Tax Law Exam Notes
4 PRINCIPLES OF TAX
INTRODUCTION TO TAX LAW
A. Origins of Taxation
- Taxation is not a modern concept, and dates back to the Roman Empire: ▪ Emperor Caligula set a disturbing trend as a tax collector by imposing taxes on food, court proceedings, wages of porters, prostitutes and even marriage. - 1770’s ( Pitt and Lord North believed that newspapers were luxury items and constituted appropriate fiscal targets. A stamp duty was placed on newspapers, which was later increased to put newspapers beyond the purchasing power of the average person. - UK ( many early taxes were indirect taxes on consumption rather than on income - Australia Tax History: ▪ The first income tax in Australia was introduced by the SA government in 1884, with a flat rate tax imposed on income from physical exertion, property and land. ▪ Each of the Australian states followed by imposing their own taxes before and after Federation. ▪ In 1915, the Federal Government imposed its first national tax due to the pressures of the war. ▪ This led to double income taxation from the States and Commonwealth. ▪ The Great Depression in the 1930’s encouraged uniformity between the two systems and led to a Royal Commission on Taxation. ▪ Finally, the ‘Uniform Taxation Scheme’ was introduced during WW2 which gave the Federal Government the sole control of income tax.
B. The Role and Purpose of Taxation
- Taxation is primarily used by the government to generate revenue. ▪ Yuri Grbich ( “tax is a means by which the government expropriates private property without compensation.” ▪ Kay & King ( “the basic function of a tax system is to raise revenue and relieve the inequalities of income and wealth.” - Taxation is the most intrusive of all government impositions. When an individual is required to pay tax in the public interest, the laws should be as clear as possible. They are not. ▪ Evans v FCT (Connolly J) ( “there is no discernible pattern in all these taxation laws. They reveal no consistent social policy. All socially desirable objects are not tax deductible.”
C. Goals of a Good Tax System
- The main objectives of a good tax system are “equity, efficiency and simplicity.” ▪ Equity ( fairness between individuals is the primary goal, including both horizontal equity (same tax / same position) and vertical equity (different tax / different positions). ▪ Efficiency and certainty ( the system should be efficient and certain so that collection can be relied on. If the system is not certain, it is difficult to penalise those who avoid its collection. ▪ Simplicity ( the tax system should be clear and simple so that taxpayers can understand it. ▪ Adequate ( the system must generate sufficient revenue for the government ▪ Politically Acceptable ( voters must endorse, or at least comply with the laws. ▪ Economically neutral ( the system must not interfere with market forces and decisions. D. Constitutional Basis for Taxation
- The Commonwealth gains its power to tax from the Constitution: ▪ s51(ii) Constitution ( Parliament can “make laws with respect to taxation, but so as not to discriminate between States or parts of States.” ▪ ( Parliament has the power to impose taxes, but it is restricted from discriminating between States or parts of States (uniformity of taxes). - Section 53 ( the Senate shall not originate or amend laws imposing tax. ▪ ( only the House of Representatives can originate laws relating to tax collection. ▪ The Senate may return proposed tax laws to the Lower House for amendment. - Section 55 ( laws imposing tax shall deal with one subject of taxation only. ▪ This section means that laws relating to tax cannot be attached to another bill to escape the scrutiny of the Parliament. ▪ It also implies that the Income Tax Assessment Act (ITAA) does not actually impose a tax – as this Act deals with administration and other matters, it cannot impose a tax. - Section 99 ( laws cannot give preference to one State or any part thereof over another State. - The Commonwealth power to impose taxes is shared concurrently with the States: ▪ The only exclusively Federal tax power is the power to levy customs and excise. ▪ Section 90 ( the Commonwealth Parliament has the exclusive power to impose excise duties. This acts as a restriction on State powers.
➢ Uniform Tax Scheme: ▪ The States used to levy their own income taxes on residents until 1942 when, during WW2, the Commonwealth took sole responsibility for raising and collecting income tax. ▪ The enactment of 4 statutes resulted in all tax revenue flowing to the Commonwealth. This practice was upheld in the Uniform Tax Cases (SA v Cth; Vic v Cth).
E. Summary of Australian Taxes
1. Definition of ‘Tax’ - Matthews v Chicory Marketing Board ( taxation is “a compulsory exaction of money by a public authority for public purposes, enforceable at law, and not a payment for services.” - A tax is basically any compulsory taking of money from citizens for public purposes.
2. Who Levies Taxes? - Every level of government levies some form of tax. - The main taxes levied by the various levels of government include:
|Federal Government |State Government |Local Government |
|Income tax (PAYG) |Land tax |Property rates |
|Capital gains tax (CGT) |Payroll tax |Other taxes |
|Fringe benefits tax (FBT) |Stamp duties | |
|Sales tax | | |
|Goods and services tax (GST) | | |
|Customs duty | | |
|Excise duty (alcohol, tobacco, petrol) | | |
|Departure tax | | |
- There are a large number of taxes imposed on society and extracted by complex legislation. - Reducing the complexity of tax laws is a political objective requiring attention
3. Classification of Taxes - Taxes may be classified as either direct or indirect taxes: ▪ Direct tax ( these are exacted directly and are ‘visible’ to the taxpayer. ▪ Indirect tax ( these are taxes that are hidden from view. The amount of tax is usually reflected in the retail price of goods but is not obvious to the consumer.
➢ Types of Direct Taxes ▪ Income Tax ( tax on a person’s income stream, usually payable on a monthly basis as income is earned (known as the PAYG or pay-as-you-go system). Income tax accounts for over half of all tax collected by the Federal Government. Levied by the Income Tax Assessment Act. ▪ Capital Gains Tax ( tax payable on the gains made from the disposal of property. CGT forms part of the income tax statute (ITAA) and is payable on land, shares, artwork, businesses and property. CGT is applicable to assets purchased after 19 September 1985. ▪ Fringe Benefits Tax ( tax paid by employers on the value of the non-salary benefits given to their employees (eg: subsidised rent, petrol, car, education etc). FBT is levied under a separate statute – the Fringe Benefits Tax Assessment Act.
➢ Types of Indirect Taxes ▪ Goods and Services Tax ( a consumption tax paid by the final consumer of goods and services. The tax is included in the price paid. The GST imposes a rate of 10%. The GST is created under the GST Act and is based on taxing people on the wealth they consume. ▪ Stamp Duties ( taxes on documents or transactions that carry out and record the transfer of land and other assets (including leases, transfers of land or shares etc) ▪ Sales Tax ( a tax on the wholesale sale of goods made and consumed in a country. The introduction of the GST has seen Australia phase out most of its sales taxes.
4. Tax Systems - There are two main types of tax systems: ▪ Graduated tax system ( the rate of tax increases with the level of income (progressive) ▪ Proportional tax system ( income is taxed on a flat-rate (same rate of tax for all income levels). - The income tax rate structure in Australia is progressive. The company tax structure is a flat rate.
F. Tax Reform in Australia
- The Australian tax system has been criticised for its complexity and because it ‘cuts-in’ too early.
1. Tax Law Improvement Project (TLIP) - The ITAA (1936) had grown from its slim original size (110 pages with 266 sections) to thousands of pages. At last, the TLIP was brought about to simplify the tax law and rewrite the Act. - The rewrite (not yet complete) of the ITAA 1936 is called the ITAA 1997. As a result, there are two statutes on income tax. - As the new Act is written, it comes into force to replace the relevant parts of the 1936 Act. Provisions in each statute refer to the words “this Act,” thereby embracing both statutes. - The rewrite project, subsumed into the “Tax Reform Plan” (A New Tax System – ANTS) in 1998 has since stalled. For now, we live with the two statute system and the resulting complexity. - The Income Tax (Transitional Provisions) Act 1997 determines when new legislation comes into effect. The Income Tax (Consequential Amendments) Act 1997 terminates the relevant parts of the 1936 Act, as they get rewritten. The 1997 Act commenced on 1 July 1997
2. Wealth Tax - Wealth tax = a tax levied on a person’s overall wealth or net worth. This means that people are taxed on the value of (Assets – Liabilities) - The rate of taxation is low, usually between 1%-5.5% and it is collected annually. - This form of taxation is desirable in light of the inequalities of the distribution of wealth (i.e. top 1% of income earners own 9-22% of wealth; bottom 50% of income earners own 9-15% of wealth)
➢ Advantages of a Wealth Tax ▪ Tax system has greater equity as it catches amounts not taxed by income tax ▪ Provides detailed information regarding ownership of wealth ▪ Reduced concentration of wealth and produces more egalitarian distribution ▪ Tax system with no tax-exempt assets would cause investors to switch to assets generating higher returns exceeding the wealth tax rate and marginal income tax rates. This would encourage more productive use of resources and boost economic growth. ▪ Wealth tax would enable a reduction in marginal tax rates ▪ Politically favourable.
➢ Disadvantages of a Wealth Tax ▪ Discourages savings and ( reduces economic growth ▪ Results in double taxation because wealth is subject to income tax ▪ Difficult to administer – identification and valuation of relevant assets; enforcing compliance and detecting tax avoidance and evasion ▪ May cause inefficient allocation of resources by discouraging investment in enterprises where initial returns are low, but long term prospects are good. ▪ May inhibit people’s willingness to take entrepreneurial risks (not willing to start new businesses).
G. Sources of Australian Tax Law
- There are three sources of tax law: 1. Statute ( legislation passes by the different levels of government, including regulations and by-laws 2. Common Law ( case law which is created by the decisions made in the courts and the system of precedents 3. ATO practices ( a de-facto source of the law. The ATO releases periodic directions and rulings which helps shape the taxation laws.
H. Interpretation of Tax Legislation
- There are three methods of interpreting statutes: 1. Literal Rule ( give words their literal meaning 2. Mischief Rule ( a purposive approach – seek out the purpose of the legislation 3. Golden Rule ( apply the literal rule, unless that would lead to an absurdity.
1. Literal Rule - Literal rule( the court seeks to ascertain the intention of the legislature through examination of the “ordinary and natural meaning of the words as understood in their context.” - Interpretation should apply even if the result is inconvenient, improbable or produces unjust results - Rationale = it is for the Parliament, not the courts, to correct the absurdity in the legislation (this approach maintains the separation of powers between the judiciary and executive) - Adopted: ▪ FCT v Westraders (Barwick CJ) ( “it is for the Parliament to specify with unambiguous clarity the circumstances which will attract an obligation on the part of the citizen to pay tax. The function of the court is to interpret and apply the language…it is not for the court to mould the language of the statute to produce some result which might not be intended.” ▪ Cape Brandy Syndicate v IR Commissioner ( “in a taxing Act, one merely has to look at what is clearly said…nothing is to be read in, nothing is to be implied.” - Criticisms: ▪ Literal rule exaggerates the degree to which the intention of Parliament may be discovered merely from the words of a statute (eg: where a word has multiple meanings) ▪ Underestimates the degree to which the judge’s personality and value system play a part in determining the intention of Parliament ▪ Deters courts from interpreting provisions to overcome the problem the statute was intended to remedy.
2. Mischief Rule (Purposive Approach) - Mischief rule ( identifies the problem the legislation was designed to cure and then interprets the legislation to ensure that Parliament’s intention is achieved. - Where the meaning of a statute is unclear, interpretation should be based on: ▪ The state of the laws before the Act in question; ▪ The ‘mischief’ created by the existing laws; ▪ The legislative remedy which Parliament intends to cure the defect. - Adopted: ▪ Hill J & Kirby P in DFCT v Chant ▪ Hepples v FCT (Murphy J) ( court may depart from the literal meaning wherever it does not conform to the legislative intent ascertained from the provisions. ▪ FCT v Ryan (Kirby) ( proper approach is that which advances and does not frustrate the purpose of the legislature. ▪ s15AA Act Interp. Act (a construction that would promote the purpose underlying the Act shall be preferred to a construction that would not promote that purpose or object. ▪ s15AB Act Interp. Act ( court may use extrinsic material to interpret the intent of the provisions (eg: explanatory memoranda, second reading speeches, law reform reports). - Criticisms: ▪ Judges are effectively rewriting the legislation by implying words which may not be intended ▪ No separation of powers ▪ There may be disagreement as to the mischief to be remedied.
3. Golden Rule - The golden rule has been suggested as a rule which could provide a ‘happy medium’ between the two approaches. - Golden rule ( the court should apply the literal meaning of the words unless that meaning “would lead to some absurdity, or some repugnance or inconsistency with the rest of the instrument.” - This rule is therefore modified to overcome any absurdity arising from a literal interpretation. - Adopted by Mason & Wilson JJ in Cooper Brookes (Wollongong) v FCT - Criticisms: ▪ This is a subjective approach – different judges may disagree on whether the result is absurd ▪ Difficult to know what is an acceptable level of deviation from the literal interpretation.
TAX ADMINISTRATION
A. Role & Function of ATO
1. Collection of Taxes - The Australian Taxation Office (ATO) administers our income tax system. - The Department is led by the Commissioner of Taxation. - The day-day-to day activities are carried on by local branches of the ATO, headed up by the Deputy Commissioner. - Under PAYG, income is withheld from employees before they receive it and is paid to the Commissioner of Taxation (this replaced the PAYE system).
2. Self-Assessment Process - Self-assessment ( each financial year, individuals and entities fill in a tax return and make a calculation of the amount of tax owed. - These returns are accepted at face value by the ATO - Tax payers are entitled to a refund for overpayment or are liable for the shortfall - Computer systems are used to cross-check data.
3. Tax File Number (TFN) System - This is the first item on the tax return ( it allows for matching of data by government departments. - The TFN is to be quoted when: ▪ an employee wants an employer to deduct PAYG payments; or ▪ a return is received on investments and don’t want company to deduct tax at the highest rate.
4. Tax Assessments
a) General Assessments - s161 [ITAA 36] ( every person must lodge a return of yearly income with the Commissioner. - s174 ( Comm’r must issue an assessment notice as soon as convenient after assessment is made. - s177 ( the assessment notice is conclusive evidence if the making of the assessment. - s170 ( the Commissioner may amend the notice at any time
b) Default Assessments - s167 [ITAA 36] ( a default assessment may be made where: ▪ a person does not furnish (supply) a return; or ▪ the Commissioner is not satisfied with the return furnished; or ▪ the Commissioner believes that not all taxable income has been disclosed. - The Commissioner will assess an amount upon which he believes income tax should be levied – - This amount is deemed to be the taxable income for the purpose of s166. - The Commissioner often relies on assets betterment or an accretion of assets statement or t-account basis (assets betterment used in McCauley v FCT & Allard)
c) Nil Assessments - Where the Commissioner deems your tax liability to be nil, you may still be liable to tax ➢ Ryan’s case: - Facts: ▪ Comm’r issued nil assessment notice in error. ▪ Realised mistake during audit & issued another assessment notice, but 4 years later (out of time). - Issues: ▪ Whether the first notice was a Notice of Assessment and the new one an Amended Assessment, in which case the second notice was invalid because it was out of time (> 3 years); or ▪ Whether the second notice became the original Notice of Assessment, in which case time only started running on its issue ( taxpayer still liable. - Decision: ▪ FCA ( first notice was the Assessment Notice, even if it said ‘nil’ due to the need for finality ▪ HCA ( the first notice was not an Assessment Notice. An Assessment Notice requires an assessment of some value from which the 3 year period can operate. Certainty and finality are not principles of the tax system ( cannot be used to justify the decision. Noted provisions of Tax Act to give a formal assessment (may have been different result if formal assessment given)
5. Post-Assessment Procedures
a) Audits - Audit ( each year the ATO will select a small number of returns for analysis and review. - There are different types of audit: ▪ Desk audit – when a person is invited to attend an interview at the ATO office ▪ Complex audit – for larger corporate taxpayers ▪ Business audits – for other businesses. - Audits are conducted at random although certain taxpayers may be singled out for anti-tax performance or reported cases. - N.B. GFC has cause ATO to target people with capital assets who might look to write off their capital losses as losses in revenue.
b) Penalties and Interest - Interest rate if the general interest charge rate - Administrative penalties ( TAA 1953 (Sch 1 Div 284 – 288) for additional or penalty taxed (new regime from 1 July 2000) - Judicial penalties ( TAA 1953 (ss8A – 1313C) where taxation offences are created & persons are prosecuted - Publicity is used for deterrence - Taplin v Pickford ( “there is a very real prospect that, if the total levels of penalty are not such to render it extremely unprofitable for individuals to cheat on their fellow citizens, the system could either break down or become extremely difficult or expensive to administer.”
c) Burden of Proof - Burden is on the taxpayer - s14ZZK [TAA 53] ( on application for a review, the applicant has the burden of proving that the assessment was excessive. - s14ZZO ( in an appeal to the Federal Court, the applicant has the burden of proving that the assessment was excessive
B. ATO Powers – Accessing Information
- s262A [ITAA 36] ( TPs carrying on a business must keep sufficient records in English for 5 years - s8L [TAA 53] ( it is an offence to keep records in a way that does not correctly explain matters - The ATO may access information via a two-step process: ▪ Step 1 – rely on CL right to ask taxpayer for information; ▪ Step 2 – rely on statutory power to gather information - Rationale = the Comm’r is given this power because income tax is the principal source of revenue for the government and systems to elude tax are notorious (common) (Grant v DFCT)
1. Accessing Books & Documents (s263) - s263 [ITAA 36] ( the Comm’r can have “full & free access to all buildings, places, books, documents and other papers” for any purpose of the Act.
➢ Authorisation - s263(2) ( investigator cannot enter or remain on premises if written authorisation is not produced when requested by the occupier ▪ FCT v Citibank ( wallet authorisation is sufficient - But: if no authorisation is requested, officer is entitled to stay as a CL invitee.
➢ ‘Full Access’ - Citibank ( “Full access” means access to whole of premises + can make copies of any books, docs or papers (but no power to seize) - Industrial Equity v DFCT ( may go on a ‘fishing expedition’ if are acting for a proper purpose; being one of top 100 companies was enough, despite no suspicion they were doing anything wrong. - JMA Accounting ( emails and documents downloaded from a computer in bulk without reference to relevance was an abuse of power. But, selective seizure of docs after determining relevance is ok. Didn’t know which docs needed, but held in FC that was acting beyond scope of powers.
➢ ‘Free Access’ - Citibank ( “Free access” conveys an absence of physical obstruction. - s263(3) ( occupier must provide officer with all reasonable facilities and assistance (ie: power, lights, photocopying, telephone, computer passwords), ▪ Kerrison v FCT ( Commissioner can seek access using reasonable force (not excessive force) ▪ But: s263(3) requires Comm’r to seek assistance before resorting to force.
➢ General Citibank Principles - FCT v Citibank (French J) ( ATO has wide and unfettered powers: ▪ No prior warning is required; ▪ Cannot remove documents but can make copies ▪ Wallet authority required, but only if asked ▪ Principles of natural justice do not apply ▪ Can go on a ‘fishing expedition’ ▪ Occupier* must provide reasonable facilities and assistance ▪ Can use reasonable force to access documents ▪ Privilege against self-incrimination does not apply; legal professional privilege applies
* N.B. Occupier not defined ( would the cleaner fit in under this?
June 1998 – 37 ATO’s showed up at Citibank, looking for offshore tax avoidance scheme, but actually took far more than this – some had permits, some did not. Citibank tried to claim client privilege. While don’t need to give warning etc, do need to give you opportunity to claim LPP.
2. Requiring Evidence (s264) - s264 [ITAA 36] ( the Commissioner may, with written notice, require any person: ▪ to furnish information ▪ to attend meetings and give evidence ▪ to produce books or documents. - This section applies to ‘any person’ – ie: accountant, tax agent, company director etc. ➢ Obligation to Furnish Information: ▪ Officer may require any person to furnish relevant info as required (( fishing expedition ok) ▪ Only those documents in the person’s custody or control must be produced ▪ Smorgon v FCT ( info is not limited to evidence regarding a particular person’s income or assessment and may be used by the Commissioner to perform any of its functions under the Act ➢ Obligation to Attend Meetings & Give Evidence: ▪ Officer may require any person to attend meetings and give evidence ▪ The notice only has to specify that the evidence required concerns the assessment of a person ▪ Examination must be carried out in private. ➢ Obligation to Produce Books & Documents: ▪ Only those books and docs in the person’s custody (possession) or control need to be provided. ▪ Notice must specify the documents with reasonable particularity (FCT v Smorgon) + the person whose income or assessment is in question (Clarke v DFCT)
- Challenging a Notice ( a s264 notice may be challenged if it was invalidly issued, invalidly drafted (The person in question(taxpayer) as well as who this letter is aimed at) or invalidly served - Time period ( notice must permit the taxpayer a reasonable time to comply (DFCT v Ganke)
3. Legal Professional Privilege (defence) - LPP may be used as a defence to allowing access to documents. - There are two limbs to LPP: ▪ (1) – confidential communications passing between solicitor and client for the dominant purpose of giving or receiving legal advice; or ▪ (2) – communications brought into existence for the dominant purpose of use in existing, or preparation for anticipated, litigation.
- Esso v CoT ( documents with several purposes can still be privileged as long as the dominant purpose is the giving and receiving of legal advice - FCT v Citibank ( officer must allow the occupier a meaningful opportunity to examine the docs under question and assert privilege. Courts said still could be privilege in this case, but either way, at the very least such a privilege should be permitted to be claimed at the very least. - Allen Allen & Hemsley ( documents which merely evidence a transaction are not privileged (ie: law firm trust accounts are not privileged as they do not concern the giving of legal advice). - Macedonia v FCT ( a solicitor’s file to an accountant was privileged but no privilege attached to a letter from a taxpayer to an accountant. - Comm’r AFP v Propend Finance ( a copy of a doc may be privileged even if original is not.
4. Other Privileges
➢ Accountants’ Concession - Chapter 7 Access Manual ( documents prepared by external professional accounting advisors independent of the taxpayer are afforded an administrative privilege. - Rationale = allow taxpayers to consult with professional accounting advisors on a confidential basis to enable full and frank discussion in respect of their rights and obligations under taxation laws - The privilege was confirmed in ONE.TEL Ltd v DCT and Deloitte Touche & Tohmatsu v DCT.
➢ Corporate Board Documents on Tax Compliance Risk - PS LA 2004/14 ( corporate board documents created by advisors (in-house or independent) for sole purpose of providing advice to the Board on tax compliance risk are afforded an administrative privilege.
5. Sanctions - Div 149 Criminal Code ( it is an offence to obstruct, hinder, intimidate or resist a public official ▪ Obstruction = physical resistance, locking a room or cabinet, hiding the key, untruthful answers to relevant questions (Case 2/2003) ▪ Hinder = to interfere with for the purpose of delaying a person - s8X TAA ( penalty for an individual is $2,000 and/or 6 mnth imprisonment; penalty for a corporation is a fine of up to $10,000.
C. ATO Obligations – Confidentiality
- s16(2) [ITAA 36] ( duty to observe secrecy: ▪ Officers shall not make a record of, or communicate to any person, any information required by them in the course of their duties respecting the affairs of another. ▪ Applies during and after employment - Consolidated Press Holdng v FCT ( s16 is designed to ensure that officers of the ATO maintain secrecy regarding the affairs of taxpayers. ▪ It is necessary to balance the interests of taxpayers privacy vs. administration of government business. - An injunction may be sought to stop a breach of s16 (eg: to prevent a newspaper publishing info) - s8XB [TAA 53] ( prohibits communication of private tax info obtained in breach of the tax laws.
D. Taxpayers’ Rights
➢ Taxpayers’ Charter - The Taxpayers’ Charter in Australia was developed by the ATO after wide consultation. It applied from 1 July 1997. - The Charter outlines: ▪ The rights for taxpayers when dealing with the tax office ▪ The service and standards that taxpayers can expect of the ATO ▪ Tax obligations ▪ Information and remedies available if a taxpayer is dissatisfied with a decision or action of the ATO
- Taxpayers’ Rights ( taxpayers’ have the right to expect the ATO to: ▪ treat them fairly & reasonable ▪ treat them as being honest in tax affairs unless act otherwise (ie. system of self-assessment) ▪ offer professional service & assistance to help them understand & meet tax obligations ▪ accept that can be represented by a person of choice & get advice about tax affairs ▪ respect privacy (ie. complying with the Privacy Act in collecting information) ▪ keep info hold confidential in accordance with the law ▪ give them access to info held in accordance with the law ▪ give them reliable advice & info ▪ explain the decision made about their tax affairs ▪ respect their right to a review ▪ respect their right to make a complaint ▪ administer the tax system in a way that minimises their costs of compliance ▪ be accountable
- Taxpayers’ Obligations ( taxpayers’ have an obligation to: ▪ be truthful & honest in dealings with ATO ▪ keep records in accordance with the law ▪ take reasonable care in preparing tax returns & other documents ▪ lodge tax returns & other required documents by the due date ▪ pay taxes & other amounts by the due date ▪ be cooperative in dealings with ATO
➢ Taxation Ombudsman - Ombudsman = public official appointed by the Cth govt - May investigate most complaints relating to tax administration & recommend that the Tax Office provides a solution or remedy to your problem - Role ( to investigate any action which “relates to a matter of administration” by a Cth government department or prescribed authority
➢ Inspector-General of Taxation - Office is for disgruntled taxpayers to air their concerns - Inspector-general reports to Parliament annually - Focuses on the way the office administers the tax system
E. Appeal to the Courts
➢ Onus of Proof - s14ZZK; s14ZZO [TAA 53] ( a taxpayer who disputes the assessment bears the onus of proving that the assessment was excessive. - The Commissioner does not have to show that the assessment was correct.
➢ Objections - s14ZW [TAA 53] ( taxpayers’ who wish to challenge an assessment must do so in writing within 4 years after the notice of assessment. - s14ZW(2),(4) ( taxpayer may apply for an extension of time and may apply to AAT if dissatisfied with the decision.
➢ Choice of Forum - Taxpayers’ may appeal to either the AAT or Federal Court (FCA): ▪ AAT ( appeals are either to the Small Taxation Claims Tribunal where the amount in dispute is less than $5,000 (s24AC AAT Act) or General Tax Division (s24AD AAT Act) ▪ FCA ( can only review errors of law - AAT ( can review the entire matter, including the exercise of any discretion, but limited remedies - FCA ( can only review matters of law; bound by rules of evidence; more remedies.
RESIDENCE – JURISDICTION TO TAX
A. International Aspects
1. Australia’s Jurisdiction to Tax - Each nation is ‘fiscally sovereign’ – ie: it makes its own tax rules. - Australia can tax individuals who are beyond its territorial boundaries - Two principles are taken into account when deciding what to tax ( (1) residence; (2) source
2. Double Tax Agreements - Australia has entered into Double Tax Agreements (DTA) with various countries. - The purpose of a DTA is two-fold: ▪ To avoid double taxation of income flowing between two countries; and ▪ To prevent tax evasion through close cooperation between the laws of two jurisdictions. - The following are examples of Australia’s Double Tax Agreements: ▪ Art 17 OECD Model Double Tax Agreement ( income derived by athletes, entertainers and musicians is taxed where the income is sourced (in the country where the contract is made) ▪ Art 7 ( business profits of athletes are taxed in the country of residence ▪ Art 12 ( royalty income is taxed in the country where it is earned at a maximum of 10% and the athlete gets a tax credit for that tax when he is taxed in his own country.
3. Source of Income - Under the ITAA 36 & 97, the source of income is important in determining tax treatment: ▪ Income sourced in Australia ( residents + non-residents are taxed in Australia. ▪ Income sourced overseas ( only residents are taxed.
4. Temporary Residence – Temporary residents’ income from foreign source is non-assessable, non-exempt: s768-910(1) ITAA97. – Foreign investment income also non-assessable, non exempt: s768-915
5. Dual Residence - Dual residence arises if two countries apply different residency tests. - The effect of dual residence is that a person may be taxed in more than one jurisdiction ( relief may be obtained under Double Tax Agreements (DTA) - Individuals ( DTA’s give priority to the State where the person has a permanent home. - Companies ( DTA’s assign residency to the State where the company has its place of effective management (also look at State of incorporation)
B. Residence
- It is essential to know whether an entity is an Australian resident for the purposes of determining whether Australia has the jurisdiction to tax that entity. - s995-1 [ITAA 97] ( resident = a person who is a resident of Aust under s6 [ITAA 36]
➢ Jurisdiction to Tax - Australia has jurisdiction to tax: ▪ Australian residents on income from all sources; ▪ Non-residents on income sourced in Australia.
|Individual – 4 tests |Company – 3 tests |
|Ordinary Concepts |Incorporated in AUS |
|Domicile |Carrying on business and Central Mgmt in AUS |
|183 Day Rule |Carrying on Bus and voting control in AUS |
|Superannuation | |
1. INDIVIDUAL RESIDENCY
➢ TEST #1 – Residence According to Ordinary Concepts - Test = you are a resident at CL if you intend to ordinarily reside in Australia – ie: ‘reside’ is to be given its ordinary meaning (TR 98/17) - Reside means ‘to dwell permanently or for a considerable time or to have one’s settled abode’ (Levene v IRC) - Q: Was the TP’s behaviour consistent with an intention to reside in Aust? (Levene; Lysaght) 1. Physical presence during the income year (Appelgate; Miller); ▪ FCT v Miller ( residence is ‘where a man eats and sleeps’ 2. Duration, frequency and regularity of visits (Pechey): ▪ If a person was previously a resident – frequency of visits need not be substantial ▪ If a person was not previously a resident – short or temporary visits will not be sufficient 3. Maintenance of a place of abode in Aust during absences (Rogers v IR) 4. Family, employment and business ties – esp. relevant to previous residents (Levene) 5. Present habits and mode of life – look for a break in habits. 6. Nationality (Crocket Born UK, Aus citizenships – didn’t renounce either so got work in UK since couldn’t in Aus re: air controlling. Despite not satisfying tests the fact he became cit meant he could be deemed resident) (but only important in borderline cases – Levene)
- IF a resident ( do not have to look at Tests 2, 3, 4 (already subject to tax) - IF not a resident at CL ( look at Tests 2, 3, 4 ➢ TEST #2 – Domicile Test - Test = you are a resident in Australia if your domicile is in Australia, unless your permanent place of abode is outside Australia. - Henderson; Udny ( your domicile is where you are born (origin) until there is an intention to fix a permanent residence in a new country (domicile of choice)
Permanent Place of Abode (PPA) - Nb: only relevant if an Australian is leaving the country. - A person who establishes a PPA abroad will not be a resident of Aus and will not be taxed in Aust. - Applegate ( lawyer transferred indefinitely to Vanuatu; gave up lease on unit; no assets in Aus; leased premises abroad; intended to return to Aus at some future point; returned home ill after 2 years ▪ H: PPA was in Vanuatu even though domiciled in Australia – a person can have a PPA abroad without intending to live in that place forever (Franki J). - Jenkins ( banker transferred to Vanuatu for 3 years fixed with possibility to extend; rented out home; stored furniture; retained bank account; lived in bank-owned house; returned home ill. ▪ H: a fixed duration overseas did not mean it was temporary. Three years was sufficient to establish a PPA outside Aust. - Case T28 ( accountant left Perth and went to London; owned apartment for 1 year; rented home in Perth; travelled and returned home; re-commenced working for Perth firm; claimed non-resident. ▪ H:UK resident due to durability of residence + intention to abandon Aust. - IT 2650; Applegate ( 6 factors to determine if a person ceases to be a resident: 1. Intended and actual duration overseas ( leaving for an unspecified or substantial period is likely to indicate a PPA overseas (two or more years is sufficient – Jenkins) 2. Establishment of a home outside Australia ( more than temporary accommodation overseas. 3. Durability of association with Aust ( maintenance of bank accounts, children’s education 4. Intention to return to Australia ( will generally remain a resident 5. Abandonment of any Australian residence 6. Continuity of presence overseas
➢ TEST #3 – 183 Day Rule (184-day rule for leap years)
- Income year = 183-day threshold is determined by reference to income year (1 July – 30 June) ▪ Where a person’s presence in Aust straddles two years of income, apply the test to each year. ▪ Presence need not be continuous – ie: can aggregate several periods during the year. ▪ Calculate presence in hours and minutes if necessary (Wilkie v IRC). - Usual place of abode = means something less than a permanent place of abode (Appelgate)
➢ TEST #4 – Superannuation Test
2. RESIDENCE OF COMPANIES - s6(1)(b) [ITAA 36] ( a company is a resident of Australia if: 1. It is incorporated in Australia; or 2. Carries on business in Australia and has its central management and control in Australia; or 3. Carries on business in Australia and has its voting power controlled by Australian residents
➢ TEST #1 – Incorporated in Australia Test - The formal act of incorporation in Aust confers Australian residence (Esquire Nominees) - This is the case regardless of where the company’s central management and control is located b/c it is the State that confers legal personality ( should be entitled to tax the worldwide profits.
➢ TEST #2 – Central Management & Control Test
- Malayan Shipping Co ( if central management and control is in Australia, then ipso facto it must be carrying on business in Australia - De Beers case ( central management and control is usually located at the place where the directors exercise their powers of management.
More than one place of management: - Koitaki’s case ( if there is more than one place of management, central management is where the ‘superior or directing authority is located, as opposed to the place of day-to-day operations’ ▪ H: office registered in PNG; rubber consigned (shipped) to Sydney & sold in Australia; profits went to Sydney co; directors met & lived in Sydney; Australian shareholders. H: Aust resident. - Unit Construction v Bullock ( wholly-owned subsidiary was incorporated in Kenya with registered office in Nairobi. Parent co was incorporated, managed & controlled in UK. ▪ H: subsidiary was a resident of UK b/c managed and controlled in UK (Substance test) - Esquire Nominees ( co was incorporated in Norfolk Is; directors were residents of NI and meetings held in NI. Agendas prepared by Australian Accountants acting on behalf of Australian residents who were the beneficial owners – H: resident of Norfolk Island. (Form test).
➢ TEST #3 – Voting Power Test
- Koitaki’s case ( business was carried on in Australia (rubber consigned to Sydney & sold in Australia) + Australian shareholders. H: Aust resident. - Patcorp ( shareholder = person entered on register of members or entitled to be registered
3. RESIDENCE OF OTHER ENTITIES ➢ Trusts - Apply the same rules for individuals or companies, depending on the nature of the trustee; or - Central management and control in Australia Test (same test as for companies)
➢ Partnerships - Do not pay tax – only the individual partners pay tax. C. Source of Income
1. Meaning of “source of income” - Nathan ( source of income is a question of fact. - The ITAA does not define source ( give it its ordinary meaning. - s995-1 [ITAA 97] ( ‘Australia source’ means income derived from a source in Australia. - To determine the source of income, consider the following factors: ▪ The location of the prime income-earning activity or structure; ▪ Where the contract is made; ▪ Where the payment is made; ▪ Where funds come from, which payments were made, location of customers paying - FCT v French ( an engineer worked in NZ on a film for 17 days; salary paid in Sydney. ▪ H: source was where the ‘personal exertion’ (activity) took place (source = NZ) - FCT v Mitchum ( performer acted in Australia for 7 weeks; worked on a film; received income of US 50,000; contract signed outside Australia. ▪ H: source of income is where duties are performed. If they are performed in more than one place, then the source will be apportioned (divided) between the two places.
2. Source Rules - The following table summarises a person’s tax liability.
| Source |Resident |Non Resident |
|Inside Australia |Pay tax in Australia |Pay tax in Australia |
|Outside Australia |Pay tax in Australia |No tax |
|Class of income |Source |
|Disposal of trading stock |Place where K of sale entered into (st sec 38 – 43 ITAA36 which deems Aust source + DTA's where |
| |concept of permanent establishment overrides domestic source rules for business profits of |
| |non-residents) |
|Disposal of property other than trading stock |Place where K of sale entered into, st special rules for shares (ie. where operations occurred) & |
| |real estate (ie. location of property) |
|Services |Place where services are performed (usually) |
|Interest |Place where loan K entered into or the obli to pay interest arises |
|Dividends |Place where profits were made |
|Royalties |Where pmt is an outgoing of an Aust business, any royalties derived by non-resident deemed to have |
| |been sourced in Aust (s6C). Otherwise, source is location of IP from which it flows |
3. Why is source important? - According to the Foreign Tax Credits Act 1986, source is important for a variety of reasons: ▪ Unless you tax at its source, the government may miss out; ▪ Taxable at source is justifiable on the basis of benefit; ▪ Non-residents taxed only on income sourced in Australia ▪ Double tax treaties rely on source ▪ Foreign tax credit (allows credits for tax paid elsewhere)
INCOME
A. Income – An Introduction
- s4-1 [ITAA 97] ( income tax is payable by each individual and entity. ▪ Assessable Income = all income according to ordinary concepts (‘ordinary income’) ▪ Taxable Income = assessable income less allowable deductions. - s6-1 ( income includes ordinary and statutory income. - s6-15 ( an amount which is not ordinary or statutory income is not assessable.
➢ Ordinary Income - s6-5 [ITAA 97] ( ordinary income is income according to ordinary concepts – this is not defined in the Act ( must look at the Common Law. - Ordinary income is income which comes from income-earning activities (eg: salaries and wages) - TEST = ordinary income is income which results from services, or an incident of employment or is the product of personal services.
➢ Statutory Income - Provisions of the tax legislation deem certain receipts to be income (eg: capital gains). - ( even though a receipt may not appear to be ‘income’ on its face, the legislation has the effect of deeming that receipt to be income (eg: royalties – s15-20)
B. Characteristics of Income
- It is necessary to distinguish income (taxable) from non-income receipts and capital (non-taxable). - Scott’s case ( income is to be determined by the ‘ordinary concepts and usages of mankind.’
1. Illegal Activities - Partridge v Mallandaine ( “the illegality of a vocation (career) does not exempt you from tax.” - s6-5 [ITAA 97] ( assessable income includes income derived directly or indirectly from all sources (( illegal profits are still taxable). - Mann v Nash ( Comm’r only looks at what your income is, not how you made it. - No. 275 v MNR ( a prostitute was held to be sufficiently commercial, active and devoted to her calling ( income was assessable. - Taxable Review Authority No. 17 ( heroin dealer could be taxed on their illegal returns. - La Rosa ( drug dealer was given a default assessment of $220,000. L said that he hid the money in the garden and its was stolen. Attempted to claim it as a deduction for a business loss. ▪ H: Entitled to the deduction – purpose of Tax Act is to tax income, not to punish wrongdoings!
C. Income vs. Capital
- Income tax is levied on income, not on the gains on capital or capital receipts, unless the Act provides. - The Tax Act does provide for taxing of capital gains and the regimes (systems) for taxing income and capital are different. - The distinction between income and capital is important because a person may wish to class a receipt as capital to receive tax advantages.
➢ What is ‘Capital’?
1. Apportionment of lump sum compensation payments - Generally ( compensation payments take their character from that for which they compensate. - McLaurin v FCT: ▪ For liquidated settlements or amounts ascertainable by calculation ( a single receipt may be apportioned amongst the heads to which it relates as either income or capital. ▪ For unliquidated settlements or single, undissected sums ( the amount is treated as capital - Spedley Securities ( Santos engaged Spedley for a loan but terminated after intro of adverse legislation. Spedley was concerned about damage to reputation as a new financier, but accepted lump sum settlement, substantially less than the commission which would have been received under K. ▪ H: The compensation was unidentified, but included revenue and capital amounts (loss of reputation/ goodwill). There was no basis for apportionment (unliquidated) ( entire capital sum.
2. Compensation for cancelling business contracts - Generally ( amounts received for the cancellation of ordinary business contracts are income and ( are assessable (Short Bros v IRC) ▪ Heavy Minerals case ( four mining contracts were cancelled; £250,000 paid in compensation. H: money received was income because it replaced the profit that would have been received. - Exception ( receipts will be capital in nature where they arise out of a cancellation of a contract affecting the fundamental structure of the business or result in the permanent loss of a fixed asset: ▪ Van den Bergh’s case ( agreement between UK and Dutch suppliers of margarine was terminated during the war. Dutch company paid slightly higher compensation to UK company, but could dictate the terms of operation of business. H: compensation was capital because it affected the working of the business. ➢ Agency Contracts - Termination of entire business ( where the cancellation of an agency contract results directly in the termination of the taxpayer’s business, the compensation received will be capital in nature. ▪ California Oil Products ( agent was exclusive distributor of oil. Contract was terminated and received compensation. H: compensation was capital because taxpayer was an exclusive agent - But: where compensation is paid for the cancellation of one among several agency contracts, the compensation will usually be treated as income. ▪ Allied Mills case ( manufacturer & distributor had their manufacturing contracts cancelled. Compensation paid. H: this was income replacing lost profits, not loss of exclusive business.
3. Compensation for sterilisation of an asset - Generally ( compensation received for the permanent sterilisation of an asset is treated as capital ▪ Glenboig Union Fireclay v IRC ( compensation paid to forgo mining rights near railway was treated as capital because the agreement permanently sterilised the asset. - Exception ( where an income-producing asset is temporarily disabled, compensation received will be treated as income: ▪ Burmah Steamship Co v IRC ( compo for delayed ship repairs was treated as income.
4. Profits from disposal of assets - Generally ( profits from the realisation or sale of an asset will be treated as capital – ie: the ‘once and for all’ test states that one-off, lump-sum receipts are capital - Exceptions ( if the gains on the sale of an asset constitute ‘business proceeds’ they will be income ▪ AGC Investments ( “profits made on the realisation of assets will be income where the investments are acquired as part of a business + there was an intention to make a profit.” - Myer Emporium ( M made a loan to a finance co and assigned the interest to Citicorp. Citicorp returned the money to M as a capital receipt. M argued that it was a once-off, lump sum payment. ▪ H: the income was received in ordinary course of business. The fact that it was a one-off transaction was not decisive (sufficient). The money receipt was for interest that would have been received (replacement principle). - Whitfords Beach case ( land developers bought a company that owned beach land; company was originally established by fishermen who wanted to live near the beach; new owners rezoned and subdivided the land and sold for large profit. ▪ Company argued that it was just a one-off venture and were just realising the property up to its maximum value ( profits were capital in nature. ▪ H: income – one-off transaction was not decisive; the large scale of the activity meant that the company was carrying on a business.
5. Insurance recoveries (loss of trading stock) - Generally ( insurance payouts are regarded as income because they are replacing income. - s15-30 [ITAA 97] ( an amount received under insurance for any loss of trading stock is income. ▪ Gliksten’s case ( fire destroyed timber at a timber merchants. Received insurance payout. H: compensation was income as the fire turned the timber into cash. - Carpark Holdings v FCT ( life insurance was paid when company director died in an accident. ▪ H: money received was income as it replaced dividends the director would have received from the company if he had remained alive. - DP Smith ( doctor took out permanent disability insurance cover and was injured in a car accident. Doctor received monthly insurance money and claimed the payments as deductions. ▪ H: payments were income as they replaced earnings ( could claim deduction - Somner v FCT ( income replacement insurance policy was taken out. Received payout as a lump-sum instead of regular payments. ▪ H: the lump-sum was income because it replaced an income stream, despite being a lump-sum.
6. Restrictive Covenants - Generally ( restraint of trade clauses to give up a substantial ‘sphere (amount) of activity’ which would otherwise be open are usually capital (Dickenson v FCT) ▪ Nb: the restraint of trade clause must restrict the taxpayer’s right to earn income and not be merely money paid in lieu of an income stream. ▪ Higgs v Olivier ( Sir Laurence Olivier was paid £15,000 in return for him agreeing not to act in any other film for 18 months. H: consideration paid was capital in nature. - Exception ( a restrictive covenant will be income if it is recurring or does not restrict the taxpayers’ right to earn an income. ▪ Case R107 ( acceptance of a sign on fee by a professional athlete is just a normal incident of employment ( income. ▪ c/f: Jarrold v Boustead ( amateur athlete turned professional received sign-on fee – H: capital receipt because it was compensation for giving up amateur status.
7. Payments for knowledge or know-how - The issue is whether payments for secret information and knowledge is classed as capital or income. - In order to determine whether a receipt is capital or income, one must apply the normal criteria for assessing income, such as whether the receipt is a regular payment. - Generally: ▪ If a business is selling the actual trademark ( this will usually be capital because the whole entity is being sold. ▪ If a business is only granting the right to use information ( this will usually be income. - Rolls Royce v Jeffery ( RR licensed its manufacturing knowledge to other companies who paid a lump sum amount + royalties in return. RR argued the payments were capital and not subject to tax. ▪ H: the payments were income, despite being called capital receipts. There was no degree of permanence as RR was merely granting a temporary licence.
8. Lease Incentive Payments - Generally ( a lease incentive payment is classed as income - FCT v Cooling ( a developer paid $160,000 to a partner in a law firm as an inducement to set up an office in the building. ▪ H: lease incentive payment was income, even though just a one-off transaction. - CT v Montgomery ( law firm in Melbourne had asbestos (poison) lining and moved offices, motivated by an incentive payment of $29.3m. ▪ H: lease payments were income – because the significant purpose was profit making.
9. Taxation of Damages Awards - When assessing damages awards, the impact of tax must be taken into account: ▪ BCT v Gourley ( a damages award which was not subject to tax was reduced by the court to prevent the recipient getting a windfall gain (unexpected bonus) (Cullen v Trappel in Australia) - s15-30 [ITAA 97] ( an amount received as compensation for loss will be treated as income. ▪ Gin v Australian Wheat Board ( as compensation is subject to tax, the full amount of the loss should be awarded, not just an after-tax amount. - Settlement of a claim: ▪ If a lump sum is received as settlement before court ( this is treated as a capital gain (s108-5) as the person has given up their right to seek compensation and has disposed of this ‘asset’ ▪ But: settlement of a claim relating to a personal injuries, profession or vocation (eg: sexual harassment), are exempt from capital gains tax.
D. Income from Personal Services
1. General Income - The first item of income from personal services are receipts from employment – these include: ▪ Salaries and wages; ▪ Payments to independent contractors; ▪ Fees paid to professional persons. ➢ TEST = receipts will be classed as income if: ▪ They are made periodically and regularly; ▪ They are relied on to meet regular living expenses; ▪ The payment is connected to the performance of services; ▪ The payment is a substitute for any income; ▪ The intention of the donor (but this is not decisive) - Nb: all of these factors must be weighed up to determine whether the receipt is personal services income.
2. Gifts in Gratitude - Generally ( a mere gift on personal grounds is not income. - TEST ( a gift will be income if it is expected and is received regularly and periodically in connection with employment (Dixon; Squatting Investment Co v FCT) - Nb: a gift is more likely to be income when: ▪ It is solicited (asked for) by the recipient (Hayes v FCT) ▪ It is repeated, periodic and regular ▪ The recipient relies on the gift for their families day-to-day existence (Dixon; Blake) ▪ It is incidental or a product to employment or a reward for success (Scott’s case) - Hayes v FCT ( accountant was given shares in gratitude for loyalty in addition to regular salary. H: gift – connection between work and shares was too remote + shares were received as a friend. - Scott v FCT ( solicitor acted for widow after husband’s death. Solicitor was properly paid but widow gave solicitor £10,000. H: money was a gift due to friendship and there was no connection. - FCT v Harris ( a bank gave a one-off payment to alleviate (reduce) the effect of inflation on the pension – H: gift because it was “unsolicited, unexpected and not related to a period of service.” - Smith v FCT ( money received from a bank under an ‘encouragement to study’ scheme was not income because it was not related to the services of the bank (purely honorary).
3. Prizes, Awards & Study Grants - TEST = prizes, awards and grants will be classed as income if they are expected and received regularly and in connection with a person’s employment (Stone v CoT) - IT 167( a prize or award received in non-cash form will be assessed according to a fair and reasonable value. - ss21, 21A [ITAA 36] ( the money value of non-cash consideration will be deemed to be paid - IT 2145 ( a BHP Award of $40,000 recognising personal achievement was deemed to be a gift. ➢ TR 99/17 - Grants: ▪ One-off financial grants recognising the personal athletic qualities are not assessable. ▪ But: grants will be assessable where they are made under an ongoing agreement + are expected and relied upon for expenditure + are periodic and regular made in substitution of income - Awards & Prizes: ▪ An award or prize received by a sportsperson on purely personal grounds recognising their sporting ability is not assessable. ▪ An award or prize will be assessable if it is made in connection with employment and is expected to be received periodically and regularly. o A medal, trophy or award will no be assessable as they are received on personal grounds recognising personal achievement in competition. o But: an award which has intrinsic value or represents an intrinsic form of remuneration to the person, above merely recognising sporting achievement, will be assessable (eg: cash, car) ➢ Stone v CoT - Facts of case ( S was a top athlete who competed in javelin and also a police officer; ATO sought to tax prize money; government grants; appearance fees; sponsorship money. - Federal Court Decision: ▪ Prize money and grants were not income ( “she entered into the competitions whether or not prize money was on offer. The grants defrayed the considerable expenses involved.” ▪ Appearance fees and sponsorship was assessable because “they were made as a reward for service, being attendance at the function or whatever was required.” - HCA ( all receipts assessable b/c S was in the business of sport – pursuit of excellence = business
4. Scholarships - TR 93/39 ( a scholarship is a sum of money or other aid granted to a scholar on the basis of general criteria - Generally (s51-10) ( scholarships to fulltime students at school, university or college are exempt from income tax. - Exceptions (s51-35) ( scholarship payments to fulltime students will not be exempt if: ▪ It is made on the condition that the student will become or continue to be an employee of the grantor. (FCT v Ransom) ▪ It is made on the condition that the student will enter into or continue to be a party to a contract with the grantor. ▪ The payment is not provided principally for educational purposes. - FCT v Ransom ( student received financial support from actuarial society in return for work during holidays. H: scholarship was taxable because it was conditional on employment - Polla Mouner ( a footballer received a scholarship but had to be an active paying member of the club. H: scholarship was not conditional on this contract ( payments were exempt from tax. - Case 9 ( a PhD student agreed to teach part time to receive extra payments. H: payments were not tax exempt because they were conditional on him teaching.
5. Tips & Testimonials - TEST = a tip or testimonial will be assessable income if it is expected and regular and linked to the recipient’s employment (eg: tips to a waitress, taxi-driver). - Federal Coke Co v FCT ( a mere gift is prima facie not income but will be assessable if it is related to, or results from income earning activities. - Calvert v Wainwright ( taxi-driver’s tips were subject to tax because they were expected.
➢ Tips to Sportspeople - Moorehouse v Dooland ( professional cricketer was entitled to the spectator collections under employment contract whenever he played well (regularly). ▪ H: income because payments were periodic and regular + linked by strong employment nexus - c/f: Seymour v Reed ( the proceeds from a cricket benefit match for a professional cricketer were not income, but rather a tribute to the player’s personal attributes. This was because: ▪ The contract did not entitle the player to the proceeds ▪ They were rarely granted more than once ▪ The takings were given spontaneously (randomly) by the public; and ▪ The player was at the end of his career and the payment was a tribute. - Moore v Griffiths ( a player received £1,000 after winning the world cup soccer. ▪ H: gift – not a reward for services b/c: (1) lack of knowledge; (2) made to reward rather than remunerate; (3) not recurrent; (4) payment was not linked to level of services performed - Kelly’s case ( a player won a ‘best and fairest’ award for $20,000. H: income because it was incidental to the player’s employment.
E. Income from a Business
- s6(1) [ITAA 36] ( ‘income from personal exertion’ includes the ‘proceeds of any business carried on by the taxpayer.’
1. The Meaning of ‘Business’ - s995-1 [ITAA 97] ( a business is ‘any profession, trade, employment, vocation or calling.’
- Golightly v CIR ( a business requires an intention and prospect of making a profit in the future (( a solicitor could not claim a business deduction for a farm he owned) - Grieve v CIR ( “businesses do not cease (stop) to be a business because they are carried out inefficiently or unprofitably or because the taxpayer derives personal satisfaction for the venture.”
➢ Small Businesses - Ferguson v FCT ( F bred cattle in a small way; he leased three cows, read farming journals, kept up with the progress of cows and deducted his lease expenses. ▪ H: was in business because he conducted his activities in a commercial, systematic and business-like way. - FCT v Walker ( W bought a goat with the intention to breed through IVF treatment. ▪ H: was in business b/c there was: (1) an intention to make a profit; (2) repetition and regularity; (3) business-like organisation; (4) personal involvement to keep himself informed.
2. Commencing a Business - A business will only be taxed and can only claim deductions when it is commenced. - TEST ( a business commences with the beginning of current operations (City Motors case) ▪ ie: there must be some commitment to a business venture (Softwood Pulp; Osborne’s case)
a) Preliminary or Preparatory Activities/Expenditure - Generally ( mere preliminary or preparatory activities do not result in the commencement of a business (Southern Estates v FCT) - Softwood Pulp ( a firm conducted investigations into the viability (possibility) of a paper mill. They abandoned the project, earned no income but claimed a deduction for their expenses. ▪ H: expenses were not incurred in a business. There was no commitment to the venture - FCT v Osborne ( there was a 6 year gap between planting and growth of trees; project was abandoned before the harvest. Claimed cost of rent, wages and depreciation on equipment. ▪ H: cannot deduct preliminary costs of preparing ground for planting (these are capital expenses) - c/f: Case 75/96 ( existing business taken over but required maintenance & expenses. H: business commenced at the time of sale b/c it was an existing business, not a new venture being explored.
b) Experimentation - Generally ( a taxpayer is not carrying on a business while merely experimenting to choose between different products (Goodman Fielder) - Goodman Fielder v FCT ( research and expenditure was carried out into a new medical product. ▪ H: not in a business because there was no final commitment – activities were provisional only. - c/f: Thomas v FCT ( land was purchased and trees planted, but harvest not due for several years. ▪ H: still carrying on a business despite its small size because there was a commitment to production in the future.
3. Terminating a Business - The main issue is whether the cost of terminating a business is deductible. - Generally ( the costs of terminating a business and costs incurred after a business has terminated are not deductible (Freeman v FCT) ➢ When does a business terminate? - TEST (Peyton v FCT) = to determine whether a business has terminated, look at: ▪ The intention of the controllers of the business ▪ The nature of the business ▪ The reasons for the cessation (stopping) of trading - Nb: a business which is merely inactive is not necessarily terminated (Avodale Motors) - AGG (Advances) v FTC ( a company in financial difficulties ceased most of its business operations and entered into a scheme of arrangement with creditors. It sold its shares to ACG and resumed business. ▪ H: the business had not been terminated at any stage, even though it changed its name, premises, clients and shareholdings.
4. Gambling & Windfall Gains - Generally ( earnings from gambling and lotteries are not taxable because they are irrational agreements which do not provide regular and periodic incomes (Graham v Green) - IF gambling constitutes a business, the earnings may be classified as income.
➢ TEST (Brajkovich v FCT) ( gambling will constitute a business if:
1. It is done in an organised and systematic manner; and ▪ Evans v FCT ( taxpayer made regular successful bets on the TAB – H: no element of system or organisation to characterise the gambling as a business – he had no research, no sources of info, no technology, no method of calculating odds, no allocation of capital, no records. ▪ Down v Compston ( professional golfer bet on own matches – H: betting not systematic and money was not derived from his regular employment ▪ Martin v FCT ( used betting system to gamble successfully for 3 years – H: not a business of gambling because just a normal and usual activity. ▪ Brajkovich v FCT ( devoted to betting on racing, AFL – H: although B satisfied business criteria (objective) his purpose was to pursue a hobby (subjective) ( not a business
2. There is a strong link between gambling and a trade or profession: ▪ Trautwein case ( betting was systematic, frequent and heavy; devoted a lot of time; established a stud farm and leased other horses. H: betting constituted a business because it was too professional in approach and T was involved in the profession of horse racing. ▪ Prince v FCT ( H: registered bookmaker and horse trainer was involved in a business due to close link with his own employment ( winnings were taxable
➢ Gambling & Capital Gains Tax - s160ZB(2) [ITAA 36] ( a capital gain does not arise from winnings from betting, a lottery or other form of gambling game with prizes ▪ But money received from the sale of assets won in a lottery are subject to capital gains tax – eg: if you win a house and then sell it, the proceeds are subject to tax.
F. Income from Property
- Generally ( income earned from property is assessable.
1. Interest - Riches v Westminster ( interest is the price of using another person’s money. - s6-5 [ITAA 97] ( interest is ordinary income ( assessable. - Myer Emporium ( a lump sum payment made in place of an income stream will be deemed to be interest ( assessable. - Types of Interest: ▪ Simple interest – all interest is assessable because it is regular and periodic. ▪ Compound interest – only the interest component is assessable, not the principal. ▪ Interest only loans – all interest is assessable ▪ Blended loans – where the amount of interest and principal repayable varies each month, only the interest portion will be assessable ▪ No interest loans – interest-free loans which are repayable at a premium (higher price) are deemed by the courts to contain an interest component (Vestey v IRC) - Interest on Compensation Payments: ▪ Federal Wharf case ( interest on a judgment is assessable. ▪ c/f: s51-57 [ITAA 97] ( any interest given on a judgment in a personal injuries matter is not assessable as income.
2. Dividends - Generally ( dividends are treated as ordinary income ( assessable. - However there is often a problem of double taxation: ▪ A double tax problem arises because many companies already pay tax on their money. ▪ Dividends which have already been taxed are known as franked dividends. Dividends which have not been taxed are called unfranked dividends. ▪ Shareholders who receive franked dividends will receive a tax credit for that amount and will only have to pay the difference between the company tax rate and their own marginal tax rate – ▪ This process is known as grossing up. - Dividends received from overseas companies are taxed differently.
3. Rent Income - Rent is the price paid for the right to use another person’s property (land, machinery, equipment) - Generally ( rent is treated as ordinary income and ( assessable (Adelaide Fruit & Produce Exchange v DFCT) - But: rent will not be assessable if the payment is merely a contribution to household expenses: ▪ Groser’s case ( G charged his parents nominal rent ($2/week). When they died, he acted as guardian for his disabled brother, continuing to charge him the same rent. G paid for the household expenses. Tried to claim mortgage payments and costs as a deduction. H: $2 was not rent, just a contribution to household expenditure ( deductions not allowed. - Nb: Rent does not have to be paid periodically or in cash ( ie: a lump sum payment or a payment made in non-cash form (goods) can still be rent.
4. Royalties - Royalties are amounts paid for the use of another person’s property, whether tangible or intangible (eg: use of copyright, patents, mining rights) - Royalties can be ordinary income (s6-5 ITAA 97), statutory income (s15-20) or a capital gain.
- TEST ( royalties will be assessable as income where they are calculated by reference to a quantity or actual usage (McCauley’s case) ▪ McCauley v FCT ( a farmer had a timber plantation and sold the right to cut and remove timber for 3 shillings/100m cut. The payments were made monthly over 1 year. H: assessable because the amount received was calculated by reference to the quantity cut and were expected and received regularly. ▪ c/f: Stanton’s case ( S sold timber on his land for £17,500, payable as a £500 deposit and instalments. H: not assessable as royalties because the lump-sum instalments were fixed and not calculated on the basis of the amount of timber sold.
5. Annuities - Annuities are an income stream which is usually purchased in return for the transfer of funds or property. - Generally, the annuity provider will estimate the interest and add it to the capital amount. They then work out regular repayments so the end balance is zero. - s27H [ITAA 36] ( annuities are divided into two components: ▪ The amount of each payment which is the return of the principal amount to the taxpayer – this amount is not taxed. ▪ The payment to the taxpayer which is interest on the capital ( this is taxed at the taxpayer’s marginal tax rate. G. Exempt Income
➢ Exempt Income - s6-20 [ITAA 97] ( ordinary or statutory income is exempt income if it is made exempt by the Tax Act or other Cth law. ▪ Exempt income is taken into account when a person has a tax loss (reduces a capital loss) - c/f: s6-15(3) ( an amount which is ‘non-assessable, non-exempt’ income is not assessable income. ▪ Non-assessable, non-exempt income is not taken into account where there is a tax loss. - Exempt income falls into three main categories: ▪ Exempt entities – s11-5 [ITAA 97] ▪ Exempt income – all taxpayers ▪ Exempt income – certain taxpayers
1. Exempt Entities - s11-5 [ITAA 97] ( defines institutions which are tax exempt:
a) Charity, Religion, Science & Education - s50-5 [ITAA 97] ( income from charitable, religious, scientific or public educational institutions are exempt from tax. - An institution is an establishment, organisation or association formed for some object, especially of public or general utility (YMCA v FCT)
➢ Charities - ‘Charitable’ must be interpreted in its technical legal sense (Royal Choral Society) - There are 4 main charitable purposes: ▪ Relief of poverty (Downing v FCT) ▪ Advancement of education (Case 62) ▪ Advancement of religion (Gilmour v Coats) ▪ Other purposes beneficial to the community (Incorporated Council of Law Reporting Qld) - The purpose must benefit the community, but not the entire community.
➢ Religious Institutions (churches) - TEST = an institution will be tax exempt if its primary and dominant objects are religious. - YMCA v FCT ( ‘religion’ is to be given a wide interpretation. - Scientology case ( criteria for religion: ▪ The church must believe in a supernatural being or principle; and ▪ The church accepts canons of conduct giving affect to that belief. - Douglas v FCT ( D built a place of worship but used parts of the building for commercial purposes. H: not tax exempt because it was primarily a commercial entity - Nb: gifts to the church may be treated as income to the clergy/priests (Moorhouse v Dooland)
➢ Scientific Institutions - TEST = an institution will be tax exempt if its objectives are predominantly (mostly) scientific. - Sulley v RCSE ( H: the Royal College of Surgeons was predominantly a professional body and its scientific objects were only incidental
➢ Public Educational Institutions - TEST = an institution will be tax exempt if it provides public education: ▪ ‘Public’ does not mean the institutions has to serve the whole community – part of the community is sufficient (O’Connell v Newcastle Municipal Corp) ▪ ‘Education’ means imparting knowledge or assisting & guiding the development of the mind (Chesterman v FCT)
b) Non-Profit Societies & Clubs - s50-45 [ITAA 97] ( clubs, societies and associations are exempt from tax if: ▪ It is established for the encouragement of ( racing; art; game or sport; literature or music; and ▪ It is not carried on for the profit or gain of its individual members. - The club will not get a tax exemption if the provision of social activities becomes of equal or greater importance to providing sporting activities (Cronulla Leagues Club v FCT) - Tweed Heads Bowls Club ( had over 900 members with substantial entertainment and catering facilities; most revenue derived from pokies (>$5m); more than 500,000 visitors per year. ATO argued that it was no longer a sporting club, but a business. ▪ H: club was still tax exempt because from its inception (beginning) it was devoted to lawn bowls – ie: that was its dominant purpose. - Terranora Lakes CC ( had over 40,000 members and over 1,000 visitors per day; 90% of revenue was from the bar and pokies. ▪ H: the club was still tax exempt because even though its social activities were extensive, they were pursued as a means of financing its sporting activities.
2. Other Exempt Income - Other exempt income includes: ▪ s11-10 [ITAA 97] ( income which is exempt for all taxpayers (includes interest of judgments for personal injuries and dividends on franked shares). ▪ s11-15 ( income which is exempt for some taxpayers (Defence force members, scholarships, family assistance payments). - Most of the above are subject to their own conditions.
H. Deriving Income (Tax Accounting)
- s4-10 ( you pay tax “for each year ending on 30 June, called the financial year.” - Generally( income that falls in the year is derived - s6-5 ( assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia during the income year. - Derived can mean either (a) when cash is received; or (b) when an amount is earned or accrued.
1. Cash Basis Accounting - Generally ( income is not derived until you receive it in cash or some other form - This method applies to individuals not carrying on a business (Brent v FCT) - Whitworth Park Coal v IRC ( “ordinary individuals do not pay tax until they get the money b/c until then it is not part of their income”
2. Accrual Basis Accounting - Generally ( income is deemed to be received when there is a right to receive it (when you can sue for payment) - The use of this method depends on the sophistication, size and degree of personal involvement - FCT v Dunn ( “the task is to determine what method of accounting is calculated to give a substantially correct reflex of the taxpayer’s true income” - Carden’s case ( Dr changed from accrual to cash, & only declared fees actually received ▪ H: cash basis suitable (appropriate in the circumstances) - Henderson v FCT ( Accounting partnership with 300 employees & 19 partners ▪ H: accrual basis appropriate given the size, scope & history of operations I. Eligible Termination Payments (Superannuation)
- On retirement, a person usually receives superannuation - The Superannuation Guarantee Scheme introduced in 1992 ensures that employers have to contribute 9% to their employee’s superannuation scheme. - s6(1) [ITAA 36] ( superannuation benefits include ‘individual personal benefits, pensions or retiring allowances.’ - Thus there are basically two forms of payments you can receive on retirement: ▪ Lump sum payments; or ▪ Pension payments (ongoing stream of income) - Special tax rules apply to eligible termination payments (ETPs) in the Act: ▪ Amounts contributed before 30 June 1983 – only 5% of these amounts were subject to tax under the former s26(d) [ITAA 36] ▪ Amounts contributed from 1 July 1983 – these ETPs are assessed according to ss27A-27J - ETPs include termination, retirement, and similar payments – includes payments made by superannuation funds, but not payments in the form of a pension or annuity. - An ETP may have different components – concessional components and undeducted contributions which attract different tax treatment
➢ Section 27A – Eligible Termination Payments - s27A [ITAA 36] ( an eligible termination payment is any payment made in respect of the taxpayer in consequence of the termination of their employment - “…in consequence of” ▪ The payment must be made ‘in consequence of’ the termination ▪ This means that the ETP must be the result of termination of employment and there must be a direct causal relationship between the termination & the employment (Reseck’s case; Haggarty) - “…termination” ▪ Termination of employment means a bona fide termination – ie: permanence is required. ▪ This means that the employee cannot be dismissed or retired and then later re-hired by the same employer with similar remuneration (pay) and duties (Grealy’s case) - A payment from a superannuation fund is an ETP unless it is otherwise ordinary income such as a pension or annuity (s27A(1)) - Nb: leave and long service leave payments are not ETPs but are accounted for under ss26AC-AD.
➢ Exemptions & Exclusions - Some payments made are not assessable ETPs, including: ▪ Advances or loans made on an arm’s length basis; ▪ Capital sums paid for a legally enforceable contract in restraint of trade, to the extent to which the Commissioner considers the payment reasonable; ▪ Capital sums paid for loss of income through personal injury, to the extent to which the Commissioner considers the payment reasonable; and ▪ Payments made after 1 July 1994 that is the tax-free amount of a bona fide redundancy payment
➢ Summary: 4-step process 1. Is the payment an ETP? – check the definitions (s27A) and exclusions 2. Identify the components that make up the ETP – s27AA 3. Has the whole or part of the ETP been rolled over? – s27D allows amounts to be rolled over and tax to be deferred 4. Consider the tax treatment of each component of the ETP.
GENERAL DEDUCTIONS
A. Deductible Amounts
- Deductions form part of the income tax system to relieve the burden of the high marginal tax rates - The relevant section for deductions is s8-1 [ITAA 97]. It replaces s51(1) [ITAA 36] although the same meaning is intended ( cases referring to the old Act still apply. - s4-15 ( your taxable income for the year equals assessable income less allowable deductions. - s12-5 ( provides a list of claimable deductions. - s8-10 ( where two provisions allow deductions of the same amount, you can deduct only under one provision ( no double deductions.
➢ TEST: Deduction Limbs
- NB: the test from s8-1 has two positive and four negative limbs ▪ To be deductible ( an expense must fall within either of the two positive limbs and not fall within any of the negative limbs.
➢ Preliminaries - “…loss or outgoing” means any money going out (but does not expressly refer to ‘expenses’) - “…to the extent that” allows expenses to be apportioned (divided): ▪ Ronpibon’s case ( if an expense is partly private and partly for the purpose of earning assessable income, the deduction can be apportioned on a fair and reasonable basis. ▪ Kowal’s case ( K purchased parent’s property, leased to parents and claimed expenses as deductions. H: property was used for mixed purposes ( 80/20 apportionment applied.
B. Positive Limbs – s8-1(1)
➢ Common Elements - There are two common elements to the positive limbs:
1. The expense must be incurred: ▪ This does not necessarily mean paid. ▪ If the entity is using an accruals basis of accounting, than expenses may be incurred before cash is received or paid out.
2. The expense was incurred in producing “your” assessable income ( ▪ You cannot claim a deduction for another person’s expense – ie: must be your deduction (Monroe’s case) ▪ But the courts are more lenient in cases of parent companies claiming deductions for activities or subsidiaries.
1. The First Limb - s8-1(1)(a) ( you can deduct any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income.
- TEST ( to be deductible there must be a sufficient connection between the expense and assessable income: ▪ The loss or outgoing must be relevant or incidental to producing your assessable income ( the degree of the connection need not be strong or proximate (close) (Ronpibon’s case) ▪ The essential character of the expense must be of a work or business nature (Lunney’s case)
➢ The Purpose Test (applicable test) - TEST = to determine if there is a sufficient connection, look at the object, purpose or intent of the expense (Magna Alloys v FCT) - Fletcher v FCT ( involved a partnership which wanted to claim interest expenses from a negatively geared annuity scheme as a deduction. ▪ The objective intention will be conclusive where an expense is involuntarily incurred in producing a larger amount of assessable income (ie: expense < income produced). ▪ But the subjective intention for claiming the expense will be relevant if no income is earned and the expense is disproportionate (much higher) than the income gained (confirmed: Spassked case) - Ure v FCT ( involved the deductibility of interest payments under a tax scheme. ▪ H: the expenses were partly incurred for the objective purpose of producing assessable income. But the subjective purpose of reducing tax liability could not be ignored ( apportion deduction. - Ilbery; Deane ( two cases concerning the deductibility of expenses from interest prepayment and share trading schemes: ▪ H: the intention of the taxpayers in incurring the expenses were to secure tax advantages, not to produce assessable income ( not deductible - Magna Alloys ( H: a company could deduct the cost of its legal expenses incurred to defend director’s bribery charges. These were subjectively necessary from the taxpayer’s perspective.
➢ The Legal Form Test (no longer applied) - TEST = an expense is deductible if the objective circumstances of the expense is regarded as income-producing – ie: the legal effect of a contract is conclusive (Europa Oil No. 2) - Cecil Bros v FCT ( shoe retailer introduced an intermediary company between the wholesaler and retailer and imposed an extra 10% mark-up claiming these additional retail expense as a deduction. ▪ H: the expenses were deductible – the legal effect of the contract was to acquire footwear - Isherwood & Dreyfus ( a Hong Kong company was interposed (inserted) as an intermediary between a supplier of trading stock and taxpayer company. The taxpayer claimed a deduction for the intermediaries 10% markup. ▪ H: full deduction allowed – the legal effect on paper related to the supply of trading stock
2. The Second Limb - s8-1(1)(b) ( you can deduct any loss or outgoing necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
- The first and second limbs overlap although the second limb is confined to those carrying on a business (second limb is largely redundant). - However, there is some differences in the wording between the two limbs:
➢ ‘Necessarily’ incurred - The expense must be ‘necessarily’ incurred in carrying on a business. - The courts have adopted a practical, non-literal interpretation such that expenses which are clearly appropriate or adapted to the business will be deductible (Magna Alloys). - W Nevill & Co ( a business claimed a deduction for a £2,500 payment made to a managing director for cancellation of his contract. ▪ H: deductible because it was necessary for efficiency, one-off and would lead to higher profits in the future. - Snowden & Wilson ( a company claimed a deduction for the cost of its defence at a Royal Commission to clear its name. ▪ H: deductible because it was necessarily incurred in the business, although not a usual expense - Magna Alloys ( H: legal expenses incurred to defend bribery charges of directors were necessarily incurred because the company could not function without the directors. - WD & HO Wills ( tobacco company established a subsidiary Singaporean insurance company to provide insurance. No claims from the insurer meant that the company was profitable. ▪ H: not unreasonable or inappropriate to deduct cost of insurance premiums, even if it is a subsidiary company. Sound commercial practice to have insurance.
➢ Excessive Expenses - The issue is whether excessive expenses are ‘necessarily’ incurred in carrying on a business. - Generally ( the Commissioner cannot tell you how to run your business. - But, where expenses claimed as deductions are excessive, it suggests that they are for more than one purpose (and ( may be apportioned). - Robert G Nall v FCT ( R was director who continued to receive full salary during winding-up. N was still involved with debt collection and management issues. Claimed a deduction for salary. ▪ H: salary expenses were not fully deductible because the amount paid was disproportionate to the income earned by the company.
C. Negative Limbs – s8-1(2)
- If any of the negative limbs apply, the expense is not deductible.
1. The Third Limb - s8-1(2)(a) ( you cannot deduct losses or outgoings of capital or of a capital nature.
- Eisner v Macomber ( capital is like the tree on which income, the fruit, is grown. - There are three tests for distinguishing capital from income expenses.
➢ ‘Once & for all Test’ - TEST = a capital expense occurs once and for all, whereas income expenses are continuous and ongoing every year (Vallambrosa Rubber) - Vallambrosa Rubber ( taxpayer owned a rubber plantation and claimed a deduction for weeding and pest control – H: not capital (deductible income expense because it was incurred every year. - BP Australia ( service stations received a payment if they sold BP products – H: income ( deductible because the trade tie was only 5 years.
➢ Enduring Benefit Test - TEST = expenditure on an item providing an enduring benefit will be capital (Sun Newspapers) - BP Australia ( the mere fact that an expense may be repeated does not necessarily mean that the taxpayer has not received an enduring benefit.
➢ Business Entity Test (main test) - TEST (Sun Newspapers): ▪ If outgoing is for the improvement of a capital asset or the acquisition of new assets = capital expenditure (( not deductible) ▪ An outgoing for the purpose of day-to-day trade which maintains the taxpayer’s position is a revenue expense ( deductible (Hallstroms) - Sun Newspapers v FCT ( H: company could not claim the cost of a payment to a rival newspaper to stop it printing newspapers within 3km of Sydney. Capital in nature. - Hallstroms case ( H: the legal expenses incurred in opposing the extension of a patent were deductible because if was for the purpose of day-to-day trade - Kemp v FCT ( H: legal expenses incurred to obtain a clearance to play rugby league were capital in nature because they provided a structural advantage to the player ( not deductible.
Demolition & Repair Expenses: - Mt Isa Mines v FCT ( H: cost of demolishing buildings was capital, not repairs ( not deductible: ▪ Expenditure which goes beyond repair and makes results in the improvement of an asset is capital and not deductible. ▪ But where demolition is undertaken in the course of day-to-day conduct of a business, the cost will be a revenue expense ( deductible.
2. The Fourth Limb - s8-1(2)(b) ( you cannot deduct a loss or outgoing to the extent that it is of a private or domestic nature.
- Most private or domestic expenses will not satisfy the first limb – ie: they will not be incurred in gaining or producing assessable income. - Non-deductible items generally include: ▪ Household expenditure – eg: food (FCT v Cooper); clothing ▪ Life insurance premiums ▪ Residence outgoings (eg: mortgage payments) ▪ Babysitting costs ▪ Travel costs to and from work
➢ Rental Costs - Rental costs = mortgage interest, rates, telephone costs (keeping in touch with tenant); legals - TEST ( these costs will be deductible to the extent that they are incurred in gaining or producing assessable income. - Groser’s case ( G bought a house from his parents and charged disabled brother $2/week rent (market rent was $75). G claimed $522 deduction for expenses, including rates, repairs & mortgage. ▪ H: not deductible as there was no purpose to earn assessable income (purely domestic). - Kowal’s case ( K charged her mother $30 rent (market rent $50). Received $165 income and claimed $1652 in deductions, including interest, mortgage and telephone expenses. ▪ H: 80% was deductible and 20% disallowed as K had a private, non-income earning purpose of providing mother a home. Rent below the market rate was evidence of dual purpose.
➢ Clothing & Grooming Expenses - Edwards ( H: expenditure on clothing required by the personal assistant to the Governor’s wife was deductible because the uniform was necessary to complete her duties. - Mansfield v FCT ( moisturiser, shoes & panty hose for flight attendant deductible. ▪ Mere fact that a particular form of clothing is required to be used in an occupation does not necessarily lead to the conclusion that expenditure on that clothing is deductible ▪ Ordinary clothing: o May be deductible if unlikely that would wear the clothing for private purposes o Also deductible if expenditure on clothing was additional to that necessary in ordinary life ▪ Distinctive uniform: o Ordinarily qualifies for a deduction b/c distinctive characteristics provide a nexus b/w the expenditure & the work activity - TR 96/18 ( cosmetics & personal grooming usually not deductible, unless you are in performance
D. General Deductions – Examples
1. Self-Education Expenses - Self-education expenses are generally deductible where there is a sufficient nexus between the outgoings and gaining assessable income (s8-1) ▪ Examples ( textbooks, tuition fees, conference fees, local travel costs (sometimes international) - s82A [ITAA 36] ( no deduction for the first $250 of self-education expenses. - Finn ( an architect could deduct overseas travel expense to bring himself up to date with changes in his profession. ▪ A self-education expense will be deductible if it relates to the taxpayer’s current occupation. ▪ An expense claimed in respect of a new field of education will not be deductible unless a relationship with earning existing assessable income exists. (TR 98/9) - Studdert ( a flight engineer was allowed to claim the cost of flying lessons. ▪ Do not have to show that the expense will lead to an increase in income – it will be deductible if it would objectively increase proficiency. - Highfield ( dentist could deduct the cost of a course in UK, airfares, accommodation and meals. ▪ The costs of maintaining a level of knowledge or increasing a person’s qualifications in their field of expertise will be deductible (TR 98/9) (but not if in a new area of income generation). - Hatchett ( a teacher was allowed deductions for obtaining a higher certificate: ▪ Expenses for improving the mind are not capital in nature (( still deductible). - TR 98/9 ( self-education expenses will be deductible if they are likely to lead to increased income.
2. Legal Expenses - Legal expenses will be deductible if they are incurred in producing your assessable income (s8-1; Magna Alloys). - The major issue is whether the legal expenses are revenue or capital in nature (see: Third Limb): ▪ Revenue ( recovery of outstanding debts arising from the sale of goods in ordinary course of business (deductible) ▪ Capital ( legal expenses for acquiring land or buildings or limiting competition (not deductible) - Legal expenses designed to reduce competition are capital in nature under the Sun Newspapers test: ▪ Broken Hill Theatres ( H: legal expenses to contest a competitor’s application for a theatre licence were capital in nature ( not deductible. ▪ Sunraysia Broadcasters ( AM broadcaster with a monopoly could not claim deduction for cost of obtaining an FM licence to prevent competition. ▪ c/f: Hallstroms case ( H: legal expenses incurred in opposing the extension of a patent were deductible because if was for the purpose of day-to-day trade. ▪ c/f: Duro Travel Goods ( expenses incurred in preventing a competitor using a similar trade name were deductible because it involved preserving a business name - Unusual Transactions: ▪ Magna Alloys ( a company could deduct legal expenses incurred in defending bribery charges against directors. ▪ Snowden & Willson ( costs of defending taxpayer’s reputation before Royal Commission were deductible, even though abnormal and not ongoing. - Specific Deductions: ▪ s25-5 [ITAA 97] ( can deduct tax-related expenses ▪ s25-20 ( can deduct expenses incurred in preparing, registering or stamping lease documents ▪ s25-25 ( borrowing expenses ▪ s25-30 ( mortgage discharge expenses
3. Child Minding Expenses - Child minding expenses are not deductible because they are private in nature, even though they are incurred so that taxpayers can earn assessable income - Lodge; Jayatilake; Martin ( child-minding expenses were non-deductible, private expenses, even though as a matter of practicality they had to be incurred to gain assessable income.
4. Home Office Expenses - The deductibility of home office expenses depends on whether the home is used as business premises or merely as a matter of convenience (Swinford v FCT). - TR 93/30 ( important to distinguish between occupancy expenses (mortgage interest, rent, insurance) and running expenses (electricity and cleaning) ▪ If used as a business premises (eg: doctor’s surgery) ( can deduct appropriate portion of occupancy and running expenses. ▪ If used as a matter of convenience (eg: private study) ( no deduction for occupancy expenses (private) but can deduct a portion of running expenses. - A home will be used as a ‘matter of convenience’ where the tasks could be performed at the usual place of work and the activity is not separate from usual employment.
- FCT v Faichney ( research scientist worked in laboratory, but also at home in evenings and weekends on his studies: ▪ H: no deduction for interest of loan (private payments) but could deduct for depreciation of office-assets (shelves, carpet, desk, curtains). - FCT v Forsyth ( rent paid by a barrister which was also his study was not deductible – ie: it was neither incidental nor relevant to the gaining of assessable income + essentially a bedroom. - Handley v FCT ( barrister had a study at home; used study 20 hours per week for 45 weeks a year. ▪ H: no deduction for occupancy expenses – the study was just another room of the house, no distinctive characteristics, used for other family purposes.
5. Preliminary Expenses - Preliminary expenses are not deductible because they are not incurred in producing assessable income and are of a capital nature. - Maddalena ( M was an electrician and also a professional rugby league player. M claimed a deduction for the cost of travelling to Sydney to arrange a football contract. ▪ H: money spent to obtain a new employment are not deductible.
6. Insurance Expenses - Generally ( an insurance premium will be deductible where the insured amount replaces assessable income. ▪ DP Smith case ( doctor took out permanent disability insurance cover and was injured in a car accident. Doctor received monthly insurance money and claimed the payments as deductions. H: payments were income as they replaced earnings ( could claim deduction - Exception ( cannot deduct the cost of a premium which replaces capital asset, unless it is paid in the ordinary course of income-producing activities ▪ Eg: fire insurance premium on a building used to produce investment income (Somers Bay)
7. Interest Expenses - Interest is a payment for the right to use borrowed funds. - Generally ( interest expenses will be deductible of borrowed for an income-producing purpose – ie: sufficient nexus with earning assessable income (Janmor Nominees)
➢ ‘Use’ Test (main test) ▪ Deductibility of interest expenses depends on the use of borrowings (Munro; Roberts & Smith) ▪ Deductible ( if borrowings are used to finance business expenses or income-producing assets, even if secured over private assets (office premises, shares etc). ▪ Not deductible ( if borrowings are used for a private or domestic purpose, even if secured over business assets (Ure v FCT; FCT v Munro)
➢ ‘But-for’ Test ▪ Has been applied in unique instances of refinancing such as Yeung and Roberts & Smith – this is known as the refinancing principle. ▪ TR 95/25 ( limits the deductibility of interest to the extent that the funds represent a refund of moneys previously invested in the partnership.
➢ Interest incurred before business commences: ▪ Steele’s case ( S acquired land with the idea of building a motel on it. Plans were drawn up but development never went ahead. Claimed interest deductions until its sale seven years later. o H: once interest is classed as an expense incurred in gaining assessable income, it will still be deductible even if the capital asset produces no income.
➢ Interest incurred after business ceases: ▪ Brown; Jones( in both cases, interest was incurred after the relevant income earning activities had ceased and borrowed funds had been lost to the taxpayer. Interest deductions were claimed: o H: in both instances, interest incurred on the loans continued to be deductible despite the cessation of the relevant income earning activities (see: TR 2004/4)
➢ Dual purpose loans: ▪ Hart v FCT ( involved a couple with a split loan which had a private and income-producing investment purpose. Claimed a deduction for interest on investment part of loan. Commissioner argued that the interest was unique because it allowed the loan to be paid off faster. o H: the interest had the same character as ordinary interest ( deductible (but HCA found that the scheme breached the anti-avoidance provisions).
SPECIFIC DEDUCTIONS
- s8-10 [ITAA 97] ( if 2 or more provisions allow a deduction for the same amount, can deduct only under the most appropriate provision.
A. Gifts & Donations (s30-15)
- Div 30 [ITAA 97] ( allows deductions for gifts to charities, educational institutions, health funds, defence etc. (can spread deduction over 5 yrs). - s30-15 ( a taxpayer can deduct a gift made in the situations set out in the table listed. The table states who the recipient can be, what type of gift can be made, how much can be deducted etc. ▪ s30-20 ( health recipients (public hospital/research/ambulance) ▪ s30-25 ( education recipients (public uni; higher education institution etc) ▪ s30-40 ( research recipients (approved research institution) ▪ s30-45 ( welfare and rights recipients (public benevolent institutions, funds) ▪ s30-90 ( sports and recreation recipients (Aust Sports Foundation; guides; scouts) ▪ s30-100 ( cultural recipients (public funds; libraries; museums; art galleries) - A gift must be made with a bona fide intention and the donor must receive no material benefit (Leary v FCT; Cyprus Mines Corp). - TD 93/185 ( a gift of services is not deductible – ie: expenses gained during unpaid work - Testamentary Gifts (Subdiv 30-D) ( not deductible unless made under Cultural Bequests Program - Anti-Avoidance Provisions (s78A(2) [ITAA 36])( deductions for gifts cannot be made where the value received is less than the gifts worth, if the recipient incurs a liability, the donor obtains a benefit or advantage, or the recipient is liable to acquire property from the donor.
B. Travelling Expenses (s25-100)
➢ Home to Work - Generally ( travel between home and work is not deductible because this is a private expense, despite fact that these expenses are incurred to produce assessable income (Lunney’s case) - Exceptions: ▪ Wiener’s case ( teacher visited 5 schools during the day and used home as a base for preparation. H: could claim deductions for travel to and from schools and between schools. ▪ Collings ( computer consultant could claim deductions for travel between home and work outside normal working hours as she was on-call 24 hours – ie: special circumstances. ▪ Vogt ( V could claim a deduction as a musician for cost of transporting heavy musical equipment between his home and place of performance. ▪ Case U29 ( carpenter could claim a deduction of travel to work because he had to transport bulky materials which could not be left on site overnight for safety reasons.
➢ Between Offices - s25-100(1) ( taxpayer may deduct transport expenses to the extent that it is incurred in your travel between workplaces. - s25-100(2) ( the purpose of travel must be to engage in activities to produce assessable income. - s25-100(3) ( no deduction where the second workplace is your home. - Garrett v FCT ( a doctor carried out a grazing business from home ( could claim deductions for the cost of travel by plane from home to medical practice. ▪ But: may be decided differently today due to s25-100(3) (ie: second workplace was G’s home) - c/f: FCT v Payne ( pilot could not claim a deduction for travel between home, where he ran a deer farm, and the airport – the type of work was not linked ( not expenses relating to income ▪ But: may be decided on different grounds today b/c s25-100(1) states that the two workplaces do not have to be related. However, s25-100(3) says second workplace cannot be your home. - Owen v Pook ( medical practitioner successfully claimed the cost of travel between his home (where he conducted his practice) and the hospital. - Cunliffe v FCT ( restaurant owner claimed $66,000 overseas travel expenses relating to new business. Also had a private purpose and took partner. ▪ H: deduction allowed but had to be apportioned to account for private purpose. - Sharma ( an academic claimed deductions of $70,000 for entertaining students and $21,000 for travel expenses and staying at Hilton. H: unreasonable, large costs suggested dual purpose.
C. Repairs (s25-10)
1. Repairs Deductible - s25-10(1) [ITAA 36] ( you can deduct expenses incurred for repairs to premises or depreciating assets held solely for producing assessable income. - s25-10(2) ( can allow a ‘reasonable deduction’ where an asset is partly held for the purpose of producing assessable income (ie: apportionment) - s25-10(3) ( cannot deduct capital expenditure (eg: improvements + additions – refer below).
2. What are ‘Repairs’? - ‘Repair’ is not defined in the Act ( use ordinary meaning: “the restoration of some material thing or structure by renewal or decayed or worn out parts” (Oxford Dictionary)
➢ TEST 1: Need for restoration - TEST = an item must be in need of restoration before it can be repaired (Case J47) - TR 97/23 ( preventative work or work done in anticipation of forthcoming defects is deductible, even if in early stages – ie: do not have to wait for serious damage (Day v Harland & Wolff)
➢ TEST 2: Entirety vs. Subsidiary Part - TEST = TP can deduct the cost of renewing or replacing subsidiary parts but not the cost of reconstructing substantially the whole asset (Lurcott v Wakely & Wheeler) - Lindsay ( the ‘entirety’ is a separately identifiable piece of capital equipment (TR 97/23) - Western Suburbs Cinemas ( replacement of ceiling was replacement of subsidiary part. - Rhodesia Railways ( H: replacement of 74 miles of 400 mile railway track was replacement of subsidiary part ( deductible. - O’Grady ( unsafe chimney replaced with a wider, higher chimney. H: replacement of entirety.
➢ TEST 3: Repair/Maintenance vs. Improvement - TEST = a repair becomes a non-deductible improvement if it results in a change in functionality and efficiency (WH Thomas & Co) - TR 97/23 ( use of different materials is not determinative – look at effect on efficiency/function. - Morcom v Campbell-Johnson ( H: replacement of a modern draining system and water tank was a mere repair because it was not improving function. - Western Suburbs Cinemas ( new fibreglass ceiling cost £3,000 whereas restoring original would have cost £603. H: improvement of a capital asset ( not deductible - Rhodesia Railways ( replacement of wooden tracks with steel tracks was not an improvement to efficiency but merely increased the useful life ( deductible.
3. Specific Situations
➢ Initial Repairs - Generally ( repairs undertaken within 6 months of purchase will be capital ( not deductible - WH Thomas & Co ( worn out property was acquired and work was carried out within first 12 months on roof, gutters, basement, walls and painting. ▪ H: capital expenditure because work was carried out in first 12 months ( not deductible - Case V83 ( no deduction even where taxpayer did not know repairs were required at time of sale - Law Shipping Co v IRC ( ship purchased for reduced price of £97,000 but required repairs of £51,558 to make it seaworthy. ▪ H: repairs were capital – its condition was reflected in its reduced price ( not deductible - c/f: Odeon v Jones ( cinemas were acquired in poor condition but they were continued to be used as restoration continued. ▪ H: deductible – the purchase price did not reflect the need for work and it was an operative going-concern at the time of purchase, despite its state.
➢ Repairs to Satisfy Regulatory & Health Standards - TR 97/23 ( work done to satisfy regulatory bodies will only be a deductible repair if it remedies a defect, deterioration or damage without improving function. - TR 97/23 ( work done to abate health risks of dangerous substances (asbestos, CFC’s etc) does not qualify as a repair unless it remedies a defect, deterioration or damage to property.
➢ Additions - Additions are capital expenditure ( not deductible - TEST = expansion of the basic structure and changes to the item’s structure will be of a capital nature (WH Thomas & Co)
➢ Notional Repairs - You cannot carry out capital improvements and then claim the notional amount which it would have cost merely to repair the item (TR 97/23) - Western Suburbs Cinema ( can only deduct for the cost of what has been done.
D. Capital Allowances / Depreciation (s40-25)
- s8-1 [ITAA 97] ( generally, expenditure of a capital nature is not deductible. - s40-25 ( you can deduct the decline in value of a depreciable asset held during the income year and used for a taxable purpose
▪ This provision replaced Div 42 under the Uniform Capital Allowance Scheme.
➢ Depreciable Assets (‘plant’) - s40-30(1) ( depreciable asset = an asset with an effective life and can reasonably be expected to decrease in value over time, except land, trading stock and certain intangible assets. - TEST ( can deduct the reduction in value of items which impact on operations, but not items which form part of the setting. ▪ Munby v Furlong ( extends to a man’s tools of trade…the things he uses from day to day - s40-30(2) ( can depreciate the following intangible assets – mining rights and info, in-house software, items of IP etc. - s40-30(3) ( improvements to land and fixtures are treated as separate, depreciable assets. - s40-30(4) ( whether ‘composite items’ are depreciated as a whole or as separate components is a question of fact and degree (eg: car (whole asset) vs. floating restaurant (individual components)). - Wangaratta Woollen Mills ( yarn dying firm erected a building with many unusual features to meet its needs ▪ H: entire building was plant as it played a part itself in the manufacturing process - Barclay’s case ( installed a dry dock – Q whether it was part of premises ▪ H: despite its size, a dry dock is a tool of the respondent’s trade ( depreciable asset - Benson v Yard Arm Club Ltd ( converted vessel into restaurant and claimed it was plant ▪ H: not plant as it was merely the structure in which the business was carried out in
➢ Asset ‘held’ during income year - s40-40 ( generally, the ‘holder’ is the legal owner of the asset (ie: economic owner). - s40-40 ( a depreciating asset subject to a lease which is fixed to land where the lessor has a right of recovery will be held by the lessor.. - s40-60 ( the value of depreciation starts from the ‘start time’ – ie: when you first use it or have it installed ready for use.
➢ ‘Taxable purpose’ - The asset must be predominantly used for the purpose of: ▪ Producing assessable income; ▪ Exploration or prospecting; ▪ Mining site rehabilitation; or ▪ Environmental protection activities.
➢ ‘Decline in value’ - You can deduct the decline in value of a depreciable asset ( this is based on the cost base and effective life of the asset, not the actual change in value. - s40-175 ( cost base has two elements: 1. The price paid to hold the asset (s40-180) 2. The cost of bringing the asset to is present condition (eg: alterations, additions) (s40-185)
- Methods to calculate decline in value: ▪ s40-95 ( effective life determined by Commissioner (s40-100) or taxpayer’s estimate based on reasonably expected ‘wear and tear’ if asset is maintained in reasonably good condition (s40-105) ▪ Diminishing Value [pic] ▪ Prime Cost = [pic]
➢ Balancing Adjustment Events - s40-295 ( a balancing adjustment event occurs where an entity stops holding or using an asset. - The balancing adjustment is the difference between the termination value and its adjustable value: ▪ s40-300 ( the termination value is the amount received under the event (eg: proceeds of sale) ▪ s40-85 ( the adjustable value is the cost of the asset less any decline in value to that point - s40-285 ( the following rules apply: ▪ If the termination value > adjustable value ( the difference is included as assess. income ▪ If the termination value < adjustable value ( the difference is deductible - s40-295(3) ( a balancing adjustment event does not occur merely because you split an asset into 2 or more depreciating assets or merge it with another depreciating asset.
E. Miscellaneous Deductions
➢ Bad Debts - s25-35(1) ( can deduct a debt or part of a debt that you write off as bad in the income year if: ▪ (a) – it was included in your assessable income for the income year or an earlier year; or ▪ (b) – it is in respect of money lent in the ordinary course of your business of lending money - Nb: bad debts only occur if accrual basis of accounting is being used.
➢ Losses Caused by Employee Theft - s25-45 ( can deduct a loss caused by “theft, stealing, embezzlement, larceny, defalcation or misappropriation” by an employee or agent if included as assessable income
➢ Theft by Outsiders - Charles Moore v FCT ( court allowed a deduction for money stolen from employees on way to depositing at bank. The loss was incurred in the income-earning activities of the business - La Rosa ((not anymore) court permitted a drug dealer to claim a deduction for money stolen in connection with drugs, despite illegality of transaction.
➢ Election Expenses - s25-60 ( expenditure relating to contesting membership of Cth or State Parliament is deductible. - s25-70 ( not deductible to the extent that it is incurred in respect of providing entertainment, unless it is in respect of: ▪ providing entertainment that is available to the public generally; or ▪ providing food or drink to the taxpayer,
➢ Rates & Land Taxes - s25-75(1) ( may deduct rates which are annually assessed + land tax in respect of premises - s25-75(3) ( where premises only partly used for income-producing or business purposes, can only deduct a portion
➢ Pensions & Retiring Allowances - s25-50(1) ( employer may deduct a pmt of a “pension, gratuity or retiring allowance” to an employee or former employee or their dependants. - s25-50(2) ( only deductible to the extent that it is made in good faith in consideration for past services for the purpose of gaining or producing assessable income - Factors to consider ( terms of employment; length of service; level of remuneration paid during period of service; any other benefits employee is entitled; the reasons for payment (ie. in good faith)
➢ Joining Work Association or Union - s25-55(1) ( can deduct a payment made for membership of a trade, business or professional association - s25-55(2) ( maximum amount deductible is $42 per income year - s25-55(3) ( no limitation on amount if deducted under s8-1
F. Non-Deductible Items
➢ Bribes - s26-25 & s26-53 ( bribes made to Australian & foreign public officials are not deductible. - An amount is a bribe if it is incurred: ▪ in providing or offering a benefit to another person who is not legitimately entitled to it; and ▪ with the intention of influencing the public official in the exercise of his duties
➢ Fines & Penalties - s26-5(1) ( cannot deduct: ▪ (a) – an amount payable by way of penalty under an Australian or foreign law; or ▪ (b) – an amount ordered by a court to be paid on the conviction of an entity for an offence against Australian or foreign law (ie. fine) - Arguably a nexus b/w a parking fine imposed on a security van parking outside a bank & the earning of assessable income by the company (but denied on public policy grounds)
➢ Entertainment Expenses - s32-10 ( entertainment means food, drink, recreation, or accommodation - General rule ( s32-5 = prohibition on deductions for entertainment expenses - Exceptions: ▪ s32-20 ( if provide entertainment by way of providing a fringe benefit ▪ s32-55 ( in-house dining facilities for employees on employers premises ▪ s32-35 ( travel, food, drink & accommodation that is reasonably incidental to individual attending a seminar for at least 4 hours
G. Tax Incentives and the Arts
- Tax incentives for philanthropy are designed to encourage greater corporate & individual gifts 1) policy of incentives to support industry 2) incentives for investment in Australian films (Div 10BA ITAA 36) 3) gifts to cultural organisations 4) cultural bequests - Div 30 [ITAA 97] ( allows deductions for gifts to charities, educational institutions, health funds, defence etc. (can spread deduction over 5 yrs) - s30-25(1) ( education recipients of deductible gifts include a ‘public university’ or a ‘higher education institution’
CAPITAL GAINS TAX (CGT)
A. Introduction
- Capital Gains Tax (CGT) = a tax on the gains from the realisation (sale) of property. - s105-5 [ITAA 97] ( CGT is not a separate tax – it is defined as assessable, statutory income. - Capital gain occurs when capital proceeds > asset cost base - Capital loss occurs when capital proceeds < asset cost base ▪ Nb: capital losses are not deductible from assessable income but they can be carried forward to offset future capital gains.
➢ TEST ( a four-step approach is used to determine a person’s capital gain liability: 1. Is there a CGT event? 2. Calculate the net capital gain or loss from the CGT event 3. Determine the capital gains discount, if any. 4. Do any CGT exceptions apply?
B. STEP 1: CGT Events
- s102-20 [ITAA 97] ( CGT is only payable when a CGT event occurs. ➢ CGT Event - CGT events include: ▪ Event A1 (s104-10) ( sale or disposal of a CGT asset ▪ Event C1 (s104-20) ( loss or destruction of a CGT asset ▪ Event D1 (s104-35) ( creating contractual or other rights ▪ Event E1 (s104-55) ( creating a trust over a CGT asset ▪ Event F1 (s104-110) ( granting, extending, or renewing a lease ➢ CGT Assets - Only ‘CGT assets’ are subject to CGT on sale or disposal. - s108-5 ( an asset is ‘any kind of property or a legal or equitable right that is not property’ - There are 3 main types of CGT assets:
1. Other / General Assets - s108-5 ( a CGT asset includes any kind of property – ie: land + buildings + shares + goodwill + debts owed to you + the right to enforce a contract . - Exemptions – the following are not subject to CGT: ▪ Cars and motorbikes (s118-5(a)) ▪ Compensation payouts and prizes from gambling (s118-37).
2. Personal Use Assets - s108-20(2) ( a personal-use asset is any asset (not a collectable) which is used or kept mainly for personal use or enjoyment (eg: boat). - s118-10(3) ( no CGT is payable on the gains from the sale of personal use assets under $10,000. - s108-20(3) ( a personal-use asset does not include land, units or buildings.
3. Collectables - A collectable is an asset kept mainly for personal use - s108-10(2) ( collectables include: art, jewellery, antiques, coins, medallions, books, manuscripts, postage stamps. - s108-10(1) ( no CGT is payable on the gains from sale of collectibles under $500.
➢ When does the CGT liability arise? - ss104-5; 109-5 ( a CGT event occurs when: ▪ you enter into a contract for the disposal of the asset; or ▪ if there is no contract, you stop being the assets owner. - s109-5 ( for assets which have been lost or destroyed, a CGT event occurs when: ▪ You first receive compensation; or ▪ If no compensation has been received, when the loss is discovered or destruction occurred.
➢ Effect of Death of a Taxpayer - Generally (s128-10) ( the death of a taxpayer does not constitute a disposal of the deceased’s assets ( any capital gain or loss is disregarded until the beneficiary/estate disposes of the asset ▪ Assets acquired before 20/9/85 ( the beneficiary is deemed to acquire the asset on the day of the taxpayer’s death at the market value (s128-15(2),(4)) ▪ Assets acquired after 20/9/85 ( the beneficiary is deemed to acquire the asset on the date of the taxpayer’s death at the cost base. (s128-15(2),(4)) - s128-15(6) ( a beneficiary will acquire a collectible or personal use asset if the taxpayer acquired it after 20/9/1985 and it was such an asset in the hands of the taxpayer when they died
C. STEP 2: Calculate the Capital Gain/Loss from the CGT Event
- s100-45 [ITAA 97] ( states the method for calculating the capital gain or loss for CGT events:
1. Work out the capital proceeds from the CGT asset: ▪ s116-20 ( capital proceeds is the money received from CGT event. ▪ Market Substitution Rule (s116-10(2)) ( the market value is to be substituted for the proceeds if: o no proceeds are received from the CGT event (ie: gift); or o the proceeds are not received at arm’s length; or o the amount received is greater or less than the market value. o c/f: s116-10(2) ( market substit. rule does not apply where a CGT asset is lost or destroyed ▪ Apportionment Rule (s116-10(3)) ( if a CGT asset has multiple uses, it may be necessary to apportion the proceeds – eg: a main residence which is also used as an office.
2. Work out the cost base for the CGT asset: ▪ s110-25(1) ( the cost base consists of five elements: o Purchase price (s110-25(2)) ( the money paid for acquiring an asset (or market value) o Incidental costs (s110-25(3))( includes professional services, stamp duty, advertising o Non-capital costs of ownership (s110-25(4))( includes interest on borrowings, maintenance, repairs and insurance costs, rates and land taxes (only if NOT an investment property)(only if asset was acquired after 21 Aug 1991). Also, if it is a rental property interest on borrowings, repairs and rates would be deductible and therefore not included in the cost base. o Capital expenses to increase value (s110-25(5)) ( includes extensions and improvements to rental or not rental will be included in cost base. o Costs of establishing or preserving title (s110-25(6)) stamp duty, legal fees, loan establishment costs (only if not rental property). ▪ Indexation ( taxpayers who acquired assets before 21 Sept 1999 may index the elements of the cost base to inflation up to this time (this does not apply to non-capital costs of ownership)
3. Subtract the cost base from the capital proceeds: ▪ If: Proceeds > Cost Base ( capital gain. ▪ If: Proceeds < Cost Base ( calculate reduced cost base.
4. Calculate the reduced cost base: ▪ The reduced cost base is calculated when the cost base exceed the capital proceeds. ▪ Reduced cost base = includes the same elements as s110-25, except for non-capital costs of ownership. No indexation is allowed for any element of the cost base.
5. Determine your CGT position: ▪ If: Reduced Cost Base > Capital Proceeds ( capital loss. ▪ If: Reduced Cost Base < Capital Proceeds (< Cost Base) ( no capital gain / no capital loss. D. STEP 3: Capital Gains Discount
- Treatment of Capital Gains: ▪ Discount method ( 50% of the gain is subject to tax; or ▪ Indexation method ( gain is indexed to reflect inflation - s115-25 ( CGT discount applies only if asset is held for at least 12 months - s115-100 ( the discount percentage is 50% of the gain made by an individual. - The discounted capital gain is included as assessable income.
E. STEP 4: Exemptions & Exceptions
1. General Exemptions - s118 [ITAA 97] ( no CGT is payable on: ▪ Motor cars (s118-5) ▪ Collectables worth less than $500 + personal-use assets worth less than $10,000 (s118-10) ▪ Assets used to produce exempt income (s118-12) ▪ Trading stock (s118-25) and depreciable assets
2. Main Residence Exemption (118-B) - s118-100 [ITAA 97] ( any capital gain or loss made from the sale of a dwelling will not be subject to CGT if: ▪ the taxpayer is an individual; and ▪ the dwelling is the main place of residence.
➢ Dwelling - s118-115 ( dwelling includes building, caravan, houseboat, or mobile home. - TR 92/158 ( yacht may be a dwelling where facilities on board make it habitable (liveable) - s118-120 ( dwelling includes up to 2 hectares of surrounding land used for domestic purposes.
➢ Main Residence - s118-170 ( there is only 1 main residence per family ( if there is more than one, must choose. - Change of Main Residence (s118-140)( if you acquire a new main residence while still owning an old one, both will be treated as your main residence for the shorter of: ▪ 6 months from when you cease to own your existing main residence; or ▪ the period between acquiring new residence and disposing of the existing residence. - s118-140(2) ( to gain the exemption, the old main residence must have been the main place of residence for 3 continuous months and be non-income producing. - Main Residence used to Produce Income: ▪ s118-190(1) ( a main residence which is also used to produce income will only receive a partial exemption from CGT ▪ s118-190(2) ( the capital gain or loss that would have been made is increased by an amount which is reasonable.
3. Small Business Concessions - s152-B ( no CGT on assets held for 15 years where disposal is due to retirement or incapacity. - s152-C ( disposal of active assets - s152-D ( retirement or Eligible Termination Payments (ETPs) subject to lifetime limits - s152-E ( rollovers: individuals converting businesses to companies, partners rearranging partnerships
FRINGE BENEFITS TAX (FBT)
A. Introduction
- Fringe Benefit = a benefit or perk that an employee receives over and above their normal salary or cash remuneration. - FBT is imposed on the employer ( there is no general obligation on the employee to reimburse the employer, although often a contractual arrangement exists between them ▪ Examples: teachers receiving free tuition for their children; pilots receiving discounted travel
➢ Old System - s26(e) [ITAA 36] ( taxpayers were required to include in their taxable income the value of all allowances, gratuities, benefits and bonuses directly or indirectly related to their employment. - This provision was inserted into the ITAA to overcome the problem of non-cash payments being paid to employees (see: Tennant v Smith) - But, the provision was ineffective because of poor administration and it placed an onus on the employee to value the benefits they received. - ( the separate FBTAA was enacted to overcome these deficiencies.
B. Fringe Benefits Tax Assessment Act 1986 (FBTAA)
- The FBTAA establishes a separate statutory regime for the taxation of fringe benefits - FBT is imposed at a rate of 48.5% on the ‘fringe benefits taxable amount’ of an employer for the year of tax (ie: 1 April to 31 March). - FBT is self-assessed and payable in accordance with the FBTAA regime.
1. FBT Elements - s136 FBTAA ( a fringe benefit is a benefit provided during the year of tax by an employer, associate or third party to an employee or associate in respect of employment.
➢ “Benefit” - Benefit is widely defined to mean ‘any right, privilege, service or facility.’ (s136(1)) - Motor Cars: ▪ s7(1) ( a car benefit arises if at any time, in respect of employment, a car is held by the employer and is applied to or available for the private use of an employee or associate. ▪ ( there must be a sufficient nexus with employment – it includes any car owned by, leased to or otherwise made available to the employer. ▪ Private use means any use which is not exclusively in the course of producing assessable income of the employee (s136(1)). - Other forms of benefit: ▪ Low interest loans (ss16-19) ▪ Expense payments (ss20-24) ▪ Airline transport (ss32-34) ▪ Meal entertainment (ss37A-37CF) ▪ Car parking (ss39A-39E) - “Provided during the income year” - The FBT income year runs from April 1 to March 31, not the financial year. - Thus the FB must be earned within this time.
➢ “By an employer, associate or third party” - The benefit must be provided by an employer, associate or third party
➢ “To an employee or associate” - The benefit must pass from the employer to an employee or associate of the employee. - This covers situation where the employer grants a benefit to a spouse, child, trustee etc of the employee.
➢ “In respect of employment” - TEST ( there must be a sufficient nexus or some ‘discernable and rational link between the benefit and the employment’ (J&G Knowles v FCT) - A mere gift on personal grounds is insufficient – ie: the reason for the benefit must be employment (ie: does not include birthday present etc) - Tax Ruling MT 2016 ( not all benefits provided to children who work in a family business will be FBT exempt
2. Exclusions - s136(1) ( exclusions from FBT include: 1) No connection with employment ( FBT is only imposed on employers for benefits paid or provided in respect of employment. 2) In-House fringe benefits ( the first $500 of in-house fringe benefits are not taxable. ▪ In-house fringe benefits are benefits of the same type normally sold to customers which are provided free or at a discounted rate to an employee 3) The “otherwise deductible” rule ( FBT is not payable by the employer if the expenditure would have been otherwise deductible as income under the s8-1 ITAA. - Employee contributions ( where an employee pays an employer for the benefits they receive, these items will not be subject to FBT. - Frequent Flyer Miles ( points are not subject to FBT because they arise out of a personal contractual relationship between the employee and airline, not by virtue of employment (TR 99/6; Payne v FCT;)
3. Calculation of FBT - The FBT rate is 48.5%. - Calculating FBT requirements is a two-step process involving the ‘grossing up’ of the benefits to an amount equivalent to its cost in after tax dollars: ▪ [pic] ▪ [pic]
- Example ( Sally is the managing director of a company. Her son’s school fees are $2000 and are paid for her by the company. What is the FBT that should be paid by the company on that benefit? ▪ [pic] ▪ [pic]
GOODS & SERVICES TAX (GST)
A. The GST System
- The GST is governed by the A New Tax System (Goods and Services Tax) Act 1999. - This system changed the emphasis from heavily taxing income to taxing consumption - The GST commenced on 1 July 2000 at a rate of 10% on taxable supplies. - GST revenue is collected by the Cth government and distributed to the States and Territories. - The GST rate cannot be altered without consensus of every State and Territory and Federal Houses of Parliament ( it is difficult to impose quick and severe increases in the GST rate. - The GST operates on an input-tax credit basis such that producers at each stage of production can claim a GST credit for tax already paid earlier in the chain (see below).
B. Taxable Supplies & Importations – n.b. the changes in the tutorial
- s7-1 GSTA ( GST is payable on taxable supplies and taxable importations.
1. Taxable Supply - s9-5 ( taxable supply = ‘a supply for consideration made in the course of an enterprise connected with Australia by a registered entity.’ - Taxable supply is the amount of GST that is reflected in the product that someone sells.
➢ Supply - s9-10 ( supply is any form of supply, including: ▪ supply of goods; ▪ supply of services; ▪ providing advice or information; ▪ grant, assignment or surrender of real property; ▪ financial supply - s9-10(3) ( it does not matter whether it is a lawful supply ( illegal acts still subject to GST - s9-4(4) ( supply does not include payment of money for goods and services, except where it is given as consideration for a supply of other money (eg: foreign exchange) - Nb: non-taxable supplies include GST-supplies + input-taxed supplies (see below)
➢ Consideration - s9-15(1) ( consideration includes any payment or act of forbearance in connection with supply or in response to or for the inducement of supply. ▪ A mere gift involves no consideration; ▪ Acceptance of goods in return for not suing is consideration. - s9-15(2) ( consideration does not have to be voluntary and can be provided by a third party. - s9-15(2A) ( does not matter if the payment is made under court order or settlement. - s9-15(3) ( payment of a gift to a non-profit body is not consideration.
➢ Enterprise - s9-20(1) ( an enterprise is an activity or series done: ▪ in the form of a business; or ▪ in the form of an adventure or concern in the nature of trade; or ▪ on a regular or continuous basis in the form of a lease, licence or other interest in property. - s9-20(2) ( does not include the activities of employees or private and recreational pursuits.
➢ Connected with Australia - s9-25 ( the supply is connected with Australia if: ▪ goods are delivered or made available in Aust to the recipient (s9-25(1)); or ▪ imports the goods into Australia (s9-25(3)) ▪ removes goods from Aust (s9-25(2)) ▪ installs or assembles goods in Aust (s9-25(3)) ▪ does the ‘thing’ (eg: service) in Aust (s9-25(5)); or ▪ makes the supply through an enterprise carried on in Aust (s9-25(5)). - s9-25(4) ( the supply of real property will be connected with Aust if the land is in Australia.
➢ Registered Entity - ss23-5; 23-15 ( must register for the GST if you are carrying on an enterprise and annual turnover meets the threshold of $75,000 (or $150,000 for non-profit organisations). - s144-5 ( taxi operators must register no matter what their turnover. - Enterprises must register to claim input tax credits.
2. Taxable Importations - s13-5 GSTA ( you make a taxable importation if goods are imported for home consumption. - s13-15 ( GST is payable by the importer, not the overseas supplier - s13-20 ( GST is payable on 10% of the value of the CIF (customs value + freight + insurance). - The GST is paid at the same time as customs duty and is payable regardless of whether an entity is registered (can only claim an input tax credit if registered). - s168-5 ( tourists taking goods out of Aust as accompanied baggage may be entitled to a GST refund under the Tourist Refund Scheme. - Nb: exports are generally GST-free
C. GST Exemptions
1. GST-Free Items - s38-1 GSTA ( if a supply is GST-free, no GST is payable + supplier can claim an input-tax credit
➢ Food (subdiv. 38-A) - s38-2 ( a supply of food is GST-free. - s38-4 ( food includes: ▪ food for human consumption ▪ ingredients for food ▪ beverages for human consumption (see Sched. 2) ▪ ingredients for beverages ▪ goods to be mixed with or added to food (incl: condiments, spices, seasonings, flavourings) ▪ fats and oils. - s38-4 ( food excludes: ▪ live animals (other than crustaceans and molluscs) ▪ unprocessed cow’s milk; ▪ any grain, cereal or sugar cane ▪ plants under cultivation that can be consumed without further process or treatment. - s38-3 ( food that is not GST-free includes: ▪ food for consumption on the premises it is supplied; ▪ hot take-away food ▪ food in Sched. 1 (prepared food, confectionary, savoury snacks, bakery products, ice-cream, biscuit goods) ▪ beverages not specified in Sched. 2 (ie: alcohol is not GST-free). - s38-5 ( premises = where supply takes place; surrounding grounds; any enclosed space where there is a clear boundary. - s38-6 ( the packing is GST-free if the food is GST-free provided the packaging is necessary and of a kind normally supplied.
➢ Health (subdiv. 38-B) - s38-7(1) ( the supply of medical services is GST-free ▪ s195-1 ( medical service = one for which Medicare is payable and necessary ▪ s37-7(2) ( a medical service is not GST-free if it is for cosmetic use. - s37-10 ( other health services are GST-free if: ▪ they are of a specified kind: o Abor health; o acupuncture; o audiology; o chiropody; o chiropractic; o dental; o dietary; o herbal med; o naturopathy; o nursing; o occupational therapy; o optometry; o osteopathy; o paramedical; o pharmacy; o psychology; o physio; o podiatry; o speech pathology; o speech therapy; o social work. ▪ The supplier is a recognised professional supplier of those services; and ▪ The supply is generally accepted as appropriate treatment. - s38-45 ( the supply of medical aids and appliances is GST-free if covered by Sched. 3 and is specifically designed for a person with an illness or disability - s38-47 ( the supply of other health goods will be GST-free if the Minister determines (eg: aspirin, condoms, sunscreen, community care, residential care, hospital care, special disability services)
➢ Education (subdiv. 38-C) - s38-85 ( education courses are GST-free ▪ s195 ( education course = pre-school, primary, secondary, tertiary, Masters or Doctoral, special education course, adult & community education course, English language, professional course, first aid or lifesaving course. - s38-90 ( excursions & field trips are GST-free if directly related to curriculum + not recreational - s38-95 ( course materials necessarily consumed and transformed by students are GST-free: ▪ GSTR 2001/1 ( includes course notes, workbooks and art supplies (eg: paint, sketch pads etc) ▪ s38-100 ( excludes textbooks, musical instruments, computers, calculators & sports equipment - s38-100 ( not GST-free: ▪ sale, lease or hire of goods (except course materials); ▪ supply of membership of a student organisation. - Student Accommodation: ▪ s38-105 ( supply of student accommodation is GST-free if students are undertaking a primary, secondary or special education course, and the supplier of the accomm also supplies the course; ▪ s38-105(3) ( student accomm = the right to occupy premises and if provided, the right to the supply of cleaning and maintenance, electricity, gas, heating, telephone, TV, radio etc. ▪ s38-105(4) ( supply of accomm is not GST-free to the extent that it consists of food. ▪ Nb: if don’t fall under this exemption – look at residential rent (s40-35) + food exemptions (s38-3 – ie: supplied on premises).
➢ Other Exemptions
1. Child care (subdiv 38-D)
2. Exports of goods (subdiv 38-E) ▪ s38-185 (Item 1) ( general export of goods is GST-free if exported within 60 days. ▪ s38-185 (Item 7) ( goods exported by travellers as accompanied baggage are GST-free if the provisions of the regulation are met ▪ s38-185(2) ( exported goods are not GST-free if the supplier reimports them (Items 1-6 only) ▪ s168-5 ( tourists taking goods out of Aust as accompanied baggage may be entitled to a GST refund under the Tourist Refund Scheme ▪ Reg 168-5 ( exported goods must be invoiced over $300, purchased within 30 days of export, and not be cigarettes or alcohol (unless wine tax is paid).
3. Religious (subdiv 38-F)
4. Charities (subdiv 38-G)
5. Water, sewerage and drainage (subdiv 38-I)
6. Going concerns (subdiv 38-J)
7. Passengers on international flights and domestic flights: ▪ s38-355 ( transport from the last place of departure in Aust to a destination outside Aust is GST-free. ▪ s38-355 ( transport on domestic legs of international flights will be GST-free if: o it is part of a wider arrangement for transport by air involving international travel; and o at the time of entering the contract, transport within Aust formed part of the ticket.
8. Cars for use by disabled persons (subdiv 38-P)
2. Input-Taxed Supplies - s40-1 GSTA ( for supplies that are input-taxed, no GST is payable on the supply but there is no input-tax credit entitlement. - There are 6 types of input-taxed supplies: 1. Financial supplies (s40-5) 2. Residential rent (40-35) ▪ No GST is payable on residential rent (ie: lease, hire, licence, rent on residential premises) ▪ ( landlord cannot charge tenant GST and cannot claim input tax credits for expenses. 3. Residential premises ▪ s40-65 ( sale of residential premises is not subject to GST ▪ s40-70 ( supply of residential premises by long term lease is not subject to GST 4. Precious metals (s40-100) 5. School tuckshops and canteens ▪ s40-130 ( supply of food is GST-free if it is made by a non-profit body through a shop operating on school grounds which supplies primary or secondary courses. 6. Fundraising events conducted by charities
D. GST Administration
➢ GST Calculation - s9-70 ( the amount of GST payable is 10% of the value of the taxable supply - s9-75 ( Value of taxable supply = Price [pic] ▪ where: price = monetary consideration + market value non-cash consideration. - s9-40 ( the person making the supply is liable for GST (except for imports)
➢ Input Tax Credits (s11-20) - The GST is a multi-stage and value-added tax because it is levied at each stage of production. - Each stage of production is entitled to an input tax-credit for GST paid earlier in the chain ( each stage is required to pay GST on its production, less GST paid at earlier stages - s11-1 GSTA ( you are entitled to input tax credits for creditable acquisitions. - s11-5 ( an acquisition includes something acquired solely or partly for a creditable purpose, including an acquisition of goods, services, advice or info, grant of real property etc. - s11-15(1) ( a thing is acquired for a creditable purpose if acquired in carrying on your enterprise - s11-15(2) ( a thing is not acquired for a creditable purpose if it relates to making supplies that would be input-taxed or is of a private or domestic nature.
- Example: Maxine buys perfume from a retailer for $275 (incl. GST), who had bought the perfume from a wholesaler for $165 (incl. GST), who had imported the perfume from France for $50 plus $20 customs duty on the perfume, insurance and transport ($70 total). Explain GST implications.
|1: Import/Wholesale | |2: Wholesaler → Retailer | |3: Retailer → Maxine | |
|GST Paid = 10% × $70 | $ 7 |GST Paid = 1/11 × $165 | $ 15 |GST Paid = 1/11 × $275 | $ 25 |
|Input Tax Credit | $ - |Input Tax Credit | $ 7 |Input Tax Credit | $ 15 |
|GST to ATO | $ 7 |GST to ATO | $ 8 |GST to ATO | $ 10 |
| | | | |TOTAL GST | $ 25 |
➢ Tax Periods and Timing - Generally (s27-5) ( GST-payment period is every 3 months (quarterly) - Exception (s27-10) ( you can elect to pay monthly. ▪ Must pay monthly if turnover is > $20m or business has been carried on for < 3 months or the enterprise has a history of not meeting its tax obligations. - s29-5(1) ( the GST payable on an accruals basis is attributable to: ▪ the period when consideration was received; or ▪ the period in which the invoice is issued. - s29-40(3) ( can choose to account on a cash basis if: ▪ annual turnover is less than $2M ▪ charitable institution; or ▪ the ATO considers it appropriate (s29-45)
➢ GST Offsets - s35-5 ( if GST credits > GST liabilities, then you get a refund within 14 days of lodging report - Refund/amt payable = GST credit – GST liability ▪ If positive ( refund ▪ If negative ( must pay net amount - s35-10 ( refunds usually paid into bank account
Philmno@gmail.com
TAX AVOIDANCE
A. General Principles
- Tax evasion = fraudulently attempting to avoid tax by breaching the law. ▪ eg – destroying records, not declaring all assessable income, claiming false deductions. - Tax avoidance = taking advantage of legal loopholes in an artificial or contrived way ▪ eg – minimising taxes in a way which is technically not illegal, but is deemed to be avoidance - Tax planning = lawful arrangement of tax affairs in a way which is not artificial or contrived ▪ Westminster principle ( person may arrange their affairs to minimise tax within the law.
B. Anti-Avoidance Part IVA
- Tax avoidance schemes may be struck down under Part IVA [ITAA 36]. - Counterbalancing principles: ▪ Westminster principle ( person may arrange their affairs to minimise tax within the law ▪ Toohey principle ( not for the Comm’r to tell the taxpayer how to arrange his business affairs ▪ Ayshire Pullman v IRC ( “no obligation on a man to arrange his legal relations to enable IR to put the largest shovel into his shores”
1. Part IVA - s177F ( the Comm’r has the discretion to cancel a tax benefit obtained under a scheme for the dominant purpose of avoiding tax.
➢ Tax Scheme - s177A ( a ‘scheme’ is widely defined to mean: ▪ (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; & ▪ (b) any scheme, plan, proposal, action, course of action or course of conduct. - The scheme must be identified: ▪ Peabody ( the individual steps of a wider scheme could comprise a separate narrower scheme if capable of standing on its own ▪ Spotless ( a scheme which is incapable of standing on its own with any practical meaning is too narrow. ▪ Hart ( identification of the scheme is critical to determining the taxpayer’s dominant purpose. The tax benefit must link to the scheme.
➢ Tax Benefit - s177C ( a tax ‘benefit’ is obtained where there is: ▪ a decrease in assessable income which would otherwise be included; ▪ an increase in deductions which would otherwise not be allowable ▪ a capital loss which would otherwise not be incurred; or ▪ a foreign tax credit which would otherwise not be allowable. - Peabody ( look at what is reasonably expected from the scheme – involves a prediction which is sufficiently reliable, more than just a possibility. - Spotless ( the court will determine what is reasonably expected by looking at the commercial reality and subjective intention of parties.
➢ Dominant Purpose of Tax Avoidance - Spotless ( the dominant, prevailing or most influential purpose must be tax avoidance. - s177D ( purpose determined by: ▪ the manner in which the scheme was entered into or carried out; ▪ the form and substance of the scheme; ▪ the timing and duration of the scheme; ▪ the results achieved; ▪ change in financial position of taxpayer; ▪ change in financial position of a person connected with the taxpayer (business, family or other); ▪ any other consequence; and ▪ the nature of any connection between the taxpayer and other person. - WD & HO Wills ( tobacco co established subsidiary Singaporean insurance co to provide insurance. No claims against the insurer meant the co was profitable. Comm’r argued purpose was tax avoidance: ▪ H: the dominant purpose was commercial. It enabled the taxpayer to obtain indemnity and allowed for more effective risk management and handling of claims - Consolidated Press Holdings ( Pt IVA applies to any person associated with the scheme ( the beneficiary need not have the purpose of tax avoidance - Hart v FCT ( where the individual steps of an overall scheme are in question, look at the dominant purpose of the smaller scheme. - Cridland ( student approached by vendor of tax scheme and became beneficiary of trust. Pursuant to the Act, student was able to average income over 5 years, despite receiving only $1 distributions. ▪ H: student was entitled to exploit this tax advantage b/c specifically allowed under Act - Nb: the benefit received does not have to match the benefit intended – the Act refers to ‘a’ benefit, not ‘the’ benefit.
2. Penalties - s177F(1), (2A) ( where a benefit is obtained in connection with a Pt IVA scheme, the Comm’r may cancel the tax benefit and include an amount as assessable income, disallow a deduction. - The taxpayer may also be subjected to: ▪ Administrative penalties (s248-C sch 1 Tax Administration Act); and ▪ Criminal penalties for defrauding the Cth (Crimes (Tax Offences) Act; Crimes Act)
C. Income Splitting
➢ Alienation of Personal Services Income - Alienation of personal services income occurs when the services of an individual are provided through an interposed entity rather than directly by the individual who performs the services - s86-10 [ITAA 97] ( individuals cannot reduce or defer their tax by alienating personal services income through companies, partnerships or trusts. ▪ ( personal services income, whether paid directly or through an interposed entity, will be treated the same way for tax purposes.
➢ Payments to Associated Persons - s26-35 ( restricts deductions for payments made to related entities (eg: spouse, relative) to those which are reasonably incurred. ▪ ( a person who employs their spouse or relative can only deduct an amount which would be reasonably paid in arm’s length circumstances for rendering those services.
-----------------------
Wholesaler (importer)
- Test = you are a resident if you have actually been in Australia, continuously or intermittently, for 183 days of the income year, unless: ▪ your usual place of abode is outside Aust; and ▪ you do not intend to take up residence in Aust.
- Test = a person will be a resident of Australia if they are: ▪ a member of a superannuation scheme established by deed under the Superannuation Act 1990, ▪ an eligible employee for purposes of the Superannuation Act 1976; or ▪ a spouse or child under 16 of such
- Test = a company not incorporated in Aust will be a resident if: ▪ It carries on business in Australia; and ▪ Its voting power is controlled by shareholders who are residents of Australia.
- Test = a company not incorporated in Aust will be a resident if it: ▪ Carries on business in Australia; and ▪ Has its central management and control in Australia.
➢ TEST = to determine whether a receipt is ‘income’ it is necessary to apply the following tests:
1. The receipt must be ‘earned’ or ‘derived’ from your office or employment (Dixon’s case)
2. The receipt must be received predictably, periodically or in a recurrent manner – ie: must expect to receive the income regularly (Stone’s case). ▪ FCT v Dixon ( employer paid a worker the difference between their war-time salary and normal salary. H: income because it was regular and expected. ▪ Myer Emporium ( M made a loan to a finance co and assigned the interest to Citicorp. Citicorp returned the money to M as a capital receipt. M argued that it was a once-off, lump sum payment. H: income received in ordinary course of business and could not be separated from the assignment
3. Must be convertible into money ( if a receipt or benefit cannot be converted into money, it is not income (Tennant v Smith – rent-free accommodation not income; Cook & Sherden – free holiday). ▪ If non-cash items can be converted into money, they may be classed as income provided the consideration is received as money’s worth (s6-1; ss21 21A)
4.
- s8-1(1) ( you can deduct from your assessable income any loss or outgoing to the extent that: a) it is incurred in gaining or producing your assessable income; or b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income - s8-1(2) ( you cannot deduct a loss or outgoing to the extent that: a) it is a loss or outgoing of capital b) it is a loss or outgoing of a private or domestic nature c) it is incurred from exempt income d) a provision of the Act prevents you from deducting it.
- The courts have adopted various tests for distinguishing between income and capital. - Eisner v Macomber ( the court described capital and income as analogous (similar to) to ‘tree and fruit’ – the capital being the tree which is planted once, and income as the fruit which is regular, periodic and expected. - TEST= Replacement Principle ( if the receipt is replacing an income stream, the receipt is income. The receipt will be capital in nature if it is replacing something else (DP Smith case) ▪ DP Smith ( H: disabled worker received payment to replace income stream – H: income. - Other tests: ▪ ‘Once and for all’ test ( one-off, lump sum receipts are capital; ongoing receipts are income: o Vallambrosa Rubber – company claimed deduction for entire rubber plantation, despite only 1/7 bearing rubber. H: regular deduction which was ongoing ( income. ▪ ‘Enduring benefit’ test ( an item of long term benefit to the taxpayer will be capital in nature (British Insulated Helsby Cables) ▪ ‘Business entity’ test ( receipts which go to the core of the business and are not part of the ordinary business practices will be capital in nature (Sun Newspapers)
- TEST (Montgomery Lockhart J) ( a lease incentive payment will be income if: ▪ It was received in the ordinary course of business (Myer Emporium) ▪ It was not received in the ordinary course of business, but was received as an ordinary incident of the business (Westfield case) ▪ It was an extraordinary transaction & gain was made with a profit-motive (Myer Emporium)
➢ TEST (TR 97/11) ( the following factors are relevant to determining whether a business exists: ▪ Intention of making a profit (major factor) (Brajkovic; Radnor; Stone v CoT) ▪ Systems and organisation (Feguson) ▪ Volume and scale of the activity (Walker; Ferguson) ▪ Commercial character of transactions (Stone v CoT) ▪ Whether ordinary business principles relevant to the industry are being applied ▪ Sustained, regular and frequent transactions (Shields) ▪
Positive
Limbs
Negative
Limbs
- s6(1) [ITAA 36] ( a resident means a person who resides in Aust, and includes a person who: ▪ Has their domicile in Australia, unless they have a permanent place of abode outside Aust; or ▪ Has been in Aust, continuously or intermittently for 183 days, unless their usual place of abode is outside Australia
Retailer
Maxine (consumer)
$70
$165
$275
INTRODUCTION TO TAX LAW
A. Origins of Taxation
- Taxation is not a modern concept, and dates back to the Roman Empire: ▪ Emperor Caligula set a disturbing trend as a tax collector by imposing taxes on food, court proceedings, wages of porters, prostitutes and even marriage. - 1770’s ( Pitt and Lord North believed that newspapers were luxury items and constituted appropriate fiscal targets. A stamp duty was placed on newspapers, which was later increased to put newspapers beyond the purchasing power of the average person. - UK ( many early taxes were indirect taxes on consumption rather than on income - Australia Tax History: ▪ The first income tax in Australia was introduced by the SA government in 1884, with a flat rate tax imposed on income from physical exertion, property and land. ▪ Each of the Australian states followed by imposing their own taxes before and after Federation. ▪ In 1915, the Federal Government imposed its first national tax due to the pressures of the war. ▪ This led to double income taxation from the States and Commonwealth. ▪ The Great Depression in the 1930’s encouraged uniformity between the two systems and led to a Royal Commission on Taxation. ▪ Finally, the ‘Uniform Taxation Scheme’ was introduced during WW2 which gave the Federal Government the sole control of income tax.
B. The Role and Purpose of Taxation
- Taxation is primarily used by the government to generate revenue. ▪ Yuri Grbich ( “tax is a means by which the government expropriates private property without compensation.” ▪ Kay & King ( “the basic function of a tax system is to raise revenue and relieve the inequalities of income and wealth.” - Taxation is the most intrusive of all government impositions. When an individual is required to pay tax in the public interest, the laws should be as clear as possible. They are not. ▪ Evans v FCT (Connolly J) ( “there is no discernible pattern in all these taxation laws. They reveal no consistent social policy. All socially desirable objects are not tax deductible.”
C. Goals of a Good Tax System
- The main objectives of a good tax system are “equity, efficiency and simplicity.” ▪ Equity ( fairness between individuals is the primary goal, including both horizontal equity (same tax / same position) and vertical equity (different tax / different positions). ▪ Efficiency and certainty ( the system should be efficient and certain so that collection can be relied on. If the system is not certain, it is difficult to penalise those who avoid its collection. ▪ Simplicity ( the tax system should be clear and simple so that taxpayers can understand it. ▪ Adequate ( the system must generate sufficient revenue for the government ▪ Politically Acceptable ( voters must endorse, or at least comply with the laws. ▪ Economically neutral ( the system must not interfere with market forces and decisions. D. Constitutional Basis for Taxation
- The Commonwealth gains its power to tax from the Constitution: ▪ s51(ii) Constitution ( Parliament can “make laws with respect to taxation, but so as not to discriminate between States or parts of States.” ▪ ( Parliament has the power to impose taxes, but it is restricted from discriminating between States or parts of States (uniformity of taxes). - Section 53 ( the Senate shall not originate or amend laws imposing tax. ▪ ( only the House of Representatives can originate laws relating to tax collection. ▪ The Senate may return proposed tax laws to the Lower House for amendment. - Section 55 ( laws imposing tax shall deal with one subject of taxation only. ▪ This section means that laws relating to tax cannot be attached to another bill to escape the scrutiny of the Parliament. ▪ It also implies that the Income Tax Assessment Act (ITAA) does not actually impose a tax – as this Act deals with administration and other matters, it cannot impose a tax. - Section 99 ( laws cannot give preference to one State or any part thereof over another State. - The Commonwealth power to impose taxes is shared concurrently with the States: ▪ The only exclusively Federal tax power is the power to levy customs and excise. ▪ Section 90 ( the Commonwealth Parliament has the exclusive power to impose excise duties. This acts as a restriction on State powers.
➢ Uniform Tax Scheme: ▪ The States used to levy their own income taxes on residents until 1942 when, during WW2, the Commonwealth took sole responsibility for raising and collecting income tax. ▪ The enactment of 4 statutes resulted in all tax revenue flowing to the Commonwealth. This practice was upheld in the Uniform Tax Cases (SA v Cth; Vic v Cth).
E. Summary of Australian Taxes
1. Definition of ‘Tax’ - Matthews v Chicory Marketing Board ( taxation is “a compulsory exaction of money by a public authority for public purposes, enforceable at law, and not a payment for services.” - A tax is basically any compulsory taking of money from citizens for public purposes.
2. Who Levies Taxes? - Every level of government levies some form of tax. - The main taxes levied by the various levels of government include:
|Federal Government |State Government |Local Government |
|Income tax (PAYG) |Land tax |Property rates |
|Capital gains tax (CGT) |Payroll tax |Other taxes |
|Fringe benefits tax (FBT) |Stamp duties | |
|Sales tax | | |
|Goods and services tax (GST) | | |
|Customs duty | | |
|Excise duty (alcohol, tobacco, petrol) | | |
|Departure tax | | |
- There are a large number of taxes imposed on society and extracted by complex legislation. - Reducing the complexity of tax laws is a political objective requiring attention
3. Classification of Taxes - Taxes may be classified as either direct or indirect taxes: ▪ Direct tax ( these are exacted directly and are ‘visible’ to the taxpayer. ▪ Indirect tax ( these are taxes that are hidden from view. The amount of tax is usually reflected in the retail price of goods but is not obvious to the consumer.
➢ Types of Direct Taxes ▪ Income Tax ( tax on a person’s income stream, usually payable on a monthly basis as income is earned (known as the PAYG or pay-as-you-go system). Income tax accounts for over half of all tax collected by the Federal Government. Levied by the Income Tax Assessment Act. ▪ Capital Gains Tax ( tax payable on the gains made from the disposal of property. CGT forms part of the income tax statute (ITAA) and is payable on land, shares, artwork, businesses and property. CGT is applicable to assets purchased after 19 September 1985. ▪ Fringe Benefits Tax ( tax paid by employers on the value of the non-salary benefits given to their employees (eg: subsidised rent, petrol, car, education etc). FBT is levied under a separate statute – the Fringe Benefits Tax Assessment Act.
➢ Types of Indirect Taxes ▪ Goods and Services Tax ( a consumption tax paid by the final consumer of goods and services. The tax is included in the price paid. The GST imposes a rate of 10%. The GST is created under the GST Act and is based on taxing people on the wealth they consume. ▪ Stamp Duties ( taxes on documents or transactions that carry out and record the transfer of land and other assets (including leases, transfers of land or shares etc) ▪ Sales Tax ( a tax on the wholesale sale of goods made and consumed in a country. The introduction of the GST has seen Australia phase out most of its sales taxes.
4. Tax Systems - There are two main types of tax systems: ▪ Graduated tax system ( the rate of tax increases with the level of income (progressive) ▪ Proportional tax system ( income is taxed on a flat-rate (same rate of tax for all income levels). - The income tax rate structure in Australia is progressive. The company tax structure is a flat rate.
F. Tax Reform in Australia
- The Australian tax system has been criticised for its complexity and because it ‘cuts-in’ too early.
1. Tax Law Improvement Project (TLIP) - The ITAA (1936) had grown from its slim original size (110 pages with 266 sections) to thousands of pages. At last, the TLIP was brought about to simplify the tax law and rewrite the Act. - The rewrite (not yet complete) of the ITAA 1936 is called the ITAA 1997. As a result, there are two statutes on income tax. - As the new Act is written, it comes into force to replace the relevant parts of the 1936 Act. Provisions in each statute refer to the words “this Act,” thereby embracing both statutes. - The rewrite project, subsumed into the “Tax Reform Plan” (A New Tax System – ANTS) in 1998 has since stalled. For now, we live with the two statute system and the resulting complexity. - The Income Tax (Transitional Provisions) Act 1997 determines when new legislation comes into effect. The Income Tax (Consequential Amendments) Act 1997 terminates the relevant parts of the 1936 Act, as they get rewritten. The 1997 Act commenced on 1 July 1997
2. Wealth Tax - Wealth tax = a tax levied on a person’s overall wealth or net worth. This means that people are taxed on the value of (Assets – Liabilities) - The rate of taxation is low, usually between 1%-5.5% and it is collected annually. - This form of taxation is desirable in light of the inequalities of the distribution of wealth (i.e. top 1% of income earners own 9-22% of wealth; bottom 50% of income earners own 9-15% of wealth)
➢ Advantages of a Wealth Tax ▪ Tax system has greater equity as it catches amounts not taxed by income tax ▪ Provides detailed information regarding ownership of wealth ▪ Reduced concentration of wealth and produces more egalitarian distribution ▪ Tax system with no tax-exempt assets would cause investors to switch to assets generating higher returns exceeding the wealth tax rate and marginal income tax rates. This would encourage more productive use of resources and boost economic growth. ▪ Wealth tax would enable a reduction in marginal tax rates ▪ Politically favourable.
➢ Disadvantages of a Wealth Tax ▪ Discourages savings and ( reduces economic growth ▪ Results in double taxation because wealth is subject to income tax ▪ Difficult to administer – identification and valuation of relevant assets; enforcing compliance and detecting tax avoidance and evasion ▪ May cause inefficient allocation of resources by discouraging investment in enterprises where initial returns are low, but long term prospects are good. ▪ May inhibit people’s willingness to take entrepreneurial risks (not willing to start new businesses).
G. Sources of Australian Tax Law
- There are three sources of tax law: 1. Statute ( legislation passes by the different levels of government, including regulations and by-laws 2. Common Law ( case law which is created by the decisions made in the courts and the system of precedents 3. ATO practices ( a de-facto source of the law. The ATO releases periodic directions and rulings which helps shape the taxation laws.
H. Interpretation of Tax Legislation
- There are three methods of interpreting statutes: 1. Literal Rule ( give words their literal meaning 2. Mischief Rule ( a purposive approach – seek out the purpose of the legislation 3. Golden Rule ( apply the literal rule, unless that would lead to an absurdity.
1. Literal Rule - Literal rule( the court seeks to ascertain the intention of the legislature through examination of the “ordinary and natural meaning of the words as understood in their context.” - Interpretation should apply even if the result is inconvenient, improbable or produces unjust results - Rationale = it is for the Parliament, not the courts, to correct the absurdity in the legislation (this approach maintains the separation of powers between the judiciary and executive) - Adopted: ▪ FCT v Westraders (Barwick CJ) ( “it is for the Parliament to specify with unambiguous clarity the circumstances which will attract an obligation on the part of the citizen to pay tax. The function of the court is to interpret and apply the language…it is not for the court to mould the language of the statute to produce some result which might not be intended.” ▪ Cape Brandy Syndicate v IR Commissioner ( “in a taxing Act, one merely has to look at what is clearly said…nothing is to be read in, nothing is to be implied.” - Criticisms: ▪ Literal rule exaggerates the degree to which the intention of Parliament may be discovered merely from the words of a statute (eg: where a word has multiple meanings) ▪ Underestimates the degree to which the judge’s personality and value system play a part in determining the intention of Parliament ▪ Deters courts from interpreting provisions to overcome the problem the statute was intended to remedy.
2. Mischief Rule (Purposive Approach) - Mischief rule ( identifies the problem the legislation was designed to cure and then interprets the legislation to ensure that Parliament’s intention is achieved. - Where the meaning of a statute is unclear, interpretation should be based on: ▪ The state of the laws before the Act in question; ▪ The ‘mischief’ created by the existing laws; ▪ The legislative remedy which Parliament intends to cure the defect. - Adopted: ▪ Hill J & Kirby P in DFCT v Chant ▪ Hepples v FCT (Murphy J) ( court may depart from the literal meaning wherever it does not conform to the legislative intent ascertained from the provisions. ▪ FCT v Ryan (Kirby) ( proper approach is that which advances and does not frustrate the purpose of the legislature. ▪ s15AA Act Interp. Act (a construction that would promote the purpose underlying the Act shall be preferred to a construction that would not promote that purpose or object. ▪ s15AB Act Interp. Act ( court may use extrinsic material to interpret the intent of the provisions (eg: explanatory memoranda, second reading speeches, law reform reports). - Criticisms: ▪ Judges are effectively rewriting the legislation by implying words which may not be intended ▪ No separation of powers ▪ There may be disagreement as to the mischief to be remedied.
3. Golden Rule - The golden rule has been suggested as a rule which could provide a ‘happy medium’ between the two approaches. - Golden rule ( the court should apply the literal meaning of the words unless that meaning “would lead to some absurdity, or some repugnance or inconsistency with the rest of the instrument.” - This rule is therefore modified to overcome any absurdity arising from a literal interpretation. - Adopted by Mason & Wilson JJ in Cooper Brookes (Wollongong) v FCT - Criticisms: ▪ This is a subjective approach – different judges may disagree on whether the result is absurd ▪ Difficult to know what is an acceptable level of deviation from the literal interpretation.
TAX ADMINISTRATION
A. Role & Function of ATO
1. Collection of Taxes - The Australian Taxation Office (ATO) administers our income tax system. - The Department is led by the Commissioner of Taxation. - The day-day-to day activities are carried on by local branches of the ATO, headed up by the Deputy Commissioner. - Under PAYG, income is withheld from employees before they receive it and is paid to the Commissioner of Taxation (this replaced the PAYE system).
2. Self-Assessment Process - Self-assessment ( each financial year, individuals and entities fill in a tax return and make a calculation of the amount of tax owed. - These returns are accepted at face value by the ATO - Tax payers are entitled to a refund for overpayment or are liable for the shortfall - Computer systems are used to cross-check data.
3. Tax File Number (TFN) System - This is the first item on the tax return ( it allows for matching of data by government departments. - The TFN is to be quoted when: ▪ an employee wants an employer to deduct PAYG payments; or ▪ a return is received on investments and don’t want company to deduct tax at the highest rate.
4. Tax Assessments
a) General Assessments - s161 [ITAA 36] ( every person must lodge a return of yearly income with the Commissioner. - s174 ( Comm’r must issue an assessment notice as soon as convenient after assessment is made. - s177 ( the assessment notice is conclusive evidence if the making of the assessment. - s170 ( the Commissioner may amend the notice at any time
b) Default Assessments - s167 [ITAA 36] ( a default assessment may be made where: ▪ a person does not furnish (supply) a return; or ▪ the Commissioner is not satisfied with the return furnished; or ▪ the Commissioner believes that not all taxable income has been disclosed. - The Commissioner will assess an amount upon which he believes income tax should be levied – - This amount is deemed to be the taxable income for the purpose of s166. - The Commissioner often relies on assets betterment or an accretion of assets statement or t-account basis (assets betterment used in McCauley v FCT & Allard)
c) Nil Assessments - Where the Commissioner deems your tax liability to be nil, you may still be liable to tax ➢ Ryan’s case: - Facts: ▪ Comm’r issued nil assessment notice in error. ▪ Realised mistake during audit & issued another assessment notice, but 4 years later (out of time). - Issues: ▪ Whether the first notice was a Notice of Assessment and the new one an Amended Assessment, in which case the second notice was invalid because it was out of time (> 3 years); or ▪ Whether the second notice became the original Notice of Assessment, in which case time only started running on its issue ( taxpayer still liable. - Decision: ▪ FCA ( first notice was the Assessment Notice, even if it said ‘nil’ due to the need for finality ▪ HCA ( the first notice was not an Assessment Notice. An Assessment Notice requires an assessment of some value from which the 3 year period can operate. Certainty and finality are not principles of the tax system ( cannot be used to justify the decision. Noted provisions of Tax Act to give a formal assessment (may have been different result if formal assessment given)
5. Post-Assessment Procedures
a) Audits - Audit ( each year the ATO will select a small number of returns for analysis and review. - There are different types of audit: ▪ Desk audit – when a person is invited to attend an interview at the ATO office ▪ Complex audit – for larger corporate taxpayers ▪ Business audits – for other businesses. - Audits are conducted at random although certain taxpayers may be singled out for anti-tax performance or reported cases. - N.B. GFC has cause ATO to target people with capital assets who might look to write off their capital losses as losses in revenue.
b) Penalties and Interest - Interest rate if the general interest charge rate - Administrative penalties ( TAA 1953 (Sch 1 Div 284 – 288) for additional or penalty taxed (new regime from 1 July 2000) - Judicial penalties ( TAA 1953 (ss8A – 1313C) where taxation offences are created & persons are prosecuted - Publicity is used for deterrence - Taplin v Pickford ( “there is a very real prospect that, if the total levels of penalty are not such to render it extremely unprofitable for individuals to cheat on their fellow citizens, the system could either break down or become extremely difficult or expensive to administer.”
c) Burden of Proof - Burden is on the taxpayer - s14ZZK [TAA 53] ( on application for a review, the applicant has the burden of proving that the assessment was excessive. - s14ZZO ( in an appeal to the Federal Court, the applicant has the burden of proving that the assessment was excessive
B. ATO Powers – Accessing Information
- s262A [ITAA 36] ( TPs carrying on a business must keep sufficient records in English for 5 years - s8L [TAA 53] ( it is an offence to keep records in a way that does not correctly explain matters - The ATO may access information via a two-step process: ▪ Step 1 – rely on CL right to ask taxpayer for information; ▪ Step 2 – rely on statutory power to gather information - Rationale = the Comm’r is given this power because income tax is the principal source of revenue for the government and systems to elude tax are notorious (common) (Grant v DFCT)
1. Accessing Books & Documents (s263) - s263 [ITAA 36] ( the Comm’r can have “full & free access to all buildings, places, books, documents and other papers” for any purpose of the Act.
➢ Authorisation - s263(2) ( investigator cannot enter or remain on premises if written authorisation is not produced when requested by the occupier ▪ FCT v Citibank ( wallet authorisation is sufficient - But: if no authorisation is requested, officer is entitled to stay as a CL invitee.
➢ ‘Full Access’ - Citibank ( “Full access” means access to whole of premises + can make copies of any books, docs or papers (but no power to seize) - Industrial Equity v DFCT ( may go on a ‘fishing expedition’ if are acting for a proper purpose; being one of top 100 companies was enough, despite no suspicion they were doing anything wrong. - JMA Accounting ( emails and documents downloaded from a computer in bulk without reference to relevance was an abuse of power. But, selective seizure of docs after determining relevance is ok. Didn’t know which docs needed, but held in FC that was acting beyond scope of powers.
➢ ‘Free Access’ - Citibank ( “Free access” conveys an absence of physical obstruction. - s263(3) ( occupier must provide officer with all reasonable facilities and assistance (ie: power, lights, photocopying, telephone, computer passwords), ▪ Kerrison v FCT ( Commissioner can seek access using reasonable force (not excessive force) ▪ But: s263(3) requires Comm’r to seek assistance before resorting to force.
➢ General Citibank Principles - FCT v Citibank (French J) ( ATO has wide and unfettered powers: ▪ No prior warning is required; ▪ Cannot remove documents but can make copies ▪ Wallet authority required, but only if asked ▪ Principles of natural justice do not apply ▪ Can go on a ‘fishing expedition’ ▪ Occupier* must provide reasonable facilities and assistance ▪ Can use reasonable force to access documents ▪ Privilege against self-incrimination does not apply; legal professional privilege applies
* N.B. Occupier not defined ( would the cleaner fit in under this?
June 1998 – 37 ATO’s showed up at Citibank, looking for offshore tax avoidance scheme, but actually took far more than this – some had permits, some did not. Citibank tried to claim client privilege. While don’t need to give warning etc, do need to give you opportunity to claim LPP.
2. Requiring Evidence (s264) - s264 [ITAA 36] ( the Commissioner may, with written notice, require any person: ▪ to furnish information ▪ to attend meetings and give evidence ▪ to produce books or documents. - This section applies to ‘any person’ – ie: accountant, tax agent, company director etc. ➢ Obligation to Furnish Information: ▪ Officer may require any person to furnish relevant info as required (( fishing expedition ok) ▪ Only those documents in the person’s custody or control must be produced ▪ Smorgon v FCT ( info is not limited to evidence regarding a particular person’s income or assessment and may be used by the Commissioner to perform any of its functions under the Act ➢ Obligation to Attend Meetings & Give Evidence: ▪ Officer may require any person to attend meetings and give evidence ▪ The notice only has to specify that the evidence required concerns the assessment of a person ▪ Examination must be carried out in private. ➢ Obligation to Produce Books & Documents: ▪ Only those books and docs in the person’s custody (possession) or control need to be provided. ▪ Notice must specify the documents with reasonable particularity (FCT v Smorgon) + the person whose income or assessment is in question (Clarke v DFCT)
- Challenging a Notice ( a s264 notice may be challenged if it was invalidly issued, invalidly drafted (The person in question(taxpayer) as well as who this letter is aimed at) or invalidly served - Time period ( notice must permit the taxpayer a reasonable time to comply (DFCT v Ganke)
3. Legal Professional Privilege (defence) - LPP may be used as a defence to allowing access to documents. - There are two limbs to LPP: ▪ (1) – confidential communications passing between solicitor and client for the dominant purpose of giving or receiving legal advice; or ▪ (2) – communications brought into existence for the dominant purpose of use in existing, or preparation for anticipated, litigation.
- Esso v CoT ( documents with several purposes can still be privileged as long as the dominant purpose is the giving and receiving of legal advice - FCT v Citibank ( officer must allow the occupier a meaningful opportunity to examine the docs under question and assert privilege. Courts said still could be privilege in this case, but either way, at the very least such a privilege should be permitted to be claimed at the very least. - Allen Allen & Hemsley ( documents which merely evidence a transaction are not privileged (ie: law firm trust accounts are not privileged as they do not concern the giving of legal advice). - Macedonia v FCT ( a solicitor’s file to an accountant was privileged but no privilege attached to a letter from a taxpayer to an accountant. - Comm’r AFP v Propend Finance ( a copy of a doc may be privileged even if original is not.
4. Other Privileges
➢ Accountants’ Concession - Chapter 7 Access Manual ( documents prepared by external professional accounting advisors independent of the taxpayer are afforded an administrative privilege. - Rationale = allow taxpayers to consult with professional accounting advisors on a confidential basis to enable full and frank discussion in respect of their rights and obligations under taxation laws - The privilege was confirmed in ONE.TEL Ltd v DCT and Deloitte Touche & Tohmatsu v DCT.
➢ Corporate Board Documents on Tax Compliance Risk - PS LA 2004/14 ( corporate board documents created by advisors (in-house or independent) for sole purpose of providing advice to the Board on tax compliance risk are afforded an administrative privilege.
5. Sanctions - Div 149 Criminal Code ( it is an offence to obstruct, hinder, intimidate or resist a public official ▪ Obstruction = physical resistance, locking a room or cabinet, hiding the key, untruthful answers to relevant questions (Case 2/2003) ▪ Hinder = to interfere with for the purpose of delaying a person - s8X TAA ( penalty for an individual is $2,000 and/or 6 mnth imprisonment; penalty for a corporation is a fine of up to $10,000.
C. ATO Obligations – Confidentiality
- s16(2) [ITAA 36] ( duty to observe secrecy: ▪ Officers shall not make a record of, or communicate to any person, any information required by them in the course of their duties respecting the affairs of another. ▪ Applies during and after employment - Consolidated Press Holdng v FCT ( s16 is designed to ensure that officers of the ATO maintain secrecy regarding the affairs of taxpayers. ▪ It is necessary to balance the interests of taxpayers privacy vs. administration of government business. - An injunction may be sought to stop a breach of s16 (eg: to prevent a newspaper publishing info) - s8XB [TAA 53] ( prohibits communication of private tax info obtained in breach of the tax laws.
D. Taxpayers’ Rights
➢ Taxpayers’ Charter - The Taxpayers’ Charter in Australia was developed by the ATO after wide consultation. It applied from 1 July 1997. - The Charter outlines: ▪ The rights for taxpayers when dealing with the tax office ▪ The service and standards that taxpayers can expect of the ATO ▪ Tax obligations ▪ Information and remedies available if a taxpayer is dissatisfied with a decision or action of the ATO
- Taxpayers’ Rights ( taxpayers’ have the right to expect the ATO to: ▪ treat them fairly & reasonable ▪ treat them as being honest in tax affairs unless act otherwise (ie. system of self-assessment) ▪ offer professional service & assistance to help them understand & meet tax obligations ▪ accept that can be represented by a person of choice & get advice about tax affairs ▪ respect privacy (ie. complying with the Privacy Act in collecting information) ▪ keep info hold confidential in accordance with the law ▪ give them access to info held in accordance with the law ▪ give them reliable advice & info ▪ explain the decision made about their tax affairs ▪ respect their right to a review ▪ respect their right to make a complaint ▪ administer the tax system in a way that minimises their costs of compliance ▪ be accountable
- Taxpayers’ Obligations ( taxpayers’ have an obligation to: ▪ be truthful & honest in dealings with ATO ▪ keep records in accordance with the law ▪ take reasonable care in preparing tax returns & other documents ▪ lodge tax returns & other required documents by the due date ▪ pay taxes & other amounts by the due date ▪ be cooperative in dealings with ATO
➢ Taxation Ombudsman - Ombudsman = public official appointed by the Cth govt - May investigate most complaints relating to tax administration & recommend that the Tax Office provides a solution or remedy to your problem - Role ( to investigate any action which “relates to a matter of administration” by a Cth government department or prescribed authority
➢ Inspector-General of Taxation - Office is for disgruntled taxpayers to air their concerns - Inspector-general reports to Parliament annually - Focuses on the way the office administers the tax system
E. Appeal to the Courts
➢ Onus of Proof - s14ZZK; s14ZZO [TAA 53] ( a taxpayer who disputes the assessment bears the onus of proving that the assessment was excessive. - The Commissioner does not have to show that the assessment was correct.
➢ Objections - s14ZW [TAA 53] ( taxpayers’ who wish to challenge an assessment must do so in writing within 4 years after the notice of assessment. - s14ZW(2),(4) ( taxpayer may apply for an extension of time and may apply to AAT if dissatisfied with the decision.
➢ Choice of Forum - Taxpayers’ may appeal to either the AAT or Federal Court (FCA): ▪ AAT ( appeals are either to the Small Taxation Claims Tribunal where the amount in dispute is less than $5,000 (s24AC AAT Act) or General Tax Division (s24AD AAT Act) ▪ FCA ( can only review errors of law - AAT ( can review the entire matter, including the exercise of any discretion, but limited remedies - FCA ( can only review matters of law; bound by rules of evidence; more remedies.
RESIDENCE – JURISDICTION TO TAX
A. International Aspects
1. Australia’s Jurisdiction to Tax - Each nation is ‘fiscally sovereign’ – ie: it makes its own tax rules. - Australia can tax individuals who are beyond its territorial boundaries - Two principles are taken into account when deciding what to tax ( (1) residence; (2) source
2. Double Tax Agreements - Australia has entered into Double Tax Agreements (DTA) with various countries. - The purpose of a DTA is two-fold: ▪ To avoid double taxation of income flowing between two countries; and ▪ To prevent tax evasion through close cooperation between the laws of two jurisdictions. - The following are examples of Australia’s Double Tax Agreements: ▪ Art 17 OECD Model Double Tax Agreement ( income derived by athletes, entertainers and musicians is taxed where the income is sourced (in the country where the contract is made) ▪ Art 7 ( business profits of athletes are taxed in the country of residence ▪ Art 12 ( royalty income is taxed in the country where it is earned at a maximum of 10% and the athlete gets a tax credit for that tax when he is taxed in his own country.
3. Source of Income - Under the ITAA 36 & 97, the source of income is important in determining tax treatment: ▪ Income sourced in Australia ( residents + non-residents are taxed in Australia. ▪ Income sourced overseas ( only residents are taxed.
4. Temporary Residence – Temporary residents’ income from foreign source is non-assessable, non-exempt: s768-910(1) ITAA97. – Foreign investment income also non-assessable, non exempt: s768-915
5. Dual Residence - Dual residence arises if two countries apply different residency tests. - The effect of dual residence is that a person may be taxed in more than one jurisdiction ( relief may be obtained under Double Tax Agreements (DTA) - Individuals ( DTA’s give priority to the State where the person has a permanent home. - Companies ( DTA’s assign residency to the State where the company has its place of effective management (also look at State of incorporation)
B. Residence
- It is essential to know whether an entity is an Australian resident for the purposes of determining whether Australia has the jurisdiction to tax that entity. - s995-1 [ITAA 97] ( resident = a person who is a resident of Aust under s6 [ITAA 36]
➢ Jurisdiction to Tax - Australia has jurisdiction to tax: ▪ Australian residents on income from all sources; ▪ Non-residents on income sourced in Australia.
|Individual – 4 tests |Company – 3 tests |
|Ordinary Concepts |Incorporated in AUS |
|Domicile |Carrying on business and Central Mgmt in AUS |
|183 Day Rule |Carrying on Bus and voting control in AUS |
|Superannuation | |
1. INDIVIDUAL RESIDENCY
➢ TEST #1 – Residence According to Ordinary Concepts - Test = you are a resident at CL if you intend to ordinarily reside in Australia – ie: ‘reside’ is to be given its ordinary meaning (TR 98/17) - Reside means ‘to dwell permanently or for a considerable time or to have one’s settled abode’ (Levene v IRC) - Q: Was the TP’s behaviour consistent with an intention to reside in Aust? (Levene; Lysaght) 1. Physical presence during the income year (Appelgate; Miller); ▪ FCT v Miller ( residence is ‘where a man eats and sleeps’ 2. Duration, frequency and regularity of visits (Pechey): ▪ If a person was previously a resident – frequency of visits need not be substantial ▪ If a person was not previously a resident – short or temporary visits will not be sufficient 3. Maintenance of a place of abode in Aust during absences (Rogers v IR) 4. Family, employment and business ties – esp. relevant to previous residents (Levene) 5. Present habits and mode of life – look for a break in habits. 6. Nationality (Crocket Born UK, Aus citizenships – didn’t renounce either so got work in UK since couldn’t in Aus re: air controlling. Despite not satisfying tests the fact he became cit meant he could be deemed resident) (but only important in borderline cases – Levene)
- IF a resident ( do not have to look at Tests 2, 3, 4 (already subject to tax) - IF not a resident at CL ( look at Tests 2, 3, 4 ➢ TEST #2 – Domicile Test - Test = you are a resident in Australia if your domicile is in Australia, unless your permanent place of abode is outside Australia. - Henderson; Udny ( your domicile is where you are born (origin) until there is an intention to fix a permanent residence in a new country (domicile of choice)
Permanent Place of Abode (PPA) - Nb: only relevant if an Australian is leaving the country. - A person who establishes a PPA abroad will not be a resident of Aus and will not be taxed in Aust. - Applegate ( lawyer transferred indefinitely to Vanuatu; gave up lease on unit; no assets in Aus; leased premises abroad; intended to return to Aus at some future point; returned home ill after 2 years ▪ H: PPA was in Vanuatu even though domiciled in Australia – a person can have a PPA abroad without intending to live in that place forever (Franki J). - Jenkins ( banker transferred to Vanuatu for 3 years fixed with possibility to extend; rented out home; stored furniture; retained bank account; lived in bank-owned house; returned home ill. ▪ H: a fixed duration overseas did not mean it was temporary. Three years was sufficient to establish a PPA outside Aust. - Case T28 ( accountant left Perth and went to London; owned apartment for 1 year; rented home in Perth; travelled and returned home; re-commenced working for Perth firm; claimed non-resident. ▪ H:UK resident due to durability of residence + intention to abandon Aust. - IT 2650; Applegate ( 6 factors to determine if a person ceases to be a resident: 1. Intended and actual duration overseas ( leaving for an unspecified or substantial period is likely to indicate a PPA overseas (two or more years is sufficient – Jenkins) 2. Establishment of a home outside Australia ( more than temporary accommodation overseas. 3. Durability of association with Aust ( maintenance of bank accounts, children’s education 4. Intention to return to Australia ( will generally remain a resident 5. Abandonment of any Australian residence 6. Continuity of presence overseas
➢ TEST #3 – 183 Day Rule (184-day rule for leap years)
- Income year = 183-day threshold is determined by reference to income year (1 July – 30 June) ▪ Where a person’s presence in Aust straddles two years of income, apply the test to each year. ▪ Presence need not be continuous – ie: can aggregate several periods during the year. ▪ Calculate presence in hours and minutes if necessary (Wilkie v IRC). - Usual place of abode = means something less than a permanent place of abode (Appelgate)
➢ TEST #4 – Superannuation Test
2. RESIDENCE OF COMPANIES - s6(1)(b) [ITAA 36] ( a company is a resident of Australia if: 1. It is incorporated in Australia; or 2. Carries on business in Australia and has its central management and control in Australia; or 3. Carries on business in Australia and has its voting power controlled by Australian residents
➢ TEST #1 – Incorporated in Australia Test - The formal act of incorporation in Aust confers Australian residence (Esquire Nominees) - This is the case regardless of where the company’s central management and control is located b/c it is the State that confers legal personality ( should be entitled to tax the worldwide profits.
➢ TEST #2 – Central Management & Control Test
- Malayan Shipping Co ( if central management and control is in Australia, then ipso facto it must be carrying on business in Australia - De Beers case ( central management and control is usually located at the place where the directors exercise their powers of management.
More than one place of management: - Koitaki’s case ( if there is more than one place of management, central management is where the ‘superior or directing authority is located, as opposed to the place of day-to-day operations’ ▪ H: office registered in PNG; rubber consigned (shipped) to Sydney & sold in Australia; profits went to Sydney co; directors met & lived in Sydney; Australian shareholders. H: Aust resident. - Unit Construction v Bullock ( wholly-owned subsidiary was incorporated in Kenya with registered office in Nairobi. Parent co was incorporated, managed & controlled in UK. ▪ H: subsidiary was a resident of UK b/c managed and controlled in UK (Substance test) - Esquire Nominees ( co was incorporated in Norfolk Is; directors were residents of NI and meetings held in NI. Agendas prepared by Australian Accountants acting on behalf of Australian residents who were the beneficial owners – H: resident of Norfolk Island. (Form test).
➢ TEST #3 – Voting Power Test
- Koitaki’s case ( business was carried on in Australia (rubber consigned to Sydney & sold in Australia) + Australian shareholders. H: Aust resident. - Patcorp ( shareholder = person entered on register of members or entitled to be registered
3. RESIDENCE OF OTHER ENTITIES ➢ Trusts - Apply the same rules for individuals or companies, depending on the nature of the trustee; or - Central management and control in Australia Test (same test as for companies)
➢ Partnerships - Do not pay tax – only the individual partners pay tax. C. Source of Income
1. Meaning of “source of income” - Nathan ( source of income is a question of fact. - The ITAA does not define source ( give it its ordinary meaning. - s995-1 [ITAA 97] ( ‘Australia source’ means income derived from a source in Australia. - To determine the source of income, consider the following factors: ▪ The location of the prime income-earning activity or structure; ▪ Where the contract is made; ▪ Where the payment is made; ▪ Where funds come from, which payments were made, location of customers paying - FCT v French ( an engineer worked in NZ on a film for 17 days; salary paid in Sydney. ▪ H: source was where the ‘personal exertion’ (activity) took place (source = NZ) - FCT v Mitchum ( performer acted in Australia for 7 weeks; worked on a film; received income of US 50,000; contract signed outside Australia. ▪ H: source of income is where duties are performed. If they are performed in more than one place, then the source will be apportioned (divided) between the two places.
2. Source Rules - The following table summarises a person’s tax liability.
| Source |Resident |Non Resident |
|Inside Australia |Pay tax in Australia |Pay tax in Australia |
|Outside Australia |Pay tax in Australia |No tax |
|Class of income |Source |
|Disposal of trading stock |Place where K of sale entered into (st sec 38 – 43 ITAA36 which deems Aust source + DTA's where |
| |concept of permanent establishment overrides domestic source rules for business profits of |
| |non-residents) |
|Disposal of property other than trading stock |Place where K of sale entered into, st special rules for shares (ie. where operations occurred) & |
| |real estate (ie. location of property) |
|Services |Place where services are performed (usually) |
|Interest |Place where loan K entered into or the obli to pay interest arises |
|Dividends |Place where profits were made |
|Royalties |Where pmt is an outgoing of an Aust business, any royalties derived by non-resident deemed to have |
| |been sourced in Aust (s6C). Otherwise, source is location of IP from which it flows |
3. Why is source important? - According to the Foreign Tax Credits Act 1986, source is important for a variety of reasons: ▪ Unless you tax at its source, the government may miss out; ▪ Taxable at source is justifiable on the basis of benefit; ▪ Non-residents taxed only on income sourced in Australia ▪ Double tax treaties rely on source ▪ Foreign tax credit (allows credits for tax paid elsewhere)
INCOME
A. Income – An Introduction
- s4-1 [ITAA 97] ( income tax is payable by each individual and entity. ▪ Assessable Income = all income according to ordinary concepts (‘ordinary income’) ▪ Taxable Income = assessable income less allowable deductions. - s6-1 ( income includes ordinary and statutory income. - s6-15 ( an amount which is not ordinary or statutory income is not assessable.
➢ Ordinary Income - s6-5 [ITAA 97] ( ordinary income is income according to ordinary concepts – this is not defined in the Act ( must look at the Common Law. - Ordinary income is income which comes from income-earning activities (eg: salaries and wages) - TEST = ordinary income is income which results from services, or an incident of employment or is the product of personal services.
➢ Statutory Income - Provisions of the tax legislation deem certain receipts to be income (eg: capital gains). - ( even though a receipt may not appear to be ‘income’ on its face, the legislation has the effect of deeming that receipt to be income (eg: royalties – s15-20)
B. Characteristics of Income
- It is necessary to distinguish income (taxable) from non-income receipts and capital (non-taxable). - Scott’s case ( income is to be determined by the ‘ordinary concepts and usages of mankind.’
1. Illegal Activities - Partridge v Mallandaine ( “the illegality of a vocation (career) does not exempt you from tax.” - s6-5 [ITAA 97] ( assessable income includes income derived directly or indirectly from all sources (( illegal profits are still taxable). - Mann v Nash ( Comm’r only looks at what your income is, not how you made it. - No. 275 v MNR ( a prostitute was held to be sufficiently commercial, active and devoted to her calling ( income was assessable. - Taxable Review Authority No. 17 ( heroin dealer could be taxed on their illegal returns. - La Rosa ( drug dealer was given a default assessment of $220,000. L said that he hid the money in the garden and its was stolen. Attempted to claim it as a deduction for a business loss. ▪ H: Entitled to the deduction – purpose of Tax Act is to tax income, not to punish wrongdoings!
C. Income vs. Capital
- Income tax is levied on income, not on the gains on capital or capital receipts, unless the Act provides. - The Tax Act does provide for taxing of capital gains and the regimes (systems) for taxing income and capital are different. - The distinction between income and capital is important because a person may wish to class a receipt as capital to receive tax advantages.
➢ What is ‘Capital’?
1. Apportionment of lump sum compensation payments - Generally ( compensation payments take their character from that for which they compensate. - McLaurin v FCT: ▪ For liquidated settlements or amounts ascertainable by calculation ( a single receipt may be apportioned amongst the heads to which it relates as either income or capital. ▪ For unliquidated settlements or single, undissected sums ( the amount is treated as capital - Spedley Securities ( Santos engaged Spedley for a loan but terminated after intro of adverse legislation. Spedley was concerned about damage to reputation as a new financier, but accepted lump sum settlement, substantially less than the commission which would have been received under K. ▪ H: The compensation was unidentified, but included revenue and capital amounts (loss of reputation/ goodwill). There was no basis for apportionment (unliquidated) ( entire capital sum.
2. Compensation for cancelling business contracts - Generally ( amounts received for the cancellation of ordinary business contracts are income and ( are assessable (Short Bros v IRC) ▪ Heavy Minerals case ( four mining contracts were cancelled; £250,000 paid in compensation. H: money received was income because it replaced the profit that would have been received. - Exception ( receipts will be capital in nature where they arise out of a cancellation of a contract affecting the fundamental structure of the business or result in the permanent loss of a fixed asset: ▪ Van den Bergh’s case ( agreement between UK and Dutch suppliers of margarine was terminated during the war. Dutch company paid slightly higher compensation to UK company, but could dictate the terms of operation of business. H: compensation was capital because it affected the working of the business. ➢ Agency Contracts - Termination of entire business ( where the cancellation of an agency contract results directly in the termination of the taxpayer’s business, the compensation received will be capital in nature. ▪ California Oil Products ( agent was exclusive distributor of oil. Contract was terminated and received compensation. H: compensation was capital because taxpayer was an exclusive agent - But: where compensation is paid for the cancellation of one among several agency contracts, the compensation will usually be treated as income. ▪ Allied Mills case ( manufacturer & distributor had their manufacturing contracts cancelled. Compensation paid. H: this was income replacing lost profits, not loss of exclusive business.
3. Compensation for sterilisation of an asset - Generally ( compensation received for the permanent sterilisation of an asset is treated as capital ▪ Glenboig Union Fireclay v IRC ( compensation paid to forgo mining rights near railway was treated as capital because the agreement permanently sterilised the asset. - Exception ( where an income-producing asset is temporarily disabled, compensation received will be treated as income: ▪ Burmah Steamship Co v IRC ( compo for delayed ship repairs was treated as income.
4. Profits from disposal of assets - Generally ( profits from the realisation or sale of an asset will be treated as capital – ie: the ‘once and for all’ test states that one-off, lump-sum receipts are capital - Exceptions ( if the gains on the sale of an asset constitute ‘business proceeds’ they will be income ▪ AGC Investments ( “profits made on the realisation of assets will be income where the investments are acquired as part of a business + there was an intention to make a profit.” - Myer Emporium ( M made a loan to a finance co and assigned the interest to Citicorp. Citicorp returned the money to M as a capital receipt. M argued that it was a once-off, lump sum payment. ▪ H: the income was received in ordinary course of business. The fact that it was a one-off transaction was not decisive (sufficient). The money receipt was for interest that would have been received (replacement principle). - Whitfords Beach case ( land developers bought a company that owned beach land; company was originally established by fishermen who wanted to live near the beach; new owners rezoned and subdivided the land and sold for large profit. ▪ Company argued that it was just a one-off venture and were just realising the property up to its maximum value ( profits were capital in nature. ▪ H: income – one-off transaction was not decisive; the large scale of the activity meant that the company was carrying on a business.
5. Insurance recoveries (loss of trading stock) - Generally ( insurance payouts are regarded as income because they are replacing income. - s15-30 [ITAA 97] ( an amount received under insurance for any loss of trading stock is income. ▪ Gliksten’s case ( fire destroyed timber at a timber merchants. Received insurance payout. H: compensation was income as the fire turned the timber into cash. - Carpark Holdings v FCT ( life insurance was paid when company director died in an accident. ▪ H: money received was income as it replaced dividends the director would have received from the company if he had remained alive. - DP Smith ( doctor took out permanent disability insurance cover and was injured in a car accident. Doctor received monthly insurance money and claimed the payments as deductions. ▪ H: payments were income as they replaced earnings ( could claim deduction - Somner v FCT ( income replacement insurance policy was taken out. Received payout as a lump-sum instead of regular payments. ▪ H: the lump-sum was income because it replaced an income stream, despite being a lump-sum.
6. Restrictive Covenants - Generally ( restraint of trade clauses to give up a substantial ‘sphere (amount) of activity’ which would otherwise be open are usually capital (Dickenson v FCT) ▪ Nb: the restraint of trade clause must restrict the taxpayer’s right to earn income and not be merely money paid in lieu of an income stream. ▪ Higgs v Olivier ( Sir Laurence Olivier was paid £15,000 in return for him agreeing not to act in any other film for 18 months. H: consideration paid was capital in nature. - Exception ( a restrictive covenant will be income if it is recurring or does not restrict the taxpayers’ right to earn an income. ▪ Case R107 ( acceptance of a sign on fee by a professional athlete is just a normal incident of employment ( income. ▪ c/f: Jarrold v Boustead ( amateur athlete turned professional received sign-on fee – H: capital receipt because it was compensation for giving up amateur status.
7. Payments for knowledge or know-how - The issue is whether payments for secret information and knowledge is classed as capital or income. - In order to determine whether a receipt is capital or income, one must apply the normal criteria for assessing income, such as whether the receipt is a regular payment. - Generally: ▪ If a business is selling the actual trademark ( this will usually be capital because the whole entity is being sold. ▪ If a business is only granting the right to use information ( this will usually be income. - Rolls Royce v Jeffery ( RR licensed its manufacturing knowledge to other companies who paid a lump sum amount + royalties in return. RR argued the payments were capital and not subject to tax. ▪ H: the payments were income, despite being called capital receipts. There was no degree of permanence as RR was merely granting a temporary licence.
8. Lease Incentive Payments - Generally ( a lease incentive payment is classed as income - FCT v Cooling ( a developer paid $160,000 to a partner in a law firm as an inducement to set up an office in the building. ▪ H: lease incentive payment was income, even though just a one-off transaction. - CT v Montgomery ( law firm in Melbourne had asbestos (poison) lining and moved offices, motivated by an incentive payment of $29.3m. ▪ H: lease payments were income – because the significant purpose was profit making.
9. Taxation of Damages Awards - When assessing damages awards, the impact of tax must be taken into account: ▪ BCT v Gourley ( a damages award which was not subject to tax was reduced by the court to prevent the recipient getting a windfall gain (unexpected bonus) (Cullen v Trappel in Australia) - s15-30 [ITAA 97] ( an amount received as compensation for loss will be treated as income. ▪ Gin v Australian Wheat Board ( as compensation is subject to tax, the full amount of the loss should be awarded, not just an after-tax amount. - Settlement of a claim: ▪ If a lump sum is received as settlement before court ( this is treated as a capital gain (s108-5) as the person has given up their right to seek compensation and has disposed of this ‘asset’ ▪ But: settlement of a claim relating to a personal injuries, profession or vocation (eg: sexual harassment), are exempt from capital gains tax.
D. Income from Personal Services
1. General Income - The first item of income from personal services are receipts from employment – these include: ▪ Salaries and wages; ▪ Payments to independent contractors; ▪ Fees paid to professional persons. ➢ TEST = receipts will be classed as income if: ▪ They are made periodically and regularly; ▪ They are relied on to meet regular living expenses; ▪ The payment is connected to the performance of services; ▪ The payment is a substitute for any income; ▪ The intention of the donor (but this is not decisive) - Nb: all of these factors must be weighed up to determine whether the receipt is personal services income.
2. Gifts in Gratitude - Generally ( a mere gift on personal grounds is not income. - TEST ( a gift will be income if it is expected and is received regularly and periodically in connection with employment (Dixon; Squatting Investment Co v FCT) - Nb: a gift is more likely to be income when: ▪ It is solicited (asked for) by the recipient (Hayes v FCT) ▪ It is repeated, periodic and regular ▪ The recipient relies on the gift for their families day-to-day existence (Dixon; Blake) ▪ It is incidental or a product to employment or a reward for success (Scott’s case) - Hayes v FCT ( accountant was given shares in gratitude for loyalty in addition to regular salary. H: gift – connection between work and shares was too remote + shares were received as a friend. - Scott v FCT ( solicitor acted for widow after husband’s death. Solicitor was properly paid but widow gave solicitor £10,000. H: money was a gift due to friendship and there was no connection. - FCT v Harris ( a bank gave a one-off payment to alleviate (reduce) the effect of inflation on the pension – H: gift because it was “unsolicited, unexpected and not related to a period of service.” - Smith v FCT ( money received from a bank under an ‘encouragement to study’ scheme was not income because it was not related to the services of the bank (purely honorary).
3. Prizes, Awards & Study Grants - TEST = prizes, awards and grants will be classed as income if they are expected and received regularly and in connection with a person’s employment (Stone v CoT) - IT 167( a prize or award received in non-cash form will be assessed according to a fair and reasonable value. - ss21, 21A [ITAA 36] ( the money value of non-cash consideration will be deemed to be paid - IT 2145 ( a BHP Award of $40,000 recognising personal achievement was deemed to be a gift. ➢ TR 99/17 - Grants: ▪ One-off financial grants recognising the personal athletic qualities are not assessable. ▪ But: grants will be assessable where they are made under an ongoing agreement + are expected and relied upon for expenditure + are periodic and regular made in substitution of income - Awards & Prizes: ▪ An award or prize received by a sportsperson on purely personal grounds recognising their sporting ability is not assessable. ▪ An award or prize will be assessable if it is made in connection with employment and is expected to be received periodically and regularly. o A medal, trophy or award will no be assessable as they are received on personal grounds recognising personal achievement in competition. o But: an award which has intrinsic value or represents an intrinsic form of remuneration to the person, above merely recognising sporting achievement, will be assessable (eg: cash, car) ➢ Stone v CoT - Facts of case ( S was a top athlete who competed in javelin and also a police officer; ATO sought to tax prize money; government grants; appearance fees; sponsorship money. - Federal Court Decision: ▪ Prize money and grants were not income ( “she entered into the competitions whether or not prize money was on offer. The grants defrayed the considerable expenses involved.” ▪ Appearance fees and sponsorship was assessable because “they were made as a reward for service, being attendance at the function or whatever was required.” - HCA ( all receipts assessable b/c S was in the business of sport – pursuit of excellence = business
4. Scholarships - TR 93/39 ( a scholarship is a sum of money or other aid granted to a scholar on the basis of general criteria - Generally (s51-10) ( scholarships to fulltime students at school, university or college are exempt from income tax. - Exceptions (s51-35) ( scholarship payments to fulltime students will not be exempt if: ▪ It is made on the condition that the student will become or continue to be an employee of the grantor. (FCT v Ransom) ▪ It is made on the condition that the student will enter into or continue to be a party to a contract with the grantor. ▪ The payment is not provided principally for educational purposes. - FCT v Ransom ( student received financial support from actuarial society in return for work during holidays. H: scholarship was taxable because it was conditional on employment - Polla Mouner ( a footballer received a scholarship but had to be an active paying member of the club. H: scholarship was not conditional on this contract ( payments were exempt from tax. - Case 9 ( a PhD student agreed to teach part time to receive extra payments. H: payments were not tax exempt because they were conditional on him teaching.
5. Tips & Testimonials - TEST = a tip or testimonial will be assessable income if it is expected and regular and linked to the recipient’s employment (eg: tips to a waitress, taxi-driver). - Federal Coke Co v FCT ( a mere gift is prima facie not income but will be assessable if it is related to, or results from income earning activities. - Calvert v Wainwright ( taxi-driver’s tips were subject to tax because they were expected.
➢ Tips to Sportspeople - Moorehouse v Dooland ( professional cricketer was entitled to the spectator collections under employment contract whenever he played well (regularly). ▪ H: income because payments were periodic and regular + linked by strong employment nexus - c/f: Seymour v Reed ( the proceeds from a cricket benefit match for a professional cricketer were not income, but rather a tribute to the player’s personal attributes. This was because: ▪ The contract did not entitle the player to the proceeds ▪ They were rarely granted more than once ▪ The takings were given spontaneously (randomly) by the public; and ▪ The player was at the end of his career and the payment was a tribute. - Moore v Griffiths ( a player received £1,000 after winning the world cup soccer. ▪ H: gift – not a reward for services b/c: (1) lack of knowledge; (2) made to reward rather than remunerate; (3) not recurrent; (4) payment was not linked to level of services performed - Kelly’s case ( a player won a ‘best and fairest’ award for $20,000. H: income because it was incidental to the player’s employment.
E. Income from a Business
- s6(1) [ITAA 36] ( ‘income from personal exertion’ includes the ‘proceeds of any business carried on by the taxpayer.’
1. The Meaning of ‘Business’ - s995-1 [ITAA 97] ( a business is ‘any profession, trade, employment, vocation or calling.’
- Golightly v CIR ( a business requires an intention and prospect of making a profit in the future (( a solicitor could not claim a business deduction for a farm he owned) - Grieve v CIR ( “businesses do not cease (stop) to be a business because they are carried out inefficiently or unprofitably or because the taxpayer derives personal satisfaction for the venture.”
➢ Small Businesses - Ferguson v FCT ( F bred cattle in a small way; he leased three cows, read farming journals, kept up with the progress of cows and deducted his lease expenses. ▪ H: was in business because he conducted his activities in a commercial, systematic and business-like way. - FCT v Walker ( W bought a goat with the intention to breed through IVF treatment. ▪ H: was in business b/c there was: (1) an intention to make a profit; (2) repetition and regularity; (3) business-like organisation; (4) personal involvement to keep himself informed.
2. Commencing a Business - A business will only be taxed and can only claim deductions when it is commenced. - TEST ( a business commences with the beginning of current operations (City Motors case) ▪ ie: there must be some commitment to a business venture (Softwood Pulp; Osborne’s case)
a) Preliminary or Preparatory Activities/Expenditure - Generally ( mere preliminary or preparatory activities do not result in the commencement of a business (Southern Estates v FCT) - Softwood Pulp ( a firm conducted investigations into the viability (possibility) of a paper mill. They abandoned the project, earned no income but claimed a deduction for their expenses. ▪ H: expenses were not incurred in a business. There was no commitment to the venture - FCT v Osborne ( there was a 6 year gap between planting and growth of trees; project was abandoned before the harvest. Claimed cost of rent, wages and depreciation on equipment. ▪ H: cannot deduct preliminary costs of preparing ground for planting (these are capital expenses) - c/f: Case 75/96 ( existing business taken over but required maintenance & expenses. H: business commenced at the time of sale b/c it was an existing business, not a new venture being explored.
b) Experimentation - Generally ( a taxpayer is not carrying on a business while merely experimenting to choose between different products (Goodman Fielder) - Goodman Fielder v FCT ( research and expenditure was carried out into a new medical product. ▪ H: not in a business because there was no final commitment – activities were provisional only. - c/f: Thomas v FCT ( land was purchased and trees planted, but harvest not due for several years. ▪ H: still carrying on a business despite its small size because there was a commitment to production in the future.
3. Terminating a Business - The main issue is whether the cost of terminating a business is deductible. - Generally ( the costs of terminating a business and costs incurred after a business has terminated are not deductible (Freeman v FCT) ➢ When does a business terminate? - TEST (Peyton v FCT) = to determine whether a business has terminated, look at: ▪ The intention of the controllers of the business ▪ The nature of the business ▪ The reasons for the cessation (stopping) of trading - Nb: a business which is merely inactive is not necessarily terminated (Avodale Motors) - AGG (Advances) v FTC ( a company in financial difficulties ceased most of its business operations and entered into a scheme of arrangement with creditors. It sold its shares to ACG and resumed business. ▪ H: the business had not been terminated at any stage, even though it changed its name, premises, clients and shareholdings.
4. Gambling & Windfall Gains - Generally ( earnings from gambling and lotteries are not taxable because they are irrational agreements which do not provide regular and periodic incomes (Graham v Green) - IF gambling constitutes a business, the earnings may be classified as income.
➢ TEST (Brajkovich v FCT) ( gambling will constitute a business if:
1. It is done in an organised and systematic manner; and ▪ Evans v FCT ( taxpayer made regular successful bets on the TAB – H: no element of system or organisation to characterise the gambling as a business – he had no research, no sources of info, no technology, no method of calculating odds, no allocation of capital, no records. ▪ Down v Compston ( professional golfer bet on own matches – H: betting not systematic and money was not derived from his regular employment ▪ Martin v FCT ( used betting system to gamble successfully for 3 years – H: not a business of gambling because just a normal and usual activity. ▪ Brajkovich v FCT ( devoted to betting on racing, AFL – H: although B satisfied business criteria (objective) his purpose was to pursue a hobby (subjective) ( not a business
2. There is a strong link between gambling and a trade or profession: ▪ Trautwein case ( betting was systematic, frequent and heavy; devoted a lot of time; established a stud farm and leased other horses. H: betting constituted a business because it was too professional in approach and T was involved in the profession of horse racing. ▪ Prince v FCT ( H: registered bookmaker and horse trainer was involved in a business due to close link with his own employment ( winnings were taxable
➢ Gambling & Capital Gains Tax - s160ZB(2) [ITAA 36] ( a capital gain does not arise from winnings from betting, a lottery or other form of gambling game with prizes ▪ But money received from the sale of assets won in a lottery are subject to capital gains tax – eg: if you win a house and then sell it, the proceeds are subject to tax.
F. Income from Property
- Generally ( income earned from property is assessable.
1. Interest - Riches v Westminster ( interest is the price of using another person’s money. - s6-5 [ITAA 97] ( interest is ordinary income ( assessable. - Myer Emporium ( a lump sum payment made in place of an income stream will be deemed to be interest ( assessable. - Types of Interest: ▪ Simple interest – all interest is assessable because it is regular and periodic. ▪ Compound interest – only the interest component is assessable, not the principal. ▪ Interest only loans – all interest is assessable ▪ Blended loans – where the amount of interest and principal repayable varies each month, only the interest portion will be assessable ▪ No interest loans – interest-free loans which are repayable at a premium (higher price) are deemed by the courts to contain an interest component (Vestey v IRC) - Interest on Compensation Payments: ▪ Federal Wharf case ( interest on a judgment is assessable. ▪ c/f: s51-57 [ITAA 97] ( any interest given on a judgment in a personal injuries matter is not assessable as income.
2. Dividends - Generally ( dividends are treated as ordinary income ( assessable. - However there is often a problem of double taxation: ▪ A double tax problem arises because many companies already pay tax on their money. ▪ Dividends which have already been taxed are known as franked dividends. Dividends which have not been taxed are called unfranked dividends. ▪ Shareholders who receive franked dividends will receive a tax credit for that amount and will only have to pay the difference between the company tax rate and their own marginal tax rate – ▪ This process is known as grossing up. - Dividends received from overseas companies are taxed differently.
3. Rent Income - Rent is the price paid for the right to use another person’s property (land, machinery, equipment) - Generally ( rent is treated as ordinary income and ( assessable (Adelaide Fruit & Produce Exchange v DFCT) - But: rent will not be assessable if the payment is merely a contribution to household expenses: ▪ Groser’s case ( G charged his parents nominal rent ($2/week). When they died, he acted as guardian for his disabled brother, continuing to charge him the same rent. G paid for the household expenses. Tried to claim mortgage payments and costs as a deduction. H: $2 was not rent, just a contribution to household expenditure ( deductions not allowed. - Nb: Rent does not have to be paid periodically or in cash ( ie: a lump sum payment or a payment made in non-cash form (goods) can still be rent.
4. Royalties - Royalties are amounts paid for the use of another person’s property, whether tangible or intangible (eg: use of copyright, patents, mining rights) - Royalties can be ordinary income (s6-5 ITAA 97), statutory income (s15-20) or a capital gain.
- TEST ( royalties will be assessable as income where they are calculated by reference to a quantity or actual usage (McCauley’s case) ▪ McCauley v FCT ( a farmer had a timber plantation and sold the right to cut and remove timber for 3 shillings/100m cut. The payments were made monthly over 1 year. H: assessable because the amount received was calculated by reference to the quantity cut and were expected and received regularly. ▪ c/f: Stanton’s case ( S sold timber on his land for £17,500, payable as a £500 deposit and instalments. H: not assessable as royalties because the lump-sum instalments were fixed and not calculated on the basis of the amount of timber sold.
5. Annuities - Annuities are an income stream which is usually purchased in return for the transfer of funds or property. - Generally, the annuity provider will estimate the interest and add it to the capital amount. They then work out regular repayments so the end balance is zero. - s27H [ITAA 36] ( annuities are divided into two components: ▪ The amount of each payment which is the return of the principal amount to the taxpayer – this amount is not taxed. ▪ The payment to the taxpayer which is interest on the capital ( this is taxed at the taxpayer’s marginal tax rate. G. Exempt Income
➢ Exempt Income - s6-20 [ITAA 97] ( ordinary or statutory income is exempt income if it is made exempt by the Tax Act or other Cth law. ▪ Exempt income is taken into account when a person has a tax loss (reduces a capital loss) - c/f: s6-15(3) ( an amount which is ‘non-assessable, non-exempt’ income is not assessable income. ▪ Non-assessable, non-exempt income is not taken into account where there is a tax loss. - Exempt income falls into three main categories: ▪ Exempt entities – s11-5 [ITAA 97] ▪ Exempt income – all taxpayers ▪ Exempt income – certain taxpayers
1. Exempt Entities - s11-5 [ITAA 97] ( defines institutions which are tax exempt:
a) Charity, Religion, Science & Education - s50-5 [ITAA 97] ( income from charitable, religious, scientific or public educational institutions are exempt from tax. - An institution is an establishment, organisation or association formed for some object, especially of public or general utility (YMCA v FCT)
➢ Charities - ‘Charitable’ must be interpreted in its technical legal sense (Royal Choral Society) - There are 4 main charitable purposes: ▪ Relief of poverty (Downing v FCT) ▪ Advancement of education (Case 62) ▪ Advancement of religion (Gilmour v Coats) ▪ Other purposes beneficial to the community (Incorporated Council of Law Reporting Qld) - The purpose must benefit the community, but not the entire community.
➢ Religious Institutions (churches) - TEST = an institution will be tax exempt if its primary and dominant objects are religious. - YMCA v FCT ( ‘religion’ is to be given a wide interpretation. - Scientology case ( criteria for religion: ▪ The church must believe in a supernatural being or principle; and ▪ The church accepts canons of conduct giving affect to that belief. - Douglas v FCT ( D built a place of worship but used parts of the building for commercial purposes. H: not tax exempt because it was primarily a commercial entity - Nb: gifts to the church may be treated as income to the clergy/priests (Moorhouse v Dooland)
➢ Scientific Institutions - TEST = an institution will be tax exempt if its objectives are predominantly (mostly) scientific. - Sulley v RCSE ( H: the Royal College of Surgeons was predominantly a professional body and its scientific objects were only incidental
➢ Public Educational Institutions - TEST = an institution will be tax exempt if it provides public education: ▪ ‘Public’ does not mean the institutions has to serve the whole community – part of the community is sufficient (O’Connell v Newcastle Municipal Corp) ▪ ‘Education’ means imparting knowledge or assisting & guiding the development of the mind (Chesterman v FCT)
b) Non-Profit Societies & Clubs - s50-45 [ITAA 97] ( clubs, societies and associations are exempt from tax if: ▪ It is established for the encouragement of ( racing; art; game or sport; literature or music; and ▪ It is not carried on for the profit or gain of its individual members. - The club will not get a tax exemption if the provision of social activities becomes of equal or greater importance to providing sporting activities (Cronulla Leagues Club v FCT) - Tweed Heads Bowls Club ( had over 900 members with substantial entertainment and catering facilities; most revenue derived from pokies (>$5m); more than 500,000 visitors per year. ATO argued that it was no longer a sporting club, but a business. ▪ H: club was still tax exempt because from its inception (beginning) it was devoted to lawn bowls – ie: that was its dominant purpose. - Terranora Lakes CC ( had over 40,000 members and over 1,000 visitors per day; 90% of revenue was from the bar and pokies. ▪ H: the club was still tax exempt because even though its social activities were extensive, they were pursued as a means of financing its sporting activities.
2. Other Exempt Income - Other exempt income includes: ▪ s11-10 [ITAA 97] ( income which is exempt for all taxpayers (includes interest of judgments for personal injuries and dividends on franked shares). ▪ s11-15 ( income which is exempt for some taxpayers (Defence force members, scholarships, family assistance payments). - Most of the above are subject to their own conditions.
H. Deriving Income (Tax Accounting)
- s4-10 ( you pay tax “for each year ending on 30 June, called the financial year.” - Generally( income that falls in the year is derived - s6-5 ( assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia during the income year. - Derived can mean either (a) when cash is received; or (b) when an amount is earned or accrued.
1. Cash Basis Accounting - Generally ( income is not derived until you receive it in cash or some other form - This method applies to individuals not carrying on a business (Brent v FCT) - Whitworth Park Coal v IRC ( “ordinary individuals do not pay tax until they get the money b/c until then it is not part of their income”
2. Accrual Basis Accounting - Generally ( income is deemed to be received when there is a right to receive it (when you can sue for payment) - The use of this method depends on the sophistication, size and degree of personal involvement - FCT v Dunn ( “the task is to determine what method of accounting is calculated to give a substantially correct reflex of the taxpayer’s true income” - Carden’s case ( Dr changed from accrual to cash, & only declared fees actually received ▪ H: cash basis suitable (appropriate in the circumstances) - Henderson v FCT ( Accounting partnership with 300 employees & 19 partners ▪ H: accrual basis appropriate given the size, scope & history of operations I. Eligible Termination Payments (Superannuation)
- On retirement, a person usually receives superannuation - The Superannuation Guarantee Scheme introduced in 1992 ensures that employers have to contribute 9% to their employee’s superannuation scheme. - s6(1) [ITAA 36] ( superannuation benefits include ‘individual personal benefits, pensions or retiring allowances.’ - Thus there are basically two forms of payments you can receive on retirement: ▪ Lump sum payments; or ▪ Pension payments (ongoing stream of income) - Special tax rules apply to eligible termination payments (ETPs) in the Act: ▪ Amounts contributed before 30 June 1983 – only 5% of these amounts were subject to tax under the former s26(d) [ITAA 36] ▪ Amounts contributed from 1 July 1983 – these ETPs are assessed according to ss27A-27J - ETPs include termination, retirement, and similar payments – includes payments made by superannuation funds, but not payments in the form of a pension or annuity. - An ETP may have different components – concessional components and undeducted contributions which attract different tax treatment
➢ Section 27A – Eligible Termination Payments - s27A [ITAA 36] ( an eligible termination payment is any payment made in respect of the taxpayer in consequence of the termination of their employment - “…in consequence of” ▪ The payment must be made ‘in consequence of’ the termination ▪ This means that the ETP must be the result of termination of employment and there must be a direct causal relationship between the termination & the employment (Reseck’s case; Haggarty) - “…termination” ▪ Termination of employment means a bona fide termination – ie: permanence is required. ▪ This means that the employee cannot be dismissed or retired and then later re-hired by the same employer with similar remuneration (pay) and duties (Grealy’s case) - A payment from a superannuation fund is an ETP unless it is otherwise ordinary income such as a pension or annuity (s27A(1)) - Nb: leave and long service leave payments are not ETPs but are accounted for under ss26AC-AD.
➢ Exemptions & Exclusions - Some payments made are not assessable ETPs, including: ▪ Advances or loans made on an arm’s length basis; ▪ Capital sums paid for a legally enforceable contract in restraint of trade, to the extent to which the Commissioner considers the payment reasonable; ▪ Capital sums paid for loss of income through personal injury, to the extent to which the Commissioner considers the payment reasonable; and ▪ Payments made after 1 July 1994 that is the tax-free amount of a bona fide redundancy payment
➢ Summary: 4-step process 1. Is the payment an ETP? – check the definitions (s27A) and exclusions 2. Identify the components that make up the ETP – s27AA 3. Has the whole or part of the ETP been rolled over? – s27D allows amounts to be rolled over and tax to be deferred 4. Consider the tax treatment of each component of the ETP.
GENERAL DEDUCTIONS
A. Deductible Amounts
- Deductions form part of the income tax system to relieve the burden of the high marginal tax rates - The relevant section for deductions is s8-1 [ITAA 97]. It replaces s51(1) [ITAA 36] although the same meaning is intended ( cases referring to the old Act still apply. - s4-15 ( your taxable income for the year equals assessable income less allowable deductions. - s12-5 ( provides a list of claimable deductions. - s8-10 ( where two provisions allow deductions of the same amount, you can deduct only under one provision ( no double deductions.
➢ TEST: Deduction Limbs
- NB: the test from s8-1 has two positive and four negative limbs ▪ To be deductible ( an expense must fall within either of the two positive limbs and not fall within any of the negative limbs.
➢ Preliminaries - “…loss or outgoing” means any money going out (but does not expressly refer to ‘expenses’) - “…to the extent that” allows expenses to be apportioned (divided): ▪ Ronpibon’s case ( if an expense is partly private and partly for the purpose of earning assessable income, the deduction can be apportioned on a fair and reasonable basis. ▪ Kowal’s case ( K purchased parent’s property, leased to parents and claimed expenses as deductions. H: property was used for mixed purposes ( 80/20 apportionment applied.
B. Positive Limbs – s8-1(1)
➢ Common Elements - There are two common elements to the positive limbs:
1. The expense must be incurred: ▪ This does not necessarily mean paid. ▪ If the entity is using an accruals basis of accounting, than expenses may be incurred before cash is received or paid out.
2. The expense was incurred in producing “your” assessable income ( ▪ You cannot claim a deduction for another person’s expense – ie: must be your deduction (Monroe’s case) ▪ But the courts are more lenient in cases of parent companies claiming deductions for activities or subsidiaries.
1. The First Limb - s8-1(1)(a) ( you can deduct any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income.
- TEST ( to be deductible there must be a sufficient connection between the expense and assessable income: ▪ The loss or outgoing must be relevant or incidental to producing your assessable income ( the degree of the connection need not be strong or proximate (close) (Ronpibon’s case) ▪ The essential character of the expense must be of a work or business nature (Lunney’s case)
➢ The Purpose Test (applicable test) - TEST = to determine if there is a sufficient connection, look at the object, purpose or intent of the expense (Magna Alloys v FCT) - Fletcher v FCT ( involved a partnership which wanted to claim interest expenses from a negatively geared annuity scheme as a deduction. ▪ The objective intention will be conclusive where an expense is involuntarily incurred in producing a larger amount of assessable income (ie: expense < income produced). ▪ But the subjective intention for claiming the expense will be relevant if no income is earned and the expense is disproportionate (much higher) than the income gained (confirmed: Spassked case) - Ure v FCT ( involved the deductibility of interest payments under a tax scheme. ▪ H: the expenses were partly incurred for the objective purpose of producing assessable income. But the subjective purpose of reducing tax liability could not be ignored ( apportion deduction. - Ilbery; Deane ( two cases concerning the deductibility of expenses from interest prepayment and share trading schemes: ▪ H: the intention of the taxpayers in incurring the expenses were to secure tax advantages, not to produce assessable income ( not deductible - Magna Alloys ( H: a company could deduct the cost of its legal expenses incurred to defend director’s bribery charges. These were subjectively necessary from the taxpayer’s perspective.
➢ The Legal Form Test (no longer applied) - TEST = an expense is deductible if the objective circumstances of the expense is regarded as income-producing – ie: the legal effect of a contract is conclusive (Europa Oil No. 2) - Cecil Bros v FCT ( shoe retailer introduced an intermediary company between the wholesaler and retailer and imposed an extra 10% mark-up claiming these additional retail expense as a deduction. ▪ H: the expenses were deductible – the legal effect of the contract was to acquire footwear - Isherwood & Dreyfus ( a Hong Kong company was interposed (inserted) as an intermediary between a supplier of trading stock and taxpayer company. The taxpayer claimed a deduction for the intermediaries 10% markup. ▪ H: full deduction allowed – the legal effect on paper related to the supply of trading stock
2. The Second Limb - s8-1(1)(b) ( you can deduct any loss or outgoing necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
- The first and second limbs overlap although the second limb is confined to those carrying on a business (second limb is largely redundant). - However, there is some differences in the wording between the two limbs:
➢ ‘Necessarily’ incurred - The expense must be ‘necessarily’ incurred in carrying on a business. - The courts have adopted a practical, non-literal interpretation such that expenses which are clearly appropriate or adapted to the business will be deductible (Magna Alloys). - W Nevill & Co ( a business claimed a deduction for a £2,500 payment made to a managing director for cancellation of his contract. ▪ H: deductible because it was necessary for efficiency, one-off and would lead to higher profits in the future. - Snowden & Wilson ( a company claimed a deduction for the cost of its defence at a Royal Commission to clear its name. ▪ H: deductible because it was necessarily incurred in the business, although not a usual expense - Magna Alloys ( H: legal expenses incurred to defend bribery charges of directors were necessarily incurred because the company could not function without the directors. - WD & HO Wills ( tobacco company established a subsidiary Singaporean insurance company to provide insurance. No claims from the insurer meant that the company was profitable. ▪ H: not unreasonable or inappropriate to deduct cost of insurance premiums, even if it is a subsidiary company. Sound commercial practice to have insurance.
➢ Excessive Expenses - The issue is whether excessive expenses are ‘necessarily’ incurred in carrying on a business. - Generally ( the Commissioner cannot tell you how to run your business. - But, where expenses claimed as deductions are excessive, it suggests that they are for more than one purpose (and ( may be apportioned). - Robert G Nall v FCT ( R was director who continued to receive full salary during winding-up. N was still involved with debt collection and management issues. Claimed a deduction for salary. ▪ H: salary expenses were not fully deductible because the amount paid was disproportionate to the income earned by the company.
C. Negative Limbs – s8-1(2)
- If any of the negative limbs apply, the expense is not deductible.
1. The Third Limb - s8-1(2)(a) ( you cannot deduct losses or outgoings of capital or of a capital nature.
- Eisner v Macomber ( capital is like the tree on which income, the fruit, is grown. - There are three tests for distinguishing capital from income expenses.
➢ ‘Once & for all Test’ - TEST = a capital expense occurs once and for all, whereas income expenses are continuous and ongoing every year (Vallambrosa Rubber) - Vallambrosa Rubber ( taxpayer owned a rubber plantation and claimed a deduction for weeding and pest control – H: not capital (deductible income expense because it was incurred every year. - BP Australia ( service stations received a payment if they sold BP products – H: income ( deductible because the trade tie was only 5 years.
➢ Enduring Benefit Test - TEST = expenditure on an item providing an enduring benefit will be capital (Sun Newspapers) - BP Australia ( the mere fact that an expense may be repeated does not necessarily mean that the taxpayer has not received an enduring benefit.
➢ Business Entity Test (main test) - TEST (Sun Newspapers): ▪ If outgoing is for the improvement of a capital asset or the acquisition of new assets = capital expenditure (( not deductible) ▪ An outgoing for the purpose of day-to-day trade which maintains the taxpayer’s position is a revenue expense ( deductible (Hallstroms) - Sun Newspapers v FCT ( H: company could not claim the cost of a payment to a rival newspaper to stop it printing newspapers within 3km of Sydney. Capital in nature. - Hallstroms case ( H: the legal expenses incurred in opposing the extension of a patent were deductible because if was for the purpose of day-to-day trade - Kemp v FCT ( H: legal expenses incurred to obtain a clearance to play rugby league were capital in nature because they provided a structural advantage to the player ( not deductible.
Demolition & Repair Expenses: - Mt Isa Mines v FCT ( H: cost of demolishing buildings was capital, not repairs ( not deductible: ▪ Expenditure which goes beyond repair and makes results in the improvement of an asset is capital and not deductible. ▪ But where demolition is undertaken in the course of day-to-day conduct of a business, the cost will be a revenue expense ( deductible.
2. The Fourth Limb - s8-1(2)(b) ( you cannot deduct a loss or outgoing to the extent that it is of a private or domestic nature.
- Most private or domestic expenses will not satisfy the first limb – ie: they will not be incurred in gaining or producing assessable income. - Non-deductible items generally include: ▪ Household expenditure – eg: food (FCT v Cooper); clothing ▪ Life insurance premiums ▪ Residence outgoings (eg: mortgage payments) ▪ Babysitting costs ▪ Travel costs to and from work
➢ Rental Costs - Rental costs = mortgage interest, rates, telephone costs (keeping in touch with tenant); legals - TEST ( these costs will be deductible to the extent that they are incurred in gaining or producing assessable income. - Groser’s case ( G bought a house from his parents and charged disabled brother $2/week rent (market rent was $75). G claimed $522 deduction for expenses, including rates, repairs & mortgage. ▪ H: not deductible as there was no purpose to earn assessable income (purely domestic). - Kowal’s case ( K charged her mother $30 rent (market rent $50). Received $165 income and claimed $1652 in deductions, including interest, mortgage and telephone expenses. ▪ H: 80% was deductible and 20% disallowed as K had a private, non-income earning purpose of providing mother a home. Rent below the market rate was evidence of dual purpose.
➢ Clothing & Grooming Expenses - Edwards ( H: expenditure on clothing required by the personal assistant to the Governor’s wife was deductible because the uniform was necessary to complete her duties. - Mansfield v FCT ( moisturiser, shoes & panty hose for flight attendant deductible. ▪ Mere fact that a particular form of clothing is required to be used in an occupation does not necessarily lead to the conclusion that expenditure on that clothing is deductible ▪ Ordinary clothing: o May be deductible if unlikely that would wear the clothing for private purposes o Also deductible if expenditure on clothing was additional to that necessary in ordinary life ▪ Distinctive uniform: o Ordinarily qualifies for a deduction b/c distinctive characteristics provide a nexus b/w the expenditure & the work activity - TR 96/18 ( cosmetics & personal grooming usually not deductible, unless you are in performance
D. General Deductions – Examples
1. Self-Education Expenses - Self-education expenses are generally deductible where there is a sufficient nexus between the outgoings and gaining assessable income (s8-1) ▪ Examples ( textbooks, tuition fees, conference fees, local travel costs (sometimes international) - s82A [ITAA 36] ( no deduction for the first $250 of self-education expenses. - Finn ( an architect could deduct overseas travel expense to bring himself up to date with changes in his profession. ▪ A self-education expense will be deductible if it relates to the taxpayer’s current occupation. ▪ An expense claimed in respect of a new field of education will not be deductible unless a relationship with earning existing assessable income exists. (TR 98/9) - Studdert ( a flight engineer was allowed to claim the cost of flying lessons. ▪ Do not have to show that the expense will lead to an increase in income – it will be deductible if it would objectively increase proficiency. - Highfield ( dentist could deduct the cost of a course in UK, airfares, accommodation and meals. ▪ The costs of maintaining a level of knowledge or increasing a person’s qualifications in their field of expertise will be deductible (TR 98/9) (but not if in a new area of income generation). - Hatchett ( a teacher was allowed deductions for obtaining a higher certificate: ▪ Expenses for improving the mind are not capital in nature (( still deductible). - TR 98/9 ( self-education expenses will be deductible if they are likely to lead to increased income.
2. Legal Expenses - Legal expenses will be deductible if they are incurred in producing your assessable income (s8-1; Magna Alloys). - The major issue is whether the legal expenses are revenue or capital in nature (see: Third Limb): ▪ Revenue ( recovery of outstanding debts arising from the sale of goods in ordinary course of business (deductible) ▪ Capital ( legal expenses for acquiring land or buildings or limiting competition (not deductible) - Legal expenses designed to reduce competition are capital in nature under the Sun Newspapers test: ▪ Broken Hill Theatres ( H: legal expenses to contest a competitor’s application for a theatre licence were capital in nature ( not deductible. ▪ Sunraysia Broadcasters ( AM broadcaster with a monopoly could not claim deduction for cost of obtaining an FM licence to prevent competition. ▪ c/f: Hallstroms case ( H: legal expenses incurred in opposing the extension of a patent were deductible because if was for the purpose of day-to-day trade. ▪ c/f: Duro Travel Goods ( expenses incurred in preventing a competitor using a similar trade name were deductible because it involved preserving a business name - Unusual Transactions: ▪ Magna Alloys ( a company could deduct legal expenses incurred in defending bribery charges against directors. ▪ Snowden & Willson ( costs of defending taxpayer’s reputation before Royal Commission were deductible, even though abnormal and not ongoing. - Specific Deductions: ▪ s25-5 [ITAA 97] ( can deduct tax-related expenses ▪ s25-20 ( can deduct expenses incurred in preparing, registering or stamping lease documents ▪ s25-25 ( borrowing expenses ▪ s25-30 ( mortgage discharge expenses
3. Child Minding Expenses - Child minding expenses are not deductible because they are private in nature, even though they are incurred so that taxpayers can earn assessable income - Lodge; Jayatilake; Martin ( child-minding expenses were non-deductible, private expenses, even though as a matter of practicality they had to be incurred to gain assessable income.
4. Home Office Expenses - The deductibility of home office expenses depends on whether the home is used as business premises or merely as a matter of convenience (Swinford v FCT). - TR 93/30 ( important to distinguish between occupancy expenses (mortgage interest, rent, insurance) and running expenses (electricity and cleaning) ▪ If used as a business premises (eg: doctor’s surgery) ( can deduct appropriate portion of occupancy and running expenses. ▪ If used as a matter of convenience (eg: private study) ( no deduction for occupancy expenses (private) but can deduct a portion of running expenses. - A home will be used as a ‘matter of convenience’ where the tasks could be performed at the usual place of work and the activity is not separate from usual employment.
- FCT v Faichney ( research scientist worked in laboratory, but also at home in evenings and weekends on his studies: ▪ H: no deduction for interest of loan (private payments) but could deduct for depreciation of office-assets (shelves, carpet, desk, curtains). - FCT v Forsyth ( rent paid by a barrister which was also his study was not deductible – ie: it was neither incidental nor relevant to the gaining of assessable income + essentially a bedroom. - Handley v FCT ( barrister had a study at home; used study 20 hours per week for 45 weeks a year. ▪ H: no deduction for occupancy expenses – the study was just another room of the house, no distinctive characteristics, used for other family purposes.
5. Preliminary Expenses - Preliminary expenses are not deductible because they are not incurred in producing assessable income and are of a capital nature. - Maddalena ( M was an electrician and also a professional rugby league player. M claimed a deduction for the cost of travelling to Sydney to arrange a football contract. ▪ H: money spent to obtain a new employment are not deductible.
6. Insurance Expenses - Generally ( an insurance premium will be deductible where the insured amount replaces assessable income. ▪ DP Smith case ( doctor took out permanent disability insurance cover and was injured in a car accident. Doctor received monthly insurance money and claimed the payments as deductions. H: payments were income as they replaced earnings ( could claim deduction - Exception ( cannot deduct the cost of a premium which replaces capital asset, unless it is paid in the ordinary course of income-producing activities ▪ Eg: fire insurance premium on a building used to produce investment income (Somers Bay)
7. Interest Expenses - Interest is a payment for the right to use borrowed funds. - Generally ( interest expenses will be deductible of borrowed for an income-producing purpose – ie: sufficient nexus with earning assessable income (Janmor Nominees)
➢ ‘Use’ Test (main test) ▪ Deductibility of interest expenses depends on the use of borrowings (Munro; Roberts & Smith) ▪ Deductible ( if borrowings are used to finance business expenses or income-producing assets, even if secured over private assets (office premises, shares etc). ▪ Not deductible ( if borrowings are used for a private or domestic purpose, even if secured over business assets (Ure v FCT; FCT v Munro)
➢ ‘But-for’ Test ▪ Has been applied in unique instances of refinancing such as Yeung and Roberts & Smith – this is known as the refinancing principle. ▪ TR 95/25 ( limits the deductibility of interest to the extent that the funds represent a refund of moneys previously invested in the partnership.
➢ Interest incurred before business commences: ▪ Steele’s case ( S acquired land with the idea of building a motel on it. Plans were drawn up but development never went ahead. Claimed interest deductions until its sale seven years later. o H: once interest is classed as an expense incurred in gaining assessable income, it will still be deductible even if the capital asset produces no income.
➢ Interest incurred after business ceases: ▪ Brown; Jones( in both cases, interest was incurred after the relevant income earning activities had ceased and borrowed funds had been lost to the taxpayer. Interest deductions were claimed: o H: in both instances, interest incurred on the loans continued to be deductible despite the cessation of the relevant income earning activities (see: TR 2004/4)
➢ Dual purpose loans: ▪ Hart v FCT ( involved a couple with a split loan which had a private and income-producing investment purpose. Claimed a deduction for interest on investment part of loan. Commissioner argued that the interest was unique because it allowed the loan to be paid off faster. o H: the interest had the same character as ordinary interest ( deductible (but HCA found that the scheme breached the anti-avoidance provisions).
SPECIFIC DEDUCTIONS
- s8-10 [ITAA 97] ( if 2 or more provisions allow a deduction for the same amount, can deduct only under the most appropriate provision.
A. Gifts & Donations (s30-15)
- Div 30 [ITAA 97] ( allows deductions for gifts to charities, educational institutions, health funds, defence etc. (can spread deduction over 5 yrs). - s30-15 ( a taxpayer can deduct a gift made in the situations set out in the table listed. The table states who the recipient can be, what type of gift can be made, how much can be deducted etc. ▪ s30-20 ( health recipients (public hospital/research/ambulance) ▪ s30-25 ( education recipients (public uni; higher education institution etc) ▪ s30-40 ( research recipients (approved research institution) ▪ s30-45 ( welfare and rights recipients (public benevolent institutions, funds) ▪ s30-90 ( sports and recreation recipients (Aust Sports Foundation; guides; scouts) ▪ s30-100 ( cultural recipients (public funds; libraries; museums; art galleries) - A gift must be made with a bona fide intention and the donor must receive no material benefit (Leary v FCT; Cyprus Mines Corp). - TD 93/185 ( a gift of services is not deductible – ie: expenses gained during unpaid work - Testamentary Gifts (Subdiv 30-D) ( not deductible unless made under Cultural Bequests Program - Anti-Avoidance Provisions (s78A(2) [ITAA 36])( deductions for gifts cannot be made where the value received is less than the gifts worth, if the recipient incurs a liability, the donor obtains a benefit or advantage, or the recipient is liable to acquire property from the donor.
B. Travelling Expenses (s25-100)
➢ Home to Work - Generally ( travel between home and work is not deductible because this is a private expense, despite fact that these expenses are incurred to produce assessable income (Lunney’s case) - Exceptions: ▪ Wiener’s case ( teacher visited 5 schools during the day and used home as a base for preparation. H: could claim deductions for travel to and from schools and between schools. ▪ Collings ( computer consultant could claim deductions for travel between home and work outside normal working hours as she was on-call 24 hours – ie: special circumstances. ▪ Vogt ( V could claim a deduction as a musician for cost of transporting heavy musical equipment between his home and place of performance. ▪ Case U29 ( carpenter could claim a deduction of travel to work because he had to transport bulky materials which could not be left on site overnight for safety reasons.
➢ Between Offices - s25-100(1) ( taxpayer may deduct transport expenses to the extent that it is incurred in your travel between workplaces. - s25-100(2) ( the purpose of travel must be to engage in activities to produce assessable income. - s25-100(3) ( no deduction where the second workplace is your home. - Garrett v FCT ( a doctor carried out a grazing business from home ( could claim deductions for the cost of travel by plane from home to medical practice. ▪ But: may be decided differently today due to s25-100(3) (ie: second workplace was G’s home) - c/f: FCT v Payne ( pilot could not claim a deduction for travel between home, where he ran a deer farm, and the airport – the type of work was not linked ( not expenses relating to income ▪ But: may be decided on different grounds today b/c s25-100(1) states that the two workplaces do not have to be related. However, s25-100(3) says second workplace cannot be your home. - Owen v Pook ( medical practitioner successfully claimed the cost of travel between his home (where he conducted his practice) and the hospital. - Cunliffe v FCT ( restaurant owner claimed $66,000 overseas travel expenses relating to new business. Also had a private purpose and took partner. ▪ H: deduction allowed but had to be apportioned to account for private purpose. - Sharma ( an academic claimed deductions of $70,000 for entertaining students and $21,000 for travel expenses and staying at Hilton. H: unreasonable, large costs suggested dual purpose.
C. Repairs (s25-10)
1. Repairs Deductible - s25-10(1) [ITAA 36] ( you can deduct expenses incurred for repairs to premises or depreciating assets held solely for producing assessable income. - s25-10(2) ( can allow a ‘reasonable deduction’ where an asset is partly held for the purpose of producing assessable income (ie: apportionment) - s25-10(3) ( cannot deduct capital expenditure (eg: improvements + additions – refer below).
2. What are ‘Repairs’? - ‘Repair’ is not defined in the Act ( use ordinary meaning: “the restoration of some material thing or structure by renewal or decayed or worn out parts” (Oxford Dictionary)
➢ TEST 1: Need for restoration - TEST = an item must be in need of restoration before it can be repaired (Case J47) - TR 97/23 ( preventative work or work done in anticipation of forthcoming defects is deductible, even if in early stages – ie: do not have to wait for serious damage (Day v Harland & Wolff)
➢ TEST 2: Entirety vs. Subsidiary Part - TEST = TP can deduct the cost of renewing or replacing subsidiary parts but not the cost of reconstructing substantially the whole asset (Lurcott v Wakely & Wheeler) - Lindsay ( the ‘entirety’ is a separately identifiable piece of capital equipment (TR 97/23) - Western Suburbs Cinemas ( replacement of ceiling was replacement of subsidiary part. - Rhodesia Railways ( H: replacement of 74 miles of 400 mile railway track was replacement of subsidiary part ( deductible. - O’Grady ( unsafe chimney replaced with a wider, higher chimney. H: replacement of entirety.
➢ TEST 3: Repair/Maintenance vs. Improvement - TEST = a repair becomes a non-deductible improvement if it results in a change in functionality and efficiency (WH Thomas & Co) - TR 97/23 ( use of different materials is not determinative – look at effect on efficiency/function. - Morcom v Campbell-Johnson ( H: replacement of a modern draining system and water tank was a mere repair because it was not improving function. - Western Suburbs Cinemas ( new fibreglass ceiling cost £3,000 whereas restoring original would have cost £603. H: improvement of a capital asset ( not deductible - Rhodesia Railways ( replacement of wooden tracks with steel tracks was not an improvement to efficiency but merely increased the useful life ( deductible.
3. Specific Situations
➢ Initial Repairs - Generally ( repairs undertaken within 6 months of purchase will be capital ( not deductible - WH Thomas & Co ( worn out property was acquired and work was carried out within first 12 months on roof, gutters, basement, walls and painting. ▪ H: capital expenditure because work was carried out in first 12 months ( not deductible - Case V83 ( no deduction even where taxpayer did not know repairs were required at time of sale - Law Shipping Co v IRC ( ship purchased for reduced price of £97,000 but required repairs of £51,558 to make it seaworthy. ▪ H: repairs were capital – its condition was reflected in its reduced price ( not deductible - c/f: Odeon v Jones ( cinemas were acquired in poor condition but they were continued to be used as restoration continued. ▪ H: deductible – the purchase price did not reflect the need for work and it was an operative going-concern at the time of purchase, despite its state.
➢ Repairs to Satisfy Regulatory & Health Standards - TR 97/23 ( work done to satisfy regulatory bodies will only be a deductible repair if it remedies a defect, deterioration or damage without improving function. - TR 97/23 ( work done to abate health risks of dangerous substances (asbestos, CFC’s etc) does not qualify as a repair unless it remedies a defect, deterioration or damage to property.
➢ Additions - Additions are capital expenditure ( not deductible - TEST = expansion of the basic structure and changes to the item’s structure will be of a capital nature (WH Thomas & Co)
➢ Notional Repairs - You cannot carry out capital improvements and then claim the notional amount which it would have cost merely to repair the item (TR 97/23) - Western Suburbs Cinema ( can only deduct for the cost of what has been done.
D. Capital Allowances / Depreciation (s40-25)
- s8-1 [ITAA 97] ( generally, expenditure of a capital nature is not deductible. - s40-25 ( you can deduct the decline in value of a depreciable asset held during the income year and used for a taxable purpose
▪ This provision replaced Div 42 under the Uniform Capital Allowance Scheme.
➢ Depreciable Assets (‘plant’) - s40-30(1) ( depreciable asset = an asset with an effective life and can reasonably be expected to decrease in value over time, except land, trading stock and certain intangible assets. - TEST ( can deduct the reduction in value of items which impact on operations, but not items which form part of the setting. ▪ Munby v Furlong ( extends to a man’s tools of trade…the things he uses from day to day - s40-30(2) ( can depreciate the following intangible assets – mining rights and info, in-house software, items of IP etc. - s40-30(3) ( improvements to land and fixtures are treated as separate, depreciable assets. - s40-30(4) ( whether ‘composite items’ are depreciated as a whole or as separate components is a question of fact and degree (eg: car (whole asset) vs. floating restaurant (individual components)). - Wangaratta Woollen Mills ( yarn dying firm erected a building with many unusual features to meet its needs ▪ H: entire building was plant as it played a part itself in the manufacturing process - Barclay’s case ( installed a dry dock – Q whether it was part of premises ▪ H: despite its size, a dry dock is a tool of the respondent’s trade ( depreciable asset - Benson v Yard Arm Club Ltd ( converted vessel into restaurant and claimed it was plant ▪ H: not plant as it was merely the structure in which the business was carried out in
➢ Asset ‘held’ during income year - s40-40 ( generally, the ‘holder’ is the legal owner of the asset (ie: economic owner). - s40-40 ( a depreciating asset subject to a lease which is fixed to land where the lessor has a right of recovery will be held by the lessor.. - s40-60 ( the value of depreciation starts from the ‘start time’ – ie: when you first use it or have it installed ready for use.
➢ ‘Taxable purpose’ - The asset must be predominantly used for the purpose of: ▪ Producing assessable income; ▪ Exploration or prospecting; ▪ Mining site rehabilitation; or ▪ Environmental protection activities.
➢ ‘Decline in value’ - You can deduct the decline in value of a depreciable asset ( this is based on the cost base and effective life of the asset, not the actual change in value. - s40-175 ( cost base has two elements: 1. The price paid to hold the asset (s40-180) 2. The cost of bringing the asset to is present condition (eg: alterations, additions) (s40-185)
- Methods to calculate decline in value: ▪ s40-95 ( effective life determined by Commissioner (s40-100) or taxpayer’s estimate based on reasonably expected ‘wear and tear’ if asset is maintained in reasonably good condition (s40-105) ▪ Diminishing Value [pic] ▪ Prime Cost = [pic]
➢ Balancing Adjustment Events - s40-295 ( a balancing adjustment event occurs where an entity stops holding or using an asset. - The balancing adjustment is the difference between the termination value and its adjustable value: ▪ s40-300 ( the termination value is the amount received under the event (eg: proceeds of sale) ▪ s40-85 ( the adjustable value is the cost of the asset less any decline in value to that point - s40-285 ( the following rules apply: ▪ If the termination value > adjustable value ( the difference is included as assess. income ▪ If the termination value < adjustable value ( the difference is deductible - s40-295(3) ( a balancing adjustment event does not occur merely because you split an asset into 2 or more depreciating assets or merge it with another depreciating asset.
E. Miscellaneous Deductions
➢ Bad Debts - s25-35(1) ( can deduct a debt or part of a debt that you write off as bad in the income year if: ▪ (a) – it was included in your assessable income for the income year or an earlier year; or ▪ (b) – it is in respect of money lent in the ordinary course of your business of lending money - Nb: bad debts only occur if accrual basis of accounting is being used.
➢ Losses Caused by Employee Theft - s25-45 ( can deduct a loss caused by “theft, stealing, embezzlement, larceny, defalcation or misappropriation” by an employee or agent if included as assessable income
➢ Theft by Outsiders - Charles Moore v FCT ( court allowed a deduction for money stolen from employees on way to depositing at bank. The loss was incurred in the income-earning activities of the business - La Rosa ((not anymore) court permitted a drug dealer to claim a deduction for money stolen in connection with drugs, despite illegality of transaction.
➢ Election Expenses - s25-60 ( expenditure relating to contesting membership of Cth or State Parliament is deductible. - s25-70 ( not deductible to the extent that it is incurred in respect of providing entertainment, unless it is in respect of: ▪ providing entertainment that is available to the public generally; or ▪ providing food or drink to the taxpayer,
➢ Rates & Land Taxes - s25-75(1) ( may deduct rates which are annually assessed + land tax in respect of premises - s25-75(3) ( where premises only partly used for income-producing or business purposes, can only deduct a portion
➢ Pensions & Retiring Allowances - s25-50(1) ( employer may deduct a pmt of a “pension, gratuity or retiring allowance” to an employee or former employee or their dependants. - s25-50(2) ( only deductible to the extent that it is made in good faith in consideration for past services for the purpose of gaining or producing assessable income - Factors to consider ( terms of employment; length of service; level of remuneration paid during period of service; any other benefits employee is entitled; the reasons for payment (ie. in good faith)
➢ Joining Work Association or Union - s25-55(1) ( can deduct a payment made for membership of a trade, business or professional association - s25-55(2) ( maximum amount deductible is $42 per income year - s25-55(3) ( no limitation on amount if deducted under s8-1
F. Non-Deductible Items
➢ Bribes - s26-25 & s26-53 ( bribes made to Australian & foreign public officials are not deductible. - An amount is a bribe if it is incurred: ▪ in providing or offering a benefit to another person who is not legitimately entitled to it; and ▪ with the intention of influencing the public official in the exercise of his duties
➢ Fines & Penalties - s26-5(1) ( cannot deduct: ▪ (a) – an amount payable by way of penalty under an Australian or foreign law; or ▪ (b) – an amount ordered by a court to be paid on the conviction of an entity for an offence against Australian or foreign law (ie. fine) - Arguably a nexus b/w a parking fine imposed on a security van parking outside a bank & the earning of assessable income by the company (but denied on public policy grounds)
➢ Entertainment Expenses - s32-10 ( entertainment means food, drink, recreation, or accommodation - General rule ( s32-5 = prohibition on deductions for entertainment expenses - Exceptions: ▪ s32-20 ( if provide entertainment by way of providing a fringe benefit ▪ s32-55 ( in-house dining facilities for employees on employers premises ▪ s32-35 ( travel, food, drink & accommodation that is reasonably incidental to individual attending a seminar for at least 4 hours
G. Tax Incentives and the Arts
- Tax incentives for philanthropy are designed to encourage greater corporate & individual gifts 1) policy of incentives to support industry 2) incentives for investment in Australian films (Div 10BA ITAA 36) 3) gifts to cultural organisations 4) cultural bequests - Div 30 [ITAA 97] ( allows deductions for gifts to charities, educational institutions, health funds, defence etc. (can spread deduction over 5 yrs) - s30-25(1) ( education recipients of deductible gifts include a ‘public university’ or a ‘higher education institution’
CAPITAL GAINS TAX (CGT)
A. Introduction
- Capital Gains Tax (CGT) = a tax on the gains from the realisation (sale) of property. - s105-5 [ITAA 97] ( CGT is not a separate tax – it is defined as assessable, statutory income. - Capital gain occurs when capital proceeds > asset cost base - Capital loss occurs when capital proceeds < asset cost base ▪ Nb: capital losses are not deductible from assessable income but they can be carried forward to offset future capital gains.
➢ TEST ( a four-step approach is used to determine a person’s capital gain liability: 1. Is there a CGT event? 2. Calculate the net capital gain or loss from the CGT event 3. Determine the capital gains discount, if any. 4. Do any CGT exceptions apply?
B. STEP 1: CGT Events
- s102-20 [ITAA 97] ( CGT is only payable when a CGT event occurs. ➢ CGT Event - CGT events include: ▪ Event A1 (s104-10) ( sale or disposal of a CGT asset ▪ Event C1 (s104-20) ( loss or destruction of a CGT asset ▪ Event D1 (s104-35) ( creating contractual or other rights ▪ Event E1 (s104-55) ( creating a trust over a CGT asset ▪ Event F1 (s104-110) ( granting, extending, or renewing a lease ➢ CGT Assets - Only ‘CGT assets’ are subject to CGT on sale or disposal. - s108-5 ( an asset is ‘any kind of property or a legal or equitable right that is not property’ - There are 3 main types of CGT assets:
1. Other / General Assets - s108-5 ( a CGT asset includes any kind of property – ie: land + buildings + shares + goodwill + debts owed to you + the right to enforce a contract . - Exemptions – the following are not subject to CGT: ▪ Cars and motorbikes (s118-5(a)) ▪ Compensation payouts and prizes from gambling (s118-37).
2. Personal Use Assets - s108-20(2) ( a personal-use asset is any asset (not a collectable) which is used or kept mainly for personal use or enjoyment (eg: boat). - s118-10(3) ( no CGT is payable on the gains from the sale of personal use assets under $10,000. - s108-20(3) ( a personal-use asset does not include land, units or buildings.
3. Collectables - A collectable is an asset kept mainly for personal use - s108-10(2) ( collectables include: art, jewellery, antiques, coins, medallions, books, manuscripts, postage stamps. - s108-10(1) ( no CGT is payable on the gains from sale of collectibles under $500.
➢ When does the CGT liability arise? - ss104-5; 109-5 ( a CGT event occurs when: ▪ you enter into a contract for the disposal of the asset; or ▪ if there is no contract, you stop being the assets owner. - s109-5 ( for assets which have been lost or destroyed, a CGT event occurs when: ▪ You first receive compensation; or ▪ If no compensation has been received, when the loss is discovered or destruction occurred.
➢ Effect of Death of a Taxpayer - Generally (s128-10) ( the death of a taxpayer does not constitute a disposal of the deceased’s assets ( any capital gain or loss is disregarded until the beneficiary/estate disposes of the asset ▪ Assets acquired before 20/9/85 ( the beneficiary is deemed to acquire the asset on the day of the taxpayer’s death at the market value (s128-15(2),(4)) ▪ Assets acquired after 20/9/85 ( the beneficiary is deemed to acquire the asset on the date of the taxpayer’s death at the cost base. (s128-15(2),(4)) - s128-15(6) ( a beneficiary will acquire a collectible or personal use asset if the taxpayer acquired it after 20/9/1985 and it was such an asset in the hands of the taxpayer when they died
C. STEP 2: Calculate the Capital Gain/Loss from the CGT Event
- s100-45 [ITAA 97] ( states the method for calculating the capital gain or loss for CGT events:
1. Work out the capital proceeds from the CGT asset: ▪ s116-20 ( capital proceeds is the money received from CGT event. ▪ Market Substitution Rule (s116-10(2)) ( the market value is to be substituted for the proceeds if: o no proceeds are received from the CGT event (ie: gift); or o the proceeds are not received at arm’s length; or o the amount received is greater or less than the market value. o c/f: s116-10(2) ( market substit. rule does not apply where a CGT asset is lost or destroyed ▪ Apportionment Rule (s116-10(3)) ( if a CGT asset has multiple uses, it may be necessary to apportion the proceeds – eg: a main residence which is also used as an office.
2. Work out the cost base for the CGT asset: ▪ s110-25(1) ( the cost base consists of five elements: o Purchase price (s110-25(2)) ( the money paid for acquiring an asset (or market value) o Incidental costs (s110-25(3))( includes professional services, stamp duty, advertising o Non-capital costs of ownership (s110-25(4))( includes interest on borrowings, maintenance, repairs and insurance costs, rates and land taxes (only if NOT an investment property)(only if asset was acquired after 21 Aug 1991). Also, if it is a rental property interest on borrowings, repairs and rates would be deductible and therefore not included in the cost base. o Capital expenses to increase value (s110-25(5)) ( includes extensions and improvements to rental or not rental will be included in cost base. o Costs of establishing or preserving title (s110-25(6)) stamp duty, legal fees, loan establishment costs (only if not rental property). ▪ Indexation ( taxpayers who acquired assets before 21 Sept 1999 may index the elements of the cost base to inflation up to this time (this does not apply to non-capital costs of ownership)
3. Subtract the cost base from the capital proceeds: ▪ If: Proceeds > Cost Base ( capital gain. ▪ If: Proceeds < Cost Base ( calculate reduced cost base.
4. Calculate the reduced cost base: ▪ The reduced cost base is calculated when the cost base exceed the capital proceeds. ▪ Reduced cost base = includes the same elements as s110-25, except for non-capital costs of ownership. No indexation is allowed for any element of the cost base.
5. Determine your CGT position: ▪ If: Reduced Cost Base > Capital Proceeds ( capital loss. ▪ If: Reduced Cost Base < Capital Proceeds (< Cost Base) ( no capital gain / no capital loss. D. STEP 3: Capital Gains Discount
- Treatment of Capital Gains: ▪ Discount method ( 50% of the gain is subject to tax; or ▪ Indexation method ( gain is indexed to reflect inflation - s115-25 ( CGT discount applies only if asset is held for at least 12 months - s115-100 ( the discount percentage is 50% of the gain made by an individual. - The discounted capital gain is included as assessable income.
E. STEP 4: Exemptions & Exceptions
1. General Exemptions - s118 [ITAA 97] ( no CGT is payable on: ▪ Motor cars (s118-5) ▪ Collectables worth less than $500 + personal-use assets worth less than $10,000 (s118-10) ▪ Assets used to produce exempt income (s118-12) ▪ Trading stock (s118-25) and depreciable assets
2. Main Residence Exemption (118-B) - s118-100 [ITAA 97] ( any capital gain or loss made from the sale of a dwelling will not be subject to CGT if: ▪ the taxpayer is an individual; and ▪ the dwelling is the main place of residence.
➢ Dwelling - s118-115 ( dwelling includes building, caravan, houseboat, or mobile home. - TR 92/158 ( yacht may be a dwelling where facilities on board make it habitable (liveable) - s118-120 ( dwelling includes up to 2 hectares of surrounding land used for domestic purposes.
➢ Main Residence - s118-170 ( there is only 1 main residence per family ( if there is more than one, must choose. - Change of Main Residence (s118-140)( if you acquire a new main residence while still owning an old one, both will be treated as your main residence for the shorter of: ▪ 6 months from when you cease to own your existing main residence; or ▪ the period between acquiring new residence and disposing of the existing residence. - s118-140(2) ( to gain the exemption, the old main residence must have been the main place of residence for 3 continuous months and be non-income producing. - Main Residence used to Produce Income: ▪ s118-190(1) ( a main residence which is also used to produce income will only receive a partial exemption from CGT ▪ s118-190(2) ( the capital gain or loss that would have been made is increased by an amount which is reasonable.
3. Small Business Concessions - s152-B ( no CGT on assets held for 15 years where disposal is due to retirement or incapacity. - s152-C ( disposal of active assets - s152-D ( retirement or Eligible Termination Payments (ETPs) subject to lifetime limits - s152-E ( rollovers: individuals converting businesses to companies, partners rearranging partnerships
FRINGE BENEFITS TAX (FBT)
A. Introduction
- Fringe Benefit = a benefit or perk that an employee receives over and above their normal salary or cash remuneration. - FBT is imposed on the employer ( there is no general obligation on the employee to reimburse the employer, although often a contractual arrangement exists between them ▪ Examples: teachers receiving free tuition for their children; pilots receiving discounted travel
➢ Old System - s26(e) [ITAA 36] ( taxpayers were required to include in their taxable income the value of all allowances, gratuities, benefits and bonuses directly or indirectly related to their employment. - This provision was inserted into the ITAA to overcome the problem of non-cash payments being paid to employees (see: Tennant v Smith) - But, the provision was ineffective because of poor administration and it placed an onus on the employee to value the benefits they received. - ( the separate FBTAA was enacted to overcome these deficiencies.
B. Fringe Benefits Tax Assessment Act 1986 (FBTAA)
- The FBTAA establishes a separate statutory regime for the taxation of fringe benefits - FBT is imposed at a rate of 48.5% on the ‘fringe benefits taxable amount’ of an employer for the year of tax (ie: 1 April to 31 March). - FBT is self-assessed and payable in accordance with the FBTAA regime.
1. FBT Elements - s136 FBTAA ( a fringe benefit is a benefit provided during the year of tax by an employer, associate or third party to an employee or associate in respect of employment.
➢ “Benefit” - Benefit is widely defined to mean ‘any right, privilege, service or facility.’ (s136(1)) - Motor Cars: ▪ s7(1) ( a car benefit arises if at any time, in respect of employment, a car is held by the employer and is applied to or available for the private use of an employee or associate. ▪ ( there must be a sufficient nexus with employment – it includes any car owned by, leased to or otherwise made available to the employer. ▪ Private use means any use which is not exclusively in the course of producing assessable income of the employee (s136(1)). - Other forms of benefit: ▪ Low interest loans (ss16-19) ▪ Expense payments (ss20-24) ▪ Airline transport (ss32-34) ▪ Meal entertainment (ss37A-37CF) ▪ Car parking (ss39A-39E) - “Provided during the income year” - The FBT income year runs from April 1 to March 31, not the financial year. - Thus the FB must be earned within this time.
➢ “By an employer, associate or third party” - The benefit must be provided by an employer, associate or third party
➢ “To an employee or associate” - The benefit must pass from the employer to an employee or associate of the employee. - This covers situation where the employer grants a benefit to a spouse, child, trustee etc of the employee.
➢ “In respect of employment” - TEST ( there must be a sufficient nexus or some ‘discernable and rational link between the benefit and the employment’ (J&G Knowles v FCT) - A mere gift on personal grounds is insufficient – ie: the reason for the benefit must be employment (ie: does not include birthday present etc) - Tax Ruling MT 2016 ( not all benefits provided to children who work in a family business will be FBT exempt
2. Exclusions - s136(1) ( exclusions from FBT include: 1) No connection with employment ( FBT is only imposed on employers for benefits paid or provided in respect of employment. 2) In-House fringe benefits ( the first $500 of in-house fringe benefits are not taxable. ▪ In-house fringe benefits are benefits of the same type normally sold to customers which are provided free or at a discounted rate to an employee 3) The “otherwise deductible” rule ( FBT is not payable by the employer if the expenditure would have been otherwise deductible as income under the s8-1 ITAA. - Employee contributions ( where an employee pays an employer for the benefits they receive, these items will not be subject to FBT. - Frequent Flyer Miles ( points are not subject to FBT because they arise out of a personal contractual relationship between the employee and airline, not by virtue of employment (TR 99/6; Payne v FCT;)
3. Calculation of FBT - The FBT rate is 48.5%. - Calculating FBT requirements is a two-step process involving the ‘grossing up’ of the benefits to an amount equivalent to its cost in after tax dollars: ▪ [pic] ▪ [pic]
- Example ( Sally is the managing director of a company. Her son’s school fees are $2000 and are paid for her by the company. What is the FBT that should be paid by the company on that benefit? ▪ [pic] ▪ [pic]
GOODS & SERVICES TAX (GST)
A. The GST System
- The GST is governed by the A New Tax System (Goods and Services Tax) Act 1999. - This system changed the emphasis from heavily taxing income to taxing consumption - The GST commenced on 1 July 2000 at a rate of 10% on taxable supplies. - GST revenue is collected by the Cth government and distributed to the States and Territories. - The GST rate cannot be altered without consensus of every State and Territory and Federal Houses of Parliament ( it is difficult to impose quick and severe increases in the GST rate. - The GST operates on an input-tax credit basis such that producers at each stage of production can claim a GST credit for tax already paid earlier in the chain (see below).
B. Taxable Supplies & Importations – n.b. the changes in the tutorial
- s7-1 GSTA ( GST is payable on taxable supplies and taxable importations.
1. Taxable Supply - s9-5 ( taxable supply = ‘a supply for consideration made in the course of an enterprise connected with Australia by a registered entity.’ - Taxable supply is the amount of GST that is reflected in the product that someone sells.
➢ Supply - s9-10 ( supply is any form of supply, including: ▪ supply of goods; ▪ supply of services; ▪ providing advice or information; ▪ grant, assignment or surrender of real property; ▪ financial supply - s9-10(3) ( it does not matter whether it is a lawful supply ( illegal acts still subject to GST - s9-4(4) ( supply does not include payment of money for goods and services, except where it is given as consideration for a supply of other money (eg: foreign exchange) - Nb: non-taxable supplies include GST-supplies + input-taxed supplies (see below)
➢ Consideration - s9-15(1) ( consideration includes any payment or act of forbearance in connection with supply or in response to or for the inducement of supply. ▪ A mere gift involves no consideration; ▪ Acceptance of goods in return for not suing is consideration. - s9-15(2) ( consideration does not have to be voluntary and can be provided by a third party. - s9-15(2A) ( does not matter if the payment is made under court order or settlement. - s9-15(3) ( payment of a gift to a non-profit body is not consideration.
➢ Enterprise - s9-20(1) ( an enterprise is an activity or series done: ▪ in the form of a business; or ▪ in the form of an adventure or concern in the nature of trade; or ▪ on a regular or continuous basis in the form of a lease, licence or other interest in property. - s9-20(2) ( does not include the activities of employees or private and recreational pursuits.
➢ Connected with Australia - s9-25 ( the supply is connected with Australia if: ▪ goods are delivered or made available in Aust to the recipient (s9-25(1)); or ▪ imports the goods into Australia (s9-25(3)) ▪ removes goods from Aust (s9-25(2)) ▪ installs or assembles goods in Aust (s9-25(3)) ▪ does the ‘thing’ (eg: service) in Aust (s9-25(5)); or ▪ makes the supply through an enterprise carried on in Aust (s9-25(5)). - s9-25(4) ( the supply of real property will be connected with Aust if the land is in Australia.
➢ Registered Entity - ss23-5; 23-15 ( must register for the GST if you are carrying on an enterprise and annual turnover meets the threshold of $75,000 (or $150,000 for non-profit organisations). - s144-5 ( taxi operators must register no matter what their turnover. - Enterprises must register to claim input tax credits.
2. Taxable Importations - s13-5 GSTA ( you make a taxable importation if goods are imported for home consumption. - s13-15 ( GST is payable by the importer, not the overseas supplier - s13-20 ( GST is payable on 10% of the value of the CIF (customs value + freight + insurance). - The GST is paid at the same time as customs duty and is payable regardless of whether an entity is registered (can only claim an input tax credit if registered). - s168-5 ( tourists taking goods out of Aust as accompanied baggage may be entitled to a GST refund under the Tourist Refund Scheme. - Nb: exports are generally GST-free
C. GST Exemptions
1. GST-Free Items - s38-1 GSTA ( if a supply is GST-free, no GST is payable + supplier can claim an input-tax credit
➢ Food (subdiv. 38-A) - s38-2 ( a supply of food is GST-free. - s38-4 ( food includes: ▪ food for human consumption ▪ ingredients for food ▪ beverages for human consumption (see Sched. 2) ▪ ingredients for beverages ▪ goods to be mixed with or added to food (incl: condiments, spices, seasonings, flavourings) ▪ fats and oils. - s38-4 ( food excludes: ▪ live animals (other than crustaceans and molluscs) ▪ unprocessed cow’s milk; ▪ any grain, cereal or sugar cane ▪ plants under cultivation that can be consumed without further process or treatment. - s38-3 ( food that is not GST-free includes: ▪ food for consumption on the premises it is supplied; ▪ hot take-away food ▪ food in Sched. 1 (prepared food, confectionary, savoury snacks, bakery products, ice-cream, biscuit goods) ▪ beverages not specified in Sched. 2 (ie: alcohol is not GST-free). - s38-5 ( premises = where supply takes place; surrounding grounds; any enclosed space where there is a clear boundary. - s38-6 ( the packing is GST-free if the food is GST-free provided the packaging is necessary and of a kind normally supplied.
➢ Health (subdiv. 38-B) - s38-7(1) ( the supply of medical services is GST-free ▪ s195-1 ( medical service = one for which Medicare is payable and necessary ▪ s37-7(2) ( a medical service is not GST-free if it is for cosmetic use. - s37-10 ( other health services are GST-free if: ▪ they are of a specified kind: o Abor health; o acupuncture; o audiology; o chiropody; o chiropractic; o dental; o dietary; o herbal med; o naturopathy; o nursing; o occupational therapy; o optometry; o osteopathy; o paramedical; o pharmacy; o psychology; o physio; o podiatry; o speech pathology; o speech therapy; o social work. ▪ The supplier is a recognised professional supplier of those services; and ▪ The supply is generally accepted as appropriate treatment. - s38-45 ( the supply of medical aids and appliances is GST-free if covered by Sched. 3 and is specifically designed for a person with an illness or disability - s38-47 ( the supply of other health goods will be GST-free if the Minister determines (eg: aspirin, condoms, sunscreen, community care, residential care, hospital care, special disability services)
➢ Education (subdiv. 38-C) - s38-85 ( education courses are GST-free ▪ s195 ( education course = pre-school, primary, secondary, tertiary, Masters or Doctoral, special education course, adult & community education course, English language, professional course, first aid or lifesaving course. - s38-90 ( excursions & field trips are GST-free if directly related to curriculum + not recreational - s38-95 ( course materials necessarily consumed and transformed by students are GST-free: ▪ GSTR 2001/1 ( includes course notes, workbooks and art supplies (eg: paint, sketch pads etc) ▪ s38-100 ( excludes textbooks, musical instruments, computers, calculators & sports equipment - s38-100 ( not GST-free: ▪ sale, lease or hire of goods (except course materials); ▪ supply of membership of a student organisation. - Student Accommodation: ▪ s38-105 ( supply of student accommodation is GST-free if students are undertaking a primary, secondary or special education course, and the supplier of the accomm also supplies the course; ▪ s38-105(3) ( student accomm = the right to occupy premises and if provided, the right to the supply of cleaning and maintenance, electricity, gas, heating, telephone, TV, radio etc. ▪ s38-105(4) ( supply of accomm is not GST-free to the extent that it consists of food. ▪ Nb: if don’t fall under this exemption – look at residential rent (s40-35) + food exemptions (s38-3 – ie: supplied on premises).
➢ Other Exemptions
1. Child care (subdiv 38-D)
2. Exports of goods (subdiv 38-E) ▪ s38-185 (Item 1) ( general export of goods is GST-free if exported within 60 days. ▪ s38-185 (Item 7) ( goods exported by travellers as accompanied baggage are GST-free if the provisions of the regulation are met ▪ s38-185(2) ( exported goods are not GST-free if the supplier reimports them (Items 1-6 only) ▪ s168-5 ( tourists taking goods out of Aust as accompanied baggage may be entitled to a GST refund under the Tourist Refund Scheme ▪ Reg 168-5 ( exported goods must be invoiced over $300, purchased within 30 days of export, and not be cigarettes or alcohol (unless wine tax is paid).
3. Religious (subdiv 38-F)
4. Charities (subdiv 38-G)
5. Water, sewerage and drainage (subdiv 38-I)
6. Going concerns (subdiv 38-J)
7. Passengers on international flights and domestic flights: ▪ s38-355 ( transport from the last place of departure in Aust to a destination outside Aust is GST-free. ▪ s38-355 ( transport on domestic legs of international flights will be GST-free if: o it is part of a wider arrangement for transport by air involving international travel; and o at the time of entering the contract, transport within Aust formed part of the ticket.
8. Cars for use by disabled persons (subdiv 38-P)
2. Input-Taxed Supplies - s40-1 GSTA ( for supplies that are input-taxed, no GST is payable on the supply but there is no input-tax credit entitlement. - There are 6 types of input-taxed supplies: 1. Financial supplies (s40-5) 2. Residential rent (40-35) ▪ No GST is payable on residential rent (ie: lease, hire, licence, rent on residential premises) ▪ ( landlord cannot charge tenant GST and cannot claim input tax credits for expenses. 3. Residential premises ▪ s40-65 ( sale of residential premises is not subject to GST ▪ s40-70 ( supply of residential premises by long term lease is not subject to GST 4. Precious metals (s40-100) 5. School tuckshops and canteens ▪ s40-130 ( supply of food is GST-free if it is made by a non-profit body through a shop operating on school grounds which supplies primary or secondary courses. 6. Fundraising events conducted by charities
D. GST Administration
➢ GST Calculation - s9-70 ( the amount of GST payable is 10% of the value of the taxable supply - s9-75 ( Value of taxable supply = Price [pic] ▪ where: price = monetary consideration + market value non-cash consideration. - s9-40 ( the person making the supply is liable for GST (except for imports)
➢ Input Tax Credits (s11-20) - The GST is a multi-stage and value-added tax because it is levied at each stage of production. - Each stage of production is entitled to an input tax-credit for GST paid earlier in the chain ( each stage is required to pay GST on its production, less GST paid at earlier stages - s11-1 GSTA ( you are entitled to input tax credits for creditable acquisitions. - s11-5 ( an acquisition includes something acquired solely or partly for a creditable purpose, including an acquisition of goods, services, advice or info, grant of real property etc. - s11-15(1) ( a thing is acquired for a creditable purpose if acquired in carrying on your enterprise - s11-15(2) ( a thing is not acquired for a creditable purpose if it relates to making supplies that would be input-taxed or is of a private or domestic nature.
- Example: Maxine buys perfume from a retailer for $275 (incl. GST), who had bought the perfume from a wholesaler for $165 (incl. GST), who had imported the perfume from France for $50 plus $20 customs duty on the perfume, insurance and transport ($70 total). Explain GST implications.
|1: Import/Wholesale | |2: Wholesaler → Retailer | |3: Retailer → Maxine | |
|GST Paid = 10% × $70 | $ 7 |GST Paid = 1/11 × $165 | $ 15 |GST Paid = 1/11 × $275 | $ 25 |
|Input Tax Credit | $ - |Input Tax Credit | $ 7 |Input Tax Credit | $ 15 |
|GST to ATO | $ 7 |GST to ATO | $ 8 |GST to ATO | $ 10 |
| | | | |TOTAL GST | $ 25 |
➢ Tax Periods and Timing - Generally (s27-5) ( GST-payment period is every 3 months (quarterly) - Exception (s27-10) ( you can elect to pay monthly. ▪ Must pay monthly if turnover is > $20m or business has been carried on for < 3 months or the enterprise has a history of not meeting its tax obligations. - s29-5(1) ( the GST payable on an accruals basis is attributable to: ▪ the period when consideration was received; or ▪ the period in which the invoice is issued. - s29-40(3) ( can choose to account on a cash basis if: ▪ annual turnover is less than $2M ▪ charitable institution; or ▪ the ATO considers it appropriate (s29-45)
➢ GST Offsets - s35-5 ( if GST credits > GST liabilities, then you get a refund within 14 days of lodging report - Refund/amt payable = GST credit – GST liability ▪ If positive ( refund ▪ If negative ( must pay net amount - s35-10 ( refunds usually paid into bank account
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TAX AVOIDANCE
A. General Principles
- Tax evasion = fraudulently attempting to avoid tax by breaching the law. ▪ eg – destroying records, not declaring all assessable income, claiming false deductions. - Tax avoidance = taking advantage of legal loopholes in an artificial or contrived way ▪ eg – minimising taxes in a way which is technically not illegal, but is deemed to be avoidance - Tax planning = lawful arrangement of tax affairs in a way which is not artificial or contrived ▪ Westminster principle ( person may arrange their affairs to minimise tax within the law.
B. Anti-Avoidance Part IVA
- Tax avoidance schemes may be struck down under Part IVA [ITAA 36]. - Counterbalancing principles: ▪ Westminster principle ( person may arrange their affairs to minimise tax within the law ▪ Toohey principle ( not for the Comm’r to tell the taxpayer how to arrange his business affairs ▪ Ayshire Pullman v IRC ( “no obligation on a man to arrange his legal relations to enable IR to put the largest shovel into his shores”
1. Part IVA - s177F ( the Comm’r has the discretion to cancel a tax benefit obtained under a scheme for the dominant purpose of avoiding tax.
➢ Tax Scheme - s177A ( a ‘scheme’ is widely defined to mean: ▪ (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; & ▪ (b) any scheme, plan, proposal, action, course of action or course of conduct. - The scheme must be identified: ▪ Peabody ( the individual steps of a wider scheme could comprise a separate narrower scheme if capable of standing on its own ▪ Spotless ( a scheme which is incapable of standing on its own with any practical meaning is too narrow. ▪ Hart ( identification of the scheme is critical to determining the taxpayer’s dominant purpose. The tax benefit must link to the scheme.
➢ Tax Benefit - s177C ( a tax ‘benefit’ is obtained where there is: ▪ a decrease in assessable income which would otherwise be included; ▪ an increase in deductions which would otherwise not be allowable ▪ a capital loss which would otherwise not be incurred; or ▪ a foreign tax credit which would otherwise not be allowable. - Peabody ( look at what is reasonably expected from the scheme – involves a prediction which is sufficiently reliable, more than just a possibility. - Spotless ( the court will determine what is reasonably expected by looking at the commercial reality and subjective intention of parties.
➢ Dominant Purpose of Tax Avoidance - Spotless ( the dominant, prevailing or most influential purpose must be tax avoidance. - s177D ( purpose determined by: ▪ the manner in which the scheme was entered into or carried out; ▪ the form and substance of the scheme; ▪ the timing and duration of the scheme; ▪ the results achieved; ▪ change in financial position of taxpayer; ▪ change in financial position of a person connected with the taxpayer (business, family or other); ▪ any other consequence; and ▪ the nature of any connection between the taxpayer and other person. - WD & HO Wills ( tobacco co established subsidiary Singaporean insurance co to provide insurance. No claims against the insurer meant the co was profitable. Comm’r argued purpose was tax avoidance: ▪ H: the dominant purpose was commercial. It enabled the taxpayer to obtain indemnity and allowed for more effective risk management and handling of claims - Consolidated Press Holdings ( Pt IVA applies to any person associated with the scheme ( the beneficiary need not have the purpose of tax avoidance - Hart v FCT ( where the individual steps of an overall scheme are in question, look at the dominant purpose of the smaller scheme. - Cridland ( student approached by vendor of tax scheme and became beneficiary of trust. Pursuant to the Act, student was able to average income over 5 years, despite receiving only $1 distributions. ▪ H: student was entitled to exploit this tax advantage b/c specifically allowed under Act - Nb: the benefit received does not have to match the benefit intended – the Act refers to ‘a’ benefit, not ‘the’ benefit.
2. Penalties - s177F(1), (2A) ( where a benefit is obtained in connection with a Pt IVA scheme, the Comm’r may cancel the tax benefit and include an amount as assessable income, disallow a deduction. - The taxpayer may also be subjected to: ▪ Administrative penalties (s248-C sch 1 Tax Administration Act); and ▪ Criminal penalties for defrauding the Cth (Crimes (Tax Offences) Act; Crimes Act)
C. Income Splitting
➢ Alienation of Personal Services Income - Alienation of personal services income occurs when the services of an individual are provided through an interposed entity rather than directly by the individual who performs the services - s86-10 [ITAA 97] ( individuals cannot reduce or defer their tax by alienating personal services income through companies, partnerships or trusts. ▪ ( personal services income, whether paid directly or through an interposed entity, will be treated the same way for tax purposes.
➢ Payments to Associated Persons - s26-35 ( restricts deductions for payments made to related entities (eg: spouse, relative) to those which are reasonably incurred. ▪ ( a person who employs their spouse or relative can only deduct an amount which would be reasonably paid in arm’s length circumstances for rendering those services.
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Wholesaler (importer)
- Test = you are a resident if you have actually been in Australia, continuously or intermittently, for 183 days of the income year, unless: ▪ your usual place of abode is outside Aust; and ▪ you do not intend to take up residence in Aust.
- Test = a person will be a resident of Australia if they are: ▪ a member of a superannuation scheme established by deed under the Superannuation Act 1990, ▪ an eligible employee for purposes of the Superannuation Act 1976; or ▪ a spouse or child under 16 of such
- Test = a company not incorporated in Aust will be a resident if: ▪ It carries on business in Australia; and ▪ Its voting power is controlled by shareholders who are residents of Australia.
- Test = a company not incorporated in Aust will be a resident if it: ▪ Carries on business in Australia; and ▪ Has its central management and control in Australia.
➢ TEST = to determine whether a receipt is ‘income’ it is necessary to apply the following tests:
1. The receipt must be ‘earned’ or ‘derived’ from your office or employment (Dixon’s case)
2. The receipt must be received predictably, periodically or in a recurrent manner – ie: must expect to receive the income regularly (Stone’s case). ▪ FCT v Dixon ( employer paid a worker the difference between their war-time salary and normal salary. H: income because it was regular and expected. ▪ Myer Emporium ( M made a loan to a finance co and assigned the interest to Citicorp. Citicorp returned the money to M as a capital receipt. M argued that it was a once-off, lump sum payment. H: income received in ordinary course of business and could not be separated from the assignment
3. Must be convertible into money ( if a receipt or benefit cannot be converted into money, it is not income (Tennant v Smith – rent-free accommodation not income; Cook & Sherden – free holiday). ▪ If non-cash items can be converted into money, they may be classed as income provided the consideration is received as money’s worth (s6-1; ss21 21A)
4.
- s8-1(1) ( you can deduct from your assessable income any loss or outgoing to the extent that: a) it is incurred in gaining or producing your assessable income; or b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income - s8-1(2) ( you cannot deduct a loss or outgoing to the extent that: a) it is a loss or outgoing of capital b) it is a loss or outgoing of a private or domestic nature c) it is incurred from exempt income d) a provision of the Act prevents you from deducting it.
- The courts have adopted various tests for distinguishing between income and capital. - Eisner v Macomber ( the court described capital and income as analogous (similar to) to ‘tree and fruit’ – the capital being the tree which is planted once, and income as the fruit which is regular, periodic and expected. - TEST= Replacement Principle ( if the receipt is replacing an income stream, the receipt is income. The receipt will be capital in nature if it is replacing something else (DP Smith case) ▪ DP Smith ( H: disabled worker received payment to replace income stream – H: income. - Other tests: ▪ ‘Once and for all’ test ( one-off, lump sum receipts are capital; ongoing receipts are income: o Vallambrosa Rubber – company claimed deduction for entire rubber plantation, despite only 1/7 bearing rubber. H: regular deduction which was ongoing ( income. ▪ ‘Enduring benefit’ test ( an item of long term benefit to the taxpayer will be capital in nature (British Insulated Helsby Cables) ▪ ‘Business entity’ test ( receipts which go to the core of the business and are not part of the ordinary business practices will be capital in nature (Sun Newspapers)
- TEST (Montgomery Lockhart J) ( a lease incentive payment will be income if: ▪ It was received in the ordinary course of business (Myer Emporium) ▪ It was not received in the ordinary course of business, but was received as an ordinary incident of the business (Westfield case) ▪ It was an extraordinary transaction & gain was made with a profit-motive (Myer Emporium)
➢ TEST (TR 97/11) ( the following factors are relevant to determining whether a business exists: ▪ Intention of making a profit (major factor) (Brajkovic; Radnor; Stone v CoT) ▪ Systems and organisation (Feguson) ▪ Volume and scale of the activity (Walker; Ferguson) ▪ Commercial character of transactions (Stone v CoT) ▪ Whether ordinary business principles relevant to the industry are being applied ▪ Sustained, regular and frequent transactions (Shields) ▪
Positive
Limbs
Negative
Limbs
- s6(1) [ITAA 36] ( a resident means a person who resides in Aust, and includes a person who: ▪ Has their domicile in Australia, unless they have a permanent place of abode outside Aust; or ▪ Has been in Aust, continuously or intermittently for 183 days, unless their usual place of abode is outside Australia
Retailer
Maxine (consumer)
$70
$165
$275
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