Taxation - Week 1 & 2 Assessable Income PDF

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Week 1 – Assessable Income Income - deduction = taxable income Tax income x rate (depends on how much you earn) = tax payable Sources of Tax Law  Income Tax Assessment Act 1936  Income Tax Assessment Act 1997  Fringe Benefit Assessment Act 1986 – any employee benefits charged to employer  Simplifying Superannuation Act 2007  Goods and Services Act Imposition – General Act 1999  Income Tax Regulations and Ratings Act  Case law interpreting legislation  Administrative Appeals Tribunal  Australian Taxation Office practice – private rulings or public rulings (Commissioners opinion of the law, not the law, do not have to follow it) Income Tax Formula

Who must pay tax?  Payable by each individual and company, and by some other entities  Each year ending 30 June, called the financial year  Income tax worked out by reference to your taxable income for the income year.  For a company, the income year is the previous financial year Income Overview Division 6 ITAA97 Assessable income comprises  s.6-5 Ordinary income

s.6-10 Statutory income (for example capital gains) o see s.10-5 for table And excludes  s.6-20 Exempt income  See s11-5 and 11-15 for the detailed list 

Ordinary Income - Income from ordinary concepts (wages, salary) Statutory income – Income from capital gain Exempt income – win for gains include gambling (no tax) Ordinary Income  ITAA97 s.6-5  Income according to ordinary concepts  “Your assessable income includes income according to ordinary concepts, which is called ordinary income.” Characteristics of ordinary income  Ordinary income is not defined in ITAA  Meaning and characteristics defined in case law  Concept of a gain - not an expense reimbursement  “Comes in” to the recipient – not simply an unrealised gain, not just recording it in the books  Character of receipt in recipient’s hands, person who is getting the money feels as though it in income coming in.  Cash or cash convertible – might get cash benefit or non-cash benefit but non-cash benefit has to be converted to cash, eg. $20,000 frequent flyer points is non-cash that can be convertible to cash. Convertibility into money? • A benefit is not income within the ordinary meaning unless it consists of money OR is capable of being converted into money • FCT v Cooke & Sherden (1980) • For employees’ benefits received from an employer not convertible into cash are not ordinary income but may be a fringe benefit – lecture 3 • For a business receiving non-cash business benefits ITAA36 s 21A may apply.

Classification of Ordinary Income  Periodic, regular and expected  Personal earnings from services rendered (self-employed or an employee)  Carrying on a business

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Profit making schemes Income from property Compensation

Periodic, regular and expected FCT v Dixon (1952)  A characteristic of income is periodicity, recurrence or regularity and expectation of continuity even if the payment is voluntary  A weekly payment to a solder from his former employer to make up the difference between his civilian and military pay.  Held: Periodic payments not directly attributable to employment Keily v FCT (1983)  Aged persons pension paid by the government also held to be ordinary income Income as a payment for personal services and employment  Salaries and wages are assessable when they are a payment for personal services or services rendered  A payment made for the services carried out by a sole practitioner accountant is also a payment for services rendered Income as a reward for personal services and employment  It is irrelevant that the payment for a service is a one-off payment or a regular series of payments  Brent v FCT (1971) o Ms Brent was the wife of an infamous train robber who escaped jail o She had an interesting story to tell which she sold to a newspaper o She didn’t write the story herself but dictated it to a journalist o Held: The payment was ordinary income as a payment for services rendered o Principles of Taxation Ch 6.30 – 6.60 Payments for services rendered Voluntary payments  Moorhouse v Dooland o Assessable where relate to services rendered o Payment is not required to come from the employer o Example: tips received by a taxi driver should be considered assessable income

Voluntary payments by third parties A weekly salary,

Plus additional money when taxpayer scored in excess of 50 runs Entitled to seek collections from the crowd for this “meritorious performance” • Collections were income as it was derived in ordinary course of employment • Regular • Contract entitled taxpayer to invite the crowd to make these payments • Need to be viewed from standpoint of the recipient Moorhouse v Dooland (1955) Principles of Taxation Ch 6.70 – 6.100 Voluntary Payments An unexpected payment - Scott v FCT (1966)  Scott, a solicitor, had acted for Mrs Freestone for a number of years  On the death of her husband he assisted her wind up his estate which included a farm  He helped her rezone the farm which led to a higher sale price  Before the invoice was prepared Mrs F told Scott she was going to gift him $10,000  Scott invoiced Mrs Freestone for the work and was appropriately paid  Held: $10,000 was a gift and not assessable income o If payment is a product of friendship, then a gift o The fact he was paid in full supported the case o He did not expect the gift Hayes v FCT (1956) Hayes ceased working for Mr Richardson as his business was declining Hayes continued to give advice to Richardson in an informal manner as they were friends Richardson’s business became profitable and he gave a number of shares in the business to Hayes Held: was a personal gift and not a payment for services rendered  He had been paid for his work  Hayes didn’t expect the payment  It was a result of a friendship Summary  Expectation of the gift: Scott v FCT  Motive of the donor (note: weight placed on the nature of receipt in the hands of the recipient): Scott v FCT  Whether the recipient has been fully remunerated for services provided: Scott v FCT; Hayes v FCT (1956)  Personal relationship: Scott v FCT; Hayes v FCT Prizes

Kelly v FCT (1985)  Income depends on personal services  Windfall gains depending primarily on luck are generally not income  Prize where the degree of skill outweighs the element of chance may be ordinary income  The footballer who won the best and fairest player award by a TV company was held to be income  Prize for the top student is generally a gift as its not related to earning income  Principles of Taxation Ch 6.110 – 6.120 Loyalty Programs Payne v FCT (1996)  Customer accumulates points while on employer business that can be redeemed as free travel, or accommodation  Issues are:  Whether the rewards are cash or cash convertible  Are the points for personal exertion?  The employee flew on company business paid by her employer and accumulated frequent flyer points.  Conclusion:  The use of the points to obtain free personal travel was not ordinary income.  The free travel was not from the employer or able to be converted to cash Principles of Taxation Ch 6.130 Restrictive Covenants FCT v Woite (1982)  A restrictive covenant or restraint of trade may be entered when you give up certain rights in return for a payment. These payments are generally a capital receipt • South Australian footballer signed agreement with North Melbourne football club that if he played football in Victoria he would only play for that club • Not bound to play for North Melbourne only that he would not play for any other club in Victoria • Money got from not playing for another club is considered capital, not ordinary income  A payment made to an employee on leaving the employer for not disclosing the secrets of the employer - capital  A payment for agreeing not to work for another employer in the same business – capital  Being paid to induce the person to join another firm would probably be income  Principles of Taxation Ch 6.160 -180

Allowances in relation to employment  Allowance = Income, therefore assessable  An allowance is a predetermined amount paid to an employee which is estimated to cover an expense regardless of whether the expense will be incurred  Contrast with a reimbursement of an actual expense incurred as part of your employment which is NOT income Therefore  Car allowances  Entertainment allowances  If paid in cash would be assessed under ITAA97 s6-5  Principles Ch 6.190 and 240 Smith v FCT (1987) Westpac paid employees, studying for degrees, an amount of money on successfully completing each subject and a further amount on completion of the course. Held: • The receipt was assessable under ITAA97 s15-2 • Payment from employer was to encourage study and was held to be an allowance • “It was an incentive to improve skills” Statutory Income  A receipt may be ‘Statutory Income’ if: o (1) it is not ‘ordinary income’ and o (2) it is included as assessable income by a specific provision of ITAA97  Examples: o From services and employment ITAA97 s15-2 o Capital gains ITAA97 s100 o Reimbursement of a car expense ITAA97 s15-70 Statutory income from services and employment  Section 15-2 deems certain gains from employment or services to be statutory income. It doesn’t matter if it’s cash or a non-cash convertible payment s15-2 (2)  However, it specifically doesn’t apply to gains from employment or services that are ordinary income and or a fringe benefit s15-2(3)  Could apply to non-cash convertible items given as a reward for volunteer work  Or A free non-cash convertible holiday given by a client to an employee of an accounting firm  Principles Ch 6.190 and 6.240

Exempt Income  Definition – s.6-20(2) ITAA97  Ordinary income is exempt to the extent that it is expressly made exempt  Exempt items listed at ITAA97 s.11-5, s.11-10 and s.11-15  Specific details contained in ITAA97 s.50 to s.52 and ITAA36 s.23  Principles of Taxation Ch 3.170 Classes of exempt income 1. Entities that are exempt no matter what kind of ordinary/ statutory income derived, e.g. charities, public universities, public hospitals - ITAA97 s11-5 2. Specific ordinary/statutory income received which is exempt  Full time students receiving income from a scholarship is exempt - ITAA97s11-15  However, s51-35 has a condition that the student will not enter into an employment contract with the donor and that the scholarship must be principally for education purposes - ITAA97 s11-5 Assessable Income  Is the amount ordinary income? o Recurrent and expected, personal services, business, return from an investment or from a profit-making scheme ITAA97 s6-5(1)  Is the amount statutory income under a specific provision such as reimbursement of a car expense s15-70 or a capital gain? S 102  Are the residency and source requirements met?  Is the amount exempt income?

Tutorial Notes Commonwealth Taxes  Income taxes, including capital gains tax (65% of revenue)  Fringe Benefits tax (1% of revenue) – a fringe benefit is extra benefit given outside of pay, eg. Company car, salary package ($90,000 salary, extra $10,000 for the company car which is paid by the company)  Medicare levy (2.0% of taxable income) – we pay the levy so we don’t have to pay it during the year at the GP.  Superannuation (15% of taxable income, 2% of revenue)  GST (10% of purchase price, 14% of revenue) State and local taxes State Taxes  Payroll taxes

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Stamp duties Land tax

Local taxes  Rates  Licence fee Components of taxable income Assessable income – salary s 6-5 Less Allowable deductions – general deductions s 8-1 Specific deductions s 8-5 (eg. bad debts) = Taxable Income Less Tax on $37,001 is (18200) x 19c 74,250 less 37,001 = 37249 x 32.5 cents

80,000 4,750 1,000

5,750 $74,520

3,572 12,105.92 15,677.92

Plus 2% Medicare levy on 74,250 Total Payment

1,485 $17,162.92

Income Tax Rates – Companies  Rates vary with the type of entity  Flat rate  Companies whose turnover exceeds $25,000,000 are subject to a flat rate of tax at 30% on their taxable income and companies whose turnover is less than $25,000,000 pay a flat rate of 27.5%.  Partnerships itself don’t pay tax, the partners pay the tax.  Sole proprietors on the other hand are tax payers.  Trading stock is deductable when you buy it

Taxable income for Australian resident Individuals 2017/18 Taxable income 0 – 18,200

Tax Nil

Marginal tax rate Nil

18,201 – 37,000 37,001 – 80,000 80,000-180,000 180,001+

nil 3,572 19,822 54,232

19c 32.5c 37c 45c

Obligation to lodge a tax return  Commissioner publishes a notice in the Government Gazette specifying the manner and time for lodgement by each category of taxpayer. s. 161(1) ITAA36  ‘Ordinary returns’ are due by 31 October.  Returns must be in a prescribed form containing prescribed information  It can be submitted by mail or electronically There are different forms for different taxpayers  Individuals  Companies  Partnerships  Trusts Assessment  Section 6 (1) Income Tax Assessment Act 1936 (ITAA36) defines an assessment as ‘ascertainment of the amount of taxable income and amount of tax payable’.  Self-assessment regime o Responsibility falls on the taxpayer to lodge a tax return with adequate disclosure o The ATO initially excepts the return at face value checking its accuracy with random audits o Penalties can be incurred for non-compliance with the law or for inaccuracies Audits The enforcement of compliance  Although tax returns are initially accepted at face value in order to raise a return, comprehensive data matching and profiling may give reason for an audit.  Ranging from a simple questionnaire to desk audits or more complex onsite audits. Objections  A taxpayer who is dissatisfied with an assessment may object (s. 175A ITAA36)  Time limit (from original assessment) o Individual with simple tax affairs - 2 years o Others – 4 years  Commissioner must give objection decision o Either allow or disallow within 60 days

Amendments of assessments General rule:  The Commissioner has two years from the date the NOA is given to the taxpayer to amend it;  Period extended to four years for some other taxpayers, eg, partners in a partnership that is not a small business entity.  Fraud or evasion: o Commissioner has unlimited time to amend. Objections, review and appeals - process  ATO makes an assessment  If TP disagrees with the decision can object  TP can appeal to the AAT Or the Federal Court.  If point of law can appeal from AAT to Federal Court  Then appeal to full Federal court  Finally, with special leave either party can appeal to High Court  The burden of proof when challenging an assessment or default assessment rests with the taxpayer.  Taxpayer has to prove that the assessment is excessive: ss 14ZZK(b) and 14ZZO(b) TAA

National Tax Practitioners Board  An independent statutory body which advises the Government on the formulation and development of tax policy.  Commissions research into areas of difficulty.  Arranges community consultation in the design and development of new legislation.

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Treasurer requested the Practitioners Board of Taxation to develop a new voluntary code requiring certain businesses to make greater public disclosure of their tax information. Supports OECD project on Base Erosion and Profit Shifting and contributes to country-by-country reporting.

Week 2 – Assessable Income Part 2 Calculating assessable income Assessable income comprises of:  Ordinary income – ITAA97 s 6-5  Statutory income ITAA97 s 6-10  Exempt income - ITAA97 6-15 Classification of ordinary income  Periodic, regular and expected  Personal earnings from services rendered  Carrying on a business  Profit making schemes  Return on capital  Income from property – rent, interest, annuities and royalties  Compensation receipts

Income from business  Definition under ITAA97 s.995-1(1)  “any profession, trade, employment, occupation or calling, but does not include occupation as an employee”  Clearly singling out employee as occupation  Normal gross earnings or proceeds from business operations are assessable as ordinary income - ITAA97 s.6-5  Principles Ch 8.10 Income from business  “There are a multitude of things which together make up the carrying on of a trade… Ultimately it is a “questions of fact and degree, a question of impression”. Two specific factors assist…in marking out activities as a business: o repetition and o the existence of the purpose of making a profit.”  Furthermore, the volume and sales of the activity may be significant as may the amount of capital employed.  While an intention to carry on a business must exist, this does not mean that the question is subjective.” (FCT v Radnor Pty Ltd (1991)) Characteristics of income from business  Profit-making intent/purpose - hobby  Commercial approach to the activity  Scale of activities - sport persons  System and organisation – gambling (generally not a business)  Sustained and frequent activity – occasionally selling surplus fruit from own tree – refer to Thomas, Fergusons, Walkers case, shows size and scale of business is not critical  Type of activity and type of taxpayer  Principles Ch 8.20 – 50 Business income Ferguson v FCT (1979) • Ferguson commenced farming with 5 cattle with the intention of building to 200 head • The issue was whether Ferguson had commenced business • FCT argued he was simply preparing for business Court ruling  All the characteristics of business had to be evaluated and one wasn’t more important than the other.

Stone v FCT 2005  Stone was a world class sportsperson and a full-time policeperson.  She earned $136,448 from her sporting activities including sponsorships, appearance fees and prizes  Held: She was carrying on a business  Although profit motive was not strong she entered into the sponsorship deals and received cash and employed a manager.  Scale of her activities  Fees paid to any sportsperson for playing would be personal exertion income whether or not carrying on a business.  Principles Ch8.80

Income from Business Broad Approach  GP International Pipecoaters v FCT (1990) o If the taxpayer is carrying on a business, then the entire “ordinary proceeds of the business” are assessable even if such amounts are applied for capital purposes Narrow approach  FCT v Merv. Brown Pty Ltd (1985) o Taxpayer decided to reduce the importation of certain products he sold as they were no longer profitable o These lines required a quota purchased from the government o Taxpayer sold these quotas o Held: Capital, because it’s not the way Merv Brown would usually make money, not assessable income. o Principles Ch 8.140 Lease incentives  FCT v Cooling (1990)  Generally a cash incentive paid to a business taxpayer to enter into a lease of business premises is assessable income Leasing Arrangements  FCT v GKN Kwikform Services (1991)  Selling assets that were being leased to others has been held to be income, or compensation received by lessor for damages to leased assets is income

Question Maria has a very large garden at the rear of her home. She grows large quantities of fruits and vegetables. She uses most of the produce for her own family and sells any excess to her neighbours and friends. Is Maria carrying on a business? Based on the three lines, no, it is not a business. Issues to discuss • Profit-making intent/purpose • Commercial approach to the activity  probably not • Scale of activities  small • System and organisation  don’t know much • Sustained and frequent activity  don’t know • Type of activity and type of taxpayer  personal, low scale Non-cash business benefits  FCT v Cooke and Sherden  Taxpayer is in the business of distributing soft drinks. The manufacturer provided free holidays to distributors. The holidays could not be assigned. The taxpayer was not obliged to take the holiday. Nothing came in or was received. No money was paid.  Held: Not ...