LAWS5144 Introduction to Taxation Law

Transcription

1 LAWS5144 Introduction to Taxation Law Final Exam Notes Semester 1, 2009 Alexander Psaltis Dated: 12 June 2009

2 Table of contents Taxation law overview General introduction Aspects of tax Introduction Tax policy The nature of taxation Defining tax Complications Types of taxation within Australia Direct taxes Indirect taxes Tax as a social process How a tax system works? Incidence of Taxation Types of tax systems How this works in Australia Functions and objects of taxation Criteria for evaluating a tax system Australia s tax system Federal power to make taxation laws The power to tax Limitations on the Commonwealth power Sources of Australian Taxation law Statute law Common law The Australian Tax Office History of Australian taxation law General overview of tax Income tax basics The tax formula The core provisions The core provisions explained Ordinary income Statutory and non-assessable income Income tax accounting Capital gains tax General deductions Specific deductions LAWS5144 Combined notes 2

3 Capital allowances and car expenses Tax offsets Tax payable Residence and source Introductory principles for calculating taxable income Introduction Section 4-10(3) Section 4-15(1) The nature of income Defining assessable income Types of income Ordinary income s The provision Commentary Statutory income s 6-10 ITAA The provision What is not assessable income s 6-15 ITAA The provision Commentary Exempt income s The provision Commentary Non-assessable non-exempt income s The provision Commentary Relationships amongst various rules about ordinary income s The provision Commentary Tying this into residence and source Residence Residence requirements generally Introduction Foreign residents Temporary Resident (from 01 July 2006) Introductory matters to residence Residence of individuals Residence defined s 6(1) ITAA The ordinary concepts test The domicile test s 6(1) ITAA The 183 day test The superannuation test LAWS5144 Combined notes 3

4 Residence of companies Introduction Incorporated in Australia Carries on business in Australia with central management and control in Australia Carries on business in Australia with voting power controlled by Australian residents Source Introduction General principles Where these rules come from Specific sources Sale of goods Source of services Source of interest Source of dividends Source of royalties Income Income according to ordinary concepts Introduction General principles Characteristics of income Specific instances of income according to ordinary concepts Income as a Flow Income must be a product of labour and/or property Reward for services rendered Gains (in the Eisen sense) must be realised Income must come in to the taxpayer There must be a gain Cash or convertible to cash NB this has been modified by s 21A (see below) Periodical gains have the character of income Disposal of capital asset versus an income stream Gratuitous payments Receipts from Illegal Activities Income from personal services Introduction Receipts related directly to employment or services (Deane) Receipts unrelated to employment or services Reward schemes Reward for services or capital? Prizes Categories of income from labour Business income LAWS5144 Combined notes 4

5 Introduction Common law Statutory expansion 3 fold Identifying a business How is a business identified? Has the business commenced? Indicators of a business Introduction System and organisation Scale of activities Sustained, regular and frequent transactions Profit motive see TR 97/ Commercial character of transactions Characteristics or quantities of property dealt in Other factors Example Farming business/passive investment Turning talent to account for profit Taxation of income from business Introduction Receipts received in the ordinary course of business Business income from certain transactions Business income from isolated transactions Business income from extraordinary transactions Lease incentives application of the Myer principle Statutory income Allowances in relation to employment and services s 15-2 ITAA Introduction s 15-2 conditions There must be a benefit etc Provided to the Taxpayer Nexus with employment or services rendered s 15-2 examples Non-cash business benefits s 21A ITAA Introduction Application Other types of income Compensation payments General principles Distinguishing income from capital Compensation categories Statutory provisions LAWS5144 Combined notes 5

6 Application of CGT on compensation payments generally Interest as Income Discounted securities and Div 16E securities Introduction Reason for the introduction of Div 16E Income from real property Introduction Negative gearing Dividend imputation The classical system Statutory dividend imputation system s ITAA Franking credits in practice Franking Credit Formula Shareholder level (shareholder in 45% bracket) Shareholder level (shareholder in 30% bracket) Shareholder level (shareholder in 15% bracket) Dividend advices Non-assessable income Non-assessable income generally s 6-15 ITAA Exempt income Category One Exempt entities Div 50 ITAA Category Two Exempt income Div 51 ITAA Category three see the legislation Interest on judgment debt Introduction Structured settlement payments Consequences of an amount being exempt income Non assessable non exempt income General principle Examples Capital gains tax (CGT) CGT as a process The 3 steps of CGT Step 1 have you made a capital gain or loss? Introduction Step 1 can be broken up into 4 questions Question 1 What attracts CGT? Introduction categories of CGT events Event A1 Disposal of a CGT asset Event B1 Use and enjoyment before title passes LAWS5144 Combined notes 6

7 Event C1 the end (loss or destruction) of a CGT asset Event C2 the end (cancellation, surrender or similar) of an intangible asset Event C3 the end of an option to acquire shares Event D1 the bringing into existence of a contractual (or other) right in another entity Event D2 the granting of an option Events D3 and D4 specific events Events E1 E9 events relating to trusts Events F1 F5 events dealing with leases Event F4 lessee receives payment for changing a lease Event F5 lessor receives payment for changing lease Events G1 G3 events dealing with shares Event G3 liquidator declares shares worthless Events H1 H2 special capital receipts Events I1 I2 ending of Australian residency Events J1 J4 reversal of rollovers Events K1 K2 other CGT events Events L1 L8 consolidated groups Question 2 What is a CGT asset? Introduction General principles Collectables Personal use assets Separate CGT assets Timing of acquisition of the assets Question 3 does an exception (Div 104) or exemption apply (Div 118)? General principles Exempt assets Exempt or loss denying transactions Anti-overlap provisions Small business relief Main residence exemption Question 4 Can there be a roll-over? Step 2 work out the amount of the capital gain or loss Introduction Step 2 can be broken down into 3 questions Question 1 what is a capital gain or loss? Question 2 what factors come into calculating a capital gain or loss? Question 3 how to calculate the gain or loss for most CGT events? Introduction Calculation 1 capital proceeds Calculation 2 cost base LAWS5144 Combined notes 7

8 Calculation 5 reduced cost base Step 3 work out your net capital gain or loss for the year Introduction Step 3 can be broken down into 2 questions Question 1 How do you work out your net capital gain or loss? Introduction Calculation 1 gains and losses for the income year Calculation 2 use previous years capital losses Calculation 3 discount percentage Calculation 4 small business concessions Calculation 5 determining the capital gains step process for net capital losses see s Question 2 How do you comply with CGT? Deductions Introduction General principles Key points The nature of deductions Substantiation: Div General deductions Introduction Limbs Positive limbs Introduction Common elements Gaining or producing your assessable income Nexus test Necessarily incurred in carrying on a business Involuntary Expenses Connection with income earning activities Temporal connection Characterising losses and outgoings Grossly excessive expenditure (TR 2006/3) Negative limbs Introduction Loss or outgoing of capital, or capital in nature Private or domestic in nature Incurred in relation to gaining or producing exempt income Where another provision in the ITAA prevents the TP from a deduction Apportionment: To the extent that Common general deduction types LAWS5144 Combined notes 8

9 Introduction Expenses incurred in gaining employment Relocation Expenses Child care expenses Travel Expenses Self-education expenses Home office expenses Clothing Expenses Interest expense Legal Expenses General principles Specific Deductions Introduction Tax related expenses Repairs Introduction What is a repair? Essential attributes Notional repairs Non-deductible repairs Additions Improvements Example Example Example Initial Repairs Example Combination of repairs and non-deductible renovations Payment for lease obligation to repair Repairs to assets used only partly for income-producing purposes Bad debts Requirements Payments to Associations Travel between work places Borrowing expenses Losses by theft Car expenses Introduction Available methods Cents per kilometre - Div 28-C % of original value - Div 28-D LAWS5144 Combined notes 9

10 1/3 of actual expenses - Div 28-E Log book method - Div 28-G Substantiation rules for car expenses Extent of substantiation required Gifts Prior year losses Principles Example Capital Allowances Key Points Introduction Expenditure on depreciating assets Deductions for depreciating assets Deducting amounts for depreciating assets taxable purpose Circumstances in which Div 40 has no application What is a depreciating asset? Holding a depreciating asset Deduction for decline in value Diminishing value method where asset is first held on or after 10 May Diminishing value method where asset is first held pre-10 May Prime cost Base value Asset s cost Effective Life Exceptions Immediate deduction for low-cost assets Low value pools Decline in value of a low-value pool Car Depreciation Limit Balancing Adjustments General principles Amount of Balancing Adjustment Black hole expenditure Capital works Tax accounting and trading stock Introduction Period and timing issues The tax period Timing of income Introduction LAWS5144 Combined notes 10

11 Salary and wages, interest, and rent Income from professional practices Income from business Pre-paid income Deemed derivation Examples Timing of deductions Introduction TR 97/7 - Summary Prepaid Expenses Trading stock Division General principles What this division is about? key features of tax accounting for trading stock What is trading stock? The taxpayer s purpose Division 70 & tax accounting When is a deduction available? Valuation of trading stock Transactions outside the ordinary course of business Extraordinary disposals Starting to hold as trading stock an item already owned Ceasing to hold an item as trading stock Private use example Gift example Tax offsets, tax payable and tax administration Tax payable General principles The formula Tax payable Tax rates PAYG pay as you go Help debt Medicare levy General principles Example of the base case Relief for Low Income Earners High income earners Medicare levy surcharge Tax offsets General principles What is a tax offset? LAWS5144 Combined notes 11

12 3 Types of Offsets General principles for offsets Common offsets Introduction Dependant rebates Entrepreneurs tax offset Low income earners rebate Medical expenses rebate Private health insurance tax offset Zone Rebate Overseas Defence Force Rebate Dividend imputation The classical system Statutory dividend imputation system s ITAA Franking credits in practice Franking Credit Formula Shareholder level (shareholder in 45% bracket) Shareholder level (shareholder in 30% bracket) Shareholder level (shareholder in 15% bracket) Dividend advices Self-assessment LAWS5144 Combined notes 12

13 Topic 1 Taxation law overview 1 General introduction Aspects of tax Introduction 1.1 This course is not about tax in terms of employees, it is generally about business taxation (e.g. small business taxation) once these concepts are understood, the taxation of partnerships, companies and trusts are readily understandable. 1.2 Tax is not all about number crunching, the way we think about tax can be divided into 3 categories which involve economists, lawyers (of all sorts), financiers, accountants etc who all deal with tax: Tax Policy what is the policy behind a particular tax rule? (i) Kerrie uses the example of the ATO fact sheet for People in the Adult Industry : (A) (B) e.g. whether or not to tax under the ATO ruling they are treated as sole traders, (ii) (iii) (iv) This is up to Treasury not the ATO i.e. the tax law is made by treasury (full of lawyers and economists, writing tax policy); ATO is an administering body, they do not make the tax laws; This is how you make tax make sense, by going to the fundamental rule/policy behind the provisions. Tax Technical taxed on income earned and then allowed a deduction on work related expenses (i) e.g. with the adult industry, could get deduction for pole dancing lessons but not gym membership Tax Compliance the need to have an ABN, file tax returns etc. (i) (ii) e.g. in the adult industry, you are required to have an ABN and if earn over a certain amount must register and charge for GST and must keep records and file tax returns etc this part of tax is not a comment on how many will apply, rather what should happen. 1.3 Cases have application to tax when you least expect it e.g. Whittaker final award of damages (with interest), ATO wanted their share (of her damages), she argued her interest was not assessable. LAWS5144 Combined notes 13

14 Tax policy 1.4 How much tax should be collected? 1.5 Who pays tax? 1.6 TB: table as to who pays (i.e. super funds, companies, individuals, trustees, partnership, mutual insurance association, etc). See 9-1 ITAA 97 The nature of taxation Defining tax 1.7 Definitions suggest it is about revenue raising (and that is exactly what it should be): Tax is a contribution levied on persons, property or business in the support of government ; a compulsory exaction of money by a public authority for public purposes enforceable by law ; and The process of raising money for the purposes of government by means of contributions from individual persons. These definitions suggest that tax is about revenue raising which is what it should be. Complications 1.8 However, the system (in Australia) is a lot more complicated than just revenue raising, divide into 2 parts: Revenue raising i.e. amount earned and tax on that etc; and Policy reasons social policy and economic policy: (i) (ii) e.g. currently complying super funds get a concessionary tax rate (15%) c.f. normal rate (30%) this has nothing to with revenue raising, it is rather, a social and economic policy to encourage saving in super for retirement; e.g. similarly, co s who invest in R&D and venture capital get larger concessions and deductions. 1.9 Therefore, think about why a provision is there and examine what its function is e.g. deductions on donations to charities to encourage us to do that v higher taxes on cigarettes etc. Types of taxation within Australia Direct taxes LAWS5144 Combined notes 14

15 Examples of direct taxes Income Taxes: personal income tax (sliding scale above), company tax (30%), poll taxes (Aus doesn t have), CGT (but somewhat of a misnomer as capital gains are included under assessable income and is therefore not really a separate tax), gift duty (Aus doesn t have), inheritance taxes (Aus doesn t have) Property Taxes: death duty (Aus doesn t have), wealth tax (Aus doesn t have) FBT is in separate legislation 1.10 CGT is not actually a separate tax (and is actually included in the ITAA) our net capital gain gets included in our income: it should not be put in with GST or FBT (paid by the employer not the employee); i.e. these are separate taxes, contained in separate pieces of legislation. Indirect taxes Examples of indirect taxes Sales Taxes: sales tax (Aus removed when GST introduced in 2000), GST (aka VAT) (10%), turnover tax (Aus doesn t have), purchase tax (GST), expenditure tax (GST), stamp duties (some have been abolished e.g. shares, and all were meant to be as part of GST), customs & excise, profits from Government industries Factor Taxes: pay-roll tax, land tax (a change from unimproved value to improved value for basis of investment recently as a result of a Court decision will probably discourage investment in Qld land), real estate tax 1.11 Stamp duties were supposed to be abolished with the introduction of GST, but these are still there. LAWS5144 Combined notes 15

16 Tax as a social process 1.12 What affects the tax system? political changes clear when a change of govt there will be tax changes e.g. Henry Review root and branch review (probably will change company tax (30% rate and imputation credits); economic changes a recession will obviously create changes Kerrie thinks it will be interesting to see what will happen in the May Budget there may be changes there (e.g. more stimulus packages); social factors this includes views such as encouraging certain behaviours over others e.g. super encouragement, alcopops tax (did it honestly have anything to do with revenue raising?) there are over 300 socially motivated taxes. 2 How a tax system works? Incidence of Taxation Types of tax systems 2.1 This is how does it work in terms of collecting money from us? i.e. what makes the system works? 2.2 Tax may be either: Regressive i.e. takes a decreasing proportion of income as income arises (e.g. takes $1 from everyone therefore it takes less of income as you earn more ($1/$10 is 10%, $1/$100 is 1% etc); Proportional i.e. takes the same portion no matter what we earn (i.e. 10% applied across the board, etc but a higher earner will have a higher amount in their pocket); and Progressive i.e. an increasing proportion of tax is paid as your income increases this is our system with tax brackets etc (e.g. $180,000 = 45% tax (on amounts over $180,000 etc). How this works in Australia 2.3 In Australia we have a progressive system; therefore, we have Marginal rates of tax and average rates of tax: Marginal rate of tax is the bracket in which you fit into (e.g. over $180,000 you pay 45c in every dollar you earn; Average rate of tax tax liability as a % of your taxable income this will always be lower than your marginal tax i.e. it changes after $180,000 for the top bracket always get the benefit of the lower marginal rate on the first part of you income: (i) you will only be paying 45% for amounts over $180,000; (ii) you will pay nothing on your first $6,000; and (iii) you will then pay increasing percentages above that until you hit $180,000. LAWS5144 Combined notes 16

17 2.4 Medicare levy = 1.5% but exemption for low-income earners (+ Medicare Levy Surcharge). See Div 785 ITAA Financial impact of a tax! i.e. who actually bears the burden of paying the tax: Formal (nominal) incidence: X is nominated as the taxpayer; Effective (actual) incidence: X shifts the impact of the tax forwards or backwards to Y, the effective incidence falls with Y; E.g. manufacturer may be the nominal taxpayer but may be able to shift the effective incidence of the tax forward on to consumers OR employees shifting an income tax backward on to employers by demanding higher wages Functions and objects of taxation 2.6 Tax was originally to generate revenue for State based projects (i.e. to allow the government to govern; now this is broader): Enables the government to provide: (i) social goods i.e. joint/non rival consumption, e.g. street lighting something we can all enjoy; and (ii) merit goods i.e. deemed beneficial to the user and must meet criteria, e.g. schools (7 year olds entitled to free education but 4 year olds not) and health-system (you have to be sick to actually use it), Supports those for whom a free market would not otherwise provide social security, unemployment benefits, pensions, low-cost housing, the $900 handout from KRudd etc (these are examples of our taxpayer money going to this); and Corrects other free market imperfections subsidies, e.g. farming subsidies, flood effected subsidies etc. Criteria for evaluating a tax system 2.7 There are various criteria for evaluating a tax system and these date back to Adam Smith who came up with the first criteria, and they alter over time. The Ralph Committee talked about: Equity, Simplicity and Certainty. 2.8 Fairness or equity: Horizontal taxpayers earning the same amount, pay the same amount of tax (in an ideal system, but does not happen due to concessions etc); and Vertical in our system, the more you earn, the more you should pay, but it is a question of how much more and what is appropriate (c.f. a regressive system or a proportional system see above). 2.9 Simplicity we all want it to be simple i.e. in order to reduce compliance costs etc, we have tried to make it simpler: e.g. E-Tax which automatically uploads information; also want simplicity in the legislation itself this has not been achieved in Australia (ITAA 1936 and ITAA was meant to be re-written and replaced with LAWS5144 Combined notes 17

18 1997, but then, this stoped and we now have 2 acts in looking for a section 1997 has in between sections e.g Certainty we want certainty of: (d) incidents (who has to actually pay); liability (easy to work out and how much to pay); avoidance (how much is being avoided, and govt trying to overcome this; and fiscal marksmanship or budgeting (how much is the govt getting so they can budget accordingly) Efficiency or neutrality any decisions (business, consumption etc) should be tax neutral: Therefore, should make decisions without having to consider how much tax will be paid as a result of the decision; but this is not the case (there will always be examples where this doesn t occur) Flexibility i.e. ability to adapt to current circumstances (e.g. hardship provisions victims of the Victorian Bushfires where there is a link built into the ATO website to discuss exemptions etc). 3 Australia s tax system Federal power to make taxation laws The power to tax 3.1 s 51(ii) of the Constitution - The Commonwealth Parliament shall have power to make laws with respect to taxation, but not so as to discriminate between States or parts of States : this is a concurrent power, but States cannot charge an income tax as this power has been ceded to the Commonwealth; the GST was going to be a problem for States, as such, they now get certain percentages (but that caused problems w/ NSW complaining) Limitations on the Commonwealth power 3.2 s 55 of the Constitution: taxation laws shall deal only with the imposition of taxation: i.e. cannot tie tax laws to other laws; 3.3 s 99 of the Constitution: the Commonwealth may not give preference to any one state i.e. can t discriminate between States and parts of States; 3.4 s 114 of the Constitution: the Commonwealth cannot impose tax on property belonging to a state; and 3.5 s 53 of the Constitution: proposed laws imposing taxation shall not originate in the Senate (must originate in House of Representatives) and the Senate cannot amend tax laws, only suggest amendments which the House of Representatives must actually amend. LAWS5144 Combined notes 18

19 Sources of Australian Taxation law Statute law 3.6 There are the two key acts, but this also includes attached regulations: Income Tax Assessment Act 1936; Income Tax Assessment Act 1997; (i) (ii) Both contain definition provisions e.g ; and See section 1-3 ITAA97: where different words are used Common law 3.7 The common law has been quite prolific in terms of tax law. Creation of law to fill a legislative vacuum i.e. where policy is lacking; and Statutory interpretation this is where tax decisions usually fall (e.g. s 6-5 ITAA97 says you are assessed on income according to ordinary concepts courts have interpreted this, because it is not defined in the ITAA97). The Australian Tax Office 3.8 The practice of the ATO can make tax determinations etc. 3.9 It is not entirely accurate to say the ATO makes law, as the ATO does not make the law, but they put out various quasi-legal documents: Rulings (TR) these are the ATO s views on how the law applies: (i) (ii) (iii) (iv) usually based on cases e.g. gives the ATO explanation of cases; are binding on the ATO to the extent that if a tax-payers situation fits within the ruling and the tax-payer relies on the ruling the ATO must follow the ruling; but are not binding on the tax-payer obviously though, ATO may take you to court over it these may sometimes be wrong (e.g. their interpretation of a case); They are a pretty good source of information and give useful examples, There are also determinations, etc. History of Australian taxation law 3.10 Pre-World War II Customs and Excise duties 1915 Commonwealth Income Tax 3.11 The 1960 s LAWS5144 Combined notes 19

20 Need for reform; and System was in dire-straits s-1980 s The era of tax avoidance greed is good; Everyone did everything they could do avoid tax the Bottom of the Harbour Schemes Labor Government reforms (Hawke and Keating) CGT (1985) remember this is really not a separate tax ; and FBT (1986) Liberal Government reforms (Howard and Costello) GST (2000); and the Ralph Business reforms (partially dealt with selling the GST) 3.15 Rudd Labor Government 2008 Henry Review, it will be interesting to see where this will lead. 4 General overview of tax Income tax basics The tax formula 4.1 The tax formula s 4-1 ITAA97 (starting point) remember this formula: Income tax Payable = Taxable Income x Tax rate Tax offsets Where Taxable Income = Assessable income deductions 4.2 Attempts to get to an income tax payable: (d) (e) Accessible income 5-6 weeks of the course CGT comes in here; When you get lost in the course, come back to the formula and work out which part we re looking at; This formula will help make the course make sense; s 4-1 ITAA97 is the starting point for the calculation of tax; and See also the pyramid which Kerrie does not think is particularly useful s 2-5 ITAA97 contains the pyramid (and this was put in to show how the act should work). LAWS5144 Combined notes 20

21 The core provisions 4.3 See below for an illustration of how the core provisions operate. The Tax Pyramid NB the international aspects of income taxation will not be dealt with in this course, we are concerned with the core provisions. The core provisions explained Ordinary income 4.4 This is always the starting point in our analysis of income tax. 4.5 We will identify the amount of income (c.f. capital) which are assessable s Div 6 of the ITAA97 deals with income and is divided into various categories (e.g. statutory and non-assessable income as well). 4.7 The first step in the taxation process is to examine a flow of money inwards and determine whether that flow of money represents income. 4.8 Since most income we will consider in this subject is assessable, it is important to identify it (as distinct from capital) and determine the amount of it (for the purposes of calculating income tax payable). Statutory and non-assessable income 4.9 The next step is to look at specific types of income and see how they are treated for taxation purposes. This includes examining exempt income and statutory income as well as income from property. Income tax accounting LAWS5144 Combined notes 21

22 4.10 Third, in the income component is the accounting treatment. This is because the law varies from accounting principles For example, trading stock is treated differently in determining the taxation burden from the accounting for stock that we have covered in our introductory studies. Capital gains tax 4.12 Capital as distinct from income flows is then considered, particularly the taxation of capital gains realised on the sale of capital items (as distinct from trading stock) Even though we imply that it is a separate tax, there is no such thing it is just included in our assessable income. General deductions 4.14 See s 8-1 ITAA97 when all of the possible sources of income have been considered and their eligibility for taxation purposes considered, those items which constitute assessable income will be added together, from which amount will be deducted items the taxation regime allows NB deductions are not offsets and are not as valuable as offsets which come off the final figure (see formula). Specific deductions 4.16 Also s 8-5 ITAA97 examples will be considered (Div 25 ITAA97 has a lot of specific deduction provisions) NB deductions are not offsets and are not as valuable as offsets which come off the final figure (see formula). Capital allowances and car expenses 4.18 We are allowed deductions for expenditure where the item purchased lasts for more than one year Tax offsets 4.19 A generic term in the ITAA97 to refer to credits and rebates have nothing to do with revenue raising (usually social policy) e.g. childcare rebate Once the income and deductions from income have been determined, a net amount of assessable income is then calculated, from which a preliminary amount of tax payable may be calculated. This amount of taxation payable is called basic tax payable. Basic tax payable may then be adjusted for amounts we will generally refer to as offsets These can throw out the idea of horizontal equity but are different to deductions they are not taken off assessable income, rather they are offset at the end and are much more valuable. Tax payable 4.22 From the previous process, we are able to account for other amounts to arrive at a sum of money which amounts to the individual taxpayer s share of the taxation burden or a refund of money owed to the taxpayer. LAWS5144 Combined notes 22

23 4.23 Kerrie wants us to look at the tax rates, from 15% up to 45% - they are in the learning unit and see if you can have a fiddle and work out how to calculate them! LAWS5144 Combined notes 23

24 Topic 2 Residence and source 1 Introductory principles for calculating taxable income Introduction 1.1 The following provisions are general provisions relating to calculating income for tax purposes i.e. your assessable income. 1.2 This does not necessarily follow ordinary meanings of income and there are process which must be applied to work out what is assessable income. 1.3 These provisions are found in Div 4 a core division of the ITAA97 and it explains the whole process of working out income tax payable. 1.4 The provisions below apply equally to assessing what is assessable income as to whether someone is an Australian resident or not for tax purposes. Section 4-10(3) 1.5 This is the tax formula and it is used to work out your income tax for the financial year: Income Tax = (taxable income x rate) offsets 1.6 This is about plugging various amounts calculated in accordance with the CL and ITAAs to work out how much tax should be paid legally. Section 4-15(1) 1.7 This is the harder part of the formula which allows you to work out your taxable income for this income year: taxable income = assessable income - deductions where: assessable income = (ordinary income + statutory income) - exempt income 1.8 This will provide the bulk of the course go back to this if you get stuck. The nature of income 1.9 Ordinary income income according to ordinary concepts or judicial notion of income developed by the courts it was fairly narrow in its development (i.e. a flow of money coming in, rather than a gain or increase in wealth) Statutory income this was developed by the legislation due to the narrow scope of ordinary income it allows for amounts that are included in assessable income by specific LAWS5144 Combined notes 24

25 statutory provisions e.g. capital gains tax included because it is a statutory income it is therefore not ordinary income also bonuses, premiums etc covered in the ITAAs. Defining assessable income 1.11 s assessable income has the meaning given by sections 6-5, 6-10 and 6-15: s 6-5 income according to ordinary concepts (ordinary income) there is no further definition in the legislation, cases have further considered this (see below) s 6-10 other assessable income (statutory income) s 6-15 what is not assessable income? 1.12 s is the starting point in terms of defining things in the tax act in this case, it does not refer us to the old act, but rather to Div 6 (i.e. the above sections) The following headings deal with the various definitions of income. Diagram showing relationships amongst concepts in Div 6 There are many differences here which need to be acknowledged. To fall within assessable income an amount must be ordinary or statutory income but, not everything that falls within those categories is assessable income. 2 Types of income Ordinary income s 6-5 The provision 2.1 s 6-5(1) [ordinary income] your assessable income includes income according to ordinary concepts, which is called ordinary income. 2.2 s 6-5(2) [Australian residents] if you are an Australian resident, 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. 2.3 s 6-5(3) [non-residents] if you are a foreign resident, your assessable income includes: the *ordinary income you *derived directly or indirectly from all *Australian sources during the income year; and LAWS5144 Combined notes 25

26 other *ordinary income that a provision includes in your assessable income for the income year on some basis other than having an *Australian source. 2.4 s 6-5(4) [doctrine of constructive receipt] in working out whether you have derived an amount of *ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct. Commentary 2.5 The provision consists of the following parts: s 6-5(2) deals with Australian residents s 6-5(3) deals with non-residents s 6-5(4) is an anti-avoidance provision (e.g. prevents Kerrie saying to the UQ to pay her salary to someone else to pay her bills) i.e. she is deemed to have received the amount, despite the fact that it was in effect paid to someone else. Statutory income s 6-10 ITAA97 The provision 2.6 s 6-10(1) [not ordinary income] your assessable income also includes some amounts that are not *ordinary income. 2.7 s 6-10(2) [definition] amounts that are not *ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income. 2.8 s 6-10(3) [doctrine of constructive receipt] If an amount would be *statutory income apart from the fact that you have not received it, it becomes statutory income as soon as it is applied or dealt with in any way on your behalf or as you direct. 2.9 s 6-10(4) [Australian resident] If you are an Australian resident, your assessable income includes your *statutory income from all sources, whether in or out of Australia s 6-10(5) [non-resident] If you are a foreign resident, your assessable income includes: your *statutory income from all *Australian sources; and other *statutory income that a provision includes in your assessable income on some basis other than having an *Australian source. What is not assessable income s 6-15 ITAA97 The provision 2.11 s 6-15(1) [not ordinary or statutory income] If an amount is not *ordinary income, and is not *statutory income, it is not assessable income (so you do not have to pay income tax on it) s 6-15(2) [exempt income] If an amount is *exempt income, it is not assessable income s 6-15(3) [non-assessable non-exempt income] If an amount is *non-assessable nonexempt income, it is not assessable income. LAWS5144 Combined notes 26

27 Commentary 2.14 There are 3 situations where amounts are not assessable income: not ordinary or statutory income; exempt income; and non-assessable, non-exempt income Therefore, you do not have to pay tax on it (e.g. $10 grandma sends on a birthday it is a gift, therefore not assessable. $10 given for baking a couple of cakes if it is just a hobby; 2.16 If an amount is exempt income it is not assessable income; similarly if it is non-assessable non-exempt income. Exempt income s 6-20 The provision 2.17 s 6-20(1) [made exempt] An amount of *ordinary income or *statutory income is exempt income if it is made exempt from income tax by a provision of this Act or another *Commonwealth law s 6-20(2) [ordinary income excluded] *Ordinary income is also exempt income to the extent that this Act excludes it (expressly or by implication) from being assessable income s 6-20(3) [statutory income exempted] By contrast, an amount of *statutory income is exempt income only if it is made exempt from income tax by a provision of this Act outside this Division or another *Commonwealth law s 6-20(4) [non-assessable non-exempt income] If an amount of *ordinary income or *statutory income is *non-assessable non-exempt income, it is not exempt income. Commentary 2.21 An example of exempt income is income derived internationally by non-australian residents. Non-assessable non-exempt income s 6-23 The provision 2.22 s 6-23 [non-assessable non-exempt income] An amount of *ordinary income or *statutory income is non-assessable non-exempt income if a provision of this Act or of another *Commonwealth law states that it is not assessable income and is not *exempt income. Commentary 2.23 C.f. with exempt income here, the Act must say that it is non-assessable non-exempt income: e.g. when you had to hand back your guns, you got compo, that was labelled thus; similarly, fringe benefits, which are covered by the FBT are described as nonassessable non-exempt income. LAWS5144 Combined notes 27

28 2.24 But, what is the difference if the legislation just labels them differently? Difference is how they are treated for tax purposes: non-assessable non-exempt income is not taken into account at all for tax purposes; exempt income is taken into account: (i) (ii) e.g. you may have to offset losses on the exempt income before you can carry forward those losses to a future year; reduce the amount of loss you can actually use Subdiv 11B ITAA97 contains examples of non-assessable non-exempt income: GST payable on a taxable supply s 17-5 ITAA97; Fringe benefits s 23L(1) ITAA36; and Amounts received from related entities, to the extent that the entity s deduction is reduced s ITAA97. Relationships amongst various rules about ordinary income s 6-25 The provision 2.26 s 6-25(1) [doubling to be included once] Sometimes more than one rule includes an amount in your assessable income: the same amount may be *ordinary income and may also be included in your assessable income by one or more provisions about assessable income; or the same amount may be included in your assessable income by more than one provision about assessable income. However, the amount is included only once in your assessable income for an income year, and is then not included in your assessable income for any other income year s 6-25(2) [statutory income will prevail] Unless the contrary intention appears, the provisions of this Act (outside this Part) prevail over the rules about *ordinary income. Commentary 2.28 This provision tries to avoid the double taxation of income it is the counterpart of s 8-10 which prevents double deductions i.e. we may end up with doubling up of income because of two different statutory provisions what do we do? this section allows it to only be included once in assessable income in that tax year; and it cannot be included again in another tax year The rule is that the statute will prevail, however: it does not provide for the situation where you have 2 statutory provisions; LAWS5144 Combined notes 28

29 therefore, stick to normal rules of statutory construction Example s : where the disposal of an asset gives rise to ordinary income and a Capital Gain, the capital gain is reduced by the amount of ordinary income included in assessable income! in the absence of such a provision CGT would have prevailed: therefore an assessable income provision prevails over CGT; i.e. if the Act includes the gain as income (say for sale of land), then your CGT liability is reduced. Tying this into residence and source 2.32 The overall rationale is: Australian resident should be taxed on all sources of income (i.e. should not be taxed on their foreign sources elsewhere); Non-Australian resident should be taxed only on Australian income sources (i.e. will be taxed on their foreign sources elsewhere) This provision is why residence and source is so important. 3 Residence Residence requirements generally Introduction 3.1 From the provisions above in Division 6, it shows that: an Australian resident is taxed on income from all sources; and a foreign resident is taxed on income sourced in Australia. Foreign residents 3.2 A non-australian resident is taxed on: income sourced in Australia (ordinary (s 6-5(3) and statutory income (s 6-10(5)); ordinary or statutory income that a provision includes in assessable income on some basis other than having an Australian source (s 6-5(3) and s 6-10(5)) (i) e.g. CGT provisions bring to account capital gains and losses of a foreign resident that arise where CGT events happen to CGT assets that constitute taxable Australian property (s (1)) (d) An entity is entitled to deduct any loss or outgoing to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for the purpose of gaining or producing assessable income (s 8-1(1)) No deductions for exempt income (s 8-1(2)) LAWS5144 Combined notes 29

30 Temporary Resident (from 01 July 2006) 3.3 A temporary resident is defined in s as: a person holding a temporary visa under the Migration Act 1958; and are not an Australian resident under the Social Security Act 1991; and your spouse is not an Australian resident within the meaning of the Social Security Act However, you are not a temporary resident if you have been an Australian resident at any time after the commencement of this provision. 3.5 All ordinary and statutory income derived from a foreign source is non-assessable nonexempt income: s (1). 3.6 Foreign source investment income (i.e. net capital gains made on assets other than those which represent taxable Australian property and interest withholding tax obligations associated with amounts owing to foreign lenders) is also non-assessable non-exempt income. 3.7 All Australian source income is assessable under s 6-5(3) ordinary income and s 6-10(5) statutory income. Introductory matters to residence 3.8 Controlled Foreign Company (CFC), Transferor Trust and Foreign Investment Fund (FIF) rules were introduced to prevent residents from manipulating income to be deemed to be foreign source income derived by a foreign resident (was therefore not taxable). 3.9 Double tax agreements (DTA): agreements which govern the way in which income derived by residents of those countries are taxed to prevent double taxation and fiscal evasion (s 4 International Tax Agreements Act 1953 (Cth) together with ITAA36 and ITAA97) N.B. foreign resident (ITAA97 term) means the same as a non-resident (ITAA36 term) 3.11 The status of a person in migration law is not conclusive for tax purposes (can be completely different i.e. a resident for tax purposes but a non-resident for migration purposes. Often this has obscure consequences may have to pay the Medicare levy, but not be entitled to public health services) 3.12 There is no test for foreign residency. You test for Australian residency, and if they fail, they are a foreign resident 3.13 Residency is determined on a year by year basis (financial year), and can change. Residence of individuals Residence defined s 6(1) ITAA s 6(1) ITAA36 sets out four tests (the first is from the common law): residence according to ordinary concepts common law test; domicile test; LAWS5144 Combined notes 30

31 (d) 183-day rule; superannuation test These tests determine whether a person is an Australian resident if they do not meet at least one tes they are a foreign resident If so, foreign residents are taxed at a different rate and do not pay the Medicare levy Three main contexts in which the question of residence arises: A taxpayer is posted overseas and is arguing that they are now a foreign resident deriving foreign source income, and is therefore outside Australia s tax jurisdiction; A taxpayer is posted overseas but still derives mainly Australian source income and is therefore arguing they are still a resident so as to avoid foreign resident tax rates; and A foreign resident is posted to Australia for a limited or indefinite period and is arguing that they are not a resident of Australia and therefore should be taxed only on Australian source income We do not decide residency status in terms of a foreign jurisdiction, only that a person is a foreign resident it does not matter where it is that they are. The ordinary concepts test 3.19 The following factors are considered: physical presence in Australia: (i) (ii) pro-rated for financial year/arrival in Australia; generally some physical presence in Australia is necessary (Case 28) unless the person has no place of abode elsewhere during the year of income frequency, regularity and duration of visits: (i) (ii) if previously a resident: frequency and duration need not be substantial. Generally the purpose is not an important factor and in particular, it is not relevant that the visits were involuntary but necessitated by business or some other reason (see Lysaght); if not previously a resident: short and temporary visits are not likely to result in residency, the quality and character of an individual s behaviour is to be assessed! if behaviour over the period of physical presence reflected a degree of continuity, routine or habit that is consistent with residing then usually regarded as a resident; maintenance of place of abode in Australia during absences: (i) (ii) house or hotel?: particularly important where the person has no place of abode outside Australia during absences; (d) family and business ties: LAWS5144 Combined notes 31

32 (i) (ii) greater weight (particularly family ties) is likely to be given to this factor in determining whether a person who was previously a resident has ceased to be a resident (see Levine); however, business ties were not seen as an important factor in Lysaght; (e) present habits and mode of life: (i) (ii) if the taxpayer s mode of life is similar before and after the alleged change in residence, then this may indicate that there has been no change; the courts may be looking for a break in habits: Levine (f) nationality normally in borderline cases only and normally will not play a role There is a long line of cases dating back to 1920s HOL cases in which the courts came up with the factors (above) Under the ordinary concepts test you can be a part-year resident: e.g. applying the factors to a person arriving during the year) they will only be considered a resident for the part of the year that they are in Australia; the rest of the time, they would be a foreign resident; N.B. see the difference in the tests below. Levine s Case Facts Taxpayer was retired and sold house in UK. For two years, lived in hotels in England. For the next 5 years, lived in hotels in England and abroad, spending less than ½ his time in UK. After this time, he bought a house in France. Held - HL Held, once he bought a house in France, he was a French resident. The two years he was living in hotels in England was an Eng resident. The real question was the 5 years where he predominantly lived abroad. He had spent 4/5 months per year in the UK to obtain medical advice, visit relatives and attend religious ceremonies. HL: said was a resident! maintained some physical presence. Treated England as home (considering medical treatment). There was no real break in habit until he bought the home in France. Lysaght Facts UK taxpayer spent considerable time abroad Partially retired with inherited estate in Ireland Sold home in England but remained a non-exec director of the family co Went back to England for 1 week each month to attend board meetings LAWS5144 Combined notes 32