Week 1. Taxes levied by Federal government excise Taxes levied by State government stamp duty, land tax, payroll tax

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1 1 Week 1 Tax Economist: leakage of income out of economy and into public sector Dictionary: contribution in support of government Courts: A compulsory exaction of money by a public authority for public purposes enforceable by law (Matthews B The Chicory Marketing Board (Vic)) (1938) 60 CLR 263 per Latham CJ at 67 Courts: raising money for the purpose of government by means of contributions from individual persons (R V Barger) (1908) 6 CLR 41 per Griffith CJ, Barton and O Connor JJ at 68 Courts: (MacCormick V FC of T; Camad Investments Pty Ltd V CF of T) ( ) 158 CLR 622 at per Gibbs CJ, Wilson, Deane and Dawson JJ identified the following characteristics of tax o Compulsory payment o Money raised for government purposes o Exactions do not constitute payment for service rendered o Payments are not penalties o Exactions are not arbitrary o Exaction should not be incontestable Characteristics of tax (Note: same as characteristics identified in above case) Compulsory payment Raised for government purposes Exactions do not constitute payment for services Payments are not penalties Exactions are not arbitrary nor incontestable Why tax Government needs revenue to govern effectively Provide social goods - Joint consumption & non- excludability (street lights) Merit goods beneficial to user (education) Support those who free market doesn t (low cost housing) Correct free market imperfections (medicare levy surcharge, excise on tobacco and alcohol) Types of taxes categorized by collection method or how burden falls Collection method: o Direct tax levied on entity (taxpayer) on receipt of income or ownership of asset (income tax) o Indirect tax levied on transactions not people (GST) How burden falls: o Progressive tax increases as income of taxpayer increases (increasing marginal tax rates) o Regressive tax no distinguishing between taxpayers (GST) o Proportional tax flat rate (Company tax, superannuation tax) Taxes levied by Federal government excise Taxes levied by State government stamp duty, land tax, payroll tax Tax design criteria (no ideal system, criterion conflict with each other making it a balancing act) Equity fairness o Vertical equity different circumstances treated differently (higher income, higher tax rates) o Horizontal equity same circumstances treated similarly (same income, same tax rates method in which income is earned does not matter) Simplicity easily understood by taxpayers and administrators o Measured by cost to administer tax by government & cost to comply by taxpayer (fees paid, time taken, psychological cost) Certainty needs to make points clear o Who bears the tax (certainty of incidence) o How tax is assessed, easy to assess accurately (no retrospective legislation) o Extracting tax from avoiders and evaders o Prediction of revenue to be collected in particular year by government (fiscal marksmanship) Efficiency efficient when administrative and compliance costs are minimized Neutrality should not influence individual or business choice o Allow market forces to operate free of interference Flexibility tax structure and rates easily adjustable to suit changing circumstances and needs Evidence taxpayers know their tax liabilities Fiscal adequacy taxes generate enough revenue for government Political acceptability accepted by the broader community Macro level objectives mindful of how tax affects macro level objectives o Optimizing economic stability and growth o Redistribution of income o Raising employment levels o Lowering inflation Commonwealth Government responsible for formulating and introduction legislation and reforms for Australia s income tax legislation

2 2 Judiciary (Courts) responsible for deciding disputes over application and enforcement of Australia s income tax laws (courts interpret legislative provisions) Courts involved in taxation law (reverse hierarchal order): Administrative Appeals Tribunal (AAT) Federal Court (single judge) Federal Court (Full court three judges) High Court of Australia (Full court) Commissioner of Taxation responsible for administrating and ensuring compliance with Australia s taxation laws (along with ATO). Including processing tax returns, collection of tax, issuing taxation rulings on application of taxation laws and auditing taxpayers Advisors (including taxation and financial advisors) either work for independent businesses (law and accountancy firms) or are an internal division of a large business. May advise both government and non- government entities on application of taxation law Federal Treasury government department responsible for economic policy of Commonwealth Government, including revenue raising, through taxation Taxpayers individuals, businesses (sole traders, partnerships trusts or companies) who must comply with income tax laws, lodge returns and pay appropriate tax to ATO. Interest groups push for tax reforms in their own area Australian Constitution a fundamental law that underpins creation and governing of the Commonwealth of Australia. Established by Australian government Defined its structure, powers and procedures Defined the rights and obligations of states in relation to the Commonwealth Any Australian Government action (including legislative), invalid if contrary to Constitution Constitutional power can limit or extend what Commonwealth government can levy Constitution can impact state government powers to levy tax (section 90 of constitution prevents states imposing customs and excise duties) Important Constitution sections: Section 51(ii) The parliament shall, subject to this constitution have power to make laws for the peace, order and good government of the Commonwealth with respect to (ii) Taxation; but so as not to discriminate between States or part of States. Section 53 Proposed laws imposing taxation shall not originate in the Senate and the Senate may not amend a proposed taxation law. (Senate can reject it or return it to the House requesting amendment) Section 55 Laws imposing taxation shall deal only with the imposition of taxation, and any provision therein dealing with any other matter shall be of no effect o Designed to prevent tracking House of Representatives adding on provisions dealing with a controversial non- tax matter to essential tax legislation. Protects Senate from an all or nothing choice Separate rating and assessment Acts Income Tax Act 1986 imposes income tax Income Tax Rates Act 1986 sets the rate Income Tax Assessment Act Sets out criteria for liability 2 major sources of Australia s tax law Legislation o Income Tax Assessment Act 1936 (ITAA36) CGT events before 1 July 1998 (indexation) o Income Tax Assessment Act 1997 (ITAA97) CGT events after 1 July 1998 (discount) o Taxation Administration Act 1953 (TAA53) o Fringe Benefits Tax Assessment Act 1986 (FBTAA) o A New Tax System (Goods and Services Tax) Act 1999 (GST Act) o State taxing acts Queensland Duties Act 2001 (imposing stamp duty) Land Tax Act 2010 (imposing land tax) Pay- roll Tax Act 1971 (imposing tax on pay paid by employers when annual staff salary greater than threshold) Case law - Precedent and interpretive approaches are central to case law o Precedents relevant legal principles established by higher court which binds lower courts (provides certainty as to future decisions of courts, though can distinguish case or can over- rule prior cases)

3 3 ATO rulings (not law) Tax office issues taxation rulings to let taxpayers know how the Commissioner of Taxation considers the law will apply to a transaction, and provide internal guidance for tax officers (Since 1 July 1992, if ruling provides less tax payable than tax law, taxpayers can rely on ruling and pay lesser amount provides certainty) Public rulings Private rulings Class rulings Product rulings ATO Interpretative Decisions (ATOIDs) Week 2 Income tax payable = [taxable income * tax rate] offsets (S.4-10 (3) ITAA97) Taxable income = assessable income deductions (S.4-15(1) ITAA97) Assessable income = ordinary income+ statutory income (S. 6-1(1) ITAA97) Effectively, income tax payable = {[(ordinary income + statutory income) deductions] * tax rates} offsets Income not defined under ITAA36 or ITAA97 ordinary meaning as interpreted by case law (Jordan CJ Scott V C of T (NSW) (1935) 215) The word income is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts. No single rule determining if particular receipt is income according to ordinary concepts. Courts have defined may test, but no single test that answers every problem Key characteristics developed by courts to identify income Income actually comes in (includes identifiable amounts accrued by taxpayer, depending if taxpayer is on accruals or cash basis) Income receipts recurrent or periodic in nature Receipts falling in traditionally recognized categories (rent, interest, wages, dividend, etc). Certain receipts not usually income unless they re proceeds of employment of business (gambling, lottery winnings, gifts and bequests) Income is either money or something that can be converted into money Income does not need to be physically received Taxpayer cannot receive income from him/herself (mutuality principle) Character of receipt in hands of recipient is of primary importance When receipt replaces revenue lost, it is income, where it replaces capital loss, it is capital Ordinary income needs sufficient nexus with an earning activity Compensation payments take same character as amount that it replaces o Compensation for loss of earnings or other income flows will be generally characterized as ordinary income o Compensation for loss, surrender or substantial impairment of a capital asset will generally be characterized as capital o Lump sum damages for personal injury are not assessable but under (Whittaker V Federal Commissioner of Taxation (1998) 153 ALR 334), the post- judgment component of interest is assessable income for the year it is received Illegal or immoral receipts may be ordinary income Capital gains are not ordinary income they are statutory income A gain, which is a mere gift, does not have the character of income Mere windfall gain does not have character of income Gain derived from property has the character of income Gain, which is a reward of service rendered or to be rendered, has the character of income Gain that arises from an act done in carrying on a business or from the carrying out of an isolated business venture has character of income Gain which is a compensation for an item that would have had the character of income had it been derived, or for an item that has the character of a cost deriving income, has itself the character of income Generally, there must be some gain to the taxpayer Mixed amounts that cannot be dissected have the character of capital Who pays income tax (S.4-1) Tax payable (S.4-10) Formula (S.4-10 (3)) How to work out taxable income (S.4-15) Total assessable income (Div 6) Allowable deductions (Div 8) Ordinary income (S.6-5) Statutory income (S.6-10, Div 10)] General deductions (S.8-1) Specific deductions (S.8-5, Div 12) Exempt income and non assessable non exempt income (Div 11)

4 4 Statutory income amount specifically included by particular provisions of ITAAs (included in taxpayer s assessable income according to S.6-10 ITAA97) Capital gains included under assessable income under S.102-5(1) ITAA97 If amount is not ordinary or statutory income, then it isn t assessable income (S.6-15 (1) ITAA97). If it s both, statutory provision prevails unless contrary intention stated (S.6-25 (2)) Exempt income Ordinary income may be exempt by virtue of specific section (S.6-20 ITAA97) Non- assessable non- exempt income amount may be ordinary income, but specific section modifies how it is treated, rendering amount non- assessable and non- exempt (S.6-23 ITAA97) Tax rates rates vary according to nature of taxpayer (individual, company, superfund). It s contained in Income Tax Rates Act 1986 Offsets rebates and credits available to taxpayers. (deducted from tax payable making it more valuable than deductions). Some offsets indexed annually in line with CPI but decrease in CPI cannot cause offset to fall (dependent rebate, housekeeper rebate) Relevant cases to principles developed by courts FC of T V Cooke and Sherden 80 ATC 4140 Income and capital have different tax treatments Capital gains taxed at concessional rate and some capital gains are exempt from tax altogether (CGT does not apply to assets acquired before 20 Sep 85) Income taxed at marginal rates Determining income or capital Receipt regular or periodic (some one off receipts may be ordinary income) Is receipt convertible to money (more likely to be income, more important before FBT legislation) Natural incident of business activities Intention to make a gain test used if isolated amount passes the natural incident of business activities test Character of receipt is based on the perspective of recipient, not payer (per Bowen J in FC of T V Federal Coke Co) Broad sense income is flow from or product of capital (including human capital Determine whether receipt has a sufficient nexus with an earning activity Determining whether receipt is assessable as ordinary income Terminology used in S.6-5 ITAA 97 o Assessable income includes income according to ordinary concepts which is called ordinary income (S.6-5 (1)) o Australian Residents - Your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia during the income year (S.6-5 (2)) o Foreign residents Your assessable income includes the ordinary income you derived directly or indirectly from all Australian sources during the income year (S.6-5 (3)) Potential problems with S.6-5 o Taxpayer resident or foreign resident of Australia (might be for incoming or departing people) o Is it ordinary income o Year in which income was derived (Accrual of cash basis) o Source of income o GST Is money received a kind of ordinary income Step 1: legislative definition of ordinary income ( income according to ordinary concepts S.6-5) Step 2: Consider o Common law characteristics of ordinary income (Scott V Commissioner of Taxation 1935) ordinary concepts and usages of mankind o Whether receipt fits under any ordinary income categories Ordinary income categories Personal exertion (Defined in S.6-1 ITAA36) basically anything given in relation to services rendered (earnings, salaries, wages, commissions, fees, bonuses, pensions, super allowances, retiring allowances, etc). o Interest is not ordinary income, unless principal business consist of lending money or interest received on goods supplied in the course of business (interest on accounts payable) o Rent or dividends is not ordinary income o Determining factors of personal income Link between amount and earning activity Product or incident of employment or reward for services rendered Amount could be for past or future services or one- off service May be paid by third party Convertible to cash

5 5 Property income from property or income derived from property means all income not being income from personal exertion (S.6 (1) ITAA36) or (income received from use of enjoyment of property or assets by some other person) o Income not capital o Comes from property itself, not taxpayer s service (receipt from property generated without active labour or business input by owner) Dividends (S.44 ITAA36) included in assessable income of shareholder, but must fall under definition of dividend in S.6 (1) ITAA36 Interest (assessable income under S.6-5 (1) ITAA97 as ordinary income) payment made for use of lender s money (periodic payment made by borrower to lender in respect of a loan) (S.6-5 (4) ITAA97) Constructive receipt provision income taken to be derived as soon as it is applied or dealt with on any way on taxpayer s behalf as directed. (Rolling over interest from a term deposit to be reinvested without ever receiving the interest) Prejudgment interest exempt under S ITAA97. o Personal injury case where prejudgment interest held as capital, but post- judgment interest as income (Whittaker V FC of T (1998) 98 ATC 4285) Annuities future income stream purchased with lump sum today Capital portion of each annuity payment excluded from assessable income with only remainder (interest component) assessable Rent (assessable as ordinary income under S.6-5 ITAA97) property (land, house, machine, car, equipment) leased by lessor to lessee (price paid for right to use property is rent) Always income from property unless taxpayer carries on rental property business rent premiums usually lump sum can be regarded as either income/capital depending on terms Royalties (definition under S.6 (1) ITAA36) amount paid for use or exploitation of another person s tangible or intangible property (should be distinguished from payment for services) Copyright payments Payments for minerals mined on a person s property o Not be income from personal exertion Business - courts have distinguished between fixed and circulating assets o Fixed assets profit yielding structure of business such as the machinery used to produce goods which are capital nature o Circulating assets assets that business parts with to create profits in the nature of income such as the goods produced and sold o Note*** Nature of business activity asset is held determines whether it is fixed or circulating (not nature of asset) Personal services remuneration S.6 (1) Gratuities/voluntary payments o Linked to services performed it is ordinary income (not gratuitous, but a reward for service - tips) Former employer makes up difference between military pay and wage that former employee had received. Payments expected and periodic (FC of T V (1952) 86 CLR 540) Best and fairest award from television station was a clearly recognized incident of recipient s employment as professional footballer (Kelly V FC of T (1985) 85 ATC 4283) Brown was an intermediary between seller of several parcels of land to a purchaser. Received a unit and associated benefits valued around $1m for services rendered (Brown V FC of T (2002) ATC 4273) Professional cricketer entitled under terms of his contract of employment to collections from spectators whenever he performed outstanding cricketing feats. Collections held as income from personal exertion (Moorhouse V Dooland (1955) 1 All ER 93) o Gifts not linked to services performed are held to be gratuities (not assessable as ordinary income) Presents (wedding gifts) Shares paid by previous employer (after relationship ended) in appreciation of past performance and assistance. Factors: during time as employee, was adequately remunerated and giving the shares in the capacity of friends (Hayes V FCT (1956) CLR 47) Monetary gift from widow to solicitor in appreciation of past services Factor: solicitor has already been adequately remunerated for services (Scott V FCT (1966) CLR 514) (Moore V Griffiths (1972) All ER 399) - $1,000 by English Football Association to players in successful England World Cup soccer squad of 1966 held as gift as it was made after player s service agreements with Association had been terminated (unexpected one- off payment made in nature of personal tribute and applause for victory) Would be assessable in Australia following High Court decision in Stone V FCT case)

6 6 Allowances (uniform, travel) allowance in relation to employment and services assessable under statutory provision (S.15-2 ITAA97) o Allowance predetermined amount to cover estimated expenses, paid regardless of whether expense was incurred (Taxation Ruling TR92/15) Termination Payments retiring allowances and retiring gratuities (are for past services and hence ordinary income, although might have concessional tax treatment) Employee share schemes employer allots shares at discount market price (value of discount is statutory income and assessable to employees, a few tax concessions available when strict conditions met) Giving up valuable rights not income from personal exertion o Football player gives up amateur status which is an asset given up indefinitely (Jarrold V Boustead (1964) 41 TC 701) o Signing on fee would be normal incident of employment for professional player (Case R ATC 717) Restrictive covenants agreement not to do something o Employee given lump sum payment for restrictive covenant, lump sum is capital in nature. Details of restrictive covenant needs to be closely looked at to ensure that it is indeed one (Taxation Ruling TR 95/3) o Lump sums held as capital nature and therefore not assessed (Beak V Robson (1943) AC 352; Higgs V Olivier (1951) Ch 899) o Nexus test allows gain to be taxed as ordinary income when either of the following: Restriction to operate during currency of existing employment or its really only payment in advance for services rendered (Riley V Coglan) Covenant is normal incident of particular employment (Case A14 69 ATC 80) In reality, no significant restriction on recipient s freedom of activity (Case A14 69 ATC 80) Fringe Benefits (Cars, loans, private expenses, etc paid by employer) FB legislation catches most non- cash benefits made available to employees and their associates (non- cash benefits not generally ordinary income) o Employer liable for FBT, but FB is not assessable income to employee under (S.23L ITAA36) Reimbursement of car expenses o Exempt car expense payment fringe benefit under S.22 FBTAA o Exempt car expense payment is treated as assessable income under S ITAA97 when reimbursement calculated by reference to distance travelled by car o Any related expenses deductible under S ITAA97 Frequent flyer points o Employee has frequent flyer agreement with airline. Employer pays for airline travel as necessary for work. Points received not assessable as they came from personal contractual relationship that was not linked to employment. (Payne V FCT (1996) 96 ATC 4407) Compensation for personal injury o Held as capital as it compensation for loss of profit making structure. (Capital gains is disregarded from CGT event if it relates to compensation taxpayer receives for any wrong taxpayer suffers personally or in occupation S ITAA97) o If compensation is made for loss of profits, it constitutes assessable income S.6-5 (1). o If compensation is made for temporary disablement of an income producing asset, will be treated as revenue in nature as it is designed to compensate for profit loss o Stress management consultant s compensation held assessable. Lump sum received from insurance (Sommer V FCT (2002) ATC 4815) Assigning rights to receive property income Loan agreement can be separated into interest payments and principal repayments. Rights may be sold or assigned to third parties for their commercial value (present value of stream of payments or single deferred payment) Full amount of consideration paid for right is assessable income to the transferor (even if full consideration has yet to be received). Applies for all property, real or personal Legitimate traders in income streams are only required to recognize net gain or loss resulting from assignment of right to receive income GST payable by business entities registered for GST purposes is neither assessable income nor exempt income, unless it is a decreasing adjustment pursuant to Division 129 or 132 of GST Act Assessable Principle of law Case law Non-assessable Principle of law Case Law Connected to employment or services rendered (1952) Kelly (1985) Receipts cannot be linked to services performed. (It must be relate to a particular year of income.) Hayes (1956) Scott (1966) Motive of donor commercial consideration Moorhouse & Dooland Motive of donor personal relationship Scott (1966)

7 7 Reasonable expectation that payment would be made Dependent on payment to meet living expenses. Periodic, regular and recurrent. Money or convertible into money. Compensation for loss of salary i.e. compensation is regarded as of the same nature as the payment which they replace. That is, if replacing salary, then it is salary. Professional sportspersons receiving best and fairest payments, or other match collections, or sign on fees in changing clubs. Allowances for travel or uniform. Allowances included in the above definition and assessable under the specific provision. Termination payment received by employees including retiring allowances and retiring gratuities. Phillips (1936) Refer to definition of income from personal exertion, and s 15-2 ITAA97 s 6(1) definition of income from personal exertion Entering into a restrictive covenant, as a reward for not working. Frequent Flyer points no employee employment relationship. Holiday incentive non convertible into cash. Was not ordinary income, but is now caught under a statutory provision. Compensation for inability to work due to injury Compensation for going out of business, or from continuing employment. Sign on fees for amateur sportsperson becoming profession. Giving up valuable rights Reimbursement for expenses incurred by taxpayer by employer. This is not a reward for services rendered. Except if an exempt car expense payment fringe benefit under s 22 FBTAA: see s ITAA97 Hepples (1991) Payne (1996) Cooke and Sherden (1980) s 21A ITAA1936 s ITAA97 Scott v C of T (NSW) 1935 Jarrold v Boustead (1963) Rowe (1997) Termination payments Wrongful dismissal is not ordinary income s 15-2(2) Fringe benefits received by employee: cars, loans, private expenses, including salary sacrifice paid by employer, are subject to fringe benefits tax and exempt from income tax and not included in assessable income. s 23L ITAA 1936