 94/45 (Lists occupations)

Protective clothing for shearers

TD 94/48

Abnormal expenditure: a footwear retailer sales manager was required to purchase and wear expensive shoes

AAT Case 63 (1987) 18 ATR 3443

Cleaning is deductible if the clothing is deductible

TD 93/232

A waiter’s black trousers, white shirt, bow tie and black shoes were conventional clothing and not deductible, but the extra costs for maintenance and cleaning costs were deductible

AAT Case 1219, Re Westcott and FCT (1997) 37 ATR 1017; 97 ATC 2129

[page 361]

CIRCUMSTANCES Traditional nurses’ uniforms

AUTHORITY TR 97/12

Conventional clothing that satisfies the deductibility tests in TR 94/22

TR 94/22

Compulsory uniforms that meet the requirements of IT 2641

IT 2641

Sunglasses with safety features for a motorcycle police officer

AAT Case 9254 (1994) 27 ATR 1233

Tinted glasses for a VDU operator worn solely at work

AAT Case 87 (1987) 18 ATR 3624

Cost of buying, hiring or replacing clothing, uniforms or footwear if these items are:

See various taxation rulings, for example:

(a) protective (b) occupation specific

TR 95/8 — employee cleaners; TR 95/9 — employee lawyers; TR 95/10 — employee shop assistants; TR 95/11 — hospitality industry employees; TR 95/12 — employee factory workers; TR 95/13 — employee police officers; TR 95/14 — employee teachers; TR 95/16 — employee hairdressers; TR 95/17 — employees of the Australian Defence Force; TR 95/18 — employee truck drivers; TR 95/19 — airline industry employees; TR 95/20 — employee performing artists; TR 95/21 — real estate employees; TR 95/22 — employee building workers; TR 98/6 — real estate industry employees; TR 98/14 — employee journalists; TR 99/10 — members of parliament

Non-deductible employee clothing expenses: s 8-1 CIRCUMSTANCES

AUTHORITY

Ordinary clothing (eg, a suit or dress) worn to earn assessable income

TR 97/12; TR 94/22

A shop assistant’s black dress

(1967) 14 CTBR(NS) Case 2

A barrister’s sombre suit worn beneath his robes

Mallalieu v Drummond [1981] 1 WLR 908

A public figure’s secretary’s clothes

(1985) 28 CTBR(NS) Case 89

Conventional clothes of a professional presenter

AAT Case 9679 (1994) 29 ATR 1077

[page 362]

CIRCUMSTANCES

AUTHORITY

Conventional clothes of a television newsreader and reporter

AAT Case 11455 (1996) 34 ATR 1098

Conventional clothing for a male nurse

AAT Case 12851, Re Geekie and FCT (1998) 39 ATR 1028; 98 ATC 2097

Even if the clothes show the employer’s brand name, they remain conventional clothing and non-deductible

TR 97/12

Formal black evening dress worn by orchestra members

TD 93/111

The cost of hiring formal clothing by a sportsperson to attend functions or presentations

TR 97/12

For non-compulsory uniforms

ITAA 1997 Div 34

Read TR 2003/16 Cosmetics and personal grooming 10.46 Cosmetics and personal grooming are generally not deductible, because they are private expenses: see TR 96/18 (unless performing artist, eg, stage make-up). Where a taxpayer’s working conditions are harsh and the taxpayer is required to be well groomed and requires rehydrating moisturiser and rehydrating conditioner, then these costs are deductible: see TR 96/17; Mansfield.

Bank fees 10.47 Bank fees related to the direct depositing of wages in a bank account are deductible.

Technical/professional publications 10.48 The cost of technical/professional publications are deductible where the publications relate to employment; for example, subscriptions to a dental journal by a dentist.

Legal expenses 10.49 Legal expenses will have sufficient connection to earning employment income if they arise out of the day-to-day activities of the taxpayer (Herald & Weekly Times v FCT (1932) 48 CLR 113; 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer’s income-producing activities: Magna Alloys & Research Pty Ltd v FCT 80 ATC 4542. An indirect nexus between the legal costs and the production of assessable income is sufficient, as long as it is not too remote: FCT v Day [2008] HCA 53. [page 363] The deductibility of legal expenses under s 8-1 is linked to the purpose of incurring the expense. The success or failure of the legal action is, however, irrelevant to the deductibility. Legal costs associated with employment or investment activities may be deductible under s 8-1. However, if the legal expenses are of a private or capital nature, no deduction is allowed; for example, legal expenses associated with the purchase or sale of real estate or shares by an investor are not deductible. Legal costs incurred by a customer in suing a restaurant for food poisoning are private expenses and therefore not deductible. Legal expenses incurred by an employee in defending the manner in which

he performed his employment were deductible in FCT v Rowe 95 ATC 4691. Also, legal costs of defending prosecution proceedings to protect professional reputation are deductible per Putnin v FCT 91 ATC 4097. However, legal expenses incurred by an employee in obtaining employment are not deductible per Maddalena. Similarly, legal expenses to defend registration to practise a profession are non-deductible capital amounts. FCT v Day [2008] HCA 53 Facts: Mr Day was a senior compliance officer employed by the Australian Customs Service. The taxpayer incurred legal expenses in defending charges against him under the former Public Service Act 1922 (Cth) (PSA). The relevant charges involved the taxpayer’s unauthorised use of an identification card to try to obtain information regarding the issue of a search warrant over his property, withholding information from Customs, the use of a false diary, misuse of a work car and misuse of attendance records. The taxpayer claimed as deductions net legal expenses of $28,954 in the year ended 30 June 2002 incurred in opposing these charges. The Commissioner argued that the taxpayer’s legal expenses were not deductible, as the expenses were incurred in defending charges extraneous to the performance of the taxpayer’s income-producing activities. High Court held (4:1): The legal expenses were deductible. Having regard to Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 296; FCT v Cooper (1991) 21 ATR 1616; and FCT v Payne (2001) 46 ATR 228, the High Court found that the words ‘in the course of’ in ITAA 1997 s 8-1(1)(a) did not require a direct nexus between an expenditure and the activity that produced the assessable income. An indirect nexus was sufficient, as long as it was not too remote. The words ‘incidental and relevant’ in s 8-1(1)(a) did not expand or narrow its operation but were an ‘attribute’ of an expenditure and not an exhaustive test for deductibility. Deductibility depended upon the employment and the duties imposed on the taxpayer that arose from his occupation. The deductibility of the expense also depended

on the determination of what was productive of assessable income, which may encompass the positive and negative duties to be performed by the taxpayer. Given that the PSA imposed standards of conduct on the taxpayer, any breach may result in disciplinary charges. On this basis, there was a connection between the legal expenses and the derivation of assessable income. In Day, the majority of the High Court stated, at [29]–[31]: Expressions used in the cases, such as ‘incidental and relevant’, as referable to a business, should not be thought to add more to the meaning of provisions such as s 8-1(1)(a) of the ITAA, or to narrow its operation. They should be taken to describe an attribute of an expenditure in a

[page 364] particular case, rather than being an exhaustive test for ascertaining the limits of the operation of the provision [Lunney v FCT (1958) 100 CLR 478 at 497 per Williams, Kitto and Taylor JJ]. Reference in some cases to the expenditure having an essential characteristic must likewise be treated with some care. As Gaudron and Gummow JJ observed in Payne, the use of the term may avoid the evaluation which the section requires [2001] ATC 4027; (2001) 202 CLR 93 at 110– 111 [45]–[48], citing Professor Parsons, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (1985) at [8.62]. It is perhaps better understood as a statement of conclusion than of reasoning. Section 8-1(1)(a) is couched in terms intended to cover any number of factual and legal situations in which expenditure is incurred by a taxpayer. Its language and breadth of application do not make possible a formula capable of application to the circumstances of each case [see Lunney at 495, 496 per Williams, Kitto and Taylor JJ]. Cases are helpful to show the connection found on the facts there present, but not always to explain how the search for the requisite connection is to be undertaken. Payne directs attention to the statement made in Ronpibon Tin, as to the question posed by a provision such as s 8-1(1)(a), as correct and appropriate to be applied. The question, as restated in Payne, is: ‘is the occasion of the outgoing found in whatever is productive of actual or expected income?’ [2001] ATC 4027; (2001) 202 CLR 93 at 100 [11]. That inquiry will provide a surer guide to ascertaining whether a loss or expenditure has been ‘incurred in [the course of] gaining or producing … assessable income’. Essential to the inquiry is the determination of what it is that is productive of assessable income.

Food 10.50

Cost of food is generally not deductible to employees.

FCT v Cooper (1991) FCR 177; 91 ATC 4396 Facts: The taxpayer claimed food and drink expenses as a professional rugby league footballer who had a weight loss problem, which diminished his ability to break the opponent’s defence line and threatened his ability to maintain his position and therefore income. The coach gave him instructions to eat steak and drink 12 cans of beer a week. Federal Court held: The costs were not deductible under the first limb, and in any case were of a private and domestic nature. However, meal costs for business people or truck drivers while living away from home are generally deductible, as is a meal allowance received by an employee for working overtime. In a limited number of situations, food can be deductible. Deductible employee food expenses: s 8-1 CIRCUMSTANCES

AUTHORITY

The costs of food are deductible when a taxpayer travels away from home to attend a conference, a seminar or work

TR 98/9

Reasonable meal costs of an academic on sabbatical

AAT Case [1999] AATA 154; Re Chaudri and FCT (1999) 42 ATR 1001; 99 ATC 2138

[page 365] Non-deductible employee food expenses: s 8-1 CIRCUMSTANCES Additional food to offset weight loss of a professional footballer

AUTHORITY FCT v Cooper (1991) 29 FCR 177; 21 ATR 1616; 99 ALR 703

Meal expenses for a truck driver who worked up to 18 hours a day (except award overtime meal allowance expenses)

AAT Case 10363, Re Carlaw and FCT (1995) 31 ATR 1190

The cost of a meal purchased between jobs

TD 93/26

Meals of truck drivers and members of parliament during a workday

TR 95/18; TR 99/10

Meals taken on the road by a long-distance truck driver

AAT Case 10666 (1996) 31 ATR 1349

Medical expenses 10.51 Medical expenses are not deductible to employees or individuals, as they are of a private nature. Case 51/93 93 ATC 542 Facts: A professional footballer claimed deductions for private health insurance and for the excess of medical expenses above the insurance reimbursement. AAT held: As per Cooper, the expenses were private and lacked sufficient connection with income-earning activities.

Re VBI and FCT; AAT Case [2005] AATA 683 Facts: An acute care nurse who dealt with seriously ill children claimed a deduction for the costs of seeking treatment from a psychologist for stress that resulted from his work. The Commissioner disallowed the deduction. AAT held: Expenses were not deductible. The treatment arose from a substance abuse problem, and the treatment was directed at improving the nurse’s ability to cope more effectively with life generally as well as with his work. Thus, the essential character of outgoings was that they were not working expenses and did not have

the required connection to the derivation of income. The outgoings incurred were not directly related to the improvement or maintenance of a professional skill or knowledge. Even if the outgoing was incurred in gaining or producing assessable income, it was of a private or domestic nature. The treatment for physical or mental health is inherently of a private nature. However, the nurse would have been entitled to a medical expenses rebate under ITAA 1936 s 159P if his general practitioner had referred him for psychotherapy (rather than seeing a psychologist). In TR 95/8, the Commissioner ruled that the cost of vaccination as a precaution against diseases that may be contracted in the course of a taxpayer’s income-producing activities is [page 366] not deductible. Also, in TD 93/22, a professional sportsperson was not entitled to a deduction for private health insurance, even though it was a condition of employment. Non-deductible employee medical expenses: s 8-1 CIRCUMSTANCES

AUTHORITY

Additional food to offset a weight loss problem of a professional footballer

FCT v Cooper (1991) 29 FCR 177; 21 ATR 1616; 99 ALR 703

Fitness course of an airline pilot who had to take medical examinations upon which his flying licence was conditional, and who was advised that he should lose weight

(1981) 25 CTBR(NS) Case 26

Travelling costs to medical and other health practitioners for treatment

AAT Case 12821, Re Rossitto and FCT (1998) 39 ATR 1019

Vaccinations as a precaution against diseases that may be contracted in gaining income

TR 95/8

Private health fund contributions that are a

TD 93/22

condition of employment for a professional sportsman

Medical examinations are deductible, however, for airline industry employees, as they are required for the renewal of a licence required for employment: TR 95/19.

Practice Problem 8 FACTS

1

An employed lawyer incurs expenses in travelling 20 km from his house to get to work, because there are no buses or trains to work

2

A law and commerce graduate incurs airfare and travel costs in going to Sydney to obtain a position with a major bank

3

Costs of studying a commerce degree by an employee working as an assistant accountant

4

Costs of studying a commerce degree by a full-time student

SUFFICIENT CONNECTION?

Practice Problem 9 List non-deductible private expenses.

[page 367]

Practice Problem 10 Willy Last, who works for a firm of solicitors, rents a pacemaker for his heart condition. Without it he could not work. Can he claim the rent as a deduction under ITAA 1997 s 8-1?

Practice Problem 11 Bruce is a factory worker who purchases steel-capped boots for work. He also buys sunglasses, which he uses only when driving to work. Are these deductible under ITAA 1997 s 8-1?

Categories of expenditure s 8-1: business 10.52 The following categories of business expenses are examined: general day-to-day business expenses; preliminary expenses; abnormal events; home-to-work travel; interest; legal expenses; home office expenses; and travel expenses.

General day-to-day business expenses 10.53

General day-to-day business expenses are deductible under the

positive limbs of s 8-1: Herald & Weekly Times; Magna Alloys. In FCT v Day, the majority of the High Court relevantly commented on the relationship between deductible expenditure and assessable income of businesses, at [33]: That no narrow approach should be taken to the question of what is productive of a taxpayer’s income is confirmed by cases which acknowledge that account should be taken of the whole of the operations of the business concerned in determining questions of deductibility [Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295 at 309 per Dixon J; W Nevill & Co Ltd v FCT (1937) 56 CLR 290 at 307 per Dixon J; [1937] HCA 9; Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344 at 349–50].

Example A hairdressers shop: Deductible s 8-1 expenses include wages, shop rent, power, hair colour and hair products, cleaning, advertising, accounting fees, business insurance, debt collection, equipment lease, water. [page 368]

Preliminary expenses 10.54 In accordance with the decision in Maddalena (see 10.39), courts have held that expenses in setting up a business are preliminary expenses and thus are not deductible. Softwood Pulp & Paper Ltd v FCT (1976) 7 ATR 101; 76 ATC 4439 Facts: The taxpayer was incorporated to establish a new paper production mill. After feasibility studies, the project was cancelled. Deductions were claimed for the studies and accounting and legal expenses. Deductible? Supreme Court of Victoria held: Not deductible, as not incurred in carrying on a business. The taxpayer decided not to proceed. The expenses were too ‘preliminary’.

However, note the exception in Spriggs and Riddell noted at 10.39 above for recurrent preliminary costs for short-term work.

Abnormal events 10.55

Abnormal events of a business may be deductible. John Fairfax & Sons Pty Ltd v FCT (1959) 101 CLR 30

Facts: A newspaper publisher incurred legal expenses in defending the acquisition of shares in another newspaper company (a competitor which it was trying to control). High Court held: Not deductible under the second limb. The business carried on by the taxpayer was publishing newspapers. The legal expenses were not incurred in carrying on that business. Rather, they were incurred in defending the acquisition of another new business and thus they were too remote.

Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344 Facts: The taxpayer operated a department store. Two of its employees, en route to the bank to deposit the daily banking, were robbed at gunpoint. The taxpayer claimed a deduction for the stolen money. The Commissioner considered that this was not deductible. High Court held: Deductible under the first limb. Banking was a part of business operations, and robbery was a normal business risk. The court stated ‘incidental and relevant’ when used in relation to the allowability of losses, as deductions do not refer to the frequency, expectedness or likelihood of their occurrence or the antecedent risk of their being incurred but to their nature or character. What matters is their connection with the operations that more directly gain or produce the assessable income: at 149.

Home-to-work travel 10.56 Home-to-work travel for self-employed persons is generally not deductible. [page 369]

Hayley v FCT (1958) 100 CLR 478 Facts: A self-employed dentist claimed deductions for travel from home to their place of business. High Court held: Not deductible under the second limb, as the expenses did not have the essential characteristic of a business expense. Travel from home to a business place is not deductible.

Interest 10.57 Interest expenses are generally deductible if the borrowed funds are used for an income-producing purpose. Steele v FCT (1999) 197 CLR 459 Facts: The taxpayer claimed interest deductions on money borrowed to purchase a property to carry out a motel development. The land was used for horse agistment over a period of 7 years. During this time, the taxpayer unsuccessfully sought council approval for building a motel. Eventually, the taxpayer sold the land without carrying out the motel development. High Court held: Deductible revenue expenses. If the taxpayer

acquired a capital asset for the purpose of gaining assessable income, it was not necessary that the income was gained in the same year as the expenditure was incurred. Whether an expense was preliminary or incurred too soon may be relevant, but contemporaneity was only one factor. 10.58 In Steele, Gleeson CJ, Gaudron, Gummow, Kirby and Callinan JJ stated at 470–1: As was explained in Australian National Hotels Ltd v FCT, interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of borrowed money during the term of the loan. According to the criteria noted by Dixon J in Sun Newspapers Ltd v FCT it is therefore ordinarily a revenue item. This is not to deny the possibility that there may be particular circumstances where it is proper to regard the purpose of interest payments as something other than the raising or maintenance of the borrowing and thus, potentially, of a capital nature. However, in the usual case, of which the present is an example, where interest is a recurrent payment to secure the use for a limited term of loan funds, then it is proper to regard the interest as a revenue item, and its character is not altered by reason of the fact that the borrowed funds are used to purchase a capital asset. The fact that the asset has not yet become, and may never become, income-producing may be relevant to a decision as to whether the case falls within the first limb of s 51(1). However, once it is determined, or accepted by hypothesis, that the interest is, during the relevant year, an outgoing incurred in gaining or producing the taxpayer’s assessable income (even though no assessable income is derived during that year, and no such income may ever be derived) the circumstance that the capital asset has produced no income is not a reason to conclude that the interest is an outgoing of a capital nature.

FCT v Anovoy Pty Ltd [2001] FCA 447 Facts: The taxpayer acquired a run-down property that it intended to restore and sell for a profit. The taxpayer’s directors lived in the property and paid rent to the taxpayer, and the taxpayer claimed large deductions for the interest on the funds borrowed to acquire the [page 370] property. The Commissioner argued that the interest was not

sufficiently connected with assessable income. Full Federal Court held: Expenses were not deductible. The property was not acquired for any clear profit-making purpose, since the future use of the property was undecided.

A car manufacturer borrows $10,000,000 to purchase a factory. The interest expenses are deductible. A deli owner borrows $50,000 to purchase a deli. The interest expenses are deductible. Then the deli owner sells the deli and uses the $50,000 sale proceeds to purchase a yacht. The interest will no longer be deductible. Interest was found not to be deductible in the BHP case (below).

The Broken Hill Pty Co Ltd v FCT 99 ATC 5193 Facts: BHP commenced negotiations for the purchase of shares in Utah companies around August 1982. The date for valuation of the underlying assets of the Utah companies was 1 January 1983, and the completion of the purchase arose in March 1984. BHP paid $2.4 billion plus interest from the date of valuation to completion. The interest amounted to $198 million. The $2.4 billion value was determined by estimating the present value of future cash flows to be derived over a 20-year period commencing on 1 January 1983. In other words, the purchase price took into account profits to be earned by the Utah companies between 1 January 1983 and the date of completion of the sale. The purchase agreement provided that the amount of interest payable would not exceed (broadly) the combined net income of the Utah companies for the period between 1 January 1983 and the date of completion of the sale. The vendor retained control of the business

until completion, although in the exercise of control, the vendor was bound to conform to undertakings for BHP’s benefit, including an undertaking to preserve the businesses intact. BHP claimed a deduction for the interest, but the Commissioner disallowed the interest, viewing it as a capital payment. It represented a payment for the retained earnings of Utah. BHP argued that the value of the retained earnings had already been taken into account in the calculation of the purchase price. Federal Court held: Not deductible. The payment was not interest in the real sense; rather, it was part of the purchase price. Deduction for interest after cessation of business 10.59 A deduction may be obtained for interest after cessation of a business.

FCT v Brown 99 ATC 4852 Facts: In November 1988, the taxpayer and his wife, as partners, borrowed $105,000 from a bank to fund the purchase of a suburban delicatessen. In March 1990, the business was sold for $65,000 and the net proceeds of the sale were applied to reduce the loan, but a balance [page 371] of $42,174 remained outstanding. Payments of interest and principal continued to be made until the loan was finally extinguished in July 1995. The Commissioner disallowed the interest deductions for the years ended 30 June 1993 and 1994, as the business had ceased; thus, there was insufficient connection to assessable income.

Federal Court held: Deductible. The cessation of the business had not broken the nexus between the liability for interest and the carrying on of the business. This is in line with Steele’s case, in that the ‘occasion’ of the loss or outgoing was determined by reference to the purpose of the taxpayer in borrowing the money and the use to which it was put. In this case, the ‘occasion’ for recurrent liability to pay interest was the obligation under the bank loan contract. Also, it made no difference that the taxpayer may have been able to repay the outstanding debt immediately on the cessation of the business but chose, in effect, to continue with the contractual payments for several years. But there may come a period of time between cessation of the business and the payment of interest when the interest is no longer sufficiently proximate to the activities of the business, so those activities no longer provide the occasion for the outgoing. In other words, ‘contemporaneity’ may become a problem depending on the circumstances. Similarly, in Jones v FCT 2002 ATC 4135, interest on a loan used to purchase equipment for a partnership business continued to be deductible after the death of one of the partners. This was allowed for some time, even though the loan was refinanced. See Taxation Ruling TR 2004/4 for the Commissioner’s views on the deductibility of interest prior to and after income-earning activities. Roberts and Smith: refinancing principle 10.60 There has been a trend away from rigid tracing of the use of funds by business to ascertain the deductibility of interest. This is evident in the views of the Federal Court in Roberts and Smith and the Commissioner in TR 95/25 and IT 2582 (permits interest deductions for money borrowed to pay income tax).

FCT v Roberts and Smith (1992) 37 FCR 246; 92 ATC 4380

Facts: The taxpayers were partners in a firm of solicitors that decided to allow partners to reduce their working capital previously contributed to the partnership. This was done so that any new partners could buy into the partnership at a lesser cost. The partnership borrowed $125,000, which was credited as a liability in the partnership accounts, and each partner’s capital account was debited accordingly. The partners used the money withdrawn from the partnership for private purposes. Federal Court held: Deductible, as interest on a loan was used to repay working capital. The refinancing takes on the same characteristics as the original borrowing and gives the interest the character of a business expense. Such deductibility of interest is known as the refinancing principle. Negative gearing 10.61 As noted above at 10.41, the fact that income derived from the use of borrowed funds is less than the interest expense does not prevent the interest from being deductible. [page 372] However, where the loan is obtained for a dual purpose (private and business), the deduction will need to be apportioned: see Ure. But Ure may not have a wide application in the corporate context where a second purpose exists, where a second general business purpose is not of a private, domestic or capital nature. FCT v Total Holdings (Australia) Pty Ltd (1979) 9 ATR 885; 79 ATC 4279 Facts: The taxpayer company borrowed money and on-lent the

money interest-free to its subsidiary. Federal Court held: Interest deductible. The purpose was to render the subsidiary profitable as soon as commercially possible so that the taxpayer could derive assessable income from the subsidiary sooner.

Legal expenses 10.62 Legal expenses will have sufficient connection to earning income if they arise out of the day-to-day activities of the taxpayer’s business (Herald & Weekly Times) and the legal action has more than a peripheral connection to the taxpayer’s income-producing activities: Magna Alloys & Research Pty Ltd v FCT 80 ATC 4542. Herald & Weekly Times v FCT (1932) 48 CLR 113; 2 ATD 169 Facts: A newspaper proprietor claimed legal defence costs and damages awarded in connection with libels the newspaper had published. High Court held: Deductible, since publishing the newspaper was the source of income and the cause of liability. The possibility of libel is a regular and almost unavoidable incident in publishing. The deductibility of legal expenses under s 8-1 is strongly linked to the purpose of incurring the expense. The success or failure of the legal action, however, is irrelevant to the deductibility. Legal costs associated with day-today business matters will be deductible under s 8-1; for example, legal costs incurred in recovering business debts, employing staff etc. However, legal expenses associated with the acquisition or disposal of a capital asset will be non-deductible capital amounts; for example, legal expenses associated with the purchase or sale of real estate, shares or a business.

Also, legal expenses incurred in respect of private matters will not be deductible. And having said all of that, there are many grey areas and much case law on this issue. The following table lists some of the leading cases. DEDUCTIBLE LEGAL EXPENSES Legal expenses that arise out of the day-today activities of the taxpayer’s business: Magna Alloys and Research Pty Ltd v FCT 80 ATC 4542

NON-DEDUCTIBLE LEGAL EXPENSES Legal expenses that enlarge or alter the structure of the profit-yielding subject: Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337

[page 373]

DEDUCTIBLE LEGAL EXPENSES

NON-DEDUCTIBLE LEGAL EXPENSES

Legal costs to improve a business (but not alter its structure)

Legal expenses associated with the reorganisation of a business: Foley Bros Pty Ltd v FCT (1965) 13 ATD 562

Legal expenses to alter a company’s constitution that resulted in a better management structure: IR Commrs v Carron Company (1968) 45 TC 18

Legal expenses to vary a company’s share capital: Archibald Thomson, Black & Co Ltd v Batty (1919) 7 TC 15

Legal costs in connection with libels that a newspaper had published: Herald & Weekly Times Ltd v FCT (1932) 48 CLR 113

Legal expenses to vary the company name and articles of association: FCT v Duro (1953) 87 CLR 524

Legal costs and damages paid for breach of an ordinary trading contract are ordinarily deductible: Stockvis v FCT (1930) 1 ATD 9

Legal expenses incurred to recover exempt income or a capital asset

Legal costs of an accountant in defending fraud claims from insolvency work: Putnin v FCT 91 ATC 4097

Legal expenses in disputing ownership of the business entity: IR Commrs (Ceylon) v Appuhamy [1963] AC 17; [1963] 1 All ER 69 (PC)

Legal costs in defending a misrepresentation action brought by a customer: Reo Motors Ltd v CT (NSW) (1931) 1 ATD 163

Legal expenses incurred in proceedings instituted by a director-shareholder to stop a public examination into the liquidation of his company: Kratzmann v FCT 70 ATC 4043

Legal costs incurred in the recovery of a debt: Scammell (G) & Nephew Ltd v Rowles [1939] 1 All

Legal costs of establishing a business and acquiring capital assets: Sun Newspapers v FCT

ER 337

(1938) 61 CLR 337

Legal expenditure to defend attacks upon the way a taxpayer carries on its business: FCT v Snowden and Willson Pty Ltd (1958) 99 CLR 431

Legal costs in acquiring shares or the control of a business: John Fairfax & Sons Pty Ltd v FCT (1959) 101 CLR 30

Legal costs in defending criminal charges against a director in regard to marketing practices adopted in selling the taxpayer’s products: Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276; 80 ATC 4542

Legal costs in acquiring patents, registered designs, copyright and trademarks

Legal costs in respect of a Royal Commission looking at the justification of price increases by the taxpayer: Sydney Ferries Ltd v C of T (NSW) (1922) 22 SR (NSW) 432

Legal costs in obtaining an initial business licence (liquor licence): Southwell v Savill Bros Ltd (1901) 2 KB 349; 4 TC 430

Legal costs of appearing before the Royal Commission in regard to unfair business practices (did not imperil business): FCT v Snowden & Willson Pty Ltd (1958) 99 CLR 431

Legal expenses in stopping a threatened extinction of the profit-yielding subject (alcohol company stopping alcohol prohibition in New Zealand): Ward & Co Ltd v C of T (NZ) [1923] AC 145

[page 374]

DEDUCTIBLE LEGAL EXPENSES Legal costs defending charges arising out of the conduct of a medical practice, as they arose out of day-to-day activities: Elberg v FCT 98 ATC 4454

NON-DEDUCTIBLE LEGAL EXPENSES Legal expenses incurred in eliminating or preventing competition: Sun Newspapers v FCT (1938) 61 CLR 337 Legal expenses in defending the right to televise major test cricket matches (did imperil entire business): PBL Marketing Pty Ltd v FCT 85 ATC 4416 Legal expenses incurred in defending title to capital assets: Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423 Legal costs of seeking compensation for damage suffered to a capital asset: Richard James Pye v FCT (1959) 33 ALJR 337

There are also various specific deductions for legal expenses in respect of: borrowing, s 25-25; discharging of certain mortgages, s 25-30; preparing, stamping or registering of leases, s 25-20; tax-related expenses, s 25-5; and establishing, defending, restructuring or ceasing a business, s 40-880. See Chapters 11 and 13.

Home office expenses 10.63 As noted previously, home office expenses are not generally deductible unless part of the home is set aside as a business area and the public accepts it as such. For example, a doctor’s surgery located as part of a residence will be a place of business. Thus, interest, rates, maintenance etc will be deductible in part. FCT v Forsyth (1981) 148 CLR 203 Facts: A barrister claimed a deduction for rent paid to a family trust for the use of a room in a house owned by the trust. The house was also used by the taxpayer’s family as their residence. The room for which rent was paid was used as a study. High Court held: The rent was not deductible; the outgoing was of a private or domestic nature because the study was physically integrated into the home and was not distinguishable from other rooms in the house. In Forsyth, Wilson J stated at 215: In my opinion, an important question is the relationship of the study and ancillary space to the house as a whole. There would appear to be complete integration, with no suggestion of any physical exclusivity. The study is indistinguishable from other rooms in the private living area

[page 375] of the house, and is so placed to the taxpayer’s bedroom that he finds it convenient to keep his clothes in the study and use it as a dressing room. The ancillary space for a desk, where the taxpayer often works, is downstairs at the side of the living room. It would seem to be intimately related, in a physical sense, to the life of the family. These matters are not decisive in themselves. Other features of the arrangement are relevant though, again, not decisive. The taxpayer maintains chambers in the city. There is no compulsion for him to work at home, as was the case with the part-time lecturer in Banks [supra]. Like many professional people, he finds it convenient to do so. The professional activity he engages in at home is mostly research and reading, presumably not requiring the services of a secretary. Resort to the house by clients and/or solicitors for the purpose of professional conferences are apparently so infrequent as to be immaterial. As I have said, in the last resort the question is one of fact and degree. Having regard to all the circumstances, I conclude that it is not open on the facts of this case to find that the outgoings in question were incurred in gaining or producing the assessable income, or were necessarily incurred in carrying on the taxpayer’s professional business. The home was not his business premises. It was not open to be described, with any show of reality, as his base, or one of his bases, of operations, to use the term adopted by the Court of Appeal in Newsom v Robertson [(1952) 2 All ER 728; 33 TC 542]; cf Lunney v FC of T (1958) 100 CLR 478 at 500; 7 AITR 166 at 180; Horton v Young (Insp of Taxes) [1972] 1 Ch 157; [1971] 3 All ER 412. The outgoings were therefore neither incidental nor relevant to the gaining of assessable income.

Although interest, rent, rates and taxes are not deductible for such home offices, the taxpayer can claim deductions for light and power, work phone calls and depreciation.

Travel expenses 10.64 Again, as set out above at 10.37, travel expenses from home to work are generally not deductible for the self-employed, as per Lunney, as the essential character is of a private or domestic nature. However, professional footballers and musicians based at home are able to deduct travel from home. Where the transport of bulky equipment is a necessary part of the job, travel will be deductible: Scott (No 3) v FCT 2002 AAT 2243. However, a stevedore’s work-related car expenses were disallowed as the AAT did not consider the essential safety and protective clothing gear was bulky: Rafferty v FC of T [2017] AATA 636. Also, travel expenses incurred in the course of the taxpayer’s work or in travelling between one place of business and another will be deductible, as are

accommodation and meals on business trips away from home. For a self test on the deductibility of common expenses see the following ATO link: http://www.ato.gov.au/deductions

GST and deductions: ss 27-1–27-5 10.65 No deduction is available for the GST component of a loss or outgoing to the extent that it relates to an input tax credit for an acquisition or to a decreasing adjustment of GST. Deductions, though, are available for increasing adjustments. [page 376]

Practice Problem 12 FACTS

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Lease paid by a law firm for its business premises

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A television station pays out a footballer’s TV contract due to his change of footy clubs. This saves the network $50,000 in future payments

SUFFICIENT CONNECTION?

Practice Problem 13 Are the following current tax year expenses incurred by Alf in a share trading business deductible under the positive limbs of s 8-1? 1 In the first year of operation, Alf incurs $1000 costs to incorporate a company, Green Pty Ltd, which he

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uses to commence his new share trading business. Then, after 2 years, Green incurs costs of establishing a new corporate bonds investment business. During the sixth year, Green incurs wages for a new employee who will research listed companies and share prices. After 10 years, Alf retires and decide to close the business on 31 March of the previous income tax year. On 30 June of the current income tax year, he incurs legal costs in defending an action taken against him for misleading advice given 2 years earlier.

Practice Problem 14 Are the following expenses deductible under the positive limbs of s 8-1? 1 petrol expenses paid by a trucking contractor 2 home-to-work travel by a cricketer who operates a promotions business 3 the Dodgy Red Winery pays $100,000 to a family trust for the provision of minor clerical services provided by a family member.

Attempt the Web Quiz for Chapter 10 [page 377]

Summary 10.66 Deductions form the other half of the equation used to calculate taxable income (see s 4-15) (Taxable income = Assessable income – Deductions). General deductions must satisfy the positive limbs (generally expenses that have sufficient connection with the earning of assessable income) and must not be precluded by the negative limbs (not of a capital or private nature or relating to exempt income). Understand the words and phrases analysis approach to s 8-1. Be able to categorise an expense in the relevant non-business or business expense category and apply the case law.

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. 1 What is a deduction? 2 Are the following items of business expenditure allowable deductions under the positive limbs of s 8-1? Provide section, case and reason. a A South Australian branch of ANZ Bank paid child care expenses for one of its employees. b A self-employed concreting contractor travels from his home to his place of work, which is always at the same location. 3 Are the following items of business expenditure allowable deductions under the positive limbs of s 8-1? Provide section, case and reason. a A self-employed electrical contractor who is an itinerant worker

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travels between two places of business, and his motor vehicle expenses are all paid by his rich uncle. b Expenses paid by a company director for his trip to visit major overseas clients and existing agencies in Brazil. As a result of the trip, he gained appointment to Chairman of the Board, and his director fees doubled from $100,000 per annum to $200,000 per annum. Are the following items of expenditure allowable deductions under s 8-1 for the following employee taxpayers? Provide section, case and reason. a A Queensland engineer borrows $200,000 at 10 per cent per annum on 1 July of the current tax year ended 30 June for the purpose of on-lending the same amount to the trustee of his family trust. The interest charged by the engineer to his trustee is 1 per cent per annum. Assuming that he derived $2000 income for the 30 June tax year from this transaction, what deduction is he entitled to, given that he has interest expenses of $20,000? b Child care fees paid by a single working mother to a child care centre. She works in a Melbourne school as a teacher. [page 378]

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Are the following items of expenditure allowable deductions under the positive limbs of s 8-1? Provide section, case and reason. a Costs incurred by a 50-year-old pharmaceutical manufacturer, a large public company, in an unsuccessful research program to develop a new drug. b Interest on a loan used by an investor to purchase shares that yield only a 2 per cent dividend. The rate of interest on the loan is 8 per cent. Are the following items of expenditure allowable deductions under the positive limbs of s 8-1? Provide section, case and reason. a A deli owner borrows money by mortgaging the business assets to purchase a family home. Are the interest expenses deductible?

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Would it make any difference if the loan was mortgaged against a family home and used to purchase business assets? Missile works as a part-time swimming instructor as an employee. He purchases swimming costumes every 6–8 weeks as a result of the damaging effect of the chlorine in the water on the swimming costumes. Is Missile’s swimwear deductible under s 8-1? Emma, a flight attendant, suffered from severe dehydration of the lips and face from cabin pressure. She therefore purchased make-up so that her lips did not crack or bleed and her skin did not dry out as much. She also incurred expenditure in respect of moisturisers. Is this expenditure deductible under ITAA 1997 s 8-1? Bob and Ben own a rental property as joint tenants. Bob obtains an independent valuation of the property of $500,000 and then borrows $250,000 to buy out Ben’s half-share in the property. Can Bob claim interest costs on the funds borrowed to acquire the share of Bob’s property under ITAA 1997 s 8-1? Ernie borrowed funds for the purchase of a rental unit. After a period of time, he redrew an amount under a redraw facility of the loan and used this for an overseas holiday. The interest charges subsequently increased and he claimed them as a deduction. Are the increased interest repayments an allowable deduction under ITAA 1997 s 8-1? Wang borrowed $200,000 from a bank on a line of credit facility and used the funds to acquire shares. The shares returned dividend income. After several years, the taxpayer sold the shares at a loss and was left with $100,000 of the original debt. He then refinanced the $100,000 loan. Is Wang entitled to a deduction under ITAA 1997 s 8-1 for interest incurred for the refinanced loan? Mr and Mrs Lovelace obtained a business loan, which was on-lent to their private company. The company used the funds to acquire shares. No loan agreement existed between them and their private company. The only income they derived from the company was salary. No loan repayments were made, as the anticipated profits of the company did not

eventuate. Are Mr and Mrs Lovelace entitled to an interest deduction under ITAA 1997 s 8-1 for moneys on-lent to the private company? [page 379] 13

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Deb borrowed funds and purchased land with the intention of constructing a rental house. For financial reasons, Deb was unable to commence the actual development of the property for a 2-year period. After that time, the property was built over a period of 8 months and then let to tenants. Is interest on a loan taken out to fund the purchase of vacant land held for future income-producing use deductible under ITAA 1997 s 8-1? Cindy took out a home loan of $500,000 to finance the purchase of her new Pier Point residence. She later refinanced the loan with a line of credit and used this to purchase a yacht for $200,000. She then rented out her residence and moved to Perth. Is she entitled to a deduction under ITAA 1997 s 8-1 for the full loan interest expenses when she rented out the house? Pedro purchased a house at Mountain Head 2 years ago with the purpose of subdividing the land and building a new house for sale at a profit. He built the new house and then sold it in the current tax year, resulting in a loss. He had a property development background. Is the loss on the sale of a new house deductible under ITAA 1997 s 8-1? The non-profit Porsche racing club derives interest income from its investments. The investments are from the bequests of its members. From this income it pays out sponsorships to its members. Can the non-profit Porsche racing club claim the payment of sponsorships as allowable deductions against interest income under ITAA 1997 s 8-1? Arthur is in the process of writing a documentary-style book. He does not carry on a business of writing books, and the project is not related to

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any employment. He has no publisher. He travels in order to conduct research for the book and incurs various associated costs totalling $22,000. Is he entitled to a deduction under ITAA 1997 s 8-1 for travel expenses incurred in conducting research? Mako has an investment portfolio that includes a shareholding in a company, WOW Ltd. He incurs air travel expenses to attend WOW’s annual general meeting in Melbourne. Is Mako entitled to a deduction under ITAA 1997 s 8-1 for travel expenses? Reddie, a company director, suffered from work-related stress, which adversely affected her ability to properly perform work-related tasks. The company paid for her to attend counselling sessions with a clinical psychologist. Are expenses incurred by the employer for a clinical psychologist for stress counselling sessions deductible under ITAA 1997 s 8-1? Barb, a self-employed doctor, is on call for 12-hour shifts at least 10 times per month for accident and emergency duties, and on call for 2 days per week for other duties. Her partner looks after the children. When Barb’s partner is away, she employs a carer. Is Barb entitled to a deduction for the carer under ITAA 1997 s 8-1? Jessie, a self-employed plumber, has large toolboxes that are heavy and are stored in her motor vehicle. However, her place of business has a secure facility for the storage of her tools. Can Jessie claim a deduction for the cost of using her motor vehicle to transport tools to and from work under ITAA 1997 s 8-1? [page 380]

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Wendy operates a renovation business, and a few months after her work is finished she gives a bottle of vodka to her client as a gift. Is Wendy entitled to a deduction under ITAA 1997 s 8-1 for the gift? Cool Ltd, a national-based company, pays the annual fees of an airport

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lounge membership for its employees. Are these fees deductible? Peter purchased an orange-coloured shirt to wear to work as a safety requirement. The shirt has no other special features and does not have a corporate logo attached. Are the shirt and laundry expenses relating to it deductible under ITAA 1997 s 8-1? A television presenter, Silvio, must be impeccably presented and incurs great expense in relation to suits, haircuts and colouring, and make-up products. Are these costs an allowable deduction under ITAA 1997 s 8-1? Employer A requires Bill to wear a distinctive uniform that is not suitable for use with Employer B, necessitating a change of clothes prior to commencing duties with the second employer. Bill uses a motor vehicle to travel between employers A and B and from home to work. Is expenditure incurred by Bill in transporting a change of clothes from home to work an allowable deduction under ITAA 1997 s 8-1? Burt is a carpenter employed in Alice Springs who normally resides in Darwin. He returns to his home on the weekends. Can Burt claim accommodation as a work-related deduction under ITAA 1997 s 8-1? Digga, a geologist, claimed weekly expenses incurred in travelling from Perth to Kalgoorlie, his place of employment, and back again. He takes small rock hammers with him. He also spends 3 hours per week at his home doing work. Are the expenses incurred by the taxpayer in travelling to the base camp and back again deductible under ITAA 1997 s 8-1? Jen is employed as a consultant by a NSW state government department. She travels from home to one of various work locations within the city. She attends several offices each day before returning home. While she could use a departmental vehicle, for convenience she uses her own vehicle. She claims costs on a cents per kilometre basis and she maintains a logbook. Can Jen claim the cost of travelling between home and work under

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ITAA 1997 s 8-1? Fonz is an apprentice mechanic who road-tests semi-trailers. Roadtesting is an essential part of the taxpayer’s normal duties. Fonz attends and pays for a semi-trailer driving training course and gains a licence. This course may also give Fonz an opportunity for higher pay. Is Fonz entitled to a deduction under ITAA 1997 s 8-1 for self-education expenses? Having ceased employment with a law firm, Briony, a lawyer, applies to undertake a postgraduate course in law at a Californian university in order to improve her professional knowledge and skills. Are Briony’s expenses incurred in undertaking a postgraduate course of study an allowable deduction under ITAA 1997 s 8-1? Dick is a CEO and signs up for a life coaching program. The coaching includes discussion of integrating work and lifestyle, prioritising actions and projects, personal [page 381]

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planning, budgeting and goal-setting, time and resource management, and career transition. Is Dick entitled to a deduction under ITAA 1997 s 8-1? Estia taught tourism as one of her subjects, and undertook a study tour overseas to improve her knowledge and practical experience. Her employer did not request her to undertake the trip and did not reimburse her $20,000 of costs. Are Estia’s overseas travel expenses deductible under ITAA 1997 s 8-1? Jane works part time as a netball coach with more than one sporting team at a number of locations for training and at a number of locations for games. She spends 1–2 hours per week on coaching activities in her home office. Are the home office expenses — such as rates, mortgage interest and house insurance — allowable deductions under ITAA 1997 s 8-1?

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Sophia, a lawyer and employee of a law firm, contributes to an income protection policy for sickness and ill health. Is Sophia entitled to a deduction under ITAA 1997 s 8-1? Gail is employed as a stockbroker and is held personally and directly liable for any bad debts for any client that she is responsible for or has introduced to the firm. Is Gail entitled to a deduction under ITAA 1997 s 8-1 for an amount paid to her employer in order to cover outstanding client bad debts? Tori arrived and remained legally in Australia on a holiday visa and wished to work here; she incurred legal expenses of $500 in trying to obtain a temporary business visa. She then obtained a temporary business visa from the Department of Immigration and Multicultural Affairs. Are her legal expenses deductible under ITAA 1997 s 8-1? Spider, a professional cricketer, was involved in an on-field breach of the sports code of conduct by hitting an umpire. His employment contract requires him to obey all instructions of his employer. The breach was committed at the instructions of his coach. As a result, a $20,000 fine was imposed by the cricket board on the cricket club, and the club (his employer) passed the fine on to Spider. Can Spider deduct the fine under ITAA 1997 s 8-1? Sandra, a certified practising accountant, is employed as an accountant and subscribes to pay TV in order to access a professional education channel. The professional education channel has received accreditation from CPA Australia. Can Sandra claim a deduction under ITAA 1997 s 8-1 for pay TV subscription fees for the business channel? Bruce is employed as a security guard and needs to be physically fit in order to carry out duties, so he joins a gym. Can Bruce claim a deduction under ITAA 1997 s 8-1 for gymnasium membership fees? Simon used a personal corporate credit card belonging to his employer to incur general expenses on behalf of his employer. However, the employer ceased business and Simon was sued by the credit card

company for $10,000, the amount owing on the card. He incurred legal expenses of $20,000 in defending the court action. Are the credit card and legal expenses incurred by Simon deductible under ITAA 1997 s 8-1?

1.

Cecil Bros Pty Ltd v FCT (1964) 111 CLR 430; FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645.

2. 3.

See TR 95/34. See TR 93/30.

[page 383]

11 Specific deductions Learning Objectives After you have studied this chapter, you should be able to: describe the structure and operation of ITAA 1997 ss 8-5, 8-10; determine whether a particular expense is deductible under a specific deduction provision (provide full legal reasoning); determine what constitutes a deductible repair; determine what constitutes a deductible gift; determine what constitutes a deductible borrowing cost; determine what constitutes a deductible loss; determine what constitutes a deductible bad debt; determine what constitutes a deductible car expense; determine what constitutes deductible travel between different workplaces; and determine what constitutes deductible superannuation.

[page 384]

Key Legislative Provisions Income Tax Assessment Act 1936 (ITAA 1936) ss 51AEA–51AEC Income Tax Assessment Act 1997 (ITAA 1997) ss 8-5, 8-10 s 36-15 ss 290-60–290-80 Div 25 Div 30

Key Cases Alcoa of Australia Ltd v FCT AAT Case [2008] AATA 1128 Falcetta v FCT; FCT v Bartlett (2004) 56 ATR 59; [2004] FCAFC 117 FCT v McPhail (1968) 10 AITR 552; 41 ALJR 346 FCT v Western Suburbs Cinemas Ltd (1952) 86 CLR 102 Law Shipping Co v IR Commrs (1924) 12 TC 621 Lindsay v FCT (1961) 106 CLR 377 Odeon Associated Theatres Ltd v Jones [1972] 1 All ER 681 Union Trustee Co of Australia Ltd v FCT (1935) 53 CLR 263 W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58

Key ATO Publications

TR 97/23 Income tax: deductions for repairs TR 2005/13 Income tax: tax-deductible gifts — what is a gift? Rental property expenses [page 385] Diagram 11.1:

Deductions — specific deductions

Chapter overview 11.1

Like the statutory income provisions, there are numerous specific

deduction provisions scattered throughout the 1936 and 1997 ITAAs. To avoid repetition, the specific deduction provisions for international tax, tax accounting, capital allowances, entities, superannuation, special taxpayer and anti-avoidance provisions are dealt with in other chapters of this book. This chapter deals with the remainder. These provisions are important, as these deduction provisions extend the range of deductible expenses beyond the general deduction provision: see ss 8-1, 8-5 and Chapter 10. Specific provisions take precedence over general deductions.1 [page 386]

Read ITAA 1997 ss 8-5, 8-10 This chapter examines the third stage of the deductions method. DEDUCTIONS METHOD Chapter 5

What tax accounting rules apply?

Chapter 10

Is the outgoing a general deduction?

This chapter — Is the outgoing a specific deduction (excluding capital allowances)? Chapter 12

Do any of the deduction limitations apply?

Chapter 13

Is the outgoing a capital allowance?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the expense is deductible

Specific deductions: ITAA 1997

Tax-related expenses: s 25-5 11.2 You can deduct non-capital expenditure that you incur to the extent that it is for managing your tax affairs or for complying with an obligation imposed on you by a Commonwealth law, in so far as that obligation relates to the tax affairs of the entity. There is no requirement that the expense relates to the production of assessable income. Rather, it must relate to an obligation of the tax affairs of the entity. In Taxation Determination TD 2017/8, the ATO considers that the cost of travelling to have a tax return prepared as deductible under s 25-5. The expenses must be in respect of a recognised tax adviser; for example, the costs of preparing a tax return by an accounting firm. A recognised tax adviser also includes a lawyer with a current practising certificate.

Read ITAA 1997 s 25-5 Falcetta v FCT; FCT v Bartlett (2004) 56 ATR 59; [2004] FCAFC 117 Facts: The taxpayers claimed deductions under s 25-5 for fees paid to their tax agent. The fees were paid in respect of their personal tax affairs and the tax affairs of associated companies of which they were director-shareholders. For Falcetta, the fees were paid for work partly related to director penalty notices for unpaid group tax and prescribed payment system liabilities of a company. The fees also related to the liquidation of the company and the incorporation of a new company, and were also for advice on the taxpayers’ personal liability to company creditors. [page 387] Full Federal Court held: Fees in respect of the liquidation of the company and the incorporation of a new company, and also for advice

on the taxpayers’ personal liability to company creditors, were not deductible under s 25-5. Deductions were allowed for advice on their tax returns and company tax returns; the taxpayers’ obligations for provisional tax, group tax and prescribed payments; tax liability on dividends; how the new company would meet tax liabilities; and logbooks. Importantly, the court noted that s 25-5 covered not only advice provided but also management and compliance issues.

Taxes other than income tax 11.3 Taxes other than income tax are generally deductible under s 8-1 if there is sufficient nexus with the production of assessable income. For example, payroll tax, land tax, debits tax, financial institutions duty, fringe benefits tax and non-capital stamp duty are generally deductible, per Magna Alloys (see Chapter 10). However, income tax, student contribution under the Higher Education Support scheme and the superannuation guarantee charge are not deductible. Goods and services tax (GST) is generally not deductible for employees, investors and non-GST-registered businesses.

Read ITAA 1997 s 25-5 Repairs: s 25-10 11.4 Section 25-10(1) states that you can deduct expenditure incurred for repairs to premises (or part of premises) or plant that you held or used solely for the purpose of producing assessable income.

Read ITAA 1997 s 25-10 Meaning of ‘repairs’ 11.5

The word ‘repairs’ is not defined in the Act; accordingly, the courts

have developed the following six principles for interpreting the word. 11.6 A repair restores an item to its previous condition without changing its function. Normal maintenance expenses, such as fixing a deteriorated machine or painting a faded wall in a business premises, that return an item to its previous state with no change of function are deductible: see W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58. 11.7 An item must need restoration before it can be repaired. No deduction was allowed for a taxpayer who shortened (ordered to do so by the council) a good awning over his shop when it was working well: see Case J47 (1958) 9 TBRD 244. There was nothing to be repaired. 11.8 A repair replaces part of an item rather than the entire item. A restoration by renewal or replacement of subsidiary parts of a whole is deductible, but the repair of the entirety is not deductible. This begs the question, what is an entirety? The courts, in determining an entirety, have taken the following approach. [page 388] 11.9 Functional approach. In this approach, the court decides whether the thing being repaired is a separately identifiable item or a functionally inseparable part of a larger item. FCT v Western Suburbs Cinemas Ltd (1952) 86 CLR 102 Facts: The taxpayer replaced the roof of a cinema. Court held: The building was the entirety and the roof was only a part. This did not mean that the expense was deductible: see 11.11 below.

W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58

Court held: The building was the entirety and the floors and walls were subsidiary parts.

Lindsay v FCT (1961) 106 CLR 377 Facts: The taxpayer repaired ships in its premises, which included two slipways. A timber slipway was replaced with concrete because timber was not available. The new slipway was longer than the old one, although the greater length produced no greater efficiency. Court held: Not a deductible repair, as the slipway was an entirety.

Alcoa of Australia Ltd v FCT AAT Case [2008] AATA 1128 Facts: The taxpayer operated an aluminium smelter and demolished and rebuilt the refractory in the anode bake furnace and refurbished and upgraded the fume scrubber in the furnace. The taxpayer obtained a private ruling as to the deductibility of the expenditure to be incurred. At issue was whether the proposed expenditure on the replacement/repair of brickwork or refractory and the replacement of waste gas ductwork were deductible under s 25-10. The Commissioner found that the work was an improvement and therefore of a capital nature. AAT held: The refractory material used to line the tubs and form the smaller pits in the tubs did not constitute an entirety, since it worked to insulate the tub from the heat generated when baking the anodes. The smaller pits did not form a separately identifiable, principal item of capital equipment. They were functionally an integral part of the bake furnace. This was the entirety. The cost of replacing the refractory, itself a subsidiary but essential element of the bake furnace, was a repair. This expenditure also was a periodic replacement and thus a repair on that basis as well. Since the bake furnace was the entirety, then the replacement of the waste gas

ductwork was a deductible repair. Alternatively, the waste gas ductwork would be a component of the entirety and therefore a repair.

[page 389]

Practice Problem 1 Give examples of parts of each entirety. ENTIRETIES

PARTS OF EACH ENTIRETY

Truck Machine House Shop building Yacht

11.10 Notional repairs are not deductible. The taxpayer must carry out the repair; you cannot carry out capital repairs and then claim the savings in any deductible repairs that would have been undertaken if the capital repair had not been made.

Practice Problem 2 You replace a 1500cc engine that needed an $800 overhaul with a larger engine that carries a greater load. You cannot claim the notional $800 deductible repairs, and the new engine is not deductible because it is an improvement.

11.11 Capital repairs are not deductible. Capital repairs are not deductible: see s 25-10(3). There are three categories of capital repairs. 1. Additions: An addition to a capital asset will not be deductible; for example, where an extra wing is added to a cement factory. 2. Improvements: A repair restores an item to its former condition, while an improvement makes the item functionally better. It does not matter that modern materials are used, provided that the materials do not improve the functional efficiency. FCT v Western Suburbs Cinemas Ltd (1952) 86 CLR 102 Facts: The taxpayer replaced a tin roof of a cinema with fibro sheeting, which had advantages over the tin ceiling. Court held: Expenses were not deductible, as it was an improvement. The work would significantly reduce future repairs. Also, the work that had been carried out was different in kind as well as in degree from the types of repairs that are properly allowed as working expenditures for cinemas.

[page 390] 3.

Initial repairs: Where you acquire a property and fix up the defects, such initial repairs are not deductible. Law Shipping Co v IR Commrs (1924) 12 TC 621 Facts: The taxpayer bought a ship for £97,000, but the ship needed work before it could gain permission to sail with freight. It cost £51,558 to get it seaworthy. Court held: The costs were not deductible; they were capital because:

1

the purchase price was substantially less than it would have been if the ship was in good repair; 2 at the time of purchase, the ship was not in a profit-earning state; and 3 there was no evidence that the expenses were properly chargeable to revenue. However, in Odeon Associated Theatres Ltd v Jones, things were viewed differently.

Odeon Associated Theatres Ltd v Jones [1972] 1 All ER 681 Facts: The taxpayer incurred expenses in repairing a cinema immediately after it was purchased. Court held: Deductible because: 1 the purchase price was not affected by the state of disrepair; 2 at the time of purchase, the cinema was in a profit-earning state and could be used to produce income; and 3 there was ample evidence that expenses incurred could be properly charged to a revenue account in accordance with accounting principles. The Australian Taxation Office (ATO) takes the Law Shipping Co view: see TR 97/23. Property held or used partly for an income-producing purpose 11.12

In relation to the cost of repairs, s 25-10(2) provides:

if you held or used the property only partly for an income-producing purpose, you can deduct so much of the expenditure as is reasonable in the circumstances.

Example Kerry, a retailer, replaces the canvas awning of his shop with an equivalent

material. The awning was in excellent condition. The expenditure is not a deductible repair under ITAA 1997 s 25-10.

Example Tony uses his car for income-producing purposes. He replaces the car’s old petrol engine with a more efficient diesel engine. The engine is not an entirety but a subsidiary part of the car. This is an improvement of the car, since it provides much greater efficiency. The new and improved engine reduces the likelihood of future repair bills. This is a capital cost under s 25-10 and not deductible: Case 82 (1953) 3 CTBR (NS). (Deduction for depreciation applies, though: see Chapter 13.) [page 391]

Example Pam has a rental property and the fence is partly worn out. She replaces the damaged parts but also replaces the entire fence. The expenditure is not deductible under s 25-10 because the whole fence was replaced; this is a reconstruction of the entirety: see Case 58 (1962) 10 CTBR (NS). (Deduction for depreciation applies, though: see Chapter 13.) Note: If Pam replaced only the damaged part of the fence, the cost would be a deductible repair under s 25-10.

Example Ian operates a dance studio, and the building’s wooden floor needs repairing. Ken replaces the floor with an entirely new one of concrete. This will save future repairs. He cannot claim a deduction; it is capital, as none of it is allowable as a repair. No deduction is allowed for the notional costs if he had repaired the wooden floor. Note: If he had repaired the old floor, the cost would have been deductible under s 25-10.

Example

Hooksy owns a car repair business in which the bitumen floor needs repairing. He replaces it with a new floor of concrete topped with a crushed paving stone. The new floor looks better than the old floor, but from a functional efficiency point of view, it is not better than the old floor. The new floor performs precisely the same function as the old one and is no more satisfactory. Since the new floor is not a substantial improvement, it is a repair and its cost is deductible under s 25-10: Case T75 (1968) 18 TBRD 377; Case 40 (1968) 14 CTBR (NS).

Example Ego needs to replace a part in a widget manufacturing machine he has used for 6 years. The new part will cost $10,000 and is made from titanium. The old part cost about $2000 and was made from steel. The new part provides an improved functional efficiency for the machine and will last five times longer. The cost of the new part is not deductible under s 25-10 because it is a significant improvement to the functional efficiency. The new part has considerable advantages over the old part.

Example Heidi buys a house to rent out but finds out that the woodwork is seriously affected by white ants. She spends $15,000 to fix the white ant infestation and the property damage. The expenditure is a capital cost not deductible under s 25-10: Case 64 (1944) 11 TBRD (OS) 202 and W Thomas & Co.

Example Greg runs a hairdressing business from premises he leases. The landlord will not spend money on maintaining the premises; thus, Greg sometimes makes repairs to the premises. He is entitled to a deduction for the cost of the repairs under s 25-10. [page 392]

Practice Problem 3 Are the following expenses deductible repairs? Provide Section, case and reason. 1 Sid runs a motel business and as a result of rust to the baggage trailer, he needed to take the trailer in for welding and painting, costing $2000. 2 Part of the ceiling of a Darwin butcher shop needed repairs, so the owner decided to replace the entire ceiling with different, better material, which improved insulation against heat. This cost $100,000 — repairing would have cost $10,000. 3 Andy purchased a second-hand machine for his business, costing $44,000. However, it had two broken springs. To get the machine working, he spent $7000 on repairs. 4 Alice runs a fashion shop and replaces the vinyl floor with another vinyl floor with a more modern design. The old vinyl was in good condition. Payments for a lease obligation to repair: s 25-15 11.13 If you leave a leased premises and are required to pay the lessor for repairs that you failed to undertake, those costs are deductible. The premises had to have been used for producing assessable income.

Lease document expenses: s 25-20 11.14 You can deduct expenditure you incur for preparing, registering or stamping a lease of property if you have used or will use the property solely for the purpose of producing assessable income. If the property is used only partly for that purpose, the expenditure is only partly deductible.

Read ITAA 1997 s 25-20 Borrowing expenses: s 25-25 11.15 You can deduct expenditure you incur for borrowing money to the extent that you use the money for the purpose of producing assessable income. Borrowing costs include loan application fees; procuration fees; legal costs; search, valuation, survey and registration fees; guarantee fees; commission paid to brokers; and stamp duty on the loan. Interest paid on a loan is not a borrowing expense and is considered for deductibility under the general deductibility provision in s 8-1. The deduction is spread over the period of the loan unless the loan period is greater than 5 years, in which case the costs are deductible over 5 years. If the loan is paid out early, the balance of the deduction is claimed in the year of payout. If the expenditure relates only partly to the production of assessable income, the borrowing costs are only partially deductible. Borrowing costs of $100 or less are fully deductible in that year: s 25-25(6). [page 393]

Read ITAA 1997 s 25-25 Practice Problem 4 On 31 December of the current tax year, Chen borrows $200,000 for a rental property with $2000 borrowing costs; the term of the loan is 25 years. What are the borrowing costs for the current year? What would the deduction be if the term of the loan was only 4 years?

Expenses of discharging a mortgage: s 25-30

11.16 You can deduct expenditure you incur to discharge a mortgage that you gave as security for the repayment of money that you borrowed if you used the borrowed money solely for the purpose of producing assessable income. If the expenditure relates only partly to the production of assessable income, the borrowing costs are only partially deductible. You cannot deduct payments of principal or interest under this provision: s 25-30(4).

Read ITAA 1997 s 25-30 Practice Problem 5 On 1 July of the current tax year, Chris, who operates a paving business, takes out a business loan over 4 years for $20,000. she pays a loan application fee and stamp duty of $500. The interest costs are $1500 per annum. She repays $5000 principal per annum. since she took a mortgage over her business assets, she has had to pay a loan exit fee of $200 at the end of another business loan. Also, she leases a commercial oven, which costs $1000 per month. To obtain the lease, the set-up costs were $500. What expenses are deductible for Chris?

Bad debts: s 25-35 11.17 You can deduct a debt (or part of a debt) that you write off as bad in the income year if it was included in your assessable income for the income year or for an earlier income year, or if it is in respect of money that you lent in the ordinary course of your business of lending money. The following four requirements must be met.

Read ITAA 1997 s 25-35 Debt must exist

11.18 A debt is money that the taxpayer is presently entitled to receive: see G E Crane Sales Pty Ltd v FCT (1971) 2 ATR 692. [page 394] Debt must be bad 11.19 You must be able to reasonably and commercially show that the debt is bad through the age of the debt, recovery action, payment arrangements, whether any payments were made and the firm’s bad debt policy. If you write off a debt early and subsequently recover the money, s 20-20 will include the amount as assessable income (assessable recoupments). Debt must be written off 11.20 There must be some written details that show that you have treated the debt as bad, and those details must be recorded in the claim year: see Point v FCT (1970) 1 ATR 577. Prior inclusion in assessable income 11.21 The debt must have previously been included in assessable income unless a moneylending business is involved.

Loss from profit-making undertaking or plan: s 25-40 11.22 You can deduct a loss arising from the carrying on or carrying out of a profit-making undertaking or plan if any profit from that plan would have been included in your assessable income by s 15-15 (profit-making undertakings and plans). If the undertaking or plan relates to property, then the property must have been acquired before 20 September 1985. A loss will not be deductible under s 25-40 unless the Commissioner was notified that the property was acquired for a profit-making purpose in the relevant income tax year.

Losses by theft by employee or agent: s 25-45 11.23 You can deduct a loss if the loss was caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by your employee or agent (other than an individual you employ solely for private purposes), provided that the money was included in your assessable income.

Read ITAA 1997 s 25-45 Misappropriation where a balancing adjustment event occurs: s 25-47 11.24 A deduction is available if a balancing adjustment event occurs for a depreciating asset held by a taxpayer and the taxpayer’s employee or agent misappropriated the amount (whether by theft, embezzlement, larceny or otherwise).

Payments of pensions, gratuities or retiring allowances: s 25-50 11.25 You can deduct a payment of a pension, gratuity or retiring allowance that you make to an employee or a former employee or a dependant of an employee or a former employee, to the extent that it is made in good faith in consideration of the past services of the employee or former employee in any business that you carried on for the purpose [page 395] of gaining or producing assessable income. These payments will also usually be deductible under s 8-1. If they are, then s 25-50 would not apply (s 25-50(3)): see Magna Alloys, although see also Union Trustee Co of Australia Ltd below.

Union Trustee Co of Australia Ltd v FCT (1935) 53 CLR 263 Facts: A retiring allowance was paid voluntarily to a business manager who was incapacitated by age and ill health and replaced by a younger person. Court held: Not deductible (see s 8-1), as not incurred to produce assessable income but made out of gratitude. Note: Such a payment would now fall within s 25-50.

Payments to associations: s 25-55 11.26 You can deduct a payment you make for membership of a trade, business or professional association up to a maximum of $42. But this Section will have a limited operation, as there is no limit if the payment is deductible under s 8-1. For example, s 25-55 will apply where a retired person continues their professional body membership, and it is not deductible under s 8-1 because the retired person is not producing assessable income from that professional activity.

Read ITAA 1997 s 25-55 Election expenses: ss 25-60, 25-65, 25-70 11.27 You can deduct expenditure you incur in contesting an election for membership of the parliament of the Commonwealth or the parliament of a state or the Legislative Assembly for the Australian Capital Territory or the Legislative Assembly of the Northern Territory of Australia. Local government candidates can deduct up to $1000: s 25-65. Note: Related entertainment expenses are not deductible: see s 25-70.

Read ITAA 1997 ss 25-60, 25-70

Work in progress payments: s 25-95 11.28 Payments made to acquire work in progress (other than goods) are deductible under s 25-95.

Travel between workplaces: s 25-100 11.29 Section 25-100 provides deductions for individuals for transport expenses incurred in travel between workplaces (places of employment or business) and overcomes the High Court decision in FCT v Payne (2001) 202 CLR 93; 46 ATR 228. [page 396] What is travel between workplaces? 11.30 Travel between workplaces is travel directly between two places, to the extent that:2 the individual at the first place was engaged in activities to gain or produce their assessable income or engaged in activities in the course of carrying on a business for the purpose of gaining or producing their assessable income; and the purpose of their travel to the second place was to engage in activities to gain or produce their assessable income or engage in activities in the course of carrying on a business for the purpose of gaining or producing their assessable income; and they engaged in those activities while they were at the second place. What is a transport expense? 11.31 A transport expense is a loss or outgoing to do with transport (ie, car, motorcycles and bicycles, and public transport fares).3 Also included is the decline in value of a depreciating asset used in

connection with transport. ‘Travel expense’ does not include expenses for accommodation, food or drink, or expenditure incidental to transport. Place of residence limitation s 25-100(3) 11.32 Travel between two places is not travel between workplaces if one of the places the individual is travelling between is a place at which they reside. Immediate travel requirement 11.33 Travel between two places is not travel between workplaces if, at the time of your travel to the second place, the arrangement under which you gained or produced assessable income at the first place has ceased, or the business in respect of which you engaged in activities at the first place has ceased.4 No deduction for capital expenditure 11.34 There is no deduction for expenditure to the extent that the expenditure is capital or of a capital nature.5 Mary works in sales in a flower shop during the day, then travels by bus from the store directly to her second job as a musician in a hotel. The bus fares she incurs in travelling directly from the store (her first workplace) to the hotel (her second workplace) are deductible under s 25-100. The transport expenses would not be deductible if she first returned home to change into her musician’s uniform. Kelly runs two businesses in two locations. At one place, she carries on a business of a butcher. At another place, she carries on a business of a baker. She does not reside at either place. She drives her car directly between the two businesses every day. The car expenses Kelly incurs in travelling directly between the two businesses (her first and second workplaces) are deductible under s 25100.

[page 397]

Stacy, an architect, is employed by a firm in Hobart. She obtains a new job with a different employer in Melbourne. She leaves her job in Hobart in the morning, flies to Melbourne and goes directly to her new job in Melbourne in the aftenoon. Her expenses incurred in travelling directly between her former workplace in Hobart and her new workplace in Melbourne are not deductible under s 25-100, since at the time of the travel, her assessable income-earning activities at her former job in Hobart have ceased.

Read ITAA 1997 s 25-100 Deductions — United Medical Protection: s 25-105 11.35 Section 25-105 provides deductions for contributions to United Medical Protection support payments.

Capital expenditure to terminate lease: s 25-110 11.36 Capital expenditure incurred to terminate a lease or licence is deductible over 5 years (20 per cent per annum).

Car expenses: Div 28 11.37 Division 28 provides substantiation rules in the form of two alternative methods for working out motor vehicle expenses for individuals or partnerships (the rules do not apply to other entities such as companies and trusts). The following vehicles are excluded:

1. 2. 3. 4.

those carrying more than 1 tonne of weight; those carrying more than eight passengers; motorcycles; and taxis. Note: No deduction is available unless the rules are met. The rules are as follows. Cents per kilometre: This method can be used where the taxpayer’s business travel is less than 5000 km. Under this method, a logbook is not required; you just need to make a reasonable estimate. The ATO publishes annual values for cents per kilometre that vary according to the size of vehicle engines. The deduction equals the number of kilometres multiplied by the cents per kilometre rate (see ). The rate for the 2016–2017 year is 66 cents per kilometre. Logbook: Under this method, a logbook is required to be kept for at least 12 weeks, and this must be repeated every 5 years. Note: Records must be kept for 5 years after the tax return is lodged where you use any of the above methods. [page 398]

Read ITAA 1997 Div 28 Gifts and donations: Div 30 11.38 Gifts or contributions are deductible if they satisfy the requirements of the table in s 30-15. This table provides: who the recipient of the gift or contribution can be; the type of gift or contribution that you can make; how much you can deduct for the gift or contribution; and any special conditions that apply. 11.39

For example, qualifying recipients include:

public hospitals; public benevolent institutions (PBIs); public universities; a gift or donation to a school; and college building funds. The donor does not have to be a resident, but the fund or authority must be in Australia. The other requirements of s 30-15 are: the gift must have a value of at least $2; the gift may be either of money or of property, but if it is property, then it must have been purchased by the taxpayer within 12 months prior to the making of the gift; and it must not be a testamentary gift (made under a will). 11.40 A PBI is a non-profit institution organised for the direct relief of poverty, sickness, suffering, distress, misfortune, disability or helplessness. The characteristics of a PBI are: it is set up for needs that require benevolent relief; it relieves those needs by directly providing services to people suffering them; it is carried on for the public benefit; it is non-profit; it is an institution; and its dominant purpose is providing benevolent relief. For example, PBIs include organisations that provide hostel accommodation for the homeless, provide home help for the aged, transport the sick or disabled, and rescue people who are lost. An organisation can be held to be a PBI even though it predominantly is engaged in fundraising for subsequent distribution for charitable works: FCT v Hunger Project Australia [2014] FCAFC 69.

Read ITAA 1997 s 30-15; TR 2005/13

Spreading of deductions 11.41 Since gift deductions cannot give rise to a tax loss under s 26-55, deductions for certain gifts can be spread over periods up to 5 years: see Subdiv 30-DB. [page 399]

Read ITAA 1997 Div 30 What is a gift? 11.42 To constitute a gift, the property must be transferred voluntarily without any strings attached. FCT v McPhail (1968) 10 AITR 552; 41 ALJR 346 A payment of $30 to a school building fund, which provided a $29.50 reduction in school fees, was held not to be a gift.

Example Emily wants to help a charity that is a deductible gift recipient (DGR). She opens a bank account for herself and deposits $50 in it each fortnight, intending to give the balance to the DGR in June. She can claim a taxdeductible gift only when she transfers the money to the DGR. Keely is a photographer and works for a DGR on a volunteer basis. She works 100 hours, which has a value of $5000 at her charge-out rate of $50 per hour. She cannot claim a tax deduction for $5000. The notional expenditure is not a tax-deductible gift; she has not transferred any property to the DGR. Noddy buys a $50 ticket in a raffle run by a DGR to win a car. The $50 is not a gift. The payment is not voluntary, as the ticket has been purchased as part of a contractual arrangement under which he has acquired rights in the raffle.

Political donations: Subdiv 30-DA 11.43 Individuals who make political contributions or gifts can claim a deduction if the requirements of Subdiv 30-DA are satisfied. Individuals can claim deductions for donations to political parties and independent candidates and members up to a $1500 cap. Persons that are not individuals, such as companies, are prohibited from claiming a deduction: ITAA 1997 s 26-22.

Conservation covenants: Div 31 11.44 From 1 July 2002, deductions can be claimed for perpetual conservation covenants established with an authorised body for no consideration. The covenant must be for land owned by the taxpayer, be permanent, restrict activities that degrade the land, be registered on the title and be approved by the Minister for the Environment and Heritage. The deduction is equal to the market value of the land before the covenant and after the covenant, as valued by the Commissioner: see Subdiv 30-DB.

Tax losses: Div 36 11.45 Under Div 36, taxpayers can carry forward tax losses from earlier years and claim these as a deduction. There are different rules for noncorporates and corporates. (Corporates are dealt with in Chapter 14.) [page 400] 11.46 Taxpayers (that are not corporate entities) may be entitled to carry forward tax losses of earlier years to assessable income of future years: s 3615(1). A tax loss is calculated as follows, s 36-10: Tax loss = deductions (except tax losses of earlier years) – assessable income – net exempt income

Example Tom has deductions of $50,000, assessable income of $40,000 and net exempt

income of $1000 in year 1. He has a tax loss of $9000, which he carries forward to year 2. His assessable income is $60,000, and deductions are $40,000 in year 2, so he can fully offset the carried forward tax loss in year 2, when his taxable income will be $11,000 ($60,000 − $40,000 − $9000). However, some deductions cannot contribute towards a tax loss. These include, s 26-55: gifts: Div 30; personal superannuation fund contributions: s 290-150; pensions, gratuities or retiring allowances: s 25-50; and conservation covenants: Div 31.

Example In year 1, Angel has deductions of $30,000 and assessable income of $20,000. Her deductions include a $5000 donation to the Red Cross. She has a tax loss of $5000, which she carries forward to year 2. If a taxpayer has two or more tax losses, they should be deducted in the order in which the taxpayer incurred them: s 36-15(5). Also, a tax loss can be deducted only to the extent that it has not already been deducted: s 36-15(6). If a taxpayer cannot deduct all or part of the tax loss in an income year, the taxpayer can carry the undeducted amount forward to the next income year. The taxpayer then applies Div 36 to work out a deduction for a tax loss in that income year: s 36-15(7). Special rules also apply to limit the losses of bankrupts,6 to limit losses where a taxpayer has foreign income and to limit film losses.

Read ITAA 1997 Div 36 Note: Special rules also apply to the tax deductibility of losses for companies and trusts: see Chapter 14.

Superannuation contributions: ss 290-60–290-80, 290150

11.47 Superannuation contributions are fully deductible for employers and the self-employed, although the self-employed are subject to concessional contribution caps (see Chapter 15). [page 401]

Other specific deductions 11.48

Other specific deductions in the ITAA 1997 include:

trading stock: Div 70 (see Chapter 5); personal services income: Divs 85, 86 (see Chapter 17); primary production: Divs 40, 393, s 70-120 (see Chapter 16); mining: Div 40 (see Chapter 16); investors in forestry schemes: Div 394 (see Chapter 16); notional sales and loans: ss 240-55, 240-50, 240-85, 240-105 and 240110; and foreign exchange losses: s 775-30.

Practice Problem 6 In the income tax year, Stella has deductions of $4000 including $500 gift deductions and assessable income of $1000, exempt income of $800 and nonassessable nonexempt income of $100. 1 What is the tax loss in the current tax year? 2 What if Stella’s assessable income was $10,000 in the following tax year?

Practice Problem 7 Is the following expense deductible? (Provide section, case and reason.) Mario allows a customer to pay for pizza on credit on 1 August of the current tax year; however, the $79 account remains outstanding as at 30 June and the customer has not been heard of or contactable since I August of the current tax year, despite Mario’s best attempts to collect the money.

Practice Problem 8 Can Phil, a professional cricketer, deduct the following expenses? (Provide section, case and reason.) Harold, a gambler, gives Phil $10,000 for preparing pitch reports and weather conditions. Phil gifts $5000 to the Elizabeth Hospital (a public hospital) and incurs $1000 in travel costs in obtaining pitch reports.

Practice Problem 9 Steve pays his accountant $2600 during the year for tax advice and planning. He pays $34,089 in income tax, $3564 in fringe benefits tax and $3231 in payroll tax. Are these expenses deductible?

[page 402]

Specific deductions: ITAA 1936 11.49 Specific deductions in the ITAA 1936 include the following: leases — leveraged arrangements: s 51AD; meal entertainment: ss 51AEA–51AEC; bad debts, debt equity swaps: ss 63E, 63F; traditional securities: s 70B; research and development: ss 73A, 73B–73G, 73P–73Z; regional headquarters: ss 82C–82CE; interest on convertible notes: ss 82L–82T; partnership losses: ss 90, 92; trust deductions: ss 95–102; unit trusts: ss 102D–102L; public trading trusts: ss 102M–102T; offshore banking units: ss 121A–121IEL; pooled development funds: ss 124ZM–124ZZD; small to medium enterprise shares loss: ss 128TG–128TL; freight for shipped goods: s 135A; insurance of non-residents: ss 141–148; finance leases, exempt income: ss 159GE–159GO; qualifying securities: ss 159GP–159GZ; share buybacks: ss 159GZZZJ–159GZZZS; infrastructure borrowings: ss 159GZZZZD–159GZZZZH; Australian branches of foreign banks: ss 160ZZVA–160ZZZJ; controlled foreign companies: ss 316–468; and tax-exempt entities becoming taxable: Sch 2D. A comprehensive list of deductions is set out at ITAA 1997 s 12-5.

Practice Problem 10 Are the following expenses deductible? (Provide section, case and reason.) 1 overseas travel paid by Channel Rex for the managing director of Channel Rex’s sports team to visit NBC’s sports management for the Athens Olympics coverage 2 what if he took his wife and he personally pays for her expenses? 3 self-education expenses of $5000 for non-HECS course fees 4 sale of a building for $30,000 — it cost gross $50,000 5 replacement of pistons in a delivery truck by a furniture retailer 6 gift of $300 to the New South Wales College of Nursing 7 subscription to the Australian Medical Association by a doctor 8 the $260 stolen when a taxi driver is held up

[page 403]

Other deductions 11.50 Division 415 deals with tax losses that are attributable to a designated infrastructure project.

Attempt the Web Quiz for Chapter 11

Summary 11.51 Specific deductions are important, as these provisions extend the range of deductible expenses beyond the general deduction provision in ITAA 1997 s 8-1. Specific provisions take precedence over general deductions. More commonly used specific provisions include: tax-related expenses; repairs; borrowing expenses; bad debts; travel between workplaces; car expenses; gifts; tax losses; and superannuation contributions.

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. 1 What deductions, if any, will be allowed to Max in respect of the following? Give section, reasons and cases if applicable. a Max owns a house, which he rents out to tenants. In November,

b

c

d

the gas hot water system breaks down. He replaces it with a new gas hot water system, which is more energy efficient, at a cost of $900. The plumber who installs the system accidentally puts his foot through the ceiling of the laundry. The plumber pays to have the damage repaired. Afterwards, the tenant complains to Max that the whole ceiling now needs repainting. Max agrees to do this himself and, while he is at it, also decides to paint the walls. The cost of the paint is $350. In the process of painting, Max accidentally drips a fair quantity of paint on the [page 404]

2

3

tiled floor. The tenant again complains and Max agrees to purchase 14 new tiles if the tenant will lay them. He is unable to find new tiles that match the existing ones, and has to purchase second-hand tiles. These cost $100. What deductions, if any, will be allowed in respect of the following? Give reasons. a Replacement of trousers torn by a self-employed private eye during the pursuit of a suspected blackmailer. b Expenses for Tony, a managing director, for a trip to visit major overseas clients and one of its many existing agencies in Europe to establish a new agency in Russia and some private sightseeing in both places, all paid for by his company, Orange Pty Ltd. c $5000 paid to a registered tax agent for taxation services by an airline employee in disputing an income tax assessment before the Administrative Appeals Tribunal. What deductions, if any, will be allowed in respect of the following? Give reasons. a An investor incurred costs for subscriptions to newspapers in the management of his investment portfolio.

b 4

5

6

7

8

The cost of dog food and vet expenses in respect of two dogs used by a car yard as watchdogs. What deductions, if any, will be allowed in respect of the following? Give reasons. An investor takes out a loan to purchase shares in Westpac Bank. This cost $2000 set-up costs for the loan on 1 July of the current tax year. The term of the loan is 20 years. A self-employed doctor in private practice in a city-based partnership sets up a specially fitted out room in her house exclusively for use as an office. She wishes to partially claim for rent payments, electricity, cleaning and phone expenses. a Can she claim these expenses? b Would your answer be any different if she occasionally watched television or read a novel in that room? c Would it make any difference if she was a sole practitioner who operated her business from home? Which of the following items of expenditure would be allowable deductions (ignoring capital allowances)? Provide section, case and reason. a Costs of establishing a trust agreement for a business venture. b A television presenter claims 50 per cent of his clothing to the extent that it is excessive expenditure required due to appearing on television each night. Olive pays cash to the following organisations. Are these costs deductible? Provide section and reason. a $45 to the Australian Sports Foundation b $20 to the Melbourne public hospital Pauline owns a café and incurs the following expenses. Briefly answer whether these expenses are deductible and refer to the relevant section. a Replaced old carpet with new carpet costing $12,000. b Repainted the ceiling, which was faded due to smokers. c Paid her accountant $5000 for doing her tax return. d A barman stole $550 of takings.

[page 405] e

9

10

11

12

13

14

She paid $270 on 1 January for an application fee on a 3-year loan taken out to pay for the carpet. f She pays $500 subscriptions to the Café Association. g She pays $2765 for replacement beer and wine glasses for the bar. Kerry incurred expenditure of tax agent fees for lodging objections and appealing objection decisions regarding income tax to the Administrative Appeals Tribunal. Are her costs deductible? Edith owns investment properties and uses her car to inspect these from time to time. She travels 4900 kilometres in doing this in the income year. Is she entitled to a deduction for car expenses using the cents per kilometre method under ITAA 1997 s 28-12? Igor acquired a car park and with it depreciating assets that were part of that property. He obtained a report from an estimator to obtain an estimate of the costs of the depreciating assets. Are the expenses incurred in obtaining an estimate of the costs of depreciating assets deductible? Jake purchased a vinyl lounge costing $500 for his spouse, who suffered from certain allergies. Subsequent specialist medical advice was given against the use of a vinyl lounge. John gave the unused lounge, with a market value of $400, to a charity 2 weeks after its purchase. The charity is registered as a deductible gift recipient. Is the gift deductible? Polly runs a lawn mower business and pays $10,000 into her superannuation fund on 30 June. Is she entitled to a deduction? Phil has a business loss of $100,000. He received $50,000 in wages and donated $1000 to the Red Cross during the income year. What are the

15

16

17

18

income tax implications for Phil? Ruth ran a café in a shopping centre. The lease was cancelled and her lease agreement required her to return the premises back to its original condition. She removed tiles from the floor and walls and removed mirrors and cupboards. Are these costs deductible? Provide detailed reasons. Just after purchasing a house in need of repair, Dave listed the property with a real estate agent for rental. After listing the property, he quickly painted and rewired the house. Is Dave entitled to a deduction for the cost of repairs? Rachelle owned a rental house for 15 years and the house had a stone front fence. The fence collapsed and most of it was demolished and rebuilt to the same dimensions on the same foundations. This involved building extra thick walls to offer ongoing structural integrity and the use of larger blocks of sandstone. Can Rachelle deduct the costs for the rebuilding of the fence? Jo owns a residential rental property and removes vinyl flooring and polishes the existing floorboards. Is Jo entitled to a deduction for the costs in removing worn vinyl flooring and polishing existing floorboards? [page 406]

19

20

Ken rented out the ground floor unit of his house for many years. He lives in the top floor of the house. He puts in a tiled roof course to replace the old tiled roof that had worn out. Is he entitled to a 100 per cent deduction for the replacement of a tiled roof? Beth owns a rental house and the ground beneath the rental property subsided as a result of the diversion of waterways. Thus, she underpinned the entire foundation. Can she claim a deduction for underpinning the entire foundations?

21

22

23

Len’s rental property had a wooden floor that was fatigued and, as some termite infestation had occurred, he demolished and rebuilt this as part of an extension to the building. The concrete floor represented 25 per cent of the total floor area involved in the extension and thus the taxpayer claimed 25 per cent of the total costs as relevant to repairs. Can Len deduct the 25 per cent extension costs? Wen took out a loan to purchase a rental house. Wen claimed deductions for borrowing expenses and the costs of transferring the title of the property. Are the costs of the transfer of title deductible? Keith purchased a heater for his home unit, which is located in a retirement village. Keith will gift the heater in the home unit to the retirement village when he and his partner leave. Can he claim a deduction for the gift?

1.

Section 8-10 states that the provision that is most appropriate takes precedence, and the legal maxim is that the specific deduction provision takes precedence.

2. 3.

s 25-100(2). s 900-220(3).

4. 5.

s 25-100(4). s 25-100(5).

6.

ss 36-35–36-40.

[page 407]

12 Deduction limitations Learning Objectives After you have studied this chapter, you should be able to: outline the operation of the deduction limitation provisions; determine whether the deduction limitations apply to a particular outgoing (provide full legal reasoning); discuss how fine and penalty expense deductions can be limited; discuss how entertainment expense deductions can be limited; discuss how prepaid expense deductions can be limited; and discuss how losses can be limited.

[page 408]

Key Legislative Provisions Income Tax Assessment Act 1936 (ITAA 1936) s 21 s 51AF s 51AGA s 51AH s 51AJ s 51AK s 82A ss 82KZL–82KZMG s 262A Income Tax Assessment Act 1997 (ITAA 1997) s 70-15 Div 26 Div 28 Div 32 Div 900 [page 409]

Diagram 12.1:

Deduction

Chapter overview 12.1 Like the specific deduction provisions, the deduction limitation provisions are scattered throughout the 1936 and 1997 ITAAs. Again, to

minimise repetition, the limitation deduction provisions for international tax, tax accounting, capital allowances, entities, superannuation and anti-avoidance regimes are dealt with in the respective chapters of this book. This chapter deals with the remainder. There are a variety of provisions that operate to limit deductions that may be otherwise available under ITAA 1997 s 8-1 or other deduction provisions: see ITAA 1997 ss 8-1(2)(d), 8-5(3). [page 410] 12.2

This chapter examines the fourth step in the deductions method. DEDUCTIONS METHOD

Chapter 5

What tax accounting rules apply?

Chapter 10

Is the outgoing a general deduction?

Chapter 11

Is the outgoing a specific deduction (excluding capital allowances)?

This chapter — Do any of the deduction limitations apply? Chapter 13

Is the outgoing a capital allowance?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the expense is deductible

Limitations: ITAA 1997 Penalties and fines: s 26-5 12.3 Section 26-5 provides that penalties and fines under an Australian or foreign law are not deductible. This ensures that a taxpayer does not indirectly

benefit from being able to claim penalties or fines under an Australian or foreign law as deductions. A restaurant is fined $5000 for having a dirty kitchen under a state government law. The fine paid is not deductible.

Leave payments: s 26-10 12.4 A deduction is not allowable for leave payments, except in respect of an amount of leave payments that is actually paid. This means that merely having a provision for such leave payments will not be sufficient for claiming a deduction.

Franchise fees windfall tax: s 26-15 12.5

A taxpayer cannot deduct franchise fees windfall tax.

Commonwealth places windfall tax: s 26-17 12.6

A taxpayer cannot deduct Commonwealth places windfall tax. [page 411]

Rebatable benefits: s 26-19 12.7 You cannot deduct a loss or outgoing incurred in gaining or producing a rebatable benefit (within the meaning of ITAA 1936 s 160AAA). Rebatable benefits are generally certain benefits paid under the Social Security Act 1991 or are a Commonwealth education or training payment. This includes, for example, Youth Allowance, Newstart Allowance, ABSTUDY and Austudy.

HECS-HELP and student assistance: s 26-20 12.8 A taxpayer cannot deduct HECS-HELP and student assistance unless it is taxed in providing a fringe benefit. This is particularly relevant for those taxpayers seeking self-education deductions.

Political donations: s 26-22 12.9 Political donations made by businesses are not deductible. Employees, though, can claim deductions for donations to political parties and independent candidates and members up to a $1500 cap: see Subdiv 30-DA.

Interest or royalty: s 26-25 12.10 Interest or royalty amounts are not deductible if withholding tax is required under Taxation Administration Act 1953 Subdiv 12-F and no tax is withheld or the requirements of Subdiv 12-F are not met.

Non-share distributions and dividends: s 26-26 12.11 A company cannot deduct non-share distributions or a return that has accrued on a non-share equity interest. Also, a company cannot deduct a dividend paid on an equity interest in the company.

Relative’s travel expenses: s 26-30 12.12 Where an employee or business person travels in the course of producing assessable income, the taxpayer is denied a deduction for the travel costs of an accompanying relative, except where the relative performs substantial duties and it is reasonable to conclude that the person would have travelled with the taxpayer even if that personal relationship did not exist.

Reductions for payments to related entities: s 26-35 12.13

Section 26-35 is designed to prevent excessive deductions for

payments made to associated persons. Such payments are deductible to the extent that the Commissioner considers reasonable. What is reasonable is not defined in the legislation but it would be expected that this amount would be the amount paid to someone who was not associated. A related entity is a relative or a partnership in which a relative is a partner. [page 412]

Family maintenance payments: s 26-40 12.14 Payments made to maintain accommodation) are not deductible.

family

members

(food

and

Recreational club expenses: s 26-45 12.15 Recreational club expenses are not deductible, except where they were paid by an employer to an employee and were subject to fringe benefits tax (FBT).

Non-business boating activities: s 26-47 12.16 Section 26-47 improves the integrity of the taxation system by preventing deductions from boating activities that are not carried on as a business being offset against other assessable income. Such excess deductions are quarantined and carried forward to be offset against future assessable income.

Leisure facility expenses: s 26-50 12.17 Leisure facilities such as tennis courts and ski lodges used for holidays are not deductible. An exception is made where the leisure facility is used to produce assessable income.

Bribes to officials: ss 26-52, 26-53 12.18 Bribes to officials are not deductible and do not form part of the capital gains tax cost base: see ss 26-52, 26-53, 110-38(2).

Illegal activities: s 26-54 12.19 Section 26-54 prevents deductions for expenses incurred in the furtherance of a physical element of an offence against Australian law. It denies deductions for losses and outgoings incurred in the furtherance of, or directly in relation to, activities in respect of which the taxpayer has been convicted of an indictable offence. An indictable offence is an offence that is punishable by imprisonment for at least 1 year.

Limits on deductions: s 26-55 12.20 This provision points out that there are limits to claiming specific deductions: payments of pensions, gratuities, retiring allowances: ITAA 1997 s 25-50; gifts: ITAA 1997 Div 30; conservation covenants: ITAA 1997 Div 31; and superannuation contributions: ITAA 1997 s 290-150. Superannuation contributions surcharge: s 26-60 12.21

A taxpayer cannot deduct superannuation contributions surcharge. [page 413]

Termination payments surcharge: s 26-65 12.22

You cannot deduct termination payments surcharge.

Other limitations

12.23 Other limitations under Div 26 include: loss from disposal of venture capital: ss 26-68, 26-70; contributions to non-compulsory and complying superannuation funds: ss 26-75, 26-80; borrowing costs on loans to pay life insurance premiums: s 26-85; superannuation supervisory levy: s 26-90; and superannuation guarantee charge: s 26-95.

Read ITAA 1997 Div 26 Entertainment expenses: Div 32 12.24 Entertainment expenses are the provision of food, drink or recreation and any associated travel and accommodation. Except in a limited number of circumstances, these expenses are not deductible. For example, an employer will be allowed a deduction if the expense is subject to FBT: s 3220.

Read ITAA 1997 Div 32 A partner in a law firm takes a client out to lunch and pays the bill. The law firm does not pay FBT on the lunch. The expenses are not deductible under Div 32.

Non-compulsory employee uniform/wardrobe: Div 34 12.25 A deduction is not allowable to an employee for non-compulsory uniforms or wardrobes, unless the clothing design is entered on a register of approved occupational clothing.

Non-commercial business losses: Div 35

12.26 A deduction is not allowable for a business loss for an individual taxpayer for certain small-scale business activities: see Chapter 17.

Trading stock not on hand: s 70-15 12.27

The cost of trading stock that is not on hand is not deductible.

Limited recourse debt: Subdiv 243-C 12.28 Subdivision 243-C provides limitations for deductions in respect of limited recourse debt. [page 414]

Capital-protected borrowings: Div 247 12.29 Capital protection provided under a relevant capital-protected borrowing to the extent that it is not provided by an explicit put option is treated (for the borrower) as if it were a put option (and thus not deductible). An amount attributable to capital protection under any relevant capitalprotected borrowing is treated (for the borrower) as a payment for a put option. As a result of FCT v Firth (2002) 120 FCR 450; 50 ATR 1, Div 247 was introduced to ensure that amounts paid by a borrower for capital protection in respect of some borrowings for the acquisition of shares, units in unit trusts and stapled securities are treated for tax purposes as a payment for a put option: s 247-5.

Tax-preferred entities (asset financing) 12.30 ITAA 1997 Div 250 replaced ITAA 1936 s 51AD and Div 16D of Pt III. Division 250 will deny or reduce capital allowance deductions in respect of an asset if the asset is put to a tax-preferred use and the taxpayer has

insufficient economic interest in the asset. Also, if capital allowance deductions are denied or reduced, Div 250 will treat the arrangement for the taxpreferred use of the asset as a loan that is taxed as a financial arrangement on a compounding accruals basis.

Substantiation: Div 900 12.31 Car, work and business travel expenses of individuals (and a partnership that includes at least one individual) must be substantiated under Div 900. Written documentary evidence is required for work expenses in excess of $300 and laundry in excess of $150. No substantiation is required for overnight business travel and certain employee allowances. Note: To be able to claim car expenses, it is necessary to meet the requirements of Div 28.

Other limitations under ITAA 1997 12.32 Other limitations under ITAA 1997 include: company bad debts: Subdivs 165-C, 166-C, 175-C; net capital loss: s 102-10; carried interest: s 118-21; personal services income: Divs 85, 86; companies’ tax losses: Div 175; thin capitalisation: Div 820; and transfer pricing: Subdiv 815.

Limitations: ITAA 1936 Employee car expenses on employer-provided cars: s 51AF 12.33

Section 51AF denies a deduction for car expenses incurred by an

employee on a car provided by the employer where the car is for use by the employee and their relatives. [page 415]

Car parking expenses of employees: s 51AGA 12.34 Where a car is used to commute from home to a place of business and is parked at or near the place of employment for more than 4 hours (between 7am and 7pm), then car parking expenses are not deductible.

Read ITAA 1936 s 51AGA Employee reimbursements: s 51AH 12.35 No deduction is allowed to an employee where the expenses are reimbursed.

Fringe benefits tax contributions: s 51AJ 12.36

FBT contributions for the private component are not deductible.

Read ITAA 1936 s 51AJ Non-cash business benefits: s 51AK 12.37 Section 51AK ensures the non-deductibility of any non-cash business benefits provided to induce business taxpayers to purchase items of plant or equipment.

Read ITAA 1936 s 51AK

You purchase computer services for $50,000 and receive a $1000 holiday from the supplier. The machine can only be depreciated at a cost of $49,000.

Self-education expenses: s 82A 12.38 You are limited to claiming the amount of self-education expenses leading to a formal qualification deductible under s 8-1 less $250 (the net amount). Note: This does not restrict deductions under other sections, such as the depreciation and repair provisions. The Commissioner accepts that expenses for computer purchase, child care and nondeductible travel from home to the place of study can be used to offset this $250 threshold.

Read ITAA 1936 s 82A A part-time student of a commerce degree working as an accountant incurs $800 of costs on textbooks and deductible study travel. Only $550 can be claimed under s 8-1, given the operation of s 82A.

[page 416]

Prepaid or advance expense rules Prepayment regime for small business entity taxpayers 12.39 Prepayments are immediately deductible for small business entity (SBE) taxpayers where the eligible service period (the period of the benefit) of the prepayment is 12 months or less and where the prepayment is otherwise deductible under ITAA 1997 s 8-1 or ITAA 1936 ss 73B, 73BA, 73BH or 73Y.1 Where the prepayments do not meet this requirement, s 82KZM

applies to pro rata deductions over the lesser of the eligible service period or 10 years. There are a number of exceptions to this general rule. An immediate deduction is available to all taxpayers for any excluded expenditure.2 Excluded expenditure includes: expenses of less than $1000, expenses required to be incurred by law3 or by an order of a court, or expenses of salary or wages made under a contract of service.4 Tax shelter5 and plantation forestry operation prepayments6 are governed by their own prepayment regimes. RED Pty Ltd is an SBE. On 30 June, it prepays $100,000 to Alf for 12 months’ worth of rent. Since the prepayment period is 12 months or less, the amount is fully deductible: ITAA 1936 s 82KZM(1). Prepayment regime for non-SBE business taxpayers 12.40 Business taxpayers outside the SBE rules do not receive any immediate write-offs for prepayments. Rather, prepayments are deducted proportionally over the lesser of the eligible service period or 10 years: ITAA 1936 ss 82KZMA, 82KZMD. The prepayment must be otherwise deductible under ITAA 1997 s 8-1 or ITAA 1936 ss 73B, 73BA, 73BH or 73Y.7 Further, the prepayment must not have been excluded expenditure or be a pre-review of business taxation obligation.8 BLACK Pty Ltd is not an SBE and on 31 December it prepays $200,000 to XAX Insurance Co for 12 months’ worth of insurance. The prepayment limits apply and it can claim only $100,000 (6 months of insurance): ITAA 1936 ss 82KZMA, 82KZMD.

[page 417] Non-SBE non-business prepayments

12.41 Special rules apply for individuals with non-business prepayments such as prepayments relating to investments. They obtain an immediate deduction for prepayments where the eligible service period of the prepayment is 12 months or less and the eligible service period ended no later than the last day of the following income period after the prepayment was incurred.9 Otherwise, the prepayment is deducted proportionally over each income year containing all or part of the prepayment’s eligible service period, up to a maximum of 10 years.10 For non-SBE non-individuals (companies and trusts) that are not carrying on a business, the prepayment is deducted proportionally over the eligible service period, up to a maximum of 10 years.11

Exempt use or exempt end users of property: ss 159GE–159GO 12.42 Deductions are restricted for certain arrangements relating to the use of property by exempt public body end users or property used outside Australia to produce exempt income.

Infrastructure borrowings: s 159GZZZZE 12.43 Section 159GZZZZE denies deductions for certain infrastructure borrowings.

Record keeping: s 262A 12.44 The tax laws generally require taxpayers carrying on a business to keep records for 5 years.12 Where, however, a taxpayer has quarantined losses, it would be appropriate that records are kept until the losses are recouped. 12.45 It is very important to bear in mind that the onus is on the taxpayer to prove that their income tax assessment is correct.13 Thus, without adequate accounting systems, records, receipts and invoices, the taxpayer may have no effective response to an ATO audit amendment. 12.46

Other specific deductions limitations under ITAA 1936 include:

trading stock chose in action: s 52A; related entities restrictions: s 65(1B) and (1C); private companies excessive payments: s 109; and tax avoidance: ss 177A–177G. [page 418]

Practice Problem 1 Are the following expenses deductible? Do any limitations apply? 1 You have $2000 of self-education expenses. 2 Eighteen months’ prepaid business rent. 3 Cost of meals with business clients. 4 A cricketer fined $10,000 by his club for not attending training. 5 The same cricketer fined for speeding while getting to training late because of media work. 6 The partner of a medical firm pays the costs of her husband joining her on a work conference in Hawaii. 7 Child support payments made by the ex-husband.

Attempt the Web Quiz for Chapter 12

Summary

12.47 You need to be aware of these limitations because they exclude or limit otherwise deductible expenses. The important limitations include: self-education; fines; prepayments; entertainment; prepaid expenses; and non-commercial business losses.

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. 1 Norm runs a phone retail business and incurs the following expenses. Briefly answer whether these expenses are deductible and refer to the relevant section. a meals with business clients, $389 b speeding fine incurred delivering a phone to meet a customer deadline, $260 c child support payments to his former wife, $23,900 d self-education expenses, $5000, to attend a business course [page 419] e

replaced engine parts in a delivery truck

2

3

4

5

6

7

f donated $300 to the NSW College of Nursing Hillside Motors Pty Ltd incurred the following expenses. Are these costs deductible? Briefly provide section references and reasons for the following: a paid a $10,000 cash ‘incentive fee’ to a local councillor to get land rezoned into a commercial use zone so the taxpayer can build a new car yard b $3000 fine from the Magistrates Court for selling stolen and defective cars c spent $200 on a lunch with a councillor to promote the idea for planning permission for a drive-through car yard. What deductions, if any, will be allowed in respect of the following? What limitations apply? a a parking fine incurred by a self-employed accountant while visiting a client on business b a $50,000 bribe paid by a major development company to a local councillor on the eastern seaboard to obtain approval for a building project Sam, who is a property developer in the northern suburbs, pays $100,000 to the political party governing the state as a gift in cash. Soon after the gift is made, the land Sam owns is rezoned for residential use. What deductions are available to Sam (if any)? Helen’s expenses in attending her part-time law degree amount to $200 for textbooks, $50 for stationery and $4000 in HECS fees. Helen works full time as a paralegal. What can she claim as a deduction? Wilma purchased a yacht and used it as an office and sailed it to some workplaces. She claimed expenses relating to the acquisition and maintenance of the boat. Can she claim a deduction for the expenses relating to a yacht used as an office? Adam owns a rental flat but fails to pay local government rates and is liable to pay interest charges calculated in accordance with the relevant

state Local Government Act. He claims the late interest charges as a tax deduction. Are the interest charges deductible?

1.

ITAA 1936 s 82KZM(1).

2. 3.

s 82KZM(1)(b). Australian Taxation Office (ATO) ID 2006/218. Prepaid fees incurred by a company for the audit of its financial reports are not an amount of expenditure required to be incurred by a law of the Commonwealth, a state or a territory and are thus not ‘excluded expenditure’.

4. 5.

s 82KZL(1). s 82KZME. The tax shelter rules require that the prepayment be amortised over the period during which the thing is to be done under the arrangement (the eligible service period).

6. 7.

s 82KZMG. s 82KZMA(1)(a).

8. 9.

ss 82KZMA(5), 82KZL. s 82KZM(1)(aa)(ii).

10. s 82KZM. 11. ss 82KZMA(2)(a)(ii), 82KZMD. 12. s 262A. 13. TAA 1953 s 14ZZK(b)(i), 14ZZO(b)(i). The ATO is not required to prove that the assessment is correct. It is up to the taxpayer to verify their taxable income.

[page 421]

13 Capital allowances Learning Objectives After you have studied this chapter, you should be able to: explain the interaction between the uniform capital allowances regime and capital gains tax (CGT), and perform calculations; outline the various capital allowances in the ITAA 1997 and 1936; explain the steps in determining a depreciation deduction; define a depreciating asset; determine the taxable purpose of a depreciating asset; distinguish between a component and an entirety of a depreciating asset; identify the holder of a depreciating asset; determine the period of a depreciating asset; explain the two methods to calculate the decline in value of a depreciating asset; outline how a taxpayer can determine the effective life of a depreciating asset; calculate a depreciation rate;

calculate a cost base of a depreciating asset; calculate depreciation; identify balancing adjustment events; calculate the balancing adjustment amounts; determine the interaction between the balancing adjustment provisions and the CGT regime; identify the special capital allowance rules; be able to operate a depreciation schedule; understand the other capital allowances in ITAA 1997 Div 40; understand the other capital allowances in ITAA 1936; and apply the capital works rules.

[page 422]

Key Legislative Provisions Income Tax Assessment Act 1997 (ITAA 1997) s 40-880 Subdivs 40-B–40E Div 41 Div 43 Subdiv 328-F

Key Cases Primary Health Care Ltd v FCT [2010] FCA 419

Key ATO Publications TR 2014/4 Income tax: effective life of depreciating assets TR 2004/16 Income tax: plant in residential rental properties TR 2011/6 Blackhole expenses under s 40-880 [page 423]

Diagram 13.1:

Deductions — Capital allowances

Chapter overview 13.1 The capital allowance provisions provide tax deductions for capital assets (non-deductible under ITAA 1997 s 8-1) such as depreciating assets, buildings and structures. Plant and equipment and other depreciating assets are generally depreciable under the depreciation provisions contained in Subdivs 40-A–40-F. Additionally, there are a number of special industry and activity allowances for certain types of capital expenditure under Subdivs 40-G–40-J. Division 41 provides a temporary investment allowance deduction for certain depreciating assets. Buildings and other structures are usually amortised under the capital works provisions in Div 43. The ITAA 1936 contains capital allowances for

research and development and Australian films. As a provision of last resort, ITAA 1997 s 40-880 may provide a deduction for capital expenditure that is otherwise not deductible and is known as blackhole expenditure. Some types of capital expenses do not enjoy any depreciation treatment at all, although the capital cost may well form part of the cost base of a CGT asset, and thus provide some [page 424] future relief against capital gains, if a CGT event relates to that CGT asset. Not surprisingly, given all these categories, finding out which allowances apply to your capital cost can be a somewhat difficult task! This chapter examines the fifth step in the deductions method. DEDUCTIONS METHOD Chapter 5

What tax accounting rules apply?

Chapter 10

Is the outgoing a general deduction?

Chapter 11

Is the outgoing a specific deduction (excluding capital allowances)?

Chapter 12

Do any of the deduction limitations apply?

This chapter — Is the outgoing a capital allowance? Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the expense is deductible

Practice Problem 1

What are the different types of capital allowances?

Capital allowances: Div 40 13.2 The capital allowance provisions in Div 40 can be categorised into two types of allowances: depreciating assets: Subdivs 40-A–40-F; and special capital allowances: Subdivs 40-G–40-J.

Read ITAA 1997 s 40-10 Depreciating assets: Subdivs 40-A–40-F 13.3 Subdivisions 40-A–40-F apply to depreciating assets acquired on or after 1 July 2001.1 The depreciating asset provisions can be summarised into eight steps: 1.

Understand s 40-25;

[page 425] 2. 3.

Must have a taxable purpose; Must have a depreciating asset;

4. 5.

Must have a holder of a depreciating asset; Calculate depreciation: Substep 1: Determine the period; Substep 2: Choose between diminishing value (DV) method or the prime cost (PC) method; Substep 3: Work out effective life and depreciation rate; Substep 4: Determine cost; and

Substep 5: Calculate depreciation; 6. 7.

Calculate balancing adjustments; Do the special rules apply?; and

8.

Complete the depreciation schedule.

Step 1: Understand s 40-25 13.4 Section 40-25 is the critical operative provision, and a good understanding of it is needed to be able to operate the legislative machinery. Subsection (1) provides: ‘you can deduct an amount equal to the decline in value for an income year (as worked out under this Division) of a depreciating asset that you held for any time during the year’. 13.5 Special rules apply to leisure facilities, depreciating assets allocated to low-value pools and cars that use the one-third of actual expenses method for Div 28 purposes.2 The one-third of actual expenses method will be removed as from the 2015–16 income tax year.

Step 2: Must have a taxable purpose 13.6 The depreciating asset must be used for a taxable purpose per s 4025(2). A taxable purpose is:3 the purpose of producing assessable income; the purpose of exploration or prospecting; the purpose of mining site rehabilitation; or environmental protection activities.

Example Ben holds a depreciating asset that he uses for private purposes for 30 per cent of his total use in the income year. If the asset declines by $1000 for the year, Ben would have to reduce his deduction by $300 (30 per cent of $1000). Ben has a 70 per cent taxable purpose.

[page 426]

Read ITAA 1997 s 40-25 Step 3: Must have a depreciating asset What is a depreciating asset? 13.7 A deduction under s 40-25(1) requires a depreciating asset. A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used: s 40-30(1).

Read ITAA 1997 s 40-30 Intangible assets that are depreciating assets 13.8 The following intangible assets are depreciating assets if they are not trading stock:4 mining, quarrying or prospecting rights; mining, quarrying or prospecting information; items of intellectual property; in-house software; IRUs (indefeasible rights to use international telecommunications submarine cable systems); spectrum licences; datacasting transmitter licences; and telecommunications site access rights. Taxpayers are able to choose self-assessing of effective life, or use the statutory effective life. As from 1 July 2017, plant and equipment depreciation deductions for investors in residential investment properties will be limited to assets not

previously used. See Treasury Laws Amendment (Housing Integrity) Bill 2017. A depreciating asset includes ‘plant’ 13.9 Since ‘plant’ is expressly excluded from Div 43 (s 43-70(2)(e)), then plant is a depreciating asset. ‘Plant’ is defined in s 45-40: (1) Plant includes: (a) articles, machinery, tools and rolling stock; and (b) animals used as beasts of burden or working beasts in a *business, other than a *primary production business; and (c) fences, dams and other structural improvements, other than those used for domestic or residential purposes, on land that is used for agricultural or pastoral operations; and (d) structural improvements, other than a *forestry road or structural improvements used for domestic or residential purposes, on land used in a business involving: (i)

planting or tending trees in a plantation or forest that are intended to be felled; or

[page 427] (ii) felling trees in a plantation or forest; or (iii) transporting trees, or parts of trees, that you felled in a plantation or forest to the place where they are first to be milled or processed, or from which they are to be transported to the place where they are first to be milled or processed; and (e) structural improvements, other than those used for domestic or residential purposes, that are used wholly for operations (carried out in the course of a business) relating directly to: (i) taking or culturing pearls or pearl shell; or

(f)

(ii) taking or catching trochus, bêche-de-mer or green snails; and that are situated at or near a port or harbour from which the business is conducted; and structural improvements that are excluded from paragraph (c), (d) or (e) because they are used for domestic or residential purposes if they are provided for the accommodation of employees, tenants or sharefarmers who are engaged in or in connection with the activities referred to in that paragraph.

(2) Plant also includes plumbing fixtures and fittings (including wall and floor tiles) provided by an entity mainly for: (a) either or both: (i)

employees in a *business carried on by the entity for the *purpose of producing assessable income; or (ii) employees in a business carried on for that purpose by a company that is a member of the same *wholly-owned group of which the entity is a member; or

(b) *children of any of those employees. *refers to defined terms in ITAA 1997.

‘Plant’ also includes anything that is plant. Thus, ‘plant’ takes on its ordinary meaning. In Yarmouth v France (1887) 19 QBD 646, Lindley J explained plant as: [Plant] in its ordinary sense, includes whatever apparatus is used by a business man for carrying on his business — not his stock in trade which he buys or makes for sale; but all goods and chattels, fixed or moveable, which he keeps for permanent employment in his business.

If an item merely provides a convenient setting, it will not be plant: see Wangaratta Woollen Mills Ltd v FCT (1969) 119 CLR 1. For example, an office building, a factory building (unless the building forms part of the manufacturing process) or a built-in bar are all not plant, as they all form part of the setting. Kitchen cupboards and built-in wardrobes are not plant. They are part of the setting of the rental income-earning activities. The cupboards and built-in wardrobes form part of the building, as they are fixed to the premises. As they are fixed to the premises, they are intended to remain in place indefinitely. Kitchen cupboards and builtin wardrobes form part of the premises; they are also not articles. Since the kitchen cupboards and built-in wardrobes are not plant, deductions for their decline in value are not available under Div 40, but deductions may be available under Div 43.

Improvements 13.10 Improvements to land or fixtures on land, whether the improvement or fixture is removable or not, are assets separate from the land and are depreciating assets: s 40-30(3). [page 428]

However, whether such an asset is a depreciating asset depends on it falling within the definition of ‘depreciating asset’.

Composite items versus components 13.11 A depreciating asset is the composite asset (and not the components of a composite asset). Whether a particular composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree, which can be determined only in the light of all the circumstances of the particular case: s 40-30(4). See Draft Taxation Ruling TR 2017/D1 for the view of the ATO on composite items.

Example A boat is made up of many separate components, but usually the boat is a depreciating asset rather than each component of the boat. This is important, given that a separate depreciating asset will be subject to depreciation under Div 40 (eg, an air conditioning unit in a building) and listed separately on the depreciation schedule. If, however, the item forms part of a larger asset (eg, electrical wiring in a building), then the capital allowances rules will apply to that asset (the electrical wiring and the building: Div 43).

Practice Problem 2 1 2

Provide examples of components of a depreciating asset. Provide examples of separate components that are separate depreciating assets.

Special rules apply for the renewal or extension of a depreciating asset that is a right and for mining, quarrying or prospecting rights: s 40-30(5)–(6).

What is not a depreciating asset?

13.12 Section 40-30(1) lists assets that are not depreciating assets: land; an item of trading stock; and an intangible asset, unless it is mentioned in s 40-30(2). Eligible work-related items 13.13 An asset that is an eligible work-related item for the purposes of s 58X of the Fringe Benefits Tax Assessment Act 1986, where the relevant benefit provided by the employer is an expense payment benefit or a property benefit (within the meaning of that Act), is excluded: s 40-45(1). [page 429]

Example If an employee salary sacrifices a laptop and the employer obtains a fringe benefits tax exemption, then the employee cannot claim depreciation on the laptop.

Capital works 13.14 Division 40 does not apply to capital works for which you can deduct amounts under Div 43 or for which you could deduct amounts under Div 43: s 40-45(2).

Films 13.15 Depreciating assets that are deductible films are excluded, as are films where a company is entitled to a tax offset in respect of the film: s 40-45(6).

Read ITAA 1997 ss 40-30(1), 40-45 Assets for which you deduct under another

Subdivision 13.16 Depreciation is not deductible if the taxpayer or another entity deducted or could deduct amounts for it under:5 Subdiv 40-F (about primary production depreciating assets); Subdiv 40-G (about capital expenditure of primary producers and other landholders); or Subdiv 40-J (about capital expenditure for the establishment of trees in carbon sink forests). Depreciation for in-house software is not deductible under Div 40 if you have allocated expenditure on the software to a software development pool: s 40-50(2).

Read ITAA 1997 s 40-50 Alterations etc to certain depreciating assets 13.17 Repairs of a capital nature or an alteration, addition or extension to a water facility or a landcare operation that is a depreciating asset will then not be treated as that same depreciating asset.6

Read ITAA 1997 s 40-53 Where certain car deduction methods are used 13.18 Additionally, where the cost per kilometre or 12 per cent original cost car deduction methods are used, you cannot claim depreciation on such cars: see s 40-55. [page 430]

Read ITAA 1997 s 40-55 Practice Problem 3 Are the following depreciating assets? TYPE OF BUSINESS

ASSET

Baker

Knife, saw, shop window

Laundromat

Chemicals, cleaning machines

Vineyard

Pumps, building

Petrol station

Land

Clothes retailer

Clothes, fixtures, concrete car park

Jewellery shop

Air conditioner, carpet

Telstra

Spectrum licence, advertising signs

Wheat farm

Fence, dam, tractor

Office

Plumbing for employees’ bathroom, computers, office furniture, telephones, stationery, office building, safe

Grape grower

Grapevines, trellis, irrigation hoses

Miner

Exploration costs for oil

Hotel

Hotel building, furniture

DEPRECIATING ASSETS

Step 4: Must have a holder of a depreciating asset 13.19 Section 40-25(1) further requires that there is a holder of a depreciating asset. Generally, the legal owner of the asset obtains the deduction. However, in other circumstances, another may also be taken to be the holder of the asset: s 40-40 items 1–9. The table at s 40-40 details who holds a depreciating asset for various asset types. In addition to the owner, another entity may be the holder of the asset under one of the eight other specific items listed in the table at s 40-40 as follows: leased luxury cars (item 1); assets on leased land (items 2 and 3); other leased assets (item 4); rights subject to right to purchase (item 5); assets subject to right to purchase, such as under hire purchase agreements (item 6); partnership assets (item 7); and mining, quarrying and prospecting information (items 8 and 9). [page 431]

Read ITAA 1997 s 40-40 Example Pat, a sole trader, purchases a photocopier from Office Supplies Inc to use in her law firm. As the legal owner, she holds the depreciating asset: s 40-40 item 10.

Example

A and B operate as a partnership and they each pay half the cost for a depreciating asset, a truck. The partnership holds the asset: s 40-40 item 7. Section 40-40 provides the following further examples: Example 1: Power Finance leases a luxury car to Kris who subleases it to Rachael. As lessee, item 1 makes Rachael the holder of the car. Power, as the legal owner, would normally hold the car under item 10. However, item 1 makes it clear that Power, as lessor, does not hold the car. As the lessee, item 1 would normally mean that Kris held the car but, again, she is also a lessor and so is not the holder (she also doesn’t have the right to use the car during the sublease). Example 2: Sandra sells a packing machine to Jenny under a hire purchase agreement. Jenny holds the machine under item 6 because, although she is not the legal owner until she exercises her option to purchase, she possesses the machine now and can exercise an option to become its legal owner. Jenny is reasonably expected to exercise that option because the final payment will be well below the expected market value of the machine at the end of the agreement. Sandra, as the machine’s legal owner, would normally be its holder under item 10 but item 6 makes it clear that the legal owner is not the holder.

Step 5: Calculate depreciation 13.20 Calculating depreciation can be broken up into five substeps: Substep 5.1: Determine the period; Substep 5.2: Choose between the DV method or PC method; Substep 5.3: Work out effective life and depreciation rate; Substep 5.4: Determine cost; and Substep 5.5: Calculate depreciation.

Substep 5.1: Determine the period 13.21 Section 40-60 states that a depreciating asset starts to decline in value when a taxpayer first uses it or has it installed ready for use for any purpose. This is known as the start time. The period for the depreciation calculation is based on the number of days from the start time to 30 June of the income tax

year (ignoring periods of any non-use or any time when the asset was not installed ready for use): s 40-70(1). [page 432]

Example Harold operates a funeral parlour and purchases a hearse without an engine on 1 July. He has an engine fitted and the hearse is ready to be used for transportation of the dead on 1 September. He acquires a laptop on 10 July and uses it immediately for private use until 1 December, when he uses it 100 per cent for business. The start time for the hearse is 1 September and for the laptop is 1 December.

Practice Problem 4 Kelly purchased a computer on 1 July. She immediately used it wholly for private purposes. However, when she commenced a new business on 1 March, she used the computer wholly for business purposes. What is the start time for this computer? What is the period for depreciation? How many days has it been used for the relevant taxable purpose per s 40-25(1)?

Substep 5.2: Choose between the DV method or PC method 13.22 There is a choice of two methods to work out the decline in value of a depreciating asset — DV method or PC method: s 40-65(1).7 Once a choice is made for an asset, it cannot be changed.8 There are times when there is no choice.

Asset acquired from associate 13.23 For a depreciating asset acquired from an associate where the associate has deducted or can deduct an amount for the asset under Div 40, the same method that the associate was using must be used: s 40-65(2).9 Holder changes but user same or associate of former user 13.24 For a depreciating asset that was acquired from a former holder of the asset, the taxpayer must use the same method that the former holder was using for the asset if: the former holder or another entity (each of which is the former user) was using the asset at a time before the taxpayer became the holder; and while the taxpayer held the asset, the former user or an associate of the former user uses the asset: ss 40-65(3). However, the DV method must be used if: the taxpayer did not know, and cannot readily find out, which method the former holder was using; or the former holder did not use a method: s 40-65(4). Note: Special rules apply for low-value pools and research and development: s 40-65(5) and (6). [page 433]

Read ITAA 1997 s 40-65 Work out DV and PC Diminishing value method (DV) 13.25 The DV is calculated as follows for depreciating assets acquired before 10 May 2006, per s 40-70:

For depreciating assets acquired after 9 May 2006, the accelerated DV rate is per s 40-72:

The base value is the asset’s cost (see 13.37) in the year the asset’s start time occurs. For further years, the base value is the sum of the opening adjustable value plus any second elements of cost for that year: s 40-70(1). Days are the number of days a taxpayer held the asset in the year from its start time (ignoring any days of non-use or where it was not installed ready to use): s 4070(1). Prime cost method (PC) 13.26

The PC is calculated as follows per s 40-75:

Under this method, the asset declines in value uniformly over its life. Cost is the asset’s cost (see 13.37). Days are the number of days a taxpayer held the asset in the year from its start time (ignoring any days of non-use or where it was not installed ready to use): s 40-70(1). Carpet acquired on 1 July 2005 in a tenpin bowling centre costing $20,000 (4-year effective life and a 25 per cent PC and 37.5 per cent DV rate) will have the following depreciation deductions under the two methods. Opening adjustable value $

15,000

12,500

5000

4688

10,000

7812

Year 3 decline in value $

5000

2930

Opening adjustable value $

5000

4882

Year 2 decline in value $ Opening adjustable value $

Year 4 decline in value $ Adjustable value $

5000

1831

0

3051

[page 434]

Leap years 13.27 In a leap year the number of days will be 366, so the depreciation calculation is based on 366/365 days.

Immediate deductions: s 40-80 13.28 Immediate deductions are provided for certain depreciating assets used in mining. Immediate deductions are also provided for depreciating assets costing no more than $300.

Read ITAA 1997 s 40-80 Substep 5.3: Work out effective life and depreciation rate 13.29 In determining the applicable depreciation rate, the effective life of the depreciating asset first needs to be determined.10 There are two choices per s 40-95(1): effective life determined by the Commissioner; or taxpayer’s estimate. If a taxpayer chooses to use an effective life determined by the Commissioner for a depreciating asset, a capped life may apply to the asset under s 40-102. The choice of an effective life determined by the Commissioner for a depreciating asset is limited to:11 the time when you entered into a contract to acquire the asset, you

otherwise acquired it or you started to construct it if its start time occurs within 5 years of that time; for plant that you entered into a contract to acquire, you otherwise acquired or you started to construct before 11.45am, by legal time in the Australian Capital Territory, on 21 September 1999 — the time when you entered into the contract to acquire it, otherwise acquired it or started to construct it; or otherwise — its start time (see s 40-60 for the meaning of start time). The choice must be made for the income year in which the asset’s start time occurs: s 40-95(3).12 Note: Special rules apply for associates, at s 40-95(4)–(6). Intangible depreciating assets 13.30 The effective life of an intangible depreciating asset is:13 standard patent, 20 years; innovation patent, 8 years; petty patent, 6 years; registered design, 15 years; copyright (except copyright in a film), the shorter of: – 25 years from when you acquire the copyright; or – the period until the copyright ends; [page 435] a licence (except one relating to a copyright or in-house software), the term of the licence; a licence relating to a copyright (except copyright in a film), the shorter of: – 25 years from when you become the licensee; or – the period until the licence ends;

in-house software, 5 years; spectrum licence, the term of the licence; datacasting transmitter licence, 15 years; and telecommunications site access right, the term of the right. Commissioner’s determination of effective life 13.31 The Commissioner may make a written determination specifying the effective life of depreciating assets.14 The determination may specify conditions for particular depreciating assets. A determination may specify a day from which it takes effect for depreciating assets specified in the determination: s 40-100(2).15 The Commissioner is to make a determination of the effective life of a depreciating asset by estimating the period (in years, including fractions of years) it can be used by any entity for a taxable purpose or for the purpose of producing exempt income or non-assessable non-exempt income, taking into account the following (s 40-100(4)): assuming that it will be subject to wear and tear at a rate that is reasonable for the Commissioner to assume; assuming that it will be maintained in reasonably good order and condition; and having regard to the period within which it is likely to be scrapped, sold for no more than scrap value or abandoned. An extract of the Commissioner’s effective life determinations is set out at Appendix 2. The Commissioner has issued Taxation Ruling TR 2017/2 dealing with the effective life of depreciating assets, effective from 1 July 2017

Example The Commissioner’s effective life for a car is 8 years (see Appendix 2).

Practice Problem 5

What is the Commissioner’s effective life for a laptop?

[page 436] Capped life of certain depreciating assets 13.32 For certain depreciating assets, capped effective life periods apply: s 40-102.

Read ITAA 1997 Table s 40-102(4) Self-assessing effective life 13.33 A taxpayer can work out the effective life of a depreciating asset by estimating the period (in years, including fractions of years) it can be used by any entity for a taxable purpose or for the purpose of producing exempt income or non-assessable non-exempt income and, if relevant for the asset, per s 40-105(1): having regard to the wear and tear reasonably expected from the expected circumstances of use; and assuming that it will be maintained in reasonably good order and condition. If, in working out that period, the taxpayer concludes that the asset would be likely to be scrapped, sold for no more than scrap value or abandoned before the end of that period, its effective life ends at the earlier time: s 40105(2). The self-assessing period is worked out from the start time of the depreciating asset: s 40-105(3). Exception: intangibles 13.34 Section 40-105 does not apply to certain intangible depreciating assets: see s 40-105(4).

Recalculating effective life 13.35 A taxpayer can choose to recalculate the effective life of a depreciating asset from a later income year if the effective life the taxpayer has been using is no longer accurate because of changed circumstances relating to the nature of the use of the asset: s 40-110(1). You need to recalculate the effective life of a depreciating asset where (s 40110(1)): your use of the asset turns out to be more or less rigorous than you expected (or was anticipated by the Commissioner’s determination); there is a downturn in demand for the goods or services the asset is used to produce that will result in the asset being scrapped; legislation prevents the asset’s continued use; changes in technology make the asset redundant; and there is an unexpected demand or lack of success for a film. A taxpayer must recalculate a depreciating asset’s effective life from a later income year if the taxpayer (s 40-110(1)): assessed its effective life; used an effective life worked out under s 40-100 (about the Commissioner’s determination) or s 40-102 (about the capped life of certain depreciating assets) and the PC method; or used an effective life because of s 40-95(4), (4B), (4C), (5), (5B) or (5C); and its cost is increased in that year by at least 10 per cent. [page 437]

Example Ted purchases a fax machine and self-assesses its effective life at 5 years. In a later year, he incurs expenditure to increase the quality of the faxes it produces. He recalculates its effective life but concludes that it remains the same.

Example Donna also purchases a fax and self-assesses its effective life at 5 years. In a later year, she incurs expenditure to improve the paper-handling system. She recalculates its effective life and concludes that it is increased to 7 years. You must recalculate a depreciating asset’s effective life for the income year in which you started to hold it if (s 40-110(3)): you are using an effective life because of s 40-95(4), (4B), (4C), (5), (5B) or (5C); and the asset’s cost is increased after you started to hold it in that year by at least 10 per cent. Special rules apply to a depreciating asset that is a mining, quarrying or prospecting right recalculating the effective life: s 40-110(3A)–(4). Intangible depreciating assets listed in s 40-95(7) are excluded from recalculating effective life: s 40-110(5).

Practice Problem 6 A depreciating asset used to transmit television signals has a remaining effective life of 11 years. The Government decides that use of the transmitters is to cease in 3 years. Thus, the effective life of the depreciating asset will be scrapped in 3 years for zero value. What is the effective life? Depreciation rate 13.36 Having determined effective life and chosen the DV or PC method, the depreciation rate can be calculated. Using the Commissioner’s effective life (as set out in the extract in Appendix 2), the table in Appendix 1 provides a conversion table into depreciation rates depending on whether the depreciating asset was acquired before or after 9 May 2006.

Example

EFFECTIVE LIFE OF DEPRECIATING ASSET

DV RATE FOR POST-10 MAY 2006 ASSETS

PC RATE

5 years

40%

20%

15 years

13.33%

6.67%

40 years

5%

2.5%

[page 438]

Practice Problem 7 What is the Commissioner’s effective life that will apply for the following items of plant acquired in the current year? What is the depreciation rate for each item? The assets were acquired after 9 May 2006. (See Appendices 1 and 2.) 1 dentist electric motor 2 kindergarten furniture 3 water supply — water mains

Substep 5.4: Determine cost 13.37 The cost of a depreciating asset that you hold consists of two 16 elements. First element of cost 13.38 The first element is generally the amount a taxpayer is taken to have paid to hold the asset under s 40-185 (unless the item is listed in the table at s 40-180(2)).17 This includes an amount you paid or are taken to have paid in relation to starting to hold the depreciating asset if that amount is directly connected with holding the asset: s 40-180(3). However, the first element of

cost excludes an amount that forms part of the second element of cost of another depreciating asset: s 40-180(4). Section 40-185 sets out the amount paid to hold a depreciating asset: This Division applies to you as if you had paid, to hold a depreciating asset or for an economic benefit for such an asset, the greater of these amounts: (a)

the sum of the amounts that would have been included in your assessable income because you started to hold the asset or received the benefit, or because you gave something to start holding the asset or receive the benefit, if you ignored the value of anything you gave that reduced the amount actually included; or (b) the sum of the applicable amounts set out below in relation to the asset or receiving the benefit.

Item 1 of the table at s 40-185 sets out the commonest situation, where you pay an amount for a depreciating asset — then the first element of the cost base is the amount paid.

Example Harry purchases a tractor for his vineyard and pays $250,000 for the tractor. The first element of the depreciating asset is $250,000.

Read ITAA 1997 Table s 40-185 Section 40-185 provides the following examples: Example Gold Medals Ltd manufactures some medals for a local sporting association’s annual meeting in return for a die cut stamping machine. The medals have a market value of $20,000. The machine

[page 439] has an arm’s-length value of $100,000 but Gold Medals has to contribute $75,000 towards acquiring it from the association. Gold Medals will have to include: ($100,000 − $75,000) = $25,000 in its assessable income because of s 21A of the Income Tax Assessment Act 1936. The first element of the machine’s cost will be the greater of: the amount it paid ($75,000) plus the market value of the non-cash benefits it provided ($20,000), which comes to $95,000; and

the amount that was assessable income from receiving the machine ($25,000) plus the amount by which that assessable income was reduced because of the payment Gold Medals made ($75,000), which comes to $100,000. So, in this case, the first element of the machine’s cost to Gold Medals is $100,000. Example Laura travels overseas to purchase a purpose-built vehicle for use in her trade. The purchase of the vehicle is the sole reason for the trip. Laura incurs expenses for airfares and accommodation. These expenses are included in the cost of the vehicle because they are ‘in relation to starting to hold’ the vehicle.

Practice Problem 8 Provide five examples of first element costs.

Special rules for first element cost bases 13.39 The table at s 40-180(2) provides first element cost rules for certain situations, such as split merged, balancing adjustment depreciating assets etc.

Read ITAA 1997 Table s 40-180(2) Second element of cost: s 40-190 13.40 The second element is worked out after you start to hold the depreciating asset.18 The second element of cost comprises the following two amounts.19 Amounts paid after holding asset: The amount you are taken to have paid under s 40-185 for each economic benefit that has contributed to bringing the asset to its present condition and location from time to time since you started to hold the asset. Balancing adjustment amounts: Expenditure you incur that is reasonably attributable to a balancing adjustment event occurring for the asset.

[page 440] Installation costs 13.41 These second element costs include freight, import duties and installation costs, as well as the purchase cost, and all form part of the cost of plant. Any costs in demolishing or removing old plant are not part of the cost of the new plant. Structural alterations to buildings to house plant are not part of installation costs. Alterations and additions to depreciating assets, dismantling, transporting and re-erecting are second cost elements. Example: s 40-190. Andrew adds a new tray and canopy to his ute. The materials and labour that go into the addition are economic benefits that Andrew received and that contribute to the ute’s present condition. The payments he makes for those economic benefits are included in the second element of the ute’s cost. Example: s 40-190. Leonie needed to replace one of her old depreciating assets that was fixed to her land with a new, more efficient one. Leonie paid a contractor a fee to demolish and remove the old asset. This resulted in a balancing adjustment event occurring for the old asset, and the fee forms part of the second element of the cost of the old asset that was demolished. For depreciation to be claimed, there must be some identifiable cost. Primary Health Care Ltd v FCT [2010] FCA 419 Facts: The taxpayer operated medical centres through a unit trust. It opened medical centres and engaged doctors in established practices to work in the new centres. The taxpayer unit trust argued that it acquired copyright in the medical records of the practices it bought,

and thus it was entitled to depreciation deductions under ITAA 1997 Div 40. Federal Court held: No depreciation was allowable. Copyright did not subsist in the medical records, although this did not mean that copyright can never exist in medical records. The records for one patient and various referral letters were copyright. Since the cost of the relevant doctor’s practice was fully allocated between goodwill and other things, it did not allocate any cost to copyright. There being no cost, then, under Div 40, no depreciation deduction was allowed. Special rules apply for non-arm’s-length situations and private arrangements: s 40-190(3).

Read ITAA 1997 s 40-190 Apportionment 13.42 If a taxpayer pays an amount for two or more things that include at least one depreciating asset, or that include a contribution to bringing a depreciating asset to its present condition and location, the cost is apportioned.20 [page 441]

Example Mahmood buys two assets (a laptop and one other non-depreciating asset) under the one transaction. He pays $3000 for the two assets and $2000 of that amount is reasonably attributable to the laptop. The first element of the depreciating asset’s cost is $2000. Exclusions from cost 13.43

The following exclusions apply:

amounts incurred before 1 July 2001: s 40-200; both cost elements are reduced to the extent the cost is deductible under a provision other than the uniform capital allowance provisions or Div 328, s 40-215; amounts that are not of a capital nature whether or not deductible: see s 40-220; and the cost of a car exceeding the car depreciation limit: ss 40-225–40-230. The car limit for 2017-2018 is $57,581. Special rules apply for split or merged assets: ss 40-205–40-210. GST and cost: ss 27-80–27-110 13.44 The cost of a depreciating asset is reduced by any input tax credits relating to the acquisition or to the second element of cost and by any decreasing adjustments to the asset. The cost of the depreciating asset, though, will increase for any increasing adjustments.

Read ITAA 1997 Div 27 Practice Problem 9 Ken modified his motor vehicle by converting it from diesel to gas. Is this a second cost element?

Practice Problem 10 Tim relocates his machine and at the same time pays to have his machine fixed so as to increase its output. Is the expenditure to overhaul and to relocate the machinery included in the second element of cost of the machinery?

Practice Problem 11 Provide five examples of second element costs.

[page 442]

Practice Problem 12 Are the following first or second element costs under ITAA 1997 Div 40 (all amounts exclude GST)?

BUSINESS

COSTS

Electrician

Buys a new work van for $20,000 plus stamp duty of $500.

Photographer

Buys a camera for $15,000 and modifies the camera. This costs $2000.

Car yard

Buys a second-hand computer for $5000 that needs to be cleared of a virus. This costs $200. The installation costs are $500. It costs $100 to remove the old computer system.

Substep 5.5: Calculate depreciation 13.45 As noted above, there are two alternative methods available for calculating depreciation, the DV and PC methods, which can be chosen on an asset-by-asset basis and year-by-year basis. But once a method is chosen for an asset, it must be applied continuously for that asset. Two key concepts in Div 40 are the terms ‘adjustable value’ and ‘opening adjustable value’ (these are similar to cost and written down value terms used in accounting). Adjustable value

13.46 The adjustable value of a depreciating asset at a particular time is set out in the following table.21 CIRCUMSTANCE

ADJUSTABLE VALUE

If a taxpayer has not yet used it or had it installed ready for use for any purpose

Cost

For a time in the income year in which you first use it, or have it installed ready for use, for any purpose

Cost less its decline in value up to that time

For a time in a later income year

The sum of its opening adjustable value for that year and any amount included in the second element of its cost for that year up to that time less its decline in value for that year up to that time

[page 443] Opening adjustable value 13.47 Opening adjustable value is the adjustable value of the asset at the end of the previous year: s 40-85(2).

Example Bevan acquires a desk for $500 on 1 July of the current tax year and uses the desk for 100 per cent work purposes during the year. He uses the DV method. The first element of cost is $500, the period is 365 days and the effective life is 20 years. Using the DV method, the depreciation deduction is:

The adjustable value at 30 June of the current tax year for the desk will be $450 and the opening adjustable value for 1 July of the next tax year will be $450.

Read ITAA 1997 s 40-85 Apportionment 13.48 Apportionment of deductions is required where: 1. a depreciating asset is held for part of the year: ss 40-70, 40-75; and 2. a depreciating asset is only part used for a taxable purpose: s 40-25(2), (7). Where a depreciating asset was previously 100 per cent used for a nontaxable purpose and now is used for a taxable purpose, the deduction is limited to the asset’s opening adjustable value. That is, you must calculate the decline in the value of the asset from the time of acquisition and bring in its opening adjustable value at the time the asset is used for a taxable purpose.

Example Emily has a laptop acquired on 1 June of the current tax year, which she used 40 per cent for work purposes. The depreciation decline is $500. Her depreciation claim needs to be apportioned as follows.

Read ITAA 1997 ss 40-25, 40-70, 40-75 Practice Problem 13 Calculate DV depreciation using the Commissioner’s ruling. (See Appendices 1 and 2.) (Costs exclude GST.)

[page 444]

DV Street photography camera 40 per cent private use acquired on 31 May of the current tax year costing $5000 Brick elevator costing $55,000 acquired on 1 July of the current tax year Automatic car-washing machine costing $29,000 acquired on 1 July of the current tax year

Practice Problem 14 Calculate the DV depreciation using the Commissioner’s ruling (see Appendices 1 and 2) and DV rates. (Costs exclude GST.) DEPRECIATION DEDUCTION Coal mining — continuous mining machine purchased on 31 December of the current tax year for $30,000 and used 100 per cent for business Tobacco kiln acquired on 1 July of the current tax year for $1.3 million plus installation costs of $200,000

Step 6: Calculate balancing adjustments Tax consequences for any balancing adjustment events 13.49 When a balancing adjustment event occurs (ie, you stop holding a depreciating asset, the asset is sold, scrapped or stops being used for a taxable purpose, or there is a partial change in ownership of the asset), a balancing adjustment must be made. There are assessable balancing adjustments and

deductible balancing adjustments: s 40-285(1), (2). Following a balancing adjustment event, the adjustable value of the depreciating asset is 0.22

Assessable balancing adjustment 13.50 Assessable balancing adjustment happens where termination value (usually selling price on disposal) is more than adjustable value just before the balancing adjustment event occurred; the difference is assessable (see s 40285(1)) unless balancing adjustment relief is used to defer or offset the gain. The amount assessable is reduced for any non-business usage: s 40-290. [page 445]

Deductible balancing adjustment 13.51 Deductible balancing adjustment happens where termination value (usually selling price on disposal) is less than adjustable value just before the balancing adjustment event occurred; the difference is deductible: see s 40285(2). The deduction is reduced for any non-business usage: s 40-290.

Meaning of balancing adjustment event 13.52 A balancing adjustment event occurs for a depreciating asset if a taxpayer:23 stops holding the asset; stops using it or having it installed ready for use for any purpose and expects never to use it or have it installed ready for use again; or has not used it; and – if the taxpayer had it installed ready for use — the taxpayer stops having it so installed; and – the taxpayer decides never to use it. A balancing adjustment event also occurs for a depreciating asset if, for any

reason, a change occurs in the holding of, or in the interests of entities in, the asset; the entity or one of the entities that had an interest in the asset before the change has an interest in it after the change; and the asset was a partnership asset before the change or becomes one as a result of the change: s 40-295(2).

Read ITAA 1997 ss 40-285, 40-295 Practice Problem 15 What do you think is the most common balancing adjustment event for depreciating assets?

Termination value 13.53 Generally, the termination value is the amount a taxpayer receives for the balancing adjustment event (item 1, table at s 40-305(1)). The sum of the amounts a taxpayer can deduct because of the balancing adjustment event is also taken into account. The table at s 40-305 lists the amounts that make up termination value. [page 446]

ITEM

AMOUNT YOU ARE TAKEN TO HAVE RECEIVED UNDER A BALANCING ADJUSTMENT EVENT

IN THIS CASE, THE AMOUNT IS:

1

You receive an amount

The amount

2

You terminate all or part of a liability to pay an amount

The amount of the liability or part when you terminate it

3

You are granted a right to receive an

The amount of the right or increase when it is granted or increased

amount or an amount to which you are entitled is increased 4

You receive a non-cash benefit

The market value of the non-cash benefit

5

You terminate all or part of a liability to provide a *non-cash benefit

The market value of the non-cash benefit or reduction in the non-cash benefit when the liability or part is terminated

6

You are granted a right to receive a *non-cash benefit or you become entitled to an increased non-cash benefit24

The market value of the non-cash benefit, or the increase, when it is granted or increased

Read ITAA 1997 s 40-305 Amounts that are ordinary income or statutory income are excluded from being part of termination value: s 40-300(3). If an amount is for two or more things that include a balancing adjustment event, apportionment that is reasonably attributable applies: s 40-310.

GST and termination value 13.54 For a GST taxpayer, the termination value is reduced by any GST payable in respect of the balancing adjustment event: s 27-95. However, where market value applies, this is defined as the GST-exclusive market value of the asset: s 995-1(1). The termination value is increased by any decreasing adjustments and reduced by increasing adjustments: see s 27-95.

Example Norm sells a desk, used 100 per cent in his business, for $120, having an adjustable value of $100 (it cost $200). The termination value is $120 and the assessable balancing adjustment is $20 ($120 − $100).

Example Pam sells plant, used 100 per cent in her business, for $80, having an

adjustable value of $100 (it cost $200). The termination value is $80 and the deductible balancing adjustment is $20 ($100 − $80). [page 447]

Practice Problem 16 What is termination value? Provide an example.

Balancing adjustments and interaction with CGT 13.55 If a depreciating asset is used for 100 per cent taxable purposes, there are no CGT implications (see ss 40-285, 118-24); however, a balancing adjustment may be required. If a depreciating asset is used for 100 per cent non-taxable purposes, there is no balancing adjustment. If a depreciating asset is used partly for non-taxable purposes, the balancing adjustment is calculated according to the proportion of business use. (The non-business use is dealt with by CGT event K7: see Chapter 9.) CGT event K7 may arise if the asset is not pre-CGT or an asset in a Simplified Tax System depreciation pool. CGT event K7, s 104-235, applies if the cost of the asset exceeds the termination value; the excess multiplied by the non-business use is the capital loss: s 104-240. If the cost of the asset is less than the termination value, the excess multiplied by the non-business use is the capital gain: s 104-240.

Read ITAA 1997 s 104-235 Haysman acquires an asset for $10,000 that is 30 per cent for private use. Over the 2 years of ownership, the

decline in the asset was $4000 PC. He sells the asset after 2 years for $7000; it has an adjustable value of $6000. Because he used the asset for 30 per cent nonbusiness use, the decline in asset value would have been 70 per cent of $4000 = $2800. Balancing adjustment Termination value, $7000 > adjustable value $6000, which is $1000 − (1000 × 30%) = $700 assessable Capital loss Since cost exceeds termination value ($10,000 − $7000) × 30% = $900 if the above asset was sold for $11,000. Balancing adjustment Termination value, $11,000 > adjustable value $6000, which is $5000 − ($5000 × 30%) = $3500 assessable Capital gain CGT event K7 Since termination value exceeds cost ($11,000 − $10,000) × 30% = $300 if the above asset was sold for $5000. Balancing adjustment Termination value, $5000 < adjustable value $6000

[page 448]

$1000 − ($1000 × 30%) = $700 deduction Capital loss Since termination less than cost ($10,000 − $5000) × 30% = $1500.

Practice Problem 17 Can CGT apply to a balancing adjustment event involving a depreciating asset?

Practice Problem 18 The cost of plant acquired on 1 July of the current tax year was $1000, depreciated at 10 per cent PC with 50 per cent private use. The balancing adjustments on disposal at 30 June of the current tax year will be as follows (depending on the termination value). All amounts exclude GST. Depreciation = $1000 × 10% × 50% = $50 What are the tax implications for the following termination values? TERMINATION VALUE

CONSEQUENCES

$1200 $990 $940 $500

Practice Problem 19 During the income year, the taxpayer disposes of the following items of plant (100 per cent used for business).

What amounts are assessable/deductible on disposal? All amounts exclude GST.

ITEM Office equipment

COST $

ADJUSTABLE VALUE $

SALE PROCEEDS $

10,000

7000

6000

Computer

3000

0

500

Diamond head drill

1000

900

1100

[page 449]

Rollover relief: s 40-340 13.56 Balancing adjustment rollover relief is available for certain CGT rollovers: disposal of asset to wholly owned company; disposal of asset by partnership to wholly owned company; transfer of a CGT asset of a trust to a company under a trust restructure; marriage breakdown; and disposal of asset to another member of the same wholly owned group. Where such relief applies, no balancing adjustment will arise, and the transferee assumes the transferor’s depreciation methods and values for the depreciating assets.

Involuntary disposals: s 40-365 13.57 An assessable balancing adjustment can be applied to replacement assets for certain involuntary disposals.

Step 7: Do the special rules apply? Low-value and software development pools: Subdiv 40-E 13.58 Taxpayers can elect to claim deductions for the decline in value of depreciating assets costing less than $1000 (low-cost assets) through a lowvalue pool. Also, if the adjustable value is less than $1000, the asset can be pooled (low-value asset). Once allocated to a pool, the asset must remain there. Exclusions include immediate deductible assets costing less than $300, horticultural plants, grapevines and Simplified Tax System depreciating assets. The proportion of non-business use must reduce the value of the asset taken to the pool. Calculating the decline for a year is the sum of: 18.75 per cent of the first and second element costs of low-cost assets allocated during the year; 18.75 per cent of the first and second element costs of low-value assets allocated during the year; 37.5 per cent of the closing pool balance for the previous year; and 37.5 per cent of the opening adjustable value (pre-1 July 2001) of lowvalue assets. CALCULATING THE DECLINE IN VALUE DECLINE IN VALUE Closing pool balance 30 June of previous tax year $10,000

$10,000 × 0.375 = $3750

Low-cost assets pooled in year $20,000

$20,000 × 0.1875 = $3750

Low-value assets pooled in year $10,000

$10,000 × 0.1875 = $1875

Total deduction for current tax year

$9375

Closing pool balance is $30,625

[page 450] If a pooled asset is disposed of, the closing pool balance is reduced by the termination value: s 40-445.

Primary production depreciating assets: Subdiv 40-F 13.59 Subdivision 40-F provides capital allowances for the following primary production depreciating assets: water facilities; and horticultural plants. All primary producers can claim an immediate deduction for capital expenditure on fencing and water facilities for income years commencing on or after 1 July 2016. All primary producers can claim accelerated depreciation over 3 years on all capital expenditure on fodder storage assets.

Read ITAA 1997 Subdiv 40-F Depreciation for small business entities 13.60 Small business taxpayers that are small business entities (SBEs) can choose the SBE depreciation regime in Subdiv 328-D. For the period 12 May 2015 (7.30pm AEST) to 30 June 2018, SBEs obtain a 100 per cent deduction for depreciating assets that cost up to $20,000 and are installed ready for use. From 1 January 2014 to 12 May 2015, SBEs obtain 100 per cent deductions for depreciating assets costing less than $1000 (previously $6500 from 1 July 2012 to 31 December 2013; and prior to that $1000) to the extent of taxable use, and a single 30 per cent depreciating asset SBE pool for other assets.25 Also, from 1 July 2012 to 31 December 2013, SBEs using SBE depreciation could claim up to $5000 as an immediate deduction for a motor vehicle in the year they start to use it or have it installed ready for use for a taxable purpose. The remainder of the asset is written off in the SBE pool: see Chapter 5.

Read ITAA 1997 Subdiv 328-D Restructures of small businesses 13.61 Subdivision 328-G also provides tax neutral consequences for a small business entity that restructures the ownership of the assets of the business, without changing the ultimate economic ownership of the assets. The amendments apply to transfers of depreciating assets, where the balancing adjustment event arising from the transfer occurs on or after 1 July 2016.

Debt forgiveness 13.62 Special rules apply in respect of debt forgiveness applied in reduction of deductible expenditure for a depreciating asset, per s 40-90. [page 451]

Step 8: Complete the depreciation schedule 13.63

Finally, apply all of the above steps in a depreciation schedule.

Example Shane runs a cricket sports shop in Melbourne and his opening adjustable values are set out in the depreciation schedule below as at 1 July of the current tax year ended 30 June. All assets were acquired after 9 May 2006 and have a 100 per cent business use (except his car, which is 90 per cent business use). He uses the DV method. Additionally, he paid $5000 for a new cash register plus $100 for electricians to install it. The register was not ready for use in the business until 1 June. The old register was sold for $200 on 1 May. Calculate the deductions available under Div 40 and the closing adjustable values, rounded to the nearest dollar.

DEPRECIATING ASSET

OPENING ADJUSTABLE VALUE 1 JULY $

DEP’N RATE %

40,562

25

589

20

12,784

10

Car Cash register, old Shop fittings Cash register, new

ADDITIONS $ TERMINATION VALUE $

200

20

Total

5100

53,935

5100

200

Less private use

DEPRECIATION $

CLOSING ADJUSTABLE VALUE 30 JUNE $

10,140

30,421

291 98

0

1278

11,506

84

5016

11,891

46,943

1014

Deduction

10,877

Calculations: Car

Cash register, old

Balancing adjustment = TV − AV = 200 − 491 = 291 deduction Shop fittings

Cash register, new

[page 452]

Practice Problem 20 DEPRECIATING ASSET

Alternators

OPENING ADJUSTABLE VALUE 1 JULY $ 91,478

DEP’N RATE %

ADDITIONS $

TERMINATION VALUE $

DEPRECIATION $

CLOSING ADJUSTABLE VALUE 30 JUNE $

Generators Power station plant

84,890 110,125

Transformer boxes

5642

Meters

8097

Total Less private use Depreciation expense

Additionally, she paid $40,000 for new transformer boxes on 1 August of the current tax year plus $8578 for electricians to install the boxes. The boxes were not ready for use in the business until 1 October. The old boxes were sold for scrap for $1000 on 1 October. Also, she paid $30,000 for new meters on 1 January of the current tax year plus $2456 for fitting costs. The old meters were sold for $10,000 on 1 January. Assume all assets listed in the depreciation schedule were acquired after 9 May 2006.

Other listed capital allowances: Subdivs 40-G– 40-J Capital expenditure of primary producers and other landholders: Subdiv 40-G 13.64 Subdivision 40-G provides capital allowances for the following capital expenditure of primary producers and other landholders: landcare operations; and electricity or telephone lines.

Read ITAA 1997 Subdiv 40-G Capital expenditure that is immediately deductible: Subdiv 40-H 13.65 Subdivision 40-H provides 100 per cent deductions for the following capital expenditure: exploration or prospecting (see Taxation Ruling TR 2017/1 and Practical Compliance Guideline PCG 2016/17); [page 453] rehabilitation of mining or quarrying sites; paying petroleum resource rent tax; and environmental protection activities.

Read ITAA 1997 Subdiv 40-H Capital expenditure that is deductible over time: Subdiv 40-I 13.66 Subdivision 40-I provides capital allowances for certain capital expenditure associated with projects over the life of the project. These projects include: certain mining capital expenditure; certain transport capital expenditure; community infrastructure; site preparation for depreciating assets; feasibility studies; environmental assessments;

obtaining project information; expenses incurred in seeking a right to intellectual property; and amounts for ornamental trees and shrubs.

Read ITAA 1997 Subdiv 40-I Capital expenditure for the establishment of trees in carbon sink forests: Subdiv 40-J 13.67 Subdivision 40-J provides deductions for capital expenditure incurred for establishing trees that meet the requirements for constituting a carbon sink forest.

Read ITAA 1997 Subdiv 40-J Five-year write-off for certain business-related costs: s 40-880 13.68 Section 40-880 is a provision of last resort, as it may provide a deduction to the extent that the expenditure is not taken into account in some way elsewhere in the income tax law. Section 40-880 makes certain capital expenditure of business deductible over 5 years, or immediately in the case of some start-up expenses for small businesses, where: the expenditure is not otherwise taken into account as a deduction or a CGT cost base amount; a deduction is not denied by some other provision; and the business is, was or is proposed to be carried on for a taxable purpose. Also, you can deduct the capital expenditure in the income year in which you incur it if: (a) the expenditure is incurred in relation to a business that is proposed to be carried on; and

[page 454] (b) the expenditure is incurred: in obtaining advice or services relating to the proposed structure, or proposed operation of the business; or in payment to an Australian government agency of fees, taxes or charges relating to establishing the business or its operating structure; and (c) you are a small business entity for the income year, or both of the following apply: you are not carrying on a business in the income year; you are not connected with, or an affiliate of, another entity that carries on a business in the income year and that is not a small business entity for the income year. However, there are numerous exclusions contained in s 40-880(5)–(9) for expenditure you incur to the extent that: it forms part of the cost of a depreciating asset that you hold, used to hold or will hold; you can deduct an amount for it under a provision of the Act other than s 40-880; it forms part of the cost of land; it is in relation to a lease or other legal or equitable right; it would, apart from s 40-880, be taken into account in working out: – a profit that is included in your assessable income (eg, under ss 6-5 or 15-15); or – a loss that you can deduct (eg, under ss 8-1 or 25-40); it could, apart from s 40-880, be taken into account in working out the amount of a capital gain or capital loss from a CGT event; a provision of the Act other than s 40-880 would expressly make the expenditure non-deductible if it were not of a capital nature; a provision of the Act other than s 40-880 expressly prevents the expenditure from being taken into account as described in s 40-880(a)–(f)

for a reason other than the expenditure being of a capital nature; it is expenditure of a private or domestic nature; or it is incurred in relation to gaining or producing exempt income or nonassessable non-exempt income. Also, there is no deduction for an amount of expenditure that, because of a market value substitution rule, was excluded from the cost of a depreciating asset or the cost base or reduced cost base of a CGT asset. An immediate deduction is available for businesses covering professional expenses that are needed to start a new business. These expenses include professional, legal and accounting expenses so as to establish a company, trust or partnership to run a business. The ATO has also indicated how businesses may be able to claim website development costs. See Taxation Ruling 2016/D1.

Example In July, ABC Pty Ltd, which carries on a slimming pill business, spends $33,100 on research into the market for an exercise machine, for the purpose of establishing a new business. The research indicates that a new exercise machine business is unlikely to be profitable, and consequently a new business is not established. As ABC Pty Ltd proposed to carry on the business for a taxable purpose, a deduction over 5 years is available for the $33,100 under s 40-880, the business-related costs provision. [page 455]

Example After being fired as an accountant, Jane decides to investigate starting her own accounting business. She spends $5000 on market research, a consultant to put together a business plan and brochures, and she contacts former clients to compile a client database. Jane’s pre-business activities would be considered indicative of a genuine commitment to carry on an accounting business. She is

entitled to deduct $1000 over 5 income years under s 40-880, the businessrelated costs provision, once she commences her business activity. Note: The non-commercial loss provisions in Div 35 may apply.

Example Pink Pty Ltd incurs expenditure on due diligence prior to purchasing an existing business that Pink proposes to carry on. Before the sale can be finalised, the seller withdraws from the sale. The expenditure on due diligence is deductible over 5 years as a business-related cost: s 40-880.

Example Toby plants and maintains a few grapevines as a hobby. He spends money to investigate the possibility of customising a room in his house for the purposes of a wine tasting facility. The expenditure is not of the type to which a capital works deduction under Div 43 applies. He seeks to claim the expenditure as being in relation to a business he proposes to carry on, under s 40-880. However, he has no evidence that he proposes to carry on a prospective business, so on an objective basis, the only benefit of the expenditure is to Toby himself; that is, the expenditure is of a private nature. He is not entitled to a deduction, as the expenditure is not a business-related cost. There must be evidence of a commitment to carry on the business at the time the expenditure was incurred. See Taxation Ruling TR 2011/6 Blackhole expenses under s 40-880 for the Commissioner’s views on the interpretation of the operation and scope of s 40-880.

Read ITAA 1997 s 40-880 Practice Problem 21 What types of business can take advantage of the capital allowance write-offs in Div 40 (excluding depreciation write-offs: Subdivs 40-A–40-E)?

Capital works: Div 43 13.69 You can deduct a portion of your construction expenditure for the following capital works set out in s 43-20: buildings, structural improvements and environmental protection earthworks, as well as extensions, alterations and improvements to these. [page 456] The deductions are at a 2.5 per cent rate (previously 4 per cent), depending on construction commencement time. The types of structures are: hotel buildings and apartment buildings used for short-term traveller accommodation; industrial buildings; research and development facilities; income-producing structural improvements; and environmental protection buildings and earthworks. Duck Hollow Fine Wines constructs a wine tasting facility for $1 million, which is completed on 31 December of the current year. It can claim a capital allowance of:

Read ITAA 1997 Div 43 Tax-preferred entities (asset financing): Div 250 13.70 Division 250 works to prevent or reduce certain capital allowance deductions that would otherwise be available in relation to an asset if the asset

is put to a tax-preferred use in certain circumstances. Section 250-5 provides as its objects: to deny or reduce your capital allowance deductions in respect of an asset if the asset is put to a tax-preferred use and you have insufficient economic interest in the asset; and if your capital allowance deductions are denied or reduced, to treat the arrangement for the tax-preferred use of the asset as a loan that is taxed as a financial arrangement (on a compounding accruals basis).

Capital allowances: ITAA 1936 13.71 There are a few other capital allowances available; for example, for research and development (ss 73A, 73B–73G) and carbon farming.

Carbon farming initiative 13.72 Expenditure incurred in establishing an offsets project under the Carbon Farming Initiative is not deductible under Div 420. However, those expenditures are deductible under the capital allowance provisions (Div 40) or the general deduction provision: s 8-1. Note: The Carbon Farming Initiative has been moved into the Emissions Reductions Fund as a consequence of the repeal of the carbon tax as from 1 July 2014.

Attempt the Web Quiz for Chapter 13 [page 457]

Summary

13.73 There are a number of different capital allowances under the ITAA 1997 and 1936. For depreciating assets, the steps involved in working out depreciation are as follows. 1 Understand s 40-25. 2 Must have a taxable purpose. 3 Must have a depreciating asset. 4 Must have a holder of a depreciating asset. 5 Calculate depreciation: Substep 1: Determine the period. Substep 2: Choose between the DV method or PC method. Substep 3: Work out effective life and depreciation rate. Substep 4: Determine cost. Substep 5: Calculate depreciation. 6 Calculate balancing adjustments. 7 Do the special rules apply? 8 Complete the depreciation schedule. There are a number of special industry and activity allowances for certain types of capital expenditure: Subdivs 40-G–40-J. As a provision of last resort, s 40-880 may provide a deduction for capital expenditure that is otherwise not deductible. Division 41 provides a temporary investment allowance deduction for certain depreciating assets. Buildings and other structures are usually amortised under the capital works provisions in Div 43. Division 250 prevents or reduces certain capital allowance deductions that would otherwise be available in relation to an asset if the asset is put to a taxpreferred use in certain circumstances. The ITAA 1936 contains capital allowances for research and development and Australian films.

Further problems

1 2 3

Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. What is a capital allowance? What special rules apply for SBE taxpayers for capital allowances? What deductions, if any, will be allowed in respect of the following expenses incurred in the current tax year? All amounts exclude GST. Give reasons. a The costs of a self-employed barrister’s wig of $1100, gown of $330, pinstripe suit of $880 and a haircut of $33, ordered by a judge. The barrister does not elect the SBE depreciation rules. [page 458]

4

What difference would it make if the barrister elects the SBE depreciation rules? b Telstra lays $110 million of international submarine cable for improving the efficiency of its telephone network. The Safe Way Trust runs a supermarket with over $15 million turnover in the current and the two prior tax years. The owners want to know whether the assets below are depreciating assets. What is their effective life? What DV rate applies? The assets were acquired after 9 May 2006.

desks and chairs

car park

plumbing for employee amenities

cash register

drinks and food for clients

air conditioning

sign/billboard

shop fittings

legal costs of trust deed

building

lighting

5

During the income year, Roger disposes of the following depreciating assets (100 per cent used for business). The taxpayer has gross sales of over $20 million turnover in the current and the two prior tax years. All amounts exclude GST. What amounts are assessable/deductible on disposal? ITEM

COST $

ADJUSTABLE VALUE AT TIME OF DISPOSAL $

SALE PROCEEDS (EXCLUDING GST) $

Table

1000

700

600

Air conditioner

5000

0

1000

Machine

7500

5000

10,000

6

7

Keely, who is not an SBE, acquires a machine for $20,000 that is used 20 per cent for private use. Over the 2 years of ownership, the decline in the asset was $8000 PC. She sells the asset after 2 years for $14,000; it has an adjustable value of $12,000 at the time of sale. All amounts exclude GST. What are the income tax implications? Provide advice to Joe, the owner of the newly opened café operating as Fresh Guys Pty Ltd, on what deductions are available in the current tax year for the following setting-up costs incurred on 1 September of this tax year (provide a depreciation schedule). Note: All amounts include GST and the annual sales are projected to be $3 million. a venetian blinds, $4400; b stove, $1100; c electric heater, $550; d trading stock, $10,000;

e f g h

lease preparation fees for the plant and equipment, $3300; legal costs in obtaining finance for 20-year loan, $9900; costs of building, $1,100,000, built in 1996; and costs of incorporating Fresh Guys Pty Ltd, $2200, incurred by Joe. [page 459]

8

Deb runs a cinema and as at 1 July of the current tax year her depreciation schedule is set out below. (She uses the diminishing rate method.) All of the opening assets were acquired after 9 May 2006. All amounts exclude GST. Deb is not an SBE.

DEPRECIATING ASSET

OPENING ADJUSTABLE VALUE 1 JULY $

Carpet

2871

Seating

23,761

Lighting

6006

Motion picture projector

2043

DEP’N RATE

%

ADDITIONS $

TERMINATION VALUE $

DEDUCTION $

CLOSING ADJUSTABLE VALUE 30 JUNE $

Total

a

b

She also acquired the following assets. A new motion picture projector for $120,000 on 1 April of the current tax year. She scrapped the old projector for no consideration on the same date. New loudspeakers acquired on 1 August of the current tax year for $16,000 but not installed until 1 September. The costs of installation were $2800. Calculate the depreciation deduction under Div 40.

9

10

11

12

13

Sepco moved depreciating assets from one location to another. The depreciating assets are used wholly for taxable purposes. Do costs incurred by Sepco for relocating a depreciating asset form part of its cost under Div 40? Brooklyn Co carries on the business of constructing motor homes and renting them on completion. Do all of Brooklyn Co’s costs of constructing a motor home form part of the first element of cost of a depreciating asset? Steel Co purchased a truck and incurred expenditure to travel interstate to have the vehicle modified to comply with Australian standards. The vehicle is used in the course of the taxpayer’s business. Does the travelling interstate to have a depreciating asset modified form part of the cost of the depreciating asset? Sheila purchased a rental property, and to get it ready for rent she constructed a new septic tank system. The improved system reduces the likelihood of damage to the environment and minimises offensive odours. Is she entitled to a deduction for the expenditure incurred in the construction of a septic tank system on the rental property? Gale proposed to carry on a business growing orange trees and bought a large block of land. Before the trees were planted, she incurred soil analysis tests and other initial tree establishment costs, with none of the expenditure being for clearing of the land. Is the capital expenditure incurred by Gale deductible? [page 460]

14

John, a relative of Paul (the taxpayer), was involved in the taxpayer’s business. John was to inherit 50 per cent of a major asset of the business upon the death of the taxpayer. A change in the taxpayer’s will substantially reduced the entitlement of John to that asset. In legal action against Paul, John claimed that a partnership existed between them and

15

16

there was an agreement for the transfer of 50 per cent of the asset upon the death of Paul. Alternatively, it was claimed that the asset was a partnership asset in which both had an equal share. The effect of the claims would be to secure a 50 per cent interest in the asset for John. Is the capital expenditure incurred by Paul to defend against claims to a major business asset and to part ownership of their business deductible under ITAA 1997 s 40-880(1)(d)? Bloomsburg was owner and lessor of the residential rental property used for the purpose of producing assessable income. A garden and storage shed constructed of asbestos and situated on the property became a potential health risk to the tenants after storm damage caused the asbestos sheeting to become friable. Bloomsburg incurred expenditure in demolishing and removing the shed (demolition expenditure). The demolition expenditure was for the sole or dominant purpose of preventing contamination or pollution of the site by harmful and potentially dangerous asbestos, in that it was primarily directed to that purpose under the duty of care owed to the tenants under common and state law. The shed was a capital work for which an amount could be deducted under Div 43 — Deduction for capital works, ITAA 1997 Pt 2-10. No amount was received by the taxpayer for the destruction or disposal of the shed. Is Bloomsburg entitled to a deduction under ITAA 1997 s 40-755 for expenditure incurred in demolishing and removing a shed constructed of asbestos from a rental property? Acme Ltd Builders constructed a roadway for the purpose of using it for its income-earning activities. In the course of that construction, the taxpayer incurred expenditure in vegetating the area beside the roadway. The dominant purpose of vegetating the area was the achievement of a visual effect. A significant other purpose was the prevention of erosion. Is Acme entitled to a deduction under ITAA 1997 s 40-755(1) for vegetating an area used in its income-earning activities for the purposes of providing a visual effect and preventing erosion?

17

18

Teresa operates a produce farm. She is proposing to construct a shed on the property for the purpose of storing produce that has been harvested when soil and weather conditions are favourable. This will minimise the adverse effect on the soils caused by heavy machinery compacting those soils during a forced harvest under adverse conditions. Without adequate storage facilities, there is a very real risk that crops may not be harvested and the land is put at great risk of erosion and further degradation through uncontrolled weed infestation. Is construction of a shed a landcare operation under ITAA 1997 s 40635(1)(e)(iii)? The New South Wales State Government has passed legislation that requires certain businesses to reduce their carbon dioxide emissions either by improving their manufacturing processes or by offsetting those emissions with the cultivation of trees. [page 461] Pink Pty Ltd intends to acquire some land in New South Wales either by purchasing freehold title or by entering into long-term leases, so that it can plant and cultivate mallee trees that will generate carbon credits that it will sell to businesses that need to reduce their carbon dioxide emissions. It is currently negotiating with some of those businesses to enter into carbon credit contracts. These businesses are unrelated parties. The amount of carbon credits that will be produced by these trees will be determined by an independent manager, who will be applying the provisions of the New South Wales legislation. The determination will be made on an annual calendar year basis. Essentially, the growth of the trees will determine the amount of carbon credits Pink Pty Ltd has available to sell. Under ITAA 1997 s 40-515, are mallee trees that are planted and cultivated for the purpose of selling the carbon credits horticultural plants?

19

20

21

Stella owned a farm in South Australia and had incurred capital expenditure on the construction of a water facility, as defined in ITAA 1997 s 40-520(1), for the purpose of conserving water for use in the primary production business undertaken by her on that farm. She met the requirements for entitlement to a deduction under ITAA 1997 s 40-515 in the year of incurring the expenditure to construct the water facility. The farm, including the water facilities, was sold as a going concern in the income year subsequent to that in which the water facility expenditure was incurred. After the farm was sold, a primary production business continued to be carried on using the water facility. Can Stella continue to claim a deduction for the water facility she constructed, under ITAA 1997 s 40-515, after she has sold the facility? Giant Ltd undertook a project that was principally designed to increase the commercial capacity of a shipping channel (the channel). The significant features of the channel include a ‘main channel’ (a body of water that connects points of the channel to each other), a ‘berthing pocket’ (a section of the channel immediately adjacent to a wharf that can accommodate fully laden marine craft berthed at low tide) and a ‘swing basin’ (a circular facility to allow marine craft to turn 180 degrees). The project was undertaken in sections, with each section involving a particular aspect (eg, deepening, widening or extending) of each channel feature, and was carried out over a considerable period of time. Does a project undertaken to increase the commercial capacity of a shipping channel comprise qualifying structural improvements under ITAA 1997 s 43-20(2)? Lidia owned and rented a residential property for many years. While the property was tenanted, she replaced the old kitchen fittings, including the cupboards. The old cupboards had deteriorated through water damage and wear and tear. The new fittings are of a similar size, design and quality as the originals. The new cupboards are of the same type and standard of material (or the modern equivalent of that material). The layout and design of the kitchen did not alter substantially from that of the original. The differences are that the old sink was replaced with a smaller sink and, as a consequence,

provided more benchtop space, and a removable cupboard replaced the space previously available for a dishwasher. [page 462]

22

23

24

Can Lidia deduct expenditure on the replacement of kitchen cupboards installed in a rental property under the capital works provision of ITAA 1997 s 43-10? Jo owned a rental property from which assessable income was earned. The electricity supply to the property was converted from overhead mains to underground power during the 2001 income year through a joint state government and local council project by the installation of underground cables. There was an increase in the amount of electricity transmitted by the relocated cables. The underground cables were installed largely on council land and owned by the council. Jo contributed to the cost of reinstalling overhead electricity cables underground by way of a levy. The tenants were not carrying on a business at the rental property at the time when the taxpayer paid the levy or thereafter. Can Jo claim a deduction under ITAA 1997 s 387-355 for a levy paid as a contribution to the cost of reinstalling overhead electricity cables underground for a rental property? Midtown Co is in the business of primary production, pig farming. Current fodder levels are extremely low due to very dry conditions. There is a forced disposal of livestock because of the low fodder levels. The property has not been officially declared in drought by a competent authority. Can Midtown’s property be considered drought affected for the purposes of ITAA 1997 Subdiv 385-E if it has not been officially acknowledged as such by a competent authority? What depreciation rate applies to a motor vehicle used: a as a taxi by Fast Car Pty Ltd; and

b

25

26

27

28 29

30

for work purposes by a sales representative for Duck Hollow fine wine merchants? c What difference would it make if the owner was an SBE? d What difference would it make if the car cost $80,000? Bling Bling Jewellers negotiates to purchase a new diamond-cutting tool. It incurs $1000 expenses in an unsuccessful attempt to purchase the tool. Can Bling Bling obtain a deduction? East Side Pty Ltd started constructing a breakwater to improve the effectiveness and efficiency of the shipping facilities and services that it provided. The breakwater was constructed of multiple layers of rock. Is East Side Pty Ltd’s breakwater plant within the meaning of that term in ITAA 1997 s 45-40? Washington incurred capital costs in restoring two buildings that he owns. He did not carry on business or use the capital works for the purpose of producing assessable income in that income year. Is a deduction allowable under Div 40 or Div 43? Lincoln owns a rental property and installs insulation batts in the roof. Are the batts deductible under ITAA 1997 Div 40? Howard uses a caravan for accommodation and as an office when he travels to various country towns for his work as a salesman. The caravan is not used for private purposes. Is he entitled to a deduction in respect of the caravan? Hawke has invented a new manufacturing process for textbooks and has applied for and been granted a patent for the process. Capital expenditure was incurred by the taxpayer in devising, testing and refining the process. He intends to exploit the patent for income-producing purposes. [page 463] Is capital expenditure incurred by the inventor in devising, testing and refining the process deductible?

31

32

33

34

35

1.

Thames Co incurred capital expenditure on constructing rail transport infrastructure, including rail transport trackwork, on which it operates a passenger rail service business. The trackwork is a composite item that consists of several components, including rails, sleepers, ballast and the earthworks or embankments on which the ballast, sleepers and rails are laid, and integral bridges, girders, culverts and tunnels. Is the composite item rail transport trackwork itself a depreciating asset within the meaning of that term in ITAA 1997 s 40-30 or are each of its components separate depreciating assets? 48th Street Pty Ltd purchased the following photographic lighting equipment and accessories: a flash generator, flash head, compact flash generator, light-shaping tool and modelling glass protector. Are these items separate depreciating assets? Central Park Co undertook a project that was generally designed to increase the commercial capacity of a shipping channel by widening and deepening it. Is a commercial shipping channel plant within the meaning of that term in ITAA 1997 Div 40? Top of the Rock Co installs a global positioning system (GPS) device in a car that is used solely for a taxable purpose. Is a GPS device acquired and installed by Top of the Rock Co in a car a separate depreciating asset? Downtown Co purchased an aircraft to use for the purpose of producing assessable income. However, soon after purchase, the taxpayer found that the aircraft was in need of major repairs. The aircraft was not used until the major repairs were undertaken. The major repairs were completed and the aircraft was placed into charter. Was a charter aircraft installed ready for use per ITAA 1997 s 40-60(2) although it required major repairs prior to being able to be made available for use?

Prior to this, Div 42 contained the depreciation rules for plant. Division 42 commenced from 1 July 1997, replacing the former depreciation provisions in ITAA 1936 ss 54–62AAV.

2. 3.

s 40-25(3)–(6). s 40-25(7). Section 40-25(8) provides special rules for taxable purpose where Div 250 applies.

4. 5.

s 40-30(2). s 40-50(1).

6. 7.

s 40-53. For the DV method, see ss 40-70 and 40-72. For the PC method, see s 40-75. In some cases, you do not have to make the choice, because you can deduct the asset’s cost: see s 40-80.

8. 9.

s 40-130. The associate is required to tell which method the associate was using: see s 40-140.

10. Although some assets have a 100 per cent depreciation rate: s 40-80. 11. s 40-95(2). 12. For rules about choices: see s 40-130. 13. s 40-95(7). 14. s 40-100(1). 15. A determination may operate retrospectively to a day specified in the determination if, per s 40100(3), there was no applicable determination at that day for the depreciating asset covered by the determination, or the determination specifies a shorter effective life for the depreciating asset covered by the determination than was previously applicable. 16. The cost may be modified by Subdiv 27-B; ss 40-90(2), 40-365(5)(a), 775-70, 775-75. 17. s 40-180. 18. s 40-190(1). 19. s 40-190(2). 20. s 40-195. 21. s 40-85(1). 22. s 40-285(3). 23. s 40-295(1). 24. Refer to defined terms in ITAA 1997. 25. Special rules apply for televisions, certain cars and in-house software: ss 40-320–40-335.

[page 465]

14 Entities Learning Objectives After you have studied this chapter, you should be able to: identify what an individual is under the tax laws; identify what a partnership is under the tax laws; calculate a partnership’s net income or partnership loss; determine the income tax liability on partnership income; identify when a partner derives partnership income; explain the consequences of a partner assigning their partnership interest to another party; identify the provisions governing uncontrolled partnership income; determine how a partner’s salary is treated in ascertaining a partnership’s net income or partnership loss; explain the various consequences in a change in composition of a partnership in respect of depreciating assets, trading stock and capital gains tax (CGT); identify what constitutes a trust; calculate the net income of a trust; determine whether a beneficiary is presently entitled to the

income of a trust; identify the difference between net income and trust income of a trust estate; determine whether a beneficiary is absolutely entitled to an asset of a trust estate; calculate the net income tax liability of the beneficiary/trustee; identify what constitutes a company under the ITAA 1997; outline the differences between a public and a private company; calculate the taxable income of a company; calculate a company’s income tax liability; explain how the imputation system works; provide a basic explanation of the consolidation regime; and compare the costs and benefits associated with the various types of entities.

[page 466]

Key Legislative Provisions Income Tax Assessment Act 1936 (ITAA 1936) s 44 s 47 Pt III Div 5 Pt III Div 6 Pt III Div 6AA Pt III Div 7 Pt III Div 7A Pt IVA Income Tax Assessment Act 1997 (ITAA 1997) s 4-15 Div 207 Div 165 Div 175 Trust Recoupment Tax Assessment Act 1985

Key Cases Coal Developments (German Creek) Pty Ltd v FCT (2007) 241 ALR 667; 68 ATR 869; [2007] FCA 1324 C of T v Bamford; Bamford v FCT (2010) 240 CLR 481; [2010] HCA 10 FCT v Slater Holdings Ltd (1984) 156 CLR 447. Jolley v FCT (1989) 86 ALR 297; 89 ATC 4197

Raftland Pty Ltd as trustee of the Raftland Trust v FCT (2008) 238 CLR 516; 246 ALR 406; 68 ATR 170

Key ATO Publications1 Imputation essentials Consolidation: overview Division 7A — An overview IT 2489 Income tax: business income of minors IT 2316 Income tax: distribution of partnership profits and losses IT 331 Income tax: trustees and beneficiaries TR 95/29 Income tax: Division 16 [page 467]

Chapter overview 14.1 The book has so far focused largely on the income tax equation and the determination of taxable income, without consideration of the special tax rules that apply to different types of tax entities (individuals, partnerships, companies and trusts). This chapter is designed to provide an overview of the complex rules that apply to these entities. Importantly, the effective use of such structures is a key part of tax planning. As a general principle, it is said that the choice of a business structure should be tax neutral, so that a taxpayer is indifferent to whether income from a business, for example, is earned as an individual (sole trader) or under a company, partnership or trust structure. In reality, however, under the current Australian tax system, the choice of business structure can be affected by the differing taxation treatment of individuals (sole traders), companies, trusts and partnerships. In this manner, it becomes very important for taxpayers to select

the appropriate tax structure for their business activities, because this can ultimately affect the tax due. This chapter examines the seventh step of determining assessable income: INCOME METHOD Chapter 4

Do international tax issues apply to the receipt?

Chapter 5

What tax accounting rules apply?

Chapter 6

Is the receipt ordinary income?

Chapters 7 and 15

Is the receipt statutory income (excluding CGT)?

Chapter 8

Does an exemption apply?

Chapter 9

Do the CGT provisions apply?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the receipt is assessable income

This chapter also examines the sixth step of determining deductions: DEDUCTIONS METHOD Chapter 5

What tax accounting rules apply?

Chapter 10

Is the outgoing a general deduction?

Chapter 11

Is the outgoing a specific deduction (excluding capital allowances)?

Chapter 12

Do any of the deduction limitations apply?

[page 468]

Chapter 13

Is the outgoing a capital allowance?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the expense is deductible

Diagram 14.1:

Income tax method — Entities

Individuals 14.2 The taxation of individuals will vary depending on whether the taxpayer is classified as a resident or a non-resident for Australian tax purposes: see Chapter 4. Where an individual taxpayer is classified as a resident for

Australian tax purposes and their taxable income exceeds $18,200 (the tax-free threshold for the income year ended 30 June 2018), they will most likely have to lodge a tax return. This book has already examined the steps [page 469] required to calculate taxable income for an individual and the tax payable on taxable income in Chapter 3.

Income averaging 14.3 Income averaging applies for certain individuals where their income fluctuates from year to year. Income averaging rules for ‘special professionals’ are found in ITAA 1997 Div 405 (ss 405-1–405-50). Where a taxpayer falls under these rules, they will not be forced into a higher tax bracket when their professional work income in the year in question is above their average income for those ‘professional work’ activities. These rules will apply to those taxpayers whose income is not made up of regular payments of similar amounts; for example, authors, inventors, performing artists, production associates and sportspersons: see Chapter 16. There are also special income averaging rules that can apply to taxpayers who are classed as ‘primary producers’ (see Income Determination ID 2003/359). These provisions are found in ITAA 1997 Div 392 (ss 392-1–39295). They allow ‘primary producers’ with fluctuating incomes to make an averaging adjustment in each year where the averaging rules apply. Again, where a taxpayer falls under these rules, they will not be forced into a higher tax bracket for the year in question.

Income of minors 14.4 Generally, a minor (a person less than 18 years old) who is not an excepted person2 is taxed at either ordinary rates of tax or higher rates. If such a minor has ‘excepted income’ (eg, income from part-time employment),

their excepted income is taxed at ordinary tax rates. Special rules apply, however, to the taxation of minors in order to discourage the diversion of income that is not excepted income (otherwise known as unearned income). This is sometimes referred to as ‘income splitting’. Such income is dealt with under ITAA 1936 Div 6AA ss 102AA–102AGA. Under this Division, income that is not excepted income of minors may include that income (including capital gains) derived by them either directly or indirectly via a trust. For the 2017–18 year, the first $416 of income that is not excepted income of a resident minor will not be affected by these special rules. Income that is not excepted income between $417 and $1307 is taxed at 66 per cent. Where income that is not excepted income is over $1307, the whole amount is taxed at 45 per cent.

Personal services income regime: ITAA 1997 Pt 2-42 14.5 The personal services income (PSI) anti-avoidance regime prevents individuals from reducing their tax by diverting PSI to an associated company, partnership, trust or individual or by claiming inappropriate business deductions. PSI is income that is mainly a reward for an individual’s personal efforts or skills. [page 470] The PSI provisions were introduced to deal with the complexity in applying the general anti-avoidance provision (in ITAA 1936 Pt IVA) to such avoidance. Broadly, these measures claw back the diverted income to be assessed to the individual. These measures also limit the deductions available in respect of PSI. Importantly, however, the PSI rules do not override the general anti-avoidance rules found in ITAA 1936 Pt IVA. The PSI rules are found in the ITAA 1997 under Divs 84, 85, 86 and 87. Division 85 limits the entitlements of individuals for deductions that relate to their PSI, and Div 86 allows for the determination of any tax consequences that may be associated with the diversion of an individual’s PSI through other entities; for example, via companies and trusts. Division 87 deals with those persons who are

conducting a ‘personal services business’ (PSB). Divisions 85 and 86 will not apply to PSI that is income from conducting a PSB. Section 84-5 generally defines ‘personal services income’ as that income which is generally derived from personal effort or individual skill. It does not apply where there has been a supply of goods or the use of property. In circumstances where the PSI rules do apply, under Div 86, PSI income of the entity will be attributed to the individual. In addition, under Div 85, any deductions that were available to the individual will be limited to only those that would have been deductible if the income had been received as wages or salary. There are also restrictions on deductions for PSBs that include PSI of one or more individuals. These rules are discussed in detail in Chapter 17.

Excess imputation credits 14.6 ITAA 1997 s 67-25 allows for a tax offset that is covered under Div 207 to fall under refundable tax offset rules unless it is otherwise stated in Div 67. However, there are priority rules. Under ITAA 1997 s 63-10, the amount refundable is that amount which remains once all other prior tax offsets are considered.

Partnerships 14.7

Partnerships are dealt with in the following six-step process: Step 1: partnership income tax basics; Step 2: partnership formation; Step 3: calculating partnership net income/loss; Step 4: distributing partnership net income/loss; Step 5: changes in partnership members; and Step 6: other partnership income tax issues.

Step 1: Partnership income tax basics 14.8

The scheme of the Act is to tax partnership income in the hands of

partners according to their individual interest in that income. [page 471]

Read ITAA 1936 s 91 What is a partnership? 14.9 The various State Partnership Acts usually provide a general law definition of ‘partnership’ as being ‘… the relation which subsists between persons carrying on a business in common with a view of profit and includes an incorporated limited partnership within the meaning of Part 5’.3 However, the ITAA 1997 provides a wider definition that extends the general law definition, having two positive limbs and one negative limb as follows (see s 995-1): Positive limbs 1. 2.

an association of persons carrying on business as partners or in receipt of (ordinary or statutory) income jointly

Negative limb 3.

but does not include a company or a limited partnership. Note: Division 830 treats certain foreign hybrid companies as partnerships. In addition, ITAA 1997 s 995-1 notes that ‘A reference to a partnership does not include a reference to a corporate limited partnership: see s 94K of the Income Tax Assessment Act 1936.’ First positive limb — what constitutes a partnership? 14.10 The existence of a partnership is very important for tax purposes, as such arrangements allow the splitting of income (ie, between husband and wife) and can therefore save considerable amounts of tax. In determining whether a partnership exists, the courts look to the real intention of the partners. Although intention is essential, it is not, by itself, sufficient to

establish the existence of a partnership; the intention must be evidenced by the conduct of the parties. For tax purposes, the following factors support the existence of a partnership:4 Intention the mutual assent and intention of the parties Conduct joint ownership of business assets registration of a business name a joint business account and the power to operate it the extent to which parties are involved in the conduct of the business the extent of capital contributions entitlements to a share of net profits business records trading in joint names and public recognition of the partnership. [page 472] As noted in ATO Taxation Ruling TR 94/8, these factors must be weighed against each other. The list is not an exhaustive one, and no one factor is decisive on its own. However, an entitlement to a share of net profits is essential. Note: A formal partnership agreement in writing is not a necessity for a partnership to be held to exist for tax purposes. Jolley v FCT (1989) 86 ALR 297; 89 ATC 4197 Facts: The taxpayer carried on a business of purchasing, reconditioning and reselling used oil drums. Shortly after establishing

the business, on the advice of his accountant he took his wife into partnership, and together they operated the business as a partnership. There was no formal or written partnership agreement entered into between the taxpayer and his wife. While she did not receive a wage, the proceeds of the business were deposited into a joint bank account that could be operated by either party. However, all withdrawals and applications of funds were made by the taxpayer alone. A business licence was obtained in his name only. The taxpayer spent the day visiting clients while his spouse stayed at home to take calls from clients. Invoices to clients were mostly in the name of the taxpayer alone, although some were in both names. Full Federal Court held: That whether a partnership existed is a mixed question of law and fact. Mutual assent and intention were held to be essential elements, and a partnership can still exist in the absence of a formal or written partnership agreement.

Case N56 81 ATC 277 The taxpayer, a builder, contributed the original capital to the business, all properties were purchased in his name, all accounts and other documents were made out in his name, and the business was advertised in his name only. However, business receipts were paid into a joint bank account with his wife. The court held that no partnership existed between the taxpayer and his wife as a matter of general law or within the meaning of the ITAA 1936 and ITAA 1997. Thus, it is important that there is a real intention for the parties to act as partners and for that to be supported by the actual activities of the partnership. A written partnership agreement is important, as it provides the basis for the rights and responsibilities of the partners (thus preventing disputes) and also supports the existence of the partnership. Second positive limb — receipt of (ordinary and statutory) income

jointly 14.11 Under this limb, holders ofjoint income-earning bank accounts and rental property will constitute a partnership for tax purposes. FCT v McDonald (1987) 18 ATR 957; 87 ATC 4541 In this case, a husband and wife were joint owners of two investment properties. They received income from those properties jointly. Under the general law, and according to the definition of a partnership under the relevant Partnership Act, their activities were not recognised [page 473] as a partnership, since they were not carrying on a business. For tax purposes, however, they received income jointly. Accordingly, they could claim deductions for ‘partnership’ losses equally only according to their proportionate share of the investment properties. This was despite the existence of an oral agreement between the husband and wife that the husband would be liable for all the losses of the partnership.

Negative limb 14.12

Companies are excluded from being a partnership. Partnerships Husband and wife, A and B, running a business together, jointly contributing capital, sharing profits and jointly trading in their names. Two or more people operating a joint bank account. Two or more people owning a rental property.

Practice Problem 1 1 2

Provide further examples of partnerships. Provide further examples of arrangements that are not partnerships.

Partnership returns 14.13 ITAA 1936 s 91 requires that a partnership furnish an income tax return, although the partnership is not liable for the income tax (the partners are liable). The main function of the partnership return is to disclose the net income or partnership loss of the partnership.

Step 2: Partnership formation 14.14 The formation of a partnership usually has a number of complex tax implications, as assets are transferred from the partners to the partnership. First, the trading stock rules (s 70-100) need to be considered for the transfer of trading stock: see Chapter 5. Second, the capital allowance provisions (ss 402-85, 40-295, 40-340) may apply to depreciating assets: see Chapter 13. CGT may apply for other assets transferred, as any contributions may involve a part disposal of an asset (s 108-5(2)(a)): see Chapter 9.

Step 3: Calculating partnership net income/partnership loss 14.15 First, partnership net income is calculated as if the partnership were a resident taxpayer (assessable income — deductions): ITAA 1936 s 90. This is similar to the taxable [page 474]

income concept in ITAA 1997 s 4-15. In any given income tax year, where assessable income of the partnership is greater than its deductions (not including carry-forward losses), this will result in the ‘partnership’s net income’ (PNI). Secondly, s 90 PNI is then divided between the partners in accordance with their profit/loss sharing ratio as outlined in the partnership agreement (oral, written or implied). Mr and Mrs Troy run a shoe shop in partnership. During the tax year, sales amounted to $400,000 and the deductible expenses were $320,000. Partnership net income is thus $80,000, as per s 90. 14.16 Where the total of deductions is greater than the total of assessable income, this is termed a ‘partnership loss’ (PL). If there is a PL, the partnership is unable to carry it forward for deduction against any PNI earned in future years. Any PL in any particular income year will be distributed to the individual partners of the partnership in the same year that the loss is incurred under ITAA 1936 s 92(2). 14.17 Note: Financial dealings with partners operating in a partnership capacity are not included in the determination of PNI under ITAA 1936 s 90. For example, salaries paid to partners and interest paid on capital contributions made by partners will not be treated as deductions for the partnership but instead are dealt with as distributions of profits to the partners themselves. A partnership is also not allowed deductions for any contributions made to superannuation funds on behalf of the partners or any premiums paid by the partnership on the life of the partner. These particular outgoings would therefore need to be added back to the net profit when calculating the amount of PNI under ITAA 1936 s 90. 14.18 Where there are financial dealings with partners not in a partnership capacity, these are included in the determination of the PNI under ITAA 1936 s 90. For example, interest expenses on loan advances made by partners to the partnership are an allowable deduction for the partnership, and interest received from loan advances made by a partnership to the partners is included in the assessable income for the partnership itself.

Taxation Ruling TR 1995/25 provides examples of interest deductions on a partner’s capital account. Example 1: Statutory partnership A and B are husband and wife. They own the family home and, using $50,000 of their own funds and initial borrowings of $100,000, they jointly purchase a rental property. A and B are deemed to be partners in respect of the rental property within the extended definition of ‘partnership’ in ITAA 1936 s 6(1), as they are in receipt of income jointly but do not in any way carry on a business so as to make them general law partners. [page 475]

Two years later, A and B borrow $50,000 to renovate the family home, and claim that the borrowing replaces a notional withdrawal of partnership capital. There is no capital account capable of being withdrawn by A and B, and, having regard to the use of the borrowed funds, the interest incurred is not deductible, being of a private or domestic nature (see Case 12/95; AAT Case 10,079).

Example 2: General law partnership D borrows $25,000, which is contributed as capital to a partnership. Two years later, the partnership borrows $25,000 to return D’s initial capital contribution. The use of the repaid funds in D’s hands will not be determinative of the deductibility of the interest to the partnership. At the time of the borrowing by the partnership, the $25,000 previously contributed by D was being employed in the partnership’s assessable income-producing business.

On these facts, the interest expense will be deductible to the partnership, as the borrowed funds can be seen to replace the partnership capital (see Roberts and Smith).5 The funds borrowed by D are no longer invested in the partnership (an income-producing asset). Whether or not D will continue to get a deduction for the interest expense on the original borrowings will depend on the use to which the funds returned to him by the partnership are put. If D uses those funds for a private purpose, then no further interest will be allowed. If the amount borrowed by the partnership exceeds the partnership capital (eg, if at the time of the second borrowing the partnership had repaid most of the capital), interest would be deductible only to the extent of the partnership capital attributable to the taxpayer. A capital gain or loss is also not included in the calculation of PSI under ITAA 1936 s 90. It is the partners themselves who are assessed on their respective share of any capital gain or loss.

Step 4: Distributing partnership net income/partnership loss 14.19 ITAA 1936 s 92 requires that a partner include in assessable income their individual interest in the net income of the partnership, or include in their deductions their individual interest in the net loss of the partnership. Thus, a partner is liable to tax on his or her share of net partnership income. Partners’ drawings have no impact on the allocation of net income. Special rules apply to non-resident partners and to exempt income of a partnership. Exempt income of a partnership reduces the level of prior year losses. Also, non-assessable non-exempt income of a partnership has no impact on tax liability.5

[page 476]

Read ITAA 1936 ss 90 and 92 A & B Partnership has assessable income of $100,000 and deductions of $60,000. A and B each has 50 per cent interests in the partnership capital and profits. Calculate and distribute partnership net income.

Practice Problem 2 Two partners, Joe and Mary, share profits in the ratio 1:3. Each has drawn out $20,000 for private expenses. The partnership return shows assessable income of $1,120,000 and deductions of $1,000,000. 1 Calculate partnership net income. 2 What is the partners’ share of the partnership net income? Partner’s salary 14.20 As noted at 14.17, the payment of a salary to a partner is simply a means of distributing partnership income. The payment is not deducted when computing net partnership income and thus cannot generate a partnership net loss: Case S75 85 ATC 544. Use the same facts as in the above example, except that A receives a salary of $10,000 from the partnership in view of the extra hours worked. Calculate and distribute partnership net income.

[page 477] Partner’s interest on current account and capital balances 14.21 Interest accrued on a credit current account or charged on a debit account is treated as a distribution of profits: FCT v Beville (1953) 10 ATD 170. Likewise, interest on capital balances would be treated as an allocation of profits. Partner’s loans and interest 14.22 As noted above at 14.18, a partner loaning funds to a partnership would provide a deduction to the partnership for interest expenses. The interest would be included in the partner’s personal income tax return as assessable income: Leonard v FCT (1919) 26 CLR 175.

Practice Problem 3 Mark and Ben are in partnership 50:50. Mark, as manager, receives $100,000 salary, while Ben is a silent partner. The profit for the year is $66,000 after Mark’s wage is deducted. 1 What is partnership net income? 2 What is the partners’ share of the net income? Payments to relatives and associated persons: ITAA 1997 s 26-35 14.23 Where a partnership makes a payment or incurs a liability to a person who is associated with a partner, then no deduction is available if it is an

unreasonable amount. The ATO can exercise its discretionary power to determine whether this is the case or not. Any excessive payments that are disallowed by the ATO are required to be included in the net profit of the partnership in order to calculate its PNI under ITAA 1936 s 90.

Read ITAA 1997 s 26-35 A and B are in partnership. A’s brother is paid a $100,000 salary, yet A provides only some part-time clerical work. Section 26-35 would apply so that no deduction is available to the extent that it is an unreasonable amount. Income splitting using partnerships 14.24 Partnerships are an effective means of splitting the income of a family business or family investments. A partnership can be a means of tax minimisation and a legitimate tax planning strategy. Mr and Mrs Smith purchase a business and shares in joint names so as to split the business income, dividend income and future capital gains.

[page 478] Uncontrolled partnership income 14.25 Uncontrolled partnership income represents that share of net partnership income that a partner is entitled to but over which they do not have any effective control or power of disposal. ITAA 1936 s 94 operates to minimise tax avoidance by imposing further rules in this regard. For example, as a measure to stem the loss of revenue through the income splitting by the

use of family partnerships, a further tax is imposed on any uncontrolled partnership income.

Read ITAA 1936 s 94 Mr and Mrs Smith operate a business in joint names, but the business was purchased by Mrs Smith, with all of the income and expenses going through her individual bank account. Mr Smith is not involved in the business at all. Here, the real and effective control of the partnership (assuming that it existed) lies solely with Mrs Smith. Section 94 would apply to Mr Smith’s partnership share of net income. Child partners 14.26 Under ITAA 1936 Div 6AA, child partners (under 18 years of age) are subject to the special rules that apply to income that is not excepted income: see 14.4. That is, a child’s partnership income is generally taxed at the highest marginal income tax rate unless the child is an excepted person or the income is excepted assessable income. An excepted person is generally a child (minor) who is engaged in a fulltime occupation on the last day of the income year per s 102AC(2)(b). The child must have worked for at least 3 months in the income tax year and ceased full-time education thereafter. Thus, a child employed full time in a partnership will be subject to ordinary rates of income tax. Ben, who is 15 years of age, works full time in the family business from 1 February to 30 June in the current income tax year. He ceased his school education in January. Ben is an excepted person; thus, his partnership income is taxed at normal income tax rates. Excepted assessable income first includes a minor’s share of partnership business income where the minor is a partner and where the share of income

is reasonable for services provided by the child in the partnership. Also, it will include the share of partnership income that represents a reasonable return on capital contributed by the child into the partnership. This will include any assets inherited by the child that are placed into the partnership. Second, excepted assessable income includes non-business partnership income. Under s 102AE(2) and (3), a child partner will be subject to ordinary income tax rates where their share of partnership income does not exceed a reasonable return on the partnership property that would not otherwise be subject to tax at the top marginal income tax rate. For example, an asset inherited by the child is used in the partnership. [page 479]

Donna is 10 years old and her sister, Ella, is 13. In their investment partnership, they jointly receive $2000 of dividend income from shares gifted to them by their grandfather. While ITAA 1936 Div 6AA usually taxes such non-earned investment income at the top marginal income tax rate, given that the shares were inherited, the dividends are taxed at normal tax rates.

Step 5: Changes in partnership members 14.27 A new partnership must be formed where there is a change in the composition of the partners in the partnership. This will happen when a partner retires, resigns or dies or when a new partner is admitted. There are numerous income tax implications. First, a new partnership results and thus a new partnership income tax return must be lodged with the Commissioner. Also, the old partnership must lodge a final income tax return. Importantly, the new partnership results in a transfer/disposal of assets, including trading stock, CGT assets, debtors, depreciating assets and work in progress.

Trading stock 14.28 A change in the partnership will trigger a notional disposal of trading stock under ITAA 1997 s 70-100(2), with a deemed disposal at market value. However, where there is a 25 per cent or more continuity between the old and new partners, they can agree to elect that the disposal of trading stock is deemed to be made at the value recorded by the old partnership per ITAA 1997 s 70-100(4). Thus, there will be a neutral impact. (This will not apply where the items were valued at market value at the end of the previous year.) Depreciating assets 14.29 A change in the partnership will trigger a deemed disposal of the depreciating assets at market value per ITAA 1997 s 40-300(2). However, the old and new partners can jointly elect to obtain rollover relief per ITAA 1997 s 40-340(3). This means that there will be no balancing adjustment, as the new partnership picks the book value of the asset and retains the same depreciation method and effective life as was used in the old partnership. The election must be made in writing, contain all relevant depreciation details and be made within 6 months of the end of the new partnership’s income year per ITAA 1997 s 40-340(4). Note: Rollover relief is also available to old and new partnerships that are both in small business entities: ITAA 1997 Subdiv 328-D. Capital gains tax 14.30 Unfortunately, since partners all hold fractional interests in partnership assets, the loss of a partner and/or the admission of a new partner will result in the disposal of an interest in the partnership’s CGT assets. For example, a partner exiting the partnership will result in a disposal of that partner’s interest in partnership assets to the other partners. Also, the admission of a new partner involves the disposal of the other partner’s interests in partnership assets to the new partner. [page 480]

As you may imagine, this makes CGT extremely problematic for partnerships, and thus many use a trust or other vehicle to hold partnership CGT assets. The following example is taken from ITAA 1997 s 106-5. When a new partner is being admitted Lyn and Barry form a partnership, each contributing $15,000 to its capital. The partnership buys land for $30,000. The land increases in value to $300,000. Andrew is admitted as an equal partner, paying Lyn and Barry $50,000 each to acquire a one-third share in the land. His cost base is $100,000. Lyn and Barry have each disposed of one-third of their interest in the land. Each has a cost base for that interest of $5,000 and capital proceeds of $50,000, leaving them with a capital gain of $45,000 each on Andrew’s admission to the partnership. The land is sold for its market value. Andrew has no capital gain on the land. Lyn and Barry have disposed of their remaining one-third original interest in the land for capital proceeds of $100,000, leaving each of them with a capital gain of: $100,000 − ($15,000 − $5,000) = $90,000).6

Income Tax Ruling IT 2540 provides further examples. Simple disposal of land but no change in partners For example, take the situation where a partnership comprising 10 partners disposes of a block of land for $150,000 that was originally purchased for $90,000. In this case, each partner is taken to have disposed of his or her interest in the land. However, individual partners may have acquired their interests at different times (eg, some may have done so before 20 September 1985, and others on or after that date) and may have paid different amounts as consideration for the acquisition of those interests. If the partners own equal interests in the land, each will be taken as receiving $15,000 as disposal proceeds. If the land had been acquired after 19 September 1985, each member who was a partner at the time of acquisition would have a cost base of $9000 in respect of the acquisition of his or her interest in the land, and the capital gain would be calculated on that basis. If another partner entered the partnership after the acquisition of the land and paid $12,000 for his or

her interest in the land, that partner would have a cost base of $12,000 and would therefore realise a capital gain of $3000 on the disposal. Disposal of land and the retirement of a partner Take the example in the preceding paragraph but assume that the land was acquired by the partnership, comprising the 10 partners, before 20 September 1985. If there were no change in the composition of the partnership, when the land was subsequently sold, there would be no capital gain or loss to any of the partners — each partner’s interest in the partnership asset having been acquired prior to the commencement of CGT. However, if one of the partners retired after 19 September 1985 and the remaining nine partners acquired a proportion of the retiring partner’s interest in the land for $1000, although the retiring partner has no CGT consequences, the other partners have each acquired a new post-19 September 1985 interest in the asset; that is, one-ninth of

[page 481]

the retiring partner’s 10 per cent interest in the land. On the subsequent sale of the block of land for $150,000, assuming that there have been no other changes, each partner would realise a capital gain in respect of that new interest. Note that for both scenarios above, the capital gain may also be subject to either indexation or discounting provisions. While this example deals with the retirement of a partner, similar types of

adjustment will be required where a new partner is admitted to a partnership. Debtors 14.31 Since most business partnerships will use an accruals accounting basis for income, there will be no consequences for the disposal of debtors, since the old partnership has already included debtors in its assessable income. Thus, there will be a neutral income tax impact for the disposal of debtors. Partnerships that use the cash basis, though, may choose not to transfer debtors, since this will bring forward the derivation of that income. From a bad debts perspective, the old partnership should write off all bad debts, since these debts will not be deductible to the new partnership by virtue of s 26-35 and the requirement that such debts must be previously included in your assessable income. Work in progress 14.32 A payment made for work in progress by the new partnership to a retiring partner or deceased estate is deductible to the new partnership per ITAA 1997 s 25-95. The recipient is, however, assessed on the work in progress payment under s 15-50. Also, the new partnership includes work in progress in its assessable income as it is billed. Assignment of partnership interests 14.33 An assignment of a partnership interest does not create a dissolution of a partnership where the assignee is limited to just a share of partnership profits and assets on dissolution.7 X and Y are in partnership 50:50. X assigns 50 per cent of his half share of partnership profits and assets on dissolution to Z. Z now has a 25 per cent assigned interest in the partnership. However, Z does not have any rights to play any role in the partnership. Note: It is not effective to merely assign partnership income without

assigning the right to a share of the partnership. This is not effective for tax purposes.8 Rather, the whole or part of the share in the partnership must be assigned — CGT will generally apply to any such assignments. [page 482]

Step 6: Other partnership tax issues Limited partnerships — Australian venture capital 14.34 Limited partnerships are treated as companies for tax purposes and are taxed as such under ITAA 1936 Pt III Div 5A. In such circumstances, the limited partnership is deemed to be a ‘corporate limited partnership’ under ITAA 1997 s 960-115. However, where a limited partnership is used to invest in Australian venture capital, then it will be treated as an ordinary partnership for tax purposes.

Practice Problem 4 X, Y and Z operate a dental surgery in equal partnership, having $800,000 in dental services income and incurring business costs of $500,000 up until 31 December of the current tax year. On 1 January of the current tax year, W joined the partnership (as an equal partner). The partnership income from this time until 30 June of the current tax year was $1.2 million and costs were $600,000. 1 What is partnership net income? 2 What is the partners’ share of the net income?

Practice Problem 5 A and B decide to establish a partnership to run a book retailing shop, and they both contribute $10,000 for working capital to get established. What are the income tax implications?

Practice Problem 6 Buying into a partnership, Harry operates his own bookmaking business. He invites Mojo, his faithful sidekick, to become an equal partner. Mojo thus pays Harry $450,000 based on half of the net present value of future cash flows and $50,000 for half of the value of the business’s office and betting equipment. What are the income tax implications?

Practice Problem 7 Using the above example, what difference would it make if Harry’s business sold racing guides as a sideline and the business had $10,000 of trading stock on hand when Mojo entered the partnership?

[page 483]

Trusts

14.35

Trusts are dealt with in the following eight-step process:

Step 1: Trust income tax basics; Step 2: Trust formation; Step 3: Calculating trust net income/loss; Step 4: Distributing trust net income and income tax liability; Step 5: Trust losses; Step 6: Termination or variation of trusts; Step 7: Deceased estates; and Step 8: Other trust income tax issues.

Step 1: Trust income tax basics Scheme 14.36 The scheme of the ITAA dealing with trusts aims to ensure that the trustee or beneficiary pays tax on the net income of the trust. The trust provisions are contained in ITAA 1936 Pt III Div 6. Notably, certain funds, for example those created under a will or those established for a public charitable purpose, are tax-exempt. What is a trust? 14.37 A trust is a fiduciary obligation imposed on a person (the trustee) to hold property or income for a particular purpose or purposes or for the benefit of other persons or classes of persons, who may or may not include the trustee.9 A trust is generally created by a document10 (trust deed) that sets out the powers and rights of the parties involved (the parties generally comprise a settlor, a trustee and a beneficiary). Usually, a relative or friend acts as settlor by gifting a small sum to the individual or company trustee of the trust. Following this, the trustee introduces assets (usually investment and/or business assets) into the trust. In summary, a trust can be described as an obligation relating to property where the trust itself is not a separate legal entity.

A common example of a trust is a deceased estate where the executor acts as trustee over the trust funds for the benefit of the beneficiaries. Another common example is the family business or investment trust where the parent or a company acts as trustee over the trust funds for the benefit of the beneficiaries (parents and children).

[page 484] Z, the settlor, gives the trustee, ABC Pty Ltd, $10 to establish the ABC Trust for beneficiaries A, B and C. The settlor and trustee sign a trust deed that governs the operation of the trust.

Note: A trustee is personally liable for all trust debt (including income tax) while acting as trustee, although the trustee has the right to be repaid out of trust assets. Further, a trustee cannot be the sole beneficiary: Re Cook [1948] Ch 212. Also, unborn children can be included as beneficiaries.

Practice Problem 8 1 2

What is a trust? What is not a valid trust?

Types of trusts 14.38

There are five types of trusts as discussed below

1.

Discretionary trust

14.39 A discretionary trust is where the trustee has the discretion to choose the share or amount of income that is to be distributed to the various beneficiaries. In this type of trust, the beneficiary has no interest in the trust estate until the trustee exercises their discretion. For example, the trust deed might say that the ‘trustee, in his unfettered discretion, distributes trust income to any or all of W, X, Y or Z in proportions the trustee determines in his unfettered discretion’. This, of course, provides tremendous flexibility and scope for tax planning in allocating trust income to various family members so as to minimise income tax. [page 485]

2.

Fixed trust

14.40 A fixed trust is where the beneficiaries in the trust are determined in the trust deed and the deed provides how they share trust income. In this type of trust, the beneficiary has a proprietary interest in the trust assets. For example, beneficiaries X and Y are to split trust income according to the trust deed 50:50. Thus, fixed trusts suffer from inflexibility. 3.

Unit trust

14.41 A unit trust is a kind of fixed trust. Basically, in a unit trust, the rights of beneficiaries are to be found in the units of the trust. This is similar to the shares of a company. The trust deed may provide for different classes of units having different entitlements from trust income and capital. The trustee

can issue more units or redeem units. Unit trusts are very popular for listed commercial property investments. XY Trust, a fixed trust, has 100 issued units to X and Y. Beneficiary X received 50 units and Y 50 units. The trustee is XY Pty Ltd.

4.

Bare trust

14.42 A bare trust is where a person or entity holds property as a nominee for one or more beneficiaries. The person or entity conveys property to the beneficiaries only as instructed. 5.

Superannuation fund

14.43 A superannuation fund is another kind of trust. Superannuation funds are dealt with in Chapter 15. [page 486]

Step 2: Trust formation 14.44 The formation of a trust will usually have complex tax implications associated with the transfer of assets into the trust from an individual, partnership or company. The trading stock rules in ITAA 1997 Div 70 will need to be considered for the transfer of trading stock. Also, the capital allowance provisions will need to be examined for the transfer of capital assets. CGT rules will also come into play for the transfer of capital assets into the trust.

Step 3: Calculating trust net income/loss 14.45

The first step in working out the income tax return for a trust is to

establish the net income of the trust estate. The second step is then to work out the amounts upon which the trustee or beneficiary can be assessed. The relevant formula for the first step is provided by ITAA 1936 s 95(1): Trust net income = assessable income (as if the taxpayer is a resident) − deductions

Read ITAA 1936 s 95 ABC Trust operates a boat hire business and receives hire fees (assessable income) of $70,000 and has deductions of $10,000 during the income year. The trust net income is $60,000 for the current income year ended 30 June. ITAA 1997 Div 6 broadly ensures that all Australian source income is subject to Australian tax and that all foreign source income is also subject to Australian tax unless: the income is attributable to a non-resident beneficiary that is presently entitled; or the income has no beneficiary presently entitled and the trust is not a resident trust. See Chapter 4 for determining the resident status of trusts. There are two approaches to calculating trust net income: the proportionate and quantum views.

Example The following example highlights the differing approaches. The Lidia and Arthur discretionary trust (Lidia and Arthur are beneficiaries, Lidia one-third and Arthur one-third) has net income for trust law of $300,000 for the year 2016–17. In addition, it also has net proceeds from a sale of property of $200,000 that had been originally purchased in 1983 in order to resell at a profit. Assume that this is assessable under ITAA 1936 s 25A as statutory income. Under trust law, however, this $200,000 amount is a

capital addition to trust property and does not form part of the income of the trust. Under the quantum view Both Lidia and Arthur are presently entitled to the share of the trust net income. This means that the ordinary income of $300,000 is distributed to them in their proportionate shares. The amount of $200,000, which is recognised as on capital account for the trust, will be [page 487] assessed in the trustee’s hands under ITAA 1936 s 99A (no beneficiary presently entitled). (Assume that the ITAA 1936 s 99 Commissioner discretion will not apply.) Under the proportionate view Under this view, the total amount of $500,000 is assessed in the hands of the beneficiaries, according to their proportionate amounts. The trustee is not assessed on any amount. In the High Court of Australia case Commissioner of Taxation v Bamford (2010) 240 CLR 48; [2010] HCA 10, it was held that the proportionate view was the correct view of the application of ITAA 1936 s 97. It was noted in that case that despite ‘net income of the trust’ taking its meaning from the legislation, the trust deed could nevertheless define what income was and what constituted capital when determining the ‘share of the income of the trust estate’. Commissioner of Taxation v Bamford; Bamford v FCT (2010) 240 CLR 481; [2010] HCA 10 Facts: The trust made a contribution to an offshore superannuation fund on behalf of a married couple, using borrowed funds. The trustee claimed a deduction for the superannuation contribution and the

interest on the loan in determining the trust net income. The net income was then distributed to the beneficiaries, including Mr and Mrs Bamford. However, in the following year, the Commissioner made determinations under Pt IVA disallowing the deductions for the superannuation and the interest. Thus, the trust’s taxable income exceeded the trust income (the accounting income). The Commissioner issued amended assessments, with Mr and Mrs Bamford being liable to tax on a proportionate share of the amount by which the taxable income exceeded the trust income (the proportionate view). Mr and Mrs Bamford objected, arguing that no beneficiary was presently entitled to the excess of the taxable income over the trust income and thus the trustee was assessable per ITAA 1936 s 99 or s 99A (the quantum view). Full High Court held: The proportionate view was preferred to the quantum view. The words ‘income of the trust estate’ in s 97(1) refer to distributable income (income ascertained by the trustee according to appropriate accounting principles and the trust deed). The net income of the B Trust included the amount of $191,701 in the 2000 year that had been wrongly claimed as a deduction. Thus, the assessable income of Mr and Mrs Bamford included a share of that amount equivalent to the share they each received of the distributable income. After this decision, the Australian Government, via Treasury, indicated that the Bamford decision raised significant uncertainties in relation to the taxation of the ‘income of the trust estate’. In particular, it was noted that the treatment of different income streams for trusts (eg, capital gains and franked dividends) needed further attention. Accordingly, changes were made in 2011 to the trust rules under the ITAA 1936. Amending legislation (the Tax Laws Amendment (2011 Measures No 5) Act 2011) was given royal assent and became law on 29 June 2011. While these rules allow for the streaming ofcapital gains and franked distributions to specific beneficiaries, they also address the misuse of

tax-exempt entities as beneficiaries where such a practice would fall under the anti-avoidance rules of ITAA 1936 Pt IVA.11 [page 488]

Step 4: Distributing trust net income and income tax liability 14.46 A trust is not a separate taxable entity (like an individual or a company), so, generally, the beneficiaries must pay tax on their share of trust net income. However, in certain circumstances, the trustee is liable to pay tax (where no beneficiary is entitled to trust income). 14.47 There are generally three situations in respect of the tax liability for the trust net income.

ITAA 1936 s 97: Presently entitled beneficiary not under a legal disability 14.48 A resident beneficiary generally includes the share of trust net income as assessable income and is liable to tax where the beneficiary is presently entitled to a share of the net income of a trust and is not under a legal disability: s 97. Thus, the resident beneficiary includes the amount in their income tax return and pays tax on it. Non-assessable non-exempt amounts in

the trust flow through to the beneficiary, although these amounts are not subject to tax. Also, exempt income of the trust flows through to the beneficiaries. Note: A capital gain that the beneficiary is ‘specifically’ entitled to is included in their assessable income under ITAA 1997 Subdiv 115-C. For example, ITAA 1997 s 115-228 states that a beneficiary of a trust estate is specifically entitled to an amount of a capital gain made by the trust estate in an income year equal to the amount calculated under the following formula:12

Exceptions 14.49 The trustee is liable for tax under ITAA 1936 s 98(3) and (4) where presently entitled non-resident beneficiaries are entitled to Australian source trust income. Presently entitled non-resident beneficiaries exclude any foreign source trust income. The beneficiaries must include these amounts in their income tax returns and obtain a credit for tax paid by the trustee: ITAA 1936 s 98A. Note: Certain exceptions for trustees apply: see ITAA 1936 ss 98(3), 98(4). [page 489] Where a beneficiary is deemed to be presently entitled under ITAA 1936 s 95A, the trustee is generally subject to tax if the beneficiary is a natural person: ITAA 1936 ss 97(2), 98(2). ITAA 1936 s 97 applies if the beneficiary is a company. ITAA 1936 s 98(1): Presently entitled beneficiary under a legal disability 14.50 The trustee is generally liable to tax at normal rates where the resident beneficiary is presently entitled to a share of the net income of a trust and is not a minor but is under a legal disability: see ITAA 1936 s 98. Nonresident beneficiaries exclude foreign source trust income. An exception applies to a beneficiary of a non-resident trust estate who is

under a legal disability. In this case, the beneficiary is subject to tax on the income. ITAA 1936 ss 99, 99A: No beneficiary presently entitled 14.51 The trustee is liable to tax where there is no beneficiary presently entitled to a share of the net income of a trust that has an Australian source: ITAA 1936 ss 99, 99A. Foreign source income is subject to Australian tax only where the trust is a resident trust estate. ITAA 1936 s 99A applies to all trust estates except trust estates that are included under ITAA 1936 s 99A(2) and the Commissioner considers it unreasonable to apply ITAA 1936 s 99A. In these circumstances, ITAA 1936 s 99 will apply. ITAA 1936 s 99 generally applies in limited cases to trusts from wills, intestacies, bankruptcy and property as set out in ITAA 1936 s 102AG(2)(c). If ITAA 1936 s 99A applies, the income is taxed at the current top marginal income tax rate. If ITAA 1936 s 99 applies, then normal tax rates will apply. ABC Trust has a net income of $100,000 and the trustee resolves to distribute only $90,000 to three beneficiaries, A, B and C. No one will be presently entitled to the remaining $10,000 and thus it will be taxed in the trustee’s hands at the top marginal rate per ITAA 1936 s 99A (unless the Commissioner considers that ITAA 1936 s 99 and normal tax rates should apply).

Read ITAA 1936 ss 97, 98, 99, 99A The key terms used in ss 97, 98, 99, 99A are explained below. Presently entitled 14.52 A beneficiary is presently entitled if the beneficiary has an absolute and indefeasible vested interest in possession in trust income and either the

beneficiary has an immediate right to obtain payment or the beneficiary would have such a right but for a legal disability. In FCT v Whiting (1943) 7 ATD 179, it was said, at 183: The words ‘presently entitled to a share of income’ refer to a right of income ‘presently’ existing — ie a right of such a kind that a beneficiary may demand payment of the income from the trustee, or that, within the meaning of s 19 of the Act, the trustee may properly reinvest, accumulate, capitalise, carry to any reserve, sinking fund or insurance fund however designated or otherwise deal with it or as he directs on his behalf.

[page 490] And in Taylor v FCT 70 ATC 4026, it was said, at 4030: … ‘presently entitled’ refers to an interest in possession in an amount of income that is legally ready for distribution so that the beneficiary would have a right to obtain payment of it were he not under a disability.

The High Court in Harmer v Federal Commissioner of Taxation (1991) 173 CLR 264; (1991) 91 ATC 5000; (1991) 22 ATR 726 at 271 summarised the meaning of ‘presently entitled’: A beneficiary will be presently entitled to a share of the income of a trust estate if at least by the end of the year of income: (a)

the beneficiary has an interest in the income which is both vested in interest and vested in possession; and

(b) the beneficiary has a present legal right to demand and receive payment of the income [including beneficiaries, that but for their legal disability, have an absolute entitlement to that income], whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

On 30 June of the current tax year, the Acme Trust has $100,000 of net income. The trustee resolves to distribute $50,000 to Eric (a beneficiary) by way of a journal entry in the trust’s books and leaves the balance unaccounted for. Eric is presently entitled to his distribution of $50,000 (ie, he can ask the trustee for this sum). However, since the balance has not been distributed, no one is presently entitled to that income.

The trust deed does not have any default clauses in the event of non-distribution of trust net income. Thus, a beneficiary can be presently entitled even though the beneficiary receives no payment. However, the beneficiary is entitled to the income and can demand that the trustee pay the income sum. Also, a beneficiary is presently entitled even if they are unaware that they have an interest in the trust: see Vegners v FCT 99 ATC 2211. However, a beneficiary can avoid any such tax liability by disclaiming any such interest in the trust.

Read ITAA 1936 s 95A Deemed present entitlement 14.53 The following three provisions deem present entitlement: ITAA 1936 s 95A(2): A beneficiary is deemed to be presently entitled to the income of a trust estate if they have a vested and indefeasible interest in the income, even though they are specifically not presently entitled. ITAA 1936 s 96B: Deems a taxpayer with an interest in a non-resident trust to be a presently entitled beneficiary who is not under a legal disability. ITAA 1936 s 101: Applies to discretionary trusts. Where a trustee exercises their discretion in favour of a beneficiary, the beneficiary is deemed to be presently entitled to the amount paid or applied to the beneficiary. [page 491] Legal disability 14.54 ‘Legal disability’ refers to a person who cannot give a trustee a discharge power in order for the trustee to make a valid trust income

distribution to them. A person under legal disability will include an infant/minor (less than 18 years old), a lunatic, a bankrupt or a felon. However, ITAA 1936 s 95B limits legal disability to an extent. Under this Section, a beneficiary presently entitled to trust income as a trustee of another trust will not be under a legal disability.

Read ITAA 1936 s 95B Minors 14.55 To prevent income splitting, ITAA 1936 Div 6AA provides a penal rate of tax for any income that is not excepted income (unearned income) of minors. Prescribed persons (those less than 18 years old) are subject to Div 6AA, unless they are an ‘excepted person’: see s 102AC(1). Also, see 14.4 above. ABC Pty Ltd, the trustee of the ABC Trust (a resident trust) who operates a fishing business, resolves on 30 June to distribute net trust income of $100,000 as follows: A B

(50 years old) $50,000 (17 years old) $20,000

C

(18 years old and a lunatic) $10,000.

Undistributed income of $20,000 since no beneficiary is presently entitled. The trustee is liable for tax at the top marginal income tax rate per s 99A.

Practice Problem 9

1 2

What is a legal disability? When is a beneficiary presently entitled?

[page 492]

Practice Problem 10 The Smith Family Trust runs a supermarket via a trust, and the trust net income is $335,000. The beneficiaries are: 1 Mr Smith; 2 Mrs Smith; 3 Jane Smith (18 years old); and 4 Alex Smith (17 years old). The trustee resolves to distribute trust income as follows.

1 2 3

Mr Smith

$100,000

Mr Smith

$100,000

Jane

$100,000

Alex

$20,000

Undistributed

$15,000

Who is presently entitled to the trust income? Who is under a legal disability? Who pays tax on the trust net income?

Step 5: Trust losses 14.56 Trust losses must be offset against any exempt income. Also, it is important to note that losses are not deductible for trust beneficiaries (unlike partners in a partnership) and must be carried forward in the trust to offset future income. Complex trust loss restrictions (ITAA 1936 Sch 2F) apply to limit the recoupment of trust losses and debt deductions. These rules aim to ensure that the tax benefit of a trust loss is not transferred to someone who did not bear the loss when it was incurred by the trust. Thus, these rules track the underlying ownership and control of loss trusts.

Step 6: Termination or variation of a trust 14.57 If a trust is terminated, this will have income and CGT consequences. Also, if a significant variation to the trust takes place, then income and CGT consequences will follow. See ATO, Trusts for further information.

Step 7: Deceased estates 14.58 Upon death, the legal title to the taxpayer’s property passes to the legal personal representative. The legal personal representative pays off debts and distributes the assets in accordance with the will. Where there is no will, statutory provisions will apply. [page 493] For tax purposes, the legal personal representative being the ‘executor or administrator’ is the trustee of the trust estate: see ITAA 1936 s 6(1). Beneficiaries, though, are not presently entitled to any income of the trust until administration is finalised: FCT v Whiting (1943) 68 CLR 199. Thus, ITAA 1936 ss 99 and 99A apply to trust income, and the trustee is liable for income tax. Also, no beneficiary is presently entitled and the trustee is liable for income

tax on amounts that were received by the trust after death that accrued prior to death: ITAA 1936 s 101A. Upon the completion of administration, if the trust retains assets rather than distributing them, then ITAA 1936 ss 97, 98, 99 or 99A applies: see Taxation Ruling IT 2622.

Step 8: Other trust income tax issues Service trusts 14.59 Business taxpayers set up trusts to provide services to the business. They typically involve a service trust incurring deductions for the acquisition of staff, clerical and administrative services, premises, plant and equipment. The service trust then bills the entities for the services provided. Franking credits 14.60 Generally, franking credits received by the trust flow through to the beneficiaries. However, an exception applies for a trust that has a net trust loss during the income year and that receives franking credits. The beneficiaries cannot enjoy a distribution of franking credits per ITAA 1997 ss 207-50, 20735(3)(b), since they have not included any trust net income in their assessable income. (Also note that the losses are trapped inside the trust and cannot be distributed to the beneficiaries.) The Flim Flam Trust, a resident fixed unit trust, has two adult beneficiaries, A and B, who each own 10 units. The trust incurred a net business income of $100,000 and had $30,000 of franking credits and $70,000 of dividends during the tax year. What are the income tax implications? Answer: The trust net income of $200,000 ($100,000 + $30,000 + $70,000) is distributed to the beneficiaries, A and B, who each receives $100,000. Also, A and B each receives $15,000 of franking credits.

Using the above facts, except that the Flim Flam Trust incurred a net business loss of $200,000 and had $30,000 of franking credits and $70,000 of dividends during the tax year, what are the income tax implications? Answer: The trust net loss is $100,000 ($200,000 − $30,000 − $70,000). However, both the loss and franking credits are trapped inside the trust, as they cannot be distributed to the beneficiaries, A and B. Losses are not distributable to beneficiaries under ITAA 1936. Also, the beneficiaries cannot enjoy $15,000 of franking credits, since they have not included any trust net income in their assessable income.

[page 494] Anti-avoidance rules 14.61 Trusts are very popular and provide a very flexible way of streaming income to beneficiaries so as to minimise overall family income tax. However, a complex series of anti-avoidance rules governs the operation of trusts. These include those listed below. ITAA 1936 Pt IVA 14.62 The general anti-avoidance provision may apply to strike down tax avoidance arrangements involving trusts: see Chapter 17. Following Bamford, two specific anti-avoidance provisions were further introduced into Pt IVA of the ITAA 1936 under the amending legislation (the Tax Laws Amendment (2011 Measures No 5) Act 2011) in order to deal with those taxpayers who inappropriately use exempt beneficiaries as a device to avoid some or all of the tax liability in respect of the net income of a trust. Section 100AA of the ITAA 1936 was introduced to deal with those exempt beneficiaries who have not been notified of or paid their present entitlement to income of the trust estate within 2 months of the end of the income year. Where this occurs, these exempt beneficiaries are treated as not being — and

never having been — presently entitled to that income. Section 100AB of the ITAA 1936 was also introduced to deal with the ‘benchmark percentage rule’. It will apply where it can be shown that an exempt entity’s entitlement to the income of the trust estate (in percentage terms) exceeds a benchmark percentage. Where either of these two specific rules applies, it is the trustee who is assessed on the share of the trust’s taxable income that corresponds to the income to which the exempt beneficiary is taken as not being entitled.13 Personal services income regime: ITAA 1997 Pt 2-42 14.63 The PSI anti-avoidance regime prevents individuals from reducing their tax by diverting PSI to an associated company, partnership, trust or individual, or by claiming inappropriate business deductions. PSI is income that is mainly a reward for an individual’s personal efforts or skills: see 14.5 above. PSI is further discussed in Chapter 17. Closely held trusts: ITAA 1936 Div 6D 14.64 ITAA 1936 Div 6D contains provisions to ensure that the assessable income of ultimate beneficiaries of a trust includes their share of trust net income. Under these provisions, the trustee of a closely held trust must notify the Commissioner of the identity of the ultimate beneficiaries of trust net income and tax-preferred amounts. A closely held trust is a discretionary trust or a trust where 20 or fewer people have at least 7 per cent of the income or capital of the trust. A tax-preferred amount is any capital of the trust or any income of the trust that is not included as assessable income. Trust stripping 14.65 ITAA 1936 s 100A prevents complex trust-stripping arrangements that convert trust income into tax-free capital amounts. Also, the Trust Recoupment Tax Assessment Act 1985 (Cth) prevents exploitation of such arrangements. [page 495]

Raftland Pty Ltd as trustee of the Raftland Trust v FCT [2008] HCA 21 Facts: Raftland Trust was controlled by three brothers who ran building businesses with a profit of $3 million. They approached a solicitor to acquire a trust with accumulated tax losses of $4 million to use the profits. They paid $250,000 for the loss trust and the loss trust was included as a beneficiary of the Raftland Trust. Subsequently, the trustee of the Raftland Trust resolved to distribute $3 million to the loss trust but paid only $250,000 in cash. The Commissioner issued a Pt IVA determination to deny the distribution to the loss trust. High Court held: The loss trust was not entitled to the trust income, and since this was applied to the benefit of others, then s 100A(1) applied to make the trustee assessable on this trust income under s 99A. The entitlement of the loss trust to the distribution was not intended to have any substantive legal effect. The loss trust never sought any further payment of its entitlement. The trust income had really been applied for the benefit of the three brothers. Notably, Kirby J found that the intention of the parties and the documentation demonstrated that the transaction was a sham. Revocable trusts 14.66 ITAA 1936 s 102 permits the Commissioner to assess the trustee to pay tax where a settlor has created a trust and can revoke or change the trust to acquire a personal interest, or where the income is payable or applied for the benefit of the settlor’s children. This provision is easily avoided by having a friend or relative of the real trust creator act as settlor. Other trust provisions 14.67 The following divisions of ITAA 1936 Pt III also deal with specific trust issues: income of certain unit trusts: Div 6B;

income of certain public trading trusts: Div 6C; and international tax provisions for trusts: see Chapter 4.

Practice Problem 11 The Jones family operates a video store through a resident discretionary trust that makes $90,000 net income. The trustee resolves to distribute $30,000 to Mr Jones, $30,000 to Mrs Jones, $20,000 to their son, Steve (28 years old), and $5000 to their daughter, Sally (15 years old). Steve works and receives a $45,000 salary and Sally has a part-time job at Hungry Jack’s and earns $4700. What are the tax consequences for the Jones family?

Companies 14.68 A vast array of company tax rules are scattered over the ITAA 1997 and ITAA 1936. Companies are dealt with in the following six-step process: Step 1: Company income tax basics; Step 2: Company formation; Step 3: Calculating company taxable income/loss and income tax liability; [page 496] Step 4: Distributing company income; Step 5: Company tax losses; and Step 6: Other company income tax issues.

Step 1: Company income tax basics 14.69 Under the Corporations Act 2001, a company is a separate legal entity from its owners (shareholders). From a tax viewpoint, ITAA 1997 s 995-1 defines a company as ‘a body corporate or any other unincorporated association or body of persons, but it does not include a partnership’. Thus, this extends the general law definition of a company to include unincorporated bodies such as clubs and associations. It also excludes partnerships. Companies are extremely popular business vehicles in Australia. Companies are the preferred vehicles for many small, as well as large, businesses. 14.70 ITAA 1936 s 252 requires that a company appoint a public officer. The public officer is responsible for meeting the tax requirements of the company and may be personally liable for any tax offences of the company. Public v private companies 14.71 Public or private company status is important, as loans and excessive payments by private companies to associated persons may be deemed to be dividends: ITAA 1936 s 109 Div 7A Pt III. 14.72 A company is a private company if the company is not a public company: ITAA 1936 s 103A(1). A public company falls within the following categories per ITAA 1936 s 103A(2): listed companies (unless there is a high concentration of ownership — greater than 75 per cent); cooperative companies as defined in ITAA 1936 s 117; mutual life assurance companies; friendly society dispensaries: ITAA 1936 s 6(1); a non-profit company government body established for public purposes; a subsidiary of a public company: ITAA 1936 s 103A(4)–(4E); where the Commissioner exercises a discretion to treat a company as a public company: ITAA 1936 s 103A(5); and where a company acts strictly as a non-profit company: Income Tax

Rates Act 1986 s 3(1). Exceptions to corporate tax rules 14.73 Note: The following types of companies are subject to specific rules: pooled development funds; registered organisations; non-profit companies; cooperatives; and life insurance companies. This text does not cover these rules, because of their specialist nature, scale and complexity. [page 497]

Step 2: Company formation 14.74 The formation of a company will usually have complex tax implications associated with the transfer of assets into the company from an individual, partnership or trust. The trading stock rules in ITAA 1997 Div 70 will need to be considered for the transfer of trading stock. Also, the capital allowance provisions will need to be examined for the transfer of capital assets. CGT rules will also come into play for the transfer of capital assets into the company, although ITAA 1997 Div 122 provides optional CGT rollover relief for the transfer of assets to a company.

Step 3: Calculating company taxable income/loss and income tax liability Company tax rules 14.75

Like other types of entities, companies are taxed on their profits or

their taxable income: see ITAA 1997 s 4-15. Taxable income is calculated as for an individual; that is: Taxable income = assessable income — deductions: see ITAA 1997 s 4-15. Unlike individual taxes, which are progressive, company tax is a flat tax. The general company tax rate for the 2017–18 income tax year is 30 per cent. However, for those small business companies with a turnover of less than $25 million, the company tax rate for the 2017–18 income tax year is 27.5 per cent. The company tax rate will continue to fall for small businesses until 2026-2027 income year, when the rate will be 25 per cent. See below: Progressive changes to the company tax rate Income year

Turnover threshold

Company tax rate for entities under the threshold

Company tax rate for entities over the threshold

2015–16

$2m

28.5%

30.0%

2016–17

$10m

27.5%

30.0%

2017–18

$25m

27.5%

30.0%

2018–19 to 2023–24

$50m

27.5%

30.0%

2024–25

$50m

27.0%

30.0%

2025–26

$50m

26.0%

30.0%

2026–27

$50m

25.0%

30.0%

See ATO, Future year company tax rates . Marina Pty Ltd operates a marina and earns $15 million in business income and incurs $12 million of deductions during the income year. Its taxable income is $3 million ($15 million − $12 million) and it pays income tax of $825,000 ($3 million × 27.5 per cent).

[page 498] Reconciling company net profit and taxable income 14.76 Due to the differences in accounting and tax rules, a company’s accounting net profit rarely equates to its taxable income, and thus a reconciliation statement is needed. The following diagram sets out the reconciliation process. Company net profit (as per profit and loss)

+ or − differences in accounting income and assessable income (eg, capital gains exemptions will cause differences)

+ depreciation allowed for accounting purposes

+ non-deductible expenditure under the ITAAs (capital expenses, provisions for leave, income tax, fines)

= adjusted net profit

Exempt income under ITAAs

Depreciation allowed under ITAAs

Special deductions under ITAAs (deductible capital expenditure for mining, quarrying, petroleum activities; buildings and structural improvements; research and development etc)

= Taxable income

Practice Problem 12 Struto Co provides the following profit and loss statement for the current income year. $ Sales

$ 100,000

Other income

20,000

Less expenses Depreciation

3000

[page 499]

Wages

13,000

Other expenses

14,000

Net profit

30,000 90,000

Struto Co received an exempt capital gain from the sale of pre-19 September 1985 land of $20,000. For tax purposes, the company claimed depreciation of $5000 and wages of $12,000 (and the accounting provision for annual leave amounted to $1000). It also claimed a capital allowance for its warehouse of $2000. Calculate Struto Co’s taxable income.

Practice Problem 13 Black Wine Co provides the following accounting profit and loss statement for the current income year. $ Sales Other income

$ 500,000 10,000

Less expenses Depreciation

20,000

Wages

110,000

Other expenses

100,000

Net profit

230,000 280,000

Black Wine Co received an exempt capital gain from a profit on the sale of wine machinery of $10,000 (other income). For tax purposes, the company is able to claim depreciation of $50,000 (given the accelerated write-off for vines) and wages of $100,000. (The accounting provision for long service and annual leave amounted to $10,000 and was included in the accounting profit and loss statement.) It also gifted $5000 to Guide Dogs for the Blind, a recognised charity for tax purposes (not included in the accounting profit and loss statement), and is also claiming a capital allowance (allowable under the tax rules) for its winery building of $12,000. Other expenses in the accounting profit and loss statement included speeding fines of $1000. Calculate Black Wine Co’s taxable income.

Step 4: Distributing company income 14.77 When a company pays out dividends to its shareholders, these amounts would seem to be taxed at the shareholder level, and thus double taxation would take place on corporate income (in fact, this occurred prior to 1 July 1987). With the introduction of the dividend [page 500] imputation system, such double taxation is largely avoided (imputation, however, does not apply to non-residents). Dividend imputation: ITAA 1997 Divs 200–215 14.78 Imputation is generally restricted to Australian resident companies and to Australian resident company members.14 The system works by providing a tax offset called a franking credit to company members who

receive dividends (franking distributions). To frank its dividends, a company must pay tax on its taxable income and elect to frank the dividends. A company is thus required to maintain a franking account to keep track of how much it can frank its dividends. A credit to the franking account is obtained when a company pays income tax and pay-as-you-go or obtains a franked distribution from another company. Thus, when it elects to frank dividends, the company debits its franking account. The explanatory memorandum to the New Business Tax System (Imputation) Act 200215 explains the operation of the imputation system: 1.8 To prevent double taxation of the distributed income of corporate tax entities (ie, once when it is received by the entity and again in the hands of the members on distribution), the income tax paid by the entity will generally be imputed (ie, passed on) to the members. Providing the means for imputing the tax paid by the corporate tax entity is the function served by both the current imputation system and the new provisions explained in this explanatory memorandum. 1.9 The imputation system is the taxation law governing how and when income tax paid by a corporate tax entity is imputed to the entity’s members. It may also be referred to as the franking system, because the tax is imputed to members by means of franking (in the sense of stamping or marking) distributions of the entity when made to members. 1.10 In essence, a franked distribution is one that is marked as carrying tax credits that can be imputed to members. Those tax credits reflect the tax already paid by the entity on the entity’s profits that are distributed to the member. 1.11 The tax credits that can be imputed to members are recorded in the entity’s franking account as franking credits. Franking credits reflect income tax paid directly by the entity, or underlying tax paid through other corporate tax entities that is imputed to the entity. 1.12 When a franked distribution is made to a member of an entity, the franking credit is referred to as an imputation credit in the member’s hands. Imputation credits usually reduce income tax by giving rise to a tax offset known as the franking rebate. In addition, if the recipient is a corporate tax entity itself, an imputation credit is also allowed as a franking credit in the entity’s own franking account, which may in turn be distributed to the entity’s members.

Acme Ltd has a $30 million taxable income and pays $9,000,000 income tax (at 30 per cent), thus showing a $9,000,000 credit balance in its franking account. It pays out $21,000,000 as a fully franked dividend to its shareholders, reducing its balance in its franking account by $9,000,000. The company members include in their assessable income the following

amounts: the cash value of the distribution (dividend) (ITAA 1936 s 44(1)); and the corporate tax paid in respect of the distribution (known as the grossup amount): ITAA 1997 s 207-20. [page 501] Additionally, the company members then receive a tax offset to reduce their income tax (known as the franking credit). A refund is available where franking credits exceed tax payable: ITAA 1997 Div 67. Continuing the above example, assume that Acme pays all of the $21,000,000 dividend to shareholder Gertrude, who has no other income. Gertrude will include in her assessable income the $21,000,000 dividend plus the gross-up amount of $9,000,000. As a resident taxpayer, and based on the 2017–18 progressive income rates, she would be liable for $13,473,232 in tax payable. However, this is reduced by the tax offset of $9,000,000; thus, the tax payable on the dividend by Gertrude is $4,473,232. She would also be required to pay the Medicare levy of 2 per cent, of her taxable income, assuming she has private health insurance. Calculation of the gross-up amount 14.79 Where the dividend is fully franked, the imputation credit is calculated by multiplying the dividend paid by the company rate of tax divided by 1 minus the company rate. For example, where the company rate of tax is 30 per cent, the imputation credit is calculated as follows: Dividend paid × (0.30/(1 − 0.30). Melinda receives a dividend cheque of $1400, which has been fully franked based on a company tax rate of 30 per

cent. What does she include as her income? Answer: She needs to include $2000 as assessable income = $1400 (see s 44(1)) plus $600 (ie, $1400 × 0.30/(1 − 0.30)).

Dividends: ITAA 1936 s 44 14.80 A shareholder in a company (whether the company is a resident or a non-resident) shall, if he or she is a: resident, include dividends paid to him or her by the company out of profits derived by it from any source and non-share dividends from any source; non-resident, include dividends paid to him or her by the company to the extent to which they are paid out of profits derived by it from sources in Australia and non-share dividends paid from Australian sources.

Read ITAA 1936 s 44 14.81 A dividend includes any distribution by a company paid to its shareholders or any amount credited by a company to its shareholders: ITAA 1936 s 6(1). Notably, dividends must be paid out of company profits for s 44(1) to apply. The courts have defined profits broadly to include company revenue or trading profits, as well as capital profits, as seen by FCT v Slater Holdings Ltd (1984) 156 CLR 447. [page 502]

FCT v Slater Holdings Ltd (1984) 156 CLR 447 Facts: The taxpayer received a dividend paid out of three sources: company revenue profits, capital gains and a gift. The question at issue

was whether the sum constituted an assessable dividend: see s 44(1). Was the amount paid out of profits? High Court held: The amount was an assessable dividend under s 44(1) because the gift constituted a profit, as it increased the company’s assets.

Practice Problem 14 Doug receives a fully franked dividend of $7000 (based on a company tax rate of 30 per cent). Doug’s other income is $75,000. What is his assessable income?

Practice Problem 15 The Adams family owns two businesses: a café that is operated through a company, Igor Pty Ltd, which has a taxable income of $10,000,000. The shareholders, Mr and Mrs Adams, both received fully franked dividends of $20,000. Also, the family has a number of investments held in the Munster Trust, which has a taxable income of $30,000. The trustee, Herman, distributed $10,000 to Mr Adams, $10,000 to Mrs Adams and $10,000 to their son, Creepy (who is 16 years old). What are the tax implications for the company and the Adams family? Distributions in liquidation: ITAA 1936 s 47 14.82 Generally, amounts distributed to shareholders by a liquidator in winding up a company or made in an informal liquidation are deemed to be dividends (assessable income) to the extent that they represent income derived

by the company: s 47(1). Such dividends can be franked if franking credits are available. Upon liquidation, the shareholder’s shares are cancelled, triggering CGT event C2: ITAA 1997 s 104-25(1). This may result in a capital gain or loss depending on whether the liquidator’s distribution for the shares exceeds the cost base.

Read ITAA 1936 s 47 Payments to associates by private companies: ITAA 1936 s 109 Div 7A 14.83 A number of provisions are designed to prevent shareholders from disguising profit distributions into a non-taxable form such as a loan. ITAA 1936 Div 7A deems a private company to have paid a dividend if it pays an amount to a shareholder or associate, makes a loan to a shareholder or associate that is not repaid, or forgives a debt to a shareholder or associate. [page 503] ITAA 1936 s 109 applies to excessive remuneration provided by a private company to a shareholder or associate. Such unreasonable payments are not deductible to the company and are deemed to be a dividend paid to the associated person. In these situations, the total amount of the deemed dividends under ITAA 1936 Div 7A will be capped at the ‘distributable surplus’ of the company under ITAA 1936 s 109Y. This is defined as the company’s net assets less paid-up capital and loans deemed as dividends: see ss 108, 109D and 109E. Note: Certain exceptions apply to the operation of ITAA 1936 Div 7A: see ITAA 1936 ss 109G, 109J, 109K, 109L, 109M.

Read ITAA 1936 s 109 Div 7A Pt III

Step 5: Company losses 14.84 Like a trust, a company’s losses (ITAA 1997 s 36-10) are trapped inside the company and cannot be distributed to its shareholders. However, companies are generally able to carry forward losses indefinitely subject to certain requirements. Companies that are part of a wholly owned group that is in the consolidated group rules are able to transfer losses within the corporate group. Losses carried forward: ITAA 1997 Divs 165, 175 14.85 While a company is able to carry forward losses, there are limitations imposed on obtaining these deductions (to prevent the trafficking of tax losses). To gain a deduction, a company must pass either a continuity of ownership test (COT) or the same business test (SBT): see ITAA 1997 Div 165. Generally, unless one of these tests is satisfied, a company will be unable to carry forward its tax losses. Other restrictions apply to prevent the deductibility of losses where either the COT or the SBT is met, but the benefit of the tax loss actually flows to other persons: ITAA 1997 Subdivs 165-CC, 165-CD, 175-A, 175-B. Similar restrictions apply to current year losses where there is a change of ownership during the tax year: Subdiv 165-B. Coal Developments (German Creek) Pty Ltd v FCT (2007) 241 ALR 667; 68 ATR 869; [2007] FCA 1324 Facts: The taxpayer sold its interest in a coal development joint venture but sought to subsequently claim deductions for carriedforward losses. The taxpayer contended that the winding-up activities it carried on after the sale of its interest in the joint venture meant that it was still carrying on the same business. The Commissioner disallowed the losses under ITAA 1997 s 165-210, since the same business test was not satisfied after it had sold its interest. Full Federal Court held: Losses were not deductible, since the taxpayer was not carrying on the same business. It had sold the

business. While the former owner of a business retains business liabilities, this does not mean that the former owner continues to carry on the same business.

[page 504] The COT 14.86 For this test to be met, a company must have the same majority owners during the ‘ownership test period’. This is measured from the start of the loss year to the end of the current income year under ITAA 1997 s 16512(1). The ‘same majority owners’ rule will be satisfied where they can demonstrate that they maintained during the ownership test period: more than 50 per cent of the voting power in the company; rights to more than 50 per cent of the company’s dividends; and rights to more than 50 per cent of the company’s capital distributions. As you can see, the COT would be very difficult for listed companies on the stock exchange to satisfy. There are concessional treatments for such companies in this regard, however: see ITAA 1997 Div 166. Generally, a listed company can satisfy the COT where they can show that the COT could apply at certain points of the income year: at the start of the loss year; or at the end of the current income year; or at the end of each intervening year; or at the time of each corporate change. (Under s 166-175, this is defined to include a takeover bid for shares, an arrangement to acquire more than 50 per cent of the company’s shares and an issue of shares in the company that results in an increase of 20 per cent or more in the issued share capital of the company or the number of shares on issue.) In addition, widely held companies (public companies, subsidiaries ofpublic companies and certain other non-public widely held companies) are able to group any direct shareholding of less than 10 per cent into one notional

shareholder. This single notional shareholder is taken into account in determining whether the COT is satisfied. Thus, companies with disposed shareholdings will find it easier to pass the COT. The SBT 14.87 Where a company does not meet the COT, it must satisfy the SBT if it wishes to deduct a tax loss: see ITAA 1997 s 165-13. Under ITAA 1997 s 165-210, this test is satisfied where a company can show, in the current tax year: that it carries on the same business as it did before the application of the test time; and that it does not derive in any assessable form any new business source or new transaction that it did not carry on before the test time. Capital losses carried forward: ITAA 1997 Subdivs 165-CA, 175CA, 175-CB 14.88 A company is able to carry forward capital losses, but there are limitations imposed on obtaining these (to prevent the trafficking of capital tax losses). To be able to apply such a capital loss, a company must pass either a COT or the SBT: see ITAA 1997 Subdiv 165-CA. Other restrictions apply to prevent the deductibility of capital losses where the same ownership test has been met but the benefit of the capital loss actually flows to other persons: ITAA 1997 Subdivs 175-CA, 175-CB. Company loss carry-back law: ITAA 1997 Div 160 14.89 Under the loss carry-back law, a company could elect to carry back all or part of a tax loss from an income year, or the previous income year, against its income tax liability [page 505] in either of the two previous income years. Thus, companies with tax losses

can carry these losses back against the tax previously paid and receive a refund. To obtain a refund, a company must claim a loss carry-back tax offset.

Step 6: Other company income tax issues Bad debts: ITAA 1997 Subdiv 165-C 14.90 Normally, a bad debt will be deductible if it meets the requirements of ITAA 1997 s 25-35 or s 8-1. However, for companies, restrictions are placed on bad debt deductions to prevent the trafficking of bad debt companies: ITAA 1997 Subdiv 165-C. Share buybacks: ITAA 1936 Div 16K Pt III 14.91 Where a company buys back shares from its shareholders, this may be funded out of company profits or capital. ITAA 1936 Pt III Div 16K deals with buybacks. Bonus shares: ITAA 1997 Subdiv 130-A, ITAA 1936 s 6BA 14.92 When companies issue bonus shares to shareholders, there can a number of tax implications. First, the CGT provisions in ITAA 1997 Subdiv 130-A need to be considered. Second, ITAA 1936 s 6BA may apply for calculating any revenue profits or losses. Share capital reductions: ITAA 1997 ss 104-25(3), 104-135(1) 14.93 A company may reduce its share capital, and this may trigger CGT. Shareholders may face CGT event C2 ITAA 1997 s 104-25(3) or G1 ITAA 1997 s 104-135(1), depending on whether the shares are cancelled. Capital streaming benefits: ITAA 1936 s 45-45D 14.94 Anti-avoidance capital streaming benefit rules are included in ITAA 1936 s 45-45D. These provisions prevent the streaming of tax-advantaged distributions (eg, capital distributions) by companies to a select number of shareholders. Consolidated groups: ITAA 1997 Pt 3-90 Divs 700–721

14.95 A wholly owned group of resident entities can elect to be a consolidated group and be treated as a single entity and thus will need to lodge only one income tax return. The head company must make the choice and it is irrevocable: see ITAA 1997 s 703-50. All subsidiaries must be part of the group. The head company is liable for all income tax payable and obtains the benefit of any group losses: see ITAA 1997 s 703-15(2) item 1. Also, the head company must lodge the group income tax return. Goods and services tax (GST) and fringe benefits tax (FBT) are not affected by consolidations, and thus all companies in the group must lodge GST and FBT returns and pay tax for GST and FBT. Under consolidations, all intra-group transactions are ignored; that is, transfer of assets, loans or payment of dividends. The transaction must be with an outside party to have an income tax impact.16 [page 506]

COMPARISON OF BUSINESS AND INVESTMENT VEHICLES BENEFITS

COSTS Individuals

Have full control

Inflexible

Simple, low administration costs

Substantiation requirements

Income averaging

Unlimited liability

No financial reporting requirements

Limited deductions for superannuation contributions if self-employed

CGT discount

Non-commercial loss restrictions No perpetuity Partnerships

No financial reporting requirements

Unlimited liability

Not a separate legal entity

Loss of control risk

Can distribute losses (not trapped like a company or trust)

No perpetuity

Low administration costs

Transferring partners’ interests is complex

CGT discount

Inflexible income splitting Non-commercial loss restrictions Trusts

Flexible income splitting

Very complex (trust law, tax law, company law)

Limited liability

Tax losses trapped

Asset protection CGT discount Companies Tax rate 30 per cent or 27.5 per cent for small companies with less than an aggregated $25 million annual turnover

Complex reporting requirements

Limited liability

Losses trapped

Superannuation deductions

Distribution inflexibility

Perpetuity

Complex to liquidate

Research and development concessions

Attempt the Web Quiz for Chapter 14 [page 507]

Summary 14.96 Companies and individuals are liable to income tax based on the income tax equation: taxable income equals assessable income less deductions. An individual pays income tax on his or her taxable income. However, a

company pays income tax on its taxable income, and any dividends paid by the company are also taxed in the hands of the shareholders. Some relief, though, is provided via the dividend imputation system for resident shareholders and companies. Partnership net income is calculated as if the partnership were a resident taxpayer (assessable income – deductions). Thus, a partner is liable for income tax on his or her share of net partnership income. Trust net income equals assessable income less deductions. Losses are not deductible for trust beneficiaries (unlike partners in a partnership) and must be carried forward in the trust. A trust is not a separate taxable entity (like an individual or a company). Generally, the beneficiaries must pay tax on their share of trust net income, but, in certain circumstances, the trustee is liable to pay tax (where no beneficiary is entitled to trust income). In summary, the income tax laws contain a plethora of rules for the various business and investment entities: partnerships, companies and trusts. Thus, this chapter sought to cover only the fundamentals. You may ponder, though, why the tax treatments for individuals, partnerships, trusts and companies are so different. Would it be far simpler, fairer and more efficient if unified tax rules applied to all entity types?

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. 1 From an income tax perspective, describe the differences between a partnership, company and trust. 2 Two partners, Lidia and Arthur, share profits in the ratio 1:2. During the income tax year, each has drawn out $20,000 for living

3

expenses. The partnership return shows assessable income of $120,000 and deductions of $10,000. a What is partnership net income? b What is the partners’ share of the net income? Sam and Mick are in partnership 50:50. During the income tax year, Sam, as managing partner, receives $100,000 salary, while Mick is a silent partner and receives no salary at all. The partnership profit for the year is $100,000 after Sam’s wage is deducted. a What is partnership net income for income tax purposes? b What is Sam’s and Mick’s share of the net partnership income for income tax purposes? [page 508]

4

5

6

Lidia and Tony are partners in an accounting business. In the current income year, the partnership has a net income of $950,000. This includes a salary payment of $900,000 to Lidia and a $350,000 salary payment to Tony. The net income of the partnership to be distributed after the payment of salaries is divided in the ratio 50:50. What is the taxable income for Lidia and Tony for the year ended 2017? On 1 January 2017, Billy and Eliza Lennon purchased four units at a cost of $1 million. At the same time, they signed a partnership agreement that provided that any losses of the partnership would be Billy’s obligation only and that if there were any partnership profits, these would be shared under the ratio 50:50. On 30 June 2017, the four units produced a net loss of $30,000. Is the partnership agreement between Billy and Eliza valid for tax purposes? Emma Smith is named as a beneficiary in the deed of settlement of the

7

8

9

10

Smith Family Trust. On 30 June, she is 17 years old. The net income of the trust in the financial year ending 30 June is $1000. The trustee of the trust passes a resolution to distribute all of the net income of the trust to Emma. She has no other income. a What are the taxation implications for Emma? For the trustee? b Would your answer be any different if Emma turned 18 during the financial year? Kangaroo Island Tourist Resort Pty Ltd owns a well-known island hotel and had sales and takings of $20,600,560, which were offset by deductions of $16,997,658 for the year to 30 June. It also received a distribution of income of $20,000 from the Wooly Sheep Trust. What is its tax payable for the year? John is a resident individual shareholder of a number of companies. He receives the following amounts in the current tax year: $1000 fully franked dividends (based on a 30 per cent company tax rate) from CC Ltd, a resident public company; $3000 unfranked dividends (based on a 30 per cent company tax rate) received from DD Pty Ltd, a resident private company; and $4000 fully franked dividends (based on a 30 per cent company tax rate) from EE Pty Ltd, a resident private company. In each of the above, what franking credits — if any — would John be entitled to? The Bob Jane Trust makes a loss of $1000 in the current tax year. This means there is no distribution to be made for the year. The trust, however, does have franking credits of $320. Can a distribution statement of the trust show income to which no beneficiary is entitled and therefore have the franking credits refunded to the trust? Company ABC Pty Ltd owes $100,000 to Sam and Sally — its only two directors, who are also shareholders in the company. Sam and Sally now want the loan to be repaid back to them. ABC Pty Ltd is able to borrow the funds required to repay the loan from an outside bank — XZY Bank.

11

Can the interest payable on the loan from XZY Bank be deductible to ABC Pty Ltd? Zowith Pty Ltd has a loss from the prior year of $1 million. On 1 July of the current year, Sid buys all of the shares in Zowith Pty Ltd upon advice from Alfie. Sid then channels [page 509]

12

13

$1 million of income from the Sid Family Trust into Zowith Pty Ltd. This reduces the trust’s income to $100,000 and leaves Zowith Pty Ltd with a zero taxable income. Is this effective for tax purposes? Mary and John are beneficiaries of the Marie Clay Discretionary Trust in the proportions one-fifth and four-fifths, respectively. At the end of the current income year, the Marie Clay Trust has net trust income of $200,000, and this amount is accordingly distributed to Mary and John as beneficiaries. Both Mary and John pay income tax on their distributions. Twelve months later, however, a deduction that had been previously allowable to the trust is disallowed. The net trust income for the previous income tax year is adjusted to be $230,000. If the proportionate view is taken, who pays tax on this extra $30,000 and in what proportion? The Svik family trust received the following amounts of income for the current income tax year: Rental income Unfranked dividend Franked dividends (based on a 30 per cent company tax rate)

$12,000 $15,000 $2000

Under the trust deed, the three beneficiaries receive one-third of the trust income each. Sara Svik is 17 and has no other income. James Svik is 21 and earns $1000 in other income. Mandy Svik is 50 and earns no other income.

Calculate the tax liability for each of the beneficiaries and the trustees of the Svik family trust for the income tax year 2017–18. (Disregard the Medicare levy.)

1.

Australian Taxation Office (ATO) publications are most easily accessed via the ATO website at .

2. 3.

See ITAA 1936 s 102AC(2) for a definition of an ‘excepted person’. See Partnership Act 1958 (Vic) s 5 for example.

4.

See ATO Taxation Ruling TR 94/8 (accessed 1 September 2017). Copyright Commonwealth of Australia, reproduced with permission. FC of T v Roberts; FC of T v Smith 92 ATC 4380; (1992) 23 ATR 494.

5. 6. 7.

ITAA 1997 s 106-5. R H Woellner, S Barkoczy, S Murphy and C Evans, Australian Taxation Law, 19th ed, CCH Australia Limited, 2009, p 879.

8. 9.

Kelly v Commr of IR (NZ) [1970] NZLR 161. Harmer v FCT 20 ATR 1461.

10. Although a trust can be based on a verbal agreement. 11. For a discussion of the ATO’s stance, please refer to Australian Taxation Office, Decision Impact Statement, Commissioner of Taxation v Philip Bamford & Ors; Philip Bamford v Commissioner of Taxation, at . 12. ITAA 1997 s 115-228. 13. See ATO, Interim Changes to the Taxation of Trusts, at . 14. The exception is New Zealand. Imputation is extended to include companies in New Zealand. 15. Copyright Commonwealth of Australia, reproduced with permission. 16. Note: Superannuation is another tax-effective vehicle: see Chapter 15.

[page 511]

15 Superannuation and eligible termination payments Learning Objectives After you have studied this chapter, you should be able to: explain what superannuation is; outline what a superannuation fund is; determine how superannuation contributions are taxed; explain the concepts of concessional contributions and nonconcessional contributions; outline how excess contributions are treated; determine what tax deductions are available for employer contributions and personal contributions; outline assessable contributions; determine how superannuation entities are taxed; determine how superannuation benefits are taxed; explain what an employment termination payment (ETP) is and how it is taxed; explain the concepts of government co-contribution, superannuation guarantee contributions and the

superannuation guarantee charge (SGC); explain the basic requirements of superannuation fund (SMSF); and explain the superannuation guarantee.

a

self-managed

[page 512]

Key Legislative Provisions Income Tax Assessment Act 1936 (ITAA 1936) Income Tax Assessment Act (ITAA 1997) Divs 82–83 Divs 280–292 Div 295 Divs 301–307 Superannuation (Government Co-Contribution for Low Income Earners) Act 2003 Superannuation Guarantee Charge Act 1992 s5 Superannuation Industry (Supervision) Act 1993 s 10 s 17A Superannuation (Excess Untaxed Roll-Over Amounts Tax) Act 2007 s4 s5 Taxation Administration Act 1953 Sch 1, Div 390

Key ATO Publications ATO fact sheet: Simpler super overview (NAT 70646) ATO fact sheet: Simpler super defined benefits funds NAT 70647-03.2007

Diagram 15.1:

Income tax method superannuation

[page 513]

Chapter overview 15.1 ‘Superannuation’ can be defined as a regulated and low-taxed savings scheme that is designed to encourage taxpayers to save for their retirement. Working taxpayers, their employers and the self-employed generally contribute to superannuation funds, which are administered by superannuation fund trustees. The superannuation savings cannot generally be accessed until retirement age or earlier death or disablement. At that time, the savings can be taken in the form of a lump sum or pension, or a combination thereof, depending on what the trust deed provides. Concessional tax treatment applies to: contributions to funds: contributions can be deductible or can be subject to

tax offsets or government co-contributions and are concessionally taxed in the superannuation fund; superannuation funds: complying superannuation funds are taxed at 15 per cent on most income, 10 per cent on 1-year capital gains and 0 per cent on income supporting an income stream; and superannuation benefits: lump sums and pensions are concessionally taxed; benefits paid from taxed superannuation schemes are tax-free for Australians aged 60 years and over, and benefits paid from a fund that has not paid tax are concessionally taxed. In 1992, the Labor Government revolutionised superannuation with the introduction of the SGC. This made it compulsory for employers to make superannuation contributions on behalf of their employees. Thus, superannuation quickly expanded to include most employees. On 1 July 2007, the Coalition Government further revamped superannuation with the rewrite of the taxation provisions from the ITAA 1936 to the ITAA 1997. From 1 July 2017, further changes have been made to the way that superannuation is taxed, most of which either increase the contribution concessions for the less wealthy or reduce them for the wealthy. Two significant changes are, first, that the amount of a superannuation fund paying a pension that gets exemption from tax on its income is limited to $1.6 million (Transfer Balance Cap) and, second, some concessional and all nonconcessional contributions can only be made if the person has less than $1.6 million (Total Superannuation Balance) in superannuation. As set out in Chapter 1 (Table 1), superannuation constitutes the Government’s major tax expenditure. The Government argues that this massive tax expenditure is justified because the superannuation system, where people provide for their own retirement, will reduce future reliance on oldage pensions, although it is interesting to consider whether those who obtain the most benefit from the superannuation concessions (high income earners) would in fact have any entitlements to a means-tested age pension. Likewise, do low and middle income earners obtain adequate benefit from the superannuation concessions? Will their superannuation savings enable them to be self-sufficient? Once again, the upside-down tax effect of tax preferences undermines their effectiveness (too much to too few).

[page 514] Superannuation is controlled by a vast array of complex tax and compliance rules governing superannuation trust funds, superannuation fund trustees, contributors, employers and employees. The main legislation is: the Superannuation Industry (Supervision) Act 1993 (SIS Act); the Income Tax Assessment Acts 1936 and 1997 (ITAA 1936 and 1997); and the Corporations Act 2001. The following government agencies enforce these provisions: the Australian Prudential Regulation Authority (APRA), the Australian Taxation Office (ATO) and the Australian Securities and Investments Commission (ASIC). Given the complexity of the superannuation system, this chapter follows a step-by-step process that focuses on the following superannuation issues: Step 1: Understand the superannuation basics; Step 2: Taxation of superannuation contributions by employers, selfemployed and employees; Step 3: Taxation of superannuation entities; Step 4: Taxation of superannuation benefits; Step 5: Taxation of ETPs; and Step 6: Other issues.

Step 1: Understand the superannuation basics What is a superannuation fund? 15.2 A superannuation fund is a scheme for payment of superannuation benefits or a superannuation fund as defined in the Superannuation Industry (Supervision) Act 1993 (SIS Act) s 10. The SIS Act s 10 defines a superannuation fund as:

(a)

a fund that is an indefinitely continuing fund which is a provident, benefit, superannuation or retirement fund; or

(b) a public sector superannuation fund.

The most common form of superannuation fund is a special purpose trust fund that is established by way of trust deed (like other types of trusts). The trustee(s) invests the contributions, and these contributions, plus earnings from investment and less expenses of the fund, can then be paid as a benefit to the members after they have retired, or to their beneficiaries if they die earlier. In order for the superannuation fund to access the tax concessions, the trust deed must be written in such a way that it fully complies with all of the rules regarding complying superannuation funds. The trust law rules for superannuation are set out in the SIS Act. The taxation code is contained in the ITAAs 1936 and 1997. A superannuation fund can be represented diagrammatically, as in the example that follows. What this shows is that contributions are made to the fund, earnings are generated on those contributions, and the contributions plus earnings and less fund expenses are paid as benefits. Note: This diagram represents an accumulation superannuation fund. [page 515]

Superannuation fund types

15.3 Superannuation funds can be categorised in a number of ways. First, they can be accumulation or defined benefit funds. Accumulation benefit funds and defined benefit funds Accumulation benefit funds 15.4 Most Australian superannuation funds are accumulation funds. The benefit that an accumulation fund pays is the contributions plus earnings on those contributions less expenses of the superannuation fund. In an accumulation fund, the amount of benefit that a member gets depends on the investment performance of the fund. Defined benefit funds 15.5 In a defined benefit fund, in contrast, the amount of benefit that the fund pays to a member is calculated by a formula in the trust deed. In that case, the member’s benefit is fixed by that formula and does not depend on the investment performance of the fund. The formula is usually a percentage of the member’s salary just before they retire, multiplied by the number of years that they have been a member of the fund. For example, a formula may say that a member is entitled to a pension of 2 per cent of their salary before they retire, multiplied by the number of years that they have been a member of the fund, up to a maximum of 40. Public sector and private sector funds 15.6 Second, superannuation funds can also be categorised as public sector and private sector funds. Ninety per cent of superannuation funds in Australia are private sector funds and the remaining 10 per cent are public sector funds. This difference is important because private sector funds pay tax on some contributions and on their income and a reduced tax when a benefit is paid, but public sector funds do not pay any tax at all, so all tax is paid when the benefit is paid. The tax on benefits paid from a fund takes into account whether the superannuation fund has paid tax or not. Employer-sponsored superannuation funds

15.7 Employer-sponsored superannuation funds are set up by employers on behalf of their employees. [page 516] Self-managed superannuation funds 15.8 SMSFs are usually set up by self-employed persons for their own benefit. Employees sometimes set up their own SMSFs. SMSFs can have no more than four members. Each member must also be a trustee, and a member cannot employ another member unless they are related. Retail superannuation funds 15.9 Insurance companies and financial institutions offer superannuation funds that anyone can invest in. These bodies must be approved trustees and administer the superannuation funds through a master superannuation deed. Industry superannuation funds 15.10 These funds are set up for workers in particular industry sectors and are usually established by union groups.

The superannuation system Overview 15.11 The key taxation elements of superannuation taxation are: superannuation benefits paid from a superannuation fund that had paid tax, either as a lump sum or as a pension, are tax-free for people age 60 and over; the tax paid on superannuation benefits paid from a superannuation fund that had not paid tax for people age 60 and over is roughly equivalent to taxes paid by a superannuation fund that pays tax; employers can claim a full tax deduction for contributions to

superannuation on behalf of employees under the age of 75; individuals can claim a full tax deduction for contributions to superannuation up to age 75; there is a limit on the amount of annual contributions to a superannuation fund that are concessionally taxed; and there is a limit on the total amount of contributions to a superannuation fund for an individual from their post-tax income (known as nonconcessional contributions) per financial year or over a 3-year period. Below is a diagram of what the taxation of a superannuation fund looks like now, using the tax rates that applied in 2007. Note: A person who earns over $250,000 per annum pays an additional 15 per cent tax on contributions and the $140,000 limit is now $200,000. Note also that the way that a fund pays tax depends on whether it is a private sector fund when some contributions are taxed, the fund earnings are taxed and, depending on the age of the member, benefits may be taxed as well. This should be compared with a public sector fund that does not pay tax on contributions or fund earnings, and any taxes are paid when the benefits are paid. [page 517]

There are limits to the amount of contributions that can be made in respect of an individual to a superannuation fund in a year. There are two limits that depend on the type of contributions. First, broadly, contributions that have been tax deductible (which are called ‘concessional contributions’) are limited to $25,000 per individual per annum. For all other contributions (called ‘nonconcessional contributions’), the annual limit per individual is six times the concessional contribution limit (currently $100,000), but individuals can bring forward 2 years’ worth of that amount, which means that they can contribute a maximum of $300,000 over a 3-year period. If the concessional contributions limit is exceeded, the excess can be added to the individual’s other income and they are entitled to a 15 per cent tax offset for the tax paid by the fund. If the non-concessional contribution limit is exceeded, the individual can withdraw it from their superannuation fund plus associated earnings or pay extra tax on the excess. Investment phase 15.12 In the investment phase, the contributions that have been made to a superannuation fund are invested by the superannuation provider: s 280-5. 1. Contributions that can be deducted are assessable income of the superannuation provider. Contributions that cannot be deducted are not assessable income of the superannuation provider. (There are some exceptions.)

2. 3.

Earnings on the investment of amounts in a superannuation plan are assessable income of the superannuation provider. The superannuation provider’s taxable income is generally taxed at the concessional rate of 15 per cent and 10 per cent for capital gains of at least 1 year. [page 518]

4.

However, superannuation providers pay no tax on income from the assets that support the payment of benefits in the form of a pension once the pension has commenced up to an amount of $1.6 million in the fund.

Benefits phase 15.13 In the benefits phase, these contributions, plus earnings from investing them and less any fund expenses, are usually paid as benefits to the member when he or she retires after reaching their preservation age. The preservation age is the earliest that retirement benefits can be paid from a superannuation fund and still get concessional taxation treatment. For people born after 1964, this is age 60. In the event of death before retiring, the benefits are usually paid to the member’s dependants: s 280-5. Different types of superannuation benefit 15.14 Superannuation benefits can be taken as lump sums, income streams (such as pensions or annuities) or combinations of both. Different tax treatment may apply, depending on whether a lump sum or an income stream is paid. Benefits phase taxation 15.15 Benefits phase taxation varies with age of recipient and type of benefit. 1. The taxation of superannuation benefits depends primarily on the age of the member. 2. If the member is age 60 or over, superannuation benefits (both lump

3.

4.

5. 6.

sums and income streams) are tax-free if the fund from which they have been paid has paid tax (in that case, the benefit is said to comprise an ‘element taxed in the fund’). This covers the great majority of superannuation members. Where a superannuation benefit contains an amount that has not been subject to tax in the fund, where, say, the superannuation fund has not paid tax (in that case, the benefit is said to comprise an ‘element untaxed in the fund’), it is subject to tax for those age 60 or over, though at concessional rates. This is relevant generally to those people (ie, public servants) who are members of a superannuation fund established by the Australian Government or a state government. If the member is less than 60, superannuation benefits may receive concessional taxation treatment, though the treatment is less concessional than for those age 60 and over. Superannuation benefits may also include a tax-free component; this component of the benefit is always paid tax-free. Additional tax concessions may apply when superannuation benefits are paid after a member’s death to a certain class of beneficiaries.

Benefits phase rollovers 15.16 A member can roll over their superannuation benefits from one complying superannuation plan to another or between different interests in the same superannuation plan without paying any tax. This is usually done to keep the benefits invested in the superannuation system or to convert a lump sum to a superannuation income stream. Tax is generally payable only when the benefits are finally taken by the member. The taxation provisions governing the superannuation system are mainly located in ITAA 1997 Pt 3-30. The rules consist of the following elements: [page 519] taxation of superannuation contributions: Divs 280–293;

taxation of superannuation benefits: Divs 301–307; and taxation of superannuation entities: Div 295. Other associated rules are contained in the superannuation fund reporting requirements in the Taxation Administration Act 1953 (TAA 1953) Div 390 Sch 1.

Step 2: Taxation of superannuation contributions by employers, self-employed and employees 15.17 Contributions are made by members themselves (employees or selfemployed) and/or by others, generally the members’ employers. Employers must make contributions for employees in accordance with the Superannuation Guarantee (Administration) Act 1992.

Employers 15.18 Employers can fully deduct all contributions that they make to a complying superannuation fund for their employees (subject to eligibility rules): ITAA 1997 ss 290-60–290-80. Z Co, a large Australian mining company, makes $400 million of deductible contributions for superannuation provided to its employees during the income year. These payments are fully deductible: ss 290-60–290-80.

Self-employed 15.19 Individuals regardless of their work status, say, self-employed, can obtain full deductions for their superannuation contributions to a complying superannuation fund until age 75: s 290-150.

Alan runs a lawn mowing business and he makes a $5000 deductible contribution to the Alan Superannuation Fund. He is 40 years old. The payment is deductible: s 290-150.

Employees 15.20 Employees can obtain a deduction for their superannuation contributions. However, some employees, rather than claiming the deduction themselves, can agree with their employer that the employer will contribute to a complying superannuation fund instead of paying salary (a practice that is called ‘salary sacrificing’), so the employee effectively gets a tax deduction for the contribution. However, the complying superannuation fund will pay tax at 15 per cent on that contribution (and an additional 15 per cent if their earnings exceed $250,000), but this still may be beneficial, as the employee would have paid tax at [page 520] their marginal tax rate, which may be more than 15 per cent (or 30 per cent) had it been paid to them as a salary.

Example Tiffy works for a merchant bank and earns a wage of $230,000. She decides to ask her employer to salary sacrifice $25,000 into her SMSF. Tiffy’s assessable wage income is reduced to $205,000. The $25,000 is taxed at 15 per cent in the superannuation fund, but had it been paid as salary it would have been taxed at 47 per cent plus the Medicare levy.

Spouse contributions 15.21 A tax offset of up to $540 is available to a person who contributes up to $3000 to a complying superannuation fund for their spouse, provided that

the spouse is earning less than $40,000 per annum of assessable income, reportable fringe benefits and reportable employer superannuation contributions: ss 290-230–290-240.

Government co-contributions 15.22 The Government will make a contribution to a superannuation fund for taxpayers on low incomes who also make a contribution. The amount of the government co-contribution is equal to 50 per cent of the after-tax contributions up to $500 made by a taxpayer whose assessable income, reportable fringe benefits and reportable employer superannuation contributions are less than a low income threshold (which is $36,813 for 2017–18). If their income (including reportable fringe benefits and reportable employer superannuation contributions) is above that amount, the contribution by the Government is reduced by 3.333c for each $1 by which it exceeds that amount, so when the employee’s income reaches $51,813, there is no government co-contribution: Superannuation (Government CoContribution for Low Income Earners) Act 2003 s 6. Low income superannuation contribution 15.23 The Government will contribute to a taxpayer’s superannuation fund an amount equal to 15 per cent of concessional contributions made to their fund, provided that their taxable income is less than $37,000 per annum.

Tax on excess contributions 15.24 If superannuation contributions for an individual exceed the concessional contributions cap, they can choose to have the excess added to their other income and are entitled to a 15 per cent tax offset. They can withdraw money from the fund to pay any extra tax. If an individual exceeds their non-concessional contributions cap, they can choose to withdraw the excess and associated earnings or leave it in the fund and be liable for extra tax on excess concessional contributions at 47 per cent on excess nonconcessional contributions. These caps limit the amount of tax concessions that individuals can get from using a superannuation fund.

[page 521]

Concessional contributions cap 15.25 If the concessional contributions to a superannuation fund for an individual exceed the $25,000 per annum cap, the excess is added to the individual’s other income and the individual is liable to tax on the total, with a 15 per cent tax offset for taxes paid by the fund. Individuals may request that the superannuation fund pay the tax out of the fund. An individual taxpayer’s concessional contributions in a financial year are generally contributions that have been made by or for that individual in that year that are included in the assessable income of a superannuation provider. However, the following types of contributions are not concessional contributions (s 292-25): rollover superannuation benefits, to the extent that they do not consist of an element untaxed in the fund of the taxable component in the transferring fund — in effect, these are amounts transferred to a superannuation fund that pays tax from a superannuation fund that does not pay tax, such as a public sector superannuation fund; the amount of a superannuation benefit transferred from a foreign superannuation fund covered by an election; and contributions made to a constitutionally protected superannuation fund.

Salary sacrifice and superannuation 15.26 Until 1 July 2017, after which all personal contributions can be deductible, one of the most popular tax planning strategies was for employees to set up their own SMSF and salary sacrifice contributions into it up to the concessional contributions cap ($25,000). They do not pay income tax on the salary-sacrificed contribution amounts, although the superannuation fund trustee will pay tax at 15 per cent on those contributions or 30 per cent if income exceeds $250,000 per annum.

Example

Ben works for Y Ltd. He receives employer superannuation and he also has his own SMSF His employer makes $10,000 of concessional contributions during the year to its superannuation fund, and Ben also agrees that his employer will contribute $15,000 of salary-sacrificed concessional contributions to his SMSF. However, care must be taken to ensure that the concessional contributions cap is not breached. Josie works for X Ltd. She receives employer superannuation and she also has her own self-managed superannuation fund. Through her employer fund she makes $15,000 of concessional contributions during the year and in her own fund she makes $20,000 of salarysacrificed concessional contributions. Josie is 35 years old. Her excess contributions of $10,000 ($35,000 − $25,000) are added to her other income and taxed, with a 15 per cent tax offset for taxes paid by the fund. The regulations may also contain rules that include additional amounts allocated from reserves in the superannuation fund to an individual member by the superannuation provider as part of the concessional contributions cap. [page 522]

Non-concessional contributions 15.27 The non-concessional contributions cap for an individual is four times the concessional contributions cap, which means a cap of $100,000 (indexed). The individual contributor is liable for tax on excess nonconcessional contributions that exceed this cap of 47 per cent if it is not withdrawn from the fund: Superannuation (Excess Non-Concessional Contributions Tax) Act 2007 s 292-80. A person’s non-concessional contributions are generally contributions that

are not included in the assessable income of the superannuation fund. Contributions made by a person into their spouse’s account and for their children are included in the recipient spouse’s or child’s non-concessional contributions cap and not in that of the person making the contribution. A person’s non-concessional contributions include (s 292-90): excess concessional contributions that have not been withdrawn from the fund — this ensures that a person cannot circumvent the nonconcessional contributions cap by making excess concessional contributions; and contributions made to a constitutionally protected fund that, had the fund been a taxed fund, would not have been taxed in the fund anyway. A person’s non-concessional contributions exclude (s 292-90): government co-contributions; certain contributions relating to personal injury payments; certain amounts from the disposal of assets that qualify for the small business capital gains tax (CGT) exemption; a rollover superannuation benefit; and amounts not included in a superannuation provider’s assessable income, such as contributions transferred to another provider and amounts covered by pre-1 July 1988 funding credits. Using the example of Josie above: she could have avoided the excess contributions tax by limiting her total concessional contributions to $25,000. If she only salary sacrificed $10,000 of contributions, she would have reached the $25,000 limit. She could have then contributed more into her superannuation fund from her after-tax salary, up to $100,000 in a year, without breaching the non-concessional contributions cap and would have avoided the excess contributions tax.

Bring-forward arrangements

15.28 A bring-forward arrangement applies to the $100,000 nonconcessional contributions cap: s 292-85. That means that a person who is under 65 years of age at the beginning of a financial year can bring forward the next 2 years of entitlements to non-concessional contributions. Therefore, non-concessional contributions of $300,000 can be made in a 3-year period at any time. However, if a person uses this rule to contribute $300,000 at any time during that 3-year period, they cannot make any further nonconcessional contributions in that 3-year period. That bring forward is automatically triggered in any year where the non-concessional contributions exceed the $100,000 annual [page 523] non-concessional contributions cap. Note: In bring-forward arrangements, the two future years of entitlements are not indexed.

Read ITAA 1997 Div 290 Step 3: Taxation of superannuation entities 15.29 The tax payable by a superannuation fund trustee is calculated using the normal provisions in ITAA 1936 and ITAA 1997, but as modified by special provisions in Div 295: s 295-10. Division 295 sets out the special rules for calculating the taxable income of (s 295-5(1)): superannuation funds; approved deposit funds (ADFs); pooled superannuation trusts; and companies (other than life insurance companies) that provide a superannuation product known as a retirement savings account (RSA). The taxable income of a superannuation fund is divided between the low tax component of its taxable income and the non-arm’s-length component of its taxable income. The low tax component is what is left of the taxable

income of the superannuation fund after deducting the non-arm’s-length component amount. The non-arm’s-length component is made up of nonarm’s-length income, discretionary trust income, non-arm’s-length fixed trust income and certain private company dividends: s 295-545. The main modifications to the way that a superannuation fund is taxed are in Div 295 and they are: the assessable income of a superannuation entity includes certain contributions per Subdiv 295-C; the trustee of a superannuation entity is liable to pay tax on the taxable income of the entity (rather than the member): s 295-5(2) and (3); capital gains are also taxed concessionally, as only two-thirds of a capital gain in respect of an asset that has been held for at least 12 months is assessable: ss 115-5–115-20; deductions are available for certain death and disability insurance costs of complying funds and RSA providers: Subdiv 295-G; and an exemption applies to investment income from assets that pay current pension liabilities: ss 295-385 and 295-390. An RSA provider is a company and is liable to pay tax on its taxable income: s 4-1. Certain specific income and deduction rules apply to RSAs: s 295-10. Public sector funds or schemes established under a state Act listed in the Income Tax Regulations 1936 are exempt (constitutionally protected funds): s 50-25, Item 8.

Modifications of provisions of the ITAA 1997 15.30 Subdivision 295-B modifies the application of some other provisions of the ITAA 1997 about income and deductions. [page 524]

Contributions included

15.31 Subdivision 295-C explains the contributions that are assessable income. There are three types of contributions: those made on behalf of someone else (eg, made by an employer); those made for the contributor’s own benefit and where they have notified that they intend to claim a tax deduction; and those transferred from other funds. Contributions made on behalf of someone else 15.32 Contributions made on behalf of someone else are assessable in the hands of the superannuation entity to which they are made: s 295-160. Contributions made on behalf of a spouse or a temporary resident of Australia are generally not assessable: ss 295-165, 295-171, 295-175, 295-185. The Government co-contributions and contributions for a child or spouse of the person contributing are also generally not assessable: s 295-170. Personal contributions and rollover amounts 15.33 Personal contributions where the contributor has provided a valid notice of their intention to deduct the contributions are assessable: s 295-190 Item 1. These contributions are typically made by individuals who receive less than 10 per cent of their income, reportable fringe benefits and reportable employer superannuation contributions as an employee. The untaxed element of a superannuation benefit rolled over into a complying fund or RSA provider is also assessable to the extent that it is not an excess untaxed rollover amount (an amount will be an excess untaxed rollover amount if it exceeds $1.355 million): ss 295-190(1) and (4). Transfers from foreign funds 15.34 A resident superannuation fund may be assessable on an amount transferred to it from a non-resident superannuation fund: s 295-200.

Contributions excluded 15.35

Subdivision 295-D provides complying funds and ADFs with an

option of reducing the contributions that would otherwise have been included in their assessable income.

Other income amounts 15.36 Subdivision 295-E includes and excludes certain amounts in assessable income: ss 295-320, 295-335.

Exempt income 15.37 Subdivision 295-F exempts some amounts from income tax, such as amounts used to fund current pension liabilities: ss 295-385–295-400. [page 525]

Deductions 15.38 Subdivision 295-G lists deductible and non-deductible amounts relating to an entity’s superannuation activities. For example, premiums paid on insurance policies to cover a liability to pay death or disability benefits to fund members are deductible: ss 295-460–295-475.

Components of taxable income 15.39 Subdivision 295-H sets out the components of the taxable income of complying funds, complying ADFs, pooled superannuation trusts and RSA providers for the purpose of applying tax rates. Complying superannuation funds, complying ADFs and pooled superannuation trusts 15.40 The income of a complying superannuation fund, complying ADF or pooled superannuation trust consists of a non-arm’s-length component and a low tax component: s 295-545(1).

The non-arm’s-length component comprises certain dividends received from private companies, non-fixed interest trust distributions and any income derived from transactions where the parties are not dealing with each other at arm’s length: ss 295-545(2), 295-550. After subtracting any deductions attributable to that income, it is taxed at the highest marginal rate. The balance of the entity’s taxable income is the low tax component, which is taxed at a concessional rate (15 per cent, or 10 per cent for capital gains from assets held for at least 12 months): s 295-545(3).

RSA providers 15.41 RSA providers calculate their assessable income attributable to providing RSAs (the RSA component), which is taxed at the concessional rate (15 per cent, or 10 per cent on capital gains from assets that have been held for at least 12 months): s 295-555. The rest of their income (the standard component) is taxed at the normal company rate.

Deductions for contributions 15.42 Superannuation entities can deduct amounts incurred in obtaining contributions, even if the contributions are not assessable: s 295-95.

Exclusions of personal contributions 15.43 Superannuation funds and RSA providers include contributions in their assessable income only where the contributor advises that they will be claiming a deduction: s 295-195. [page 526]

No tax file number contributions income 15.44

Subdivision 295-I governs superannuation and RSA providers that

receive superannuation contributions that are included in assessable income but where no tax file number (TFN) is attached to the receiving member’s account.

No TFN income tax offset 15.45 Subdivision 295-J allows a superannuation provider to obtain a refund of no TFN contributions income tax paid where a TFN is subsequently quoted.

Read ITAA 1997 Div 295 Superannuation fund reporting requirements 15.46 The new superannuation provider reporting obligations are rationalised in TAA 1953 Div 390.

Read TAA 1953 Div 390 Step 4: Taxation of superannuation benefits 15.47 To encourage people to fund their retirement, superannuation has always been taxed on a concessional basis under the ITAAs 1936 and 1997. There are two types of superannuation benefits: a superannuation member benefit; and a superannuation death benefit.

Superannuation member benefits paid from complying plans 15.48 Division 301 sets out the taxation arrangements that apply to superannuation member benefits paid from complying superannuation funds.

Member benefits are generally all superannuation benefits that are paid to the member from a superannuation fund, other than benefits paid to someone else after the death of the member. A superannuation benefit paid to a person age 60 and over (as either a superannuation lump sum or a superannuation income stream benefit) from a superannuation fund that has paid tax is not assessable income, as it is nonassessable non-exempt income: s 301-10. Subdivision 301-C applies to superannuation benefits that include an element untaxed in the fund (ie, where the benefit comes from a superannuation fund that has not paid tax, such as a public sector superannuation plan). The tax-free component of a superannuation member benefit paid to a person who has reached his or her preservation age and is below age 60 is not assessable income and is not exempt income: s 301-15. [page 527] The taxable component of a superannuation lump sum benefit paid to a person who has reached his or her preservation age and is below age 60 is assessable income taxed at 0 per cent up to the low rate threshold amount (which is $200,000 for 2017–18) and 15 per cent on the excess above that amount: s 301-20.

Example Bill is age 57 and has just been paid $400,000 from his taxed superannuation fund. Of that amount, $100,000 was contributions that he had made to the fund and for which he received no tax deductions. He will not pay any tax on that $100,000 and no tax on the first $200,000 of the balance. He will pay tax at 15 per cent on the remainder. Departing Australia superannuation payments 15.49 A person’s departing Australia superannuation payment is not assessable income and not exempt income: s 301-175(1). However, the benefit is subject to a final withholding tax in accordance with the

Superannuation (Departing Australia Superannuation Payments Tax) Act 2006 s 301-175(2).

Superannuation lump sum of less than $200 15.50 A member benefit that is less than $200 in value is not assessable income and not exempt income if it is paid as a superannuation lump sum and it is the entire benefit in the plan: s 301-225.

Read ITAA 1997 Div 301 Superannuation death benefits 15.51 Division 302 governs the taxation of superannuation death benefits. The taxation of such arrangements varies according to whether the person who receives the superannuation death benefit is a ‘death benefit dependant’ of the deceased and whether the amount is paid as a lump sum superannuation death benefit or a superannuation income stream death benefit. A lump sum superannuation death benefit paid to a death benefit dependant from a superannuation fund that paid tax is tax-free. A superannuation income stream benefit paid to a death benefit dependant from a taxed superannuation fund where either the deceased was at least age 60 or the death benefit dependant is at least age 60 is also tax-free.

Example Bob died at age 61 and the $350,000 in his taxed superannuation fund was paid to his widow, Blanche. Blanche pays no tax on that lump sum amount.

Read ITAA 1997 Div 302 Rollovers 15.52

A rollover superannuation benefit is a lump sum superannuation

member benefit paid into, or received from, a complying superannuation plan: s 306-10. A rollover [page 528] superannuation benefit is not assessable income and not exempt income and is also generally not taxed at the time that the rollover occurs: s 306-5.

What is a superannuation benefit? 15.53 A member of a superannuation fund has rights against the trustee to have the superannuation fund administered according to the trust deed and superannuation law. In this way, members receive superannuation benefits that are generally paid from superannuation funds, RSAs, ADFs or superannuation annuities. A superannuation annuity covers superannuation income streams purchased from life insurance companies and other similar providers. See the table at s 307-5. There are two types of superannuation benefits: a superannuation member benefit (see the table at s 307-5(1) column 2); and a superannuation death benefit (see the table at s 307-5(1) column 3). The following are not superannuation benefits (s 307-10): payments as an income stream because a person is temporarily unable to perform his or her normal duties as an employee — these are considered to be replacement of regular income and are therefore taxable as normal income; a benefit to which ITAA 1936 s 26AF(1) or s 26AFA(1) applies; an amount required by the Bankruptcy Act 1966; and payments received from a commutation of a superannuation income stream and wholly applied to pay a superannuation contributions surcharge liability — these are tax-free.

Components of a superannuation benefit 15.54 There are two components in a superannuation benefit: the tax-free component and the taxable component: s 307-120. Tax-free component 15.55 The tax-free component of a superannuation interest is the total value of the contributions segment and the crystallised segment: s 307-210. The contributions segment typically includes all contributions made from 1 July 2007 that have not been included in the assessable income of the superannuation provider (ie, non-concessional contributions): s 307-220(1). The crystallised segment includes the following existing components of an interest that are being consolidated into the tax-free component (s 307-225): undeducted contributions; the pre-July 1983 component; the CGT-exempt component; the concessional component; and the post-June 1994 invalidity component. The segment is calculated by assuming that an ETP representing the full value of the superannuation interest is paid just before 1 July 2007: s 307-225. [page 529] The pre-July 1983 component comprises superannuation benefits accrued or accumulated before 1 July 1983: s 307-225. The CGT-exempt component and a post-June 1994 invalidity component occur where these components have been rolled into a superannuation interest prior to 1 July 2007. The value of these components is crystallised on 30 June 2007: s 307-225. A concessional component would also exist in a superannuation interest only if a redundancy, early retirement or invalidity payment that was made before 1 July 1994 was rolled over into superannuation. The value of the concessional component is crystallised on 30 June 2007: s 307-225.

Taxable component 15.56 The taxable component of a superannuation lump sum is included in the taxpayer’s assessable income: s 301-20. The taxable component of the superannuation interest is calculated by subtracting the tax-free component from the total value of the superannuation interest. The taxable component of a superannuation benefit paid from a superannuation interest consists of the element taxed in the fund and the element untaxed in the fund: s 307-215. The taxable component of a superannuation benefit consists of an element taxed in the fund except in limited circumstances: s 307-275. The taxable component of superannuation benefits paid from untaxed superannuation schemes (ie, government superannuation schemes for public servants) has an element untaxed in the fund, to the extent that no contributions and earnings tax has been paid. These untaxed superannuation schemes are constitutionally protected funds that are specifically exempted from tax on all contributions and earnings (s 307-280) and superannuation funds that pay tax on contributions and earnings but are partially unfunded: s 307-295.

Example Brian has $400,000 in the account of his taxed superannuation fund. Of that $400,000, $100,000 is the tax-free component made up of a ‘crystallised component’, being amounts that would have been concessionally taxed under the rules before July 2007 and calculated then, plus concessional contributions that he had made to the fund from that date. In that case, the balance of his account, being $300,000, is the taxable component. If Brian is paid a lump sum of the whole amount before he is age 60, then the $100,000 is tax-free, as is the first $200,000 of the taxable component, with the balance taxed at 15 per cent.

Example If, instead of being paid from a taxed superannuation fund, the $400,000 was paid to Brian from a non-taxed superannuation fund, such as a government fund, then the $100,000 tax-free component would still be tax-free. However,

the balance would be taxed at 15 per cent on the first $200,000 and 30 per cent on the balance. [page 530]

Read ITAA 1997 Div 307 Step 5: Taxation of employment termination payments 15.57 Until July 2007, when superannuation taxes were simplified, payments made in consequence of the termination of employment were taxed in exactly the same way that benefits paid from a superannuation fund were taxed. From 1 July 2007, payments that were made on the termination of employment, such as retirement, but that were not paid from a superannuation fund, are now taxed as ETPs under separate provisions. These provisions tax ETPs that are made in consequence of termination where such a payment is not made from a superannuation entity. An ETP is a lump sum payment made in consequence of the termination of an individual’s employment: s 82-130(1). To qualify as an ETP, the payment must generally be made within 12 months of the termination of employment. The rate of tax on ETPs depends on whether the payments are made to someone during their lifetime or to someone else on their death, and also depends on the amount of the payment. Tax concessions apply for amounts up to the ETP cap amount — which started as $140,000 in 2007–08 and is indexed in $5000 amounts, so it is $200,000 for 2017–18. A life benefit termination payment is an ETP made in consequence of a person’s termination of employment, other than as a result of death: s 82-130(1)(a)(i) and (2). A death benefit termination payment is an ETP made to a person after another person’s death: s 82-130(1)(a)(ii) and (3).

Excluded from employment termination payments

15.58 The following payments are excluded from being an ETP (ss 82130(1)(c), 82-135): superannuation benefits; payments from a pension or an annuity (to exclude from these provisions an income stream that may be paid by an employer); unused annual leave payments; unused long service leave payments; the part of a genuine redundancy payment or an early retirement scheme payment that is tax-free; foreign termination payments; payment made by a company or trust per s 152-310(2); advances or loans on arm’s-length terms; a payment that is deemed to be a dividend; reasonable capital payments for personal injury; reasonable capital payments for restraint of trade; payments resulting from the commutation of a superannuation income stream that are wholly applied in paying any superannuation contributions surcharge; and an amount included in assessable income under ITAA 1936 Pt III Div 13A. [page 531]

Tax treatment of life benefit termination payments 15.59 Provided that the payment is not subject to the ‘whole-of-life cap’, an ETP up to the ETP cap amount, which was $200,000 for 2017–18 that is paid after a taxpayer reaches their preservation age, is taxed at 15 per cent. If the taxpayer is below that age, that amount is taxed at 30 per cent: s 82-10(4). Amounts in excess of the ETP cap amount are taxed at the highest marginal tax rate: ss 82-140–82-160.

Tax treatment of death benefit termination payments 15.60 An ETP up to the ETP cap amount, which was $200,000 for 2017– 18, that is paid on the death of a person to someone who is a death benefit dependant, is tax-free up to that cap amount. If the payment is made to someone who is not a death benefit dependant, an amount up to that cap amount is taxed at 30 per cent. Amounts in excess of the ETP cap amount that are paid on death are taxed at the highest marginal tax rate: ss 82-65–8275.

Other payments on termination 15.61 Division 83 includes provisions for unused annual leave, unused long service leave, genuine redundancy payments, early retirement scheme payments and foreign termination payments. Unused annual leave payments 15.62 Unused annual leave, recreational leave and annual holidays are included as assessable income: ss 83-10(1) and (2). To the extent that an unused annual leave payment is made in connection with a genuine redundancy payment, early retirement scheme payment or the individual’s invalidity, or is related to employment before 18 August 1993, the rate of tax will be no more than 30 per cent (plus the Medicare levy). An unused annual leave payment is a payment or bonus in relation to unused annual leave in consequence of an employment termination: s 83-10(3). All other unused annual leave payments are taxed at marginal income tax rates. Unused long service leave payments 15.63 Unused long service leave payments that are paid in consequence of an employment termination are included as assessable income. Unused long service leave and the criteria for entitlement to a tax offset are set out in ss 8375–83-115. Genuine redundancy payments and early retirement scheme payments

15.64 Genuine redundancy payments and early retirement scheme payments continue to receive the same concessional tax treatment. The taxfree part of the payment is excluded from assessable income and is not exempt income: s 83-170(2). The tax-free part of a payment is determined by reference to a base amount plus an amount per year of service: s 83-170(3). Where a payment on redundancy or early retirement exceeds the available tax-free amount, the excess will qualify as an ETP and be taxed on that basis: ss 82-130, 83-175(4). [page 532] Foreign termination payments 15.65 Special rules apply to termination payments related exclusively to overseas employment or service. Payments that meet the conditions in ss 83235 and 83-240 are not subject to tax in the hands of the recipient and they are not exempt income: Subdiv 83-D.

Read ITAA 1997 Divs 80, 82, 83 Step 6: Other issues Untaxed transfers 15.66 Untaxed benefits that are transferred or rolled over from an untaxed superannuation scheme into a taxed superannuation fund remain subject to tax as taxable contributions. From 1 July 2007, the Superannuation (Excess Untaxed Roll-Over Amounts Tax) Act 2007 imposes a withholding tax at the top marginal tax rate for transferring untaxed amounts above $1.445 million 2017–18. Up to $1.445 million of the transferred benefit is a taxable contribution by the receiving fund: ss 4, 5. The balance is an exempt component in the receiving fund and is not taxed further.

Superannuation guarantee contributions 15.67 The employer’s superannuation guarantee contributions for employees did only apply up to the age of 70, but that age limit was abolished from July 2013.

SGC 15.68 The SGC was introduced from 1 July 1992. The charge provides a liability for employers that do not contribute the correct amount of superannuation contributions on behalf of their employees. Where employers do not meet the requisite level of superannuation contributions for their employees, which is currently 9.5 per cent of ordinary time earnings, they are required to pay the non-deductible SGC plus an administration fee and interest: Superannuation Guarantee Charge Act 1992 (SGCA) s 5.

Read SGCA 1992 s 5 The amount of contributions that employers are required to make to avoid the liability is called a charge, and it is equal to the superannuation guarantee shortfall. Employers are required to make contributions on behalf of their employees to complying superannuation funds, RSAs and the superannuation holding accounts reserve. The superannuation holding accounts reserve is a fund maintained by the ATO. This fund is designed for employees with only small amounts of superannuation contributions so that their funds are not eroded by fund manager fees and charges. [page 533] The Commissioner notifies each employee in respect of SGC payments made on their behalf. The employee should then notify the Commissioner as

to which complying superannuation fund, ADF or RSA this money should be paid to.

Superannuation and RSA supervisory levy 15.69 A superannuation and RSA supervisory levy is imposed on superannuation funds to assist with the regulation costs: Superannuation Supervisory Levy Imposition Act 1998; Superannuation (Self-Managed Superannuation Funds) Supervisory Levy Imposition Act 1991. These levies are deductible: ITAA 1997 s 25-5.

Practice Problem 1 What is superannuation?

Practice Problem 2 1 2 3

How are employer superannuation funds taxed? How are self-employed superannuation funds taxed? Are employee and self-employed contributions to superannuation funds taxed?

Practice Problem 3

Are superannuation pensions subject to tax?

Attempt the Web Quiz for Chapter 15

Summary 15.70 Superannuation is a regulated and concessionally taxed savings scheme that encourages taxpayers to save for retirement. [page 534] Follow the step-by-step process to identify the superannuation issues: Step 1: Understand the superannuation basics; Step 2: Taxation of superannuation contributions by employers, selfemployed and employees; Step 3: Taxation of superannuation entities; Step 4: Taxation of superannuation benefits; Step 5: Taxation of ETPs; and Step 6: Other issues. Concessional tax treatment applies to: contributions to funds: can be deductible or subject to tax offsets or be exempt from fringe benefits tax; superannuation funds: complying superannuation funds are taxed at 15 per cent and at 10 per cent on 1-year capital gains; and superannuation benefits: lump sums and pensions are concessionally taxed

— Australians age 60 and over who receive a benefit from a fund that has paid tax do not pay tax on their superannuation benefits (either as a lump sum or as a pension). An ETP is, broadly, a payment made to a person as a consequence of the termination of their employment made by employers, superannuation funds, RSAs and ADFs. These are also generally concessionally taxed.

Further problems

1 2 3 4

5 6 7 8

Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. What types of tax concessions are available for superannuation? How much are the tax concessions for superannuation worth? (That is, what is the Government’s tax expenditure?) Do superannuation tax concessions represent good tax policy? Provide an outline of how the Australian superannuation regime works for: employers; employees; and the self-employed. What is an ETP? What are the types of superannuation funds? What is the difference between the concessional and non-concessional contributions cap? Outline a complying superannuation fund.

[page 535]

16 Special taxpayers Learning Objectives After you have studied this chapter, you should be able to: outline which main types of taxpayers are subject to special rules; determine what special deductions are available to these taxpayers; determine what special income rules are available to these taxpayers; and determine what tax offsets are available to these taxpayers.

[page 536]

Key Legislative Provisions Income Tax Assessment Act 1997 (ITAA 1997) s 40-80 s 40-370 ss 40-630–40-645 s 40-735 s 995-1 Div 385 Div 392 Div 393 Div 405

Diagram 16.1:

Special taxpayers

[page 537]

Chapter overview 16.1 The income tax provisions contain numerous special rules for particular types of taxpayers. This chapter examines the following special cases: 1. mining; 2. primary producers; 3. artists, authors, inventors, sportspersons, production associates; and 4. Australian film. 16.2

A limited number of other taxpayers are also affected by special rules,

but these are not considered in this text. These include life insurance companies, co-operative companies, public trading trusts, corporate unit trusts, corporate limited partnerships, pooled development funds, mutual insurance associations and non-profit associations. 16.3 This chapter examines the eighth step of determining assessable income. INCOME METHOD Chapter 4

Do international tax issues apply to the receipt?

Chapter 5

What tax accounting rules apply?

Chapter 6

Is it ordinary income?

Chapters 7 and 15

Is it statutory income (excluding capital gains)?

Chapter 8

Does an exemption apply?

Chapter 9

Do the capital gains tax provisions apply?

Chapters 14 and 15

Do the entity rules apply?

This chapter — Do the special taxpayer rules apply? Chapters 17

Do the anti-avoidance provisions apply?

Determine whether the receipt is assessable income This chapter also examines the seventh step of the deduction method. Chapter 4

Do international tax issues apply to the receipt?

Chapter 5

What tax accounting rules apply?

Chapter 10

Is it a general deduction?

Chapter 11

Is it a specific deduction (excluding capital allowances)?

Chapter 12

Do any of the deduction or denial limitations apply?

Chapter 13

Is it a capital allowance?

[page 538]

Chapters 14 and 15

Do the entity rules apply?

This chapter — Do the special taxpayer rules apply? Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the expense is deductible

Mining 16.4 Mining companies have a number of tax concessions governing deductions as well as mining income.

Mining income concessions Mining payments to Aboriginals: ITAA 1997 s 59-15 16.5 A mining withholding tax of 4 per cent is payable on mining payments to Aboriginals for the use of Aboriginal land for mining and exploration. Such payments that are subject to withholding tax are nonassessable non-exempt income per s 59-15.

Mining deduction concessions 100 per cent deductions for exploration or prospecting — depreciable assets: s 40-80 16.6 Section 40-80 provides an immediate deduction for expenses on depreciable assets first used for exploration or prospecting for minerals (which includes petroleum under s 40-730(5)) or quarry materials obtainable by mining operations where, at the time the taxpayer first uses the asset or installs it ready for use: the taxpayer carried on mining operations; it is reasonable to conclude that the taxpayer proposed to carry on mining operations; or

the taxpayer carried on a business of exploration or prospecting for minerals or quarry materials by mining operations, and the expenses were necessarily incurred in carrying on that business. For the meaning of ‘a depreciable asset’, see s 40-30. 16.7

Section 40-730(7) defines mining operations as: mining operations on a mining property for extracting minerals, except petroleum, from their natural site; mining operations for obtaining petroleum; or quarrying operations on a quarrying property for extracting quarry materials from their site. Note: Section 40-80 does not permit deductions for drilling for petroleum or running a mining operation, quarrying operation or petroleum field. [page 539]

Read ITAA 1997 s 40-80 Practice Problem 1 What constitutes mining operations under ITAA 1997 Div 40?

100 per cent deductions for exploration or prospecting: s 40-730 16.8 Section 40-730(1) provides an immediate deduction for expenses (excluding expenses on depreciable assets) on exploration or prospecting for minerals, or quarry materials obtainable by mining operations, where: the taxpayer carried on mining operations;

it is reasonable to conclude that the taxpayer proposed to carry on mining operations; and the taxpayer carried on a business of exploration or prospecting for minerals or quarrying materials by mining operations, and the expenses were necessarily incurred in carrying on that business. Note: Section 40-730 does not permit deductions for drilling for petroleum or working a mining property, quarrying operation or petroleum field. Subdivision 40-I may, however, apply to these.

Read ITAA 1997 s 40-730 Practice Problem 2 What types of expenses are deductible under ITAA 1997 s 40-730?

Rehabilitation of mining, quarrying or petroleum sites: ITAA 1997 s 40-735 16.9 Expenses incurred on the rehabilitation of mining, quarrying or petroleum sites are 100 per cent deductible in the year incurred. Rehabilitation means restoring or rehabilitating a site or part of a site to its pre-mining condition or a reasonable approximation of that condition. [page 540]

Read ITAA 1997 s 40-735 Practice Problem 3

What kind of expenses qualify as deductible rehabilitation expenses under ITAA 1997 s 40-735?

Petroleum resource rent tax: ITAA 1997 s 40-750 16.10 750.

Payments of the petroleum resource rent tax are deductible: see s 40-

Environmental protection: ITAA 1997 ss 40-755–40765 16.11 Environmental protection activity expenses may be deductible under s 40-755(1). These activities prevent, fight or remedy pollution resulting from the taxpayer’s income-earning activity or are carried on to treat, clean up, remove or store waste from the taxpayer’s income-earning activity. Note: This provision applies not only to mining but also to other types of taxpayers.

Read ITAA 1997 s 40-755 Capital write-offs for mining capital expenditure: ITAA 1997 Subdiv 40-I 16.12 The following mining capital expenditure (excluding depreciable asset costs) may be deductible over the estimated life of the project: see ITAA 1997 ss 40-830–40-875: listed mining capital expenditure: see s 40-860(1); and listed transport expenditure: see s 40-865(2).

Read ITAA 1997 ss 40-830–40-875

Primary production 16.13 Primary producers have a number of tax concessions governing deductions, income and tax offsets. These are set out below.

What is a primary production business? 16.14 First, to take advantage of the concessions, a taxpayer must generally carry on a business of primary production. ITAA 1997 s 995-1(1) lists a wide range of types of primary [page 541] production activities, including cultivating or propagating plants, maintaining animals, fishing and forestry operations.

Read ITAA 1997 s 995-1(1) primary production business Practice Problem 4 1 2

What types of activities involve primary production? What types of activities do not constitute primary production?

The real issue is generally whether the taxpayer’s activities constitute a business rather than a hobby or pastime. As discussed previously (see Chapter 3), there are a number of factors that need to be taken into account in determining whether a business exists. It is important to note that activities may be preparatory and do not amount to a business operation: Nelson v FCT [2014] FCA 57.

Practice Problem 5 When does a taxpayer carry on a business of primary production?

Primary production income 16.15 Primary production income includes receipts from the sale of produce, livestock and skins as well as insurance payments for lost profits and assessable balancing charges. This is important for the averaging rules. Further, the Australian Taxation Office (ATO) has issued rulings in respect of: cotton income; wheat and barley income; wool income; and forest operations (see ).

Primary production income concessions Forced disposal or death of livestock: ITAA 1997 Subdiv 385-E 16.16 The profit from the forced disposal or death of livestock from a primary production business may be spread over 5 years. This election is available where the forced disposal or death of livestock occurs when there is: [page 542] a compulsory acquisition or resumption of land; a drought, fire or flood; a compulsory destruction under Australian law for the control of disease;

a statutory notification regarding contamination; or a state or territory leasing land for cattle tick eradication. Alternatively, a taxpayer may elect to defer the tax profit by applying it against the cost of replacement trading stock.

Livestock and timber insurance recoveries: ITAA 1997 Subdiv 385-F 16.17 Insurance recoveries for the loss of livestock in a primary production business may be spread over 5 years where a taxpayer makes the election under s 385-130. Also, insurance recoveries for the loss of trees by fire in a primary production business may be spread over 5 years where a taxpayer makes the election under s 385-130. The concession is available only if the election has been made.

Double wool clips: ITAA 1997 Subdiv 385-G 16.18 Where an advanced shearing occurs as a result of a drought, fire or flood, a wool grower may elect to have the profit from the advanced shearing deferred to the following income tax year. An election must generally be made on or before the due date for lodging the first tax return when the impact of the election applies: s 385-150.

Primary production depreciating assets: ITAA 1997 Subdiv 385-F Water facilities 16.19 Capital expenditure incurred by primary producers on water facilities is deductible over 3 years. Water facilities include dams, tanks, bores, wells, pipes, windmills, pumps, water channels and water towers. Capital expenditure includes the costs of constructing, manufacturing, acquiring, installing or improving plant or structural improvement for the purpose of

conserving or conveying water for use of a primary production business operated by the taxpayer.

Read ITAA 1997 ss 40-515–40-575; IT 252; TD 96/41 Horace is engaged full time in the business of farming. He spends $100,000 on building a dam on his dairy cattle farm. In the income year in which he incurs the expenditure (and each of the subsequent two income years), Horace will be entitled to deduct $33,333.1

[page 543]

Practice Problem 6 What is a water care facility?

Horticultural plants 16.20 The capital cost incurred in establishing horticultural plants if the plants are used or held ready for use in a business of horticulture is deductible at accelerated rates. A horticultural plant can be a depreciable asset. Where the effective life of a plant is less than 3 years, a 100 per cent deduction is provided. Effective life for plants is provided in TR 2000/18. A sliding scale for write-off rates applies to plants with effective lives exceeding 3 years.

Read ITAA 1997 ss 40-515–40-575 In February 2002, Astri plants 2000 avocado trees on

her farm, which she plans to harvest for commercial use. Four years later, the first avocados from these trees are able to be harvested and sold commercially. Therefore, the decline in value commences in 2006 when the avocados are ready for picking, this being when the first commercial season starts. If the avocados are ready for picking, but Astri has not yet picked them, and a hailstorm destroys all the avocados, Astri will still be entitled to deduct an amount that is the decline in value of the plants for that income year.2 XYZ Pty Ltd grows lemons for the domestic market. On 1 March 2002, XYZ Pty Ltd spent $400,000 establishing a lemon farm by planting lemon trees. The first lemons are ready for picking on 1 March 2006. The plants have an effective life of 20 years. The decline in value for these plants is: 2005–06 income year establishment expenditure × (write-off days in income year/365) × write-off rate $400,000 × (122/365) × 13% = $17,380.82 2006–07 income year establishment expenditure × (write-off days in income year/365) × write-off rate $400,000 × (365/365) × 13% = $52,000 Because the decline in value over the 20-year effective life of the lemon trees would exceed the $400,000 capital expenditure, s 40-515 provides a cap on the amount that can be deducted, ensuring that a taxpayer cannot deduct more than the amount of capital expenditure incurred on the depreciating asset.3

[page 544]

Following on from the previous example, because it was decided that the lemon trees have an effective life of 20 years, XYZ Pty Ltd must deduct the capital expenditure in 7 years and 253 days (s 40-545(3), item 5 in the table). By deducting the capital expenditure over this period, XYZ Pty Ltd will not be able to deduct more than the amount of capital expenditure incurred on the depreciating asset. It is important to note that the time periods in the table in subs 40-545(3) cannot be extended. If XYZ Pty Ltd, for example, did not use the lemon trees for commercial horticulture and did not hold them ready for that use in the 2008–09 income year, XYZ Pty Ltd will not be able to deduct an amount for the decline in value of the lemon trees for that income year. Thus, at the end of the 7 years and 253 days, XYZ Pty Ltd may still have an amount that could be deducted, but it will not be entitled to deduct this amount in the following income year because it is outside the 7 years and 253 days time frame.4

Practice Problem 7 What is a horticultural plant?

Landcare operations: ITAA 1997 s 40-630 16.21 A 100 per cent deduction applies to capital expenditure incurred on landcare operations by a taxpayer carrying on a primary production business or a taxpayer carrying on a business other than mining or quarrying for a taxable purpose from the use of rural land. Landcare expenditure includes:

destruction of weed or plant growth that is detrimental to the land; eradication or extermination of animal or vegetable pests; erection of fences to exclude livestock or vermin to prevent or combat land degradation; preventing or combating land degradation; construction on the land of drainage works for controlling salinity; and construction of levee banks. [page 545]

Read ITAA 1997 ss 40-630–40-675 Practice Problem 8 What is a landcare operation?

Electricity and telephone lines: ITAA 1997 s 40-645 16.22 The capital cost incurred by the landowner or a share farmer for connecting power to land or upgrading the connection or extending or situating telephone lines on land used for primary production business can be written off over 10 years.

Read ITAA 1997 s 40-645 Timber deductions: ITAA 1997 Subdiv 70-E 16.23 Where a taxpayer acquires land that is carrying trees or a right to fell trees on someone else’s land, a deduction is provided for the cost of the trees

acquired. Thus, when the taxpayer sells the trees, he or she is able to deduct the acquisition cost.

Read ITAA 1997 s 70-120 Timber plantation prepayments: ITAA 1936 s 82KZMG 16.24 Timber plantation prepayments invested in timber plantation managed investment schemes are excluded from the prepayment restrictions. This generally applies to the expenses of planting and tending trees for felling and must be incurred between 2 October 2001 and 1 July 2006. The investor has to include the prepayment as assessable income in the year the deduction is available for the investor: ITAA 1997 s 15-45.

Read ITAA 1936 s 82KZMG Farm management deposits: ITAA 1997 Div 393 16.25 Under the Farm Management Deposits Scheme, a primary producer can move income from good to poor years to provide relief for drought, flood or economic changes. The scheme is complex but basically it provides a 100 per cent deduction for a farm management deposit, provided that the taxpayer did not give more than $65,000 of non-primary production income, die, become bankrupt, or cease being a primary producer for more than 120 days in the year. However, upon the withdrawal of the farm management [page 546] deposit, that amount must be included in assessable income. The total amount that can be held is $400,000.

Averaging tax offset: ITAA 1997 Div 392 16.26 The averaging system for primary producer taxpayers attempts to smooth out incomes where such taxpayers experience fluctuating incomes: ITAA 1997 ss 392-1–392-95. Thus, in high income years, primary producers enjoy an averaging adjustment (by way of a tax offset against income tax) that alleviates the tax burden. In low income years, the adjustment increases the tax payable. Averaging generally applies to individuals, whether alone or in partnership. Certain individuals presently entitled to trust income will also be included where the trust carries on a primary production business and, in accordance with s 392-20(2): the share of the trust income to which the beneficiary is presently entitled is less than $1040; and the Commissioner is satisfied that the beneficiary’s interest in the trust was not acquired so as to access the averaging concessions. Beneficiaries in discretionary trusts are not deemed to be carrying on a primary production business where the trustee does not exercise their discretion in the beneficiaries’ favour, although a beneficiary can be deemed to be carrying on a primary production business in a loss year or nil income year of a trust: Case Z35 92 ATC 326. Thus, averaging does not apply to companies (other than as trustee) or to trust income to which no beneficiary is presently entitled. A taxpayer may withdraw from averaging, but once this is done, it is irrevocable: s 392-5. Ordinary rates of tax will apply in the year of the election and in all following tax years.

Read ITAA 1997 ss 392-1–392-95 Permanent loss of income: s 392-95 16.27 Where a permanent loss of income occurs, a prior high income year may be dropped out of averaging. This may occur upon retirement or another

event where taxable income is reduced to less than two-thirds of average taxable income.

Applying averaging 16.28

Averaging involves a five-step process. This process is set out below.

Step 1: Calculate current year basic taxable income 16.29 Basic taxable income refers to taxable income that: excludes an assessable death benefit employment termination payment (ETP) or an excessive component of an ETP; [page 547] excludes above-average special professional income (see 16.35 below); and excludes deductions that are not allowed under the non-commercial loss provisions.

Step 2: Calculate the comparison rate of tax 16.30 The comparison rate of tax refers to the rate of tax payable in the current year at basic rates of tax on the primary producer’s average income. Basic rates of tax: Basic rates of tax refer to the normal marginal income rates for residents or non-residents. Average income: Average income is the basic taxable income averaged over the 4 previous years and the current year (over a maximum of 5 years). PRIMARY PRODUCER COMMENCED ON 1 JULY 2001 YEAR ENDED 30 JUNE

BASIC TAXABLE INCOME $

2001

50,000

2002

100,000

2003

200,000

2004

50,000

2005

400,000

Total

800,000

The average income in the current tax year is $160,000. Note: At the commencement of averaging, the second year of basic taxable income must exceed the first year for averaging to be applied. Using the above example, averaging can apply from 2001 and thus be treated as the first year. However, if the basic taxable income in 2002 was only $25,000, then 2001 would be the first year for averaging. Comparison rate of tax: The comparison rate of tax is calculated as follows: Zarah, a resident primary producer, has an average income of $58,000 in the current income tax year and her comparison rate of tax is: ($58,000 at basic rates of tax)/$58,000 = $13,572/$58,000 = 23.4%

Step 3: Calculate the averaging component 16.31 The averaging component is the primary producer’s taxable primary production income and non-taxable primary production income. Averaging applies to this amount. A primary producer has taxable primary production income where the primary production assessable income exceeds the primary production deductions. The non-commercial loss

[page 548] restricted deductions are excluded. Non-taxable primary production income forms part of the averaging component if it is less than $5000. Between $5000 and $10,000, shading rules apply. However, where it is greater than $10,000, it is excluded. Zarah’s basic taxable income of $58,000 comprises $35,000 of taxable primary production income and $23,000 of non-taxable primary production income, and her averaging component is $35,000. Jake’s basic taxable income of $20,000 comprises $16,000 of taxable primary production income and $4000 of non-taxable primary production income, and his averaging component is $20,000.

Step 4: Compare tax payable 16.32 A comparison is made of (1) the tax payable on the basic taxable income for the current year at the comparison rate of tax and (2) the tax payable on the basic taxable income for the current year at the basic rates of tax. If (1) is less than (2), a tax offset results. If (1) exceeds (2), additional tax is payable.

Step 5: Calculate the averaging adjustment 16.33 This is calculated as follows (ITAA 1997 s 392-75): Gross averaging amount (averaging component divided by basic taxable income) The gross averaging amount is the difference as calculated in step 4 (16.32).

Tax payable for an individual is then calculated as normal with an adjustment made for the above averaging adjustment (tax offset or additional tax). Investors in forestry schemes: Div 394 16.34 Division 394 provides initial investors in forestry schemes with a 100 per cent tax deduction. Secondary investors will receive a tax deduction equal to 100 per cent of their ongoing contributions. There must be a reasonable expectation that at least 70 per cent of the scheme manager’s expenditure under the scheme (at arm’s-length prices) is expenditure attributable to establishing, tending and felling trees for harvest.

Artists, authors, inventors, sportspersons, production associates 16.35 Income averaging applies to special professionals in ITAA 1997 Div 405. These include artists, authors, inventors, sportspersons and production associates. Basically, the rules provide tax relief for any above-average special professional income and capital gains by applying an average tax rate. A complex series of calculations is required: see Div 405. [page 549]

Australian film 16.36 Division 375 governs certain deductions on Australian films. Subdivision 375-G allows a tax loss, but the film component of the tax loss is quarantined. Subdivision 375-H provides deductions for shares in a Film Licensed Investment Company (FLIC).

Streamlining concessions for Australian films and Australian film production: Div 376 16.37 Division 376 provides three refundable tax offsets in relation to Australian expenditure incurred in making films (a company may use these offsets). The offsets are designed to support and develop the Australian screen media industry by providing concessional tax treatment for Australian expenditure. The three tax offsets are:5 (a) a refundable tax offset for Australian expenditure in making an Australian film (the producer offset); (b) a refundable tax offset for Australian expenditure in making any film (the location offset); and (c) a refundable tax offset for Australian expenditure on post, digital and visual effects production for any film (the PDV offset).

Attempt the Web Quiz for Chapter 16

Summary 16.38 In determining a taxpayer’s assessable income, deduction and tax offsets, you need to be aware of the rules that apply to special taxpayers. These include: miners; primary producers; artists, authors, inventors, sportspersons and production associates; and Australian film.

Further problems

Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. [page 550] 1

2

3

4

DNA Oil discovers oil in the current tax year and incurs the following costs in that year for exploration: wages for oil expert, $200,000; wages for workers, $400,000; oil drilling rig, $5,000,000; and oil drilling rig maintenance costs, $300,000. What deductions are available? Deep Down Coal Inc operates coal mines in New South Wales but closed one of its mines in the current tax year due to the low level of its coal reserves. It incurs the following costs: in-fill costs to cover up the mine site excavations, $2,000,000; wages for clean-up workers, $300,000; truck costs, $500,000; and trees and shrubs, $5000. What deductions are available? a How does the averaging tax offset system for primary producers work? b Can primary producers obtain any other tax benefits in high income years? Which of the following taxpayers can access averaging? a Mozart is a professional piano player.

5

6

7

8

b Wright flies planes for a big airline company. c Duck Hollow Wines operates a fine wine vineyard. d Edith writes books about adventures. e Bernie is a ballet dancer. f Shane is a cricketer. Ingrid, on the advice of Alfie, invests in a forest plantation. It costs her $10,000 and she owns a part of the new Alice Springs hardwood plantation. Is this deductible? Highlander Minerals dumps 300,000 tonnes of mining waste into a nearby river and this devastates the surrounding jungle area. It pays $5 million to clean up part of the pollution. What deductions are available? Safety Battery company has a toxic discharge that contaminates a nearby small country town. It pays $2 million to clean up the pollution. What deductions are available? Mr D Hollow, a winemaker, establishes his own vineyard and on 1 June of the current tax year incurs $100,000 of costs in planting new vines and installing trellis. He also constructs a levee bank costing $5000 and incurs $10,000 of costs for extending a telephone line to his cellar door. What deductions are available?

1.

The Explanatory Memorandum, New Business Tax System (Capital Allowances) Act 2001, para 5.11, example 5.1.

2.

The Explanatory Memorandum, New Business Tax System (Capital Allowances) Act 2001, para 5.18, example 5.2. The Explanatory Memorandum, New Business Tax System (Capital Allowances) Act 2001, para 5.28, example 5.3.

3. 4. 5.

The Explanatory Memorandum, New Business Tax System (Capital Allowances) Act 2001, para 5.29, example 5.4. s 376-2.

[page 551]

17 Anti-avoidance Learning Objectives After you have studied this chapter, you should be able to: distinguish between tax planning, tax avoidance and tax evasion; outline the general anti-avoidance rules; determine whether a scheme under ITAA 1936 Pt IVA exists; determine whether a tax benefit under ITAA 1936 Pt IVA has been obtained; determine a taxpayer’s purpose in obtaining a tax benefit under ITAA 1936 Pt IVA; determine whether general anti-avoidance rules in ITAA 1936 Pt IVA apply; outline the specific anti-avoidance rules; apply the non-commercial loss (NCL) rules; apply the alienation of personal income rules; and identify the promoter penalty rules.

[page 552]

Key Legislative Provisions Income Tax Assessment Act 1936 (ITAA 1936) Pt IVA Income Tax Assessment Act 1997 (ITAA 1997) Div 35 Divs 84–87

Key Cases AAT Case 2/2015 [2015] AATA 45 AAT Case 3/99 (1999) 99 ATC 134 AAT Case W58 (1989) 89 ATC 524 Applicant and FCT, Re AAT Case [2004] AATA 349; (2004) 55 ATR 1082 British American Tobacco Australia Services Ltd v FCT (2010) 189 FCR 151; 80 ATR 813; ATC 20-222 Cameron v FCT [2011] FCA 1378 Channel Pastoral Holdings Pty Ltd v FCT [2015] FCAFC 57 Eastern Nitrogen v FCT (2001) 108 FCR 216; 206 ALR 207; 55 ATR 712 Farnan v FCT (2005) 58 ATR 1350; ATC 2093; [2005] AATA 302 FCT v Dixon Consulting Pty Ltd (2006) 65 ATR 290; ATC 4832; [2006] FCA 1748 FCT v Futuris Corporation Ltd [2012] FCAFC 32 FCT v Hart (2004) ATR 712; (2004) ATC 4591; [2004] HCA 26 FCT v Peabody (1994) 181 CLR 359; 123 ALR 451; ATC 4663

FCT v Sleight (2004) 55 ATR 555; (2002) ATC 4477; [2004] FCAFC 94 FCT v Spotless Services Ltd (1996) 168 CLR 404; 141 ALR 92 Fletcher v FCT (1992) 92 ATC 2045; 23 ATR 555 Fowler v FCT (2008) 167 FCR 425; 72 ATR 64 Heaney and FCT, Re (2013) 60 AAR 59; [2013] AATA 331 Metal Manufacturers Ltd v FCT (1999) 99 ATC 5229; 43 ATR 375 Park and FCT, Re [2011] AATA 567 Richard Walter Pty Ltd v FCT (1997) 97 ATC 4051; 34 ATR 467 R v Jones; R v Hili [2010] NSWCCA; 76 ATR 249 Ryan and FCT, Re (2004) 82 ALD 140; 56 ATR 172; ATC 2181 Re Tabone and FCT AAT Case [2006] AATA 466; (2006) ATC 2211 Watson v DCT [2010] FCAFC 17 WD & HO Wills (Australia) Pty Ltd v FCT (1996) 65 FCR 298; 32 ATR 168; 96 ATC 4223

Key ATO Publications Part IVA: the general anti-avoidance rule for income tax Alienation of personal services income: what is personal services income? — fact sheet Non-commercial losses (NCL): overview — fact sheet [page 553]

Diagram 17.1:

Income tax method — anti-avoidance

Chapter overview 17.1

The tax laws contain both general (ITAA 1936 Pt IVA) and specific

anti-avoidance provisions. Part IVA is a general anti-avoidance provision of last resort. Clearly, if a specific provision applies to a transaction (eg, alienation of personal services income (PSI) or NCLs), an amount will be assessed as income or denied as a deduction. However, the application of Pt IVA is not as clear-cut. First, there are the complex requirements in Pt IVA that need to be satisfied. Second, the courts are often reluctant to apply Pt IVA merely because a taxpayer takes advantage of a loophole in the tax laws, unless an artificial and contrived arrangement [page 554] is involved. Also, a number of tax offences (including criminal offences) apply to taxpayers or their advisers who undertake tax avoidance or tax evasion. This chapter examines the ninth step in the income method and the eighth step in the deductions method. INCOME METHOD Chapter 4

Do international tax issues apply to the receipt?

Chapter 5

What tax accounting rules apply?

Chapter 6

Is it ordinary income?

Chapter 7

Is it statutory income (excluding capital gains tax (CGT))?

Chapter 8

Does an exemption apply?

Chapter 9

Do the CGT provisions apply?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

This chapter — Do the anti-avoidance provisions apply? Determine whether the receipt is assessable income DEDUCTIONS METHOD Chapter 5

What tax accounting rules apply?

Chapter 10

Is it a general deduction?

Chapter 11

Is it a specific deduction (excluding capital allowances)?

Chapter 12

Do any of the deduction limitations apply?

Chapter 13

Is it a capital allowance?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

This chapter — Do the anti-avoidance provisions apply? Determine whether the expense is deductible

The initial and important question is: what is tax avoidance as opposed to tax evasion? Also, it is important then to identify what is simply good tax planning. Gleeson CJ stated in R v Meares (1997) 37 ATR 321 at 323: Although on occasion, it suits people for argumentative purposes, to blur the difference, or pretend that there is no difference, between tax avoidance and tax evasion, the difference between the two

[page 555] is simple and clear. Tax avoidance involves using, or attempting to use, lawful means to reduce tax obligations. Tax evasion involves using unlawful means to escape payment of tax. If the parties to a scheme believe that its possibility of success is entirely dependent on the revenue authorities never finding out the true facts, it is likely to be a scheme of tax evasion, not tax avoidance.

Tax evasion 17.2 Tax evasion involves a clear violation of the law; for example, overstating your expenses or understating your income on your tax return. Tax evasion can very often result in a jail sentence or massive tax assessments. For example, two men were sentenced to 1-year jail terms for illegal tobacco possession and evasion of excise of $325,000,1 and a Sydney brothel owner was ordered to pay $947,000 in unpaid tax for concealed income.2

R v Jones; R v Hili [2010] NSWCCA 108; 76 ATR 249 Facts: The taxpayers made fraudulent claims for deductions for management and other fees paid to overseas entities, which were then returned to the taxpayers as loans under a round-robin arrangement. The tax evaded was $700,000. The taxpayers pleaded guilty to the offences. Their original sentence was 18 months (7 months recognisance release period). The Crown appealed the jail sentence. NSW Court of Criminal Appeal held: The court had erred in exercising its discretion to impose a sentence of only 18 months and increased the sentences to 3 years.

Tax avoidance 17.3 Tax avoidance means taking advantage of legal loopholes in a highly artificial or contrived manner. Such schemes generally involve complex structures, unusual financing arrangements (eg, round-robin financing and non-recourse loans), no-risk guarantees and an emphasis on secrecy, and do not provide for independent advice. In the 1970s, tax avoidance was rife throughout Australia as people took advantage of the courts’ narrow interpretation of the anti-avoidance rules and the complacency of the Government in failing to reform the inadequate anti-avoidance measures. However, in the 1980s, the Government introduced a new general antiavoidance provision and has since introduced a massive stream of specific antiavoidance provisions. Additionally, the courts have taken more of a purposive approach to interpreting the tax statutes, and this has nullified many schemes under the general income tax provisions such as s 8-1.3 Further, the courts have more actively applied the new general anti-avoidance provision. This has been demonstrated by the judicial clampdown on the mass-marketed schemes.4 As an attempt to limit tax avoidance the Government signs information-sharing agreements with other governments.

[page 556]

Tax planning 17.4 Tax planning is basically arranging a taxpayer’s dealings in a way that minimises their tax liability. This differs from tax avoidance in that it does not involve highly artificial or contrived arrangements. Examples of good tax planning are using the most suitable entity or taking advantage of concessions such as the CGT discount or the main residence exemption: see Chapter 20. It is usually easy to distinguish between tax evasion and tax avoidance; however, the line between tax avoidance and tax planning can be very blurred! Indeed, the courts have had considerable difficulty in making the distinction. This chapter focuses on the general anti-avoidance provision Pt IVA and certain other specific provisions aimed at particular arrangements. The specific anti-avoidance measures are also considered in earlier chapters.

General anti-avoidance: ITAA 1936 Pt IVA 17.5 Part IVA, the general anti-avoidance provision, applies to arrangements entered into after 27 May 1981. Part IVA is designed to apply to schemes entered into with the sole or dominant purpose of obtaining a tax benefit, although Pt IVA will not apply to normal tax planning and family tax planning arrangements. In the 2015 Federal Budget, the Government announced new measures to combat multinationals attempting to divert profits from Australia to lower or nil tax jurisdictions. The measures introduced in the Tax Laws Amendment (Tax Integrity Multinationals Anti-Avoidance Law) Bill 2015 do not use the dominant purpose test. Instead, a principal purpose test is used. As of April 2017, the ATO had raised $2.9 billion in tax liabilities as part of the new multinational anti-avoidance measures.

Read ITAA 1936 ss 177c and 177D 17.6 Part IVA is really a last stop measure, as, generally, other approaches will be applied to strike down blatant, artificial or contrived arrangements before the Commissioner relies on Pt IVA. For example, sham transactions5 will not need to rely on Pt IVA for the tax avoidance to be struck down, as in Richard Walter below. [page 557]

Richard Walter Pty Ltd v FCT (1997) 34 ATR 4051; 97 ATC 4051 Facts: The taxpayer received $9 million in what it described as a loan from a related offshore company. The Commissioner contended that the $9 million was income. Federal Court held: The sum was income. The arrangement was a sham; the $9 million was not, in reality, a loan but a transfer of beneficial ownership of money, with no obligation to repay the amount. Further, the general income and deductions provisions in the ITAA 1997 (ss 6-5 and 8-1) will work to counter many tax minimisation arrangements that seek to convert an income amount to a non-income amount, or convert non-deductible expenses to deductible expenses. For example, in Myer Emporium, the assignment of an interest income stream for a lump sum payment of $45 million was held to be income under ordinary concepts. In Fletcher, the court relied on the general deductions provision to prevent a tax avoidance arrangement. Fletcher v FCT 92 ATC 2045; 23 ATR 555

Facts: The taxpayer entered into an annuity scheme that provided large interest deductions and minimal income in the early years. In the later years, the interest expenses fell and the income rose. However, the taxpayer had the option of exiting out of the scheme, such that the interest expenses would have exceeded any assessable income. AAT held: The interest expenses were not deductible to the extent that they exceeded assessable income. The excess expenditure over income could not be characterised as earning assessable income; rather, the purpose was to minimise tax. Also, see the High Court case Fletcher v FCT (1991) 173 CLR 1; 91 ATC 495. Federal Court held: The sum was income. The arrangement was a sham; the $9 million was not, in reality, a loan but a transfer of beneficial ownership of money, with no obligation to repay the amount.

Application of ITAA 1936 Pt IVA 17.7 Part IVA has been revised,6 and the new rules apply to schemes entered into, or commenced to be carried out, on or after 16 November 2012. These reforms were made in order to have the following effects:7 1. to put it beyond doubt that the ‘would have’ and ‘might reasonably be expected to have’ limbs of each of the s 177C(1) paragraphs represent alternative bases upon which the existence of a tax benefit can be demonstrated; 2. to ensure that when obtaining a tax benefit that depends on the ‘would have’ limb of one of the paragraphs in s 177C(1), that conclusion is 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; [page 558]

3.

4.

to ensure that when obtaining a tax benefit that depends on the ‘might reasonably be expected to have’ limb of one of the paragraphs in s 177C(1), that conclusion is 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; and to require the application of Pt IVA to start with a consideration of whether a person participated in the scheme for the sole or dominant purpose of securing for the taxpayer a particular tax benefit in connection with the scheme and so emphasising the dominant purpose test in s 177D as the ‘fulcrum’ or ‘pivot’ around which Pt IVA operates.

17.8 For Pt IVA to apply, there are three basic requirements: 1. there is a scheme; 2. there is a basis for identifying a tax benefit; and 3. the scheme has a purpose of obtaining a tax benefit.

Is it a scheme? 17.9

ITAA 1936 s 177A(3) widely defines a scheme as: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct.

Read ITAA 1936 s 177A Practice Problem 1

Provide an example of a scheme.

A tax benefit must be obtained 17.10

A tax benefit is defined in s 177C:

(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to: (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably [page 559] be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or (ba) a capital loss being incurred by the taxpayer during a year of income where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred by the taxpayer during the year of income if the scheme had not been entered into or carried out; or (baa) a loss carry back tax offset being allowable to the taxpayer where the whole or a part of that loss carry back tax offset would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into or carried out; or (bb) a foreign income tax offset being allowable to the taxpayer where the whole or a part of that foreign income tax offset would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into or carried out; or (bc) the taxpayer not being liable to pay withholding tax on an amount where the taxpayer either would have, or might reasonably be expected to have, been liable to pay withholding tax on the amount if the scheme had not been entered into or carried out; and, for the purposes of this Part, the amount of the tax benefit shall be taken to be: (c) in a case to which paragraph (a) applies — the amount referred to in that paragraph; and (d) in a case to which paragraph (b) applies — the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph; and

(e)

in a case to which paragraph (ba) applies — the amount of the whole of the capital loss or of the part of the capital loss, as the case may be, referred to in that paragraph;

(ea) in a case where paragraph (baa) applies — the amount of the whole of the loss carry back tax offset or of the part of the loss carry back tax offset, as the case may be, referred to in that paragraph; and (f) in a case where paragraph (bb) applies — the amount of the whole of the foreign income tax offset or of the part of the foreign income tax offset, as the case may be, referred to in that paragraph; and (g) in a case to which paragraph (bc) applies — the amount referred to in that paragraph. Further, s 177C(4)–(5) provides: (4) To avoid doubt, paragraph (1)(a) applies to a scheme if: (a) an amount of income is not included in the assessable income of the taxpayer of a year of income; and (b) an amount would have been included, or might reasonably be expected to have been included, in the assessable income if the scheme had not been entered into or carried out; and (c) instead, the taxpayer or any other taxpayer makes a discount capital gain (within the meaning of the Income Tax Assessment Act 1997) for that or any other year of income. (5) Subsection (4) does not limit the generality of any other provision of this Part.

Under the former rules, the problem with this test is that it required the Commissioner to hypothesise about what might happen if the scheme had not been entered into. This caused problems in FCT v Peabody 94 ATC 4663, although, in Spotless, the court was able to form a reasonable expectation that the amount would have been included in assessable income if not for the scheme. Other relevant cases are Ryan and Futuris. [page 560]

Re Ryan and FCT (2004) 82 ALD 140; 56 ATR 172; 2004 ATC 2181 Facts: The taxpayer set up a company to provide IT services to its customers. The taxpayer and his wife were both directors, shareholders and employees of the company. The company claimed deductions for wages and superannuation contributions paid on behalf of the wife. The Commissioner asserted that a tax benefit existed in

the difference between the fees received by the company and the salary paid to the taxpayer husband. AAT held: No tax benefit existed, as the payment of the wife’s wages and superannuation contributions was reasonable. Also, the AAT found that the company’s agreements with its clients were not part of any scheme.

FCT v Futuris Corporation Ltd [2012] FCAFC 32 Facts: The taxpayer wanted to sell its Building Products Division, which was owned by two of its subsidiaries, W and B. The assets and the shares in B were transferred to W to enable the sale. W acquired the B shares at a discount of $83 million. Thus, the value of the taxpayer’s shareholding in W increased. As B shares were transferred between group companies for less than their cost base or market value, the former value shifting provisions in ITAA 1936 Div 19A operated; thus, the cost base of the W shares to the taxpayer was increased by $83 million. The W shares were sold by the taxpayer for $150 million, which resulted in a net capital gain to the taxpayer of $2.3 million. The Commissioner argued that Pt IVA applied in respect of the tax benefit, the $83 million adjustment. Full Federal Court held: Part IVA did not apply to a scheme under which the value shifting provisions operated to increase the cost base of the shares held by the taxpayer in one of its subsidiaries by some $83 million, with the result that the capital gain made by the taxpayer on the sale of the subsidiary was reduced by that amount. No tax benefit resulted, since if the scheme had not been carried out, it would have been reasonable to expect that the sale would have taken place by the sale of the other subsidiary, and this would lead to the same tax outcome. It should be noted that the reference to income in s 177C (1)(a) can include

the capital gains provisions: see AAT Case 2/2015 [2015] AATA 45. This is also supported by s 177C(4). Exclusions from tax benefits 17.11 Where a tax benefit is obtained from making an agreement, choice, declaration, election, selection, notification or option that is expressly provided for in the ITAA, then this is outside the scope of Pt IVA: see s 177C(2)–(3).

Read ITAA 1936 s 177C A taxpayer operates his truck business through a discretionary trust to obtain a lower tax rate, rather than as a sole trader; this will not be caught by Pt IVA. However, where a taxpayer earns personal exertion income, he or she cannot operate their activity through a trust or company so as to split income. In that situation, a tax benefit would be obtained and Pt IVA will apply.

[page 561]

Practice Problem 2 1 2

What situations provide a tax benefit? What situations would not create a tax benefit?

The bases for identifying tax benefits 17.12

Section 177CB (1)–(4) provide the bases for identifying tax benefits

as follows: (1) This section applies to deciding, under section 177C, whether any of the following (tax effects) would have occurred, or might reasonably be expected to have occurred, if a scheme had not been entered into or carried out: (a) an amount being included in the assessable income of the taxpayer; (b) the whole or a part of a deduction not being allowable to the taxpayer; (c) the whole or a part of a capital loss not being incurred by the taxpayer; (ca) the whole or a part of a loss carry back tax offset not being allowable to the taxpayer; (d) the whole or a part of a foreign income tax offset not being allowable to the taxpayer; (e) the taxpayer being liable to pay withholding tax on an amount. (2) A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme). (3) A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme. (4) In determining for the purposes of subsection (3) whether a postulate is such a reasonable alternative: (a) have particular regard to: (i) the substance of the scheme; and (ii) any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of this Act); but (b) disregard any result in relation to the operation of this Act that would be achieved by the postulate for any person (whether or not a party to the scheme).

Schemes for the purpose of obtaining a tax benefit 17.13 Under the revised ITAA 1936 Pt IVA rules, you must consider the following in determining whether the obtaining of a tax benefit is the purpose of a scheme (see s 177D): Scheme for the purpose of obtaining a tax benefit (1) This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of: (a)

enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or [page 562]

(b) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain

a tax benefit in connection with the scheme; whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers. Have regard to certain matters (2) For the purpose of subsection (1), have regard to the following matters: (a) the manner in which the scheme was entered into or carried out; (b) the form and substance of the scheme; (c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (f)

any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out; (h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f). Note: Section 960-255 of the Income Tax Assessment Act 1997 may be relevant to determining family relationships for the purposes of paragraphs (f) and (h). Tax benefit (3) Despite subsection (1), this Part applies to the scheme only if the relevant taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme. When schemes entered into etc. (4) Despite subsection (1), this Part applies to the scheme only if: (a) the scheme has been or is entered into after 27 May 1981; or (b) the scheme has been or is carried out or commenced to be carried out after that day (and is not a scheme that was entered into on or before that day). Schemes outside Australia (5) This section applies whether or not the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia.

177DA Schemes that limit a taxable presence in Australia 17.14

The anti-avoidance rules are expanded under s 177DA:

(1) Without limiting section 177D, this Part also applies to a scheme if: (a)

under, or in connection with, the scheme:

(i)

a foreign entity makes a supply to an Australian customer of the foreign entity;

and (ii) activities are undertaken in Australia directly in connection with the supply; and

[page 563] (iii) some or all of those activities are undertaken by an Australian entity who, or are undertaken at or through an Australian permanent establishment of an entity who, is an associate of or is commercially dependent on the foreign entity; and (iv) the foreign entity derives ordinary income, or statutory income, from the supply; and (v) some or all of that income is not attributable to an Australian permanent establishment of the foreign entity; and (b) it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a principal purpose of, or for more than one principal purpose that includes a purpose of: (i) enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit, or both to obtain a tax benefit and to reduce one or more of the relevant taxpayer’s liabilities to tax under a foreign law, in connection with the scheme; or (ii) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit, or both to obtain a tax benefit and to reduce one or more of their liabilities to tax under a foreign law, in connection with the scheme; whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers; and (c) the foreign entity is a significant global entity for a year of income in which the relevant taxpayer, or one or more other taxpayers, would (but for this Part): (i) obtain a tax benefit; or (ii) reduce one or more of their liabilities to tax under a foreign law; in connection with the scheme. Have regard to certain matters (2) For the purposes of paragraph (1)(b), have regard to the following matters: (a) the matters in subsection 177D(2); (b) the extent to which the activities that contribute to bringing about the contract for the supply are performed, and are able to be performed, by: (i) the foreign entity; or (ii) another entity referred to in subparagraph (1)(a)(iii); or (iii) any other entities; (c) the result, in relation to the operation of any foreign law relating to taxation, that (but

for this Part) would be achieved by the scheme. Deferral of foreign tax liabilities (3) For the purposes of paragraph (1)(b), a deferral of a taxpayer’s liabilities to tax under a foreign law is taken to be a reduction of those liabilities, unless there are reasonable commercial grounds for the deferral. Tax benefit (4) Despite subsection (1), this Part applies to the scheme because of this section only if the relevant taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme.

[page 564] Commissioner not required to enquire into foreign tax matters (5) The Commissioner is required to have regard to a matter referred to in paragraph (2)(c) only so far as information relevant to that matter is available to the Commissioner, and is not required to acquire further information in order to have regard to that matter. Schemes outside Australia (6) This section applies whether or not the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia.

With retrospective effect from 1 January 2016, the Government has amended the multinational anti-avoidance law so that it applies to corporate structures involving the interposition of partnerships that have any foreign resident partners; trusts that have foreign resident trustees and foreign trusts that temporarily have their management and control in Australia. The Government has also proposed to strengthen this area with the introduction of the Anti-Money Laundering and Counter-Terrorism Financing Amendment Bill in 2017. What is the purpose of obtaining a tax benefit? 17.15 If an arrangement is motivated purely or predominantly by commercial reasons, then it will not have the requisite purpose. This authority is clear from the pre-16 November 2012 cases that follow. FCT v Peabody (1994) 181 CLR 359; 123 ALR 451; 94 ATC 4663

Facts: The taxpayer, the majority shareholder of the company, purchased the shares of a minority shareholder and subsequently floated the company on the stock market. The arrangement circumvented ITAA 1936 s 26AAA, which would have otherwise brought the profit into assessable income. The Commissioner viewed the arrangement to be tax avoidance; Pt IVA applied. High Court held: Part IVA did not apply, as the arrangement was predominantly for a commercial purpose.

WD & HO Wills (Australia) Pty Ltd v FCT (1996) 65 FCR 298; 32 ATR 168; 96 ATC 4223 Facts: The taxpayer established a subsidiary in Singapore to act as its insurer for any claims made for health problems associated with using its products. The taxpayer could not otherwise obtain insurance, as no insurance company would write such a policy. The Commissioner viewed that Pt IVA applied. Federal Court held: Part IVA did not apply, as the arrangement was purely commercial and any tax advantages were merely incidental.

Metal Manufacturers Ltd v FCT 99 ATC 5229; 43 ATR 375 Facts: The taxpayer claimed deductions under a sale and leaseback arrangement of factory plant. The arrangement had a number of artificial features. The Commissioner argued that the plant was a fixture and the taxpayer retained legal title, thus the rent paid could not be deductible, and that Pt IVA applied. Court held: Part IVA did not apply. Despite the artificiality of the arrangements, the lease was intended to be effective, and the purpose of the arrangement was to reduce short-term debt. The taxpayers did not have the sole or dominant purpose in entering the scheme to

obtain a tax benefit. Also see Metal Manufacturers v FCT [2001] FCA 365.

[page 565] Other cases involving purpose are set out below. Eastern Nitrogen v FCT (2001) ATC 4164; [2001] FCA 366 Facts: The taxpayer claimed deductions under a sale and leaseback arrangement of its ammonia plant. The arrangement had a number of artificial features. The Commissioner argued that the plant was a fixture and the taxpayer retained legal title, thus the rent paid could not be deductible, and that Pt IVA applied. It was a capital sum and the matter was a sham. Federal Court held: Part IVA did not apply, as the taxpayer’s dominant purpose in entering the scheme was for commercial reasons.

FCT v Spotless Services Ltd (1996) 186 CLR 404; 141 ALR 92 Facts: The taxpayer, a resident, had $40 million of surplus funds. At this time, ITAA 1936 s 23(q) exempted foreign source income that was subject to foreign tax. so the taxpayer invested the money in the Cook Islands, paying a low 5 per cent tax. The Commissioner viewed that the arrangement was tax avoidance and breached Pt IVA. High Court held: Part IVA applied. The most influential, prevailing and ruling purpose was to obtain a tax benefit.

AAT Case W58 89 ATC 524 Facts: The taxpayer, a computer consultant, entered into an arrangement whereby his services were provided through his family company. His personal exertion income was then split between the family members so as to minimise tax. The Commissioner considered that Pt IVA applied. AAT held: Part IVA applied. The dominant purpose of redirecting his personal exertion income was to obtain a tax benefit.

Re Applicant and FCT AAT Case [2004] AATA 349; 55 ATR 1082 Facts: The taxpayer, an individual, contracted to the Torres Pilots’ Association as a ship pilot. He set up a company to limit his liability in providing services. Also, he interposed the company between himself and the association, with the company contracted to provide pilot services even though all services were provided personally by the taxpayer. The ATO applied Pt IVA to assess the income to the taxpayer individual. AAT held: Part IVA applied, as the company was interposed to ensure that fees were not derived by the taxpayer; thus, the taxpayer obtained a tax benefit. No penalties were applied, though, as the taxpayer entered into the arrangement as normal practice for Torres Strait pilots.

FCT v Hart (2004) ATR 712; ATC 4591; [2004] HCA 26 Facts: The taxpayer claimed interest on a mass-marketed wealth maximiser split loan used partly for private use (home loan) and partly for business use (rental property loan). The repayments were

streamed only to the private loan, whereas interest was capitalised on the business loan. The Commissioner disallowed the higher amount of deductible interest from the compounding on the business loan. [page 566] High Court held: Part IVA did apply to the broad scheme concerning the split loan facility because the taxpayer’s main purpose was to obtain a tax benefit. The taxpayer had no dominant commercial purpose. The full amount of the compound interest was not deductible.

FCT v Sleight (2004) 55 ATR 555; (2002) ATC 4477; [2004] FCAFC 94 Facts: The taxpayer claimed prepaid expenses and interest as deductions for a tax-effective scheme involving tea tree oil. The arrangement involved non-recourse borrowing, prepayments, roundrobin financing and a management agreement. The Commissioner argued that Pt IVA applied to deny the deductions. At the first instance, the Federal Court rejected Pt IVA. The Commissioner appealed to the Full Federal Court. Full Federal Court held: Part IVA applied to deny the deductions, as the dominant purpose of entering the scheme was to obtain tax deductions. The court pointed to the non-recourse borrowing, prepayments, round-robin financing, management agreement and promotional material in its decision. The taxpayer also entered the arrangement on the last day of the tax year. Further, the prospectus stated that it would take 17 years to produce a profit.

British American Tobacco Australia Services Ltd v FCT (2010)

189 FCR 151; 80 ATR 813 Facts: The taxpayer disposed an asset and obtained a capital gain but argued that the same asset rollover provisions in ITAA 1997 Subdiv 126-B applied. The taxpayer asserted that the tax benefit would be excluded from the operation of ITAA 1936 Pt IVA pursuant to s 177C(2A)(a). The relevant scheme must be limited to the steps necessary to effect the ITAA 1997 Subdiv 126-B rollover relief. The Commissioner argued that ITAA 1936 Pt IVA applied. Full Federal Court: Agreed with the Commissioner. Section 177C(2A) did not apply, as the scheme was entered into for the purpose of creating the preconditions necessary for the rollover choice. The entire sequence of events had the effect of avoiding possible adverse CGT consequences for the taxpayer, and thus constituted a scheme under Pt IVA.

Income splitting 17.16 Where a taxpayer seeks to split income that is generated from personal exertion by using a partnership, company or trust, the Commissioner will seek to apply Pt IVA: see TR 2001/8. This follows the courts’ strict approaches in cases such as Gulland v FCT, Watson v FCT, Pincus v FCT 85 ATC 4765 and also AAT Case 3/99. AAT Case 3/99 99 ATC 134 Facts: The taxpayer worked as a sharebroker and investment adviser, and in 1974 he joined A as an employee. In 1982, he negotiated with A to change his basis of remuneration from salary to commission. He then used M Pty Ltd (M), a trustee of a family trust, as the entity to carry on the business of investment adviser. He paid himself a salary from this income, employed family members and distributed trust income to family members. No clients were advised

that they were now dealing with M rather than A. The Commissioner assessed the trust income to the taxpayer and added penalty. [page 567] AAT held: There was no business; the commission was nothing more than personal earnings of the taxpayer that were assigned after derivation by him to M. Accordingly, Pt IVA applied to the arrangement; the only objective purpose that could be seen from the arrangement with M was the reduction of personal income and the diversion of income to other beneficiaries of the family trust. There was no commercial justification for the arrangements. The Commissioner allowed for the salary to Mrs S and Miss C, accountancy fees, bank charges, printing and stationery, and motor vehicle expenses but disallowed superannuation contributions equivalent. However, in Macarthur v FCT 2002 ATC 2212, Pt IVA did not apply to an engineer who used a company to provide services to his ex-employer where there had been a 4-year break in employment. Note: The PSI anti-avoidance regime was introduced from the 2000–01 tax year to prevent individuals from reducing their tax by diverting PSI to an associated company, partnership, trust or individual or by claiming inappropriate business deductions: see Chapter 14. For an examination of the interaction between Pt IVA and the consolidation provisions of Pt 3-90, see Channel Pastoral Holdings Pty Ltd v FCT [2015] FCAFC 57.

Home loan interest deduction arrangements 17.17

The Commissioner will use Pt IVA to oppose home loan interest

deduction arrangements: see Taxation Ruling TR 2002/18; TD 2012/1.8 This approach was supported in Tabone. Re Tabone and FCT AAT Case [2006] AATA 466; (2006) ATC 2211 Facts: In the income tax years 1999–2003, the taxpayer claimed interest expenses in relation to borrowings to invest in the Tabone Unit Trust to construct his family home. The taxpayer transferred land that he owned to the unit trust and then obtained a loan (guaranteed by the trustee of their unit trust, which mortgaged the property as security to Westpac) to build the house. At the same time, units in their unit trust were issued to the taxpayer. After construction, he and his family moved into the new house. The taxpayer argued that he paid $130 per week rent to the unit trust. However, no records were kept of any regular payments. The taxpayer did not obtain any income from the unit trust in the income tax years 1999–2003. AAT held: The unit trust arrangement amounted to a scheme entered into for the dominant purpose of obtaining a tax benefit, and thus the general anti-avoidance rules in ITAA 1936 Pt IVA applied. FCT v Janmor Nominees Pty Ltd (1987) 19 ATR 254 was distinguished, as the taxpayer in that case sought a deduction for interest on a loan that was for a commercial purpose. Also, the AAT noted that Janmor was decided under ITAA 1936 s 260, not Pt IVA. Further, the AAT found that the interest expense was not deductible under ITAA 1997 s 8-1.

[page 568]

Mass-marketed tax schemes 17.18

Mass-marketed tax schemes have found little joy with the courts so

far with the application of ITAA 1936 Pt IVA. In Howland-Rose v FCT 2002 ATC 4200, Pt IVA was applied to deny interest claims under such a scheme involving non-recourse loans where there was little likelihood of commercial returns. Also, in Puzey v FCT 2002 ATC 4853, Pt IVA was applied to prevent deductions for the grossly inflated cost of seedlings under a sandalwood plantation scheme: see Sleight above.

Multinationals 17.19 Tax Laws Amendment (Combating Multinational Tax Avoidance) Act 2015 now prohibits significant global entities from entering into complex contrived schemes to avoid a tax presence in Australia. In addition, a new diverted profits tax as from 1 July 2017, for multinationals that attempt to shift their Australian profits offshore to avoid paying tax. See Diverted Profits Tax Act 2017 and the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act 2017.

Practice Problem 3 1 2

What is a sole or dominant purpose? Provide examples. What is not a sole or dominant purpose? Provide examples.

ITAA 1936 Pt IVA: weaknesses 17.20 The central problem or weakness of Pt IVA lies in the potential difficulty the Commissioner has in convincing the courts to apply the legislation. The courts are sometimes reluctant to apply Pt IVA merely because a taxpayer takes advantage of a loophole in the tax laws, and, given the number of loopholes in the tax laws, this may not be surprising. Orow found that Pt IVA has a conceptual flaw:9 That flaw is that it does not provide a reasonably coherent and discernible rule that guides and

defines its operation. It was established that this undermines broadly accepted principles of law and taxation. More particularly it creates a significant element of uncertainty in the operation of the Act as a whole … Where there is no alternative solution to the problem of tax avoidance, then the legislature may have no choice but to adopt some form of a general anti-avoidance provision. However, it is submitted that the principle enunciated by the High Court in Cooper Brookes (Wollongong) Pty Ltd v FCT,10 which looks to the purpose and policy of the Act as a guide to its meaning, provides a more coherent approach which, on balance, is more likely to produce results that

[page 569] are consistent with legislative intention. Where the ordinary and charging provisions operate as intended, there can be no tax avoidance and no policy justification for the application of a general anti-avoidance provision like Pt IVA.

As previously stated in Chapter 1, it is preferable for Parliament to omit tax preferences altogether; a comprehensive income tax base minimises tax avoidance. Further, any departures from such a tax base should be accompanied by legislation that sets out the clear purpose and policy for the exemptions so that they can be interpreted and applied. Of course, whatever the tax base may be, tax administrators must also be given the power and resources to ensure its effectiveness.

Specific anti-avoidance provisions Overview of specific anti-avoidance rules 17.21 There are numerous specific anti-avoidance provisions in the ITAAs 1936 and 1997 (see Chapters 4–16). Specific anti-avoidance measures covered previously in this text are outlined below. Tax accounting rules 17.22 There are specific rules that prevent the manipulation of the derivation of assessable income rules: see ITAA 1997 ss 6-5(4) and 6-10(4).

Similarly, there are specific rules preventing an abuse of prepaid expenditure: see ITAA 1936 ss 82KL–82KZO. The trading stock rules have measures dealing with: disposals outside the ordinary course of business: s 70-90; disposal when you stop holding trading stock: s 70-100; and disposal when you stop holding trading stock but still own it: s 70-110. The small business entity rules are complex anti-avoidance rules that are designed to prevent large taxpayers from taking advantage of the concessions: see Div 328 and Chapter 5. Statutory income 17.23 A number of statutory income provisions have been introduced to plug some of the loopholes that have emerged in the application of the ordinary income provision: s 6-5. These include: benefits from employment or services: ITAA 1997 s 15-2; assessable recoupments: Subdiv 20-A; disposal of car where lease is deducted: Subdiv 20-B; non-cash business benefits: ITAA 1936 21A; and lease premiums: s 26AB. Non-assessable income 17.24 The exempt entity rules contain numerous rules that restrict the types of entities that can gain exemption, and also have strict requirements for the conduct of exempt entities’ activities: see Chapter 8. [page 570] Capital gains and losses 17.25 The CGT provisions are broadly designed to limit the loss of revenue that results from the capital–income distinction in the ordinary income provision (discussed in Chapters 6 and 9). Thus, many capital gains

are brought into the assessable income net, and this greatly strengthens the tax code. Section 8-1 deductions 17.26 The courts have interpreted ITAA 1997 s 8-1 in a way that has instilled it with an anti-avoidance role. For example, see Fletcher (17.6), where the High Court looked at the purpose of the expenditure under the scheme in order to determine its deductibility. Deductions limitations 17.27 There are numerous restrictions on the types of expenses that are allowable deductions. These provisions were set out in Chapter 12. Capital allowances 17.28 The capital allowances rules contain a number of anti-avoidance measures such as: the luxury car depreciation limit: s 40-202; the denial of double deductions in s 49-50(1); and exclusion of eligible work-related items in s 40-45(1). And see Chapter 13 for the restrictions in the 5-year business-related costs in s 40-880. This chapter focuses in more detail on the specific anti-avoidance provisions detailed below.

Non-commercial loss restrictions: ITAA 1997 Div 35 17.29 The NCL provisions in Div 35 exclude deductions for losses from a business activity for an individual taxpayer (whether alone or in partnership) unless one of the exceptions below applies. If these exceptions do not apply, the loss is quarantined and can only be offset against future profits from the business activity. The exceptions are as follows: 1. the $20,000 assessable income exception;

2. 3. 4. 5. 6. 7.

profits exception; real property exception; other assets exception; non-high income earner exception; the primary producer and professional arts exception; and the Commissioner’s discretion exceptions where there are special circumstances or because of the nature of the loss. If a taxpayer derives exempt income during the year, then this must be applied to reduce any quarantined losses under s 35-10(2)(b).11 Further, if a taxpayer becomes bankrupt or enters a scheme of arrangement, then any NCLs brought forward are no longer deductible.12 [page 571] Rationale 17.30 The NCL rules are aimed at improving the integrity of the tax system by restricting the extent to which losses from an individual’s noncommercial business activities (particularly lifestyle activities) are used to reduce the tax paid on other income such as salary or wage income.13 Business and business activity 17.31 Division 35 requires as a first step a determination of whether an individual is carrying on a business. Further, the NCL provisions add another layer of complexity, since they apply separately to each business activity of taxpayers that cannot be grouped together as business activities of a similar kind.14 This poses a difficult issue of what constitutes a business activity of a similar kind. The Commissioner provides examples of similar businesses, such as a florist that introduces a new delivery service for customers. The delivery service is integral to the floristry business and thus does not constitute a distinct and separate business,15 whereas a taxpayer running a vineyard who starts up contracting work for neighbours involving spraying, mowing, weeding and

digging would have two separate and distinct activities. Further, applying the relevant factors, the following activities could not be described as being of a similar kind: see s 35-10(3).16 FACTOR

GRAPE GROWING

CONTRACT SERVICES

Location

On Des’s small vineyard

On properties of neighbours

Goods or services provided

Sale of grapes

Provision of contract services such as spraying, mowing etc

Market conditions

Governed by domestic and world market conditions for grapes

Dependent on demand of other farmers for services provided using the equipment; whether services of any other contractors available locally

Assets employed

Des’s land, and vineyard equipment used for grape growing

Various items of machinery

Other characteristics

Nature of income derived from sales of produce from land affected by risk of crop failures etc

Nature of income derived from the provision of services

The ATO regards the following activities as similar: grazing sheep and grazing cattle, growing grapes and growing olives, and manufacturing shirts and manufacturing jeans,17 [page 572] whereas activities such as manufacturing and farming or repairing cars and making furniture would not be described as similar activities.18 Thus, the NCL provisions have a much greater scope, since they can deny deductions for ancillary businesses even where the primary business is profitable. Gordon Cooper19 queries whether the service station owner who sells food and heat beads has separate business activities that require a separate profit and loss. Watson v DCT [2010] FCAFC 17

Facts: For the 2003–04 income year, the taxpayer derived income from his business as a financial planner and payments from a personal income protection insurance policy. The taxpayer had, since 1996, been partly incapacitated for work. During the 2003–04 year, his business traded at a loss. At issue was whether or not such loss could, for tax purposes, be set off against the policy income. Full Federal Court held: Division 35 applied. The policy income was not income from the taxpayer’s business activity; his business deductions could not be offset against such income for tax purposes for the 2003–04 income year. The exceptions 17.32 If any one of the following first four tests is satisfied, the taxpayer will avoid the NCL restrictions. If these are not satisfied, the taxpayer can then rely only on either the primary producer and artists exception or the Commissioner’s discretion exceptions (exceptions 5 and 6). 1.

The $20,000 assessable income exception

17.33 The assessable income test20 requires that the amount of assessable income from the business activity for the year is at least $20,000. If you started to carry on the business activity or stopped carrying it on during the year, then a reasonable estimate is made of what would have been the amount of that assessable income if you had carried on that activity throughout the year. The ATO sets out the following factors relevant in making a reasonable estimate:21 any orders you have received; any forward contracts you have entered into; the size of your business; the amount you have invested in the business activity; the type of business activity you are engaged in, and the typical income patterns for that industry; how your actual income would translate into an annual income on a pro rata basis; and

any cyclical or seasonal patterns in your business area and the effect they would have on your annual income. [page 573] 2.

Profits exception

17.34 The profits test requires22 that the business activity makes taxable income in three of the past five income years, including the current income year. The profits test, though, ignores any NCL carried forward. 3.

Real property exception

17.35 The rule in s 35-10 does not apply to a business activity for an income year if a taxpayer uses at least $500,000 of real property or interests in real property on a continuing basis in carrying on the activity in that year. The real property tests, though, exclude dwellings and curtilage used for private purposes. All but the larger of small businesses and the majority of small hobby-type farms would not satisfy this test. 4.

Other assets exception

17.36 The rule in s 35-10 does not apply to a business activity for an income year if the total value of assets that are counted for this test and are used on a continuing basis in carrying on the activity in that year is at least $100,000.23 This test includes depreciable assets, trading stock, leased assets, trademarks, patents and copyrights but excludes real property, cars, motorcycles and similar vehicles. Thus, this test favours small businesses with large amounts of depreciable assets and/or trading stock. 5.

High income earners

17.37 Taxpayers with an adjusted taxable income of greater than $250,000 have business losses quarantined to the business activity under Div 35. The current NCL limitations will apply to taxpayers with adjusted taxable incomes of $250,000 or more. Any excess deductions from a non-commercial business activity that are subject to Div 35 are to be disregarded in working out the

adjusted taxable income of the individual. The adjusted taxable income is the sum of an individual’s: taxable income; reportable fringe benefits; reportable superannuation contributions; and total net investment losses. Such high income earners, though, will be able to apply to the Commissioner to exercise his or her discretion to not apply the NCL rules if they can satisfy the Commissioner that, based on an objective expectation, the business activity will produce assessable income greater than available deductions within a commercially viable period for the industry concerned. 6.

The primary production business and professional arts exception

17.38 The NCL limitations do not apply if the business activity is a primary production business or professional arts business and your assessable income from other sources that do not relate to that activity is less than $40,000.24 This may lead to some manipulation of income. Taxpayers may refuse a pay rise or decrease their working hours to [page 574] remain under the threshold. Self-employed taxpayers may utilise business structures such as trusts, companies and partnerships to split income so as to satisfy the $40,000 exception. 7.

The Commissioner’s discretion exceptions

17.39 Where the above first four tests do not apply, the Commissioner may exercise his or her discretion not to apply the NCL provisions in the following two circumstances.25 Special circumstances 17.40

The Commissioner may exercise his or her discretion not to apply

the NCL provisions where the business activity was or will be affected in that or those income years by special circumstances outside the control of the operators of the business activity. These special circumstances include drought, flood, bushfire or some other natural disaster.26 This is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances. TR 2001/14 also provides that special circumstances may include: earthquakes; diseases affecting livestock or crops; pest plagues; hailstorms; an oil spill; a chemical spray drift; a gas plant explosion; a power plant shutdown; a water authority malfunction; government authority restriction imposed on land use; or other events (eg, illness of the operator or employee) that have significantly affected the ability of the operator to carry on the business activity.27 Because of its nature and objective expectation test 17.41 1.

This discretion has the following three requirements.28

Business activity has started to be carried on

17.42 It is clear that an individual must have started to carry on a business activity. This broadly requires that the individual has made a decision to commence the business activity, acquired the minimum level of business assets to allow that business activity to be carried on and actually commenced business operations.29 A mere intention to start carrying on a business activity will not be sufficient.

[page 575] 2.

Because of its nature

17.43 The business activity has started to be carried on and, because of its nature, it has not yet satisfied one of the first four tests set out above.30 For example, it may take many years for the activity to reasonably be expected to produce income, as when pine trees are planted for harvesting for wood chipping. The activity will not pass the four tests. It is the nature of the activity that means that it will not generate assessable income for a number of years that is considered, not whether it is too small an activity. 3.

Objective expectation

17.44 There must be an objective expectation, based on evidence from independent sources (where available), that, within a period that is commercially viable for the industry concerned, the activity will either meet one of the four tests or produce a profit.31 The Commissioner explains that such evidence includes:32 Appropriate independent sources include industry bodies or relevant professional associations, government agencies, or other taxpayers conducting successful comparable businesses. The evidence to be presented to the Commissioner to show that the second arm of the discretion should be exercised, should also deal with the nature and extent of the investment required to establish a viable and profitable activity. A business plan could provide this information where it has been prepared on the basis of the relevant independent evidence and is accompanied by copies of the relevant material.

While this requirement should not cause too many problems for wellestablished industries, there may be some concerns for new and innovative industries that have difficulty accessing such industry information. Clearly, the NCL provisions penalise businesses that require a longer lead time than the industry norm (perhaps due to poor or inexperienced management or human error), since the discretion cannot be applied and the losses will be quarantined. Further, the Commissioner cannot exercise the discretion at a time after the earlier of the time at which it would be reasonable to expect the activity to first produce a profit or meet one of the four tests. For example, if a start-up business obtained a $20,000 grant or

subsidy in the first year, it would not be able to obtain the Commissioner’s discretion for losses during the lead time until profitable production.

Read ITAA 1997 Div 35 The following AAT cases illustrate the operation of Div 35. [page 576]

Farnan v FCT AAT Case [2005] AATA 302 Facts: The taxpayer, a motor car driving instructor, claimed a $25,000 loss incurred in carrying on his business. He contended that the NCL restrictions in ITAA 1997 Div 35 did not apply, since his activity constituted a professional arts business, and he thus sought the special concessions under s 35-10(4). His method involved letting clients get a feel for driving and gain freedom from thought and the mechanics of driving. He used dual control cars and sometimes ran 10-hour driving sessions. The taxpayer noted that the business had cost him a lot of money in repairs from minor collisions. He also argued that the Commissioner should have exercised his discretion under s 35- 55 for special circumstances outside the control of the taxpayer, and thus allow his claim. AAT held: The taxpayer’s objection should be disallowed. Clearly, a driving instructor business does not amount to a professional arts business. Further, there were no special circumstances outside the control of the taxpayer, such as drought, flood or other natural disasters, to allow his claim.

Re Heaney and FCT AAT Case [2013] AATA 331

Facts: The taxpayer, a medical practitioner, owned two loss-making farms that conducted cattle breeding and sheep farming. His 2010 income tax return claimed losses of $179,187 in relation to the farming business. The taxpayer argued that the Commissioner should exercise his discretion under the NCL rules, s 35-55(1)(a), in relation to one of the farms, due to special circumstances — namely, drought. Also, the taxpayer argued that the Commissioner should exercise his discretion under s 35-55(1)(c) in respect of the other farm, due to that farm being in start-up phase. AAT held: The NCL rules applied to limit losses. The taxpayer had not discharged the onus of proving, on the balance of probabilities, that but for the special circumstances of drought, assessable income would have exceeded deductions. Further, the taxpayer did not discharge the onus of proving that the start-up farm would produce assessable income greater than deductions within a commercially viable period for the industry. Both farms were highly negatively geared and thus made losses.

Practice Problem 4 What types of entities are subject to the NCL provisions?

Practice Problem 5 Having regard to the NCL provisions, under which scenario can Elvis, a music retailer in business, claim deductions for a $10,000 business loss in the current year ended 30 June? Elvis had adjusted taxable income of

$150,100. The business started on 1 July of the current tax year.

[page 577]

OTHER INCOME TAXPAYER’S WAGES (NON-BUSINESS INCOME)

ASSESSABLE INCOME FROM BUSINESS (EXCLUDING GST)

VALUE OF REAL PROPERTY

VALUE OF DEPRECIABLE ASSETS

a

$49,000

$1000

$30,000

$120,000

b

$30,000

$16,000

0

$60,000

c

$55,000

$14,000

$200,000

$50,000

d

$33,000

$19,000

0

$92,000

Practice Problem 6 Having regard to the NCL provisions, under which scenario can Xi, an artist, claim deductions for a $100,000 business loss in the current year ended 30 June? Xi had adjusted taxable income of $50,000. The business started on 1 July of the current tax year. OTHER INCOME TAXPAYER’S WAGES (NON-BUSINESS INCOME)

ASSESSABLE INCOME FROM BUSINESS (EXCLUDING GST)

VALUE OF REAL PROPERTY

VALUE OF DEPRECIABLE ASSETS

a

$49,000

$1000

$30,000

$10,000

b

$60,000

$16,000

0

$60,000

c

$55,000

$14,000

$200,000

$50,000

d

$35,000

$19,000

0

$92,000

Practice Problem 7 which of the following businesses are potentially subject to the NCL restrictions? Assume that the adjusted taxable income is less than $250,100. 1 A farming partnership with $30,000 of cattle sales. 2 A sole accountant with $100,000 of fees. 3 An employee with $50,000 of wage income. 4 A metal manufacturer with a factory worth $1,000,000. 5 A person running a shop at a loss. The person owns the shop and the shop cost $500,000 and was purchased 1 year ago — the turnover is $60,000 per annum. 6 A grape grower who in his first year of operation incurs a $40,000 loss for his 20 acre property. Vines take 4 years to become productive. 7 A wheat farmer who incurs a $20,000 loss as a result of a major drought.

[page 578]

Alienation of personal services income: ITAA 1997 Pt 2-42, Divs 84–87

Overview 17.45 Previously, taxpayers were inappropriately alienating PSI through the use of interposed entities. The income received by the entity would be taxed at a lower rate and/or diverted to low-taxed associates. Such entities also claimed deductions (such as a motor vehicle and home office expenses) that would not be available to an individual providing the same services as an employee. Thus, Pt 2-42 requires that income that relates to personal services, whether paid directly to an individual or via an interposed entity, be treated in the same way as employee income. Also, deductions for individuals and other entities in the gaining of PSI are also required to be treated similarly to employees. Individuals and interposed entities subject to Pt 2-42 are those who derive 80 per cent or more of their income from one source, with no employees and no separate business premises, and who do not obtain a determination from the Commissioner that they are a PSB.

Personal services income: ITAA 1997 Div 84 17.46 PSI is income (whether ordinary or statutory income) that is gained mainly as a reward for the personal efforts or skills of an individual: s 84-5. Also, income that is gained by an entity (eg, a company, partnership or trust) for the personal efforts or skills of an individual will still be PSI: s 84-5. However, PSI does not include income that is not paid mainly as a reward for an individual’s personal effort; that is, income that is: ancillary to an entity supplying goods or granting a right to use property; or principally generated by assets an entity holds. PSI also includes income that is for doing work or for producing a result: s 84-5(3). The result must be produced mainly from the individual’s personal effort or skills. Further, income that is paid under a contract does not stop the income being for an individual’s personal effort or skill: s 84-5(4).

PSI

NOT PSI

salary or wages paid into a family trust income payable under a contract that is wholly or principally for the labour or services of a person paid into a company income of a sole professional person (accountant, lawyer, medical practitioner) paid into a trust computer consultant for exercise of personal expertise

retail shop owner income payable under a contract that is wholly or principally for goods professional partnership computer consultant for provision of his or her own copyright software and the ancillary exercise of personal expertise entertainer’s endorsements

[page 579]

PSI

NOT PSI

income of an entertainer income of a professional sportsperson income paid to engineers for the exercise of personal expertise

professional sportsperson endorsements backhoe operator who under contract to a local government body provides a backhoe and his or her services

Re Park and FCT [2011] AATA 567 AAT held: The PSI rules applied to a taxpayer IT worker to include in his assessable income amounts derived by his company. He provided personal services as an IT specialist to third-party clients. However, Pt 2-42 does not make the individual an employee for the purposes of any Australian law or any instrument made under an Australian law: s 84-10. Fowler v FCT [2008] FCA 528

Facts: A computer consultant was the sole director and shareholder of a company that derived income from contracts entered into with labour hire firms. He was also the sole employee of the company. The work was carried out at the premises of the labour hire firms using their equipment and software and for set periods of time. The taxpayer disputed the Commissioner’s assessment under the PSI rules: ITAA 1997 Pt 2-42 Divs 84–87. Federal Court held: The amounts received by the company from the labour hire firms were statutory income per ITAA 1997 Pt 2-42 Divs 84–87.

Deductions for individuals for PSI: Div 85 17.47 Division 85 operates to restrict individuals to the deductions that could be claimed against PSI by an employee under the rules about deductions in the ITAA 1997. (See Subdiv 86-B for entities other than individuals.) An individual cannot deduct an amount that relates to his or her PSI per s 85-10(1) where: the income is payable to the individual, except as an employee; and the individual would not be able to deduct the amount if the income were payable to the individual as an employee. Also, Div 85 prevents an individual’s deductions for an amount of rent, mortgage interest, rates or land tax relating to his or her residence and restricts an individual’s deductions for payments to associates and superannuation contributions for associates. Christine is a bookkeeper and operates under the business name of GT Bookkeeping Services. She does all the work herself and receives PSI from MEZ Pty Ltd, which she contracts with to prepare its financial accounts. She travels from home to MEZ’s offices each day. Under ITAA 1997 s 8-1, an employee will generally not

be able to deduct these travel costs because they are not incurred in the course of gaining assessable income and because they are private in nature. For this reason, Christine will not be able to deduct these costs against her PSI under the rule in s 85-10(1).

[page 580] Exceptions to the limitation in s 85-10(1) 17.48 The following exceptions apply: deductions that relate to PSI derived by an individual conducting a PSB: s 85-30; deductions in employing an associate (ITAA 1936 s 318) to perform work where that work forms part of the principal work for which the individual gains or produces his or her PSI: ITAA 1997 s 85-10(2)(e);33 deductions for superannuation fund or retirement savings account contributions: s 85-10(2)(f); complying with obligations under a workers compensation law: s 8510(2)(g); deductions for compensable work-related trauma: s 85-10(2)(g); and deductions that relate to meeting GST obligations: s 85-10(2)(h). Deductions not allowed for an individual against personal services income 17.49 The following deductions are not allowed for an individual against PSI: rent, mortgage interest, rates or land tax to the extent that these relate to gaining or producing the individual’s PSI: s 85-15;

payments to associates that relate to PSI: s 85-20(1); and superannuation contributions for associates: s 85-25(1). Exception for individuals conducting a personal services business 17.50 Division 85 does not apply to individuals gaining PSI in the course of conducting a PSB: s 85-30 (see 17.56 for a definition of a PSB). Exception for employees and certain office holders 17.51 The rules in Div 85 do not apply to amounts received as an employee and for certain office holders — Defence Force members, members of Parliament and members of local government bodies: s 85-35.

Restricting individuals — alienating income: Subdiv 86A Attributing PSI to the individual who performs the services 17.52 An individual will be required to include in his or her assessable income any income, whether ordinary or statutory, that another entity gains for the individual’s personal services: s 86-15(1). This rule does not apply if: the other entity gains the income in the course of conducting a PSB; or the income is promptly paid to the individual by the entity as salary or wages. Section 86-15 does not apply to attribute to an individual exempt or nonassessable income, or income that is neither exempt nor assessable: s 86-15(5). [page 581] Where chains of personal services entities are interposed between an individual and the entity that the individual performs work for, then the income gained by those interposed entities will still be PSI attributable to the individual per s 86-15.

PSI that is not to be attributed to the individual 17.53 PSI is not attributed to an individual under s 86-15(1) if: the personal services entity gains the income in the course of conducting a PSB: s 86-15(3); or the PSI is paid promptly as salary to the individual: s 86-15(4). Calculating PSI to be included in an individual’s assessable income 17.54 Income in relation to an individual’s personal services will be included in that individual’s assessable income under s 86-15(1) where the income is gained by an entity that is not a PSB. To calculate an individual’s assessable income, the method statement in s 86-20 must be used.

Personal services entity deductions: Subdiv 86-B 17.55 A personal services entity cannot deduct an amount to the extent that it relates to gaining or producing an individual’s PSI unless the individual could have deducted the amount under the ITAA 1997 if the circumstances giving rise to the deduction had applied to the individual: s 86-60. This does not apply if the personal services entity gains the individual’s PSI in the course of conducting a PSB: s 86-60(b).

Personal services business: Subdiv 87-A 17.56 The PSI rules do not have such a great impact if a PSB exists. An individual or personal services entity will be considered to be carrying on a PSB where (s 87-15(1)): it meets at least one of the four PSB tests: – results test; – unrelated clients test; – employment test; – business premises test; or it has a PSB determination in force.

Results test 17.57 The results test will be met where the entity works to produce a result and provides tools and equipment needed to produce the result, and it is liable for the cost of rectifying any defective work: s 87-18. Unrelated clients test 17.58 An individual or personal services entity meets the unrelated clients test if, during the year, per s 87-20(1): the individual or entity gains or produces income from providing services to two or more entities that are not associates of each other, the individual or the personal services entity; and [page 582] the services are provided as a direct result of the individual or entity making offers or invitations to the public or a section of the public to provide the services. Cameron v FCT [2011] FCA 1378 Facts: The taxpayer carried on a drafting business through his private company. The Commissioner assessed the taxpayer on the basis that he failed the unrelated clients test and business premises test for the purposes of the PSI rules in Div 87. The AAT upheld the Commissioner’s position. The taxpayer appealed to the Federal Court. Federal Court held: The taxpayer failed the unrelated clients test for the purposes of the PSI rules in respect of a drafting business he carried on through his private company. The offers and invitations made by the taxpayer in contacting various clients by phone or email via his personal contacts or relationships in the industry did not amount to making offers or invitations to the public at large or a

section of the public per s 87-20(1)(b). Word-of-mouth advertising and direct offers did not satisfy s 87-20(1)(b). Employment test 17.59 An individual meets the employment test for the income year if he or she engages one or more entities to perform work, and those entities together perform at least 20 per cent, by market value, of the individual’s principal work. The employment test will also be met if, for at least half the year, the individual has an apprentice: s 87-25(1) and (3). Business premises test 17.60 An individual or a personal services entity meets the business premises test for the income year if, at all times during the income year, the individual or entity exclusively maintains and uses business premises: s 8730(1). FCT v Dixon Consulting Pty Ltd (2006) 65 ATR 290; ATC 4832; [2006] FCA 1748 Facts: The taxpayer is a personal services entity for the purposes of ITAA 1997 Div 87. Mr Dixon provided personal computer services to the taxpayer, from which it derived income. The taxpayer argued that its business premises were separate from the residence of its controller (a business analyst consultant) for the purposes of the business premises test in s 87-30(1). The taxpayer’s business was operated from a separate two-storey building. Two cars owned by the taxpayer and used by Mr Dixon and his wife for business and private use were also garaged in the building. The services provided by Mr Dixon to the company were mainly provided from the upper storey of the garage. Federal Court held: The business premises were not separate from the residence of its controller for the purposes of the business premises test in s 87-30(1). In order to satisfy s 87-30(1)(b), the

taxpayer must show that it had exclusive use of the whole of the garage. The AAT had erred in finding that the taxpayer had satisfied the business premises test because of exclusive use of premises that are physically separate from premises used for private purposes.

[page 583]

Personal services business determinations: ITAA 1997 Subdiv 87-B 17.61 An individual conducts a PSB during an income year if a PSB determination is in force relating to the individual: s 87-60. Thus, the Commissioner is required to make a PSB determination for an individual. The Commissioner is allowed to take into account any unusual circumstances the individual is experiencing that prevent him or her from satisfying the tests for the income year in question. The Commissioner may, by giving written notice to a personal services entity whose income includes an individual’s PSI, make a PSB determination relating to the individual’s PSI included in the entity’s ordinary or statutory income: s 87-65.

PAYG withholding and PSI: TAA 1953 Div 13 Sch 1 17.62 TAA 1953 Div 13 Sch 1 applies the pay-as-you-go (PAYG) withholding arrangements to PSI attributed to an individual under ITAA 1997 s 86-15(1). A personal services entity must pay an amount to the Commissioner if, per TAA 1953 Sch 1 s 13-5(1), it: receives an alienated personal services payment; and receives that payment during a PAYG payment period for which it is a personal services payment remitter. An alienated personal services payment is a payment of PSI that is received

by a personal services entity and assessed to an individual under the rules in ITAA 1997 Div 86.

Practice Problem 8 Do the following constitute PSI? 1 Brett is a cricketer who appears in a TV commercial and earns $50,000. 2 A doctor earns income from her sole practice of $200,000. 3 Andy, a computer programmer, uses his company, Handy Andy Pty Ltd, to invoice a customer for services of $100,000. 4 A, B and C are partners in an accounting practice that grosses $1 million in income.

Taxation offences 17.63 A number of tax offences apply to taxpayers or their advisers who undertake tax avoidance or tax evasion. For example, the tax scheme promoter penalty regime — Taxation Administration Act 1953 Sch 1 Divs 290, 298 — provides measures to deter the promotion of tax avoidance and evasion schemes (known as tax exploitation schemes). The rules also deter the implementation of schemes that have been promoted on the basis of conformity with a product ruling in a way that is materially different from that described in the product ruling. The provisions apply to schemes starting from 6 April 2006. Other tax offences are set out in Chapter 21. [page 584]

Practice Problem 9 List five specific anti-avoidance provisions. (See previous chapters for these measures.)

Income tax transparency laws 17.64 Australia’s income tax transparency laws authorise the disclosure of protected taxpayer information by imposing a duty on the Commissioner to publish certain tax information. For every corporate tax entity that reports $100 million or more in total income, the Commissioner is required to publish the entity’s reported name and Australian Business Number, total income, taxable income or net income (if any), and income tax payable.

Attempt the Web Quiz for Chapter 17

Summary 17.65 The tax laws contain both general and specific anti-avoidance provisions. If an anti-avoidance provision applies to a transaction (ie, ITAA 1936 Pt IVA, alienation of PSI or NCLs), an amount otherwise excluded will be assessed as income or an amount will be denied as a deduction. For Pt IVA to apply, there are three basic requirements. 1. Is there a scheme? 2. Is there a basis for identifying a tax benefit? 3. Does the scheme have a purpose of obtaining a tax benefit? There are numerous specific anti-avoidance rules, and this chapter examines

in detail the NCL rules and alienation of PSI rules. A number of tax offences apply to taxpayers or their advisers who undertake tax avoidance or tax evasion.

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. [page 585] 1 2 3 4

5

Distinguish between tax evasion and tax avoidance. What is a sham transaction? What are the requirements for Pt IVA to operate? Henry sought advice from Alfie on 30 June, the last day of the tax year, about his capital gains on shares that amounted to $100,000. Alfie suggested that Henry sell his loss shares in Dingo Mines for 5c per share to generate a $90,000 capital loss to offset the gain and then buy back the shares in Dingo Mines at 5c a share. Henry took Alfie’s advice. Is this tax effective? Which of the following businesses are potentially subject to the NCL restrictions? (That is, they do not satisfy any of the four requirements in ss 35-30–35-45.) Assume that the adjusted taxable income is less than $250,000. a A wine-making partnership with $19,000 of sales. b A part-time self-employed dentist with $21,000 of fees.

6

7

8 9 10

11

c A miner with a mine worth $200,000. Which of the following businesses are potentially subject to the NCL restrictions? Assume that the adjusted taxable income is less than $250,000. a A person running a pizza shop at a loss. The person rents the shop and has $50,000 worth of plant. b A timber plantation operator who in his 10th year of operation incurs a $2000 loss for his 2000 pine tree property. Timber takes 15 years to become productive. c A newsagent who incurs a $10,000 loss as a result of a flood. Henrietta works as a doctor in Sydney. She obtains advice that she can set up a company and pay tax at a flat 30 per cent rate. Her taxable income is $500,000. On 1 July, she sets up Cut Price Medical Pty Ltd and conducts her practice through the company. The company’s taxable income is $500,000. Is this tax effective? What is the purpose of the alienation of PSI provisions? How do the alienation of PSI provisions work? Do the following constitute PSI? a Joe has a newsagency, which turns over $450,000 in the year. b Dave provides his services as a waiter to a restaurant via his consulting company, receiving $40,000. c Chad is a professional AFL player who earns $300,000 from his club, the Mighty Nomads. Dingo Traders Pty Ltd proposes to undergo a corporate restructure and simplification process in relation to particular assets that it owns, which will result in one company holding all assets. The restructure will involve the transfer of trading stock from the taxpayer to a partnership. The partnership will comprise the taxpayer and a subsidiary. Each partner will hold a 50 per cent interest in the partnership. The transfer of assets will involve a two-stage process in which the trading stock will be transferred to the partnership, followed by the partnership transferring the trading

stock to the subsidiary. The subsidiary will ultimately own 100 per cent of the taxpayer’s trading stock. An election will be made under ITAA 1997 s 70-100(4) to treat the assets as [page 586] having been disposed of for what would have been their value as trading stock of the transferor on hand at the date of transfer. Does ITAA 1936 Pt IVA apply where Dingo is undergoing a corporate restructure and makes an election under ITAA 1997 s 70-100(4)? 12

Mary took out a loan to purchase a residential property, which she and her husband used as their main residence in Adelaide. She then purchased another property, which was used for rental in Perth. She took out a split loan facility with a bank, with one account being used to refinance the loan for Adelaide and the other account being used to purchase the Perth property. The split loan facility required a minimum principal and interest repayment. She allocated all of their repayments to the account that related to the Perth property. As interest was capitalised on the account that related to the Adelaide property, compound interest, being interest on the capitalised interest, accrued on that account. Is Mary entitled to a deduction for compound interest incurred on funds borrowed, under a split loan facility, to acquire the Perth property?

1.

ATO Media Release, No 2003/28, 13 March 2003.

2. 3.

ATO Media Release, Nat 03/23, 6 March 2003. For example, see Fletcher v FCT at Chapter 10.

4. 5.

For example, see Howland-Rose v FCT 2002 ATC 4200. A sham was explained in Snook v London & West Riding Investments Ltd [1967] 2 QB 786 at 802, where Lord Justice Diplock said: ‘As regards the contention of the plaintiff that the transactions between himself, Auto Finance and the defendants were a sham it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the sham which are intended by them to give third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations

(if any) which the parties intend to create. But one thing, I think, is clear in legal principle, morality and the authorities [see Yorkshire Railway Wagon Co v Maclure (1882) 21 Ch d 309 and Stoneleigh Finance Ltd v Phillips [1965] 2 QB 537], that for acts or documents to be a sham, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.’ 6.

7. 8. 9.

This change appears to have been made in response to some Australian Taxation Office (ATO) losses involving cases such as Futuris, where the ATO could not show that the taxpayer had obtained a tax benefit. Explanatory Memorandum, Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013, para 1.71. Part IVA may apply to an investment loan interest payment arrangement, even where the taxpayer’s subjective purpose is to pay off a home loan sooner. N F Orow, ‘Part IVA — Seriously Flawed in Principle’ (1998) Journal of Australian Taxation 57, 76–7.

10. 81 ATC 4292. 11. s 35-15. 12. s 35-20. 13. P Costello, Second Reading Speech, New Business Tax System (Integrity Measures) Bill 2000. Copyright Commonwealth of Australia, reproduced with permission. 14. s 35-10(3). 15. TR 2001/14 paras 120–123. 16. Above n 15, paras 124–130. 17. Australian Taxation Office, Tax Facts, . Copyright Commonwealth of Australia, reproduced with permission. 18. Above n 17. 19. G Cooper, Tax Reform: Non-Commercial Losses (2000) 35 No 3 TIA 160, 162. 20. s 35-30. 21. Australian Taxation Office, Tax Facts, . Copyright Commonwealth of Australia, reproduced with permission. 22. s 35-35. 23. s 35-45. 24. s 35-10(4). 25. s 35-55(1). 26. s 35-55(1)(a). 27. TR 2001/14 paras 70–72. 28. s 35-55. 29. TR 2001/14 para 76. 30. ss 35-30, 35-35, 35-40 or 35-45. 31. s 35-55(1)(b)(ii). 32. TR 2001/14 para 82. Copyright Commonwealth of Australia, reproduced with permission.

33. Explanatory Memorandum, New Business Tax System (Alienation of Personal Services Income) Act 2000 para 1.54: The principal work of an individual is the work that is central to meeting the individual’s obligations under agreements between himself or herself, or a personal services entity, and the acquirer of the personal services.

[page 587]

18 Fringe benefits tax Learning Objectives After you have studied this chapter, you should be able to: explain how fringe benefits tax (FBT) works; determine what is a fringe benefit; determine who is subject to FBT; determine the categories of fringe benefits; determine the exemptions for fringe benefits; determine any reductions for fringe benefits; explain the FBT equation; calculate a fringe benefits taxable amount; and calculate an FBT.

[page 588]

Key Legislative Provisions Fringe Benefits Tax Assessment Act 1986 (FBTAA) Pt IIA Pt III Pt IIIA Pt IV Pt XII Income Tax Assessment Act 1936 (ITAA 1936) s 318

Key Cases FCT v Indooroopilly Children Services (Qld) Pty Ltd (2007) 158 FCR 325; 239 ALR 85; 65 ATR 369 John Holland Group Pty Ltd v FCT [2015] FCAFC 82 Qantas Airways Ltd and FCT, Re AAT Case [2014] AATA 316 Slade Bloodstock Pty Ltd v FCT (2007) 68 ATR 911

Key ATO Publications Fringe benefits tax — a guide for employers NAT 1054 Fringe benefits tax for small business NAT 8164 IT 2675 Income tax and fringe benefits tax: entertainment — morning and afternoon teas; light meals and in-house dining facilities

MT 2016 Fringe benefits tax: benefits not taxable unless provided in respect of employment MT 2025 Fringe benefits tax: guidelines for valuation of housing fringe benefits MT 2027 Fringe benefits tax: private use of cars: home to work travel MT 2022 Fringe benefits tax: purchased goods sold by retailers to employees at cost or above TD 94/16 Fringe benefits tax: where an employee is provided with a car by the employer TR 96/26 Fringe benefits tax: car parking fringe benefits TR 2007/12 Fringe benefits tax: minor benefits [page 589] Diagram 18.1:

FBT pyramid

Chapter overview 18.1 This chapter is designed to provide a general analysis of FBT. It covers the levels of the FBT pyramid: Level 1 — the FBT equation; Level 2 — the Fringe Benefits Tax Assessment Act 1986; Level 3 — analysis of components of FBT equation; Determining a fringe benefit; Specifying a category; Checking for exemptions and reductions; Calculating taxable value; and Calculating FBT liability. These basics will provide the necessary background for a sound understanding of FBT. FBT was introduced on 1 July 1986 to overcome the shortcomings (with compliance and valuation) of Income Tax Assessment Act 1936 (ITAA 1936) s 26(e). It shifts the liability for the tax from the employee to the employer, and is a separate tax to income tax. It essentially [page 590] captures the taxable value of certain benefits the employer provides to the employee (or their associate) in respect of employment over and above salary. This makes it a fairer system as, rather than escaping tax, those benefits are taxed through the employer. Generally, the cost of providing the benefits and also the FBT paid are tax deductible to the employer. The most common fringe benefits are: cars; car parking; expense payments; and

meals and entertainment. Common exempt benefits include: portable electronic devices primarily used in employees’ employment; minor benefits valued at less than $300; and certain taxi travel.

FBT pyramid 18.2 At the top of the pyramid rests the key tax equation for FBT that is used to calculate tax payable. From 1 April 2015 until 31 March 2017, the FBT rate is based on taxing employers at 49 per cent (previously 46.5 and 47 per cent) for fringe benefits provided to employees, as set out in Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) s 5B and Fringe Benefits Tax Act 1986 s 6 (see Diagram 18.1 above). The second level provides an overview of the legislation. The third level of the pyramid consists of the following five-step process, which provides a detailed analysis of the components of the FBT equation: 1. Is there a fringe benefit? 2. What category is that fringe benefit? 3. What exemptions and reductions apply? 4. Calculating your taxable value. 5. Calculating your FBT liability.

Level 1: The FBT equation 18.3 As set out in Diagram 18.1, the application of the FBT revolves around the following equation in FBTAA 1986 s 5B (with the rate of tax set in Fringe Benefits Tax Act 1986 s 6) for the current FBT year ending 31 March: FBT liability = (Fringe benefits taxable amount × FBT rate) – rebates

Fringe benefits taxable amount = Type 1 aggregate × FBT gross-up factor + Type 2 aggregate × FBT gross-up factor + aggregate non-exempt amount As noted above, there are five steps in this calculation. These are explained in the level 3 analysis at 18.20 below. [page 591]

Level 2: Legislation overview of FBTAA 18.4

The FBTAA 1986 consists of the following Parts: Part I — Preliminary; Part II — Administration; Part IIA — Core provisions; Part III — Fringe benefits; Part IIIA — Rebates of tax; Part IV — Liability to tax; Part V — Returns and assessments; Part VII — Collection and recovery of tax; Part X — Statutory evidentiary documents; Part XA — Endorsement of charitable institutions etc; Part XI — Miscellaneous; Part XIA — Record keeping exemption; Part XIB — Reportable fringe benefits totals; Part XIC — Application of the Act to nominated state or territory bodies; and Part XII — Interpretation. Additionally, the FBTAA 1986 is supported by the Fringe Benefits Tax Regulations 1992, which govern a range of FBT areas, and the Fringe Benefits Tax Act 1986, which imposes the tax rate.

Part I — Preliminary 18.5 Part I deals with the commencement of FBT and the application of the criminal code. Part II — Administration 18.6 Part II provides that the Commissioner administers the Act and must furnish annual reports. Further, the secrecy provisions are set out. Part IIA — Core provisions 18.7 Part IIA contains three Divisions, which set out the core provisions and the key FBT equations. Division 1 shows how to calculate an employer’s fringe benefits taxable amount and aggregate non-exempt amounts. Division 2 provides the workings for an employer’s aggregate fringe benefits amount. Division 3 explains how to work out an employee’s individual fringe benefits amount. Part III — Fringe benefits 18.8 Part III contains various specific categories of fringe benefits. This Part is vital, as a liability for FBT arises only in respect of one of these listed fringe benefits. These categories also list numerous exempt benefits. Notably, exempt benefits are not fringe benefits and cannot result in any FBT. [page 592] Part IIIA — Rebates of tax 18.9 Part IIIA lists rebatable employers. Since non-profit entities cannot obtain a tax deduction for FBT paid, a rebate of FBT is provided per s 65J to place them on the same footing as income tax paying employers. Part IV — Liability to tax 18.10

Section 66 provides that FBT is imposed in respect of the fringe

benefits taxable amount of an employer of a year of tax and is payable by the employer. Section 67 contains the general anti-avoidance provision. Part V — Returns and assessments 18.11 Part V comprises two Divisions. Division 1 deals with FBT annual returns, further returns, keeping records of indirect tax transactions and the obligation of a tax agent to give the taxpayer a copy of the notice of assessment. Division 2 concerns assessments. Part VII — Collection and recovery of tax 18.12

Part VII deals with the collection and recovery of tax.

Part X — Statutory evidentiary documents 18.13 Part X deals with the retention of statutory evidentiary documents, when business use percentage and estimate of business kilometres must be specified, and the special circumstances when the substantiation requirements are not to apply. Part XA — Endorsement of charitable institutions etc 18.14 Part XA sets out the endorsement required by the Commissioner for public benevolent institutions, health promotion charities and other charitable institutions. Part XI — Miscellaneous 18.15 Part XI deals with a variety of matters, including assessments, judicial notice of signature, evidence, access to premises etc, Commissioner to obtain information and evidence, agents and trustees, records to be kept and preserved, service on partnerships and associations, and, finally, regulations. Part XIA — Record keeping exemption 18.16 Part XIA provides that, if certain conditions are satisfied, an employer need not keep or retain most of the records otherwise required to be kept and retained under s 132(1).

Part XIB — Reportable fringe benefits totals 18.17 This Part sets out an employee’s reportable fringe benefits total for a year of income as the sum of each of the employee’s reportable fringe benefits amounts for the year of income. This amount is relevant in working out some income tax rebates, Medicare levy surcharge and superannuation surcharge and for the repayment of a debt under the Higher Education Support Act 2003. Part XIC — Application of the Act to nominated state or territory bodies 18.18 Part XIC deals with the application of the Act to nominated state or territory bodies. This provides the states and territories with FBT treatment that is the same as the treatment given to the Commonwealth. [page 593] Part XII — Interpretation 18.19 Part XII provides a list of defined terms, including the all-important definitions of what constitutes a fringe benefit, an employee, an employer etc.

Level 3: Analysis of components of FBT equation Step 1: Is there a fringe benefit? 18.20 FBTAA 1986 s 136(1) widely defines a fringe benefit as a ‘payment’ to an employee but in a different form to salary or wages: … fringe benefit, in relation to an employee, in relation to the employer of the employee, in relation to a year of tax, means a benefit: (a) provided at any time during the year of tax; or (b) provided in respect of the year of tax;

being a benefit provided to the employee or to an associate of the employee by: (c) the employer; or (d) an associate of the employer; or (e) a person … in respect of the employment of the employee.

Section 136(1) excludes the following: a payment of salary or wages; a benefit that is an exempt benefit in relation to the year of tax; a benefit constituted by the acquisition by the employee, or by a relative of the employee, of a share or a right over a share; the making of a payment of money to a superannuation fund; the making of a payment of money to a retirement savings account (within the meaning of the Retirement Savings Accounts Act 1997) that is held by the employee; an eligible termination payment; consideration of a capital nature for, or in respect of, a legally enforceable contract in restraint of trade by a person or personal injury to a person; a grant or acquisition of such a carried interest or of an entitlement to such a payment; and a deemed dividend paid to the recipient.

Read FBTAA 1986 s 136(1) ‘fringe benefit’ Thus, a fringe benefit has the following requirements. Must be a benefit 18.21 This is widely defined to include any right, privilege, service or facility: s 136(1). However, not all fringe benefits are subject to FBT, as exempt benefits are excluded: see Div 13 and ss 8, 17, 20A, 21, 22, 47 and 47A. [page 594]

In respect of employment 18.22 Another requirement for a fringe benefit is that it must be provided in respect of employment. Whether a fringe benefit is provided ‘in respect of employment’ was considered in J & G Knowles & Associates Pty Ltd v FCT (2000) 44 ATR 22. The Full Federal Court held that a discernible and rational link must exist between the benefit and the employment. Thus, a gift would not appear to satisfy this requirement. The Australian Taxation Office (ATO) provides the following examples to illustrate whether there is sufficient connection of a fringe benefit to employment.1 Example — benefit provided in respect of employment David is an employee and is employed under the provisions of a particular industrial award. The award requires David’s employer to reimburse David for his home telephone rental costs. David’s employer reimburses him, but only because of the award provisions. If David was not an employee, the reimbursement would not have been made. The reimbursement is therefore a benefit provided in respect of employment and, consequently, it is a fringe benefit. A benefit that is not provided in respect of employment is not a fringe benefit. Example — benefit not provided in respect of employment An adult daughter, Sarah, is employed in the family business. Her parents give her a birthday present. The gift is given because of the family relationship and would have been given even if Sarah had not been employed in the family business. Although the recipient of the gift is an employee, the gift was not provided in respect of employment and is therefore not a fringe benefit.

See Taxation Ruling MT 2016 for further examples. FCT v Indooroopilly Children Services (Qld) Pty Ltd (2007) 158 FCR 325; 239 ALR 85; 65 ATR 369 Facts: ABC Development Learning Centres (a public company) sought a private ruling on behalf of its franchisees to decide whether the issue of ABC shares to franchisees gave rise to a fringe benefit as defined in FBTAA s 136(1), in relation to ABC or its franchisees. A wholly owned subsidiary, ABC Public, established an employee share scheme using a discretionary trust to help attract staff. The terms of

the trust deed provided that the trustee was required to allocate shares for the benefit of franchisee employees according to certain criteria. The Commissioner found that the shares were property, and thus a benefit, and since ABC issued the shares to the trustee, this provided property to the trustee pursuant to FBTAA s 154. The trustee was an associate of the franchisee employees and the benefit was provided to employees in respect of their employment, notwithstanding that a benefit provided to a trust might not be provided in respect of a specific employee. Thus, the Commissioner ruled that it gave rise to a fringe benefit. Full Federal Court held: The reference to the employee in the definition of ‘fringe benefit’ meant that a particular employee had to be identified. The court therefore dismissed the Commissioner’s appeal.

[page 595]

Slade Bloodstock Pty Ltd v FCT (2007) 68 ATR 911 Facts: The taxpayer operated a racehorse acquisition and syndication business and provided benefits to its director/controllers Mr and Mrs Slade to partially discharge a loan to the taxpayer. The Commissioner assessed the taxpayer as providing fringe benefits to its employees Mr and Mrs Slade. In the first instance, the AAT decided that the benefits related to Mr and Mrs Slade’s beneficial ownership of the business, and accordingly FBT did not apply (Re Slade Bloodstock Pty Ltd and FCT; AAT Case [2006] AATA 666). Federal Court held: The benefits were in respect of the employment of the Slades, and this was so even where the benefits also indirectly or directly related to the Slades’ beneficial ownership of the business. Notably, they were the sole employees, the benefits

were the only remuneration received by the Slades from the taxpayer, and under the loan agreement the repayments could be set off against the Slades’ personal obligations (FCT v Slade Bloodstock Pty Ltd [2007] FCA 188). Full Federal Court: Allowed the taxpayer’s appeal and upheld the original AAT decision that benefits were not fringe benefits. FBT legislation was never intended to apply to repayment of a loan made by an employee to an employer. Provided during the year of income 18.23 The fringe benefit must be provided during the year of income. Section 136(1) defines ‘provide’ to include ‘allow, confer, give, grant or perform’. The FBT year of income commences on 1 April and ends on 31 March.2 Must be to an employee or an associate 18.24 An ‘employee’ means a current, future or former employee: s 136(1). A ‘current employee’ is a person who receives or is entitled to receive salary or wages. An ‘associate’ is widely defined in ITAA 1936 s 318 and includes relatives, partners, de factos, trustees and beneficiaries.

Practice Problem 1 1 2

List things that are fringe benefits. List things that are not fringe benefits.

Exempt employers 18.25 Some employers are exempt from FBT3 (see Div 13): religious institutions; foreign government representatives;

[page 596] international bodies that are exempt from tax; and public benevolent institutions,4 public hospitals and public ambulance services — although there are limits to the concessional treatment provided to employees.

Practice Problem 2 Provide examples of exempt employers.

Who pays? 18.26 Employers pay a tax on the value of fringe benefits that they provide to employees. What FBT tax rate and gross-up factor? 18.27 If the employer is entitled to a GST input tax credit the FBT grossup factor (known as type 1) applies, where the employer is not entitled to a GST credit, the factor (type 2) applies. FBT YEAR ENDED

FBT RATE

TYPE 1 GROSS-UP RATE

TYPE 2 GROSS-UP RATE

31 March 2018

47%

2.0802

1.8868

31 March 2017

49%

2.1463

1.9608

31 March 2016

49%

2.1463

1.9608

31 March 2015

47%

2.0802

1.8868

31 March 2014

46.5%

2.0647

1.8692

What is an FBT year? 18.28 The FBT year commences on 1 April of a year and ends on 31 March of the next year. GST and fringe benefits 18.29 While a goods and services tax (GST) of 10 per cent generally applies to the supply of most goods and services, where a good or service is supplied to an employee and the employee does not make a contribution to the benefit, there is no GST liability: A New Tax System (Goods and Service Tax) Act 1999 (GSTA) s 9-75(3). However, where a contribution [page 597] is made, the employer must include 1/11th of the contribution as a supply of a fringe benefit (unless it is GST-free or input taxed). FBT and personal services income 18.30 Where an amount is non-deductible as a result of the personal services income rules, the taxable value of the fringe benefit is reduced by this amount: FBTAA s 61G.

Step 2: What category is that fringe benefit? 18.31 The FBT rules (Divs 2–12) categorise fringe benefits into 13 types, as listed below. Each category contains special rules for calculating the value of fringe benefits (Step 4): 1. car fringe benefit; 2. debt waiver fringe benefit; 3. loan fringe benefit; 4. expense payment fringe benefit; 5. housing fringe benefit;

6. 7. 8. 9. 10. 11. 12. 13.

living-away-from-home allowance (LAFHA) fringe benefit; airline transport fringe benefit; board fringe benefit; meal entertainment fringe benefit; tax-exempt body entertainment fringe benefit; car parking fringe benefit; property fringe benefit; and residual fringe benefit.

Car benefits 18.32 A car fringe benefit commonly arises when a car that is owned or leased by an employer is made available for the private use of an employee. Section 7 provides that a car is taken to be made available for private use by an employee on any day that: it is actually used for private purposes by the employee; the car is not at the employer’s premises, and the employee is allowed to use it for private purposes; and the car is garaged at an employee’s home, regardless of whether or not the employee has permission to use it privately. As a general rule, travel to and from work is private use of a vehicle. ‘Cars’ includes the following: motorcars, station wagons, panel vans and utilities (excluding panel vans and utilities designed to carry a load of 1 tonne or more); any other goods-carrying vehicles with a designed carrying capacity of less than 1 tonne; and any other passenger-carrying vehicles with a designed carrying capacity of fewer than nine occupants. [page 598]

Read FBTAA 1986 Pt III, Div 2 Debt waiver fringe benefit 18.33 Section 14 provides that a debt waiver fringe benefit is the waiving or forgiving of an employee’s debt. An airline employer who has sold an air ticket to Darwin later advises the employee not to pay the amount. This is a debt waiver fringe benefit.

Read FBTAA 1986 Pt III, Div 3 Loan fringe benefit 18.34 Section 16 provides that a loan fringe benefit arises from a loan to an employee on which a low rate of interest is charged or that is an interest-free loan. See Westpac Banking Corporation v FCT (1996) 34 ATR 143, where the Full Federal Court found that waiving of loan establishment fees for employees was a separate residual fringe benefit and not part of the same loan fringe benefit that the low-interest loan generated. A low rate of interest is one that is less than the published annual statutory rate of interest. A ‘loan’ is broadly defined to include an employee debt to an employer by way of a cash advance or provision of credit. When an employer releases an employee from the obligation to repay the loan, a debt waiver fringe benefit may arise.

Read FBTAA 1986 Pt III, Div 4 Expense payment fringe benefit 18.35 Section 20 applies only to expenses incurred by an employee that are paid or reimbursed by the employer. There are two types of expense payment fringe benefits: 1. where an employer reimburses an employee for expenses incurred by the

employee; and 2. where an employer pays a third party in satisfaction of expenses incurred by an employee. In either case, the expenses may be work or business expenses, private expenses or a combination thereof. Eddie receives a $5000 clothing allowance from his employer, a radio station. He was also reimbursed for home phone costs of $2670. There are no FBT implications for the clothing allowance, since that is ordinary income: ITAA 1997 s 65. The reimbursement of the home phone cost, however, is an expense payment benefit: FBTAA s 20.

[page 599]

Read FBTAA 1986 Pt III, Div 5 Housing fringe benefit 18.36 Section 25 provides that, where an employee is provided with the right to use a unit of accommodation and if that unit of accommodation is the usual place of residence of the employee, then the right to use the unit of accommodation is a housing fringe benefit. The general scheme of the Act is to bring the market value of the accommodation into the value of fringe benefits. There are concessional rates for calculating the market value of housing located in remote areas of Australia that may apply. TYPO Ltd provides residential accommodation to staff so they can live close to work. TYPO enters into a rental agreement with a landlord to provide accommodation for an employee. FBT applies to this benefit. This is a housing fringe benefit per s 25.

Read FBTAA 1986 Pt III, Div 6 Living-away-from-home allowance fringe benefit 18.37 Section 30 covers the payment of an LAFHA to an employee; such an allowance is an LAFHA fringe benefit. This is paid to compensate for any non-deductible additional expenses incurred because the employee is required to live away from home in order to perform his or her duties of employment. The taxable value of an LAFHA benefit is the amount of the benefit reduced by any exempt accommodation component and any exempt food component.5 In respect of benefits provided in relation to on or after 1 October 2012, the reduction applies only if the employee maintains a home in Australia at which they usually reside (thus, the concessional FBT treatment is for a maximum period of 12 months) or the employee is working on a genuine fly-in fly-out or drive-in drive-out basis.6 For oil and gas rig workers at sea, the value of the LAFHA fringe benefit is equal to the allowance received: see s 31(b).

Read FBTAA 1986 Pt III, Div 7 Airline transport fringe benefit 18.38 Section 32 provides that an airline transport fringe benefit arises where employees of airlines or travel agents are provided with free or discounted air travel. The travel must be on a stand-by basis: s 136(1). The taxable value is generally 37.5 per cent of the standard fare with the first $1000 of benefits exempted: s 62. [page 600]

Read FBTAA 1986 Pt III, Div 8 Board fringe benefit

18.39 Section 35 includes the provision of a meal to an employee as a board fringe benefit if the employee is entitled to the provision of accommodation and, under an industrial award, the employee is to be provided with at least two meals a day or, under an employment arrangement, at least two meals a day are ordinarily provided. The meal must be supplied by the employer at the work site or premises. This will typically be provided to workers on an oil rig or ship, to shearers and to live-in housekeepers.

Read FBTAA 1986 Pt III, Div 9 Meal entertainment fringe benefit 18.40 Under ss 37A–37AG, a meal entertainment fringe benefit occurs where food, drink or associated travel are provided to employees. Also, the reimbursement of such expenses incurred by employees will be included. The taxable value may be calculated using a 50/50 split method (ss 37B and 37BA) or a 12-week register (ss 37C–37CA).

Read FBTAA 1986 Pt III, Div 9A Tax-exempt body entertainment fringe benefit 18.41 Section 38 provides that entertainment expenditure of the kind that is non-deductible for income tax purposes can give rise to a tax-exempt body entertainment fringe benefit where it is provided by an employer that is a taxexempt body.

Read FBTAA 1986 Pt III, Div 10 Car parking fringe benefit 18.42 Section 39A generally provides that a car parking fringe benefit may arise when an employer provides car parking facilities for an employee at or near his or her place of employment and where there is a commercial parking station available for all-day parking within a 1 kilometre radius of the premises

on which the car is parked. The Full Court in Virgin Blue Airlines Pty Ltd v FCT [2010] FCAFC 137 held that, under s 39A(1)(f), 2 kilometres away was not ‘in the vicinity of’ the primary place of employment, and therefore the subsidised car parking was not a taxable fringe benefit. Re Qantas Airways Ltd and FCT AAT Case [2014] AATA 316 AAT held: Car parking facilities provided by Qantas to its employees in certain locations were subject to FBT for the 2007 to 2010 FBT years. The taxpayer provided car parking facilities to its employees with primary places of work at or near its city airports. The airports, except for Canberra, had long-term and/or short-term parking facilities that were available to

[page 601]

members of the public. Canberra airport had no parking spaces available to members of the public. Thus, no commercial parking station was within 1 kilometre of the premises, and the taxpayer was not liable for FBT.

REMO Ltd uses a nearby car park for its employees free of charge. REMO leases the car park from a third party. The provision of car parking spaces to employees at a third party’s business premises constitutes a car parking fringe benefit under FBTAA s 39A; thus, REMO must pay FBT. A car parking fringe benefit will arise on each day on which an employer provides a car parking space for the use of an employee and all of the conditions in FBTAA s 39A are satisfied. The definition of a ‘fringe benefit’ in FBTAA s 136(1)

includes a benefit provided to an employee of an employer under an arrangement between the employer (or associate) and a third party. An ‘arrangement’ is defined in FBTAA s 136(1). FBTAA s 39A(1)(a)(i) states that the car must be parked on the business premises or associated premises of the provider. A ‘provider’ is defined in FBTAA s 136(1) as meaning the person who provides the benefit. The provider will usually be the employer, but this need not be the case. Either the car park owner or the taxpayer satisfies the requirements of being the ‘provider’ as required in FBTAA s 39A(1)(a)(i).

Read FBTAA 1986 Pt III, Div 10A Property fringe benefit 18.43 Section 40 includes, as a property fringe benefit, the value of any property provided free or at a discount to an employee by an employer. ‘Property’ is widely defined to include all goods, including gas and electricity; animals; real property, such as land and buildings; and choses in action, such as shares or bonds. Concessional valuation rules apply where the property is manufactured, produced or processed (in-house) by the employer.

Read FBTAA 1986 Pt III, Div 11 Residual fringe benefit 18.44 Section 45 provides that any fringe benefit that is not subject to any of the other rules is called a residual fringe benefit. As noted previously, ‘benefit’ is widely defined. For example, a residual fringe benefit would include the provision of services insurance cover and the use of property. Sylvia sells surgical products and wins the company

award for her efforts. As a result, she is sent to a conference in Palm Cove, which costs $3000. Also, she is awarded a non-redeemable, non-transferable aroundthe-world air ticket worth $4000 to go on a holiday. The conference at Palm Cove is a work-related business expense deductible under ITAA 1997 s 8-1(2)(b) and thus is not a fringe benefit. The around-the-world ticket is a residual fringe benefit: FBTAA s 45.

[page 602]

Read ITAA 1986 Pt III, Div 12 Practice Problem 3 Provide examples of fringe benefits for each category of fringe benefits.

Step 3: What exemptions and reductions apply? 18.45 The taxable values may be reduced by exemptions or reductions. Many exemptions are noted within the particular categories, such as s 8 exempt car benefits, s 17 exempt loan benefits and s 41 exempt property benefits. The categories for expense payment and residual benefits contain a wider range of exemptions and reductions, as stated below. Expense payment fringe benefits exemptions 18.46 The following is a list of exemptions that may apply to expense payment fringe benefits (see Div 5): no-private-use declaration: s 20A;

living-away-from-home accommodation: s 21; car expenses: s 22; certain in-house expenses: s 22A; and certain external expense payments: s 23. Also within this Division, s 24, the otherwise deductible rule, works as a reduction to the fringe benefit. HEBO Ltd provides residential accommodation to staff in remote areas. Its employee Simone leases a house in the outback privately and pays the rent from after-tax earnings. Her lease expires and HEBO then enters into a new rental agreement with the same landlord on the same property in order to provide accommodation for Simone. FBT does not apply to this benefit. HEBO, the employer, is located in a remote area and it provides accommodation to its employees as their usual place of residence. The requirements of FBTAA s 58ZC are satisfied. The housing benefit is an exempt remote housing benefit.

Practice Problem 4 Explain what a ‘no-private use declaration’ is and its effect.

[page 603] Residual benefits exemptions 18.47

The following is a list of exemptions that may apply to residual

fringe benefits (Div 12): use of motor vehicles; use of public transport; use of recreational or child care facilities; use of property that is located on an employer’s business premises; living-away-from-home accommodation; building and construction sites; transport for oil rig and remote area employees; priority of access to a child care facility; and no-private-use declaration: s 47A. Tami works for REMO. REMO provides after-school care to her child, who is 6 years of age. The after-school care facility is located on REMO’s premises and is a facility designed for children who are under or over the age of 6 years. The exemption under FBTAA s 47(2) applies to REMO for a residual benefit that consists of the provision of care of children of a current employee in a child care facility that is located on the business premises of the employer. FBTAA s 136(1) defines ‘child’ as in relation to a person, which includes an adopted child, a stepchild or an exnuptial child of the person. FBTAA s 136(1) defines ‘child care facility’ as a facility at which a person receives or is ready to receive two or more children under the age of 6 years, for the purpose of minding or caring, without provision for residential care. The age of any particular child attending the centre is irrelevant, as the definition of a ‘child’ does not mention any age. As long as the centre meets the requirements of a ‘child care facility’, the concession would apply

regardless of the age of any particular child being cared for. The facility qualifies even if it is empty or there are no children attending who are under the age of 6 years; however, the facility must be ready to receive a minimum of two children under 6 years of age. This means that the centre must have available staff and facilities that are required under applicable state and territory legislation in order to be licensed to provide care to two or more children under 6 years of age. Consequently, where a ‘child’ (as defined) is cared for in a ‘child care facility’ (as defined), the benefit would be an exempt residual benefit under FBTAA s 47(2).

Practice Problem 5 Identify whether provision of vending machines on a business premises would constitute an exempt benefit.

[page 604] Miscellaneous exempt benefits 18.48 Division 13 also covers miscellaneous exempt benefits. Among these are minor benefits (s 58P) that are infrequent and irregular and less than $300 for the current year for an employee. Specified work-related items such as a portable electronic device, a briefcase and a tool of trade are also exempt (s 58X). These items must be provided for work purposes, and only one item of each type per year is permitted to be exempt. Employees are not entitled to any depreciation on the items. These items are not covered under the otherwise deductible rule that applies to one-off deductions and therefore is

not applicable to an item that can be claimed over a number of years through depreciation. Crazy Daze provides a Christmas party for its 10 employees. Each employee receives a hamper that includes a bottle of wine that costs $100. They also attend the Christmas party with their partner, which costs $150 for each couple. As the total cost per employee is less than $300 and is infrequent and irregular, this is a minor benefit (s 58P) and is therefore exempt from FBT. As it is not subject to FBT, it cannot be claimed as a tax deduction.

Practice Problem 6 An employer pays $120 for an employee for a 4-week health program at the gym. Would this be subject to FBT? The unreimbursed recipient’s contribution 18.49 Where the recipient of the fringe benefit makes a contribution to the cost of the benefit, the taxable value of the fringe benefit is reduced so only the net benefit is taxed. Note: Car fringe benefits explicitly include this in the determination of the taxable value. Fred receives a car fringe benefit from his employer that has a taxable value (not including employee contributions) of $5000. If Fred pays $2000 for some of the car expenses during the year, the taxable value of the fringe benefit would then be $3000. Reduction to taxable value: the otherwise deductible rule

18.50 The taxable value of a fringe benefit can also be reduced by the otherwise deductible rule under most categories. However, it does not apply to car or debt waiver fringe benefits or to a decline in value for depreciating assets, except when the cost of the benefit is less than $301. This rule prevents double taxation by reducing the taxable value of the fringe benefit to the extent that an employee cannot deduct the expense, since it was incurred [page 605] by the employer. This rule, though, does not apply to benefits provided to associates of an employee. Where an employer has reimbursed the employee, the amount that relates to an employment-related expense is important, as that is the only part that the otherwise deductible rule covers. John Holland Group Pty Ltd & Anor v FCT [2015] FCAFC 82 Federal Court held: Flights for fly-in fly-out mining workers would have been deductible under s 8-1 had the cost been incurred by the employees directly. Therefore, John Holland was entitled to reduce to nil its FBT liability on the flights by the ‘otherwise deductible rule’. Edmonds J stated that the John Holland employees ‘were travelling in the course of their employment, subject to the directions of John Holland and being paid for it. That situation subsisted until they disembarked the plane at Perth Airport at the end of their rosteredon work time. At no time during that period were they travelling to work; they were travelling on work and the cost of doing so under the statutory hypothesis in s 52(1) FBTAA would be an allowable deduction to them under s 8-1 of the ITAA 1997’.

Sarah incurred expenditure of $2000 for self-education expenses and $1000 in Higher Education Loan Programme (HELP) charges. Her employer reimbursed her expenses of $3000. As the self-education expenses

would be otherwise deductible, there is no FBT liability for those, but the HELP charges are not deductible, so the employer would incur FBT on that amount.

Other reductions in taxable value 18.51 There are a number of fringe benefits that attract concessional treatment. The concession is a reduction in the taxable value of the fringe benefit that results in a reduced amount of FBT, or even no FBT being payable. For example, in-house fringe benefits (covering expense, property or residual) are reduced by $1000 for each employee: s 62. The following is a list of other reductions that may apply (see Div 14): remote area residential fuel; remote area housing; remote area holiday transport; overseas employment holiday transport; relocation transport, temporary accommodation and meals; employment interviews and selection tests; work-related medical and migrant language training; living-away-from-home food costs; entertainment expense costs; and education of children of overseas employees.

Step 4: Calculating your taxable value 18.52 Each type of fringe benefit has its own calculation of taxable value. Following are examples of the more difficult ones. [page 606] Car fringe benefit — taxable value

18.53 In calculating a car fringe benefit, the taxable value of the benefit must be calculated in accordance with either of two methods: the statutory formula method or the operating cost method. The employer has a choice of methods; however, where no nomination is made, the statutory method is applied. Statutory formula method 18.54 This method is based on the car’s cost price. The taxable value is a percentage of the car’s cost price, based on the following formula:

A = the base value of the car B = the statutory fraction C = the number of days when the car was used or available for private use of employees in the FBT year D = the number of days in the FBT year E = the employee contribution 18.55 Base value: The base value for purchased cars includes the original purchase price, the cost of any fitted accessories not required for business use of the car, dealer delivery charges, GST and luxury car tax. For leased cars, the base value of a car is similarly based on the costs incurred by the lessor. 18.56 Employee contribution: An employee contribution is the amount paid by an employee for use of the car or a contribution to its running costs. 18.57 Statutory fraction: The statutory fraction (s 9(2)(c)) is a flat rate of 20 per cent, regardless of distance travelled, for a car made available from 1 April 2014. Prior to this, the following applied: STATUTORY FRACTION Total km travelled during the FBT year

Contracts enacted before 10 May 2011

New contracts from 10 May 2011

New contracts from 1 April 2012

New contracts from 1 April 2013

Less than 15,000

26

20

20

20

15,000 to 24,999

20

20

20

20

25,000 to 40,000

11

14

17

20

Over 40,000

7

10

13

17

[page 607]

Jasper uses a work car, a BMW, which cost $55,000 including GST of $5000. He used the car throughout the current FBT year and travelled 14,000 km. He paid $20 per week towards petrol for 48 weeks. The employer is registered for GST and claims input tax credits on the car. What is the taxable value of the car? Answer:

Read FBTAA 1986 s 9 Practice Problem 7 Jayne is a new employee who has the use of a company car. The car was purchased for Jayne’s use on 1 November, and in the period to 31 March (151 days), Jayne travelled 12,000 km. The car cost $50,000 including GST. Jayne paid $400 towards petrol during the year. The employer is registered for GST and claims input tax credits on the car. Calculate the taxable value for the current FBT year ended 31 March using the statutory fraction.

Operating cost method (cost basis) 18.58 This method is based on the costs of operating the car and is based on the following formula (s 10(2)): (C × (100% − BP)) − R C = Operating costs BP = Business use percentage R = Recipient’s payment 18.59 Total operating costs: The operating costs of a car include actual costs and deemed costs. 18.60 Actual costs: Actual operating costs include GST and are paid by the employer or employee or an associate. Operating costs include: repairs (excluding expenses met by an insurance company or others); maintenance; fuel; registration and insurance; and leasing costs. 18.61 Deemed costs: Deemed operating costs are used if a car is owned and not leased. Apportion these costs where the car is used for only part of the year. They include depreciation and deemed interest expenses. 18.62 Depreciation: Deemed depreciation is calculated by multiplying the depreciated value of the car at the start of the FBT year by 25 per cent (cars purchased on or after [page 608] 1 April 2008), 18.75 per cent (cars purchased on or after 1 July 2002 and before 1 April 2008) or 22.5 per cent (cars purchased before 1 July 2002). The

depreciated value is the dealer delivery, GST and luxury tax inclusive cost of the car, which includes the cost of non-business accessories but not stamp duty or registration. Note: The tax depreciation cost limit does not apply for FBT purposes. 18.63 Deemed interest expenses: Deemed interest is calculated by multiplying the depreciated value of the car by the statutory interest rate. The statutory interest rates7 are: FBT YEAR ENDED

DEEMED INTEREST RATE

31 March 2011

6.65%

31 March 2012

7.80%

31 March 2013

7.40%

31 March 2014

6.45%

31 March 2015

5.95%

31 March 2016

5.65%

31 March 2017

5.65%

31 March 2018

5.25%

Estimated percentage of private use 18.64 An estimate of the percentage of business and private use is based on logbook and odometer records. Jones drives his employer’s BMW, which cost $55,000 including GST of $5000 paid on 1 April of the current FBT year. He used the car throughout the current FBT year and travelled 18,000 km, of which 10,000 km were for business. The employer is registered for GST and claims input tax credits on the car. The total running costs for the car were $10,000 during the period. Included in the cost is a payment made by Jones of $960 for comprehensive car insurance. Calculate the FBT using the operating costs method.

Answer: The actual operating costs are $10,000. The deemed depreciation amounted to $55,000 × 25% = $13,750 and the deemed interest was $55,000 × 7.40% = $4070. Thus, the taxable value using total operating costs: (($10,000 + $13,750 + $4070) × 8000/18,000) − $960 = $11,404.

[page 609]

Practice Problem 8 Claire drives her employer’s car, which cost $36,000 including GST. The car was acquired on 1 April of the current FBT year. She used the car throughout the current FBT year and travelled 25,000 km, of which 5000 km were for business. The employer is registered for GST and claims input tax credits on the car. The total running costs for the car were $6000 during the period. Included in the cost is a payment made by Claire of $580 for registration. Calculate the taxable value using the operating cost method.

Read FBTAA 1986 s 10 Loan fringe benefit — taxable value 18.65

Taxable value of a loan fringe benefit is the amount of interest that

the employee saved by not paying commercial rates. Hence, the difference between the statutory interest rates (refer to deemed interest rates for car fringe benefits at 18.63) and those charged by the employer is required to be calculated. Kathy receives a $300,000 low-interest loan at 5 per cent from her employer, Big Banker, for the current FBT year ended 31 March. She uses half the money for an investment property and half to build another room on her house. The loan is a loan fringe benefit per s 16. The taxable value is the difference between the statutory rate of interest (or notional rate) and the low interest rate of 5 per cent: s 18. As the statutory rate is 5.95 per cent for the current FBT year ended 31 March, the taxable value is $300,000 × (5.95% − 5%) = $2850. But $150,000 of the loan was used for investment purposes; thus, the otherwise deductible rule in s 19 applies. The taxable value is: ($300,000 − $150,000) × (5.95% − 5%) = $1425. Expense payment fringe benefit — taxable value 18.66 Generally, the taxable value of the fringe benefit will equal the sum reimbursed. However, this may be reduced where the expense would have been deductible to the employee if the employee paid for it, or if the expenditure would not be deductible to the employer. Where an employer has reimbursed the employee, the amount that relates to the employmentrelated expense impacts on the amount applicable for the otherwise deductible rule. Note: The reimbursement to an employee for the cost of using his or her own car is not subject to FBT if the per-kilometre basis is used for deductions. This sum is assessable income to the employees, and deductions are claimable. [page 610]

Wendy incurred expenditure of $1000, 80 per cent of which was employment related and 20 per cent was private. Her employer reimbursed her $700. What is the FBT liability if the employer: 1. reimbursed only the employment-related component? 2. reimbursed without regard for whether the expenditure was for business or private purposes? Answer: 1. The taxable value of the expense payment fringe benefit (without the otherwise deductible rule) would be $700. The amount that would have been hypothetically deductible to Wendy (if her employer had not reimbursed her) would have been $800. The amount of Wendy’s expenditure that is actually allowed as a deduction is ($1000 × 80%) − $700 = $100. The difference between the hypothetical and actual amount is $800 − $100 = $700. The taxable value of $700 is reduced by $700 to nil. 2. The taxable value of the expense payment fringe benefit (without the otherwise deductible rule) would be $700. The amount that would have been hypothetically deductible to Wendy (if her employer had not reimbursed her) would have been $800. The amount of Wendy’s expenditure that she is entitled to claim as a deduction is ($1000 − 700) × 80% = $240 (as it is reduced by the amount of reimbursement). The difference between the hypothetical and actual amount is $800 − $240 = $560. The taxable value of $700 is reduced by $560 to $140. Meal entertainment fringe benefits — taxable value

18.67 There are two methods to calculate the taxable value of meal entertainment: the 50/50 split method and the 12-week register method. The employer must make an election for these methods to apply; otherwise, a meal entertainment fringe benefit is treated as an expense payment fringe benefit, a property fringe benefit or a tax-exempt body entertainment fringe benefit. The 50/50 split method is based on 50 per cent of the employer’s total meal entertainment expenditure regardless of whether an employee or someone else received the benefit of the expenditure. The 12-week register method is also based on the employer’s total meal entertainment expenditure. A 12-week register needs to be kept to take into account an appropriate percentage of employee participation. An employer’s total meal entertainment expenditure for the FBT year is $20,000. The employer has kept a 12week register, which determined that 35 per cent of meal entertainment was provided as a fringe benefit. The taxable value is 35 per cent × $20,000 = $7000. If no register was maintained, the taxable value would be 50 per cent × $20,000 = $10,000.

Step 5: Calculating your FBT liability 18.68 The FBT liability is calculated per FBTAA s 5 and Fringe Benefits Tax Act 1986 s 6: FBT liability = (Fringe benefits taxable amount × FBT tax rate – rebates. [page 611] Note: The cash value of benefits received by employees of public benevolent institutions and health promotion charities, public and not-forprofit hospitals, public ambulance services and certain other tax-exempt entities will be maintained with an increase in annual FBT caps.

Z Co has a fringe benefits taxable amount of $30,000 in the current FBT year ended 31 March. During the year, Z Co paid four quarterly FBT instalments of $3000 each (total $12,000). Calculate the FBT payable. Answer: FBT payable ($30,000 × 49%) − $12,000 = $2700. Fringe benefits taxable amount 18.69 Due to differences in entitlements to GST credits, fringe benefits have to be divided into two different types. Type 1 is for GST-creditable supplies (s 149A), and type 2 reflects GST-free or input-taxed supplies. This higher gross-up rate reflects the fact that the employer can claim input tax credits as well as the expense of FBT. This lower gross-up rate reflects the lack of ability to claim GST input tax credits. Hence, the fringe benefits taxable amount is calculated as follows per s 5B(1A): Type 1 — aggregate fringe benefits amount × 2.0802 + Type 2 aggregate fringe benefits amount × 1.8868 + Aggregate non-exempt amount = Fringe benefits taxable amount Under a 49 per cent tax rate, the FBT gross-up factor (known as Type 1) is 2.1463; and (Type 2) is 1.9608. These terms are explained below. Type 1 aggregate fringe benefit amounts 18.70 Type 1 aggregate fringe benefit amounts are calculated as follows per FBTAA s 5C(3):

Total of employer’s employees’ individual fringe benefits amounts that are GST creditable + taxable value of excluded fringe benefit amounts that are GST creditable = Type 1 aggregate fringe benefits amount. Type 2 aggregate fringe benefit amounts 18.71 Type 2 aggregate fringe benefit amounts are calculated as follows per FBTAA s 5C(4): [page 612] Total of employer’s employees’ individual fringe benefits amounts that are not GST creditable + taxable value of excluded fringe benefit amounts that are GST creditable = Type 2 aggregate fringe benefits amount.

Read FBTAA 1986 Div 1 A car retailer that is registered for GST provided a fringe benefit to an employee in the current FBT year of an interstate holiday with a taxable value of $1100 (including GST). The FBT liability is: FBT payable = taxable value × gross-up rate × FBT rate = $1100 × 2.0802 × 47% = $1075.46 Thus, FBT is calculated on the GST-inclusive cost of the benefit, and the employer claims an input tax credit of $100. Also, the employer claims an income tax deduction of $2311 under ITTAA 1997 s 8-1(1)(b), which includes the cost of providing the benefit ($1100) less GST recovered ($100) and the FBT payable ($1075.46).

W Co is registered for GST and exports computer

chips. During the FBT year, W Co provided its employees with a taxable value of $10,000 for car benefits and a taxable value of $5000 for an overseas holiday. W Co also provided a taxable value of $1000 for restaurant entertainment expenses. Calculate the FBT liability. Answer: Calculate Type 1 aggregate fringe benefit amounts The car and entertainment benefits are Type 1 aggregate fringe benefit amounts that total $11,000. The car benefits are individual fringe benefits amounts that are GST creditable. The restaurant entertainment expenses (excluded from reporting fringe benefits) provided to employees are GST creditable. Calculate Type 2 aggregate fringe benefit amounts The overseas holiday is GST free and thus constitutes a Type 2 aggregate fringe benefit amount of $5000. Calculate the fringe benefits taxable amount: s 5B(1A) Type 1 aggregate fringe benefits amount × 2.0802 $11,000 × 2.0802 = $22,882 + Type 2 aggregate fringe benefits amount × 1.8868 $5000 × 1.8868 = $9434 + aggregate non-exempt amount $0 = Fringe benefits taxable amount $32,316 Thus, the employer’s FBT liability is $32,316 × 47% = $15,188.52

Practice Problem 9 Ivy Co is registered for GST and manufactures glass containers. During the FBT year, Ivy Co provided its

employees with a taxable value of $3000 for car benefits, $4000 for loan interest payments and $2000 for meal entertainment. Calculate the FBT liability.

[page 613] Reportable fringe benefits 18.72 Employers must record the gross-up taxable value of fringe benefits on employees’ payment summaries where they total over $2000 for an employee:s 135Q. Note: The minimum gross-up value changes to $3773. The gross-up rate will always be Type 2: s 135P. This will impact on the employee’s liability for some income tax rebates, Medicare levy surcharge and superannuation surcharge, and repayments of a debt under the Higher Education Support Act 2003: see s 135M. There are also certain fringe benefits that are excluded from the reporting requirements but are still subject to FBT: s 5E(3). These include: car parking fringe benefits that are not eligible car parking expense payment benefits; fringe benefits for entertainment facility leasing expenses; food and drink entertainment; amortised and reducible fringe benefits; and fringe benefits excluded by legislation. For the current FBT year, Jane’s employer provided her with a work car that had a taxable value of $3000 and an overseas holiday that had a taxable value of $2000. The amount that will be included in Jane’s payment summary is ($3000 + $2000) × 1.8868 = $9434. Aggregate non-exempt amounts: s 5B(1E) 18.73

Only employers that are public benevolent institutions or qualifying

public or non-profit hospitals have aggregate non-exempt amounts. These are calculated as follows per ss 5B(1E)–5B(1L): Total of employer’s employees’ individual gross-up non-exempt amounts (Type 1 and 2): $17,000 from each employee’s individual gross-up nonexempt amounts for certain employers (qualifying hospitals, public ambulance services) $30,000 from each employee’s individual gross-up non-exempt amounts for certain employers (certain public benevolent institutions) = Aggregate non-exempt amounts. St Paul’s Ambulance Service provides its 10 employees with car and housing fringe benefits of $20,000 per employee during the FBT year. The total of the employees’ individual gross-up non-exempt amounts is $200,000; however, this is reduced by $170,000 ($17,000 × 10), the employees’ individual gross-up nonexempt amounts. Thus, the aggregate non-exempt amount is $30,000, and this is also the fringe benefits taxable amount. Thus, the FBT liability is $14,700 ($30,000 × 49%). FBT concessions on salary packaged entertainment benefits 18.74 A separate grossed-up limit of $5000 applies for salary-sacrificed meal entertainment and entertainment facility leasing expenses for certain employees of not-for-profit organisations — and all use of these salarysacrificed benefits will become reportable for the 2016–17 FBT year onwards. [page 614] Rebatable tax-exempt employers 18.75 Rebatable employers are eligible for a rebate of, generally, 48 per cent of the amount of FBT, since such employers cannot claim a deduction

for FBT paid. The amount has not changed, even though the FBT rate dropped on 1 April 2006. Rebatable employers include the following organisations that are not public benevolent institutions or charities (see s 65J): certain religious, educational, charitable, scientific or public educational institutions; trade unions and employer associations; non-profit organisations established for the encouragement of music, art, literature or science; non-profit organisations established for the encouragement or promotion of a game, sport or animal races; non-profit organisations established for community service purposes; non-profit organisations established for the purpose of promoting the development of aviation or tourism; non-profit organisations established for the purpose of promoting the development of Australian information and communications technology resources; and non-profit organisations established for the purpose of promoting the development of the agricultural, pastoral, horticultural, viticultural, aquacultural, fishing, manufacturing or industrial resources of Australia.

Attempt the Web Quiz for Chapter 18

Summary 18.76 This chapter covered: how to calculate FBT liability following the five steps; what would be considered a fringe benefit — basically, this covered items in addition to wages and salary provided by an employer to an employee for the employee’s private use;

determining which of the 13 different categories applied to the fringe benefit; whether there were any exemptions or reductions that applied and their impact on fringe tax liability; calculating taxable value — this differed with each category; and calculating an employer’s fringe tax liability — this required an understanding of the impact of GST on the various benefits (determining Type 1 and Type 2) and using an equation to calculate the result. [page 615]

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3):8 identify the question at issue; research and make a decision; explain well; and use clear language. 1 What is FBT? 2 An employer provides the following benefits to an employee. Which are fringe benefits? a uniform allowance an early retirement scheme payment private use of the company yacht 3

4

A public ambulance service provides its five employees with fringe benefits with a gross-up non-exempt amount of $100,000 in total. What is the FBT liability? A boat builder, registered for GST, provided a fringe benefit to an employee in the current FBT year of a television with a taxable value of

5

6

7

8

9

$4400 (including GST). What is the FBT liability? What is the income tax deduction? A farmer, who is not registered for GST, celebrated the birth of his employee’s daughter by giving the employee’s wife a baby hamper valued at $400 including GST. What is the FBT liability? What is the income tax deduction? David, an employee of a real estate firm, has the use of a BMW. The car was purchased on 1 October of the current FBT year for $80,000 including GST and luxury car tax. He used the car for 182 of the 365 days in the current FBT year and travelled 20,000 km. He paid $80 for petrol during the year. The employer is registered for GST and claims input tax credits on the car. Calculate the FBT using the statutory percentage. Sue drives her employer’s Land Rover, which cost $70,000 including GST and luxury car tax. It was purchased on 1 April of the current FBT year. She used the car throughout the current FBT year and travelled 32,000 km, of which 26,000 km were for business. The employer is registered for GST and claims input tax credits on the car. The running costs for the car were $9000 during the period. Included in those costs was a contribution made by Sue of $590 for fuel. Calculate the FBT using the operating costs method. Best Tax Group provides its employees with the following fringe benefits in the current FBT year. Ben receives the Australian Financial Review on weekdays (at a cost of $500), a laptop computer to use at work (at a cost of $1200), a flat screen television (at a cost of $2500) and a return flight to Thailand for a holiday (at a cost of $800). Best Tax Group also pays the secretary’s child care costs of $900. Calculate Best Tax Group’s fringe benefits taxable amount for the year (Best Tax Group is registered for GST). Casual Ltd has four employees, Adrien, James, Bev and Claire, and it provides the following individual fringe benefits amount for each employee in the current FBT year:

[page 616]

10

11

12

13

14

Adrien — $2000; James — $2500; Bev and Claire — $1000 each. It also provides meal entertainment to its employees worth $3500. These are excluded fringe benefits per s 5E. Calculate the aggregate fringe benefits amount. Wine Co’s employee Dave has work in the countryside in the Coonawarra, well away from his Adelaide residence. Thus, Dave stays in the local hotel. Wine Co reimburses Dave’s accommodation costs. Does FBT apply on the reimbursement? Trading Pty Ltd provides a house (for the FBT year) located in Adelaide for Henry, an employee tradesman. Henry pays Trading $100 per week for the house (market rent is $380). Does FBT apply? Dick has a company car, which he drives from home to work and parks at his place of work near his employer’s business. A commercial parking station charging more than the car parking threshold fee is more than 1 km from this car park. The car park is also available for business use of other employees. Dick’s car is not parked at the employer-provided parking for more than 4 hours. Does FBT apply? Clean Wash manufactures washing machines for sale to the public. An employee purchases a washing machine for $1000, and the lowest selling price to the public for such an item is $1400. What type of fringe benefit is this? What is the taxable value? Rail Co’s employees are allowed to choose up to two rail travel tickets a year. The employer then purchases the ticket on behalf of the employee. The employer requires the employee to repay the cost of the ticket (the loan) over the life of the ticket. No interest is charged by the employer on the loan. The rail travel ticket is valid for a 12-month period. The notional taxable value calculated on the amount of the interest-free loan is less than $100 for the current year.

15

16

17

18

Does FBT apply? Generous Ltd reimburses an employee’s HELP fees for her commerce degree. Does FBT apply to this benefit? Flu is a serious respiratory infection that can be spread easily from one person to another. Thus, JB Ltd makes free flu vaccinations available to all its employees, although not all of the employees take up this offer. The vaccinations have been administered by a nurse or doctor. Does FBT apply to this benefit? Trish was reimbursed $400 by her employer for her home phone. Her employer always reimburses her for her phone. Her total bill was $600 for the year and she uses her phone 70 per cent for work-related calls. What is the taxable value of the fringe benefit? Kerri received a $400,000 loan from her employer at 2 per cent interest payable for the current FBT year ended 31 March. She uses $250,000 to purchase a rental property and the remaining $150,000 to replace the roof on her own home and for an overseas holiday for the family. Calculate the employer’s FBT liability. [page 617]

19

20

A Ltd’s employee died. To help the deceased’s family, A Ltd organised and paid for the funeral expenses of the deceased employee. Does FBT apply to this benefit? BBB Ltd pays for an employee to attend a structured quit smoking program that provides counselling services to assist the employee to stop the habit of cigarette smoking. BBB has a non-smoking policy for the workplace. The non-smoking policy is devised to improve or maintain the quality of the employee’s performance at work. The benefit is available to any employee and is not provided wholly or principally as a reward for services rendered.

Does FBT apply to this benefit?

1.

ATO, Fringe benefits tax — a guide for employers, NAT 1054, Copyright Commonwealth of Australia, reproduced with permission.

2. 3.

This chapter focuses on the current FBT year ended 31 March 2018. From 1 July 2005, public benevolent institutions and health promotion charities attract concessional treatment only where the Commissioner has approved the concession.

4.

TR 2003/5 defines a public benevolent institution as a non-profit institution organised for the direct relief of such poverty, sickness, suffering, distress, misfortune, disability, destitution or helplessness as arouses compassion in the community. See Ambulance Service of New South Wales v DCT (2003) 53 ATR 391. Bodies that perform government functions are not public benevolent institutions. ss 31–31B.

5. 6. 7.

ss 31C–31E. Refer to TD for relevant period, as it changes annually; for example, from 1 April 2012, refer to TD 2012/7.

8.

These questions focus on the current FBT year ended 31 March 2018.

[page 619]

19 Goods and services Learning Objectives After you have studied this chapter, you should be able to: understand the goods and services tax (GST) pyramid; explain the GST equation and how GST works; understand the steps involved in determining GST liability; determine when a supply is a taxable supply, GST-free supply or input-taxed supply; explain the requirements for a supply to be a taxable supply; determine who needs to register for GST or cancel their registration; determine who is an entity and who is an enterprise; calculate an entity’s GST turnover; explain how to register for GST; identify who is liable for GST on a taxable supply; identify the various GST-free supplies for food, health, education etc; identify the various input-taxed supplies such as financial, rented premises etc; determine what an input tax credit is;

explain the requirements for a creditable acquisition or a creditable importation; identify the various special GST rules; explain when an importation will be taxable or non-taxable; explain when an importation will be creditable; determine who is entitled to an input tax credit on an importation; calculate the GST payable on taxable importation and the input tax credit on a creditable importation; explain what is meant by an adjustment event; determine when an entity will have a decreasing or increasing adjustment; [page 620] calculate the adjustments; calculate the GST on a taxable supply and a partly taxable supply; calculate input tax credits; calculate the net amount of GST; determine the tax periods for accounting for GST; explain the cash basis and non-cash basis of accounting for GST; and be aware of the great caution needed in ascertaining the GST liability for large transactions such as property and business sales.

[page 621]

Key Legislative Provisions A New Tax System (Goods and Services Tax) Act 1999 (GST Act 1999) Div 2 Div 5 Div 7 Div 9 Div 11 Div 13 Div 15 Div 17 Div 23 Div 29 Div 37 Div 38 Div 40 Div 42 Div 135 Div 165 s 195-1 Schs 1, 2

Key Cases AGR Joint Venture and FCT 70 ATR 466; AAT Case [2007] AATA 1870; 2007

ATC 2692 Bayconnection Property Developments Pty Ltd and FCT, Re [2013] AATA 40 Brookvale Investments Pty Ltd and FCT, Re [2013] AATA 154 Clothing Importer and FCT, Re [2011] AATA 281 Drysdale and FCT, Re (2008) 69 ATR 717; [2008] AATA 154 FCT v Reliance Carpet Co Pty Ltd (2008) 236 CLR 342; 246 ALR 448; 68 ATR 158; [2008] HCA 22 FCT v Swansea Services Pty Ltd (2009) 72 ATR 120 FKLY and FCT [2016] AATA 810 Food Supplier and FCT, Re AAT Case [2007] AATA 1550; 2007 ATC 157; 66 ATR 938 Hornsby Shire Council and FCT, Re (2008) 71 ATR 442; [2008] AATA 1060 Igloo Homes Pty Ltd v Sammut Constructions Pty Ltd [2004] NSWSC 1213; 58 ATR 198 JMB Beverages Pty Ltd v FCT [2010] FCAFC 68; 76 ATR 76 Karmela Co Pty Ltd and FCT, Re (2004) 56 ATR 1012; [2004] AATA 481; (2004) ATC 2075 Keenhilt Pty Ltd (as Trustee for the CHC Services Trust) and FCT (2007) 67 ATR 988; AAT Case [2007] AATA 2095; 2007 ATC 2794 No Worries Management Pty Ltd v Dolman (2004) 55 ATR 780; 55 ATR 780; [2004] QSC P & N Beverages Australia v FCT (2007) 210 FLR 202; 65 ATR 391; [2007] NSWSC 338 Private Tutor and FCT, Re [2013] AATA 136 [page 622] Professional Admin Service Centres Pty Ltd v FCT [2013] FCA 1123 Rio Tinto Services Ltd v FCT [2015] FCA 94 Rod Mathiesen Truck Hire Pty Ltd (as trustee for the Mathiesen Family Trust) and

FCT, Re [2013] AATA 496 Snugfit Australia Pty Ltd and FCT, Re AAT Case [2013] AATA 802 Tam v Mannall [2010] NSWSC 250 Touram Pty Ltd and FCT, Re (2008) 70 ATR 991 Uber B.V. v FCT [2017] FCA 110 Vidler v FCT (2009) 74 ATR 520; [2009] FCA 1426

Key ATO Publications Guide to GST1 GSTR 2002/5 Goods and services tax: when is a ‘supply of a going concern’ GST-free? MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise Fact sheets GST food guide NAT 3338-07.2005

Diagram 19.1:

GST Pyramid

[page 623]

Diagram 19.2:

GST calculation

Chapter overview 19.1

This chapter is designed to provide a legal analysis of GST. It covers: the levels of the GST pyramid; – the GST equation; A New Tax System (Goods and Services Tax) Act 1999; GST tax calculations; – taxable supplies; – GST-free supplies; – input tax supplies; – input tax credits; – increasing and decreasing adjustments; – GST instalments; and

– administration. These basics will provide the necessary background for a sound understanding of GST. The GST2 is effectively a tax on final private consumption in Australia. The general rules on how it works are as follows.3 It’s a tax on supplies and importations (unless input taxed or GST-free) GST is a tax on a supply or importation of anything (goods and services or anything else), except to the extent that the supply or importation is input taxed or GST-free made by anyone registered.

[page 624] However, the supplier or importer (except an importer of goods) must be registered under this Act. Anyone carrying on an enterprise (a term that includes a business) may be registered. A thing is taxed each time it’s supplied or imported. A thing can attract GST each time it is supplied or imported along the commercial chain to its final consumption in Australia. GST is borne by consumers. GST is effectively borne by consumers when they acquire anything to consume. GST is remitted by suppliers who make supplies in carrying on their enterprise. Suppliers do not bear the GST because the tax is included in the price of what they supply. GST is paid by importers. Importations of goods are different. The Australian Customs Service collects the GST, from the importers, on imported goods when they are imported. There is no requirement for the importer to be registered or even carrying on an enterprise. Suppliers and importers get input tax credit. To ensure that GST is effectively borne by consumers, anyone who is registered is generally entitled to an input tax credit for the GST on what they acquire or import for the purpose of their enterprise. Generally, the amount of the input tax credit is the same as the amount of GST that was: included in the purchase price of the acquisition; or paid to Customs on the importation. In effect, the input credit is a reimbursement of the GST paid on the acquisition or importation. However, there is no input credit for anything acquired or imported for private consumption. The effect of this is that consumers are not reimbursed for the GST paid on their acquisitions or importations. Consumers therefore bear the GST.

HOW GST WORKS CLAY MINER The clay miner sells clay to the brick manufacturer for $220. That purchase price includes the $20 GST payable on the supply. The clay miner must remit $20 to the Commissioner. He is not out of pocket for the $20 because it was included in the price he charged. BRICK MANUFACTURER Because the brick manufacturer acquired the clay for the purpose of her enterprise, she is entitled to an input tax credit from the Commissioner for that acquisition. The amount of the input tax credit is $20. This is the amount of tax included in the price that she paid for the clay, so she is not out of pocket for the GST included in the purchase price. The brick manufacturer makes bricks out of the clay and sells them to the brick retailer for $440. That purchase price includes the $40 GST payable on the supply. The brick manufacturer must remit $40 to the Commissioner, but she is not out of pocket for it because it was included in the price she charged.

[page 625]

BRICK RETAILER Because the brick retailer acquired the bricks for the purpose of his enterprise, he is entitled to an input tax credit for that acquisition from the Commissioner. The amount of the input tax credit is $40. This is the amount of GST included in the price that he paid for the bricks, so he is not out of pocket for the GST included in the purchase price.

The brick retailer sells the bricks to the consumer for $550. That purchase price includes the $50 GST payable on the supply. The brick retailer must remit $50 to the Commissioner, but he is not out of pocket for it because it was included in the price he charged. CONSUMER The consumer is not entitled to an input tax credit for buying the bricks, because she did not buy them for the purpose of an enterprise. Therefore, she bears the $50 GST included in the purchase price she paid for the bricks. COMMISSIONER The Commissioner is paid a total of $110 GST for the supplies by the clay miner ($20), the brick manufacturer ($40) and the brick retailer ($50). However, the Commissioner pays, in total, $60 in input tax credits to the brick manufacturer ($20) and the brick retailer ($40). The difference between the amount the Commissioner is paid and the amount the Commissioner pays equals $50, which corresponds to the GST that was included in the purchase price paid by the consumer.

GST pyramid 19.2 At the top of the pyramid rests the key tax equation for GST that is used to calculate tax payable/refundable. GST is generally based on taxing sales (taxable supplies) less the credits for purchases (input tax credits), as set out in A New Tax System (Goods and Services Tax) Act 1999 (GST Act 1999) s 17-5 (see Diagram 19.2 above). The second level of the pyramid provides an overview of the legislation.

The third level of the pyramid consists of the following eight-step process, which provides a detailed analysis of the components of the GST equation: 1. What are your taxable supplies? 2. What are your GST-free supplies? 3. What are your input-taxed supplies? 4. Do the special GST rules apply? 5. What are your input tax credits? 6. What are your adjustments? 7. What are your GST instalments? 8. Calculating your GST. After discussing the pyramid, this chapter examines the administration of the GST and notes the interaction that GST has with other taxes. [page 626]

Level 1: The GST equation 19.3 As set out in Diagram 19.2, the application of the GST revolves around the following equation (s 17-5): GST payable on taxable supplies for the tax period LESS input tax credits on creditable acquisitions and creditable importations PLUS LESS

increasing adjustments decreasing adjustments

LESS GST instalments EQUALS GST payable/refundable

As noted at 19.2, there are eight steps in this calculation, which are explained in the Level 3 analysis below.

Level 2: Legislation overview of GST

19.4 The GST Act contains the following six Chapters and three Schedules: CHAPTERS

SCHEDULES

1

Introduction

1

Food that is not GST-free

2

The basic rules

2

Beverages that are GST-free

3

The exemptions

3

Medical aids and appliances

4

The special rules

5

Miscellaneous

6

Interpreting this Act

Chapter 1: Introduction 19.5 Chapter 1 provides that GST revenue will be granted to the states, the Australian Capital Territory and the Northern Territory, and that the rate and base of the GST will be maintained in accordance with the agreement endorsed at the Special Premiers’ Conference in Canberra on 13 November 1998. Additionally, an overview of the GST Act and information about defined terms, the status of guides and other non-operative material are provided in Ch 1.

Chapter 2: The basic rules 19.6 Chapter 2 consists of eight Parts providing the basic rules that cover methods of calculation, types of supplies and acquisitions, tax periods, registration and returns: see Diagram 19.3. [page 627]

Section 5-5 shows how the basic rules in GST Act Ch 2 relate to each other, as well as their interaction with the exemptions in Ch 3 and the special rules in Ch 4.

Chapter 3: The exemptions 19.7

Chapter 3 consists of three Divisions: GST-free supplies: Div 38; input-taxed supplies: Div 40; and non-taxable importations: Div 42. Division 38 lists the supplies that are GST-free. If a supply is GST-free, no GST is payable on the supply, but the entitlement to an input tax credit for anything acquired or imported to make the supply is not affected (ie, input tax credits can be claimed and refunded). The main exemptions include basic food, health, education, child care and exports. Division 40 sets out the supplies that are input taxed. If a supply is input taxed, no GST is payable on the supply; however, there is no entitlement to an input tax credit for anything acquired or imported to make the supply. These supplies include financial supplies, residential rent and residential premises. Division 42 lists the kinds of importations that are non-taxable. No GST is payable on an importation that is non-taxable.

Chapter 4: The special rules 19.8 The special rules for the GST apply only in certain circumstances and are quite limited in their scope. These provisions generally override the provisions of Ch 2.

Chapter 5: Miscellaneous 19.9 Chapter 5 consists of two Divisions. Division 176 deals with the endorsement by the Commissioner as a charitable institution and the endorsement by the Commissioner as a trustee of a charitable fund. Division 177 includes a variety of matters.

Chapter 6: Interpreting this Act 19.10 Chapter 6 provides rules for interpreting the Act and the meaning of some important concepts. The dictionary is contained in s 195-1. [page 628] Diagram 19.3:

The basic rules in GST Act Ch 2

Schedule 1: Food that is not GST-free 19.11 Schedule 1 lists food that is not GST-free. This includes prepared food, confectionery, savoury snacks, bakery products, ice cream food and biscuit goods.

Schedule 2: Beverages that are GST-free 19.12 Schedule 2 lists beverages that are GST-free. These include milk products, soy milk and rice milk, tea, coffee, fruit and vegetable juices, beverages for infants or invalids, and water.

Schedule 3: Medical aids and appliances 19.13 Schedule 3 contains various GST-free supplies of medical aids and appliances.

A New Tax System (Goods and Services Tax) Regulations 1999 19.14 The regulations provide a number of important GST rules. For example, they set out the requirements for tax invoices. They also provide information on financial input-taxed supplies. [page 629]

Read GST Act 1999 Divs 1, 2 and 5 Level 3: Analysis of components of GST equation Step 1: What are your taxable supplies? 19.15 ‘Taxable supplies’ is the pivotal GST term, as GST is based on the taxable supplies made by an entity. A taxable supply must satisfy the following requirements: see s 9-5: you are registered or required to be registered;

you make the supply in the course or furtherance of an enterprise that you carry on; you make a supply for consideration; the supply is connected with the indirect tax zone (ITS); and the supply is not GST-free or input taxed.

Read GST Act 1999 Div 9 19.16 Further, there are exceptions for taxable supplies where a supply is GST-free or input taxed. Where a supply is partly GST-free or partly input taxed, or both, the supply is taxable to the extent that it is not GST-free or input taxed.

Diagram 19.4:

Taxable supplies, GST-free supplies, input-taxed supplies

[page 630] Registration (first taxable supply requirement) 19.17 An entity must be registered to be in the GST system so it can charge GST and obtain credit for GST paid on its purchases (input tax credits). Per GST Act 1999 s 23-5–23-10, a taxpayer must be registered4 if the taxpayer is: an entity; carries on or intends to carry on an enterprise; and has a GST turnover that meets or exceeds the registration turnover

threshold (RTT)5 of $75,000 (non-profit bodies of $150,000). Note: The RTT is determined by regulation.

Read GST Act 1999 Div 23 What is GST turnover? 19.18 Whether your GST turnover meets the RTT depends on the current GST turnover and projected GST turnover: Div 188. An entity must register in the following two situations: if the current GST turnover meets or exceeds the RTT ($75,000, or $150,000 if a non-profit body) and the Commissioner is not satisfied that the projected GST turnover is below the RTT, then the entity must register: s 188-10(1)(a); and if the projected GST turnover is at or above the RTT, then the entity must register: s 188-10(1)(a).

Current GST turnover 19.19

Current GST turnover is the sum of values of all supplies (taxable

and GST-free supplies) made or likely to be made in the last 12 months, including the current month: s 188-15(1). Current GST turnover excludes:6 input-taxed supplies; [page 631] supplies not made for consideration; supplies that are made otherwise in connection with the carrying on of the enterprise; supplies not connected with Australia; supplies made between members of a group; transfers of capital assets or transfers associated with closing down the business or permanently reducing its size;7 and insurance payments or repayments of principal. Projected GST turnover 19.20 Projected GST turnover is the sum of values of all supplies (taxable and GST-free supplies) made or likely to be made in the following 12 months, including the current month: s 188-20(1). Projected GST turnover excludes:8 input-taxed supplies; supplies not made for consideration; supplies that are made otherwise in connection with the carrying on of the enterprise; supplies not connected with Australia; supplies made between members of a group; transfers of capital assets or transfers associated with closing down the business or permanently reducing its size; and insurance payments or repayments of principal. In summary, there are four possibilities in s 188-10, as follows: CURRENT GST TURNOVER

PROJECTED GST TURNOVER

DO THEY HAVE TO

OF ENTITY IS:

OF ENTITY IS:

REGISTER?

Above this limit

Above this limit

Yes

Below this limit

Below this limit

No

Above this limit

Below this limit

No

Below this limit

Above this limit

Yes

Read GST Act 1999 Div 188 Practice Problem 1 Pink Pty Ltd had the following transactions in the previous 12 months: $20,000 Taxable supplies $20,000 GST-free supplies $10,000 Giveaways $6000 Input-taxed supplies What is the current GST turnover?

[page 632]

Practice Problem 2 Which of the following entities has to register for GST? CURRENT GST TURNOVER $

PROJECTED GST TURNOVER $

Red Pty Ltd

80,000

150,000

Brown Pty Ltd

40,000

105,000

Black Pty Ltd

101,000

40,000

What is an entity? 19.21 Section 184-1 provides that an entity is: an individual; a body corporate; a corporation sole; a body politic; a partnership; any other unincorporated association or body of persons; a trust; and a superannuation fund.

Read MT 2006/1 What is an enterprise? 19.22 Section 9-20 widely defines what is an enterprise so as to ensure that the GST has a broad base. Also, certain things are included as enterprises so that input tax credits are available to them. An enterprise includes: a business, trade or profession; a lease, licence or other grant of interest in property; certain activities of gift-deductible funds, authorities or institutions; certain activities of charitable institutions; certain activities of religious institutions; certain activities of governments and government corporations; and trustees of funds listed in ITAA 1997 s 30-15, Item 2 in table. However, certain things are excluded from being an enterprise and are not subject to GST; these include hobbies, private recreational pursuits and

employee wages. For individuals and partnerships, there must also be a reasonable expectation of profit or gain. An art collection can constitute an enterprise, as seen in Swansea Services. [page 633]

FCT v Swansea Services Pty Ltd (2009) ATC 20-100 Facts: A private company, the taxpayer, was controlled by an individual who operated a property development business through a group of companies. Between 1997 and 2005, the taxpayer bought 225 antique items and 87 paintings for $4.8 million. The controlling individual of the taxpayer kept these on display at his two private houses. The taxpayer had no bank account and the purchases were made via unsecured loans from the individual and his company group. Over an 8-year period, three items were sold for a loss of $34,865. The Commissioner cancelled the taxpayer’s GST registration, as the taxpayer was not carrying on an enterprise but rather a private recreational hobby per GST Act 1999 s 9-20(2)(b). AAT held: The taxpayer carried on an enterprise. The taxpayer acquired and consolidated a valuable collection of sound saleable artwork to make a profit.

Re Private Tutor and FCT [2013] AATA 136 Facts: The taxpayer tutored part time a few hours per day in addition to his full-time job. The taxpayer’s business activity statements (BASs) over a 4-year period showed that his input tax credit claims exceeded the amounts of GST declared as owing. The Commissioner considered that he was not carrying on an enterprise, that the taxpayer tutored part time but was an employee of various

colleges, thus the claims for input tax credits should be refused, and that his GST registration should be cancelled. AAT held: The taxpayer was carrying on an enterprise. The taxpayer’s tutoring activities, although small in scale, nevertheless constituted an enterprise under s 9-20 of the GST Act 1999. The tutoring activities were carried out by the taxpayer in the form of a business (for a commercial purpose), with a view to making a profit.

Re Bayconnection Property Developments Pty Ltd and FCT [2013] AATA 40 Facts: The taxpayer companies were all owned by members of the same family who had been involved in property development and construction activities. The taxpayers were registered for GST purposes and lodged BASs, claiming input tax credits for acquisitions that were mainly from related parties. The taxpayers contended that the acquisitions were related to the development of a training and education centre for the relevant periods. AAT held: Input tax credit claims were denied. The taxpayers were not carrying on an enterprise. The taxpayers provided no concrete details of any kind as to the specific activities that were supposedly being carried on in relation to the development of the centre. The behaviour of the taxpayers showed intentional disregard. The 75 per cent penalty and 20 per cent uplift imposed by the Commissioner were affirmed.

Uber B.V. v FCT [2017] FCA 110 Facts: Are persons who are Uber drivers required to be registered for GST purposes? The issue is one of statutory construction. Whilst enterprises with a turnover of less than $75,000 do not need to

register for GST, a special rule in s 144-5 provides that taxi and limousine [page 634] operators are required to be registered, regardless of turnover. Taxi travel is defined in s 195-1 as meaning ‘travel that involves transporting passengers, by taxi or limousine, for fares’. Federal Court held: UberX service supplied by one of its drivers constituted the supply of ‘taxi travel’ within the meaning of GST Act s 144-5(1), and drivers are required to be registered.

Example Irena studies at university. She also makes small amounts of soap, which she sells to friends for $400 during the year. The scale and nature of her activities are not sufficient to be an enterprise. They are carried on in a very small way and in an ad hoc manner. She is not entitled to an Australian business number (ABN).9

Example Dodgers soccer club has 300 members, and many play for the club. Membership fees total $10,000 per annum. It also runs a bar and barbecue at its club rooms with an annual turnover of $40,000 and a net profit of $10,000. The bar is staffed on a voluntary basis and the club maintains records of its income and expenditure. The club has a committee and has an annual general meeting. The club’s activities are done in a businesslike manner. The club can register for GST since it is: an unincorporated association of persons; and carrying on an enterprise, as the activities are done in the form of a business. It is entitled to an ABN.

Example A poker card club has 10 members. The club has rules that the members agree to be bound by. They do not have to pay membership subscriptions. Meetings are held at members’ houses to which members bring food and drinks. Members supply their own cards. The club is an unincorporated association but the activities done by the members for the club are not carried on in a businesslike manner. The activities are not done in the form of a business and, as such, there is no enterprise being carried on. The club is not entitled to an ABN. How to register for the GST 19.23 Subdivision 25-A sets out the registration requirements for GST. To register, you must lodge an application to obtain an ABN and an application for GST registration. An entity must apply for registration within 21 days of becoming required to be registered. The Commissioner has wide powers to register a business, notwithstanding that it has not applied for registration. This will occur where an unregistered business has run up a GST debt. [page 635]

Practice Problem 3 Max runs a video shop. The business commenced 3 months ago and competition is fierce to the extent that Max’s accountant does not expect the business to make a profit in this financial year. However, through the use of innovative marketing methods, Max is establishing a solid base of repeat customers. Does Max’s activity constitute an enterprise?

Practice Problem 4 Saint Sue’s is a charitable institution. It runs a secondhand book store. Donations of used books are sold at nominal prices to the general public and the money raised is used to fund meals for the needy. Do the activities of the charity come within the definition of an enterprise?

Practice Problem 5 Felix enjoys restoring cars. He spends many hours every weekend enjoying this pastime. Felix decides to sell two of the restored cars because he is planning to purchase another old wreck. Do Felix’s activities constitute an enterprise?

Practice Problem 6 Consider each of the following scenarios and indicate whether the entity is required to register for GST. 1 Jane’s GST turnover for the past year was $65,000. This consisted of a one-off sale of a boat and trailer during the period. Jane is a Commonwealth public servant whose annual income is $75,000. 2 The Port Soccer Club, a non-profit association, received $120,000 in membership fees and club facility hiring charges in the last 12 months. It expects to increase membership and hiring fees by 50 per cent in the next 12 months because of an

3

aggressive marketing plan. Pretty Gardens Pty Ltd is an entity supplying gardening services. It operates a mowing business with a current GST turnover of $33,000. It also operates a garden design service with a current GST turnover of $50,000.

What is a supply (second taxable supply requirement)? 19.24 ‘A supply’ is widely defined as any form of supply whatsoever: see s 9-10(1). This includes (Subs (2)): (a) a supply of goods; (b) a supply of services; [page 636] (c) (d) (e) (f) (g)

a provision of advice or information; a grant, assignment or surrender of real property; a creation, grant, transfer, assignment or surrender of any right; a financial supply; an entry into, or release from, an obligation: (i) to do anything; or (ii) to refrain from an act; or (iii) to tolerate an act or situation; (h) any combination of any two or more of the matters referred to in paras (a)–(g). However, it does not include a supply of money unless the money is provided as consideration for a supply that is a supply of money. The transfer of bitcoin is a ‘supply for GST purposes’, as bitcoin is not ‘money’ for the purposes of the GST Act.10

Read GST Act 1999 s 9-10 Keenhilt Pty Ltd (as Trustee for the CHC Services Trust) and FCT (2007) 67 ATR 988; AAT Case [2007] AATA 2095; 2007 ATC 2794 Facts: The trustee of the trust was part of a corporate group. The trustee provided tax schemes (NVI arrangements) to clients in return for a fee. The fees from the clients were credited to the accounts of individuals or entities connected to the trust. Ultimately, under the scheme, the income was loaned back to clients as non-taxable payments. The corporate trustees of the various trusts were companies within the Cleary Hoare Corporate Group. Further, the trustee companies’ directors were also directors of CHC Pty Ltd. The Commissioner argued that the trust was liable for GST for supplying schemes that were carried out by related entities. These transactions of the trust were a ‘supply’ per GST Act 1999 s 9-10. AAT held: The trust was providing supplies for consideration in the course of carrying on a business. The trust was in the business of supplying tax minimisation and avoidance schemes, and these schemes constituted a supply per s 9-10. Section 9-15 does not require that a payment be made to the person supplying the services; it requires only that the consideration be paid in connection with the supplies.

Re Hornsby Shire Council and FCT AAT Case [2008] AATA 1060; 71 ATR 442 Facts: In 1994, the taxpayer council rezoned the land on which a quarry was located, which was owned by CSR. Under the Hornsby Local Environmental Plan 1994 (LEP), CSR then exercised its rights to make the council acquire the land. CSR needed to institute legal action to require the council to acquire the land for, and pay

compensation to, CSR of $25,099,500. The council paid this amount in two instalments and claimed an input tax credit of $2,409,888 associated with the payments to CSR. The Commissioner denied the taxpayer’s claim to which the taxpayer objected. This transaction did not amount to a supply within GST Act 1999 s 9-10. [page 637] AAT held: The CSR’s giving of the notice under the LEP resulted in the acquisition of the quarry. Thus, CSR had made a supply within GST Act s 9-10(2)(g). Also, in terms of the dictionary definition of ‘surrender’, CSR had made a supply within s 9-10(2)(d) or (g). Since the supply was made for consideration, the council was entitled to the input tax credit, despite the fact that CSR was the initiating party to the acquisition.

Practice Problem 7 Provide examples of supplies.

Supply in the course or furtherance of an enterprise 19.25 ‘In the course or furtherance’ is not defined but is broadly worded to cover any supplies made in connection with an enterprise. An act done for the purpose or object of furthering an enterprise or achieving its goals is a furtherance of an enterprise, although it may not always be in the course of that enterprise. ‘In the course or furtherance’ does not extend to the supply of private commodities, such as when a car dealer sells his or her own private car.11

Supply for consideration (third taxable supply requirement) 19.26 Section 9-15 widely defines ‘consideration’ to include: any payment, or any act or forbearance, in connection with a supply of anything; and any payment, or any act or forbearance, in response to or for the inducement of a supply of anything. It does not matter whether the payment, act or forbearance was voluntary or whether it was by the recipient of the supply. Also, it does not matter whether the payment, act or forbearance was in compliance with an order of a court or of a tribunal or other body that has the power to make orders, or whether the payment, act or forbearance was in compliance with a settlement relating to proceedings before a court or before a tribunal or other body that has the power to make orders. For the avoidance of doubt, the fact that the supplier is an entity of which the recipient of the supply is a member or that the supplier is an entity that makes supplies only to its members does not prevent the payment, act or forbearance from being consideration. The supply of a right or option will be taxed when it is supplied. The later exercise of that right or option will be another supply. That later supply will not be taxable unless there is further consideration when the right or option is exercised: s 9-15(3). A payment made as a gift to a non-profit body or a government-togovernment appropriation is not the provision of consideration: s 9-15(3)(b), (c). [page 638]

Re Rod Mathiesen Truck Hire Pty Ltd (as trustee for the Mathiesen Family Trust) and FCT [2013] AATA 496 Facts: In March 2008, the taxpayer trust agreed to sell a property for $3.177 million plus GST. On settlement on 16 May 2008, the trust

and the purchaser entered into a settlement balance facility agreement and the trust received a payment of over $2 million from the purchaser. However, the transfer instrument recorded the consideration of $3.495 million. The trust paid GST on the $2 million, but the Commissioner assessed the trust on the amount of $3.495 million. AAT held: All of the consideration in relation to the sale of the property was received by the trust at the time of settlement on 16 May 2008. It received full consideration on the transfer of the property in the 2008 tax year, in part through the vendor finance agreement.

Practice Problem 8 Provide examples of consideration.

Connected with the Indirect Tax Zone (ITZ) (fourth taxable supply requirement) 19.27 Section 9-25 sets out seven situations where a supply is connected with the ITZ. A supply is connected with the ITZ generally where the supply of goods or services is provided within the ITZ. The ITZ generally means Australia (within the meaning of the *ITAA 1997), s 195-1. GST applies on offshore intangible supplies to Australian consumers with effect from 1 July 2017 (the ‘Netflix’ tax), ss 9-25(5)(d) and 9-25(7). The tax is imposed on intangible supplies such as supplies of digital content, games and software, and will also extend to services performed offshore for customers in Australia. Non-residents (overseas suppliers) will be the ones who charge, collect and remit the GST for digital and physical products. As is the case in Australia, only vendors with an Australian turnover of $75,000 will need to register and charge the GST.

Read GST Act 1999 s 9-25 Sale of vacant land can be a taxable supply. Re Touram Pty Ltd and FCT [2008] AATA 1167 Facts: The taxpayer purchased a vacant block of land under a contract that stated that the purchase price of $226,737 included GST. The vendors were farmers who had owned the land for about 12 years, and they purchased the land as an investment with a view to capital appreciation. The taxpayer claimed that the sale of the land was a taxable supply and thus an input tax credit of $20,612 applied. The Commissioner argued that the sale was not made in the furtherance of an enterprise being carried on; thus, no input tax credit was claimable. [page 639] AAT held: The vendors had acquired the land with a view to selling it for a profit. While the vendors did not intend to develop the land themselves, the vendors provided the groundwork for a development. Thus, the vendors were involved in a property investment enterprise and the vendors made a taxable supply of the land to the taxpayer within the meaning of GST Act 1999 s 9-5.

Re Clothing Importer and FCT [2011] AATA 281 Facts: The taxpayer imported goods into Australia to supply to Australian customers. The taxpayer did not carry on a business in Australia and had no premises or employees in Australia. A broker in Australia advised the taxpayer to register for GST so as to enter into a deferral scheme. The Commissioner argued that a GST liability

arose when the taxpayer imported the goods. This was offset by an input tax credit for the creditable importation. When the taxpayer supplied the goods to Australian customers, this constituted a taxable supply and thus the taxpayer was liable for GST. AAT held: The taxpayer made taxable supplies to Australian customers. The supplies were connected with Australia. As per s 9-5, the taxpayer was liable for GST.

Low value importations 19.28 Previously, certain importations under Customs Tariff Act 1995 Sch 4, such as most goods with a customs value equal to or less than the prescribed amount of $1000 (low value goods) were non-taxable importations. From 1 July 2018: supplies of goods valued at $1000 or less at the time of supply connected with the ITZ if the goods are, broadly, purchased by consumers and are brought to the ITZ with the assistance of the supplier; treat the operator of an electronic distribution platform as the supplier of low value goods if the goods are purchased through the platform by consumers and brought to the ITZ with the assistance of either the supplier or the operator; treat redeliverers as the suppliers of low value goods if the goods are delivered outside the ITZ as part of the supply and the redeliverer assists with their delivery into the ITZ as part of, broadly, a shopping or mailbox service that it provides under an arrangement with the consumer; allow non-resident suppliers of low value goods that are connected with the ITZ only because of these amendments to elect to be limited registration entities; and prevent double taxation by making importations of goods non-taxable importations if the supply of the goods is a taxable supply only as a result of these amendments and notice is provided in the approved form.

The supply is not GST-free or input taxed (fifth taxable supply requirement) 19.29 Taxable supplies exclude supplies that are GST-free or input taxed. See steps 2 (19.30) and 3 (19.55) below. [page 640]

Step 2: What are your GST-free supplies? Non-taxable supplies 19.30 There are two types of exemptions from taxable supplies: 1. GST-free supplies: Div 38; and 2. input-taxed supplies: Div 40.

GST-free supplies 19.31 If a supply is GST-free, you do not charge GST on the supply but you are entitled to input tax credits on the things you acquired to make the supply. While this appears beneficial to certain businesses, there may be considerable compliance costs as well as cash flow problems in waiting for the GST refunds for input tax credits. GST-free supplies are set out in the following Subdivisions: Subdivision 38-A — Food; Subdivision 38-B — Health; Subdivision 38-C — Education Subdivision 38-D — Child care; Subdivision 38-E — Exports and other supplies for consumption outside Australia; Subdivision 38-F — Religious services;

Subdivision 38-G — Activities of charitable institutions etc; Subdivision 38-I — Water, sewerage and drainage; Subdivision 38-J — Supplies of going concerns; Subdivision 38-K — Transport and related matters; Subdivision 38-L — Precious metals; Subdivision 38-M — Supplies through inwards duty free shops; Subdivision 38-N — Grants of land by governments; Subdivision 38-O — Farm land; Subdivision 38-P — Cars for use by disabled people; Subdivision 38-Q — International mail; Subdivision 38-R — Telecommunications supplies for global roaming in Australia; and Subdivision 38-S — Supplies of eligible emissions units.

Basic food for human consumption: Subdiv 38-A 19.32 Most basic food for human consumption will be GST-free. Determining GST-free food involves three steps. The food: 1. must be food; 2. must not be excluded from being GST-free; and 3. must be for human consumption. [page 641] Step 1: Must be food 19.33 The presumption is that food12 is GST-free: s 38-2. Food means any of these or any combination of any of these (s 38-4): food for human consumption (whether or not requiring processing or treatment); ingredients for food for human consumption;

beverages for human consumption; ingredients for beverages for human consumption; goods to be mixed with or added to food for human consumption (including condiments, spices, seasonings, sweetening agents or flavourings); and fats and oils marketed for culinary purposes. Food, though, does not include: live animals (other than crustaceans or molluscs) or unprocessed cow’s milk; any grain, cereal or sugar cane that has not been subject to any process or treatment resulting in an alteration of its form, nature or condition; or plants under cultivation that can be consumed (without being subject to further process or treatment) as food for human consumption. Step 2: Must not be excluded from being GST-free 19.34 Section 38-3 sets out food that is not GST-free: food for consumption on the premises from which it is supplied; hot food for consumption away from those premises; food of a kind specified in the third column of the table in Cl 1 Sch 1 or food that is a combination of one or more foods at least one of which is food of such a kind; a beverage (or an ingredient for a beverage), other than a beverage (or ingredient) of a kind specified in the third column of the table in Cl 1 Sch 2; or food of a kind specified in regulations made for the purposes of s 38-3(1). However, s 38-3 does not apply to a supply of food of a kind specified in regulations made for the purposes of s 38-3(2). It should be noted that Sch 1 and 2 are not exhaustive, and the ATO has the power to determine the GST status of other foods in the GST Regulations. 19.35

Restaurant/takeaway or prepared meals: Food for human consumption,

which is not GST-free, includes: food for consumption on the premises where it is supplied, such as restaurants; food supplied as a hot takeaway food, such as hamburgers and chicken pieces; or food supplied as prepared food, such as pizzas and sandwiches sold in supermarkets. 19.36 What is covered by the term ‘premises’? The term ‘premises’ describes the place where food is sold or supplied to consumers. It includes the actual place where the food is supplied, the grounds surrounding the outlet (where they are used in connection with the supply of food) or any enclosed space such as a football ground or garden. Food consumed on the premises from which it is supplied, or supplied as hot takeaway food or as prepared food, will have GST applied to it. [page 642] Step 3: Must be for human consumption 19.37 For example, food to be consumed by animals will not qualify as being GST-free.

Examples of GST-free food and GST-included food 19.38 The following table shows examples of food that is GST-free and food that has GST included. GST-FREE FOOD13

GST-INCLUDED FOOD

Meat and fish Meat products uncooked (unless pet food) Processed meats and deli products Chicken (raw, frozen and cooked but sold cold) Fresh fish, seafood (tinned and frozen) (excluding prepared meals)14

Restaurant/takeaway food and drinks for consumption on the premises where it is supplied, such as restaurants Supplied as a hot takeaway, such as hamburgers and chicken pieces

Fruit and vegetables

Prepared food

Vegetables (fresh, frozen and canned) Fruit (fresh, dried, frozen and canned) Fruit and vegetable juices (90 per cent minimum by volume of juice)

Includes food that directly competes with takeaways/restaurants Food marketed as a prepared meal, excluding soup Hamburgers, chicken burgers Processed meat products (eg, sausages) Hotdogs Pizzas Quiches Prepared sandwiches and rolls Fruit (fresh, dried, frozen and canned) Platters of fruit, cheese and cold meat (sold as a pre-prepared platter)

Dairy produce Eggs Cheese Cream Butter, margarine Yoghurt Beverages Fruit and vegetable juices (90 per cent minimum by volume of juice) Milk (to the extent of at least 95 per cent), soy and rice milk — but not including flavoured beverages Tea, coffee, malt drinks Herbal tea and coffee substitutes

Beverages Cordial Flavoured milk or beverages Soft drink Fruit and vegetable juices (if less than 90 per cent minimum by volume of juice) Beer, wine, spirits Sports drinks

[page 643]

Non-carbonated natural water Dry preparations marketed for flavouring milk Water, bottled natural water, non-carbonated without additives Bread Bread and rolls, including savoury bread (but without sweet filling or coating) Breakfast cereals Flour Rice (uncooked) Pasta (uncooked)

Beverages marketed in a ready-to-drink form Bakery products Cakes, muffins and puddings Pies (meat, vegetable or fruit), pasties, sausage rolls Donuts, pastries, tarts, scones Bread and buns with sweet filling or coating

Infant food Infant formula rusks for infants Beverages for infants Tinned baby food

Confectionery Confectionery — including food marketed as ingredients for confectionery Popcorn Muesli bars and health food bars Edible cake decorations Crystallised fruit, glacé fruit

Spreads Mustard Jam Vegemite, Marmite, Promite Peanut butter

Savoury snacks Chips and crisps Processed seeds and nuts (eg, salted, spiced, roasted) Caviar Seeds and nuts (raw and unprocessed)

Condiments Gravy mixes Herbs and spices Mustard Tomato or other flavoured sauces Vinegar and other cooking oils Chutney Pickles

Ice cream food Ice cream, frozen yoghurt and similar frozen confectionery (ie, ice cream substitutes)

Other Soup (tinned, dried and prepared) Sugar Honey Cake mixes All canned food Salad dressing

Biscuits Biscuits, cookies, crackers, pretzels

P & N Beverages Australia v FCT (2007) 210 FLR 202; 65 ATR 391; [2007] NSWSC 338 Facts: A beverages manufacturer sought a declaration from the Supreme Court of New South Wales that a carbonated fruit drink it manufactured was GST-free under the exemption for non-alcoholic carbonated beverages consisting wholly of juices of fruits or vegetables, [page 644]

per GST Act Cl 1 of Sch 2 (Item 11). The drink was reconstituted with water from a fruit concentrate with 1 per cent of non-fruit additives. Court held: To be exempt, the fruit drinks must consist of 100 per cent of juices of fruit. The introduction of 1 per cent of non-fruitbased additives meant the exemption was not attracted. The court adopted a purposive approach and looked at Parliament and its broad intention of exempting fresh, natural and unprocessed food.

Food Supplier and FCT AAT Case [2007] AATA 1550; (2007) ATC 157; 66 ATR 938 Facts: The taxpayer sold a package containing GST-free food, coffee and other taxable promotional items such as cups, containers, alarm clocks, radios and cricket balls. The items were packaged with the GST-free food and branded with the food supplier’s name, and the promotional items were labelled as being ‘free’. The package was sold for the same price as the food alone. The taxpayer treated the whole package as GST-free. The Commissioner disagreed. AAT held: Promotional items were supplied for consideration and thus constituted a taxable supply. Thus, apportionment of the value between the taxable and GST-free components was required under GST Act 1999 s 9-80. This judgment is consistent with GST Ruling GSTR 2001/8.

JMB Beverages Pty Ltd v FCT [2010] FCAFC 68; 76 ATR 76 Facts: The taxpayer manufactured and sold de-alcoholised wine. The taxpayer argued that the wine was GST-free. Full Federal Court held: GST applied. To be GST-free, the wine had to be, at a minimum, juices of fruit under either of those Items 11 or 12 in GST Act 1999 Sch 2. The fermentation process had changed

the juices of fruits to wine. The de-alcoholisation process did not result in the product being returned to its original state. Food packaging 19.39 Packaging for GST-free food is GST-free where the packaging is necessary and is the sort of packaging usually used for that type of food: s 386.

Health: Subdiv 38-B 19.40 Most medical and hospital care services and health insurance are GST-free. Medical services 19.41 Medical services are GST-free if they are provided by a medical practitioner or an approved pathology practitioner or are commonly used health services supplied by a recognised professional.15 Examples of GST-free health services are: ambulance services; [page 645] general practitioner and specialist consultations; and diagnostic, surgical and therapeutic procedures (eg, ophthalmology, neurology, optometry, radiation oncology, anesthetics, radiology, ultrasound etc) and pathology. Other medical services that are GST-free where the service provider is a recognised professional include: Aboriginal or Torres Strait Islander health; audiology, audiometry; chiropody;

chiropractic; dental; dietary; nursing; occupational therapy; optical; osteopathy; paramedical; pharmacy; psychology; physiotherapy; podiatry; speech pathology; speech therapy; and social work. Hospitals, residential care and community care 19.42 Health care provided at hospitals, nursing homes, hostels, residential care, community care and similar establishments is GST-free.16 This includes nursing care services supplied to patients at home, and accommodation, drugs, dressings and meals supplied to patients or nursing home residents. Food served in hospital cafeterias and non-health care goods and services rented to patients, though, are subject to GST under the general rules. Medical appliances and aids 19.43 The supply of certain medical appliances for use by people with medical conditions or disabilities, such as wheelchairs, crutches, artificial limbs and modifications to motor vehicles for the disabled, is GST-free.17 Re Snugfit Australia Pty Ltd and FCT AAT Case [2013] AATA 802

AAT held: The supply of a sleep positioning system is GST-free under s 38-45(1) GST Act, since it is a medical aid. The product is made of foam with a fabric cover and is designed to be used in conjunction with a mattress to encourage side sleeping. Thus, it is GST-free under Item 82 of Sch 3 to s 38-45(1) under the category of night-time positioning equipment modifications.

[page 646] Drugs, medicines and goods 19.44 The supply of certain drugs and medicines that can be provided only on prescription or Pharmaceutical Benefits Scheme, and Repatriation Pharmaceutical Benefits Scheme medicines provided on prescription, such as drugs prescribed by medical practitioners, dental practitioners and pharmacists, are GST-free.18 Goods of a kind that the Health Minister determines are also GST-free.19 Private health insurance 19.45

Health insurance is also GST-free.20

Education: Subdiv 38-C 19.46 Generally, the following educational services are GST-free: education courses; the provision of accommodation at boarding schools; and TAFE, university, trade and professional courses. Excursions, field trips, course materials provided to students and the lease or hire of goods for student use are all GST-free.21 Not all related goods and services are GST-free. Things other than educational services supplied to students by an educational institution are

subject to GST in the normal way. Examples of supplies that are not GST-free include: computers and books; the food component of boarding fees, and food and beverages sold to students (eg, in tuck shops); school bus services and uniforms; fees charged for equipment hire (eg, musical instruments); and supplies for fundraising purposes. Note: Goods loaned to students free of charge will not be taxed. The recognition of prior learning to access education or for membership of a professional body or trade or licence or registration for occupation are GSTfree.22

Read GST Act 1999 subdiv 38-B Child care: Subdiv 38-D 19.47 Child care supplied by a registered child care provider is GST-free: see Subdiv 38-C. [page 647]

Exports: Subdiv 38-E 19.48 Exports are GST-free. Exported goods must be physically exported from Australia, and exported services must be performed outside Australia for them to be GST-free: see s 38-185.

Religious services: Subdiv 38-F 19.49

Religious services are generally GST-free: see s 38-220. Churches

and other institutions that supply religious services that are integral to the practice of the religion supply those services GST-free.

Supplies of businesses that are going concerns: Subdiv 38-J 19.50 The supply of a going concern is GST-free if: the supply is for *consideration; the *recipient is *registered or *required to be registered; and the supplier and the recipient have agreed in writing that the supply is of a going concern. A supply of a going concern is a supply under an arrangement under which the supplier upplies to the *recipient all of the things that are necessary for the continued operation of an *enterprise, and the supplier carries on, or will carry on, the enterprise until the day of the supply (whether or not as a part of a larger enterprise carried on by the supplier).23 Re Brookvale Investments Pty Ltd and FCT AAT Case [2013] AATA 154 Facts: The taxpayer, a property developer, sold the land to the purchaser for $3.5 million in June 2006 under a standard contract form, with settlement on July 2006. The taxpayer did not report the sale for GST purposes. After an audit in 2011, the Commissioner determined that the GST payable on the sale was $318,182. In May 2011, the purchaser and the directors of the taxpayer each signed statutory declarations that at the time of the contract and settlement, the land was purchased as a going concern. The taxpayer argued that the sale of land was a GST-free supply of a going concern, as per s 38325 of the GST Act 1999. AAT held: Taxable supply. To satisfy the condition in s 38-325(1)(c), the agreement that the relevant supply is of a going concern must be made at or before the time the supply is made. The tribunal found no

evidence of a written agreement between the parties (at the date of supply or at settlement) that the sale of the land was a supply of a going concern. The taxpayer had not discharged its onus of proving that the assessment was excessive.

Charitable activities: Subdiv 38-G 19.51 Non-commercial supplies by charities and gift-deductible entities are GST-free: see s 38-250. Raffles and bingos conducted by charitable bodies are GST-free: see s 38-270. [page 648]

Tourists and international travel: Subdiv 38-K 19.52 Goods and services consumed by tourists in Australia are generally subject to GST. International air and sea travel, though, are GST-free, as is any domestic air travel purchased overseas by non-residents.24 Tourists and Australian residents going overseas are able to recover the GST they pay on goods they purchased in Australia and take away with them when they leave. Refunds apply to purchases of at least $300 made from any one business within 28 days of departure. Where the goods are subsequently brought back, that is, imported into Australia, GST will be payable at that time as for all imports.

Supplies of eligible emissions units: Subdiv 38-S 19.53 Supplies of eligible emissions units are GST-free. The normal GST rules apply to financial derivatives of eligible emissions units and payments of grants of government assistance and other transactions under the carbon pricing mechanism.

Other GST-free supplies 19.54 Other GST-free supplies include: water and sewerage services: Subdiv 38-I; precious metals: Subdiv 38-L; supplies through inwards duty free shops: Subdiv 38-M; grants of freehold and similar interests by governments: Subdiv 38-N; subdivided farm land: Subdiv 38-O; cars for use by disabled people: Subdiv 38-P; international mail: Subdiv 38-Q; and telecommunications supplies for global roaming in Australia: Subdiv 38R.

Read GST Act 1999 Subdiv 38-J Supplies of going concerns You run a farm and you sell your truck. Since the truck is not a going concern, the supply is not GST-free.

Practice Problem 9 Provide examples of GST-free supplies.

[page 649]

Step 3: What are your input-taxed supplies? 19.55 If a supply is input taxed, you do not charge GST on the supply, but you are not entitled to input tax credits on the things you acquired to make the supply. Generally, supplies are input taxed where it is impractical to impose GST on them, but it is not appropriate to allow the supply to be GST-free. Input-taxed supplies include the following: Div 40.

Financial supplies: Subdiv 40-A 19.56 In general, financial supplies are input taxed: see s 40-5. Some financial supplies for which there is a readily identifiable fee or charge, such as investment advice, are subject to GST. Exports of financial services will be GST-free, in line with the treatment of other exports. Input-taxed financial transactions include: dealing with money; lending; issuing securities/shares; life insurance (general insurance is taxable and health insurance is free); superannuation fund management; and mortgages. Supplies that are incidental to financial supplies (eg, house valuation) are also input taxed. However, the following supplies are taxable: advisory services (even if of a financial or investment nature); general insurance, which is insurance other than life insurance or health insurance; legal services; accounting services; tax agents’ services;

safe custody service for cash, documents or other things; and payroll services.

Residential rents: Subdiv 40-B 19.57 Residential rents will be input taxed to ensure comparable treatment for renters with owner-occupiers: ss 40-35, 40-70. Rio Tinto Services Ltd v FCT [2015] FCA 94 Facts: Rio Tinto paid input tax credits (ITCs) of nearly $600,000 for acquisitions made by its GST members groups companies — Hamersley and PICS — in providing, and maintaining, residential accommodation for Hamersley’s workforce in the Pilbara region. The accommodation was leased to the workers and this was an input taxed supply under s 40-35. The court said Hamersley makes losses on providing the accommodation, and the rent charged is generally subsidised by the company. The taxpayer argued that the acquisitions were made wholly for a creditable purpose since the supply was not an end commercial objective in itself but was wholly incidental to Hamersley’s mining operations as a necessary and essential part of those [page 650] operations. The Commissioner argued that GST Act s 11-15(2)(a) applied because it related to making supplies that would be input taxed. The court found that the acquisition was not a creditable acquisition since it relates to making supplies that were input taxed. Per s 40-35(1) (a), input taxed supplies include a supply of residential premises by way of lease.

Residential premises: Subdiv 40-C 19.58 Supplies of residential premises other than the sale of a new house are input taxed: s 40-65. Re Karmela Co Pty Ltd and FCT (2004) 56 ATR 1012; ATC 2075; [2004] AATA 481 Facts: A landlord argued that a house separately occupied by four licensees was a boarding house for the purposes of the GST Act and thus he could claim input tax credits on costs. The landlord, though, did not provide any meals to the boarders nor did he live at the premises as would be the case with a boarding house. AAT held: Disallowed the input tax credits for the landlord’s costs of supplying accommodation, as the property constituted residential premises.

Vidler v FCT (2009) 74 ATR 520; [2009] FCA 1426 Facts: The taxpayer sold two blocks of vacant land in December 2004 and May 2005. The first block was zoned as residential and the second block was zoned as mixed residential. The taxpayer did not pay GST on the sale of the land, because he argued that the sales were input-taxed supplies, being residential premises to be used predominantly for residential accommodation per GST Act s 40-65(1). Federal Court held: GST taxable. The two blocks of land were not occupied at the time of sale. For the land to satisfy the definition of residential premises, they must, at the time of sale, have been capable of providing some shelter and basic living facilities.

Re FKYL and FCT [2016] AATA 810

Facts: The taxpayer was a sole trader carrying on a house construction business and entered into contracts for the construction of four residential houses on vacant blocks. On completion, the properties were initially rented then subsequently sold. The taxpayer did not provide any tax invoices to the ATO and did not claim any input tax credits (ITCs) for the purchase of the properties. The margin scheme did not apply. The ATO treated the property sales as sales of new residential premises and were subject to GST and that she was not entitled to apply the margin scheme. The GST liability was calculated as 1/11th of the sale price of the properties totalling $116,091. She was not entitled to 100 per cent of her claimed ITCs relating to construction costs since the properties were rented prior to sale. The ATO allowed $45,652 ITCs for construction costs and a further $8115 for non-construction costs. The taxpayer’s GST liability was now $55,052.A 25 per cent penalty applied for failure to take reasonable care in completing the BASs during the relevant period. The taxpayer argued that the properties were more than 5 years old when they were sold and therefore not subject to GST. Also, the margin scheme applied. [page 651] AAT held: Four properties sold by a property developer were new residential premises and therefore subject to GST. It held the properties were not subject to the 5-year rule under GST Act s 40-75 and that the margin scheme did not apply.

Precious metal: Subdiv 40-D 19.59 The first supply of precious metal after refinement is GST-free. Subsequent supplies are input taxed: s 40-100.

AGR Joint Venture and FCT (2007) 70 ATR 466; AAT Case [2007] AATA 1870; (2007) ATC 2692 Facts: The taxpayer sold coin blanks to the Royal Australian Mint and Gold Corporation. The question at issue was whether GST applied on the gold or silver component of the coin blanks. The taxpayer argued that of the two supplies, for the supply of a credit to the customer’s metal account and for the service of fabricating the metal into coin blanks, the credits provided a separately enforceable right to precious metal that is GST-free or input taxed. Only the fabrication of the coins was a taxable supply. AAT held: The supply of coin blanks is a taxable supply and GST applied. The transactions involved one supply, being the supply of coin blanks. Alternatively, the AAT found that if there were two supplies, then each supply would be taxable. There was no supply or right to supply gold in investment form, which would otherwise be GST-free under GST Act ss 9-30, 38-385, 40-100 and 195-1.

School tuck shops and canteens: Subdiv 40-E 19.60 School tuck shops and canteens run by a non-profit body are input taxed: s 40-130.

Read GST Act 1999 Div 40 Practice Problem 10

Provide examples of input-taxed supplies.

Partly taxable/GST-free/input-taxed supplies 19.61 For partly taxable/GST-free/input-taxed supplies, you need to apportion the taxable value according to the percentage it is taxable/GSTfree/input taxed. A bank provides a service partly for input-taxed banking services and taxable financial advice. The value of the supply must be apportioned according to the percentage that is taxable/input taxed.

[page 652]

GST importations 19.62 Generally, GST applies to all imports (taxable importations): Div 13. Division 42 provides four types of non-taxable imports: GST-free; input taxed; duty free goods under customs law; and imports of money.

Read GST Act 1999, Divs 13, 42 Practice Problem 11

Felix sells his rental house purchased in 1998 in the current tax year. What are the GST implications?

Practice Problem 12 Penelope sells her home that she built 2 years ago in the current tax year. What are the GST implications?

Practice Problem 13 Bertie purchased his rental house in 1996. He evicts the tenants, demolishes the house and sells off the land in the current tax year. What are the GST implications?

Step 4: Do the special GST rules apply? Special rules 19.63 Special rules modify the general rules and work to tailor the operation of the GST to particular situations or provide special concessions. These special rules include: GST groups and joint ventures: Divs 48–51; GST branches: Div 54; second-hand goods: Div 66 (dealers can claim input tax credits on certain acquisitions of second-hand goods);

non-deductible expenses: Div 69; [page 653] associates: Div 72 (special rules apply for suppliers at less than market value and to gifts); sale of freehold interests: Div 75; insurance: Div 78; payment of taxes: Div 81; long-term commercial accommodation: Div 87; company amalgamations: Div 90; supplies partly connected with Australia: Div 96; security deposits: Div 99 (see 19.64 below); cancelled lay-by sales: Div 102; supply in satisfaction of a debt: Div 105; valuation of supplies: Div 108; importations without entry for home consumption: Div 114; valuation of exports made for repair or renovation: Div 117; diesel fuel credits: Div 123; gambling: Div 126 (special simple rules apply for calculating GST); adjustments for changes in creditable purpose: Div 129; supplies of things acquired or imported to make supplies: Div 132; supplies of going concerns: Div 135; cessation of registration: Div 138; taxi drivers: Div 144; representatives for incapacitated entities: Div 147; agents etc and insurance brokers: Div 153; progressive supplies: Div 156;

changing accounting basis: Div 159; and anti-avoidance: Div 165.

Read GST Act 1999 Divs 135, 159 Division 99: Deposits as security 19.64 Section 99-5 provides that a deposit held as security for the performance of an obligation is not treated as consideration for a supply, unless the deposit: is forfeited because of a failure to perform the obligation; or is applied as all or part of the consideration for a supply. This section has effect despite s 9-15 (which is about consideration). FCT v Reliance Carpet Co Pty Ltd (2008) 236 CLR 342; 68 ATR 158; 2008 ATC 20-028; [2008] HCA 22 Facts: The taxpayer received a 10 per cent deposit of $297,500 due under a sale contract, but the purchaser subsequently failed to settle in time and the taxpayer issued a rescission notice. The contract was subsequently rescinded and the deposit was forfeited to the taxpayer. The Commissioner assessed the taxpayer to GST on the forfeited deposit under GST Act [page 654] Div 99. Section 99-5 provides that a deposit is not treated as consideration for a supply until it is forfeited or applied. In the first instance, the AAT held in Reliance Carpet Co Pty Ltd v FCT (2006) 63 ATR 1001 that the forfeiture of the deposit was consideration for a supply. High Court held: That s 9-10 (definition of a supply) and s 9-15

(definition of consideration) were satisfied, and thus the taxpayer made a taxable supply per s 9-5. The payment of the deposit by the purchaser was in connection with a supply by the taxpayer and within the definition of consideration per s 9-15. The payment of the deposit was treated as consideration for a supply when the deposit was forfeited by virtue of s 99-5. A supply was made before the forfeiture as a result of s 9-10, even though there was a lack of temporal connection between the supply and the consideration. Section 99-10, however, attributed the GST to the tax period in which the deposit was forfeited.

Read GST Act 1999 Div 37 Practice Problem 14 Classify the following supplies as taxable, GST-free or input taxed: 1 a café sells hot coffee 2 a drycleaner cleans clothes for a customer 3 a farmer sells tomatoes to a supermarket 4 a demolition company sells one of its trucks 5 a landlord charges residential rent to a tenant 6 a lawyer provides advice to a criminal 7 cakes sold by a supermarket 8 child care provided by a registered child care centre 9 an export of barley by a farmer 10 university fees for an MBA course paid by a student.

Step 5: What are your input tax credits?

19.65 ‘Input tax credit’ is a key GST term, as a credit reduces the GST payable by an entity for an acquisition if the acquisition is for use in the entity’s enterprise. If the entity uses a thing in its enterprise, for example by selling it on to someone else, GST will be included in that sale. Therefore, to avoid double taxing that thing, the entity receives a credit for the GST included in the price the entity paid for the thing. The entity therefore has a creditable purpose if it acquires a thing for the purpose of its enterprise. Entitlements to input tax credits arise on creditable acquisitions: see s 71(2). If you make a creditable acquisition, you are entitled to an input tax credit: see s 11-20. Note: There is generally a 4-year time limit for claiming input tax credits: Div 93. [page 655]

Diagram 19.5:

Input tax credits

Creditable acquisitions 19.66 Section 11-5 provides that you make a creditable acquisition if the following four steps are satisfied: 1. you made the acquisition solely or partly for a creditable purpose; 2. the supply of the thing to you was a taxable supply; 3. you provide or are liable to provide the consideration for the acquisition; and 4. you are registered or required to be registered.

Read GST Act 1999 s 11-5

Step 1: Acquisition for a creditable purpose (input tax credit requirement) 19.67 What is an acquisition? An acquisition is broadly defined as any form of acquisition whatsoever: see s 11-10(1). The GST Act lists the following things as being acquisitions. Note: This is not an exhaustive list. (a) an acquisition of goods (b) an acquisition of services (c) a receipt of advice or information [page 656] (d) an acceptance of a grant, assignment or surrender of real property (e) an acceptance of a grant, transfer, assignment or surrender of any right (f) an acquisition of something the supply of which is a financial supply (g) an acquisition of a right to require another person (i) to do anything; or (ii) to refrain from an act; or (iii) to tolerate an act or situation; (h) any combination of any two or more of the matters referred to in paras (a)–(g). However, an acquisition does not include an acquisition of money unless the money is provided as consideration for a supply that is a supply of money. Note: Money that is provided as consideration (payment) for an acquisition is not in itself an acquisition: see s 11-10(2).

Read GST Act 1999 s 11-10

19.68 What is a creditable purpose? Section 11-15 provides that if you acquire a thing in carrying on your enterprise, you acquire it for a creditable purpose. However, if the acquisition is partly of a private or domestic nature or relates to making input-taxed supplies,25 then you acquire it for a creditable purpose, except to the extent that the acquisition is of a private or domestic nature or relates to making input-taxed supplies.26 An entity is not entitled to an input tax credit for acquiring a thing if its acquisition of the thing relates to an input-taxed supply. Since no tax will be charged on that supply, the entity does not have a creditable purpose. Jonathon runs a hardware store. His sales of hardware are taxable supplies. The hardware that he acquires to sell to his customers is acquired for the purposes of his enterprise and is therefore creditable acquisition. Jonathon also buys a new broom for sweeping the floor of his shop. This too is a creditable acquisition because the broom was acquired for the purpose of his enterprise. However, the bus ticket that Jonathon buys and uses to get to and from his business is not acquired for a purpose of his enterprise. It is acquired for a private or domestic purpose. It is not a creditable acquisition. MidBank acquires a new computer network. The new computer network is going to be used only in running its financial services. Financial services are input taxed. The acquisition is therefore related to making input-taxed supplies. MidBank is not entitled to a credit for the acquisition.

[page 657]

Read GST Act 1999 s 11-15 Step 2: Supply of the thing to you was a taxable supply

19.69 The supply to you must be a taxable supply. The requirements of a taxable supply were set out at 19.15–19.29: see also s 9-5.

Step 3: Provide or are liable to provide the consideration 19.70 You must provide or be liable to provide the consideration. The term ‘consideration’ was set out at 19.27.

Step 4: Registration 19.71 You must be registered or required to be registered for GST. This term was set out at 19.18.

Amount of input tax on creditable acquisitions (input tax credit requirement) 19.72 If your acquisition is only partly creditable, you work out the amount of input tax credit you are entitled to using the formula in s 11-30 rather than s 11-25. Where it is only partly for a creditable purpose, your reduced input tax credit is the input tax credit you would have been entitled to if it was not reduced (full input tax credit) multiplied by your extent of creditable purpose: see s 11-30(3). Extent of creditable purpose 19.73 The extent of creditable purpose is calculated as a percentage figure based on the proportion that the creditable purpose is of the total purpose of the acquisition. That is:

Example

Tom’s Fences purchases a fence for $3000 to be used 100 per cent in the business. He is registered and operates a fence shop. The fence has been acquired solely for the purpose of the enterprise. It has therefore been acquired solely for a creditable purpose. The input tax credit on the acquisition is equal to the amount of GST on the price of the fence; that is, 1/11th of $3300 = $300.

Example: Partly for a creditable purpose Using the facts above, if Tom used the fence 10 per cent for private use for his residence, the input tax credit on the acquisition is equal to the amount of GST on the price of the fence; that is 1/11th of $3300 × 10% = $30. [page 658]

Example: Only part consideration Cynthia’s Fashions purchases a computer for $1100 to be used 100 per cent in the business. She paid for only one-half of the computer; her clothes supplier paid for the balance. She is registered and operates a fashion shop. The computer has been acquired solely for the purpose of the enterprise. It has therefore been acquired solely for a creditable purpose. The input tax credit on the acquisition is based on the consideration paid by Cynthia; that is, 1/11th of $1100 × 50% = $50. Re Drysdale and FCT (2008) 69 ATR 717; [2008] AATA 154 Facts: The taxpayer, a self-employed mussel farmer, claimed an input tax credit on the purchase of a Dufour yacht. After purchasing the yacht, he entered into a sub-dealer agreement and was appointed as a dealer of Dufour yachts. He was granted exclusive distribution rights in Victoria. However, his main role was not selling the vessels but rather promoting the brand via boat shows. He did not sell any yachts in the period. The Commissioner denied the claim, since the purchase was not a creditable acquisition per the GST Act.

AAT held: The taxpayer could not claim an input tax credit on the purchase of the Dufour yacht. Eligibility for an input tax credit requires a creditable acquisition having a creditable purpose acquired for an enterprise. The yacht was not used in the carrying on of a business by the taxpayer, given his commitments to the mussel farm. Notably, the depreciation expenses of the yacht greatly exceeded the income projections. Further, the absence of adequate or reasonable planning, control or revenue projections suggested that there was no yachting business; rather, the yacht was used for private use.

Re Private Tutor and FCT [2013] AATA 136 Facts: The taxpayer tutored part time a few hours per day in addition to his full-time job. The taxpayer’s BASs over a 4-year period showed that his input tax credit claims exceeded the amounts of GST declared as owing. The Commissioner considered that the taxpayer was not carrying on an enterprise but was an employee of various colleges; thus, the claims for input tax credits should be refused and the taxpayer’s GST registration should be cancelled. AAT held: The taxpayer was carrying on an enterprise but denied the taxpayer’s input tax credit claims. The input tax credits were disallowed, since the taxpayer claimed credits in respect of acquisitions that were not subject to GST. The taxpayer also claimed full credits for acquisitions that were partly private or domestic in nature. The taxpayer had failed to show that the Commissioner’s assessments were excessive.

Professional Admin Service Centres Pty Ltd v FCT [2013] FCA 1123 Federal Court held: Edmonds J found that there was no entitlement to input tax credits. The taxpayer made claims for input

tax credits concerning the provision of litigation funding services to former First Assistant Commissioner of Taxation Nick Petroulias (now known as Michael Felson). There was no acquisition of services by the taxpayer by way of taxable supply and no enterprise of funding litigation. The lawyers engaged by Mr Felson made no supply to the taxpayer. The activities of the taxpayer in funding Mr Felson’s defence of his criminal proceedings did not constitute an enterprise. The invoices for management services were a sham.

[page 659]

Practice Problem 15 Which of the following are creditable acquisitions? 1 An accountant’s office purchases stationery from the local supermarket for its office staff. 2 A solicitor employs his son Shane to maintain the garden at the front of his offices for $50 a month. Shane is a student who does the work one weekend a month.

Input tax credits on importations 19.74 Under Div 13, GST is payable on importations that are taxable importations regardless of whether the person is registered or required to be registered, although an input tax credit for GST paid on an importation will be available only to a registered person or a person required to be a registered person. The GST is 10 per cent of the value of the importation. Generally, GST is payable by the entity importing the goods at the same time and in the same manner as customs duty, although approved importers can defer the GST until they lodge a BAS.

Importations that are GST-free or input taxed are not subject to GST: see s 13-10. A limited number of importations are non-taxable importations under Div 42. This will, for example, include an importation that is not altered and that is subsequently exported. Entitlement to input tax credits arise on creditable importations: see ss 71(2), 15-15. Section 15-5 provides three criteria for a creditable importation: 1. you import the goods solely or partly for a creditable purpose; 2. the importation is a taxable importation; and 3. you are registered or required to be registered.

Read GST Act 1999 Div 13 Practice Problem 16 1 2 3

BHP Billiton imports a machine for its iron ore mine. Is this a taxable importation? Ernie imports French champagne for his personal consumption. Is this a taxable importation? Trudy imports GST-free medical supplies for her personal consumption. Is this a taxable importation?

Practice Problem 17 Can input tax credits be claimed in the following circumstances? 1 A car manufacturing company imports parts for its vehicles from Japan. 2 Jack, a university lecturer, imports a yacht to live in.

[page 660]

Step 6: What are your adjustments? 19.75 Adjustments are needed to accommodate changing circumstances; for example, where you have accounted for GST or input tax credits but subsequent events mean that GST or input tax credits were incorrectly accounted. Thus, you will have received either too much or too little input tax credit, or you will have paid too much or too little GST. Diagram 19.6:

Adjustments

There are two types of adjustments — increasing and decreasing. 1. Increasing adjustment increases your net amount of GST payable. You will have an increasing adjustment if you received too much input tax credit or paid too little GST.

2.

Decreasing adjustment decreases your net amount of GST payable. You will have a decreasing adjustment if you have received too little input tax credit or paid too much GST. Adjustments can arise in several ways: from adjustment events: Div 19; from bad debts: Div 21; and from a change in your extent of creditable purpose: Div 129.

Adjustment events: Div 19 19.76 The following constitute adjustment events: cancellation of a supply or acquisition; change in the consideration for a supply or acquisition; or an event that causes the supply or acquisition to become or stop being a taxable supply or creditable acquisition. [page 661]

Adjustment for supplies 19.77 Adjustment for supplies occurs where: GST on a supply was attributable to an earlier tax period; you have an adjustment event; and the GST you previously attributed is no longer correct because of the adjustment event. Increasing adjustment 19.78

Corrected GST amount > previously attributed GST amount.

Decreasing adjustment 19.79

Previously attributed GST amount > corrected GST amount.

Jim is a bricklayer and registered for GST. He undertakes to lay bricks for Steve, who is also registered. Jim sends Steve a bill of $2200 for the bricklaying provided in a quarter. Steve pays the bill. Jim accounts for $200 in GST. Later, Steve talks about the huge cost of bricklayers to a friend, who assures Steve that he has paid too much. Steve complains to the Master Builders Association, which persuades Jim to reduce his bill and refund Steve $550. Jim has already attributed the GST on his services and therefore needs to make an adjustment. As the corrected GST amount is smaller than the previously attributed GST amount, Jim has paid too much GST and has a decreasing adjustment, reducing his net amount. The amount of the adjustment will be 1/11th of $550, which equals $50.

Adjustment for acquisitions 19.80 Adjustment for acquisitions occurs where: you have an adjustment event for an acquisition; an input tax credit for the acquisition was attributable to an earlier period; and the input tax credit previously attributed is no longer correct because of the adjustment event. Increasing adjustment 19.81 Previously attributed input tax credit amount > corrected input tax credit amount. Decreasing adjustment 19.82 Corrected input tax credit amount > previously attributed input tax credit amount.

Continuing the example of Jim and Steve above, Steve had already attributed the input tax credit for the bricklayer services based on a bill of $2200. When he is refunded $550, he needs to make an adjustment. As the corrected input tax credit amount is smaller than the previously attributed input tax credit amount, Steve makes an increasing adjustment, reducing his net amount. The amount of the adjustment will be 1/11th of $550, which equals $50.

[page 662]

Read GST Act 1999 Div 19; ATO GSTR 2000/19 Adjustments — bad debts: Div 21 Bad debts — taxable supplies 19.83 Where you account for GST other than on a cash basis, you may account for the GST on a taxable supply before you receive any cash (consideration). If you have accounted for GST on a supply and you later write off as a bad debt some of the cash you were due to receive for the supply, you would have paid too much GST. A decreasing adjustment would be required (see s 21-5(1)), reducing your net amount in the tax period in which you write off the bad debt. The decreasing adjustment is 1/11th of the amount written off. The requirements for a decreasing adjustment are: you must have made a taxable supply for consideration in money; you must have lodged a return for the relevant tax period and properly accounted for GST on the supply; and you must have written off as a bad debt all or part of the consideration not paid.

Subsequently, if the amounts previously written off are recovered, an increasing adjustment is required; that is, for 1/11th of amounts recovered: see s 21-10. Bad debts — creditable acquisitions 19.84 Similarly, if you account for GST other than on a cash basis, you may account for the input tax credit on a creditable acquisition before you pay any cash. If you have accounted for the input tax credit on an acquisition and the supplier later writes off as a bad debt all of the cash you were liable to pay for the supply, you would pay too little GST. You are only entitled to input tax credits for GST included in the consideration for acquisitions you make: see s 11-25. If the supplier writes off some of the consideration as a bad debt, you would have accounted for an amount of input tax credit for an amount of GST that the supplier has been refunded. In either case, you would have accounted for too much input tax credit: see s 21-15(1). You therefore have an increasing adjustment to increase your net amount in the tax period in which the supplier writes off the bad debt: see s 21-15(1). For example, if all of the consideration is written off as a bad debt, the increasing adjustment is 1/11th of the total consideration. Subsequently, if the amounts previously written off are repaid by you, a decreasing adjustment is required; that is, for 1/11th of the amount you paid: see s 21-20. This is to ensure that you will have received enough input tax credit for the GST paid on the amount recovered.

Step 7: GST instalments 19.85 For taxpayers who pay GST by instalments during a tax year, the annual GST return will require that the GST instalments be taken into account. The GST instalments will reduce the GST payable or increase the GST refundable (see GST returns in Chapter 22, 22.82).

[page 663]

Step 8: Calculating your GST 19.86 In each tax period you have to calculate your GST, input tax credits and adjustments that total up to a net amount of GST payable/refundable: see s 7-5. As discussed previously, the formula for the net amount is set out at s 17-5: Calculate the GST on taxable supplies for the tax period; ie, 1/11th of the price LESS input tax credits on creditable acquisitions and creditable importations PLUS LESS

increasing adjustments decreasing adjustments

LESS

GST instalments

Read GST Act 1999 Divs 7, 17 Practice Problem 18 Rarnie’s taxable sales are $110,000 for the period and her expenses are $55,000. The increasing adjustments are $2000 and decreasing adjustments are $1000. All of the expenses are creditable acquisitions. How much GST is payable?

Tax periods: Pt 2-6 19.87 Tax periods are the periods for which you have to work out the GST and input tax credits, lodge a GST return (BAS) and pay the GST (if the GST exceeds the input tax credits) or receive a refund. What tax period? 19.88

Most businesses use quarterly tax periods (s 27-5), which run as

follows: QUARTERLY TAX PERIOD ENDING

GST PAYMENT DUE DATE

31 March

28 April

30 June

28 July

30 September

28 October

31 December

28 February

Small business entities may lodge an annual return with GST instalments paid quarterly. A reconciliation statement is made in the annual return. However, monthly periods are compulsory where (s 27-15): an entity’s GST turnover is $20 million or greater; an entity carries on an enterprise in Australia for less than 3 months; an entity has a history of non-compliance; or an entity uses a substituted accounting period for income tax. [page 664] Also, businesses may elect to have a monthly tax period even if their GST turnover is less than $20 million: see s 27-10. Note: They also have the option of reverting back to 3-month periods. There are also special rules that allow an entity to change the end of a tax period (s 27-35) and in certain circumstances change the specified period that is a tax period: see s 27-30.

Read GST Act 1999 Div 27 Accounting rules 19.89 There are two possible accounting bases for determining the appropriate tax period for taxable supplies and input tax credits:

1. 2.

cash; and other than cash.

Cash basis 19.90 An entity may choose to use the cash basis, with effect from the first day of the tax period, in any of the following situations:27 you are a small business entity for the income year in which you make your choice; you do not carry on a business and your GST turnover does not exceed the cash accounting turnover threshold (CATT) ($2,000,000); for income tax purposes, you account for your income using the receipts method; or each of the enterprises that you carry on is an enterprise that the Commissioner determines, in writing, to be a kind of enterprise in respect of which a choice to account on a cash basis may be made under this section. To be a small business entity, an entity must meet two requirements: 1. it must be carrying on a business; and 2. it must satisfy the $2,000,000 aggregated turnover test. This basically means that the income of the entity and any associated entities must be less than $2,000,000 (ITAA 1997 Subdiv 328-C; see Chapter 5). Whether your GST turnover meets the CATT of $2,000,000 depends on the current GST turnover and the projected GST turnover. An entity can use cash accounting in the following two situations: if the current GST turnover meets or is less than the CATT ($2,000,000 unless the entity is a non-profit body) and the Commissioner is satisfied that the projected GST turnover is at or below the CATT: ss 29-40, 188-10(1)(a); and if the projected GST turnover meets or is less than the CATT: ss 29-40, 188-10(1)(a). An entity can apply to the Commissioner to use the cash basis. The

Commissioner must be satisfied that it is the appropriate accounting basis for the enterprise: see s 29-45. The Commissioner must have regard to the following: [page 665] the nature of the enterprise; the size of the enterprise; the accounting system; and how the entity accounts for income tax. Charities can generally use the cash basis regardless of turnover: Div 157.

Sally is a sole practitioner specialist dentist. She has a GST turnover of $2,100,000. Sally’s normal accounting system operates on a cash basis; that is, it relates to the money she receives rather than the money she is liable to receive as a dentist. This is also how she accounts for income tax. It may therefore be appropriate for Sally to account for GST on a cash basis. Sally should apply to the Commissioner to use the cash basis. However, if Sally also owned and ran a restaurant that accounted on an accruals basis, it would probably be inappropriate for Sally to account for GST on a cash basis. GST on a cash basis 19.91 GST is attributable on a taxable supply in the period when a payment is received; this amount is included in the BAS for the period: see s 29-5. Note: If you receive half the payment for the taxable supply, you attribute

GST on only half of the taxable supply. Input tax credits on a cash basis 19.92 An input tax credit is attributable to the tax period in which you paid for the creditable acquisition: see s 29-10. Also, you cannot claim the input tax credit unless you have a tax invoice when you lodge your BAS. Note: If you pay for only half of the creditable acquisition, you can claim only half of the input tax credit for that tax period.

Example Anthea has an enterprise that makes shoes. She is GST registered. She uses the cash basis of accounting. Chen has an enterprise that sells shoes. He is GST registered and uses the cash basis of accounting. Chen obtains his shoes from Anthea. They have the same tax periods. Chen acquires new shoes from Anthea for sale. The supply of the shoes is a taxable supply by Anthea. The acquisition of the shoes by Chen is a creditable acquisition. Anthea supplies the shoes in the second tax period for the year. Anthea also issues the tax invoice for the supply in the second tax period for the year. Chen pays for the shoes in the third tax period for the year. Chen attributes the input tax credit to tax period 3 because he paid for the taxable supply in that tax period and he had a tax invoice. Anthea attributes the GST on the taxable supply to tax period 3 because she received Chen’s payment for the taxable supply in that tax period. [page 666] Adjustment events on a cash basis 19.93 You attribute your increasing or decreasing adjustment to the tax period in which an amount that is payable as a result of the adjustment event is paid: see s 29-20. If you have a decreasing adjustment, you cannot attribute the adjustment until you have an adjustment note for the tax period for which you lodge a return.

Other than a cash basis 19.94 You attribute all the GST on a taxable supply to the tax period in which the earliest of the following occurs: you receive any consideration in connection with the supply; or an invoice is issued in relation to the supply. This is included in your BAS for that tax period: see ss 29-5 and 33-5 (this is similar to the accruals system of accounting). Input tax credits on an other than cash basis 19.95 You attribute all the input tax credit on a creditable acquisition to the tax period in which the earliest of the following occurs: you provide any consideration; or you become liable to provide any consideration for the acquisition or importation. This is included in your BAS for that tax period (see s 2910) if you have a tax invoice. Adjustment events on an other than cash basis 19.96 Supplies: You attribute all of your increasing or decreasing adjustment for an adjustment event to the tax period in which you know about the adjustment event: s 29-20(1). 19.97 Acquisitions: You attribute all of your increasing or decreasing adjustments for an adjustment event to the tax period in which you know about that adjustment event: see s 29-20(1). You cannot attribute the adjustment unless you have an adjustment note when you lodge your return for the tax period.

Read GST Act 1999 Div 29 Practice Problem 19 Which of the following entities may choose to use the

cash basis of accounting? 1 Ben’s Bikes has an aggregated turnover of $325,000. 2 Mario’s Meats Pty Ltd has an aggregated turnover of $2,005,000. However, it normally accounts on a cash basis for income tax and has an accounting system on this basis, following the meat industry’s practice in this regard. 3 Madge operates a large video hire chain with an aggregated turnover of $10 million. Madge’s accounting system is set up on a cash basis, but this has a built-in conversion system because the ATO has required her to lodge her income tax returns on a non-cash basis.

[page 667]

Calculating GST on taxable supplies 19.98 There are two important GST pricing terms — value and price. 1. Value is the GST-exclusive price. Section 9-70 provides that the amount of GST on a taxable supply is the value of the taxable supply multiplied by 10 per cent. With a GST rate of 10 per cent, the value of a taxable supply is 10/11ths of the price paid for the supply. 2. The price paid for a taxable supply always includes the GST. The price is the amount of money paid for the supply.28 GST is calculated on 1/11th of the value of taxable supplies or 1/11th of the price.

Read GST Act 1999 Subdiv 9-C A table retailer sells tables with a value of $1000. The

GST is $100 (1/10th of the value). The price is $1100 (GST is 1/11th of the price).

However, working out whether a particular sale is GST-inclusive or GSTexclusive is not always a straightforward matter. This is a perennial issue in all countries that have a value-added tax such as the GST. The following case illustrates how a GST dispute can occur over the sale of land. Igloo Homes Pty Ltd v Sammut Constructions Pty Ltd [2004] NSWSC 1213; 58 ATR 198 Facts: The purchaser of land (the plaintiff) contended that the purchase price of the land included GST. Clause 13.2 of the contract provided: ‘normally, if a party must pay the price or any other amount to the other party under this contract, GST is not to be added to the price or amount’. Clause 17, entitled ‘Further Provisions’, however, stated that GST was not included in the price. Supreme Court held: Clause 17, ‘Further Provisions’, overrode clause 13, and thus the purchaser must also pay an amount equal to the GST payable by the vendor. The term ‘normally’ in clause 13 meant that if another relevant clause applied, then that other clause would take precedence. Thus, the ‘Further Provisions’ in clause 17 meant that there was ‘no ambiguity in the contract which is in need of resolution’. The purchaser also requested rectification of the contracts. That is, all parties to the contracts had a common intention that differed from what the contracts stipulated, and thus the contract should be rectified. In that case, the purchaser has the onus of proof to show that the contracts were intended to include GST. The court was not satisfied, though, that the onus had been discharged.

[page 668]

Calculating GST on input tax credits 19.99 The amount of input tax credit for a creditable acquisition is an amount equal to the GST payable on the supply of the thing acquired (reduced if acquisition is only partly creditable).

Read GST Act 1999 ss 11-25, 11-30 Value of partly taxable, partly GST-free or input-taxed supplies 19.100 The value of a supply that is partly taxable and partly GST-free or input taxed is calculated using s 9-80. The value of the whole supply is calculated as if it were wholly a taxable supply; that is, its value is 10/11ths of the price of the whole supply. Then the proportion the taxable part of the supply is of the whole supply is calculated. That proportion is then multiplied by the value of the whole supply.

Example Gary’s Gems is GST registered and its total GST for a tax period is $3300. He has total input tax credits of $2900 and $150 worth of increasing adjustments. His net amount for the tax period is $550 ($3300 – $2900 + $150). He pays this amount to the Commissioner when he lodges his return for the tax period. If the net amount for a tax period is less than zero, a refund is due: see Subs 35-5(1).

Example Continuing the above, in Gary’s next tax period, he has total GST of $2500 and total input tax credits of $2800. He has no adjustments. His net amount for the tax period is $300. The Commissioner pays this amount to Gary after he has lodged his return for the period.

Example Thelma is a kitchen appliance wholesaler. She is registered. This table shows

the creditable acquisitions and taxable supplies she attributes to one tax period: CREDITABLE ACQUISITIONS ITEM

TAXABLE SUPPLIES

CONSIDERATION

ITEM

400 wizzes

$30,000

550 toasters

500 bread bakers

$20,000

200 juicers

CONSIDERATION $20,000 $4000

200 toasters

$4000

400 microwaves

$12,000

New computer

$3000

200 bread bakers

$18,000

200 toasters

$10,000

Accounting software update 600 juicers

$450 $5350

Accountant’s services

$500

100 dicers

$600

200 blenders

$4000

[page 669]

CREDITABLE ACQUISITIONS 150 dicers Total creditable acquisitions

TAXABLE SUPPLIES $300

$63,600

350 wizzes Total taxable supplies

$50,000 $118,600

Assuming that there are no adjustments for that tax period, Thelma’s net amount is 1/11th of the difference between the total creditable acquisitions and the total taxable supplies for the tax period [($118,600 – $63,600) × 1/11 = $5000]. Her net amount for this tax period is $5000. As her total GST exceeds her total input tax credits, this net amount is the amount that she pays to the Commissioner when she lodges her return for that tax period.

GST example

19.101 Tony is a tie retailer whose business, Tony’s Ties, has an annual turnover of $240,000. Tony sells on a cash and Visa card basis but purchases his stock on a 60-day credit cycle. He also offers a lay-by facility. The following table explains the issues Tony needed to consider before he started his business. TONY

BECAUSE

needs to register for GST

he is conducting an enterprise, and his GST turnover is $240,000 a year.

can choose either the cash basis or the non-cash basis of accounting

his turnover is under the cash basis accounting threshold.

can choose either a quarterly or a monthly tax period

an enterprise with GST turnover under the tax period turnover threshold can elect to have lmonth tax periods.

Tony decides to account for GST using the general rules: quarterly tax periods; and a non-cash basis of accounting. To work out the net amount he must pay to the ATO at the end of the tax period, he needs to calculate: the amount of GST payable; and the amount of input tax credits he can claim against the GST amount. [page 670] The following table explains how Tony’s GST is calculated: IN THE 3-MONTH TAX PERIOD, TONY

SO THE GST IS

had $55,000 in sales

$55,000 ÷ II = $5000

retained $88 in deposits from cancelled lay-by sales

$88 ÷ 11 = $8

The sum of Tony’s GST in this tax period is:

$5000 from sales $8 from cancelled lay-bys $5008 TOTAL The following table explains how Tony’s input tax credits are calculated, on the assumption that he holds tax invoices for the transactions. IN THE 3-MONTH TAX PERIOD, TONY

SO THE INPUT TAX CREDIT FOR THIS ACQUISITION IS

was invoiced for shop rent payments of $1100 each month

$3300 ÷ 11 = $300.

received an internet bill of $550

$550 ÷ 11 = $50.

purchased a computer for $2200 to be used 50 per cent in the business

$2200 ÷ 11 = $200, then reduced to the portion of the purchase that is used for a creditable purpose; that is, $200 reduced by 50% = $100.

purchased trading stock for which total invoices of $33,000 have been received, and paid one of those invoices of $11,000, which offered an early payment discount of 10 per cent, so Tony paid only $10,000

$32,000 ÷ 11 = $2909, because the discount was received in the same tax period.

The sum of Tony’s input tax credits in this tax period is: $300 for the lease payments $50 for the telephone $100 for the computer $2909 for stock purchases $3359 TOTAL If the discount was received in the next tax period, then: this tax period’s input tax credit would be calculated on the full invoiced amount of $33,000; and the net amount for the next tax period would be increased by the GST Tony did not actually pay on those purchases; that is, $1000 ÷ 11 = $91. [page 671]

Tony’s net amount of GST is calculated as follows: $5008 GST minus $3359 input tax credits $1649 net Tony needs to send in the $1649 with his GST activity statement by the 21st day of the month after the end of the tax period.

Practice Problem 20 Calculate the amount of GST on the following supplies: 1 Kate owns a rug shop and sells a Turkish rug. The normal price was $30, but Kate had reduced the price to $22. 2 Bob invoiced Ben $35 for lawn mowing.

Practice Problem 21 What are the GST consequences for the deposits and expenses for the following businesses? SUPERMARKET COLLECT GST? YES PAYMENTS $ Taxable supplies

1,100,000

GST-free food

440,000

Purchases taxable supplies

550,000

Purchases GST-free supplies

220,000

Rent

110,000

Electricity

RECEIPTS $

55,000

CLAIM ITC? NO

YES

NO

[page 672] Wages

110,000

Accounting fees

11,000

Water rates

6600 TYRE RETAILER COLLECT GST? PAYMENTS $

Tyres and fitting Purchases tyres

Electricity

22,000

Computer equipment

NO

YES

NO

220,000 66,000

Accounting fees

YES

550,000

Rent

Wages

RECEIPTS $

CLAIM ITC?

110,000 5500 33,000 BANK COLLECT GST? PAYMENTS $

RECEIPTS $

Interest income

2.2 billion

Financial advice

1.1 billion

Bank fees

1.1 billion

Interest paid

YES

CLAIM ITC? NO

YES

NO

1.1 billion

[page 673] Rent offices

110 million

Electricity

88 million

Wages

1.1 billion

Accounting fees

22 million

Computer contracting

550 million

Practice Problem 22 Cindy runs a clothing store and she purchases a computer for $6600. She uses the computer 30 per cent for private purposes and 70 per cent for business purposes. Calculate the input tax credit available to the store owner.

Practice Problem 23 Jeremy has a bicycle business. He has the following figures for the tax period ending 30 June. Calculate the net amount for the period: 1 decreasing adjustments, $34; 2 GST payable on supplies, $7720; 3 increasing adjustments, $2040; and 4 input tax credits, $4905.

Practice Problem 24 Benny operates a banana shop. His current GST turnover is $1,831,044 and his projected GST turnover is $651,058. In the current tax period he lodges a 3month BAS statement. His aggregated turnover is less than $2 million. All sales are in cash and expenses are paid in cash. In this period he: sells $88,000 of bananas to be consumed by people and also has $22,000

sales for cold lemonade drinks (gross amounts including GST if applicable); pays $6600 rent for his shop (gross amounts including GST if applicable); pays $2200 electricity (gross amounts including GST if applicable); pays $1100 water rates (gross amounts including GST if applicable); and pays wages $11,100 (gross amounts including GST if applicable). He also has a decreasing adjustment of $400 in this period. 1 Should he register? Provide brief reasons and section(s). 2 Calculate his GST collections for this current 3month tax period. 3 Calculate his input tax credits for this current 3month tax period. 4 How much GST is payable / refundable for this current 3-month tax period?

[page 674]

Simplified accounting for small food business 19.102 Simplified accounting methods (SAMs) are available to small businesses that deal with taxable and GST-exempt food. These include convenience stores, milk bars, grocers and supermarkets, bakeries and hot bread shops, cake shops, sandwich bars, delicatessens, takeaway outlets, fresh fish retailers who sell cooked fish, fish and chip shops with fresh fish sales, and butchers with some taxable sales. Under the simplified rules, businesses estimate their total GST-free sales at the end of each tax period, instead of

having to record each GST-free product when it is sold. There are three alternative ways to account for trading stock, as follows. 1. the business norms method, where you choose to use standard percentages and apply them to sales and purchases to estimate GST-free sales and purchases; 2. the snapshot method, where you choose to take a snapshot of your purchases and sales to estimate GST-free purchases and sales; and 3. the stock purchases method, where you take a snapshot of purchases to estimate the percentage of GST-free purchases and sales. Further business norms have been developed for hot bread shops and for convenience stores that prepare takeaway food but do not sell fuel or alcohol. Also, business norms are available for convenience stores that do not prepare takeaway food and do not sell fuel or alcohol. The Commissioner of Taxation has the power to develop SAMs for all entities with a GST turnover of less than $2 million that make mixed supplies — taxable and GST-free — or mixed purchases. Thus, businesses can ask the ATO to develop an SAM to simplify their GST calculations and reduce their compliance costs.

Read GST Act Div 123 Administration Tax invoices 19.103 An invoice is a notice of an obligation to pay, while a tax invoice is a document that substantiates a creditable acquisition. Given that a tax invoice will generally be required, it is expected that most ordinary invoices will include the additional information required by a tax invoice. When is a tax invoice issued? 19.104

Tax invoices are generally issued by the supplier. Tax invoices do

not have to be issued unless requested by the recipient of a supply (the recipient). Suppliers must, if requested by the recipient, issue a tax invoice for all taxable supplies with a GST-inclusive value of $82.50 or more within 28 days of the request: see ss 29-70(1), (2) and 29-80(1). Section 29-70(1) states that tax invoices must: show the ABN of the entity issuing it; show the price for the supply; [page 675] contain such information as the regulations require; and be in the form approved by the Commissioner. Returns 19.105 Returns are required to be lodged for each tax period within 21 days of the end of the tax period (even if it is a zero value return). All returns must be signed, and electronic returns must have an electronic signature. Entities with a turnover of $20 million or more need to lodge electronically. Payments 19.106 Where GST collected exceeds input tax credits, the net GST must be paid within 21 days of the end of the tax period. Entities that lodge electronically must pay electronically. The Commissioner has powers to extend or bring forward the date of payment. Importers must pay GST at the same time as customs duty. Refunds 19.107 A refund is payable where the GST collected is less than the input tax credit, and is payable within 14 days. The Commissioner has the power to apply the refund against any outstanding tax liabilities. A refund is generally payable only to a financial institution (you must provide the ATO with bank account details).

GST turnover 19.108 Your GST turnover is an aggregate of the turnovers for all the enterprises that you carry on. This is relevant for the following thresholds: the RTT; the tax period turnover threshold; the CATT; and the electronic lodgment turnover threshold.

Streamlined GST reporting 19.109 Streamlined GST reporting applies for businesses with GST turnover of less than $20 million, requiring a simpler remittance form. Businesses with GST turnover of less than $2 million have an option of paying the quarterly instalments of GST based on 25 per cent of the previous year’s net GST amount adjusted by a gross domestic product factor, and will have to submit only one annual return.

GST and other taxes 19.110 Generally, GST on sales is not assessable income and GST paid is not deductible/depreciable. GST payments to the ATO are not deductible. Supplies to employees will not be subject to GST if fringe benefits tax applies or the supplies are exempt (unless the employee makes a contribution). [page 676]

GST and contractual disputes 19.111 A dispute about GST liability commonly occurs where parties enter into a transaction without clearly setting out the responsibility for GST. This

can later lead to an onerous impost, especially as the ATO extends its GST audit activities. No Worries Management Pty Ltd v Dolman (2004) 55 ATR 780; [2004] QSC 153 Facts: The applicant leased a unit from the owners for a term of 5 years commencing on 7 June 1999, and the applicant, as sub-lessor, leased the unit to short-term holiday tenants. With the introduction of GST, the sub-lessor was liable to pay GST on holiday lettings as supplier of the units of accommodation to the tenants. The lease agreement failed to specify who was liable for GST. The lease between the applicant sub-lessor and the owner of the unit provided for a monthly rental calculated as the gross receipts from the unit less the deductible expenses. Deductible expenses meant all and any of various categories of expenses, which included a letting fee equivalent to 12 per cent of the gross receipts. The letting fee excluded any expense or outgoing incurred by the lessee on behalf of the owner or otherwise in connection with the letting of the demised premises. Who, under the lease between the owner and the sub-lessor, should bear the burden of GST payments on the holiday letting? Supreme Court of Queensland held: The owner is liable for GST. The court adopted a business common-sense approach in determining the construction of the lease. Citing Lord Reid in Wickman Machine Tool Sales Ltd v L Schuler AG [1974] AC 235 at 251: The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.

Thus, the court found that GST came within the definition of deductible expenses as set out in the lease, as GST was incurred in respect of subletting the premises. There was a strong connection between the obligation to pay GST and the subletting. Further, the 12

per cent letting fee was an entitlement clear of any expense incurred by the sub-lessor.

Tam v Mannall [2010] NSWSC 250 Facts: The plaintiff was the successful bidder of the premises at an auction. A clause in the contract stated that if the plaintiff was required to pay the price to the defendant under the contract, GST was not to be added to the price. The defendants argued that the contract was altered by a collateral oral contract that meant that GST was to be paid on top of the purchase price. NSW Supreme Court held: The defendants failed to prove that the common intention existed, and thus the purchase price of the vacant shop premises was GST-inclusive. It was necessary to determine whether a common intention existed between the plaintiff and defendants that GST was to be added to the purchase price. Inconsistencies existed between the parties’ evidence as to whether the auctioneer clearly stated that the purchase price was GST-exclusive. It found that it was unlikely that the solicitor who wrote the contract had intended that GST was to be added to the purchase price, since the relevant clause was unamended and unqualified.

[page 677]

Attempt the Web Quiz for Chapter 19

Summary 19.112 5:

GST revolves around the application of the GST equation in s 17-

GST payable (refundable) on taxable supplies for the tax period LESS input tax credits on creditable acquisitions and creditable importations PLUS LESS

increasing adjustments decreasing adjustments

LESS

GST instalments

To calculate GST, use the following eight steps: 1. What are your taxable supplies? 2. What are your GST-free supplies? 3. What are your input-taxed supplies? 4. Do the special GST rules apply? 5. What are your input tax credits? 6. What are your adjustments? 7. What are your GST instalments? 8. Calculate your GST. The key GST concepts that must be understood are ‘taxable supplies’, ‘input tax credits’, ‘creditable acquisitions’, ‘creditable importations’ and ‘adjustments’. In addition to taxable supplies, there are GST-free supplies and input-taxed supplies. Each type of supply has different consequences for charging GST and obtaining input tax credits as follows: GST ON OUTPUTS

INPUT TAX CREDIT

Taxable supplies

Yes

Yes

GST-free supplies

No

Yes

Input-taxed supplies

No

No

Note: GST paid (input tax credits) is deductible for non-registered businesses.

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; [page 678]

1

2

3

explain well; and use clear language. a Explain how the GST works. b What is the difference between a taxable supply, an input-taxed supply and a GST-free supply? Consider each of the following scenarios and indicate whether the entity is required to be registered for GST (refer to the relevant legislation): a In January, Liberty Pty Ltd supplied bags to the value of $10,000. In the previous 11 months, the value of sales was $35,000. In the next 11 months, Liberty Pty Ltd expects total sales to reach $95,000. b As per (a), however, of the $95,000 expected over the next 11 months, $9000 is due to the sale of excess factory fittings. c While sales in Australia for World Cup Brazil Pty Ltd averaged $20,000 per month for the 12 months ending 30 June, sales are expected to decline to $4000 per month over the next 11 months. The current month is June. d Country Ambulance Incorporated (a charity) has made supplies valued at $200,000 over the past year, $50,000 of which were given away free in promotions and another $60,000 were sold GST-free. Taxable supplies for the next year are expected to total $300,000. Which of the following entities may choose to use the cash basis of accounting (refer to the relevant legislation)? a Eva’s cars has aggregated turnover for the previous year of

4

5

6

$2,025,000 and agregated turnover for the current year of $2,750,000. b Melbourne Outreach, a charitable institution, has aggregated turnover for the previous year of $2,465,000 and aggregated turnover for the current year of $3,750,000. Henry is registered for GST and he sold a dinner setting to Pete’s Restaurant for $1100 on 21 January of the current tax year. a How much GST was payable by Henry for the period ended 31 March in relation to this supply? b Pete’s Restaurant complains to Henry that the setting cracked with dishwashing, so Henry refunds $220 to Pete’s on 14 April of the current year. Calculate the correct GST amount and adjustment for Henry. What adjustment event applies? Bob, a plumber, is GST registered. He agreed to supply his labour to unblock drains at his neighbour Alex’s house, in exchange for 2 weeks’ accommodation at Alex’s unit on the Gold Coast. (Refer to the relevant legislation.) a What is the supply? b What is the consideration for the supply? c If Alex’s father agreed to pay the cost of the plumbing work as a gift to his son, is there still consideration for the supply? Sarath decided to donate some money to his local church as a gesture of appreciation to the pastor who gave him instruction in his faith. Would this constitute consideration? (Refer to the relevant legislation.) [page 679]

7

Calculate the amount of GST on the following supplies (refer to the relevant legislation): a Dave provided legal advice. The value of the taxable supply is

8

9

10

11

12

$40,000. b Youi Yachts sold a toy yacht for $450. Is this a creditable acquisition? Springsteen, a singer, is registered for GST and purchases $99 of petrol from a service station for a work vehicle. The vehicle is used 50 per cent for business purposes and 50 per cent for private purposes. How much are the input tax credits for the creditable acquisition? (Refer to the relevant legislation.) Select a small business and provide details for the GST consequences of its: a business expenses/acquisitions; and b sales/supplies. Classify the following supplies as taxable, GST-free or input taxed (all enterprises are GST registered if applicable): (Refer to the relevant legislation.) a a doctor provides advice to a patient b raw meat sold by a supermarket c food packaging for eggs sold by a supermarket d an export of chocolate by a confectioner e school fees paid for a student f sale of new cars by a car yard. Classify the following supplies as taxable, GST-free or input taxed (all enterprises are GST registered if applicable): (Refer to the relevant legislation.) a a café sells a bottle of water b a boutique sells clothes to a customer c a farmer sells subdivided farm land d a demolition company sells its trucks and business e a landlord charges rent to a tenant in a shop. Can input tax credits be claimed for the following expenses? (All enterprises are GST registered.) (Refer to the relevant legislation.)

a b c d

13

a supermarket buys in shelving a school purchases a computer an import of chocolate by a confectioner a new car is purchased by a self-employed accountant and it is partly used for private use (30 per cent) e a landlord installs a new lock in a residential flat. Can input tax credits be claimed for the following expenses? (All enterprises are GST registered.) (Refer to the relevant legislation.) a a café buys bottles of water b a hardware store buys nails to onsell c a dairy farmer buys parts for the milking machinery d a demolition company pays for truck repairs and wages e a landlord buys parts to repair a window for a tenant in a shop f a doctor pays for a new computer. [page 680]

14

15

16

Simo is a sole trader and supplies goods. He sells a table that is a personal asset that is never used for business purposes. His supply of the goods is connected with Australia and he is an entity registered for GST. When he sells a personal asset, is he making a taxable supply under GST Act 1999 s 9-5? Pam is not carrying on an enterprise but sells apples. Her supply of apples is connected with Australia but she is not registered for GST. Does she make a taxable supply under GST Act 1999 s 9-5 when she sells apples? Noddy Partnership operates a construction business and sells a truck in Australia for consideration. It is selling the truck in the course of an enterprise that it carries on. Noddy Partnership is registered for GST. Does Noddy Partnership make a taxable supply under GST Act s 9-5

17

18

19

20

when it sells a capital asset? Orange Ltd supplies a fresh fruit and vegetable juice drink that contains more than 90 per cent of juices of fruits or vegetables by volume. The fresh fruit and vegetable juice drink is non-alcoholic, non-carbonated and not consumed on the premises from which it is supplied. The entity is registered for GST. Is Orange making a GST-free supply under GST Act 1999 s 38-2 when it supplies a fresh fruit and vegetable juice drink? Acme Co supplies a hydroponically grown herb plant with roots attached. The plants are grown in sand, gravel or liquid without soil and with added nutrients. The plants are placed in a plastic bag that is labelled with instructions and refrigerated. The hydroponic plant is fit for human consumption. It is not provided for consumption on the premises from which it is supplied. The entity is registered for GST. Is Acme Co making a GST-free supply under GST Act 1999 s 38-2 when it supplies a hydroponically grown herb plant with its roots attached? Burt is a qualified massage therapist. He is not a physiotherapist, acupuncturist, chiropractor, nurse, occupational therapist or osteopath. He supplies a massage service to his patient. He is registered for GST. The supply satisfies the other positive limbs of GST Act s 9-5. Does he make a GST-free supply under GST Act 1999 s 38-10(1) when he supplies a massage service to a patient? Smoothlines Co is a registered private hospital. The entity is providing hospital care to patients recuperating from cosmetic surgery. The hospital care involves accommodation and nursing services. The cosmetic surgery is not a professional service for which a Medicare benefit is payable under the Health Insurance Act 1973 Pt II. No post-operative complications such as infection develop in the course of supplying the hospital care. The entity is registered for GST. The supply satisfies the other positive limbs of GST Act s 9-5. Does Smoothlines Co make a GST-free supply under GST Act 1999 s 38-20(1) when it supplies hospital care services to a patient recovering from cosmetic surgery?

21

Victor is an Australian resident and a taxidermist. He is contracted by a non-resident individual to preserve and mount a crocodile for display. The crocodile was hunted in Australia by the non-resident. The animal remains the property of the non-resident at all times. The non-resident is not in Australia when the entity carries out the taxidermy. [page 681]

22

23

On completion of the taxidermy, the entity sends the preserved and mounted animal overseas to the non-resident. The non-resident does not acquire the entity’s services in carrying on its enterprise. He is registered for GST. The supply satisfies the other positive limbs in GST Act 1999 s 9-5. Does Victor make a GST-free supply under GST Act 1999 Div 38 when he performs taxidermy services on an animal in Australia and then sends that animal overseas to its non-resident owner? Dodgy Brothers operates a pawnbroker business, which provides a loan to a customer that is secured by pawned goods. To recover the goods, the customer must pay a ‘fee’. The fee is the amount of the loan (the principal) plus interest on that loan. The transaction is connected with Australia and the entity is registered for GST. Does Dodgy Brothers make an input-taxed financial supply under GST Act 1999 s 40-5(1) when it provides a loan to a customer that is secured by pawned goods and charges the customer a fee for the recovery of those goods? Hopefull Pty Ltd sells shares. The shares were the property of the entity immediately before the supply. The entity is registered for GST and the supply is for consideration. The supply is connected with Australia and is in the course or furtherance of the enterprise that the entity is carrying on. Is Hopefull Pty Ltd, a supplier of securities, making an input-taxed supply under GST Act 1999 s 40-5(1) when it sells shares?

24

25

26

Clint is a guarantor. He has a client who is purchasing goods from another company. He is providing a guarantee to his client to the effect that if the client defaults on the payments for the goods, he will personally be responsible for the payments to the company. He does this in the course or furtherance of his enforcement enterprise in Australia. He is charging a fee for the service of providing the guarantee and he is registered for GST. Is Clint making a financial supply that is input taxed under GST Act 1999 s 40-5(1) when he provides a guarantee to his client? Doris is a property developer. She purchased a vacant block of land and built residential premises earlier in the current year. She is now selling the residential premises with the land and intends that the residential premises be used for residential accommodation. Prior to the sale, the premises were not used to make any input-taxed supplies. She is registered for GST. The supply satisfies the other positive limbs of GST Act 1999 s 9-5 and is not a GST-free supply under GST Act Div 38. Is she making an input-taxed supply under GST Act 1999 s 40-65 when she builds and sells residential premises? Tonic Pty Ltd is a property developer. The entity builds residential premises that it plans to rent out for a period of more than 5 years, after which it plans to sell the residential premises. The premises are to be used predominantly for residential accommodation; they are not commercial premises. The premises will not be the subject of a sale or a long-term lease prior to the planned sale. The entity is registered for GST. Is Tonic Pty Ltd making an input-taxed supply under GST Act 1999 s 40-65 when it sells residential premises for the first time after it has been rented out for a period of more than 5 years? [page 682]

27

Goodies is a charitable institution and gift-deductible entity. The entity is selling fundraising aids to a separate fundraising organisation in Australia.

28

29

30

31

The fundraising organisation uses the aids for its own fundraising campaign. The entity sells the fundraising aids for an amount that is more than 75 per cent of the consideration that the entity has provided to acquire the fundraising aids and that is more than 50 per cent of the GST-inclusive market value of the fundraising aids. The entity is registered for GST. Is Goodies making a taxable supply under GST Act 1999 s 9-5 when it sells fundraising aids to a separate fundraising organisation? Hilda’s Hot Buns acquires goods for use in the enterprise that it carries on. The supply of the goods to the entity is a taxable supply under GST Act 1999 s 9-5. The entity holds a tax invoice for the acquisition and provides consideration for the supply of the goods. The entity is registered for GST. Is Hilda’s Hot Buns entitled to an input tax credit under GST Act 1999 s 11-20 when it acquires goods? Royal Dogs Co is registered for GST and organises competitions in Australia for the exhibition of dogs. It receives an entry fee from each participant who enters the competition and provides a monetary prize to the winner of the competition. The prizewinner makes a taxable supply under GST Act 1999 s 9-5 where they receive prize money for the exhibition of the dog. Is Royal Dogs Co, a dog show competition organiser, making a creditable acquisition under GST Act 1999 s 11-5 when it pays prize money to the winner of a competition? Trustme Bank provides its customers with internet banking services in the course of its banking and it charges its customers a monthly access fee. The bank provides a PIN number for its customers to access its internet banking services. The bank is not supplying software to its customers. The supply is made in the course of the bank’s enterprise and is connected with Australia. The bank is registered for GST. Is the bank making an input-taxed financial supply under GST Act 1999 s 40-5(1)? Mr Fin sells land for a living. He enters into a deal with Mr Fish for the sale of land for $1.1 million. Mr Fin assures Mr Fish that the contract

32

33

stipulates that the total price including GST is $1.1 million. However, after acquiring the land, Mr Fin’s accountant, Mr Gekko, advises him that he has a problem. Mr Gekko explains that the contract price for the land is $1.1 million excluding GST. That is, Mr Fish needs to pay Mr Fin $110,000 in GST! Advise Mr Fin. Hannah opens a florist shop and her current and projected turnover will be less than $2 million. Advise Hannah on the GST concessions that are available to her. Sam is not registered for GST purposes and has an owner-builder’s licence. He purchases land and subcontracts other builders to construct a house. Sam’s intention is to reside in the house upon completion of construction. He then resides in the house for approximately 3 years after construction is completed. He now sells the house with the intention of making a profit. Over the past 20 years, he has personally constructed and resided in five houses. He resided in each of those premises for more than 3 years. [page 683]

34

Is Sam, an unregistered owner-builder, making a taxable supply under GST Act 1999 s 9-5 when he sells a private residence? Outback University (OU) is a supplier of management services. It employs staff to provide those services. It does not employ the staff as agent for the recipient. OU contracts with the recipient and is paid for its management services. The recipient pays a separate amount that the entity uses to pay its employees’ salary and wages. OU is registered for GST. The transaction is for consideration. The transaction is made in the course or furtherance of an enterprise carried on by OU in Australia. Is OU, a supplier of management services, making a taxable supply under

35

36

37

38

39

GST Act 1999 s 9-5 when it receives a separate payment for its services that it uses to pay the salary and wages of its employees? Sue, a professional horse rider, carries on an enterprise in Australia and is registered for GST. She pays an entry fee to the show organiser for the right to participate in a competition held in Australia, and shows her horse. She wins $200. Is Sue making a taxable supply under GST Act 1999 s 9-5 when she receives $200? Sid operates a food shop and sells jars filled with fruit in alcohol. The fruit in alcohol is not marketed as confectionery or as an ingredient for confectionery or food consisting principally of confectionery. He is registered for GST. Is Sid making a GST-free supply under GST Act 1999 s 38-2 when he sells fruit in alcohol? Maxi carries on a boat retail business from a commercial property that he owns. He is now selling the commercial property but wishes to continue to carry on its enterprise from the property, so he leased the property to a related entity prior to sale. Both he and the purchaser are registered for GST. The supply satisfies the other positive limbs of GST Act s 9-5. Is Maxi making a GST-free supply of a going concern under GST Act 1999 s 38-325(1) when he sells a leased commercial property that is subject to a sublease between the lessee and the entity? Doug owns a block of residential flats that are all let. He then sells the entire block of flats, with leases intact, to Kate for $1 million. Kate is not an existing tenant. Both are registered for GST. They have also agreed in writing that the supply is of a going concern. The entity carries on the enterprise of leasing until the day of the supply. Does Doug make a GST-free supply of a going concern under GST Act 1999 s 38-325 in selling the flats? Kam, a camel breeder, enters into an arrangement with a purchaser under which he sells his entire business operation to the purchaser except for the trading name of the business. The trading name is licensed to the purchaser for a specified period of time. The sale and the licence are for

40

consideration. Kam and the purchaser have agreed in writing that the supply of the business is the supply of a going concern. In addition, the entity carries on the business until the day of the supply. Both are registered for GST. Does Kam make a GST-free supply of a going concern under GST Act 1999 s 38-325 when he sells all things necessary for the continued operation of its business (except for the trading name)? Ann provides 1-month training courses on share trading. Upon successful completion of the course, a participant is awarded a Diploma in Share Trading. However, this [page 684]

41

qualification is not legally required for entry into, or commencement of practice in, the field of stockbroking in Australia. There is not any professional or trade association that requires its members to obtain this qualification, either nationally or on a state basis. Ann is neither a higher education institution nor a registered training organisation (RTO), nor is she recognised or funded as a provider of an adult education course as defined in GST Act s 195-1. Further, she is not a body corporate operating on a not-for-profit basis. She is registered for GST. The supply satisfies the other positive limbs of GST Act s 9-5. Does Ann make a GST-free supply under GST Act 1999 s 38-85 when she supplies a share trading course? Gold Pty Ltd provides training courses that lead to the issuing of licences to operate forklifts. The operation of the machine is a prescribed occupation under the relevant state laws. The relevant state laws require that a person must have the appropriate authority before they can perform work in a prescribed occupation. The courses that the entity provides have no prerequisites and provide the appropriate authority as required by the relevant state laws. The entity is not an RTO and operates on a for-profit basis. The training is open to any person wishing to gain qualifications to benefit their

42

employment opportunities and to comply with workplace health and safety requirements. The entity is registered for GST. Is Gold Pty Ltd, a provider of training courses, making a GST-free supply under GST Act 1999 s 38-85 when it supplies training courses that lead to the issuing of licences to operate forklifts, where such a licence is essential to enter a particular trade or profession? Foodworld sells mineral water bottled from a naturally carbonated spring. The water has not been subject to further processing and does not contain any added chemicals. The naturally carbonated mineral water is not supplied for consumption on the premises from which it is supplied. The entity is registered for GST. Is Foodworld making a GST-free supply under GST Act 1999 s 38-2 when it supplies naturally carbonated mineral water?

1.

See for Australian Taxation Office (ATO) publications or use Google if you find that easier.

2. 3.

The GST is commonly known as the value-added tax (VAT) in the rest of the world. Explanatory Memorandum, A New Tax System (Goods and Services Tax) Act 1999. Copyright Commonwealth of Australia, reproduced with permission.

4. 5.

An entity also needs to be registered if it wants to be a deductible gift recipient. s 23-15.

6. 7.

ss 188-15, 188-22, 188-25. That is, sale of business capital assets such as buildings, plant and equipment.

8. 9.

ss 188-20, 188-22, 188-25. The ABN is a unique business identifier that is required to be quoted on all tax invoices. Also, it will be used for the BASs; that is, tax returns.

10. GST Ruling GSTR 2014/3 (GST: the GST implications of transactions involving bitcoin). 11. See Case N43 (1991) 13 NZTC 3361. 12. See definition at s 38-4. 13. Conditionally GST-free food, as it is not GST-free if restaurant or hot takeaway food etc. 14. So a frozen pack of fish is GST-free, but a frozen fish in a white wine sauce marketed as a prepared meal is not GST-free. 15. ss 38-7, 38-10. 16. ss 38-20–38-40. 17. s 38-45. 18. s 38-50.

19. s 38-47. 20. s 38-55. 21. ss 38-90–38-97. 22. s 38-110. 23. Asterisked words are defined in s 195-1. 24. Subdiv 38-K. 25. Input-taxed supplies: see 19.55. Basically, if a supply is input taxed, then you do not have to charge GST on that supply, and, of course, it follows that you cannot obtain any input tax credits for such supplies. 26. The creditable purpose test is broader than the test of deductibility for income tax in the Income Tax Assessment Act 1997 s 8-1. For example, input tax credits may be available in relation to the acquisition of capital items, whereas your capital purchases are not deductible for income tax. 27. s 29-40. 28. If the consideration for the supply is not in money, or not only in money, the price is the sum of the amount of money, if any, and the tax-inclusive market value of the non-money part of the consideration: s 9-75.

[page 685]

20 Tax planning Learning Objectives After you have studied this chapter, you should be able to: determine what tax planning is as opposed to tax avoidance and tax evasion; outline the principles for minimising assessable income; outline the principles for maximising deductions; outline the averaging concessions; identify the withholding tax concessions; identify the international tax concessions; outline the anti-avoidance rules; understand the role of the income/deduction methods and the legal reasoning model in the provision of tax planning advice; and understand the role of lobbying.

[page 686]

Key Legislative Provisions Please refer to Chapters 1–19. Diagram 20.1:

Income tax planning

Chapter overview 20.1 Tax planning should be undertaken all year; it is a year-round preoccupation. Effective tax planning requires a good understanding of taxation policy and taxation law, as well as detailed knowledge of the financial circumstances of a particular taxpayer, their business and assets structure, the type of entity involved and the number of persons or family groups involved. Tax planning applies to all taxpayers, since everyone should ensure that all

deductions are claimed and that assessable income is correctly accounted for in a way that minimises their tax liabilities. In particular, tax planning is especially important if there are changes to tax laws or if you are: establishing or acquiring a new business/asset; restructuring a business/asset; changing the ownership of a business/asset; selling or disposing of a business/asset; proposing a business transaction/contract; varying a business contract; having unusual income or deductions in a particular year; engaging in international transactions; [page 687] retiring; divorcing; or involved in a death or a birth. As a tax adviser, you need to be very careful in the tax planning advice you provide, given the complexities and ongoing changes in taxation laws. A tax adviser must advise a client about the potential risks as well as benefits of a tax planning arrangement; otherwise, you may be sued for professional negligence: see Sacca v Adam 83 ATC 4326; Symond v Gadens Lawyers Sydney Pty Ltd (No 2) [2013] NSWSC 1578.1 Further, you may be subject to the tax exploitation scheme promoter penalties if you advise others to enter into various tax minimisation arrangements. The key aspects of income tax planning are set out in Diagram 20.1. To be able to employ these strategies, you will first need to know the income and deduction methods set out in this book. Second, you will need to apply the legal reasoning model to a particular entity, or group of entities, so as to provide sound tax planning advice for current and future circumstances.

Practice Problem 1 What types of businesses need tax planning?

Minimise assessable income 20.2 Assessable income can be minimised by deferring income or by taking advantage of the various income exemptions as follows.

Deferring income 20.3 Avoiding the realisation of business and investment income or a capital gain until a later tax period may provide significant tax savings: see discussion on income derivation, small business entities (SBEs) and capital gains tax (CGT) in Chapters 5 and 9. The CGT provisions generally do not apply until a taxpayer realises an asset, so, in a sense, CGT is optional. The CGT provisions also contain numerous concessions and rollover provisions. [page 688]

Income exemptions 20.4 There are many income exemptions available under the ITAA 1936 and ITAA 1997, and these include: mere realisations of capital receipts: see Chapter 6; exempt scholarships and other exempt income: see Chapter 8; foreign income exemptions: see Chapter 4; international tax exemptions: see Chapter 4;

trading stock elections: see Chapter 5; special taxpayer concessions: see Chapter 16; CGT exemptions such as: see Chapter 9: – pre-CGT assets (acquired before 20 September 1985); – CGT applies only on disposal; – CGT on death exempted; – CGT personal residence exemption; – CGT motor vehicle exemption; – 50 per cent individual and trust CGT exemption; – ⅓ superannuation CGT exemption; – small business exemptions; salary sacrificing by employees into superannuation, motor vehicle benefits, laptop computer: see Chapter 18; and SBE exemptions: see Chapter 5.

Practice Problem 2 How could a new or a well-established business minimise assessable income?

Maximise deductions 20.5 Maximising deductions will also reduce taxable income. This can be achieved by claiming all of the deductions and prepaying expenses.

Claiming all deductions

20.6 It is vital to ensure that a good record-keeping system is in place to properly record and document deductible tax expenses. Deductions available include: general deductions: Chapter 10; specific expenses: see Chapters 10 and 11; superannuation deductions: see Chapter 15; [page 689] negative gearing: see Chapter 10; trading stock: see Chapter 5; capital allowances: see Chapter 13: – depreciation expenses; – investment allowances; – 100 per cent depreciation deductions; – certain blackhole expenses; and SBE deductions: see Chapter 5.

Concessionary deductions 20.7 The following categories of expenses have special tax incentives (see Chapters 13 and 16): development allowances; pooled development funds; income-producing buildings; Australian films; intellectual property rights; research and development; environmental expenses;

primary production expenses; gifts; and mining expenses.

Prepaying expenses 20.8 Prepaying expenses is a way of increasing your deductions in a tax year. However, there are limits to prepayments, as set out previously in Chapter 5.

Practice Problem 3 How can deductions?

a

self-employed

individual

maximise

Use of tax offsets 20.9 Tax offsets that are not utilised in a tax year are lost, so care must be taken to ensure that no offsets are wasted: see Chapter 3. [page 690]

Use of entities 20.10 Given the preferential tax rates and income-splitting abilities of partnerships, companies, trusts and superannuation funds, consider using these entities to minimise tax payable: see Chapter 14.

Practice Problem 4 What is the optimal tax structure for a family business?

Use of averaging 20.11 Averaging provisions apply for primary producers, artists, composers, inventors and sportspersons, allowing income to be smoothed over time and thus reducing tax payable: see Chapter 16.

Use of withholding tax provisions 20.12 Withholding tax provisions may provide a lower tax rate. For example, a non-resident deriving Australian-sourced interest, dividend and royalty income will be subject to withholding taxes of between 10 and 30 per cent, considerably lower than the top marginal personal income tax rate: see Chapter 4.

Use of international tax concessions 20.13 The international tax provisions have not been considered at length in this book, but there are many international tax exemptions, loopholes and concessions. Many multinationals and individuals exploit these in order to minimise income tax: see Chapter 4.

Compliance with anti-avoidance provisions

20.14 It is vital to know the specific anti-avoidance rules and the parameters of the general anti-avoidance provision, Pt IVA: see Chapter 16. In particular, you must be aware of the Commissioner’s views (review the relevant tax rulings) on what is acceptable tax planning versus what is tax avoidance, in order to prevent a potentially costly legal dispute. Additionally, care must be taken that the promoter penalty regime, TAA 1953 Sch 1 Divs 290, 298, does not apply to your tax planning arrangements. [page 691]

Case in point 20.15 Some taxpayers get caught up in overpaying income tax because of a poor knowledge of the income and deduction methods. The classic trap is CGT. What looks like clever tax or business planning in the current tax year can lead to a significant future CGT liability. Tom obtains advice to purchase his Perth office block through a company structure to take advantage of the low company income tax rate. Tom does this but, because of the negative gearing, the property does not produce any profit and the company accumulates small losses. After 3 years, Tom sells the property for a $1 million capital gain. However, the company cannot access the CGT discount! As an individual, Tom could have accessed the CGT discount and effectively claimed negatively geared deductions. Dick runs a butcher’s shop in inner-city Brisbane. He rents this shop. Dick acquires the shop next door as an investment and rents it out. After 10 years, he makes a $1 million profit on the sale of the investment shop. Dick cannot access the SBE CGT concessions for the shop sale because he did not use it as an active asset!

(That is, Dick should have sold the shop he used in his business to gain the SBE CGT concessions, assuming that other requirements were met.) Harry is an Australian resident and a filmmaker. He gets advice that his Australian film income of $1 million can be transferred into a Bermuda-listed company, making it tax-free. Only a $50,000 administration fee payable to Gekko & Co is required. Harry enters the scheme and 2 years later he is under investigation by the authorities. Three years later he is in jail!

Current and proposed tax changes 20.16 It is vital that the tax professional keeps up proposed changes as a result of the annual Federal initiatives. In particular, regard must be had to government tax review processes, which may map reform.

to date with current and Budgets or other policy the findings of current out future paths for tax

Interactions with GST, FBT and superannuation rules 20.17 Be aware of the GST, fringe benefits tax (FBT) and superannuation consequences, as well as the income tax consequences, of your tax planning proposals: see Chapters 15, 18 and 19. [page 692]

Record keeping and documentation

20.18 The best laid plans of mice and men often go astray.2 From a tax perspective, tax problems (ie, from Australian Taxation Office (ATO) audits) often stem from poor record keeping and lack of documentation. Good record-keeping practices are a vital part of tax planning, as they provide the best defence to ATO scrutiny. The onus of proof rests with the taxpayer if the Commissioner considers that their taxable income is understated.

Lobbying and media 20.19 Lobbying and use of media also form part of tax planning (especially for influential wealthy taxpayers and corporates).3 The impact of lobbying in Australia seems extensive, given the many tax exceptions, exemptions and special rules that apply to certain taxpayers. However, as discussed in Chapter 1, this significantly damages equity, revenue, efficiency and simplicity. For example in 2012, the mining industry successfully opposed the impact of the proposed $10 billion mining tax with extensive lobbying and a reported $22 million advertising campaign. Subsequently, amid a fierce media blitz, the Prime Minster was removed and the mining tax substantially weakened and then repealed. The Australian Government has a Lobbying Code of Conduct and a Register of Lobbyists, and lobbying is a legitimate activity! Lobbying activities include communications with a government representative in an effort to influence government decision-making, including the making or amendment of legislation and the development or amendment of a government policy or program. A government representative includes a minister, a parliamentary secretary, a person employed or engaged by a minister or a parliamentary secretary, an agency head or a person employed under the Public Service Act 1999.

Attempt the Web Quiz for Chapter 20

[page 693]

Summary 20.20 Effective tax planning requires a good understanding of taxation policy and taxation law and an intimate knowledge of a taxpayer’s working, investment, financial and business affairs. A tax planner must look into the impact of future tax reforms as well as the tax implications of future investment and business transactions. The key steps of tax planning are: minimise assessable income; maximise deductions; use tax offsets; use entities; use averaging; use withholding tax provisions; use international tax concessions; comply with anti-avoidance rules; and interact with GST, FBT and superannuation rules.

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3): identify the question at issue; research and make a decision; explain well; and use clear language. 1 What is the difference between legitimate tax planning and illegal tax avoidance?

2 3 4 5

List 10 tax planning techniques for small businesses. List 10 tax planning techniques for investors. List 10 tax planning techniques for employees. Sally owns a profitable electronics store in Melbourne generating $200,000 of taxable income in the current year. She is married to Larry and they have two children: Michael, who is 15 years old, and Danielle, who is 19 years old. Currently, Sally is a sole trader and also owns a rental property bringing in $20,000 net rental income and has shares that provide $10,000 of dividend income. Larry does not work. Sally is 52 years old and is thinking of selling the business in 5 years’ time. Sally complains to you about the level of tax she pays. What steps can she take to reduce her current and future tax liability?

1.

An ownership structure for the Aussie Home Loans business was proposed and advice given that Mr Symond could withdraw funds from that business tax-free in order to build his house. Subsequently, the advice resulted in significant personal and company tax liabilities. Mr Symond’s damages were set by the court at $4,979,800.

2.

Robert Burns’ poem To a Mouse, 1786. In destroying a mouse’s nest while ploughing a field, Burns penned: … But, Mousie, thou art no thy lane [you aren’t alone] In proving foresight may be vain: The best laid schemes o’ mice an’ men Gang aft a-gley, [often go awry] An’ lea’e us nought but grief an’ pain, For promised joy. T S Adams, ‘Ideals and Idealism in Taxation’ (1928) 18 American Economic Review: ‘Modern taxation or tax making in its most characteristic aspect is a group contest in which powerful interests vigorously endeavor to rid themselves of present or proposed tax burdens.’

3.

[page 695]

21 Tax administration Learning Objectives After you have studied this chapter, you should be able to: explain the system of self-assessment of income taxation; identify taxpayer income tax return and record-keeping requirements; explain what an income tax assessment is; identify the Commissioner’s powers to access records; identify the Commissioner’s powers to amend assessments; provide an overview of the penalty regimes for taxpayer understatements; identify the review rights available to taxpayers in respect of a tax assessment or taxation decision; outline the private and public rulings system; understand the requirements of the Taxpayers’ Charter; identify an Australian business number (ABN); and explain the pay-as-you-go (PAYG) withholding and instalment systems.

[page 696]

Key Legislative Provisions Income Tax Assessment Act 1936 (ITAA 1936) s 166 s 167 s 170 s 263 s 264 Taxation Administration Act 1953 (TAA 1953) s 8A–13C Pt IVC Sch 1 Div 358 Sch 1 Div 359 Sch 1 Divs 284–288

Cases Ohl and FCT, Re (2012) 85 ATR 798; [2012] AATA 3

Key ATO Publications Overview of the Taxpayers’ Charter Objections, amendments & reviews essentials How to apply for a private ruling

Introduction to PAYG income tax instalments Diagram 21.1:

Tax administration

[page 697]

Chapter overview 21.1 This chapter provides an overview of a variety of compliance requirements, procedural matters and review rights of the taxation system.

Self-assessment and income tax returns 21.2 The income taxation system in Australia operates on a self-assessment basis; that is, taxpayers’ income tax returns are generally accepted at face value

and form the basis of the Commissioner’s assessments — although the Australian Taxation Office (ATO) implements various cross-checks, computer checks, computer analysis and audits so as to ensure taxpayer compliance with the ITAA. Under self-assessment, taxpayers are required to provide only basic information about certain income, expense and tax offset items. Taxpayers are required to keep records in respect of the calculation of their taxable income. Substantiation rules require taxpayers to retain records to verify claims for deductions. Many of the requirements for making and lodging elections and notifications do not require any forms to be lodged with the Commissioner, although taxpayers must retain the forms. See Chapter 22 for the requirements of the various tax returns for income tax, goods and services tax (GST) and fringe benefits tax (FBT).

Assessment 21.3 Taxpayers are required to lodge annual income tax returns and keep records so as to substantiate their income tax return details. Under ITAA 1936 s 166, the Commissioner is required to make an original assessment of the taxpayer’s taxable income and tax payable based on the income tax return. If a taxpayer does not lodge a return or if the Commissioner is dissatisfied with a return, the Commissioner can make a default or arbitrary assessment under s 167. Where a taxpayer’s return has an error, the Commissioner has extensive powers, pursuant to s 170, to amend the assessment made.

Read ITAA 1936 ss 166 and 167 Audits 21.4 While returns are not generally examined in detail prior to the issuing of an assessment, the ATO has wide-ranging data-matching programs (ie, the ATO checks bank interest and company dividend information against income

tax returns) to monitor taxpayer compliance with the tax laws. As a result of the data-matching results, other industry information and dob-ins, the ATO conducts tax audits across a wide cross-section of the community. [page 698]

Commissioner’s access to records 21.5 Under ITAA 1936 s 263, the Commissioner gained wide powers to full and free access to all buildings, places, books, documents and other papers for the purposes of the ITAAs 1936 and 1997. In reality, these powers have limits. First, legal professional privilege applies to certain communications between a lawyer and a client. Further, guidelines exist for access to accountants’ papers. Additionally, the Commissioner has wide powers to obtain information by issuing a request for information under s 264.

Read ITAA 1936 ss 263 and 264 Power to amend assessments 21.6 The Commissioner has time limits to amend assessments. Generally, the limit is 2 or 4 years (depending on the type of taxpayer) from the date that the tax became due and payable. Under the self-assessment measures, the Commissioner will generally have a 2-year amendment period for the assessments of most individuals or very small business entities. However, the Commissioner may extend the period in which to issue the taxpayer with a notice of amended assessment from 2 to 4 years under ITAA 1936 s 170(1) and item 5 of the table in reg 20 of the Income Tax Regulations 1936. In the case of fraud or evasion, the Commissioner may amend an assessment at any time, but otherwise there is generally a 4-year limit on amending

assessments. If an assessment is amended to increase a taxpayer’s tax liability, the taxpayer may be required to pay interest. Taxpayers can request an amendment to an assessment if they have omitted something or made an error in their tax return. The Commissioner may then amend the assessment without having to first check all the taxpayer’s claims.

Read ITAA 1936 s 170 Penalties, interest and offences 21.7 In view of the self-assessment system, a series of penalty tax and interest provisions and criminal offences all attempt to provide deterrents to tax avoidance or evasion. There are two alternative penalty regimes. The Commissioner may impose either administrative or judicial penalties.

Administrative penalties 21.8 For offences such as providing false and misleading statements in a tax return or the failure to provide information, the Commissioner may impose a penalty under TAA 1953 Sch 1 Divs 284–288 or related penalty provisions. [page 699] Any difference between the reported tax liability and the correct tax liability (the tax shortfall) is subject to flat percentage penalties in accordance with the degree of culpability of the taxpayer. Culpability is based on whether the taxpayer’s position on a question of law is reasonably arguable, whether reasonable care was taken and whether there was recklessness or deliberate evasion involved. If a taxpayer exercised reasonable care and had a reasonably arguable position, they will not be subject to tax shortfall penalties. Penalty tax will be reduced where the taxpayer voluntarily discloses a tax shortfall; the reduction

is much greater if the disclosure is made before the taxpayer is notified of any audit action. Similar provisions apply to franking tax shortfalls. Also, penalties apply for the late lodgment of tax returns. These penalties do not apply if the judicial penalties are applied. As noted in Chapter 17, penalties also apply to promoters of tax exploitation schemes. Re Ohl and FCT (2012) 85 ATR 798; [2012] AATA 3 The AAT has affirmed a 75 per cent shortfall penalty imposed on two taxpayers in relation to failing to lodge their income tax returns on time for the 2005 income tax year.

Read TAA 1953 Sch 1 Divs 284–288 Judicial penalties 21.9 For more serious taxation offences such as fraud and tax evasion, the Commissioner may instigate a court prosecution action under TAA 1953 ss 8A–13C or Criminal Code 1995 Divs 136, 137.

Review rights 21.10 TAA 1953 Pt IVC provides taxpayers with the right to object to, review and appeal a tax assessment or other taxation decision. Further, under the Taxpayers’ Charter, taxpayers have rights to an internal review within the ATO and can complain to the Tax Ombudsman. Importantly, the onus of proof is on the taxpayer to prove that the assessment is incorrect: ss 14ZZK(b) and 14ZZO(b). Thus, proper record keeping and accounting records are vital. Under Pt IVC, a taxpayer may request a review to the Administrative

Appeals Tribunal or the Small Taxation Claims Tribunal. The period within which a taxpayer can object to an assessment is 2 years for most individuals and small businesses, and for other taxpayers it is 4 years after the notice of assessment is served on the taxpayer: s 14ZW(1). Taxpayers can also object to private rulings. If a taxpayer is dissatisfied with the objection, he or she may appeal to the Federal Court. If unsuccessful before the Full Federal Court, a taxpayer can seek special leave to appeal to the High Court. [page 700]

Read TAA 1953 Pt IVC Public and private rulings 21.11 In an attempt to provide greater certainty to the taxation system, the Government introduced a public and private rulings system into the TAA. This enables the Commissioner to make legally binding public rulings (see TR 92/1) and provides taxpayers, upon request, with legally binding private rulings: see TR 93/1. Under the new self-assessment measures, the updated rulings regime will apply to income tax, FBT, withholding tax, mining withholding tax, the Medicare levy, franking deficit tax, venture capital deficit tax, over-franking tax, product grants, and benefits Acts and regulations. It will also cover provisions about the administration and collection of those taxes.

Read TAA 1953 Sch 1 Divs 358, 359 Taxpayers’ charter

21.12 Given the enormous powers vested in the ATO through such provisions as ss 263 and 264 (regarding the Commissioner’s access powers), together with the complexity of the taxation laws, it is clear that there had to be a transparent mechanism to ensure accountability of ATO services and to ensure that taxpayers are fully informed of their rights and obligations, thus the rationale for the Taxpayers’ Charter. The charter has four main elements:1 1. taxpayer rights 2. service and other standards taxpayers can expect from the ATO 3. remedies for dissatisfied taxpayers, and 4. taxpayers’ obligations. These elements involve the following matters. 21.13 Under the charter, taxpayers have rights and they can expect the ATO to:2 treat you fairly and reasonably; treat you as being honest in your tax affairs unless you act otherwise; be accountable for what the ATO does — that is, meeting service standards; offer you professional service and assistance to help you to understand and meet your tax obligations; respect your privacy pursuant to the Privacy Act 1988; give you access to information that the ATO holds about you, in accordance with the law pursuant to the Freedom of Information Act 1982; explain to you the decisions the ATO makes about your tax affairs; accept that you can be represented by a person of your choice and get advice about your tax affairs; [page 701] give you advice and information that you can rely on; and

help you to minimise your costs in complying with the tax laws.

Remedies for dissatisfied taxpayers 21.14 In the event that a taxpayer believes that their legal rights or the standards outlined in the charter have not been met, the following remedy is provided:3 Step 1

Tell the tax officer with whom you are dealing

Step 2

Talk to that officer’s manager if you are not satisfied

Step 3

Ring the Problem Resolution Service if you are still not satisfied

Also, taxpayers have the right to an independent review from outside the ATO, including the right to complain to the Commonwealth Ombudsman. Recently, the Institute of Chartered Accountants was successful in enforcing charter rights in requesting a review of advice provided by the Commissioner disallowing deductions claimed in relation to linked bonds and notes. The taxpayers were originally asked to advise the ATO of any deductions claimed and to waive their rights to object to their tax assessments. Consequently, and in accordance with charter guidelines, the objection rights were restored.

Taxpayers’ obligations 21.15 Of course, taxpayers are obliged to pay the correct amount of tax under the law. In meeting this responsibility, the charter expects taxpayers to be truthful in their dealings with the ATO, to keep records in accordance with the law, to take reasonable care in preparing tax returns and other documents and in keeping records, to lodge tax returns and other required documents or information by the due date, and to pay taxes and other amounts by the due date.4

Australian business number (ABN)

21.16 The Australian Business Number Act 1999 sets out the procedures for registering for an ABN and the obligations that apply once registered, and provides for a person to apply to the Administrative Appeals Tribunal for a review of certain decisions relating to ABN registrations. The Act also sets out the administration requirements for the Australian Business Register, provides for public access to the register on payment of the prescribed fee, and contains provisions to prevent misuse of the ABN.

Purpose 21.17 Section 3 provides that the ‘main object of this Act is to make it easier for business to conduct their dealings with the Australian Government. This is done by establishing [page 702] a system for registering businesses and issuing them with unique identifying numbers so that they can identify themselves reliably’. Further, s 3 provides the aims of ‘reducing the number of government registration and reporting requirements by making the system available to State, Territory and local government regulatory bodies’. Obtaining an ABN will be essential for the vast majority of businesses, given that it is mandatory for any entity requiring to be registered for GST purposes. An entity will be required to have an ABN to register for GST purposes and thus obtain input tax credits and to be able to provide tax invoices. The use of the ABN will also extend to cover other tax reform measures such as the wine equalisation tax, luxury car tax, business activity statement, PAYG, diesel and alternative fuels grants scheme, and charities/deductible gift recipient endorsement. The ABN benefits business with more accurate and up-to-date information and services provided by the Commonwealth. It reduces the administrative costs for small business by limiting the number of times a business is asked for similar information by different agencies. This means that there is a reduction

in the number of forms and other procedural obligations that businesses are burdened with. It reduces the need for difficult judgments by businesses about whether the service providers they engage are employees or contractors. (If a business receives an invoice without an ABN, it is required to withhold tax from that payment, just as it does for payments to its workers.) It allows small businesses to access basic identification information about other entities that they are dealing with.

Pay-as-you-go (PAYG): TAA 1953 Sch 1 Pts 25, 2-10 21.18 The PAYG collection system provides the rules for the ATO to collect all withholding payments. The PAYG arrangements5 consist of two separate systems: 1. the PAYG withholding system applicable to payments; and 2. the PAYG instalments system.

PAYG withholding: TAA 1953 Sch 1 Pt 2-5 21.19 Under the rules for the PAYG withholding system, amounts are collected in respect of particular payments or transactions from the person who makes the payment. These amounts are then paid to the Commissioner. Certain non-cash benefits are also caught and, before providing the benefit, the provider is required to pay an amount to the Commissioner representing what would have been withheld from a cash payment.

PAYG instalments: TAA 1953 Sch 1 Pt 2-10 21.20 Under the PAYG instalments system, businesses that register for GST generally pay their income tax in four quarterly payments at the same time as their GST. Businesses

[page 703] are able to offset credits for GST against instalments of income tax or other payments (eg, withholding tax remittances and FBT instalments) that are made at the same time. Non-GST payers also make quarterly PAYG instalments unless they have a tax liability of less than $8000, in which case they can pay an annual instalment.

Foreign resident capital gains withholding payments regime 21.21 A non-final withholding payments obligation is imposed on the purchaser of certain Australian real property and related interests where the property is acquired from a foreign resident vendor, TAA 1953 Sch 1, Subdiv 14-D. The withholding rate is 12.5 per cent; and the withholding threshold is $750,000.

Common Reporting Standard 21.22 The Taxation Administration Act 1953 (TAA 1953) requires certain financial institutions in Australia to report information to the Commissioner about financial accounts held by foreign tax residents. In turn, the Commissioner will provide this information to the foreign residents’ tax authorities, and in parallel, will receive information on Australian tax residents with financial accounts held overseas. Thus, financial institutions will need to carry out the due diligence procedures outlined in the Standard for Automatic Exchange of Financial Account Information in Tax Matters, commonly known as the Common Reporting Standard (CRS). The CRS is an international framework developed by the Organisation for Economic Co-operation and Development (OECD) and non-OECD G20 countries at the request of the G20 to tackle and deter cross-border tax evasion. It establishes a common international standard for financial institutions to identify the financial accounts of foreign tax residents, report information on those account holders

and their financial accounts to their local tax authority and for the authority to exchange that information with the tax authority of the foreign resident.

Inspector-General of Taxation 21.23 The Inspector-General of Taxation provides advice to the Government on taxation issues and identifies any problems with the administration of the taxation laws.6 Recently, the Inspector-General of Taxation has expressed concerns about the repeated computer outages at the ATO.7

Australian Taxation Office and the internet 21.24 The ATO has a comprehensive website at , which provides a vast amount of information about tax administration as well as the ATO views on tax law, legal research resources and much more. The site has search engines and is divided into taxpayer [page 704] groups such as individuals, businesses and superannuation funds to facilitate its navigation. In researching your assignment, you should use this site to obtain the ATO view of the law for contentious issues. Alternatively, you may use Google to find ATO publications; you may find this easier. The ATO is also on the social networking site Twitter. This provides the latest changes on new rules, changes to legislation and reminders of upcoming due dates: see .

ATO is being ‘reinvented’ 21.25

The new Commissioner, Chris Jordan, argues that he is ‘reinventing’

the ATO by changing the culture and making the ATO a contemporary and more service-orientated organisation.8 The new mission is to contribute to the economic and social wellbeing of Australians by fostering willing participation in the tax and superannuation systems. New technologies and ways of doing things are being embraced. Personnel changed, with downsizing and a large redundancy program, while tax and audit professionals recruited from outside the ATO. Certainly, the increasing reliance on computers means that the ATO today is more like a technology company than a people-based service and audit provider. The traditional threats for computer use are now the key threats for the ATO, as seen with past and recent ATO computer systems outages and, in 2016-17, Australia’s biggest tax fraud involving difficulty policing computerised payroll PAYG tax systems and phoenix companies. The ever changing ATO website, its complexity and use of small light coloured fonts all create issues in navigating the tax maze. The 125 different tax laws appear unmanageable and challenge the information technology systems, and both need re-invention and reform to be managable.

Tax transparency 21.26 The ATO provides tax transparency reports which provide some useful information about the tax affairs of Australia’s largest entities. These are designed to: discourage aggressive tax practices; inform public debate about corporate tax policy; address concerns by the Group of Twenty (G20) and the Organisation for Economic Cooperation and Development (OECD) regarding tax base erosion and profit shifting by multinational entities. This has enabled some indication that larger and wealthier entities are paying their fair share of tax revenue. There is, though, limited disclosure of tax losses and tax offsets, involving annual revenues of over A$1.7 trillion.9 Given the issues of companies accumulating large tax losses this is a major failing in such tax integrity reporting. [page 705]

Commissioner’s Remedial Power 21.27 The Commissioner has a Remedial Power for Taxation to allow for a more timely resolution of certain unforeseen or unintended outcomes in the taxation and superannuation laws, TAA 1953 s 370-5. The power allows the Commissioner to make, by disallowable legislative instrument, one or more modifications to the operation of a taxation law to ensure the law can be administered to achieve its intended purpose or object. The power can only be validly exercised where: the modification is not inconsistent with the intended purpose or object of the provision; the Commissioner considers the modification to be reasonable, having regard to both the intended purpose or object of the relevant provision and whether the costs of complying with the provision are disproportionate to achieving the intended purpose or object; and the Department of the Treasury or the Department of Finance advises the Commissioner that any impact on the Commonwealth budget would be negligible. Before exercising the power, the Commissioner must be satisfied that any appropriate and reasonably practicable consultation has been undertaken. This allows an opportunity to identify and consider all implications from the exercise of the power and to ensure that the exercise of the power is appropriate in the circumstances. This is consistent with the approach to amendments of primary legislation, which are subject to public consultation. Further, the Commissioner will consult with a technical advisory group and the Board of Taxation prior to any exercise of the power.

Attempt the Web Quiz for Chapter 21

Summary

21.28 Important aspects of tax administration include: self-assessment and income tax returns; assessment; audits; Commissioner’s access to records; power to amend assessments; penalties, interest and offences; review rights; public and private rulings; Taxpayers’ Charter; taxpayers’ rights; ABN; PAYG; and Inspector-General of Taxation.

1.

ATO, ‘Taxpayers’ Charter’: see . Copyright Commonwealth of Australia, reproduced with permission.

2. 3.

Above n 1. Above n 1.

4. 5.

Above n 1. PAYG commenced on 1 July 2000 and it abolished or replaced the company instalment and provisional tax systems as well as a number of other reporting and payment systems, including payas-you-earn (PAYE), the prescribed prepayments system (PPS) and the reportable payments system (RPS).

6. 7.

See . P Durkin, ‘Technology crisis engulfs Tax Office’, Australian Financial Review, 17 July 2017, 6.

8.

Chris Jordan, Commissioner of Taxation, ‘Keynote address to the Institute of Chartered Accountants Australia (ICAA) Practice Forum’, Sydney, Thursday, 12 June 2014. R Lanis, B Govendir and R McClure ‘The tax office’s transparency reporting is looking a little opaque’, The Conversation, 13 December 2016.

9.

[page 707]

22 Taxation in practice Learning Objectives After you have studied this chapter, you should be able to: have a general understanding of the requirements for completing income tax returns and schedules for individuals, partnerships, trusts, companies and self-managed superannuation funds (SMSFs); broadly understand the requirements for completing fringe benefits tax (FBT) returns; broadly understand the requirements for completing goods and services tax (GST) returns and business activity statements (BASs); apply the legal analysis undertaken in the preceding chapters to the completion of tax returns; and recognise the requirements for business taxpayers to provide key accounting data in certain taxation returns and schedules.

[page 708]

Chapter overview 22.1 This chapter is designed to give you a practical feel for the completion of the various tax returns for income tax, FBT and GST. This chapter also ties in with the legal analysis undertaken in the preceding chapters. The process of completing tax returns is principally a process of allocating dollar amounts to numerous labels contained in the income tax returns (and schedules), FBT returns and GST returns (and BASs). This chapter sets out the various tax returns, statements and schedules with the labels that need to be allocated dollar amounts. The previous chapters in this book have provided a legal analysis for the meaning of many of these labels.1 Business taxpayers are also required to provide key accounting data in these labels.

Income tax returns 22.2 Most taxpayers need to lodge an income tax return, which requires that all four components of the income tax equation be included (assessable income, deductions, tax offsets and credits). The previous chapters have mainly concentrated on developing your tax technical legal skills (apart from the calculations of income tax, capital gains tax (CGT) and depreciation) in understanding and deriving these four components. The format of the income tax returns varies according to entity type (individuals, partnerships, trusts, companies or superannuation funds). The front page of these tax returns generally requires the taxpayer’s name, address, tax file number (TFN) etc. The other pages of these tax returns require fairly extensive quantitative data, as broadly set out below. Thus, your accounting or quantitative skills will come to the fore in the process of allocating amounts from taxpayers’ financial statements to the many labels (classifications) in the income tax returns (this is especially so for business and investor taxpayers).

The following example tax return details are based on previous years’ income tax returns.2

Individuals 22.3 Two types of income tax returns may need to be completed for individuals: an individual income tax return; or a supplementary individual income tax return. There are also six schedules that may need to be completed: 1. a business and professional items schedule: for business and professional taxpayers (sole traders); 2. a capital allowances schedule: where a deduction for a decline in value of depreciating assets is made; [page 709] 3.

an employment termination payment (ETP) schedule: for taxpayers that receive more than one ETP during the year; 4. an individual pay-as-you-go (PAYG) payment summary schedule: for the business and professional items schedule for individuals who receive a payment summary; 5. a statutory declaration: needed if a payment summary is lost, destroyed or has not been received from the payer (ie, the employer); and 6. a superannuation lump sum schedule: for taxpayers who receive more than one superannuation lump sum during the year. This chapter focuses on the two returns and the more common schedules: the business and professional items schedule and the capital allowances schedule.

Individual income tax return Assessable income 22.4 This is the key individual tax return that most individual taxpayers need to complete. There is a short form for simple tax affairs and a long form for others. The long form requires assessable income to be allocated into the following components (the ‘X’ indicates where a dollar amount is required, if applicable): $ Salary or wages

X

Allowances, earnings, tips, director’s fees etc

X

Employer lump sum payments

X

ETPs

X

Australian Government allowances and payments

X

Australian Government pensions and allowances

X

Australian annuities and superannuation income streams

X

Australian superannuation lump sum payments

X

Attributed personal services income (PSI)

X

Gross interest

X

Dividends

X

Employee share schemes

X

Income that you show on the supplementary section of the tax return

X

The sum of the above amounts will result in the total income. Working out what constitutes assessable income is examined in Chapters 4–9 and 14–17. [page 710]

Deductions 22.5 This form also requires deductions to be allocated into the following components: $ Work-related car expenses

X

Work-related travel expenses

X

Work-related clothing, laundry and dry-cleaning expenses

X

Work-related self-education expenses

X

Other work-related expenses

X

Low-value pool deduction

X

Interest deductions

X

Dividend deductions

X

Gifts or donations

X

Cost of managing tax affairs

X

Deductions that you show on the supplementary section of the tax return

X

Losses Tax losses of earlier income years

X

Working out what constitutes a deduction is examined in Chapters 4, 5 and 10–17. Taxable income or loss 22.6 The return will then show either a taxable income (if assessable income exceeds deductions) or a loss (if deductions exceed assessable income). Tax offsets 22.7 This form also requires tax offsets to be allocated into the following components:

$ Franking credits — dividends

X

Spouse (without dependent child or student), child-housekeeper or housekeeper

X

Senior Australians (includes age pensioners, service pensioners and self-funded retirees)

X

[page 711]

Pensioner

X

Australian superannuation income stream

X

Private health insurance

X

Education tax refund

X

Tax offsets that you show on the supplementary section of the tax return

X

Working out what constitutes a tax offset is examined in Chapters 3, 4 and 14. Credits 22.8 The following credits also need to be allocated in the return for withholding tax in respect of: $ Salary or wages

X

Allowances, earnings, tips, director’s fees etc

X

Employer lump sum payments

X

ETPs

X

Australian Government allowances and payments

X

Australian Government pensions and allowances

X

Australian annuities and superannuation income streams

X

Australian superannuation lump sum payments

X

Attributed PSI

X

Interest income

X

Dividend income

X

Working out what constitutes a credit is examined in Chapters 3 and 4.

Supplementary individual income tax return 22.9 Individuals may also need to complete a supplementary individual income tax return form. Individual investors and business taxpayers will need to do this. [page 712] Assessable income 22.10 This form has the following categories that need to be completed for assessable income: $ Partnerships and trusts

X

PSI

X

Net income or loss from business

X

Deferred non-commercial business losses

X

Net farm management deposits or withdrawals

X

Capital gains

X

Foreign entities

X

Foreign source income and foreign assets or property

X

Rent

X

Bonuses from life insurance companies and friendly societies

X

Forestry managed investment scheme income

X

Other income

X

The sum of the above amounts will result in the total supplement income or loss. The total supplement income/loss is then transferred to the individual tax return. Working out what constitutes assessable income is examined in Chapters 4–9 and 14–17. Deductions 22.11 This form also requires deductions to be allocated into the following components: $ Deductible amount of undeducted purchase price of a foreign pension or annuity

X

Personal superannuation contributions

X

Deduction for project pool

X

Forestry managed investment scheme deduction

X

Other deductions

X

[page 713] The total supplement deductions are then transferred to the individual tax return. Working out what constitutes a deduction is examined in Chapters 4, 5 and 10–17. Tax offsets 22.12 This form also requires tax offsets to be allocated into the following components: $

Superannuation contributions on behalf of your spouse

X

Zone or overseas forces

X

Total net medical expenses

X

Dependent (invalid and carer)

X

Landcare and water facility

X

Net income from working — supplementary section

X

Other non-refundable tax offsets

X

Other refundable tax offsets

X

The total supplement tax offsets are then transferred to the individual tax return. Working out what constitutes a tax offset is examined in Chapters 3, 4 and 14.

Business and professional items schedule for individuals 22.13

Individuals in business (sole traders) need to complete this tax return.

Assessable income 22.14 PSI needs to be allocated. Sole traders also need to allocate their business income according to whether it is primary production and/or nonprimary production and then into the following categories. $ Gross payments where Australian business number (ABN) not quoted

X

Gross payments subject to foreign resident withholding

X

Gross payments — voluntary agreement

X

Gross payments — labour hire or other specified payments

X

Assessable government industry payments

X

Other business income

X

Working out what constitutes assessable income is examined in Chapters 4–9 and 14–17. [page 714] Deductions 22.15 Sole traders also need to allocate their business deductions and stock according to whether it is primary production and/or non-primary production and then in the following categories: $ Opening stock

X

Closing stock

X

Purchases and other costs

X

Cost of sales

X

Foreign resident withholding expenses

X

Contractor, subcontractor and commission expenses

X

Superannuation expenses

X

Bad debts

X

Lease expenses

X

Rent expenses

X

Interest expenses overseas

X

Interest expenses within Australia

X

Depreciation expenses

X

Repairs and maintenance

X

Motor vehicle expenses

X

All other expenses

X

Other specific items Business deduction for project pool

X

Section 40-880 deduction

X

Landcare operations and business deduction for decline in value of water facility

X

Working out what constitutes a deduction is examined in Chapters 4, 5 and 10–17. Net income or loss from business this year 22.16 Subtracting business income from deductions will provide the net income or loss from business for the year. This amount is transferred to the supplementary individual income tax return. [page 715]

The capital allowances schedule Depreciating assets first deducted in the current income year 22.17

The information needed for this form is: $

Total cost of depreciating assets (excluding motor vehicles)

X

Assets each costing less than $1000

X

Total cost of depreciating assets (excluding motor vehicles)

X

Assets each costing $1000 or more

X

Total cost of motor vehicles

X

Depreciating assets 22.18

Information from the depreciating assets worksheet needed is: $

Total assessable balancing adjustment amounts

X

Total deductible balancing adjustment amounts

X

Total deduction for decline in value — diminishing value method

X

Total deduction for decline in value — prime cost method

X

Total adjustable values at end of income year

X

Also, information is needed for low-value pool worksheets and any recalculations of the effective life of depreciating assets. Other deductions 22.19 Details of the following capital allowance deductions are also needed: project pools; entities engaged in exploration or prospecting; and taxation of financial arrangements (TOFAs). Working out what constitutes a capital allowance is examined in Chapter 13.

Declarations 22.20 The individual must sign and declare that the information in the tax return is true and correct. If applicable, the tax agent must sign and declare that the tax return has been prepared in accordance with information supplied by the taxpayer, that the taxpayer has given them a declaration stating that the information provided to the tax agent is true and correct, and that the taxpayer has authorised the tax agent to lodge the tax return.

[page 716]

Partnerships 22.21 A partnership needs to lodge an income tax return and may also need to complete the following schedules: PSI schedule (deals with PSI); capital allowances schedule (see 22.17 above); and Schedule 25A.

Partnership income tax return 22.22 Partnerships need to allocate their business income and expenses according to whether the income or expenses arose from primary production or non-primary production. Assessable income (excluding foreign income) 22.23

The information required for working out assessable income is: $

Business income: primary production and/or non-primary production Gross payments where ABN not quoted

X

Gross payments subject to foreign resident withholding

X

Assessable government industry payments

X

Other business income

X

Other income Primary production income Distribution from partnerships

X

Distribution from trusts

X

Non-primary production income Distribution from partnerships less foreign income

X

Distribution from trusts less net capital gain and foreign income

X

Franked dividends from trusts Gross rent

X

Forestry managed investment scheme income

X

Gross interest

X

Dividends

[page 717]

Unfranked amount

X

Franked amount

X

Franking credit

X

Other Australian income Foreign income Attributed foreign income Listed country

X

Section 404 country

X

Unlisted country

X

Foreign investment fund (FIF)/foreign life insurance policy (FLP) income

X

Other foreign income Other assessable foreign source income

X

Australian franking credits from a New Zealand company

X

Working out what constitutes assessable income is examined in Chapters 4–9 and 14–17. Deductions 22.24 Information required for working out what deductions may be claimed is: $ Business: primary production and/or non-primary production Foreign resident withholding expenses

X

Contractor, subcontractor and commission expenses

X

Cost of sales

X

Superannuation expenses

X

Bad debts

X

Lease expenses

X

Rent expenses

X

Total interest expenses

X

Total royalty expenses

X

[page 718]

Depreciation expenses

X

Motor vehicle expenses

X

Repairs and maintenance

X

All other expenses

X

Rent Interest deductions

X

Capital works deductions

X

Other rental deductions

X

Other deductions Deductions relating to Australian investment income

X

Forestry managed investment scheme deduction

X

Other deductions

X

Working out what constitutes a deduction is examined in Chapters 4, 5 and 10–17. Credits 22.25

The information on tax credits that is required is: $

Tax withheld Credit for tax withheld — foreign resident withholding

X

Tax withheld where ABN not quoted

X

Partnerships and trusts: share of credits from income X

Share of credit for tax withheld where ABN not quoted Share of credit for TFN amounts withheld from interest, dividends and unit trust distributions

X

Share of franking credit from franked dividends

X

Share of credit for tax withheld from foreign resident withholding

X

Interest and dividends TFN amounts withheld from gross interest

X

TFN amounts withheld from dividends

X

Working out what constitutes a credit is examined in Chapters 3 and 4. [page 719] Tax offsets 22.26

The following information is required in relation to tax offsets: $

National Rental Affordability Scheme tax offset entitlement

X

Working out what constitutes a tax offset is examined in Chapters 3, 4 and 14. Key financial information 22.27

Key financial information required includes: $

All current assets

X

Total liabilities

X

Total assets

X

Proprietors’ funds

X

Opening stock

X

Purchases and other costs

X

Closing stock

X

Trade debtors

X

Trade creditors

X

Total salary and wage expenses

X

Payments to associated persons

X

Intangible depreciating assets first deducted

X

Other depreciating assets first deducted

X

Termination value of intangible depreciating assets

X

Termination value of other depreciating assets

X

Deduction for project pool

X

Section 40-880 deduction

X

Fringe benefit employee contributions

X

Interest expenses overseas

X

Royalty expenses overseas

X

[page 720]

Deduction for environmental protection expenses

X

Trading stock election

X

Small business entity (SBE) depreciating assets

X

Distribution of net income/loss 22.28

A statement of income/loss distribution must be completed for each

partner allocating their share of income/loss to primary or non-primary production. Also, credits and tax offsets must be allocated on the statement according to the following headings: $ Credit for tax withheld where ABN not quoted

X

Franking credit

X

TFN amounts withheld

X

Credit for tax withheld — foreign resident withholding

X

Australian franking credits from a New Zealand company

X

Share of net SBE income

X

Share of National Rental Affordability Scheme tax offset

X

Declarations 22.29 A partner must sign and declare that the information in the tax return is true and correct. If applicable, the tax agent must sign and declare that the tax return has been prepared in accordance with information supplied by the taxpayer, that the taxpayer has given them a declaration stating that the information provided is true and correct, and that the taxpayer has authorised the tax agent to lodge the tax return.

Personal services income schedule 22.30 The PSI schedule is to be used by companies, partnerships and trusts that are associated with PSI. If PSI is attributed to an individual, the income is not assessable to the company, trust or partnership. The PSI must be adjusted in the company, partnership or trust tax returns.

Schedule 25A

22.31 A partnership, trust, company or superannuation fund must complete Schedule 25A if: the aggregate amount of the transactions or dealings with international related parties was more than $1 million — the aggregate amount of the dealings is the total amount of all [page 721] dealings (revenue or capital account, including the balance of any loans or borrowings outstanding with international related parties); or the entity had marked their tax return in respect of an overseas branch, an interest in a foreign company, a foreign trust, an FIF or an FLP.

Trusts 22.32 A trustee needs to lodge an income tax return and may also need to complete the following schedules: a capital allowances schedule (see 22.17); a PSI schedule (see 22.30); Schedule 25A (see 22.31); a losses schedule; and a CGT schedule.

Trust income tax return 22.33 In their tax returns, trustees need to allocate their business income and expenses according to primary production and/or non-primary production. Assessable income (excluding foreign income)

Business income: primary production and/or non-primary production 22.34

The information required in relation to business income is: $

Gross payments where ABN not quoted

X

Gross payments subject to foreign resident withholding

X

Assessable government industry payments

X

Other business income

X

Other income Primary production income Distribution from partnerships

X

Distribution from trusts

X

Non-primary production income Distribution from partnerships less foreign income

X

Distribution from trusts less net capital gain and foreign income

X

Gross rent

X

[page 722]

Forestry managed investment scheme income

X

Gross interest

X

Dividends Unfranked amount

X

Franked amount

X

Franking credit

X

Superannuation lump sums and ETPs

X

Other Australian income Net capital gain

X

Working out what constitutes assessable income is examined in Chapters 4–9 and 14–17. Assessable income: foreign income 22.35

The information required in relation to foreign assessable income is: $

Attributed foreign income Listed country

X

Section 404 country

X

Unlisted country

X

FIF/FLP income

X

Other foreign income Other assessable foreign source income

X

Australian franking credits from a New Zealand company

X

Working out what constitutes assessable income is examined in Chapters 4–9 and 14–17. Deductions 22.36 The following information is required in relation to claimed deductions:

$ Business: primary production and/or non-primary production Foreign resident withholding expenses

X

[page 723]

Contractor, subcontractor and commission expenses

X

Cost of sales

X

Superannuation expenses

X

Bad debts

X

Lease expenses

X

Rent expenses

X

Total interest expenses

X

Total royalty expenses

X

Depreciation expenses

X

Motor vehicle expenses

X

Repairs and maintenance

X

All other expenses

X

Rent Interest deductions

X

Capital works deductions

X

Other rental deductions

X

Other deductions Deductions relating to Australian investment income

X

Forestry managed investment scheme deduction

X

Other deductions

X

Tax losses deducted

X

Working out what constitutes a deduction is examined in Chapters 4, 5 and 10–17. Credits 22.37

The following information is required for claims for credits: $

Tax withheld Credit for tax withheld — foreign resident withholding

X

Tax withheld where ABN not quoted

X

[page 724]

Share of credits from income Share of credit for tax withheld where ABN not quoted

X

Share of franking credit from franked dividends

X

Share of credit for TFN amounts withheld from interest, dividends and unit trust distributions Share of credit for tax withheld from foreign resident withholding

X X X

Share of credit for tax withheld from managed investment trust fund payments Interest and dividends TFN amounts withheld from gross interest

X

TFN amounts withheld from dividends

X

Working out what constitutes a credit is examined in Chapters 3 and 4. Tax offsets 22.38

The following information is required in relation to tax offsets: $

Foreign income tax offsets

X

Australian franking credits from a New Zealand company

X

Landcare and water facility tax offset

X

National Rental Affordability Scheme tax offset entitlement

X

Determining what constitutes a tax offset is examined in Chapters 3, 4 and 14. Key financial information 22.39

The following key financial information is required: $

All current assets

X

Total assets

X

Total current liabilities

X

Total liabilities

X

Proprietors’ funds

X

[page 725]

Opening stock

X

Purchases and other costs

X

Closing stock

X

Trade debtors

X

Trade creditors

X

Total salary and wage expenses

X

Payments to associated persons

X

Intangible depreciating assets first deducted

X

Other depreciating assets first deducted

X

Termination value of intangible depreciating assets

X

Termination value of other depreciating assets

X

Deduction for project pool

X

Section 40-880 deduction

X

Fringe benefit employee contributions

X

Interest expenses overseas

X

Royalty expenses overseas

X

Landcare operations and deduction for decline in value of water facility

X

Deduction for environmental protection expenses

X

Unpaid present entitlement to a private company

X

SBE depreciating assets

X

Medicare levy reduction or exemption 22.40 Where the Medicare levy is applied, then the Medicare levy reduction or exemption information is to be provided.

Statement of distribution 22.41 The name and TFN (or postal address) and date of birth must be provided for each beneficiary. A statement of income/loss distribution must be completed for each beneficiary, allocating their share of income/loss to primary or non-primary production. Also, credits and tax offsets must be allocated on the statement according to the following headings: [page 726]

$ Credit for tax withheld where ABN not quoted

X

Credit for tax withheld — managed investment trust fund payments

X

Credit for tax withheld — foreign resident withholding

X

Australian franking credits from a New Zealand company

X

Franking credit

X

TFN amounts withheld

X

Net capital gain

X

Attributed foreign income

X

Other assessable foreign income

X

Foreign income tax offsets

X

Share of National Rental Affordability Scheme tax offset

X

Income to which no beneficiary is presently entitled and in which no beneficiary has an indefeasible and vested interest must also be shown, as well as the trustee’s share of credit for tax deducted.

Declarations 22.42

The trustee or a public officer must sign and declare that the

information in the tax return is true and correct. If applicable, the tax agent must sign and declare that this tax return has been prepared in accordance with information supplied by the taxpayer, that the taxpayer has given them a declaration stating that the information provided is true and correct, and that the taxpayer has authorised the tax agent to lodge the tax return.

Losses schedule 22.43 A company, trust or superannuation fund must complete a losses schedule if one of a number of tests applies. For example, this happens where the tax losses or net capital losses exceed $100,000 or where certain foreign losses exist.

Capital gains tax schedule 22.44 below.

The CGT schedule consists of numerous parts. These are discussed

Capital gains from CGT assets and CGT events 22.45 Capital gains from CGT assets and CGT events must be allocated according to whether they relate to non-active assets or active assets and whether indexation, CGT discount or another capital gain is involved: [page 727]

NON-ACTIVE ASSETS

CAPITAL GAINS — INDEXATION METHOD $

CAPITAL GAINS — CGT DISCOUNT METHOD $

OTHER CAPITAL GAINS $

Shares and units (in unit trusts)

X

X

X

Real estate

X

X

X

Other CGT assets and any other CGT events

X

X

X

Collectables

X

X

X

Forestry managed investment scheme interest

X

X

X

X

X

Hedging financial arrangements Shares and units (in unit trusts)

X

X

X

Real estate

X

X

X

Other CGT assets and any other CGT events

X

X

X

Collectables

X

X

X

Forestry managed investment scheme interest

X

X

X

Total current year capital gains (CYCGs)

X

X

X

Current year capital losses from CGT assets and CGT events — other than capital losses from collectables 22.46 Part B of the schedule sets out the current year capital losses from CGT assets and CGT events, excluding capital losses from collectables in the following categories: $ Shares and units (in unit trusts)

X

Real estate

X

Other CGT assets and any other CGT events

X

Forestry managed investment scheme interest

X

Hedging financial arrangements

X

Applying capital losses against current year capital gains 22.47 Capital losses against CYCGs are allocated into the following categories:

[page 728]

CAPITAL GAINS — INDEXATION METHOD $

CAPITAL GAINS — CGT DISCOUNT METHOD $

OTHER CAPITAL GAINS $

Current year capital losses applied

X

X

X

Prior year net capital losses applied

X

X

X

Capital losses transferred in applied

X

X

X

Total capital losses applied

X

X

X

Current year capital gains after applying capital losses 22.48

CYCGs after applying capital losses are determined as follows: CAPITAL GAINS — INDEXATION METHOD $

CAPITAL GAINS — CGT DISCOUNT METHOD $

OTHER CAPITAL GAINS $

Active assets

X

X

X

Non active assets

X

X

X

Totals — CYCGs after applying capital losses

X

X

X

Applying the CGT discount on capital gains 22.49 The CGT discount on capital gains is set out for non-active and active assets. Applying the CGT concessions for small business 22.50

The CGT concessions for small business are applied as follows: CAPITAL GAINS —

CAPITAL GAINS

OTHER

INDEXATION METHOD $

— CGT DISCOUNT METHOD $

CAPITAL GAINS $

Small business active asset reduction

X

X

X

Small business retirement exemption

X

X

X

Small business rollover

X

X

X

Calculating net capital gain 22.51 The net capital gain is calculated here based on the totals in the above steps. [page 729] Other information 22.52 The schedule then requires the following information: unapplied net capital losses carried forward to later income years; exempt capital gains — small business 15-year exemption; scrip-for-scrip rollover for exchanging taxpayer; and scrip-for-scrip rollover for acquiring entity — to be completed by companies and trusts only.

Company 22.53 A company needs to lodge an income tax return and may also need to complete the following schedules: a capital allowances schedule (see 22.17); a CGT schedule (see 22.44); a PSI schedule (see 22.30);

a losses schedule (see 22.43); a consolidated subsidiary members schedule; a consolidated groups losses schedule; a dividend and interest schedule; a non-individual PAYG payment summary schedule; a research and development (R&D) tax concession schedule; and a thin capitalisation schedule.

Company income tax return Company’s net profit or loss 22.54 First, the company’s net profit or loss is allocated to various income and expense categories as follows. Income is allocated in the following way: $ Gross payments subject to foreign resident withholding

X

Gross payments where ABN not quoted

X

Other sales of goods and services

X

Gross distribution from trusts

X

Gross distribution from partnerships

X

Forestry managed investment scheme income

X

Gross interest

X

[page 730]

Gross rent

X

Dividends

X

Fringe benefit employee contributions

X

Assessable government industry payments

X

Unrealised gains on revaluation of assets to fair value

X

TOFA

X

Other gross income

X

Expenses are allocated as follows: $ Foreign resident withholding expenses

X

Cost of sales

X

Contractor, subcontractor and commission expenses

X

Superannuation expenses

X

Bad debts

X

Lease expenses within Australia

X

Lease expenses overseas

X

Rent expenses

X

Interest expenses within Australia

X

Interest expenses — overseas

X

Royalty expenses — overseas

X

Depreciation expenses

X

Motor vehicle expenses

X

Repairs and maintenance

X

Unrealised losses on revaluation of assets to fair value

X

TOFA

X

All other expenses

X

The difference between the total of income and expenses provides the

profit or loss. [page 731] Reconciliation to taxable income or loss 22.55 This total profit or loss amount is then reconciled to taxable income or loss as follows: $ Total profit or loss amount shown

X

Add: Net capital gain

X

Non-deductible exempt income expenditure

X

Franking credits

X

Australian franking credits from a New Zealand company

X

TOFA income from financial arrangements not included above

X

Other assessable income

X

Non-deductible expenses

X

Certain accounting expenditure subject to R&D tax concession

X

Less: Section 46FA deductions for low-on dividends

X

Deduction for decline in value of depreciating assets

X

Forestry managed investment scheme deduction

X

Immediate deduction for capital expenditure

X

Deduction for project pool

X

Capital works deductions

X

Section 40-880 deduction

X

R&D tax concession

X

Landcare operations and deduction for decline in value of water facility

X

Deduction for environmental protection expenses

X

Offshore banking unit adjustment

X

Exempt income

X

Other income not included in assessable income

X

[page 732]

TOFA deductions from financial arrangements not included above

X

Other deductible expenses

X

Tax losses transferred in (from or to a foreign bank branch or a permanent establishment of a foreign financial entity)

X

Tax losses deducted

X

Taxable income or loss

X

Determining what constitutes assessable income is examined in Chapters 4–9 and 14–17. Working out what constitutes a deduction is examined in Chapters 4, 5 and 10–17. Establishing what constitutes a credit or tax offset is examined in Chapters 3, 4 and 14. Financial and other information 22.56

The financial and other information required is: $

Opening stock

X

Purchases and other costs

X

Closing stock

X

Trade debtors

X

All current assets

X

Total assets

X

Trade creditors

X

All current liabilities

X

Total liabilities

X

Total debt

X

Commercial debt forgiveness

X

Shareholders’ funds

X

Franked dividends paid

X

Unfranked dividends paid

X

Franking account balance

X

Balance of conduit foreign income

X

[page 733]

Conduit foreign income distributed during income year

X

Excess franking offsets

X

Balance of unfranked non-portfolio dividend account at year end

X

Loans to shareholders and their associates

X

Intangible depreciating assets first deducted

X

Other depreciating assets first deducted

X

Termination value of intangible depreciating assets

X

Termination value of other depreciating assets

X

Total salary and wage expenses

X

Payments to associated persons

X

Gross foreign income

X

Net foreign income

X

Tax-spared foreign income tax offset

X

Attributed foreign income Listed country

X

Section 404 country

X

Unlisted country

X

Transferor trust

X

FIF income

X

Section 128F/128FA exempt interest paid

X

Interest to financial institution exempt from withholding under a double tax agreement

X

Total TOFA gains

X

Total TOFA losses

X

SBE depreciating assets Low-cost assets

X

Deduction for pool assets

X

SBE aggregated turnover

X

[page 734]

Other PSI

X

National Rental Affordability Scheme tax offset

X

Licensed clubs only — % non-member income

X

Losses information

X

Life insurance companies and friendly societies information

X

First Home Saver Account providers

X

Pooled development funds

X

Retirement savings accounts providers

X

Landcare and water facility tax offset

X

Foreign income tax offset

X

R&D tax incentive

X

Tax calculation statement 22.57

The company income calculation statement is summarised as follows: $

Taxable or net income

X

Tax

X

R&D recoupment tax

X

Less tax offsets: refundable carry-forward tax offsets; non-refundable non-carry-forward tax offsets;

X

refundable tax offsets; franking deficit tax offsets Less eligible credits

X

PAYG instalments raised

X

Tax payable/refundable

X

Declarations 22.58 The public officer must sign and declare that the information in the tax return is true and correct. If applicable, the tax agent must sign and declare that the tax return has

[page 735] been prepared in accordance with information supplied by the taxpayer, that the taxpayer has given the tax agent a declaration stating that the information provided to the tax agent is true and correct, and that the taxpayer has authorised the tax agent to lodge the tax return. Consolidated subsidiary members 22.59 If an entity is a subsidiary member of a consolidated group for the entire income year, it does not lodge an income tax return, but if it is a subsidiary member for only part of an income year, it must lodge an income tax return covering the period(s) in which it was not part of a group.

Consolidated groups losses schedule 22.60 A head company of a consolidated group or multiple entry consolidated group must complete this schedule if the total of the group’s tax losses and net capital losses carried forward is more than $100,000 or where certain other criteria are met.

Dividend and interest schedule 22.61 Companies must lodge this schedule showing the name, address, date of birth, gender, and TFN or ABN (if quoted) of all shareholders to whom dividends (or deemed dividends) have been paid during the income year. This includes the amount of dividend paid to each shareholder and any franking credits for that amount.

Non-individual PAYG payment summary schedule 22.62 Companies that have an amount withheld from payments covered by PAYG withholding must complete this schedule. A PAYG withholding applies to several withholding events, including: payments for a supply where no ABN is quoted;

payments arising from investments where no TFN or ABN is quoted; and certain payments to foreign residents have foreign resident withholding provisions.

Research and development tax concession schedule 22.63 All companies claiming a deduction or tax offset for the R&D tax concession must complete this schedule.

Thin capitalisation schedule 22.64 If the company is subject to the thin capitalisation rules, it must complete the thin capitalisation schedule. [page 736]

Self-managed superannuation funds Assessable income 22.65 SMSFs must supply the following information regarding assessable income: $ Net capital gain

X

Gross rent and other leasing and hiring income

X

Gross interest

X

Forestry managed investment scheme income

X

Net foreign income

X

Australian franking credits from a New Zealand company

X

Transfers from foreign funds

X

Gross payments where ABN not quoted

X

Gross distribution from partnerships

X

Unfranked dividend amount

X

Franked dividend amount

X

Dividend franking credit

X

Gross trust distributions

X

Assessable contributions

X

Other income

X

Assessable income due to changed tax status of fund

X

Net non-arm’s-length income

X

Exempt current pension income

X

Total assessable income

X

Deductions 22.66

The following information is required when claiming deductions: $

Interest expenses within Australia

X

Interest expenses overseas

X

[page 737]

Capital works deductions

X

Deduction for decline in value of depreciating assets

X

Death or disability premiums

X

Death benefit increase

X

Approved auditor fee

X

Investment expenses

X

Management and administration expenses

X

Forestry managed investment scheme deduction

X

Other deductions

X

Tax losses deducted

X

Total deductions

X

Income tax calculation statement 22.67 The following information is required when filling in the tax calculation statement: $ Taxable income

X

Gross tax

X

Refundable carry-forward tax offsets; non-refundable non-carry-forward tax offsets

X

Section 102AAM interest charge

X

Eligible credits

X

PAYG instalments raised

X

Supervisory levy

X

Total amount due or refundable

X

Determining what constitutes assessable income is examined in Chapters 4–9 and 14–17. Working out what constitutes a deduction is examined in Chapters 4, 5 and 10–17. Establishing what constitutes a credit or tax offset is examined in Chapters 3, 4 and 14.

Losses

22.68 Tax losses are carried forward to later income years and net capital losses are carried forward to later income years. [page 738]

Member information 22.69 data.

Details of the fund members are required, as well as the following

Assets and liabilities 22.70 This section of the return requires details of the fund’s assets and liabilities. $ Employer contributions

X

Personal contributions

X

CGT small business retirement exemption

X

CGT small business 15-year exemption amount

X

Personal injury election

X

Spouse and child contributions

X

Other third-party contributions

X

Directed termination (taxable component) payments

X

Assessable foreign superannuation fund amount

X

Non-assessable foreign superannuation fund amount

X

Transfer from reserve: assessable amount

X

Transfer from reserve: non-assessable amount

X

Any other contributions (including super co-contributions)

X

Contributions from non-complying funds

X

Total contributions

X

Allocated earnings or losses

X

Inward rollover amounts

X

Outward rollover amounts

X

Benefit payments and code

X

Closing account balance

X

[page 739]

Regulatory information 22.71 The tax returns set out questions about the operational status of the SMSF. Penalties will apply for false or misleading information.

Audit report and declarations 22.72 The auditor must provide their details and provide the date of audit completion and state whether the audit is qualified. The trustees and directors must sign that they have authorised the annual return and it is documented as such in the SMSF’s records and that they have received the audit report and are aware of any matters raised. If applicable, the tax agent must sign and declare that the tax return has been prepared in accordance with information supplied by the taxpayer, that the taxpayer has given them a declaration stating that the information provided is true and correct, and that the taxpayer has authorised the tax agent to lodge the tax return.

Fringe benefits tax returns

22.73 A taxpayer must lodge an FBT return if they have an FBT liability for the current FBT year ended 31 March.

Return calculation 22.74

The FBT return requires the following calculations:

A Type 1 aggregated amount

X

B Type 2 aggregated amount

X

C Aggregated non-exempt amount (hospitals, ambulances, public benevolent institutions, health promotion charities only)

X

Fringe benefits taxable amount (A + B) or C

X

Amount of tax payable: FBT tax rate % of above figure

X

Aggregate non-rebatable amount

X

Amount of rebate: (48% of tax payable less aggregate non-rebatable amount)

X

Subtotal

X

Less instalments on activity statements

X

Payment or credit due

X

[page 740]

Fringe benefits provided 22.75 The FBT return also requires details of fringe benefits provided as follows: TYPE OF BENEFITS PROVIDED Cars using the statutory formula

NUMBER

GROSS TAXABLE VALUE $ A

EMPLOYEE CONTRIBUTION $B

VALUE OF REDUCTIONS $C

TAXABLE VALUE OF BENEFITS $ A-B-C

X

X

X

X

X

Cars using the operating cost method

X

X

X

X

X

Loans granted

X

X

X

X

X

Debt waiver

X

X

X

X

X

Expense payments

X

X

X

X

X

Housing — units of accommodation provided

X

X

X

X

X

Employees receiving livingaway-from-home allowance (show total paid including exempt components)

X

X

X

X

X

Airline transport (airlines and travel agents only)

X

X

X

X

X

Board

X

X

X

X

X

Property

X

X

X

X

X

Income taxexempt body — entertainment

X

X

X

X

X

Other benefits (residual)

X

X

X

X

X

Car parking

X

X

X

X

X

Meal entertainment

X

X

X

X

X

The terms ‘Type 1 aggregated amount’, ‘Type 2 aggregated amount’, ‘aggregated non-exempt amount’, ‘fringe benefits taxable amount’, ‘aggregate non-rebatable amount’, ‘amount of rebate’ and ‘fringe benefit types’ are explained in Chapter 18.

[page 741]

Declarations 22.76 The employer must sign and declare that the information in the tax return is true and correct. If applicable, the tax agent must sign and declare that the tax return has been prepared in accordance with information supplied by the taxpayer, that the taxpayer has given the tax agent a declaration stating that the information provided to the tax agent is true and correct, and that the taxpayer has authorised the tax agent to lodge the tax return.

GST tax returns Introduction 22.77 Most business taxpayers need to lodge GST tax returns that require that all components of the GST equation be included (taxable supplies, input tax credits, increasing and decreasing adjustments, and credits). The reporting and payment period will be monthly, quarterly or annually. The types of GST tax returns are: BAS — quarterly and monthly; annual GST return; and annual GST report. Taxpayers whose turnover is $20 million or more must report and pay their GST monthly. This method may also be chosen irrespective of turnover. Most businesses report and pay their GST quarterly. These taxpayers need to complete a BAS. There are three options: see 22.78 below. Taxpayers that report and pay GST quarterly may choose between option 1 or 2. Under option 1, taxpayers must report and pay GST quarterly. Under option 2, taxpayers pay GST quarterly and report annually. Eligible taxpayers that elect to use option 3 pay a GST instalment quarterly and report annually. Under this option, taxpayers must pay a quarterly GST instalment amount worked

out by the ATO (or varied by the taxpayer). A twice-yearly payment can be made in special cases. Thus, taxpayers under option 2 and option 3 need to complete an annual GST return. Also, taxpayers that voluntarily register for GST report and pay GST annually and complete an annual GST return. Taxpayers paying GST monthly or quarterly are required to complete a BAS. Business activity statement 22.78 The quarterly BAS requires the following information: Option 1: Calculate GST and report quarterly — information required for supplies and acquisitions: $ Sales

X

Export sales

X

Other GST-free sales

X

[page 742]

Capital purchases

X

Non-capital purchases

X

Option 2: Calculate GST quarterly and report annually — total sales need only be reported. Option 3: Pay GST instalment amount quarterly — the quarterly GST instalment amount needs to be included here. If this is varied, the net GST for the year needs to be included along with the varied amount. PAYG tax withheld and PAYG income tax instalment 22.79 The BAS form also provides for payment of PAYG tax withheld on salaries and wages paid and for quarterly PAYG income tax instalments.

Tax payable/refundable 22.80

The tax payable or refundable is calculated as follows: $

Amounts you owe the ATO GST on sales or GST instalment

X

PAYG tax withheld

X

PAYG income tax instalment

X

Deferred company/fund instalment

X

Amounts the ATO owes you GST on purchases

X

Credit from PAYG income tax instalment variation

X

Tax payable/refundable

Working out GST on sales and GST on purchases was explained in Chapter 19. Declarations 22.81 The authorised person must sign and declare that the information in the tax return is true and correct and that the tax invoice requirements are met.

The annual GST return 22.82 For taxpayers that choose to pay GST annually or by instalments, the following information is required. Supplies and acquisitions 22.83

Information is required for supplies and acquisitions as follows:

[page 743]

$ Sales

X

Export sales

X

Other GST-free sales

X

Capital purchases

X

Non-capital purchases

X

GST payable/refundable 22.84 The GST payable or refundable (along with the wine equalisation tax and the luxury car tax) is calculated as follows: $ Amounts you owe the ATO GST on sales

X

Wine equalisation tax

X

Luxury car tax

X

Amounts the ATO owes you GST on purchases

X

Wine equalisation tax refundable

X

Luxury car tax refundable

X

GST instalments

X

GST payable/refundable

X

Declarations 22.85

The authorised person must sign and declare that the information in

the tax return is true and correct and that the tax invoice requirements are met.

Annual GST report 22.86 Taxpayers that choose option 2: to calculate GST quarterly and report annually in at least one quarter during the year must supply the following information for supplies and acquisitions: [page 744]

$ Export sales

X

Other GST-free sales

X

Capital purchases

X

Non-capital purchases

X

Summary 22.87 The process of completing income tax, GST and FBT returns is principally a process of allocating dollar amounts to the respective labels in these tax returns. The previous chapters in this book have provided a legal analysis for the meaning of many of these labels. TaxPack and guides to the above tax returns and schedules, available at , provide further and the most up-to-date detail on this allocation process. The most critical thing for an income tax taxpayer is to include all of their assessable income, deductions, tax offsets and credits in their income tax returns and schedules. This is why understanding what constitutes assessable income, deductions, tax offsets and credits is so important. For an FBT taxpayer, the important requirement is to include all fringe

benefits provided, rebates and FBT instalments on activity statements. For a GST payer, the vital object is to include all taxable supplies, input tax credits and GST instalments on the activity statements and allow for increasing and decreasing adjustments. This is why understanding what constitutes taxable supplies, input tax credits, GST instalments, and increasing and decreasing adjustments is so important.

Further problems 1 2 3 4 5 6 7 8

1. 2.

What income tax returns need to be completed by an individual? What income tax returns need to be completed by a partnership? What income tax returns need to be completed by a trust? What income tax returns need to be completed by a company? What income tax returns need to be completed by an SMSF? Provide details of the GST returns required by a small business. Provide details of the GST returns required by a very large business. What FBT returns are required to be completed by employers?

For a detailed explanation of these income tax return labels, refer to the Australian Taxation Office (ATO) website: . Some changes will apply in the current tax year, but this information is not available at the time of this publication.

[page 745]

23 Solving complexity Learning Objectives After you have studied this chapter, you should be able to: apply the income and deductions methods, as well as the techniques of legal reasoning, in solving tax problems; recognise a routine tax issue; apply legislation and case law to simple situations; recognise a complex issue; recognise tunnel vision in your problem-solving processes; apply the step-by-step process in answering a complex issue; identify questions at issue and the relevant taxpayer; apply legislation, case law and the Australian Taxation Office (ATO) view to complex situations; use the taxation methodology; research the detailed commentary services; research the ATO view; be able to use the ATO legal database; identify and use reputable tax websites; use the statutory interpretation rules;

use correct legal footnoting; and be able to make a well-reasoned, researched and explained decision.

[page 746]

ROUTINE TRANSACTIONS

COMPLEX TRANSACTIONS

Step 1: Identify the question(s) at issue and the relevant taxpayer

Step 1: Identify the question(s) at issue and the relevant taxpayer

Step 2: Use the taxation methodologies and the legal reasoning model to identify and cite the most relevant piece(s) of legislation and cases and provide brief reasons

Step 2: Use the taxation methodologies and the legal reasoning model to identify and cite the most relevant piece(s) of legislation and cases and provide brief reasons Step 3: Research the detailed commentary/analysis and case law Step 4: Research the ATO’s database Step 5: Research the Explanatory Memorandum (EM) accompanying the relevant Act (if needed for very complex issues) Step 6: Research refereed taxation and legal journals and books on taxation law (if needed for very complex issues) Step 7: Use the taxation internet sites Step 8: Use the Australian Guide to Legal Citation

Chapter overview

23.1 Having worked your way through the numerous taxation Acts, cases, examples, problems and additional questions in respect of income tax, goods and services tax (GST), superannuation and fringe benefits tax (FBT), it is time to test your knowledge in solving comprehensive ‘real world’-style tax problems and to engage in tax research. Please understand that the largely singular focus of Chapters 1–21 means that it is usual for you to suffer from tax ‘tunnel vision’. However, such tunnel vision is not restricted to first-time tax students; it is an occupational hazard for people who work in the taxation field and it stems from the complexity of the many steps in the methodology for GST, income tax, superannuation and FBT and their complex inter-relationships. You only have to look at the many correcting technical amendments that are made to the tax laws to see how things can get missed! Warning: Certain problems in this chapter are very difficult and full of twists and turns, so proceed with the utmost caution. In the real world, when a tax professional incorrectly advises someone about the taxation consequences of a transaction (ie, over- or under-states the tax payable), the consequences can be severe for both the tax professional and the taxpayer! [page 747] Thus, this chapter reinforces the methodologies used in previous chapters and the legal reasoning model. It classifies transactions into routine and complex categories to guide your research effort. For complex issues, you need to do the research. Read the legislation, the cases and the taxation commentaries and ascertain the ATO view. To broaden your tax vision, first revisit the income tax methodology for assessable income and deductions: INCOME METHOD Chapter 4

Do international tax issues apply to the receipt?

Chapter 5

What tax accounting rules apply?

Chapter 6

Is the receipt ordinary income?

Chapter 7

Is the receipt statutory income (excluding capital gains tax (CGT))?

Chapter 8

Is the receipt non-assessable income?

Chapter 9

Do the CGT provisions apply?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the receipt is assessable income DEDUCTIONS METHOD Chapter 5

What tax accounting rules apply?

Chapter 10

Is the outgoing a general deduction?

Chapter 11

Is the outgoing a specific deduction (excluding capital allowances)?

Chapter 12

Do any of the deduction limitations apply?

Chapter 13

Is the outgoing a capital allowance?

Chapters 14 and 15

Do the entity rules apply?

Chapter 16

Do the special taxpayer rules apply?

Chapter 17

Do the anti-avoidance provisions apply?

Determine whether the expense is deductible

Now you have to apply this methodology to comprehensive business problems. As in the real world, the difficulty in working out the tax consequences of various transactions varies greatly. Therefore, you need to ascertain whether the transaction is a routine, straightforward matter or whether it is complex.

Routine transactions 23.2 In working out the tax consequences for routine transactions, you need to work through a number of steps.

1. 2.

Identify the question(s) at issue and the relevant taxpayer. Use the taxation methodology and legal reasoning model to identify and cite the most [page 748] relevant piece(s) of legislation and cases and provide brief reasons, using this textbook and the Concise Tax Legislation texts as your guide, and form a view. What are the GST and income tax consequences of sales of raw meat for human consumption of $500,000 received by a butcher during the income tax year? Answer: 1. You are given the question(s) at issue and the relevant taxpayer is the butcher. 2. GST: GST does not apply to sales of raw meat, as it is exempt under GST Act 1999 s 38-2; exclusions in s 383 do not apply. 3. Income tax: The sales of raw meat constitute ordinary income under ITAA 1997 s 6-5 and Californian Copper Syndicate Ltd v Harris (1904) 5 TC 159, being receipts received in the ordinary course of the butcher’s business. What are the GST and income tax consequences for the butcher’s depreciating assets during the income tax year? Answer: 1. You are given the question(s) at issue and the relevant taxpayer is the butcher. 2. The butcher can claim input credits on new acquisitions of depreciating assets to the extent of business use — see Chapter 19.

Complete the depreciation schedule for the depreciating assets (excluding GST) and identify and cite the relevant legislation and the case (if applicable) and provide brief reasons, as set out in Chapter 13. What are the GST and income tax consequences for the butcher’s CGT events during the income tax year? Answer: 1. You are given the question(s) at issue and the relevant taxpayer is the butcher. 2. Complete the seven CGT steps for the CGT events and identify and cite the relevant legislation and the case (if applicable) and provide brief reasons, as set out in Chapter 9.

Complex transactions 23.3 In working out the tax consequences for complex transactions, you also need to use the taxation methodologies and the legal reasoning model. Given the research required for this task, this involves the following eight steps.

Step 1 23.4

Identify the question(s) at issue and the relevant taxpayer. [page 749]

Step 2 23.5

Use the taxation methodology to identify and cite the relevant

legislation and cases and provide brief reasons, using this textbook and the Concise Tax Legislation texts as your guide, and form an initial view. Beware of tunnel vision in this step. There are two sides to every complex transaction. In dealing with the uncertainty, you should arm yourself with alternative strategies. For example: What are the alternative views? What alternative provisions can I apply to the facts? The classic tricky situation in tax law is the revenue–capital dichotomy in ordinary income: ITAA 1997 s 6-5. Consider both sides of the argument under s 6-5 and then reach a conclusion. If you are arguing that a receipt is not ordinary income because it is a capital amount, you must also consider whether CGT and other statutory income provisions apply. Also, do the international tax, entity, special taxpayer or anti-avoidance rules apply? Alternatively, if you are arguing that a receipt is ordinary income, you must also consider whether CGT and other statutory income provisions apply. If these provisions apply, this will give you a better argument for the inclusion of the receipt as assessable income. The other classic area of uncertainty in tax law is the revenue–capital dichotomy in general deductions: s 8-1. Consider both sides of the argument under s 8-1 and then reach a conclusion. If you are arguing that an expense is not deductible because it is a capital amount, you must also consider whether other specific deductions or Div 40 (depreciation) and Div 43 (capital works) apply. In particular, s 40-880 provides a deduction for many blackhole expenses of business. Does the expense fall into a CGT cost base? Also, do the international tax, entity, special taxpayer or anti-avoidance rules apply? Alternatively, if you are arguing that an expense is deductible under s 8-1 because it is not a capital amount, you should consider whether other specific deductions or Divs 40 and 43 apply as a fallback position. In particular, s 40880 provides a deduction for many blackhole expenses of business. Does the expense fall into a CGT cost base? Also, do the international tax, entity, special taxpayer or anti-avoidance rules apply?

Step 3 23.6

Research the detailed commentary/analysis and case law by searching

or browsing the detailed online taxation commentaries provided by Thomson Reuters and CCH. These should be available in your university library either in a series of looseleaf ring binders or via the internet home page of Thomson Reuters or CCH (depending on the sites that your university subscribes to). Cite any relevant views of these commentaries in your argument to substantiate your view. Read the relevant cases, as these are very important to your argument. Cite the relevant case law in your argument to substantiate your view. Hint: It is often easier to browse through the commentary on tax legislation than use the search engine. The commentary is arranged according to Divisions of the legislation. For example, for ordinary income ITAA 1997 matters, browse down to ITAA 1997 Div 6 and then down to s 6-5, ‘Income according to ordinary concepts (ordinary income)’, and you will find detailed commentary for various types of receipts. For example, for general deduction ITAA 1997 matters, browse down to Div 8 and then down to s 8-1, ‘General deductions’, and you will find detailed commentary for various types of expenses. [page 750]

Step 4 23.7 Research the ATO’s database of taxation rulings as well as case law by searching or browsing the ATO website at and clicking on Legal Database. The ATO view is generally provided by its taxation rulings (TR series), taxation determinations (TD) and class rulings (CR series). The ATO also publishes ATO Interpretative Decisions (ATOIDs) that show its interpretation of grey area issues. Edited versions of its private rulings (known as Case Decision Summaries) can also be found here. Cite any relevant ATO views in your argument to substantiate your opinion. The ATO also publishes numerous fact sheets and explanatory guides, such as the income tax return TaxPack and employee expense deduction guides. The ATO legal database includes: legislation and supporting material;

public rulings, determinations and bulletins; legislative determinations; ATO interpretative decisions; case decision summaries; practice statements; taxpayer alerts; tax-related case law; ATO policy papers; ATO superannuation circulars; a freedom of information index; and a schedule of sources of precedential ATO view.

Step 5 23.8 To aid your understanding of how the legislation applies to the question at issue, go through the statutory interpretation steps (see Chapter 1) to research the EM accompanying the relevant Act. The EM is available on the ATO website at ; click on Legal Database, then click on Legislation and supporting material and, finally, click on Go to Extrinsic Material. If you do not know what Act introduced the particular provision that you are dealing with, you will need to use the search function in the ATO Legal Database to obtain this. Then go to Extrinsic Material and click on the relevant Act to download the EM.

How do I locate the EM for the recent CGT cost base changes in s 110-25(5)? Answer: Use the search function in the ATO Legal Database. Select Legislation and then search for Section 110-25(5). This brings up all of the Acts dealing with s 110-25(5). The most recent changes to s 110-25(5) were introduced in the Tax

Laws Amendment (2006 Measures No 1) Act 2006 (32 of 2006). Then go to Extrinsic Material and click on this to download the EM.

[page 751]

Step 6 23.9 For more detailed commentary/analysis and case law, there are numerous refereed taxation and legal journals and books on taxation law. So have a look in your university’s library and scan these to find further views to support your argument.

Step 7 23.10

Use the following taxation internet sites to help your research:

Australian Taxation Office

Taxation Institute of Australia

LexisNexis Butterworths

Chris Wallis’s TaxMatrix

Step 8 23.11 For a popular legal footnoting guide, follow the Australian Guide to Legal Citation, 3rd ed, at . Talk to your lecturer to clarify the applicable guide. The following practice problem provides both routine and complex questions for you to solve.

Practice Problem 1 Miss Duck Hollow is not an SBE and operated a business solely involved in winemaking in the Hunter Valley. She commenced this business on 11 November 1984. She held a 40-year contract (known as the ‘wine contract’) with a UK company, Zed Co, to supply it with 400,000 bottles of wine per annum at $10 per bottle, indexed with inflation. The wine contract commenced on 11 November 1984. On 1 July of the current income tax year, she transferred her rights under the wine contract to Pyramid Pty Ltd for a quarterly cash payment. The quarterly cash payment was based on 10 per cent of the sales value of the wine supplied to Zed Co by Pyramid Pty Ltd under the wine contract. During the current tax year, she received four payments totalling $500,000 (excluding GST) from Pyramid Pty Ltd under this arrangement. On 31 December of the current income tax year, she sold her business goodwill to Acme Pty Ltd for $5,000,000 (excluding GST). On 31 December, she also sold her trading stock to Acme Pty Ltd for $600,000 (excluding GST). Other wine sales to 31 December (when she ceased business) were $1,600,000 (excluding GST). During the current income tax year ended 30 June, she paid out the following gross expenses:

[page 752]

Legal costs of $50 on a loan taken out on 1 July for working capital. The loan has a 6-year term

$50

Interest expenses of $800 were paid on this loan

$800

Raw materials, chemicals, petrol, wages, electricity and gas (wages comprise $20,000 of this amount) Water

$55,000 $280,000

Legal costs to sell her business (Acme Pty Ltd reimbursed her for $5000 of these legal fees)

$23,000

Tax agent’s costs for tax advice

$10,000

Gifted cash to the Australiana Fund

$200

After she sold the business, she incurred legal expenses of $35,000 to defend damages sought from a former customer who slipped on some grapes and fell into the dam

$35,000

Leasing costs of vine equipment, business vehicles

$45,785

Repairs and maintenance of winemaking machinery and equipment, including $10,000 to replace a winemaking machine engine on 1 August

$21,771

Her depreciation schedule for the current year ended 30 June is set out below. All assets have 100 per cent business use and were acquired after 1 January 2000 and before 10 May 2006. She uses the diminishing value method. DEPRECIATING ASSET

OPENING ADJUST VAL $

Air bag press

211,478

Computer

1890

Desks

1125

DEP’N RATE %

ADDITIONS $

TERMINATION VALUE $

DEDUCTION $

CLOSING ADJUST VAL $

Total

On 31 December of the current income tax year, she sold all of the winemaking machinery to Acme Pty Ltd for $200,000 (excluding GST). Also on 31 December,

she kept the desks for private use (market value of these items was $500). On the same date, she scrapped her computer. use the Commissioner’s effective life. Provide the following: 1. a statement of assessable income and deductions to calculate Miss Duck Hollow’s taxable income for the income tax year ended 30 June; 2. a depreciation schedule for the income tax year ended 30 June; 3. reasons for the amounts included/excluded from assessable income in your assessable income and deductions statement — provide full details of Sections, cases, commentaries and ATO rulings where applicable (Note: Provide headings for each item); 4. reasons for the amounts included/excluded from deductions in your

[page 753]

5.

assessable income and deductions statement — provide full details of Sections, cases, commentaries and four ATO rulings where applicable (Note: Provide headings for each item); and reasons for the amounts included/excluded from the depreciation schedule — provide full details of Sections, cases, commentaries and ATO rulings where applicable. (Note: Provide headings for each item.)

CGT transactions 1. On 1 July of the current tax year, Miss Duck

Hollow gifted a piece of artwork worth $10,000 to her best friend. The painting cost $9000 and was acquired on 29 September 1985. 2. She acquired a rental house in Henley Beach for $100,000 and the purchase contract was dated 30 June 1990. Other costs on acquisition were stamp duty of $3000 and legal costs to purchase of $300. Her costs of running the house included interest of $30,000 and repairs of $3000. On 24 June 2000, she spent $10,000 building an extension on to the back of the house. On 31 December of the current tax year, she sold the house for a contract price of $305,000. This sum included $5000 for dresses that she also supplied to the purchaser as part of the deal. Her advertising costs on sale were $2000 and the sales commission was $6000. 3. She sold shares for $10,000 on 30 June of the current tax year. The shares cost $20,000 on 23 July 1988. She had a carried-forward capital loss of $50,000 from the previous income year ended 30 June. Calculate the capital gain or loss for each of the three above CGT events for the income year ended 30 June. Then calculate the net capital gain or loss for the income year ended 30 June for the above CGT events.

Summary 23.12 Beware of tax tunnel vision. Follow the income tax (income, deductions), GST and FBT methodologies.

Use the legal reasoning model. Identify routine transactions. Then identify the question(s) at issue and the relevant taxpayer. Use the taxation methodology and legal reasoning model to identify and cite the most relevant piece(s) of legislation and cases; provide brief reasons. Identify complex transactions. Then identify the question(s) at issue and the relevant taxpayer. Use the taxation methodology and legal reasoning model to identify and cite the most relevant piece(s) of legislation and cases. Research the detailed commentary/analysis. Research the ATO’s database. Research relevant EMs. Research taxation/legal journals and books. [page 754] Use taxation internet sites. Follow an appropriate guide to legal citation. The author hopes you have enjoyed the experience of working with this textbook and that you now feel more confident in dealing with Australia’s taxation laws. The author would greatly appreciate your feedback on this book and, in particular, would welcome your ideas for complex tax problems that are suitable for this chapter.1 Good luck to you all.2

Further problems Remember to apply the legal reasoning model (as discussed in Chapter 3):

identify the question at issue; research and make a decision; explain well; and use clear language.

Part 1 1

2

During the current income tax year ended 30 June, Tom, who is an Australian resident, operated a horse property in Victoria. The following occurred during the current tax year. a He operated the farm for many years. Due to the discovery of copper, he entered into a 10-year agreement with Red Mines. Under the terms of the agreement, Tom received 10 per cent of the value of copper mined. This amounted to $1,000,000 in the income tax year ended 30 June. b Red Mines also paid him a lump sum payment of $100,000 to compensate him for permanent damage to his farm as a result of the mine operation. c Additionally, Tom started exploring the Coral Sea for shipwrecks and found a wreck. The wreck contained valuable gold coins, and the proceeds from the sale to an English company amounted to $2,000,000 in the income tax year ended 30 June. d Sales of horses and crops amounted to $20,156,000. Provide reasons for the amounts included/excluded from assessable income in Tom’s business. Provide full details of Sections, cases, commentaries and ATO rulings where applicable. (Note: Provide headings for each item.) During the income tax year ended 30 June, Tom pays out the following gross expenses: a b c

interest expenses paid on a loan for the gold coins hunt feed for horses wages, farm and ship’s crew

$23,675 $115,000 $999,765

d

11-metre shipping boat to explore for gold acquired on 1 July of the current tax year

$213,000

[page 755] e

closing stock of animals at cost value (Note: The opening stock value was $26,000) f incurred legal expenses of $10,000 to negotiate compensation for damage to his land g monthly leasing costs of farm trucks and motor vehicles totalled h repairs and maintenance of vehicles, plant and equipment

$29,000 $10,000 $29,085 $312,781

Provide reasons for the amounts included/excluded from deductions in his business. Provide full details of Sections, cases, commentaries and ATO rulings where applicable. (Note: Provide headings for each item.) 3 Tom’s depreciation schedule for the year ended 30 June is set out below. All assets have a 100 per cent business use and he uses the diminishing value method. All values exclude GST. All depreciating assets were acquired after 10 May 2006. DEPRECIATING ASSET

OPENING ADJUSTABLE VALUE 1 JULY $

Fences

12,608

Cattle yard (permanent)

23,890

Total

DEP’N RATE %

ADDITIONS $

TERMINATION VALUE $

DEDUCTION $

C ADJUSTABLE VALUE

4

Additionally, on 1 July of the current tax year, he purchased a new barbed wire fence for $55,000, as the old barbed wire fence was in need of fixing up. He scrapped the old fence on 1 August when the new fence was installed. All values exclude GST. Provide a depreciation schedule for the income tax year ended 30 June for all depreciating assets in this part. Include reasons for the amounts included/excluded from the depreciation schedule. Provide full details of Sections, cases, commentaries and ATO rulings where applicable. (Note: Provide headings for each item.) Tom’s CGT transactions were as follows. a He sold shares for $100,000 on 30 June of the current tax year. The shares cost $50,000 on 23 July 1989. b On 1 July, a piece of artwork worth $10,000 was stolen from his house. The painting was a gift from a friend and it was worth $7000 when it was gifted on 1 September 1998. It was not insured. c He acquired a house for $400,000 for rental. Other costs were stamp duty of $23,000 and the legal costs to purchase of $2000. The contract was dated 1 March 1992 and all costs were paid on 31 March 1992. His costs of holding the house included interest of $70,000 and repairs of $63,000. The house was not eligible for capital allowance deductions. [page 756] An $11,000 cost of a new shed was incurred on 2 May 1998. There were $1000 of capital allowance deductions for the shed. On 31 December, he sold the house for a contract price of $800,000. His advertising costs on sale were $3000 and the sales commission was $29,000. Calculate the capital gain or loss (if applicable) under the ITAA 1997 for the above CGT transactions. (Hint: Set out your answer by following the

5

first six steps of CGT as per Chapter 9.) Provide a legal analysis for each step for each event. Then calculate the net capital gain or loss (step 7 of CGT). Prepare a statement of assessable income and deductions to calculate Tom’s taxable income for the income tax year ended 30 June.

Part 2 6

Kate was born in Adelaide and lives in Australia, so she is an Australian resident. During the current income tax year ended 30 June, she ran a Sydney office construction business. During the year, she received the following deposits into her bank account and had the following transactions: a

b

c

d

7

Sales of $23,808,000 This does not include $307,900 of advance payments from customers. This is treated as a liability in the books, and refunds are never provided. Closing stock as at 30 June of the previous tax year is $1,150,000 and the closing stock as at 30 June of the current tax year is $1,350,000 (cost) or $1,850,000 market value). (These amounts exclude GST.) She successfully sued a rival builder for illegally $30,000 using a copy of one of her designs and received $30,000 compensation. Lottery winnings $23,000

Provide reasons for the amounts included/excluded from assessable income in her business. Provide full details of Sections, cases, commentaries and ATO rulings where applicable. (Note: Provide headings for each item.) During the income tax year ended 30 June, Kate pays out the following gross expenses: a

Stamp duty on a loan taken out on 1 July of the

$12,000

b c d e f g

current tax year to increase working capital. The loan has a 4-year term. Interest expenses of $71,000 were paid on this loan Building materials, petrol, electricity and gas (all subject to GST) Wages Legal costs to sue the rival builder (see 6c above) Gifted to the Australian Liberal Party She attempted to buy a business to expand operations interstate. She made an offer for a business and paid a deposit but withdrew the offer when she found out about certain dubious dealings regarding that business.

$71,000 $915,000 $299,765 $13,000 $100

[page 757] She incurred legal expenses of $15,000 to defend $15,000 damages sought from the prospective seller for breach of contract. h Leasing costs of business trucks and motor vehicles $24,785 i Repairs and maintenance of vehicles, plant and $31,701 equipment

8

Provide reasons for the amounts included/excluded from deductions in her business. Provide full details of Sections, cases, commentaries and ATO rulings where applicable. (Note: Provide headings for each item.) Kate’s depreciation schedule for the year ended 30 June is set out below. All assets have a 100 per cent business use and she uses the diminishing value method. All values exclude GST. (Note: All assets listed were acquired after 10 May 2006.)

DEPRECIATING ASSET

OPENING ADJUSTABLE VALUE 1 JULY

DEP’N RATE

%

ADDITIONS $

TERMINATION VALUE $

DEDUCTION $

CLOSING ADJUSTABLE VALUE 30

$ Light crane Pump

JUNE $

10,125 5642

Total

9

Additionally, the following happened during the current tax year. On 1 July of the current tax year, she purchased a winch for $10,000 in need of fixing up. She replaced the worn-out parts at a cost of $1000 in July. Following the repairs, she then started using the winch on building sites on 1 August. All values exclude GST. Also, she purchased a brick elevator on 1 August for $50,000. On 1 December, she acquired vacant land for $200,000. The land was used as a car park for her leased vehicles. All values exclude GST. She sold the light crane on 30 October for $12,000. The light crane cost $25,000. All values exclude GST. Provide a depreciation schedule for the income tax year ended 30 June for all depreciating assets in this part. Include reasons for the amounts included/excluded from the depreciation schedule. Provide full details of Sections, cases, commentaries and ATO rulings where applicable. (Note: Provide headings for each item.) Kate’s CGT transactions were as follows. a On 1 July 1991, she signed a contract to buy a rental property at a contract price of $500,000. The stamp duty was $20,000 and the legal costs to purchase were $1000. Settlement and the payment for these costs were incurred on 1 August 1991. From 1 July 1991 to 31 December 2004, she incurred the following costs in keeping the house: interest of $50,000 and repairs of $100,000. The house was not eligible for capital allowance deductions.

She paid $44,000 for a new brick shed on 23 May 1999. The shed was acquired for the purpose of increasing the selling price of the property. She claimed $4000 of capital allowance deductions for the shed. The $21,000 cost of a new swimming pool was incurred on 2 May 2000. She initially acquired the pool with the purpose of increasing the selling price of [page 758]

10

the property. In January 2003, at the request of the tenants, she filled in the pool with dirt and planted grass over the pool. She claimed $1000 of capital allowance deductions for the pool. At the time of sale, 31 December of the current tax year, she incurred advertising costs of $2000 and sales commission of $7000 and she sold the house for $900,000. b On 20 August 1997, she acquired shares in a high tech company, IAS, for $300,000. On 1 July of the current tax year, she sold the shares for $120,000 cash, plus the purchaser assumed her liability of $20,000 owing on the shares. c Also, she sold a valuable stamp. She received $50,000 in cash as well as a car worth $10,000 on 30 June of the current tax year. She was given the stamp as a gift by her grandmother in June 1988. At the time of gifting, it had a market value of $30,000. Calculate the capital gain or loss (if applicable) under the ITAA 1997 for the above CGT transactions. (Hint: Set out your answer by following the first six steps of CGT as per Chapter 9.) Provide a legal analysis for each step for each event. Calculate the net capital gain or loss (step 7 of CGT). (Note: She had carry-forward capital losses of $20,000 from the previous tax year.) Prepare a statement of assessable income and deductions to calculate

Kate’s taxable income for the income tax year ended 30 June.

Part 3 11

Trudy immigrated to Australia from Germany 3 years ago. Subsequently, she ran cattle on a farm she acquired in the Adelaide Hills. She made a $25,000 farm loss in the previous tax year. The farm had a market value of $400,000 and depreciable assets of $20,000. Her farm assessable income in the previous year was $15,000. The farm was operated as a genuine business operation. She sold her farm on 30 June of the previous tax year for a loss. She applied the sales proceeds against her farm business loan, but $50,000 was still outstanding as at 1 July of the current tax year. In the current income tax year, she paid $5000 of interest expenses associated with the loan on the failed farm business. Trudy was employed at Adelaide Airport as a finance manager earning $100,000 per annum. Can Trudy claim the farm losses in the previous or the current income tax year?

1.

Email: [email protected].

2.

All references in this chapter refer to the current income tax year ended 30 June 2018.

[page 759]

Appendix 1 Depreciation rates Conversion of Effective Life to Prime Cost and Diminishing Value % DV PRE 10 MAY 2006 DEPRECIATING ASSETSA %

DV POST 9 MAYB 2006 DEPRECIATING ASSETS %

PRIME COST %

0.5

100.00

100.00

100.00

1

100.00

100.00

100.00

1.5

100.00

100.00

66.67

2

75.00

100.00

50.00

3

50.00

66.67

33.33

3.333

45.00

60.01

30.00

4

37.50

50.00

25.00

4.5

33.33

44.44

22.22

5

30.00

40.00

20.00

6.666

22.50

30.00

15.00

7

21.43

28.57

14.29

8

18.75

25.00

12.50

8.333

18.00

24.00

12.00

10

15.00

20.00

10.00

12

12.50

16.67

8.33

13

11.54

15.38

7.69

EFFECTIVE LIFE

13.333

11.25

15.00

7.50

15

10.00

13.33

6.67

16.666

9.00

12.00

6.00

20

7.50

10.00

5.00

25

6.00

8.00

4.00

33.333

4.50

6.00

3.00

[page 760]

40

3.75

5.00

2.50

50

3.00

4.00

2.00

66.666

2.25

3.00

1.50

100

1.50

2.00

1.00

A. 150% ÷ Effective Life B. 200% ÷ Effective Life

Note: Depreciation is limited to 100% of cost under the diminishing value method.

[page 761]

Appendix 2 TR 2017/2 Income tax depreciation effective life This taxation ruling sets out the effective lives of selected types of assets that are listed in two tables (A and B). Table A sets out effective lives by industry category, and Table B sets out effective lives by asset category. In using these tables, go to Table A first to identify whether there is an industry effective life. If there is none, then go to Table B to find the general effective life. Given the large size of this taxation ruling,1 the following extracts are provided: Table A:

Effective lives (years) by industry category

AGRICULTURE, FORESTRY AND FISHING Fence: electric

20

Bores

30

Dams (including earth or rock fill and turkey nests)

40

Harvester/sweeper

6 2/3

Grapevines, wine

20

Shearing machines

30

MINING Pumps: generally

20

Off-highway trucks (articulated, rigid dump, service, fuel and water trucks)

10

Underground mobile mining machines: compressors

10

Workshop plant

20

Oil and gas extraction LNG train assets

30

Wellhead and Christmas tree

30

Iron ore mining Materials handling assets — feeders: vibrating

10

[page 762]

MANUFACTURING Bakery product manufacturing Rack ovens

8

Flour silos

25

Beer manufacturing (except non-alcoholic beer) Bottle filling machines

20

Pipes

25

Wine Oak barrels

4

Air bag press

15

ELECTRICITY, GAS, WATER AND WASTE SERVICES Underground cables

50

Wind turbine

20

Generators — gas turbine

30

Hydro turbines and generators

40

Power transformers

40

Solar panels

20

Irrigation water providers Dams and weirs

100

CONSTRUCTION Block and brick elevators (portable)

10

Chain blocks, rod shears, jacks, etc

13 1/3

Cranes (mobile): light and medium

15

Pumps

10

Winches

13 1/3

RETAIL TRADE Carpet

8

Shelving

10

[page 763]

ACCOMMODATION AND FOOD SERVICES Carpets

7

Furniture, freestanding: generally (including guestrooms)

7

Window blinds and curtains

6

Hot water systems (excluding commercial boilers and piping)

10

Cafés, restaurants, takeaway food services, pubs, taverns, bars and clubs Carpet

5

Cooking appliances, large commercial type

10

Glassware

1

Poker/gaming machines

7

TRANSPORT AND STORAGE

Taxis

4

Locomotives: generally (including diesel-electric and electric)

25

Water transport and support services Fishing vessels: longer than 10 metres

20

Ski boats

10

Airport operations and other air transport support services Aerobridges

20

INFORMATION MEDIA AND TELECOMMUNICATIONS International telecommunications submarine cable

15

Motion picture and sound recording activities Digital cameras

5

Grips’ assets: camera cranes

10

Studio lights — fixed

15

Motion picture film projectors

10

Speakers

7

Motion picture exhibition Carpets

5

[page 764]

Cinema seating (includes frame, seat body and cover)

7

Curtains, wall and acoustic treatments

7

Lighting (includes dimmers, aisle and seat)

10

Loud speakers and sound reproduction equipment

10

Television broadcasting Audio boards, consoles and mixers

12

Studio cameras

10

Residential property operators Carpet

10

Furniture, freestanding

13

Hot water systems — gas

12

Window blinds, internal

10

Ovens

12

PROFESSIONAL, SCIENTIFIC AND TECHNICAL SERVICES Veterinarians’ assets: anaesthesia machines

10

ADMINISTRATIVE AND SUPPORT SERVICES Building cleaning, pest control and other support services Lawnmowers: ride-on

5

HEALTH CARE AND SOCIAL ASSISTANCE Hospital Endoscopic ultrasound systems

5

Haemodialysis machines

7

Operating tables and attachments: electronic

10

Surgical instruments: hand-held manually operated instruments

8

Wheelchairs

10

Dental services Dental chairs

10

Hand-held manually operated instruments

3

[page 765]

Radiology and diagnostic imaging services

X-ray assets — fixed systems

15

Sport, gambling and recreation services Pinball machines

3 1/2

Pool/billiard tables

10

Racehorses

10

Swinging rides (including pirate ship, spaceloop and rainbow)

15

Water rides

20

Bowling alleys

13 1/3

Bowling balls

5

Table B:

Effective lives (years) by asset category TYPE OF DEPRECIATING ASSET

EFFECTIVE LIFE

Advertising signs: billboards (hoarding)

20

Aeroplane: general use

20

Air conditioning — packaged units

15

Alternator (motor generators)

20

Bending machines (bar, angle and rod)

10

Blinds — venetian

20

Buildings: to the extent that they form an integral part of plant and machinery: brick, stone or concrete structures

100

Camera — overhead bare

50

Camera — used for street photography

4

Carpets: in commercial office buildings

8

Carpets: tenpin bowling

4

Cinema — seating

7

Cinema — lighting

10

Cinema — loudspeakers

10

[page 766]

Cinema — motion picture projector

10

Coal mining continuous mining machine

8

Computers: generally

4

Computers: laptops

2

Dentist — electric motor

20

Engines

20

Fences: electric

20

Fences: wire mesh

20

Floor coverings (linoleum and vinyl)

10

Forklifts

11

Furniture — chairs

10

Furniture — desks

20

Furniture play equipment — kindergarten

5

Generator (motor)

20

Heater electric

10

Jet ski

4

Judges’ robes: court dress for ceremonial occasions

15

Judges’ working robes

10

Library (professional)

10

Lighting plant (electric)

20

Livestock (working beasts, beasts of burden in business other than primary production and camels)

10

Log trailer

10

Merry-go-round

20

Motorcycle

3

Motor vehicles designed to carry a load of less than one tonne and fewer than nine passengers: generally

8

Motor vehicles — taxis

4

Motor vehicles — light commercial

12

Plumbing — employee amenities

20

[page 767]

Power station plant

20

Power —management unit

15

Refrigeration assets

10

Tobacco kiln

20

Shop fittings

20

Transformer boxes

50

Trucks with a gross vehicle mass greater than 3.5 tonnes (excluding offhighway trucks used in mining operations)

15

Musical instruments etc: associated portable equipment (including amplifiers, microphones, speakers, mixers and music stands)

6 2/3

Office machines and equipment: calculators

10

Photocopying machines

5

Point of sale assets: cash registers, standalone type

10

Power transformers

45

Projectors

10

Pumps

20

Refrigerator

10

Stove

20

Suitcase

10

Synthetic lawn surface

10

Tarpaulin

5

Telephone cable — overhead bare

50

Tractor

12

Telephone: cellular mobile

3

Television receivers: generally

10

Vending machine

5

Water assets: bores

30

Water assets: dams

40

Water supply — water mains

50

Wheelbarrows

10

1.

Go to for the full income tax ruling.

Index References are to paragraph numbers 183-DAY rule residence …. 4.23–4.26

A ABN (see Australian business number) Accounting anti-avoidance …. 17.22 Australian government taxes …. 1.6 Goods and Services Tax (GST) …. 19.89 income tax business income …. 5.12; 5.13 consolidated groups …. 5.68 financial arrangements …. 5.17 interest …. 5.7 no payment made during income year …. 5.21–5.28 overview …. 5.1; 5.69 payment made during income year …. 5.20 prepaid income …. 5.15 rent …. 5.8 salary and wages …. 5.6 Simplified Tax System (STS) …. 5.14 small business entities …. 5.67 tax period …. 5.2 interest …. 5.7

onus of proof …. 6.47 Organisation For Economic Co-operation And Development (OECD) …. 1.2 trading stock …. 5.35 Accruals Taxation financial securities, income for …. 7.55 foreign source income …. 4.68 Aggregated Turnover defined …. 5.60 passive assets …. 9.91 test …. 5.59 Annuities exempt income …. 8.29 Anti-Avoidance avoidance defined, tax …. 17.3 capital allowances …. 17.28 capital gains and losses …. 17.25 capital streaming benefits …. 14.94 deductions home loan interest deduction arrangements …. 17.17 personal services income (PSI) (see personal services income (PSI)) specific provisions …. 17.26; 17.27 evasion, tax …. 17.2 income splitting …. 17.16 ITAA 1936 Pt IVA application of …. 17.5–17.8 home loan interest deduction arrangements …. 17.17 income splitting …. 17.16 mass-marketed tax schemes …. 17.18

multinationals …. 17.19 scheme …. 17.9; 17.14 weaknesses …. 17.20 mass-marketed tax schemes …. 17.18 non-assessable income …. 17.24 non-commercial loss restriction business and business activity …. 17.31 exceptions …. 17.29; 17.32–17.44 rationale …. 17.30 overview …. 17.1; 17.65 personal services income (PSI) alienation of …. 17.45 assessable income, individual’s …. 17.54 attributing individual who performs services …. 17.52 business premises test …. 17.60 deductions for individuals employees and office holders …. 17.51 exceptions to limitation …. 17.48 limitations …. 17.47 non-allowable …. 17.49 personal services business …. 17.50 defined …. 17.46 employment test …. 17.59 entity deductions …. 17.55 not attributable to individual …. 17.53 pay-as-you-go (PAYG) withholding and …. 17.62 personal services business …. 17.56; 17.61 regime …. 14.5 results test …. 17.57

taxation offences …. 17.63 transparency laws …. 17.64 unrelated clients test …. 17.58 planning, tax …. 17.4 specific provisions …. 17.21–17.28 statutory income …. 17.23 tax accounting rules …. 17.22 tax benefits bases for identifying …. 17.12 defined …. 17.10 exclusions …. 17.11 purpose of obtaining …. 17.15 scheme for purpose of obtaining …. 17.13 Apportionment capital proceeds …. 9.122 cost apportionment …. 13.42 depreciating assets of deductions …. 13.48 input-taxed supplies …. 19.61 source of income …. 4.58 Artists income averaging …. 16.35 non-commercial loss restrictions …. 17.32 Assessable Income accrued leave payments …. 7.7 bonuses …. 7.21 deductions …. 10.10 determination of …. 8.2 exclusion …. 8.1

forestry agreements …. 7.15 managed investment schemes, receipts of …. 7.16 insurance (see Insurance, assessable income) mining …. 7.14 personal services income (PSI) …. 17.54 prospecting …. 7.14 quarrying …. 7.14 tax planning …. 20.2 tax returns business and professional items schedule …. 22.14 deductions …. 22.5 individual tax …. 22.4 partnerships …. 22.23 Self-managed superannuation funds (SMSF) …. 22.65 supplementary individual income tax …. 22.9; 22.10 trading stock (see Trading stock, assessable income) Asset Realisation business venture, as …. 6.33 extraordinary transaction, as …. 6.34 mere realisation …. 6.32 ATO (see Australia Taxation Office (ATO)) Australia Australian business number (ABN) (see Australian business number (ABN)) Australian films (see Australian films) Australia Taxation Office (ATO) (see Australia Taxation Office (ATO)) comparison of tax with others (see Organisation For Economic Cooperation And Development (OECD), Australian tax with others, comparison of)

foreign banks, branches of …. 3.18 Gini coefficient, measuring income inequality by …. 2.10 Goods and Services Tax (GST) …. 19.27 government taxes …. 1.6 incorporation of companies …. 4.31 limited partnership …. 14.34 qualifying shipping activities …. 8.22 sources Australia Taxation Office (ATO) rulings …. 1.25 case law …. 1.24 general …. 1.22 statutes …. 1.23 Australian Business Number (ABN) administration requirements …. 21.16 GST registration, requirement for …. 19.23 purpose …. 21.17 registration for …. 21.16 Australian Films assessable income …. 7.47 deductions …. 16.36 depreciating assets …. 13.15 tax offsets …. 16.37 Australia Taxation Office (ATO) anti-avoidance measures …. 17.5 assessable income exception …. 17.33 Australian taxation law, sources of …. 1.22 business income …. 6.47 domicile test …. 4.22 employee work-related expenses …. 10.30

fringe benefit tax …. 18.22 goods and services tax contractual disputes …. 19.111 payments not deductible …. 19.110 residential premises …. 19.58 legal citation guidelines …. 1.44 mutuality, principle of …. 6.8 overpayments of tax and early payments of tax, interest on …. 7.13 payments to relatives and associated persons …. 14.23 primary production …. 16.15 record keeping and documentation …. 12.44; 20.18 remedial power, Commissioner’s …. 21.27 residency test …. 4.18 superannuation holding accounts reserve …. 15.68 tax administration audits …. 21.4 pay-as-you-go (PAYG) …. 21.18 reinvention …. 21.25 review rights …. 21.10 self-assessment and income tax returns …. 21.2 taxpayers’ charter …. 21.12; 21.13 transparency …. 21.26 website …. 21.24; 23.7; 23.8 travelling cost as deduction …. 11.2 Authors income averaging …. 16.35

B Bad Debts

companies …. 12.32; 14.90 creditable acquisitions …. 19.84 deductions …. 11.17–11.21 goods and services tax (GST) …. 19.83 taxable supplies …. 19.83 Balancing Adjustments capital allowances (see Capital allowances, balancing adjustments) cost bases first element …. 13.39 second element …. 13.40 statutory income …. 7.28 Banks fees as deductions …. 10.47 foreign banks, branches of …. 3.18 Beneficiaries assessable income …. 7.54 CGT, impact of death on …. 9.72 distribution trusts (see Trusts, partnership) rebates …. 3.41 Black Economy Taskforce crackdown …. 2.53 tax evasion …. 2.34 Boating Expenses non-deductibility …. 12.16 Bonuses assessable income …. 7.21 early completion of apprenticeship, for …. 8.15 short-term life insurance bonuses …. 7.48

Borrowing Expenses deductibility …. 11.15 Bounties assessable income …. 7.8 Bribes to Officials non-deductibility …. 12.18 Business Income accounting …. 5.12; 5.13 double tax agreements …. 4.53 onus of proof …. 6.47 source of income …. 4.51

C Capital Allowances anti-avoidance …. 17.28 balancing adjustments assessable …. 13.50 CGT, interaction with …. 13.55 deductible …. 13.51 involuntary disposals …. 13.57 meaning …. 13.52 rollover relief …. 13.56 tax consequences …. 13.49 termination value defined …. 13.53 GST and …. 13.54 capital works …. 13.69 carbon farming initiative …. 13.72 costs

apportionment …. 13.42 composition …. 13.37 exclusions from …. 13.43 first element of …. 13.38 GST and …. 13.44 installation …. 13.41 second element of …. 13.40 special rules for first element …. 13.39 deductible, immediately …. 13.65 deductible over time …. 13.66 depreciating assets adjustable value …. 13.46; 13.47 alterations …. 13.17 application …. 13.3–13.63 apportionment …. 13.48 associate, assets acquired from …. 13.23; 13.24 calculation …. 13.20; 13.45 car deductions …. 13.18 composite items versus components …. 13.11 debt forgiveness …. 13.62 deductible assets under another subdivision …. 13.16 defined …. 13.7 Diminish value method (DV) …. 13.22; 13.25 effective life …. 13.29–13.36 exclusions (see exclusions of depreciating assets) holder of …. 13.19 immediate deductions …. 13.28 improvements …. 13.10 intangible assets …. 13.8

leap years …. 13.27 low-value development pools …. 13.58 overview …. 13.1; 13.2; 13.73 period, determination of …. 13.21 plants …. 13.9 primary production …. 13.59 Prime cost method (PC) …. 13.26 Prime cost method (PV) …. 13.22 schedule …. 13.63 schedule, depreciation …. 13.43 small business entities …. 13.60; 13.61 software development pools …. 13.58 taxable purpose …. 13.6 exclusions of depreciating assets capital works …. 13.14 eligible work-related items …. 13.13 films …. 13.15 intangible asset not mentioned in s 40-30(2) …. 13.12 land …. 13.12 trading stock, item of …. 13.12 ITAA 1936 …. 13.71–13.72 overview …. 13.73 partnerships …. 22.21 primary producers and landholders …. 13.64 research and development …. 13.71 schedule (see Returns, capital allowances schedule) tax-preferred entities …. 13.70 trees establishment …. 13.67

write-off for business-related costs, five year …. 13.68 Capital Gains Tax (CGT) application …. 6.46 assets acquisition, time of …. 9.32 ‘collectables’ …. 9.29 defined …. 9.28 disposal of …. 9.10 identification …. 9.27 personal use assets …. 9.30 receipt for event relating to …. 9.20 separate assets and attachments …. 9.31 calculating capital gain/loss event, CGT …. 9.119 misappropriation rule …. 9.126 choices …. 9.6 concessions (see Small business entities (SBEs), CGT concessions) cost base by net input tax credits, reduction of …. 9.7 death, effect of beneficiary or legal personal representative, impact on …. 9.72 deceased, impact to …. 9.71 small business concessions, access to …. 9.80; 9.109 demerger relief …. 9.69 event assets into existence, bringing …. 9.15 cancellation, surrender and similar endings …. 9.13 consolidated groups …. 9.26 contractual rights …. 9.14 deposit, forfeiture of …. 9.19

disposal of assets …. 9.10 emission units, registered …. 9.24 general …. 9.78 leases …. 9.17 loss or destruction …. 9.12 other specified events …. 9.25 receipt relating to CGT asset …. 9.20 residency, end of …. 9.21; 9.22 scope …. 9.9–9.26 shares …. 9.18 taxpayer, asset owned by …. 9.79; 9.80 trusts …. 9.16 use and enjoyment before title passes …. 9.11 exemptions additional …. 9.49 assets used to produce exempt income …. 9.37 carried interests …. 9.41 cars, motorcycles and valour decorations …. 9.34 collectables and personal use assets …. 9.36 compensation/damages …. 9.48 deceased estates, dwellings acquired from …. 9.53 demutualisation of Tower Corporation …. 9.57 depreciating assets …. 9.43 earnout rights, look-through …. 9.58 emissions unit, registered …. 9.39 film copyright …. 9.46 financial arrangements …. 9.45 free carbon unit, right to …. 9.39

look-through earnout rights …. 9.58 main residence …. 9.50; 9.51 partial …. 9.52 pooled development fund, shares in …. 9.38 pre-CGT assets …. 9.35 reduction where amount otherwise assessed …. 9.40 research and development …. 9.47 termination payments, eligible …. 9.42 Tower Corporation, demutualisation of …. 9.57 trading stock …. 9.44 transactions and events, assets …. 9.33 venture capital …. 9.56 giving property as part of transaction …. 9.3 interest …. 9.41 investments …. 9.73 leases …. 9.17; 9.74 money or property, entitlement to receive …. 9.4 operative operations …. 9.2 options …. 9.75 overview …. 9.1; 9.137 partnership …. 14.30 pay money or give property …. 9.5 pre-CGT assets ceased to be …. 9.76 replacement …. 9.35 residence …. 9.8; 9.21; 9.22; 9.50; 9.51 rollover relief (see Rollover relief) special rules, application of …. 9.66–9.116 superannuation

insurance and …. 9.54 lump sums …. 9.42 pooled superannuation trusts, units in …. 9.55 transfers to wholly owned company …. 9.67 trusts (see Trusts, capital gains tax) Capital Protected Borrowings deductibility …. 12.29 Capital Receipts income distinguished from …. 6.30 lump sums, undissected …. 6.45 restrictive covenants examples of …. 6.36 payments for …. 6.35 sale of property, gains from business venture, realization as …. 6.33 classification of …. 6.31 extraordinary transaction, realization as …. 6.34 mere realization …. 6.32 Capital Works capital allowances exclusion …. 13.14 deductibility …. 13.69 Carbon Farming Initiative capital allowances on …. 13.72 Carbon Tax additional taxes on …. 2.22 capital allowances on carbon farming initiative …. 13.72 free carbon unit, right to …. 9.39 Car Fringe Benefits

base value …. 18.55 constitution of …. 18.32 employee contribution …. 18.56 formula method …. 18.54 operating cost method …. 18.58–18.63 actual costs …. 18.60 deemed costs …. 18.61 deemed interest expenses …. 18.63 depreciation …. 18.62 total operating costs …. 18.59 parking …. 18.42 private use, estimated percentage of …. 18.64 statutory fraction …. 18.57 taxable value …. 18.53 unreimbursed recipient’s contribution …. 18.49 Cars capital gains and losses from …. 9.34 depreciating assets …. 13.18 disposal of …. 7.26 expenses on employer-provided cars …. 12.33 luxury cars, leases of …. 7.38 motor vehicles (see also Motor vehicles) Child Care Deductions …. 10.36 Collectables defined …. 9.29 personal use assets and …. 9.36 Companies appointment of public officer …. 14.70

bad debts …. 14.90 bonus shares …. 14.92 capital streaming benefits …. 14.94 consolidated groups …. 14.95 defined …. 14.69 exceptions to corporate tax rules …. 14.73 formation …. 14.74 income, distribution of associates by private companies, payments to …. 14.83 dividend imputation system …. 14.77; 14.78 dividends …. 14.80; 14.81 gross-up amount, calculation of …. 14.79 liquidation …. 14.82 income tax returns …. 22.53 losses carry forward losses …. 14.84; 14.85; 14.88 loss carry-back law …. 14.89 ownership test (COT) …. 14.86 same business test (SBT) …. 14.87 overview …. 14.68; 14.96 public v private companies …. 14.71; 14.72 share buybacks …. 14.91 share capital reductions …. 14.93 taxable income/loss and income tax liability, calculation of …. 14.75; 14.76 Company Income Tax distribution …. 1.9 returns …. 22.2 – 22.5 tax rates …. 3.54

Company Income Tax Return CGT schedule …. 22.53 consolidated groups losses schedule …. 22.60 declarations …. 22.58 dividend and interest schedule …. 22.61 financial and other information …. 22.56 net profit or loss …. 22.54 non-individual PAYG payment summary schedule …. 22.62 reconciliation to taxable income or loss …. 22.55 research and development tax concession schedule …. 22.63 subsidiary members, consolidated …. 22.59 tax calculation statement …. 22.57 thin capitalization schedules …. 22.64 Compensation Payments business agencies, contracts relating to …. 6.43 contracts, cancellation or variation of …. 6.40 structure, contracts relating to …. 6.42 capital assets, sterilisation of …. 6.39 categories of …. 6.37 exempt income part-time defence reservists’ jury compensation …. 8.12 pay or allowance for warlike service, loss of …. 8.11 loss of income and income-earning capacity …. 6.38 lost trading stock …. 5.52 lump sums, undissected …. 6.44; 6.45 ordinary trading contracts …. 6.41 sterilisation of capital assets …. 6.39 Complex transactions

tax consequences …. 23.3–23.11 Concessions death, effect of (see Capital gains tax (CGT), death, effect of) foreign source income …. 4.66 international tax …. 4.90 mining deduction concessions (see Mining, deduction concessions) small business concessions (see Small business entities (SBEs), CGT concessions) superannuation …. 2.20 Conservation covenants deductions …. 11.44 Consolidated groups CGT events …. 9.26 company income tax issues …. 14.95 losses schedule in company income tax return …. 22.60 regime …. 5.68 Consolidations international tax …. 4.89 Constitutional taxation powers Commonwealth’s power to tax …. 1.13 legislative enactment …. 1.13 limitations imposition …. 1.15 in respect of taxation …. 1.14 laws not originating in Senate …. 1.21 no discrimination between states …. 1.17 no preference to states …. 1.18 one subject of taxation …. 1.16 prohibition from imposition …. 1.19

state-owned properties …. 1.19 territorial …. 1.20 Cost base net input tax credits …. 9.7 Small business entities (SBEs) defined …. 9.128 exclusions …. 9.129 incidental costs …. 9.130 indexation …. 9.132 modifications …. 9.131 reduction …. 9.131; 9.133 Costs revenue cost …. 2.14 tax expenditures …. 2.14

D Damages exempt or loss-denying transactions …. 9.48 Death capital gains tax (see Capital gains tax (CGT), death, effect of) deceased estates (see Deceased estates) small business concessions, access to …. 9.80; 9.109 trading stock …. 5.50 Deceased estate dwellings acquired from …. 9.53 trusts …. 14.58 Deductions anti-avoidance (see Anti-avoidance, deductions) bank fees …. 10.47

business entity test …. 10.24 business expenses abnormal events …. 10.55 categories of …. 10.52 day-to-day expenses …. 10.53 examination of …. 10.52–10.64 home office expenses …. 10.63 home-to-work travel …. 10.56 interest …. 10.57–10.60 legal expenses …. 10.62 negative gearing …. 10.61 preliminary expenses …. 10.54 travel expenses …. 10.64 capital costs …. 5.53 capital or capital nature …. 10.20 capital-protected loans …. 10.42 ‘carrying on a business’ …. 10.17 child minding expenses …. 10.36 clothing …. 10.45 cosmetic and personal grooming …. 10.46 deriving income and incurring …. 10.18 enduring benefit test …. 10.22 exempt income, incurred in gaining …. 10.26 fixed versus circulating capital …. 10.23 food …. 10.50 gifts and donations …. 11.38-11.43 GST, and …. 10.65 insurance …. 10.44 interest

business categories …. 10.57–10.60 non-business expenses …. 10.40 ITAA 1997 provisions …. 10.2–10.9 limitations business benefits, non-cash …. 12.37 car expenses …. 12.33 exempt use of property …. 12.42 fringe benefits …. 12.36 general …. 10.27 infrastructure borrowings …. 12.43 ITAA 1936 (see Income Tax Assessment Act (ITAA) 1936, deduction limitations) ITAA 1997 provisions (see Income Tax Assessment Act (ITAA) 1997, deduction limitations) overview …. 12.1; 12.2; 12.47 parking expenses …. 12.34 prepaid or advance expense rules (see Prepaid expenses, limitations) record keeping …. 12.44–12.46 reimbursements, employee …. 12.35 self-education expenses …. 12.38 losses and outgoings (see losses and outgoings, assessable income, connection with) medical expenses …. 10.51 mining concessions (see Mining, deduction concessions) necessarily incurred …. 10.16 negative limbs …. 10.19 non-business categories bank fees …. 10.47 child minding expenses …. 10.36

clothing …. 10.45 cosmetic and personal grooming …. 10.46 employees and investors …. 10.28–10.51 food …. 10.50 home office expenses …. 10.38 insurance …. 10.44 interest …. 10.40 legal expenses …. 10.49 living expenses …. 10.29 managed investment scheme expenses …. 10.43 medical expenses …. 10.51 negative gearing …. 10.41 preliminary expenses …. 10.39 technical/professional publications …. 10.48 travel expenses …. 10.37 work-related expenses, employee …. 10.30 no payment made during income year …. 5.21–5.28 once and for all test …. 10.21 overview …. 10.1; 10.66 positive limbs …. 10.3 preliminary expenses …. 10.39 private or domestic nature …. 10.25 recoupment (see Recoupment) self-education employment …. 10.34 employment skill or knowledge, maintains or improves …. 10.32 formal and informal expenses …. 10.31 increase in income, leads to or likely to lead to …. 10.33 youth allowance …. 10.35

specific associations, payments to …. 11.26 bad debts …. 11.17–11.21 borrowing expenses …. 11.15 capital expenditure to terminate lease …. 11.36 car expenses …. 11.37 conservation covenants …. 11.44 discharging mortgage, expenses of …. 11.16 election expenses …. 11.27 gifts and donations …. 11.38–11.43 income tax, other than …. 11.3 ITAA 1936 …. 11.49 ITAA 1997 …. 11.2–11.48 lease document expenses …. 11.14 misappropriation, loss from …. 11.24 others …. 11.48 overview …. 11.1; 11.51 pensions, gratuities or retiring allowances, payments of …. 11.25; 12.20 profit-making undertaking or plan …. 11.22 repairs …. 11.4–11.13 superannuation contributions …. 11.47 tax related expenses …. 11.2 theft by employee or agent, loss from …. 11.23 travel expenses (see travel expenses, specific deductions) United Medical Protection …. 11.35 work in progress payments …. 11.28 superannuation contributions surcharge …. 12.21

guarantee charge …. 12.23 supervisory levy …. 12.23 superannuation contributions …. 11.47 tax losses …. 11.45; 11.46 tax losses attributable to infrastructure projects …. 11.50 trading stock …. 5.37 travel expenses (see Travel expenses, specific deductions) United Medical Protection …. 11.35 Depreciating assets apportionment …. 13.48 Australian film …. 13.15 capital allowances (see Capital allowances, depreciating assets) capital gains tax (CGT) exemptions …. 9.43 exclusion …. 13.12 horticultural plants …. 16.20 intangible assets …. 13.8 partnership …. 14.29 plants …. 13.9 pooled development funds …. 13.58 primary production …. 13.59 schedule, capital allowances …. 22.17; 22.18 trading stock …. 13.12 water facilities …. 16.19 Derivation of income aggregated turnover …. 5.60 annual turnover …. 5.61 business …. 5.12; 5.13 deductions, incurring …. 10.18 deemed derivation …. 5.16

‘derived’ meaning …. 5.4 exempt income copyright collecting agency …. 8.16 resale royalty collecting society …. 8.17 interest …. 5.7 ordinary income …. 6.4 prepaid income …. 5.15 timing …. 5.5; 6.4 Dictionaries Income Tax Assessment Act 1997 …. 3.11 statutory interpretation …. 1.37 Discounts CGT …. 9.59–9.64 Discretionary trusts connected entities …. 5.64; 5.65 defined …. 14.39 Disposals CGT assets …. 9.10 involuntary disposals …. 13.57 leased cars …. 7.26 trading stock cease to hold …. 5.49 ordinary course of business, outside …. 5.48 Diverted profits tax (DPT) international tax …. 4.91 Dividends company income distribution dividend imputation system …. 14.77; 14.78

general …. 14.80; 14.81 gross-up amount, calculation of …. 14.79 deductions …. 12.11 double tax agreements …. 4.76 intercorporate non-portfolio dividends …. 4.63 source of income …. 4.56 statutory income …. 7.52 tax offsets …. 3.48 Domicile tests ATO view …. 4.22 legal relationship of person and state …. 4.20 lengthy period of time …. 4.19 place of abode …. 4.21 Double tax agreements business income, source for …. 4.53 business profits …. 4.73; 4.80 dividends …. 4.76 foreign source income …. 4.72 interest …. 4.75 pensions …. 4.79 personal services …. 4.74 real property …. 4.78 royalties …. 4.77 services income …. 4.81 Drugs, illegal additional taxes on …. 2.22

E Earnout rights

CGT treatment …. 9.127 look-through earnout rights …. 9.58 sale and purchases of businesses involving …. 9.117 Education and training exempt income …. 8.9; 8.13; 8.27 GST free …. 19.46 non-deductibility …. 12.38 scholarship plan …. 7.19 self-education (see Deductions, self-education) election deductions …. 11.27 Employment Termination Payment (ETP) death benefits …. 15.60 exclusion …. 15.58 foreign termination payments …. 15.65 leave payments annual leave payments, unused …. 15.62 long service leave payments, unused …. 15.63 life benefits …. 15.59 other payments …. 15.61 rate of tax …. 15.57 redundancy …. 15.64 Equity Gini coefficient …. 2.10 horizontal …. 2.8 impact on …. 2.7 land tax …. 2.23 vertical …. 2.9 Ethics

administrators, tax …. 2.40 deficiencies of tax system …. 2.36 defined terms …. 2.35 tax professionals …. 2.39 Excess imputation tax tax offset …. 14.6 Exempt income ITAA 1936 credit union interest …. 8.35 Defence Force members …. 8.33 foreign employment …. 8.34 infrastructure borrowings, interest on …. 8.37 non-assessable and non-exempt …. 8.42 non-cash business benefit …. 8.36 United Nations service …. 8.32 United States Government projects, income connected with …. 8.31 ITAA 1997 annuities and lump sums …. 8.29 Australian qualifying shipping activities …. 8.22 bonuses for early completion of apprenticeship …. 8.15 classes of …. 8.3 compensation payments …. 8.11 copyright collecting agency, income derived by …. 8.16 Defence Force reserves …. 8.8 education and training …. 8.9 emergency reserve forces …. 8.8 entities …. 8.4; 8.5 foreign investment …. 8.19

full-time students, payments to …. 8.13 maintenance …. 8.18 mutuality principle …. 8.7 non-assessable and non-exempt …. 8.39–8.41 other exemptions …. 8.30 part-time defence reservists’ jury compensation …. 8.12 payments …. 8.27; 8.28 payments not exempt …. 8.43 pensions, benefits and allowances …. 8.24 personal injury, interest on judgment debt relating to …. 8.20 prizes, Prime Minister’s …. 8.21 resale royalty collecting society, income derived by …. 8.17 residents, temporary …. 8.6 secondary student, payments to …. 8.14 social security payments …. 8.25 unclaimed money and property, interest on …. 8.23 veterans’ entitlement pensions …. 8.26 welfare …. 8.10 overview …. 8.44 Exemptions capital gains tax (CGT) (see Capital gains tax (CGT), exemptions) depreciating assets …. 9.43 exempt income …. 8.30 foreign source income …. 4.60–4.67 fringe benefits tax (FBT) (see Fringe benefits tax (FBT), exemptions) goods and services tax (GST) …. 19.7 pooled development funds …. 9.38 registered emission units …. 9.39 research and development (R&D) …. 9.47

trading stock …. 5.54; 9.44 Expense payment fringe benefit defined …. 18.35 exemptions …. 18.46 taxable value …. 18.66

F Family maintenance payments non-deductibility …. 12.14 Family tax benefit tax offsets …. 3.38 Farm management deposits primary production …. 16.25 FBT (see Fringe benefits tax (FBT)) Film Australian investments …. 7.47 copyright …. 9.46 depreciating assets, exclusion from …. 13.15 Financial arrangements CGT asset …. 9.45 derivation of income …. 5.17 taxation of …. 5.17; 5.34; 7.36 Financial supplies input-taxed supplies …. 19.56 Financial transactions assessable income …. 7.37 Fines and penalties non-deductibility …. 12.3

First home saver account contributions (FHSA) employer contributions assessable …. 7.22 Fiscal adequacy social security benefit …. 2.28 tax collection …. 2.3 Food in-house dining facility, meals in …. 7.27 meal entertainment benefit employer provided travel …. 18.40 taxable value …. 18.67 Foreign residents capital gains withholding payments …. 21.21 emission units, registered …. 4.83 reporting standard …. 21.22 services income …. 4.81 source income …. 4.71 sovereign immunity …. 4.84 withholding tax …. 4.82; 9.136 Foreign source income accruals taxation …. 4.68 branch profits …. 4.62 capital gains and foreign branch income …. 4.65 CGT concessions …. 4.66 conduit foreign income …. 4.64 double tax agreements …. 4.72 exemptions …. 4.60–4.67 intercorporate non-portfolio dividends …. 4.63 losses …. 4.70 overview …. 4.59

taxation of foreign residents …. 4.71 tax credits …. 4.69 temporary residents …. 4.67 Forestry assessable income agreements …. 7.15 managed investment schemes, receipts of …. 7.16 investors in …. 16.34 prepaid expenses …. 5.33 Franchise fees windfall tax deductibility …. 12.5 Fringe benefits tax (FBT) categories of benefits airline transport benefit …. 18.38 board benefit …. 18.39 cars (see also Car fringe benefits) debt waiver benefit …. 18.33 expense payment benefit …. 18.35 housing benefit …. 18.36 living-away-from-home allowance benefit …. 18.37 loan benefit …. 18.34 property benefit …. 18.43 residual benefit …. 18.44 special rules …. 18.31 tax-exempt body entertainment benefit …. 18.41 defined …. 18.20; 18.21 employee or associate …. 18.24 employment, in respect of …. 18.22

equation …. 18.3 exempt employers …. 18.25 exemptions deductible rule …. 18.50 expense payments …. 18.46 miscellaneous exempt benefits …. 18.48 other reductions …. 18.51 residual benefits …. 18.47 taxable values …. 18.45 unreimbursed recipient’s contribution …. 18.49 goods and services tax (GST) and …. 18.29 gross-up factor …. 18.27 income, provided in year of …. 18.23 liability to pay …. 18.26 liability to pay, calculating …. 18.68 non-exempt amounts …. 18.73 overview …. 18.1; 18.4–18.19; 18.76 personal services income, and …. 18.30 pyramid …. 18.2 rate …. 18.27 rebatable tax-exempt employers …. 18.75 reportable …. 18.72 returns (see Returns, fringe benefits tax) salary packaged entertainment benefits …. 18.74 taxable amount …. 18.69–18.71 taxable value calculation of …. 18.52 car fringe benefit …. 18.53 expense payment benefit …. 18.66

loan benefit …. 18.65 meal entertainment benefit …. 18.40; 18.67 operating cost method …. 18.58–18.63 private use, estimated percentage of …. 18.64 statutory formula method …. 18.54–18.57 year …. 18.28 Funeral policy benefits assessable income …. 7.18

G Gambling additional taxes on …. 2.22 winnings …. 6.13 Gifts and donations deductions …. 11.38-11.43 defined …. 11.42 ordinary income …. 6.12 political donations …. 11.43; 12.9 Gini coefficient equity, measuring …. 2.10 Goods and services tax (GST) accounting rules …. 19.89 adjustments acquisitions …. 19.80–19.82 bad debts …. 19.83 events …. 19.76 supplies …. 19.77–19.79 types of …. 19.75 administration

payments …. 19.106 refunds …. 19.107 returns …. 19.105 tax invoices …. 19.103; 19.104 turnover …. 19.108 Australian tax office (ATO) (see (ATO), goods and services tax) calculating GST …. 19.86–19.101 examples …. 19.101 input tax credits …. 19.99; 19.100 taxable supplies …. 19.98 cash basis …. 19.90–19.93 contractual disputes, and …. 19.111 deductions and …. 10.65 deposits as security …. 19.64 enterprise …. 19.22 entity …. 19.21 equation …. 19.3 exemptions …. 19.7 GST-free supplies beverages …. 19.12 charitable activities …. 19.51 child care …. 19.47 education …. 19.46 emission units …. 19.53 exclusions …. 19.11 exports …. 19.48 food …. 19.31–19.39 going concerns, by …. 19.50 health …. 19.40–19.45

input tax credits …. 19.29 medical aids and appliances …. 19.13 non-taxable …. 19.30 other specified …. 19.54 packaging, food …. 19.39 religious services …. 19.49 tourists and international travel …. 19.52 income tax …. 2.21 input-taxed supplies (see Input-taxed supplies) instalments …. 19.85 legislation overview …. 19.4–19.14 non-cash basis …. 19.94–19.97 other taxes, and …. 19.110 overview …. 19.1; 19.112 pyramid …. 19.2 registration …. 19.17 reporting …. 19.109 requirements for registration …. 19.23 small food business …. 19.102 special rules …. 19.8; 19.63 supply connected with indirect tax zone (ITZ) …. 19.27 consideration, for …. 19.26 defined …. 19.24 in course or furtherance of enterprise …. 19.25 indirect tax zone (ITZ), connected with …. 19.27 taxable supplies …. 19.15; 19.16 tax periods …. 19.87; 19.88

tax returns annual return …. 22.82–22.85 business activity statement …. 22.78 declarations …. 22.81; 22.85 overview …. 22.77; 22.87 payable/refundable, tax …. 22.80; 22.84 PAYG income tax instalment …. 22.79 PAYG tax withheld …. 22.79 report, annual …. 22.86 supplies and acquisitions …. 22.83 trading stock …. 5.45 turnover current …. 19.19 defined …. 19.18 projected …. 19.20 Government taxes cash accounting framework …. 1.6 company income tax distribution …. 1.9 indirect taxes …. 1.10 personal income tax distribution …. 1.8 tax expenditures …. 1.12 tax mix …. 1.7 tax revenue …. 1.11 Gratuities assessable income …. 7.4 deductibility of payments …. 11.25 limitations on deductions …. 12.20

H

HECS-Help benefit, exempt income …. 8.9 payments not deductible …. 12.8 Henry review land tax …. 2.23 road congestion tax …. 2.26 tax system …. 2.48; 2.49 uniform resource rent tax …. 2.25 Home loans interest deduction arrangements …. 17.17 Home office expenses business categories deduction …. 10.63 non-business categories deduction …. 10.38 Hospitals GST-free supplies …. 19.40; 19.42 Housing fringe benefits tax …. 18.36 meals in in-house dining facility …. 7.27

I Illegal activities drugs, illegal …. 2.22 non-deductibility of expenses …. 12.19 receipts from …. 6.15 Importations gains and services tax on …. 19.62 input tax credits on …. 19.74 low value …. 19.28 Improvements

depreciating assets, as …. 13.10 income assessable (see Assessable income) averaging (see Income averaging) business (see business income) company income tax return (see Company income tax return) derivation of (see Derivation of income) exempt (see Exempt income) foreign source (see Foreign source income) non-assessable non-exempt (see Non-assessable non-exempt (NANE) income) personal services (see Personal services income) sources of (see Source of income) statutory (see Statutory income) tax (see Income tax) Income arrears rebate Lump sum payments …. 3.46 Income averaging artists …. 16.35 authors …. 16.35 averaging tax offset …. 16.26 calculation of …. 16.33 individuals …. 14.3 inventors …. 16.35 production associates …. 16.35 special professionals …. 14.3 sportspersons …. 16.35 income splitting anti-avoidance …. 17.16

minors, income of …. 14.4 partnerships …. 14.24 income tax accounting (see Accounting) analysis …. 3.35 calculating amount payable/refundable …. 3.58–3.64 company …. 1.9 equation …. 3.3 free riders …. 2.17 GST …. 2.21 ITAA 1936 (see Income Tax Assessment Act (ITAA) 1936) ITAA 1997 (see Income Tax Assessment Act (ITAA) 1997) legislation …. 3.4 overview …. 3.1; 3.66; 22.1 personal …. 1.8 progressive broad-based …. 2.18 exceptions …. 2.19 pyramid …. 3.2 rates individuals …. 3.53 superannuation funds …. 3.55 surcharge …. 3.57 rates, setting of …. 2.27 returns …. 22.2 superannuation concessions …. 2.20 tax offsets …. 3.36 Income tax assessment Act (ITAA) 1936 administration …. 3.16

anti-avoidance (see Anti-avoidance, ITAA 1936 Pt IVA) controlled foreign companies …. 3.24 deduction limitations car expenses on employer-provided cars …. 12.33 exempt use or exempt end users of property …. 12.42 fringe benefits tax contributions …. 12.36 non-cash business benefits …. 12.37 parking expenses …. 12.34 prepaid or advance expense rules (see Prepaid expenses, limitations) reimbursements, employee …. 12.35 self-education expenses …. 12.38 defined terms …. 3.29 foreign banks, Australian branches of …. 3.18 legislation, levels of …. 3.26 liability to taxation …. 3.17 Medicare levy surcharge …. 3.22 miscellaneous …. 3.23 overview …. 3.5; 3.14–3.26 regulations …. 3.27 returns and assessments …. 3.19 schedules …. 3.25 schemes to reduce tax …. 3.20 statutory income (see Statutory income, ITAA 1936) surcharge, medical levy …. 3.22 tax file numbers …. 3.21 Income tax assessment Act (ITAA) 1997 administration …. 3.10 deduction limitations

asset financing …. 12.30 boating activities, non-business …. 12.16 bribes to officials …. 12.18 business losses, non-commercial …. 12.26 capital protected borrowings …. 12.29 Commonwealth places windfall tax …. 12.6 employee uniform/wardrobe, non-compulsory …. 12.25 entertainment expenses …. 12.24 family maintenance payments …. 12.14 franchise fees windfall tax …. 12.5 HECS-HELP and student assistance …. 12.8 illegal activities …. 12.19 interest or royalty …. 12.10 leave payments …. 12.4 leisure facility expenses …. 12.17 limited recourse debt …. 12.28 non-share distributions and dividends …. 12.11 other limitations …. 12.23; 12.32 payments to related entities, reductions for …. 12.13 penalties and fines …. 12.3 political donations …. 12.9 prepaid or advance expense rules (see Prepaid expenses, limitations) rebatable benefits …. 12.7 recreational club expenses …. 12.15 relative’s travel expense …. 12.12 specific deductions …. 12.20 substantiation …. 12.31 superannuation and contribution surcharge …. 12.21 tax preferred entities …. 12.30

trading stock not on hand …. 12.27 defined terms …. 3.29 dictionaries …. 3.11 international aspects …. 3.9 legislation, finding …. 3.33 levels of …. 3.12 liability rules general application …. 3.7 specialist liability rules …. 3.8 non-assessable and non-exempt income …. 8.39–8.41 non-operative material classification …. 3.30 guides …. 3.31 legislation, finding …. 3.33 notes and examples …. 3.32 overview…. 3.5; 3.6; 3.34 regulations …. 3.13 statutory income (see Statutory income, ITAA 1997) Income tax rating acts imposition of …. 3.28 Income tax regulations 1936 implementation …. 3.27 Indirect tax government tax …. 1.10 Indirect tax zone (ITZ) connected with …. 19.27 low value importations …. 19.28 Individuals

excess imputation credits …. 14.6 income averaging …. 14.3 minors …. 14.4 personal services regime …. 14.5 rates of tax …. 3.53 resident/nonresident …. 14.2 tax returns (see Returns, individual tax) Infrastructure borrowings interest on …. 8.37 non-deductiblity on …. 12.43 Infrastructure projects deductions for losses …. 11.50 Input tax credits acquisitions, creditable …. 19.66 amount of tax …. 19.72 calculating GST …. 19.99; 19.100 consideration …. 19.70 cost base …. 9.7 creditable purpose …. 19.67; 19.68; 19.73 defined …. 19.65 importations, on …. 19.74 registration …. 19.71 taxable supply …. 19.69 Input-taxed supplies …. 19.55 apportionment …. 19.61 financial supplies …. 19.56 importations …. 19.62 precious metal …. 19.59 premises, residential …. 19.58

residential rents …. 19.57 school tuck shops and canteens …. 19.60 Inspector-general of taxation tax administration …. 21.23 Insurance assessable income life insurance companies …. 7.40 payments …. 7.12 premium income …. 7.41 recoupment, assessable …. 7.23; 7.24 deductions …. 10.44 life (see Life insurance) private health insurance premiums …. 3.43 short-term life insurance bonuses …. 7.48 statutory income, ITAA 1997 assessable recoupment …. 7.23; 7.24 general insurance …. 7.41 payments as assessable income …. 7.12 superannuation and, …. 9.54 Intangible assets assets not mentioned in s 40-30(2)…. 13.12 depreciating assets, considered …. 13.8 Interest accounting …. 5.7 business deductions …. 10.57–10.60 Capital gains tax (CGT) …. 9.41 CGT assets …. 9.103 credit unions …. 8.35

deduction limitations …. 12.10 double tax agreements …. 4.75 infrastructure borrowings, interest on …. 8.37 non-business deductions …. 10.40 overpayments and early payments of tax …. 7.13 personal injury, interest on judgment debt relating to …. 8.20 redemption of non-interest-bearing securities …. 7.51 source of income …. 4.55 tax entities assignment of partnership interest …. 14.33 loans and interest, partner’s …. 14.22 partner’s current account and capital balances …. 14.21 unclaimed money and property, interest on …. 8.23 International loans and capital raising international tax …. 4.86–4.88 International tax consolidations …. 4.89 corporate concessions …. 4.90 debt, enforcement of …. 4.7 diverted profits tax (DPT) …. 4.91 harmonisation of …. 4.8 international loans and capital raising …. 4.86–4.88 neutrality, lack of …. 4.4 norms and problems …. 4.3 overview …. 4.1; 4.2; 4.92; 4.93 residence rules …. 4.9 tax avoidance …. 4.5 tax minimisation …. 4.6 transfer pricing …. 4.85

INVENTORS income averaging …. 16.35 ITAA 1936 (see Income Tax Assessment Act (ITAA) 1936) ITAA 1997 (see Income Tax Assessment Act (ITAA) 1997)

L Landcare operations primary production …. 16.21 Land tax equity …. 2.23 Henry Review findings …. 2.23 Leases capital gains tax (CGT) …. 9.17; 9.74 cars, disposal of …. 7.26 incentives …. 6.29 luxury cars …. 7.38 obligation to repair, amounts received for …. 7.11 plants …. 7.29 premiums on surrender of leases …. 7.46 specific deductions capital expenditure to terminate lease …. 11.36 lease document expenses …. 11.14 Leave payments asessable income, accrued leave payments as …. 7.7 deduction limitations …. 12.4 employment termination payment (ETP), excluded from annual leave payments, unused …. 15.62 long service leave payments, unused …. 15.63 Legal expenses

business …. 10.49 non-business categories …. 10.49 Legal reasoning model development of …. 3.65 Leisure facility expenses non-deductibility …. 12.17 Life insurance assessable income …. 7.40 short-term life insurance bonuses …. 7.48 Limited recourse debt assessable income …. 7.39 deduction …. 12.28 Liquidation income, distribution of …. 14.82 Living expenses living-away-from-home allowance benefit …. 18.37 non-deductibility …. 10.29 Loans capital-protected loans …. 10.42 international loans and capital raising …. 4.86–4.88 partner’s loans and interest …. 14.22 Lobbying tax planning …. 20.19 Losses and outgoings assessable income, connection with degree of …. 10.10 essential character test …. 10.12 incidental and relevant test …. 10.11 legal rights view …. 10.14

perceived connection test …. 10.13 purpose test …. 10.15 defined …. 10.5 transport expense …. 11.31 Lotteries investment related to …. 7.49 ordinary income …. 6.14 Low income earners government co-contributions …. 15.22 superannuation contributions …. 15.23 tax offsets …. 3.39 Lump sums capital receipts …. 6.45 compensation payments …. 6.44; 6.45 exempt income …. 8.29 superannuation …. 9.42 Tax offsets …. 3.47

M Maintenance payments exempt income …. 8.18 family …. 12.14 Managed investment schemes deductions …. 10.43 forestry …. 7.16 Meal entertainment benefit employee provided travel …. 18.40 Meals (see Foods) Medical expenses

deductions …. 10.51 tax offsets …. 3.42 United Medical Protection …. 11.35 Medical supplies aids and appliances …. 19.13; 19.43 drugs, medicines and goods …. 19.44 services …. 19.41 Medicare levy calculation of …. 3.61 imposition of …. 3.56 lump sum arrears offset …. 3.47 reduction or exemption …. 22.40 surcharge …. 3.22; 3.57 Mining assessable income, payments for …. 7.14 deduction concessions capital write-offs for capital expenditure …. 16.12 environmental protection …. 16.11 exploration or prospecting …. 16.6–16.8 petroleum resource rent tax …. 16.10 quarrying or petroleum sites …. 16.9 income tax concessions …. 16.4; 16.5 Minors child as partners in partnership …. 14.26 deductions, child care as …. 10.36 income of …. 14.4 spouse and child affiliates …. 9.92–9.96 trust net income, distribution of …. 14.55 Misappropriation

capital gain/loss, calculating …. 9.126 deduction of loss from …. 11.24 Mortgage discharging mortgage, expenses of …. 11.16 Motor vehicles cars (see Cars) motorcycles, capital gains and losses from …. 7.26 Mutuality principle non-assessable income …. 8.7 ordinary income …. 6.8

N Negative gearing business expenses …. 10.61 non-business categories …. 10.41 Non-assessable non-exempt (NANE) income consequences …. 8.38 GST payable on taxable supply …. 8.39 ITAA 1936 provisions …. 8.42 ITAA 1997 provisions …. 8.38–8.41 overview …. 8.1

O OECD (see Organisation For Economic Cooperation And Development (OECD)) Offsets (see Tax offsets) Optimal tax theory defined terms …. 2.16 tax expenditures versus …. 2.12

Ordinary income asset realisation (see Asset realisation) business, receipts from carrying on …. 6.23–6.29 convertible into money …. 6.5–6.7 derivation …. 6.4 employment or services incidental to, receipts …. 6.20 receipts related to …. 6.19 unrelated to, receipts …. 6.21; 6.22 gains from use of property …. 6.16 gambling winnings …. 6.13 gifts …. 6.12 illegal activities, receipts from …. 6.15 lease incentives …. 6.29 lottery winnings …. 6.14 mutuality principle …. 6.8 onus of proof …. 6.47 overview …. 6.1–6.3; 6.48 periodical gains …. 6.9; 6.10 personal services, income from …. 6.17; 6.18 precedence rules …. 7.2 timing …. 6.4 windfall gains …. 6.11 Organisation for economic co-operation and development (OECD) Australian tax with others, comparison of accrual accounting framework …. 1.2 petrol taxation …. 1.5 tax burden …. 1.3 tax mix …. 1.4

taxation, impact of …. 2.4 Overpayments of tax interest payments …. 7.13 Overseas forces rebate tax offsets …. 3.45

P Parents family tax benefit …. 3.38 sole parent rebate …. 3.38 Partnership assignment of interests …. 14.33 capital allowances schedule …. 22.21 partners in partnership, SBE and …. 9.83 passive assets …. 9.86–9.88 returns (see Returns, partnership) statutory income …. 7.53 tax entities Australian venture capital …. 14.34 capital gains tax (CGT) …. 14.30 child partners …. 14.26 debtors …. 14.31 defined …. 14.9 depreciating assets …. 14.29 first positive limb …. 14.10 formation …. 14.14 income splitting …. 14.24 income tax …. 14.8 interest (see Interest, tax entities)

limited partnership …. 14.34 members, changes in …. 14.27 negative limb …. 14.12 net income/loss calculation of …. 14.15–14.18 distribution of …. 14.19 overview …. 14.7 relatives and associated persons, payments to …. 14.23 returns …. 14.13 salary, partner’s …. 14.20 scheme …. 14.36 second positive limb …. 14.11 trading stock …. 14.28 uncontrolled partnership income …. 14.25 work in progress …. 14.32 Trusts (see Trusts, partnership) venture capital …. 14.34 Passive assets business of affiliate or connected entity …. 9.85 partnership, used in …. 9.86–9.88 small business entities (SBEs) and …. 9.84 working out aggregated turnover …. 9.91 Pay-as-you-go (PAYG) personal services income (PSI) …. 17.62 tax administration collection system …. 21.18 instalments …. 21.20 withholding …. 21.19 Penalties

administrative penalties …. 21.8 deduction limitations …. 12.3 interest, offences and …. 21.7 judicial penalties …. 21.9 Pensions deductions …. 11.25; 12.20 double tax agreements …. 4.79 exempt income …. 8.24 tax offsets for seniors and pensioners …. 3.40 veterans’ entitlement …. 8.26 Personal income tax distribution …. 1.8 Personal services income (PSI) alienation of …. 7.33 anti-avoidance (see Anti-avoidance, personal services income (PSI)) double tax agreements …. 4.74 ordinary income …. 6.17; 6.18 source of income …. 4.50 statutory income …. 7.33 trust income tax issues …. 14.63 Personal use assets (PUA) collectables and …. 9.36 tax treatment …. 9.30 Petroleum rehabilitation of sites …. 16.9 Petrol taxation excise duty on unleaded …. 1.5 Organisation For Economic Co-operation And Development (OECD), compared with …. 1.5

petroleum resource rent tax …. 16.10 PLANTS capital allowances …. 13.1 defined …. 13.9 depreciating assets …. 13.9 disposal of leased …. 7.29 Pooled development funds CGT exemption …. 9.38 depreciating assets …. 13.58 Precedent doctrine of …. 1.43 Prepaid expenses general …. 5.26 limitations non-SBE non-business prepayments …. 12.41 non-small business entity taxpayers …. 12.40 small business entity taxpayers …. 12.39 restrictions forestry expenditure …. 5.33 prepaid expenditure tax shelter arrangements …. 5.32 regimes …. 5.29 small business and non-business taxpayers …. 5.30 taxpayers, other …. 5.31 Primary production capital expenditure of primary producers …. 13.64 death of livestock …. 16.16 defined …. 16.14 depreciating assets …. 13.59; 16.19; 16.20

double wool clips …. 16.18 electricity and telephone lines …. 16.22 farm management deposits …. 16.25 forced disposal …. 16.16 forestry schemes, investors in …. 16.34 horticultural plants …. 16.20 income …. 16.15 investors in forestry schemes …. 16.34 landcare operations …. 16.21 livestock and timber insurance recoveries …. 16.17 loss of income …. 16.27 prepayments, timber plantation …. 16.24 primary producer averaging tax offset …. 3.50 special tax rules …. 16.13 statutory income …. 7.42 tax offset, averaging (see Tax offsets, primary production) timber deductions …. 16.23 water facilities …. 16.19 Private health insurance GST free supplies …. 19.45 surcharge …. 3.57 tax offsets …. 3.36; 3.43 Prizes exempt income …. 8.21 investment-related lotteries …. 7.49 Production associates income averaging …. 16.35 Professional practices income from …. 5.9

large professional practice …. 5.11 small sole practitioners …. 5.10 tax professionals …. 2.39 Prospecting assessable income, payments for …. 7.14 PSI (see Personal services income (PSI)) PUA (see Personal use assets (PUA))

Q Quarrying assessable income, payments for …. 7.14 deduction concessions …. 16.9

R R&D (see Research and development (R&D)) Real property double tax agreements …. 4.78 source of income …. 4.54 Rebates (see Tax offsets) Record keeping deduction limitations …. 12.44–12.46 onus of proof …. 6.47 Recoupment assessable …. 7.23; 7.24 listed …. 7.25 types of …. 7.23 Reform ethics, breaches of comprehensive income and …. 2.36 future reform …. 2.57

governments …. 2.37 optimal tax theory (see Optimal tax theory) surprise tax policy …. 2.56 tax committee inquiries …. 2.38 tax expenditures (see Tax expenditures) tax laws …. 2.50–2.55 Refunds calculating amount payable/refundable …. 3.58–3.64 tax credits …. 3.52 Registered emission units capital gains tax event …. 9.24 exemptions …. 9.39 GST-free supplies …. 19.53 residence …. 4.83 Relatives payments to relatives and associated persons …. 14.23 travel expenses …. 12.12 Religious services GST-free supplies …. 19.49 Rent accounting …. 5.8 uniform resource rent tax …. 2.25 Research and development (R&D) capital allowances …. 13.71 CGT exemptions …. 9.47 tax offsets …. 3.36; 3.49 Residence 183-day rule …. 4.23–4.26

capital gains tax …. 9.8; 9.21; 9.22; 9.50; 9.51 central management and control test …. 4.33–4.39 companies …. 4.31 domicile test (see Domicile test) emission units, registered …. 4.83 exempt income for temporary residents …. 8.6 foreign residents, taxation of (see Foreign residents) income tax liability, determination of …. 4.9 incorporation in Australia …. 4.32 individual residence tests …. 4.10–4.30 international tax …. 4.9 resides test (see Resides test) shareholder test …. 4.40–3.46 source income (see Foreign source income) superannuation test …. 4.27–4.30 Resides test ATO view …. 4.18 family, employment or business ties …. 4.13 frequency, regularity and duration of visits …. 4.15 habits and mode of life …. 4.16 nationality …. 4.17 ordinary principles …. 4.11 physical presence …. 4.12 place of abode, maintenance of …. 4.14 Restrictive covenants capital receipts …. 6.35; 6.36 Retirement savings accounts (RSAS) superannuation …. 15.41

supervisory levy …. 15.69 Returns assessable income (see Assessable income, tax returns) business and professional items schedule deductions …. 22.15 net income or loss …. 22.16 personal services income, allocation of …. 22.14 sole traders …. 22.13; 22.14 capital allowances schedule declarations …. 22.20 depreciating assets …. 22.17; 22.18 other deductions …. 22.19 partnerships …. 22.21 trusts …. 22.32 fringe benefits tax …. 22.73 declarations …. 22.76 details provided …. 22.75 return calculation …. 22.74 income tax …. 22.2 individual tax assessable income …. 22.4 credits …. 22.8 deductions …. 22.5 income tax returns, types of …. 22.3 taxable income or loss …. 22.6 tax offsets …. 22.7 overview …. 22.1 partnerships assessable income …. 22.23

credits …. 22.25 declarations …. 22.29 deductions …. 22.24 distribution of net income/loss …. 22.28 income tax return …. 22.22–22.28 key financial information …. 22.27 personal services income schedule …. 22.30 schedule 25A …. 22.31 tax offsets …. 22.26 supplementary individual income tax assessable income …. 22.9; 22.10 deductions …. 22.11 tax offsets …. 22.12 Road congestion tax Henry Review recommendations …. 2.26 Rollover relief balancing adjustments …. 13.56 replacement asset rollovers …. 9.68 reversal of …. 9.23 same asset …. 9.70 small business CGT rollover …. 9.113 Routine transactions tax consequences …. 23.2 Royalties deduction limitations …. 12.10 double tax agreements …. 4.77 resale royalty collecting society …. 8.17 source of income …. 4.57

statutory income …. 7.10 uniform resource rent tax …. 2.25

S Salary and wages accounting …. 5.6 partners …. 14.20 sacrifice, salary …. 15.20; 15.26 timing of derivation …. 14.20 Securities accrual taxation of income for …. 7.55 redemption of non-interest-bearing securities …. 7.51 traditional …. 7.50 Self-managed superannuation funds (SMSF) fund types …. 15.8 salary sacrifice …. 15.26 tax returns assessable income …. 22.65 assets and liabilities …. 22.70 audit report and declarations …. 22.72 deductions …. 22.66 income tax calculation statement …. 22.67 losses …. 22.68 member information …. 22.69 regulatory information …. 22.71 Seniors and pensioners tax offsets …. 3.36; 3.40 Shares bonuses …. 14.92

buybacks …. 14.91 capital reductions …. 14.93 CGT assets …. 9.103 CGT events …. 9.18 employee share schemes …. 7.32 pooled development fund …. 9.38 Shipping Exempt income …. 8.22 Simplified tax system (STS) accounting …. 5.14 Small business entities (SBES) active asset test …. 9.100–9.102 affiliates …. 5.62 annual turnover …. 5.61 capital gain/loss apportionment rule …. 9.122 assumption of liability …. 9.125 calculating …. 9.119 earnout rights …. 9.127 market substitution rule …. 9.121 misappropriation rule …. 9.126 net gain or loss …. 9.135 no gain or loss produced, where …. 9.134 non-receipt rule …. 9.123 proceeds …. 9.120 repaid rule …. 9.124 CGT concessions 15-year business asset exemption …. 9.110 50% active asset reduction …. 9.111

active asset test …. 9.100–9.102 aggregated turnover, defined …. 5.60 annual turnover …. 5.61 asset owned by taxpayer …. 9.79 conditions …. 9.81 death …. 9.80; 9.109 defined …. 9.82 determination …. 9.77 eligibility …. 5.58 participation percentage …. 9.106–9.108 partners in partnership, SBE and …. 9.83 passive assets (see Passive assets) retirement exemption …. 9.112 rollover …. 9.113 shares, tests for …. 9.103 significant individual …. 9.105 special rules …. 9.89 stakeholder …. 9.104 superannuation funds …. 9.99 tax concessions …. 5.55–5.57 test, aggregated turnover …. 5.59 trust, interest in …. 9.103 winding up businesses …. 9.90 connected entities …. 5.63 cost base (see Cost base, Small business entities (SBEs)) earnout rights …. 9.127 earnout rights, sale and purchases of businesses involving …. 9.117 indirect control of entity …. 5.66

maximum net asset value test …. 9.97; 9.98 restructures of …. 9.114 shares, tests for …. 9.103 special rules …. 9.115 spouse and child affiliates …. 9.92–9.96 superannuation funds …. 9.99 tax accounting rules …. 5.67 tax concessions …. 5.55–5.57 tax incentives for early stage investors …. 9.118 trading stock exemption …. 5.54 trusts (see Trusts, small business entities (SBEs)) value shifting rules …. 9.116 Social security benefit beneficiary rebates …. 3.41 interaction with …. 2.28 road congestion tax …. 2.26 Source of income apportionment …. 4.58 business income …. 4.51 defined term …. 4.48 dividend income …. 4.56 double tax agreements …. 4.53 general …. 4.47 interest income …. 4.55 natural resources …. 4.52 personal services …. 4.50 real property …. 4.54 royalties …. 4.57 types of …. 4.49

Sportspersons income averaging …. 16.35 Statutory income ITAA 1936 accruals taxation of income for financial securities …. 7.55 Australian film investment …. 7.47 beneficiaries of trust …. 7.54 dividends …. 7.52 non-cash business benefits …. 7.44 partnership income …. 7.53 prizes from investment-related lotteries …. 7.49 profit making, property acquired for …. 7.45 provisions …. 7.44–7.55 redemption of non-interest-bearing securities …. 7.51 securities, traditional …. 7.50 short-term life insurance bonuses …. 7.48 surrender of leases …. 7.46 ITAA 1997 accrued leave payments …. 7.7 balancing adjustment events …. 7.28 bonuses …. 7.21 bounties and subsidies …. 7.8 car disposal used for income producing purposes …. 7.26 car expenses, reimbursed …. 7.20 employment or services rendered …. 7.4 financial arrangements, taxation of …. 7.36 financial transactions …. 7.37 First Home Saver Account contributions (FHSA) …. 7.22

foreign currency gains and losses …. 7.43 forestry agreements …. 7.15 forestry managed investment schemes …. 7.16 franking credits …. 7.35 funeral policy benefits …. 7.18 insurance (see Insurance, statutory income, ITAA 1997) lease obligation to repair, amount received for …. 7.11 life insurance companies …. 7.40 limited recourse debt …. 7.39 luxury cars, leases of …. 7.38 meals in in-house dining facility …. 7.27 mining, quarrying or prospecting information …. 7.14 net capital gains …. 7.34 overpayments and early payments of tax, interest on …. 7.13 personal services income, alienation of …. 7.33 plants, leased …. 7.29 primary production …. 7.42 profit-making undertakings or plans …. 7.9 provisions …. 7.3–7.43 return to work payments …. 7.6 royalties …. 7.10 scholarship plan …. 7.19 share schemes, employee …. 7.32 termination payments, employee …. 7.31 trading stock …. 7.30 work in progress payments …. 7.17 overview …. 7.1; 7.56 precedence rules …. 7.2 Statutory interpretation

Acts Interpretation Act 1901 (AIA) …. 1.38 Commonwealth statutes …. 1.41 definitions …. 1.32–1.34 dictionaries …. 1.37 drafting style, changes in …. 1.40 ejusdem generis …. 1.31 extrinsic aids, use of …. 1.39 golden rule …. 1.28 intrinsic materials …. 1.35 judicial rules, other …. 1.31 legislation …. 1.42 literal rule …. 1.27 mischief rule …. 1.29 noscitur a sociis …. 1.31 precedent, doctrine of …. 1.43 principles …. 1.26 publications, legal …. 1.36 purposive approach …. 1.30 Subsidies assessable income …. 7.8 Superannuation benefits, taxation of components …. 15.54–15.56 death benefits …. 15.47; 15.51 defined …. 15.53 departing Australia payments …. 15.49 lump sum …. 15.50 member benefits …. 15.47; 15.48

rollovers …. 15.52 bring-forward arrangements …. 15.28 capital gains tax (see Capital gains tax (CGT), superannuation) contributions cap, concessional …. 15.25 deduction for employer contributions …. 15.18 deductions contributions …. 11.47 limitations (see Deductions, superannuation) defined …. 15.2 employees …. 15.20 employer contributions …. 15.17 entities, taxation of contributions included …. 15.31–15.34 deductions …. 15.38; 15.42 excluded, contribution …. 15.35 exempt income …. 15.37 ITAA 1997, modifications of …. 15.29; 15.30 other income …. 15.36 personal contributions, exclusions of …. 15.43 reporting requirements …. 15.46 retirement savings accounts (RSA) providers …. 15.41 taxable income, components of …. 15.39; 15.40 tax file numbers (TFN) contributions income …. 15.44 tax offset, no tax file numbers (TFN) …. 15.45 excess contributions, tax on …. 15.24 funds, compliance of superannuation …. 9.99 fund types accumulation benefit funds …. 15.3; 15.4 defined benefit funds …. 15.5

employer-sponsored …. 15.7 industry …. 15.10 public and private sector funds …. 15.6 retail …. 15.9 Self-managed superannuation funds (SMSF) …. 15.8 government co-contributions …. 15.22 GST concessions …. 2.20 income tax rates …. 3.55 low income contributions …. 15.23 non-concessional contributions …. 15.27 overview …. 15.1; 15.11; 15.70 residence test …. 4.27–4.30 salary sacrifice and …. 15.26 self-employed …. 15.19 Self-managed superannuation funds (SMSF) (see Self-managed superannuation funds (SMSF), tax returns) spouse contributions …. 15.21 superannuation guarantee contributions (SGC) …. 15.67; 15.68 supervisory levy …. 15.69 system benefits phase …. 15.13–15.16 investment phase …. 15.12 overview …. 15.11 tax offsets …. 3.51 trust …. 14.43 untaxed transfers …. 15.66 Surcharge liability …. 3.57 Medicare levy surcharge …. 3.22; 3.47; 3.57

superannuation contributions surcharge …. 12.21 termination payments surcharge …. 12.22

T Tax administration access to records …. 21.5 administrative penalties …. 21.8 assessment …. 21.3 audits …. 21.4 Australian business number (ABN) …. 21.16 Australian Tax Office (ATO) (see Australian Tax Office (ATO), tax administration) charter, taxpayers’ …. 21.12; 21.13 dissatisfied taxpayers, remedies for …. 21.14 Inspector-General of taxation …. 21.23 judicial penalties …. 21.9 obligations …. 21.15 overview …. 21.1; 21.28 pay-as-you-go (PAYG) (see Pay-as-you-go (PAYG), tax administration) penalties, interest and offences …. 21.7 power to amend assessments …. 21.6 public and private rulings …. 21.11 purpose …. 21.17 review rights …. 21.10 self-assessment and income tax returns …. 21.2 Tax administrators ethics …. 2.40 Taxation abbreviations …. 1.46

case citations …. 1.47 complex transactions …. 23.3–23.11 Constitutional powers (see Constitutional taxation powers) equation, income tax …. 3.3 financial arrangements …. 7.36 financial securities …. 7.55 foreign residents (see Foreign residents) future reform …. 2.57 guides …. 1.45 history …. 2.42–2.47 impact of …. 2.4 legal citations …. 1.44 overview …. 1.48; 2.58; 23.1; 23.12 reform (see Reform) routine transactions …. 23.2 sources (see Australia, sources) statutory interpretation (see Statutory interpretation) surprise tax policy …. 2.56 tunnel vision …. 23.1; 23.5; 23.12 Taxation offences anti-avoidance …. 17.63 penalties, interest and …. 21.7 Tax audits administration …. 21.4 report and declarations …. 22.72 Tax avoidance anti-avoidance …. 17.3 international tax …. 4.5 Tax burden

Organisation For Economic Co-operation And Development (OECD) …. 1.3 Tax credits cost base reduction by net input tax credits …. 9.7 excess imputation credits …. 14.6 foreign source income …. 4.69 franking credits …. 7.35 refund …. 3.52 Tax declarations audit report and …. 22.72 capital allowances schedule …. 22.20 company income tax return …. 22.58 fringe benefits tax …. 22.76 Goods and Services Tax (GST) …. 22.81 partnerships …. 22.29 trust income tax return …. 22.42 Tax entities interest (see Interest, tax entities) partnership (see Partnership, tax entities) planning …. 20.10 small business entities (see Small business entities) superannuation (see Superannuation, entities, taxation of) Tax evasion anti-avoidance …. 17.2 Black economy taskforce recommendations …. 2.34 Tax expenditures analysis …. 2.13 benefits …. 2.15 costs …. 2.14

government taxes …. 1.12 optimal tax theory versus …. 2.12 prepaid expenses forestry expenditure …. 5.33 prepaid expenditure tax shelter arrangements …. 5.32 Tax minimisation international tax …. 4.6 Tax mix government taxes …. 1.7 Organisation For Economic Co-operation And Development (OECD) …. 1.4 Tax offsets beneficiary rebates …. 3.41 carry forward …. 3.36 defined …. 3.36 dependent tax …. 3.37 dividends …. 3.48 excess imputation credits …. 14.6 family tax benefit …. 3.38 franked dividends …. 3.48 income arrears rebates …. 3.46 individual income tax return …. 22.7 invalid and carer …. 3.37 low income …. 3.39 medical expenses …. 3.42 Medicare levy surcharge lump sum arrears …. 3.47 overseas forces rebate …. 3.45 primary producer averaging tax offset …. 3.50 primary production

adjustment, averaging …. 16.33 averaging, applying …. 16.28 component, averaging …. 16.31 income averaging adjustment …. 16.26 payable, tax …. 16.32 permanent loss of income …. 16.27 rate of tax …. 16.30 taxable income …. 16.29 private health insurance …. 3.43 R&D tax incentive …. 3.49 seniors and pensioners …. 3.40 sole parent rebate …. 3.38 superannuation …. 3.51 tax incentive, R&D …. 3.49 transferable to spouse …. 3.36 zone rebates …. 3.44 Taxpayers artists, authors, inventors, sportspersons, and production associates …. 16.35 Australian film …. 16.36; 16.37 form of …. 14.1 onus of proof …. 6.47 preferences, survey of …. 2.41 prepaid expense restrictions other taxpayers …. 5.31 small business and non-business taxpayers …. 5.30 special …. 16.38 special rules …. 16.1–16.3 Tax planning

anti-avoidance …. 17.4; 20.14; 20.15 assessable income, minimising …. 20.2 averaging, use of …. 20.11 current and proposed tax changes …. 20.16 deductions claiming all …. 20.6 concessionary …. 20.7 maximising …. 20.5 prepaying expenses …. 20.8 deferring income …. 20.3 entities, use of …. 20.10 income exemptions …. 20.4 interactions with GST, FBT and superannuation rules …. 20.17 international tax concessions, use of …. 20.13 lobbying and media …. 20.19 overview …. 20.1; 20.20 record keeping and documentation …. 20.18 tax offsets …. 20.9 withholding provisions, use of …. 20.12 Tax policy Australian wine industry case study …. 2.29 criteria …. 2.5 economic efficiency …. 2.6 equity (see Equity) expenditures (see Tax expenditures) fiscal adequacy …. 2.3 optimal tax theory (see Optimal tax theory) overview …. 2.1 scope …. 2.2

simplicity, impact of …. 2.11 surprise tax policy …. 2.56 wine industry case study …. 2.29 Tax professionals ethics …. 2.39 Tax revenue government tax …. 1.11 Tax system administrators, tax …. 2.40 Australian government taxes (see Government taxes) ethics …. 2.36 evasion …. 2.34 free riders revenue costs of …. 2.30 sets of …. 2.17 Henry Review …. 2.48; 2.49 losers …. 2.32 OECD (see Organisation For Economic Co-operation And Development (OECD)) overview …. 1.1; 2.33 Simplified Tax System (STS) …. 5.14 winners …. 2.31 Theft employee or agent, deduction of loss from …. 11.23 Timber deductions …. 16.23 investors in forestry schemes …. 16.34 livestock and timber insurance recoveries …. 16.17 prepayments, timber plantation …. 16.24

Timing deductions, of …. 5.18; 5.19 derivation, of …. 5.5 income, of …. 5.3 ordinary income …. 6.4 Tobacco additional taxes on …. 2.22 Trading stock accounting …. 5.35 assessable income cease to hold, disposals when …. 5.49 cease to hold but still owning …. 5.51 compensation for lost trading stock …. 5.52 death of owner …. 5.50 ordinary course of business, disposal outside …. 5.48 sales of …. 5.47 capital costs, deductions for …. 5.53 CGT exemptions …. 9.44 closing stock, value of …. 5.41 cost …. 5.42 death …. 5.50 deductions …. 5.37; 12.27 defined terms …. 5.36 depreciating assets, exclusions from …. 13.12 disposals cease to hold trading stock …. 5.49 ordinary course of business, outside …. 5.48 goods and services tax …. 5.45

market selling value …. 5.43 ‘on hand’ …. 5.38; 5.39 opening stock, value of …. 5.40 partnership …. 14.28 replacement price method …. 5.44 small business entities exemption …. 5.54 special valuation rules …. 5.46 statutory income …. 7.30 valuing trading stock …. 5.45 Transfer pricing shift profits …. 4.85 Travel expenses business categories …. 10.64 non-business categories …. 10.37 non-deductibility …. 12.12 specific deductions capital expenditure …. 11.34 immediate travel requirement …. 11.33 place of residence …. 11.32 transport expense …. 11.31 workplaces, between …. 11.29; 11.30 Trees capital allowance …. 13.67 capital cost deductions …. 5.53 depreciating asset …. 13.9 Trust income tax returns capital gains …. 22.44; 22.45; 22.47; 22.48; 22.49; 22.51 capital losses …. 22.46 credits …. 22.37

declarations …. 22.42 deductions …. 22.36 defined …. 22.33 foreign income …. 22.35 key financial information …. 22.39 losses schedule …. 22.43 Medicare levy reduction or exemption …. 22.40 other information …. 22.52 primary and non-primary production …. 22.34 small business …. 22.50 statement of distribution …. 22.41 tax offsets …. 22.38 Trusts beneficiaries of …. 7.54 capital allowances schedule …. 22.32 capital gains tax event, CGT …. 9.16 net capital gains, trusts with …. 9.65 pooled superannuation trusts, units in …. 9.55 partnership anti-avoidance rules …. 14.61; 14.62 bare …. 14.42 closely held trusts …. 14.64 deceased estates …. 14.58 defined …. 14.37 discretionary …. 14.39 distribution deemed present entitlement …. 14.53

disability, beneficiary under …. 14.50 entitled beneficiary not under disability …. 14.48 exceptions …. 14.49 legal disability …. 14.54 minors …. 14.55 net income and tax liability …. 14.46; 14.47 no beneficiary presently entitled …. 14.51 presently entitled …. 14.52 eight-step process …. 14.35 fixed …. 14.40 formation of …. 14.44 franking credits …. 14.60 international tax …. 14.67 losses …. 14.56 net income/loss, calculating …. 14.45 personal services income regime …. 14.63 public trading trusts …. 14.67 revocable trusts …. 14.66 service trusts …. 14.59 stripping, trust …. 14.65 superannuation …. 14.43 termination or variation …. 14.57 trust stripping …. 14.65 types of …. 14.38 unit …. 14.41 unit trusts …. 14.67 small business entities (SBEs) concessions, CGT …. 9.103 discretionary trusts …. 5.65

interest in trust …. 9.103 other entities other than discretionary trusts …. 5.64 Turnover aggregated (see Aggregated turnover) annual …. 5.61 GST (see Goods and Services Tax (GST), turnover)

U Uniform resource rent tax Henry Review recommendations …. 2.25 royalties …. 2.25

V Venture capital limited partnership …. 14.34

W Wealth tax transfer of …. 2.24 Winnings gambling …. 6.13 lottery …. 6.14 Withholding tax foreign residents …. 4.82; 9.136 foreign residents capital gains withholding payments …. 21.21 pay-as-you-go (PAYG) …. 21.19 tax planning …. 20.12 Work in progress payments deductions …. 11.28

Related LexisNexis Titles Kenny & Walpole, Concise Tax Legislation 2018 Khoury, LexisNexis Case Summaries: Tax, 8th edition, 2015 Sangkuhl and Buttigeig, LexisNexis Questions and Answers: Taxation Law, 2016 Taylor, Walpole, Burton, Ciro & Murray, Understanding Taxation Law 2018