Australian practical tax examples [3rd edition.] 9781922347367, 1922347361

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Disclaimer No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publication is sold on the terms and understanding that (1) the authors, consultants and editors are not responsible for the results of any actions taken on the basis of information in this publication, nor for any error in or omission from this publication; and (2) the publisher is not engaged in rendering legal, accounting, professional or other advice or services. The publisher, and the authors, consultants and editors, expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this publication. Without limiting the generality of the above, no author, consultant or editor shall have any responsibility for any act or omission of any other author, consultant or editor.

ABOUT WOLTERS KLUWER Wolters Kluwer is a leading provider of accurate, authoritative and timely information services for professionals across the globe. We create value by combining information, deep expertise, and technology to provide our customers with solutions that contribute to the quality and effectiveness of their services. Professionals turn to us when they need actionable information to better serve their clients. With the integrity and accuracy of over 45 years’ experience in Australia and New Zealand, and over 175 years internationally, Wolters Kluwer is lifting the standard in software, knowledge, tools and education. Wolters Kluwer — When you have to be right. Enquiries are welcome on 1300 300 224. “Cataloguing-in-Publication Data available through the National Library of Australia.” First edition published: February 2018 Second edition published: September 2019 This edition published: September 2020 ISBN 978-1-92234-736-7 © 2020 CCH Australia Limited All rights reserved. No part of this work covered by copyright may be reproduced or copied in any form or by any means (graphic, electronic or mechanical, including photocopying, recording, recording taping, or information retrieval systems) without the written permission of the publisher.

PREFACE Wolters Kluwer is pleased to publish the second edition of Australian Practical Tax Examples — an ideal companion to Wolters Kluwer’s best-selling Australian Master Tax Guide. The book contains over 200 detailed examples presented in an ‘‘Issue’’ and ‘‘Solution’’ format. The book has been newly revised and updated to conform with the law in force at 30 June 2020; and, new for this edition, a number of additional examples have been written, dealing with issues — such as the various COVID-19 stimulus measures — that have been added to tax law since the second edition was published in 2019. These examples are grouped under 12 core topics, with each example containing crossreferences to the Australian Master Tax Guide. The examples have been written to provide readers with an understanding of how tax legislation and case law applies to everyday tax issues and situations. In using this book, be aware that the suggested solutions to the issues raised in the examples are not

intended to be legal, accounting or professional advice. The solutions are only intended to be helpful illustrations of answers, and professional judgment should be exercised before applying the suggested solutions to client situations. I would like to thank the team of writers who worked on the first edition of Australian Practical Tax Examples, much of whose work has been carried over into this new edition. I would also like to thank the in-house Tax, Accounting & Superannuation content specialists and editors for their work in reviewing the manuscript and help in producing this title. Mark Chapman September 2020

WOLTERS KLUWER ACKNOWLEDGMENTS Wolters Kluwer wishes to thank the following who contributed to and supported this publication: Regional Director – Research and Learning: Lauren Ma Head of Content Asia Pacific: Diana Winfield Head of Legal Content: Carol Louw Editor: Reshma Korah Cover Designer: Mathias Johansson Production Coordinator: Alexandra Gonzalez

About the Author Mark Chapman has over 25 years’ experience as a tax professional in both the United Kingdom and Australia, specialising in tax for individuals and SMEs. He is a fellow of the Institute of Chartered Accountants in England and Wales and CPA Australia and a member of the Chartered Institute of Taxation. He holds a Master of Taxation Law degree from the University of New South Wales. Mark has been Director of Tax Communications with H&R Block Australia since 2015. He writes regularly on tax issues for numerous media outlets and presents on current tax topics at seminars and other events. He broadcasts frequently on radio and television and writes a regular column for Money Magazine and Yahoo7 Finance. As a tax practitioner in the United Kingdom, Mark occupied a number of senior positions before moving to Australia in 2007 to join the Australian Taxation Office (ATO) as a senior director. Mark is also the author of Life and Taxes: A Look at Life Through Tax, published by Wolters Kluwer CCH in August 2017 and the second edition of this book, published in 2019.

ABBREVIATIONS The following abbreviations appear in this book. AAT

Administrative Appeals Tribunal

ABN

Australian Business Number

ATC

Australian Tax Cases (Wolters Kluwer)

ATO

Australian Taxation Office

BAS

Business Activity Statement

CGT

Capital gains tax

ETP

Employment termination payment

FBT

Fringe benefits tax

FBTAA

Fringe Benefits Tax Assessment Act 1986

FC of T

Federal Commissioner of Taxation

FOI Act

Freedom of Information Act 1982

GIC

General interest charge

GST

Goods and services tax

GST Act

A New Tax System (Goods and Services Tax) Act 1999

GST Regulations

A New Tax System (Goods and Services Tax) Regulations 1999

HELP

Higher Education Loan Program

ITAA36

Income Tax Assessment Act 1936

ITAA97

Income Tax Assessment Act 1997

ITR97

Income Tax Assessment Regulations 1997

LAFHA

Living-away-from-home allowance

PAYG

Pay As You Go

R&D

Research and development

TAA

Taxation Administration Act 1953

TFN

Tax file number

ASSESSABLE INCOME Assessable income; royalties

¶1-000

Sharing economy; rental marketplace; Airbnb

¶1-020

Social media income; professional artist business

¶1-040

Disaster and relief payments

¶1-060

Illegal activities

¶1-080

Compensation for breach of business agreement

¶1-100

Strata title body corporate; mutuality principle

¶1-120

Mutuality principle; taxable income on apportionment of expenses

¶1-140

Excess superannuation contributions

¶1-160

Income or capital; mere realisation or carrying on a business

¶1-180

Non-cash business benefits

¶1-200

Lease incentive payments

¶1-220

Australian resident or non-resident

¶1-240

Residence: meaning of permanent place of abode

¶1-250

Source of income for resident or non-resident

¶1-260

Alienation of personal services income

¶1-280

Personal services income: unrelated clients test; personal services business

¶1-290

Allowances and reimbursements

¶1-300

Derivation; agreement for right to use proprietary software and related services ¶1-320 When is income derived; cash basis

¶1-340

When is income derived; accruals basis

¶1-360

Employee share scheme

¶1-380

Employee share scheme offered by start-up company

¶1-400

Employment termination and genuine redundancy payments

¶1-420

¶1-000 Worked example: Assessable income; royalties Issue Creativity Pty Ltd (CPL) is an Australian based company in the business of creating content for print books, eBooks and short films. In July 2019 CPL entered into a contract with a US-based company, Digital Media Inc (DMI), for the provision of technical expertise in relation to the storage of that content. Under the contract CPL would pay DMI an initial lump sum and a fee for each occasion on which CPL sought technical advice. In August 2019 CPL finalised content for a book on Australian landscapes and assigned copyright to print the book to a publishing house in return for a 10% fee for each book sold. In September 2019, CPL assigned the film rights to the book to Film Oz Pty Ltd for a lump sum, based on a pre-estimate of each occasion on which the film would be shown.

Do any of these payments constitute royalties and if so, what are the tax consequences? Solution For income tax purposes a royalty, which is within the common law meaning of the term, would be ordinary income and assessed under ITAA97 s 6-5. Royalties are given an extended meaning under the definition of “royalty” or “royalties” in ITAA36 s 6(1) and may also be included in the assessable income of a taxpayer under ITAA97 s 15-20 or treated as a capital gain. The High Court in Stanton v FC of T (1955) 92 CLR 630 defined the essence of a royalty as payments “made in respect of the particular exercise of the right to take the substance and therefore should be calculated either in respect of the quantity of value taken or the occasions on which the right is exercised”. Copyright assignment — 10% fee The 10% fee received by CPL for their assignment of copyright and based on the number of books sold fits the definition of a royalty and will be assessed as ordinary income under s 6-5. Lump sum payment for anticipated future use A lump sum payment based on a pre-estimate of the anticipated future use may also be a royalty. The lump sum received by CPL in return for assigning the film rights to the book to Film Oz Pty Ltd may qualify as a royalty because it is based on a pre-estimate of future use, that is future screenings. This payment would then be assessable as ordinary income under s 6-5. Alternatively, ITAA97 s 15-20 would include in the assessable income of CPL an amount received by way of royalty within the ordinary meaning of “royalty” not assessable as ordinary income under s 6-5. If the lump sum was held not to be a royalty within the ordinary meaning of the term it could still be included in assessable income as a capital gain, given that intellectual property does constitute an asset for CGT purposes. Lump sum and fee payment to DMI In relation to the lump sum and fee payments made to DMI for the provision of technical expertise, two earlier decisions, that is FC of T v United Aircraft Corporation (1943) 68 CLR 525 and FC of T v Sherritt Gordon Mines Limited 77 ATC 4365, held that payments for the provision of technical assistance were not royalties. However, under the extended definition of royalties in s 6(1), payments such as those made to DMI are now included as royalties. The issue in relation to the royalty payments to DMI is whether these payments are foreign source income or Australian source income in the hands of DMI. Payments made to the non-resident US-based DMI, under an agreement for the supply of technical expertise sourced from the US, would be foreign source income. However, under ITAA36 s 6C, the royalties received by DMI are deemed to have an Australian source and would be subject to withholding tax payable by CPL at the rate specified in Australia’s double tax agreement with the US, that is 5%. AMTG: ¶10-510, ¶21-060, ¶21-070, ¶22-030

¶1-020 Worked example: Sharing economy; rental marketplace; Airbnb Issue In June 2019 Orpheus Parker purchased a ground floor two-bedroom townhouse in Neutral Bay, Sydney. He decided to rent out part of his townhouse on Airbnb while still living in the property. The total floor area of the townhouse is 850 sq feet (79 m2). The floor space of Orpheus’ bedroom and his private area is 250 sq feet (23.2 m2). The rented second bedroom area is 200 sq feet (18.6 m2). The shared area comprising lounge, kitchen and laundry cupboard is 400 sq feet (37.2 m2). The property has been listed since 1 September 2019 and Orpheus has achieved consistent occupancy rates. During the period of 1 September 2019 to 30 June 2020, the room was rented for 150 days. Orpheus only offered the room to solo travellers and he has received a total of $22,500 in rental income. During this period, expenses relating to occupancy costs, such as mortgage interest, municipal rates, strata levies and home insurance amounted to $50,000. Orpheus also spent $250 on expenses relating to renting the room, that is advertising fees and consumables supplied for the room.

Advise Orpheus of the tax consequences of using his townhouse to produce rental income for the 2019/20 income year. Solution Rental income and deductions The income that Orpheus receives as rent is assessable as ordinary income (ITAA97 s 6-5) and, accordingly, the $22,500 income should be included in his tax return for the 2019/20 income year. Since the $22,500 rental income is included as assessable income, expenses relating to the income are allowable as deductions (ITAA97 s 8-1). As Orpheus still lives in the townhouse, any tax deductions must be apportioned to only the incomeproducing portion as some of these expenses relate to private use by Orpheus. It would be reasonable to consider that expenses relating to the second bedroom and a share of the lounge, kitchen and laundry cupboard would be directly related to the income-producing activity. Where expenses can be directly related to the second bedroom, then the deduction would be allowed in full, otherwise expenses would be calculated on the basis of the number of days the property was rented out and the proportion of the floor area that is rented (and shared). The apportionment of the deduction is based on the total occupancy percentage of 47% (ie (18.6 + 37.2 / 2) / 79). This includes the rented second bedroom area and a 50% share between Orpheus and the guest of the spared area (ie lounge, kitchen and laundry cupboard). The allowable deductions available against the income received are deductible at a rate of 47% for each night a guest stays at the property. The expenses that relate to occupancy costs, such as mortgage interest, municipal rates, strata levies and home insurance premiums are relevant and incidental to the derivation of rental income. As occupancy costs relate to a property as a whole, they must be apportioned between the incomeproducing purpose and the private purpose. Applying the occupancy percentage against the number of days the townhouse was used for income-producing purposes in the income year (150 days), the allowable deduction for the 2019/20 income year is $9,631 calculated as follows: $50,000 × 150/366 × 47% = $9,631 Note that this apportionment takes into account that the room was only available to rent for 10 months of the year. Orpheus can deduct, with any apportionment, the expenses relating to the actual rental of the room, such as the advertising fees paid and any consumables supplied for the room. The taxable income that Orpheus is required to declare in his 2019/20 tax return is $12,619 (ie $22,500 − ($9,631 + $250)). Orpheus is also permitted to deduct the decline in value for any furniture, fixtures and appliances used in the townhouse using the same apportionment methodology. A schedule from a quantity surveyor would need to be prepared and the cost of preparation may be prohibitive compared to the deduction available. GST registration Fortunately for Orpheus, the provision of residential accommodation is input taxed and the property is used predominantly for private purposes (GST Act s 40-35). Accordingly, there is no GST liability as this type of supply is not included in the turnover test for GST registration (GST Act s 23-5). Unlike other sharing economy participants such as Uber drivers, Orpheus is not required to be registered for GST. AMTG: ¶2-135, ¶10-105, ¶11-760, ¶16-010, ¶30-005

¶1-040 Worked example: Social media income; professional artist business Issue Catherine Wise works full-time in sales. For the past three years she has pursued her hobby on weekends as a make-up artist for weddings and other special occasions. Generally, she receives tips and gifts of champagne and flowers for her services but does not include any income or deductions relating to her make-up activities in her tax return.

Catherine has gathered a following of over 200,000 people on YouTube where she posts videos on her channel showing her make-up skills. She has decided to “monetize” her channel by enabling AdSense and now earns about $2,000 each month from this endeavour. She is ready to give up her day job and work full-time in the business. Advise Catherine on the tax treatment of the income she has received from her social media endeavours. Solution Assessable income includes income according to ordinary concepts, that is ordinary income as defined in ITAA97 s 6-5. Income received from carrying on a business is considered ordinary income. Whether the revenue (moneys, cash) received by Catherine from her social media endeavours is income received from carrying on a business or income from a hobby is a question of fact and degree. This distinction is important because income received from pursuing a hobby is not considered assessable income. There are no statutory rules or case law for determining whether Catherine’s social media activities amount to the carrying on of a business. This new economy is yet to be tested by the courts and authorities. With the low barrier to entry for operating a business and 24/7 communications in the virtual world compared with the “old bricks and mortar” economy, a perceived hobby can factually convert into a business instantaneously. This makes it difficult to determine when the timing of the crossover from hobby to business actually occurred. The courts, however, have developed a series of indicators that can be applied to help determine whether a business is being carried on (Taxation Ruling TR 97/11) and these should apply regardless of the type of business being conducted. These indicators include: • whether the activity has a significant commercial purpose or character • whether the taxpayer has more than just an intention to engage in business • whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity • whether there is regularity and repetition of the activity • whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business • whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit, the size, scale and permanency of the activity, and • whether the activity is better described as a hobby, a form of recreation or sporting activity. No one indicator is decisive in determining whether a business exists (Evans v FC of T 89 ATC 4540). The indicators must be considered in combination and as a whole. Although the fundamentals for determining when business activities are being carried on are the same for traditional businesses and online businesses, there are further characteristics to consider in Catherine’s case. Based on the nature of Catherine’s work, she could be considered carrying on a business as a professional artist (Taxation Ruling TR 2005/1). A professional artist is a person who carries on the activities of a “professional arts business” (ITAA97 s 35-10(5)) as either: (a) an author of a literary, dramatic, musical or artistic work (b) a performing artist, or (c) a production associate. TR 2005/1 states that the nature of art activity means that arts businesses typically have different characteristics to those found in other businesses. For example, people who engage in professional arts businesses are often motivated by creative purposes and the desire to influence public opinion. Art is not

always produced with a pre-existing market in mind; rather, an innovative artist may have to create a new market for their work. For this reason, a large part of being in business as a professional artist may involve activities directed towards reputation building and audience/market creation. This would appear to be relevant when considering many online social media type revenue streams. The usual indicators described above still apply to these artistic businesses. However, with the high risk associated with arts businesses, profit may not be an appropriate factor (Taxation Ruling TR 2005/1) and other indicators may need to be considered such as: • repetition • activities of the same kind, and • size and scale. At the outset, Catherine was only doing make-up as a hobby. Even with her YouTube success it would be reasonable to accept that her activities would still not be considered carrying on a business, as the activities were yet to be monetised. When Catherine started receiving monthly payments from AdSense (AdSense has a payment threshold), this would be the point in time when she had the business indicators of repetition, size, scale, and business records. It would be at the time that her activities moved from being a hobby and became a business. At this juncture, she would be required to include the money from her social media activities as assessable income in her tax return. Once Catherine is carrying on a business, the earnings or proceeds of her business are to be included in her assessable income, and deductions will be allowable for all expenses of a revenue nature incurred in the course of deriving that income. If the online business is going well, then she must include the taxable income from the business in her tax return along with her salary and wages from her sales assistant job. However, if she is making a loss from her online business, then this loss may not be able to offset her taxable income derived from her sales assistant role. The non-commercial business loss integrity provisions under ITAA97 Div 35 may be triggered to quarantine her losses. There are certain thresholds that need to be satisfied to permit the losses to be applied. AMTG: ¶2-135, ¶10-105, ¶16-020

¶1-060 Worked example: Disaster and relief payments Issue Jasper Onyx operates the Speedy cleaning and courier business in the Hunter Valley. In November 2019, a bushfire caused major damage in and around the region and Speedy was closed until April 2020. Jasper had insured his business for any loss of profit that could be due to natural disasters. He claimed the premiums as allowable deductions each year and always paid the correct amount by the due date through Speedy. After providing substantiation, Jasper received $200,000 on 23 June 2020 as a payout on the insurance policy for lost income relating to the forced closure. A public fund was established to accept donations from people wishing to provide assistance to victims of the bushfire. The fund received donations from the public that were tax deductible and large contributions from the NSW and federal government. The charity made one-off payments of $5,000 to individuals and $50,000 to small businesses impacted by the bushfire. The payments were unconditional. Jasper received $5,000 for himself and $50,000 for Speedy in February 2020. Are Jasper or Speedy required to declare any of these amounts as assessable income in either of their 2019/20 tax returns? Solution Insurance payout

Insurance payments or other receipts in respect of lost trading stock by fire or destruction and amounts received for loss of profits or income due to an interruption to business caused by fire are assessable either as ordinary income (ITAA97 s 6-5) or statutory income (ITAA97 s 15-30). As the insurance payment was received on 23 June 2020, Speedy should include the $200,000 payment in the 2019/20 income year. Payments from the public fund The receipt of money or other property by way of a simple gift and nothing more is not a receipt of income. A receipt of a voluntary payment of money or a voluntary transfer of property is prima facie not income in the hands of the recipient. Government payments received by a charity that form an unidentifiable part of the overall funds received for the purpose of providing aid to persons in need do not alter the non-taxable nature of the aid provided by the charity (Taxation Determination TD 2006/22). On this basis, both Jasper individually and Speedy are not required to treat the amounts from the public fund as income. The amounts are considered tax free and therefore need not be declared as assessable income in either of their 2019/20 tax returns. AMTG: ¶10-070, ¶10-170, ¶44-130

¶1-080 Worked example: Illegal activities Issue Natasha Romanov is the CFO of E Corp Pty Ltd (E Corp). During the 2017/18 income year she misappropriated $360,000 worth of company funds. In the 2019/20 income year, as a result of data matching, the ATO identified the amount that was misappropriated from E Corp. As a result of the audit, Natasha was indicted and convicted in December 2019. She was issued a court restitution order to repay $300,000 to E Corp. She was also fined $120,000. In January 2020, Natasha needed additional funds to repay the money. She appeared on a current affairs television show to discuss her crime and was paid $50,000. What are the tax outcomes for Natasha in relation to the income and the expenses arising from her illegal activities? Solution Income derived from illegal or ultra vires transactions conducted in a systematic, regular and organised way with a view to a profit can constitute business income. Accordingly, this income, although from illegal activities, is subject to the same tax provisions as any other business income. For example, the appropriation of cash by a managing director was considered assessable income in the hands of the managing director (Case B32 70 ATC 153). Therefore, Natasha is required to include the additional $360,000 as taxable income for the 2016/17 income year and pay any shortfall interest amounts and penalties associated. Losses or outgoings necessarily incurred in carrying on illegal or ultra vires business will be deductible, according to ITAA97 s 8-1. However, amounts obtained from an illegal activity that are subsequently repaid or recovered, for whatever reason, will not be allowable deductions because such amounts are not incurred in any way for the purpose of obtaining the illegal proceeds. Generally, repayment or restitution is imposed on the offender as a means of retribution and is not incurred by the offender in earning the proceeds. Such payments represent a repayment of income as opposed to an outgoing incurred in deriving that income. On this basis, Natasha is not permitted to deduct the restitution amount of $300,000 in the 2019/20 income year. However, since the amount directly relates to assessable income of $360,000 previously recognised in the 2017/18 income year, the $300,000 is permitted to reduce the $360,000 from the 2017/18 income year. Accordingly, additional assessable income for the 2017/18 income year is reduced to $60,000 — any shortfall interest charge is also reduced. Further, fines and penalties payable are specifically not allowable deductions (ITAA97 s 26-5).

Accordingly, Natasha is not permitted to deduct the $120,000 fine in the 2019/20 income year. Natasha would also be required to include the $50,000 from the television interview in her assessable income for the 2019/20 income year as the appearance was part of her “business activities” and there was a view to a profit from the interview. AMTG: ¶10-010, ¶10-450, ¶16-010, ¶16-105

¶1-100 Worked example: Compensation for breach of business agreement Issue Australian Oil Distributors (AOD) supplies petrol and oil products to a number of independent service stations (Independents). AOD receives bulk petrol and oil products under an agreement with Mid-Eastern Oil (MEO) for which AOD pays MEO $1m annually. MEO advised AOD that it was terminating the agreement and would be entering into a supply agreement with a competitor of AOD. AOD sought compensation of $2m from MEO for the impact on its business arising from breach of the agreement. The action against MEO was subsequently settled with MEO agreeing to pay AOD a lump sum of $1.5m on the condition that AOD would not enter into any contract or agreement with any other oil producer in order to acquire petrol and oil products for supply to independent service stations for two years. The payment included compensation for any damage to AOD’s reputation in the industry. Advise AOD on the tax consequences of receiving the payment of $1.5m from MEO. Solution In general, compensation takes on the character of what it replaces (C of T (NSW) v Meeks (1915) 19 CLR 568 and Heavy Minerals Pty Ltd v FC of T (1966) 115 CLR 512). Amounts received in connection with the breach or cancellation of commercial contracts may be of an income nature. In the case of agency contracts, if the cancellation is for one of a number of contracts compensation may be regarded as a normal trading risk and would be treated as ordinary income (Allied Mills Industries Pty Ltd v FC of T (1989) 20 FCR 288). However, where the agency agreement is the whole or greater part of the business earnings such that cancellation would damage or destroy the profit-making structure of the business, the compensation will be of a capital nature (Californian Oil Products (In liq) v FC of T (1934) 52 CLR 28, Case Y24 91 ATC 268). The first issue is to determine whether the $1.5m received by AOD is of an income or capital nature and assessable as ordinary income under ITAA97 s 6-5 or assessable as a capital gain under ITAA97 s 10425. If ITAA97 s 6-5 is held not to apply, it may be necessary to consider whether the compensation is assessable as an assessable recoupment under ITAA97 s 20-25. It is also necessary to consider the substance of the $1.5m payment, that is whether it comprises liquidated or unliquidated damages and if the sum can be dissected into income and/or capital components. Where the relevant payment can be dissected into income and capital components, the income components will be assessable income, under ITAA97 s 6-5(1). Capital components may attract capital gains tax. If the payment cannot be dissected the entire amount is treated as capital and taxed as a capital gain (McLaurin v FC of T (1961) 104 CLR 381, Allsop v FC of T (1965) 113 CLR 341 and FC of T v CSR Ltd 2000 ATC 4710). Finally, the impact of the restrictive covenant condition in the settlement needs to be considered as well as allowance for damage to AOD’s reputation in the industry. If AOD argues that the $1.5m is unliquidated damages and cannot be dissected into income and capital components then the entire amount will be assessable income under the capital gains tax provisions. The capital gain being the disposal of the asset, that is AOD’s right to sue for damages (Taxation Ruling TR 95/35). However, if the $1.5m can be dissected into component elements then: • The amount attributable to loss of sales revenue will be treated as ordinary income and assessable under s 6-5.

• Any amount that is an indemnity or recoupment of a deductible expense, which is not otherwise assessable income under s 6-5, will be an assessable recoupment under ITAA97 s 20-20. • Amounts attributable to damage to or sterilisation of AOD’s profit-making structure (Van den Berghs Ltd v Clark [1935] AC 431) or damage to business reputation will be treated as an assessable capital gain. • The amount received in relation to agreeing to the restrictive covenant will be a capital gain, namely CGT event D1 (ITAA97 s 104-35(1)). • The amount assessed as compensation for damage to business reputation will be of a capital nature and taxed as a capital gain. The underlying asset being business goodwill (FC of T v Murry 98 ATC 4585). AMTG: ¶10-020, ¶10-114, ¶10-115, ¶10-170, ¶10-175, ¶11-280

¶1-120 Worked example: Strata title body corporate; mutuality principle Issue The Eumeralla Road Body Corporate (Eumeralla) has been established to control, manage and administer ten separate strata titled residential units and associated common property. The strata title and body corporate has been registered and governed in Victoria under the Owners Corporations Act 2006 (Vic) and Subdivision Act 1988 (Vic). Each owner (proprietor) has a title comprising a two bedroom unit and a car park. The common property includes additional car parking, driveways, garden, as well as unit access areas. During the 2019/20 income year, the following income was received by Eumeralla: • monthly fees contributed by each proprietor to the body corporate common fund • a fine paid by one proprietor who breached the by-laws — equivalent to one month of fees • interest on late payment of monthly fees • interest on the Eumeralla Common Fund bank account, and • lease fees of $200,000 received from a billboard advertising company placing advertising on the outside facing wall (common property). What is the tax treatment for income received by Eumeralla and/or the proprietors for the 2019/20 income year? Solution A strata title body is a company for income tax purposes (Taxation Ruling TR 2015/3). A strata title body corporate is constituted by the proprietors but is a separate legal entity with specified powers, authorities, duties and functions. These include: • the power and authority to impose a levy on the proprietors, to make by-laws, to carry out necessary work, to invest and to borrow, and • the duty and function to control, manage and administer the common property, to maintain the common property and keep it in a good state of repair, to effect insurances on the building and common property and to keep records and books of account. The tax treatment of the income amounts received by Eumeralla is as follows: Monthly fees The principle of mutuality applies where an amount will not be included in its assessable income under

ITAA97 s 6-5 that is otherwise assessable to the strata title body corporate. Amounts levied on proprietors by a strata title body in accordance with the state or territory Acts which form part of a fund used for the day-to-day expenses, general maintenance and repair of common property or for the establishment of special purpose funds as set out under those Acts are mutual receipts and are not assessable to Eumeralla (Taxation Ruling TR 2015/3). Fines for breaching Eumeralla by-laws The amount paid to Eumeralla by the proprietor was paid outside the normal capacity as member of the body corporate. Accordingly the mutuality principle does not apply. This amount will be considered assessable income of Eumeralla under ITAA97 s 6-5. Interest on late payment of monthly fees The payment of the monthly fees represent the proprietor’s share in the mutual liabilities of Eumeralla and are considered mutual receipts. The interest is imposed to compensate the other proprietors for a measurable detriment suffered by the common fund. On this basis, the interest amount is akin to the monthly fees and treated as a mutual receipt. The interest is non-assessable to Eumeralla. Interest on bank account The income from the bank account is a non-mutual receipt and assessable income to Eumeralla. Lease fees from advertising company Under Victorian legislation, common property is owned by the proprietors and not owned by the body corporate as trustee. Similar rules apply in other states and territories under strata legislation. Accordingly, income from common property is assessable to the proprietors and not Eumeralla. In this case, each of the proprietors would include the tenth share of the $200,000 ($20,000) as assessable income. Tax return Eumeralla is required to lodge a strata title body corporate tax return and include the income from the fines and the bank interest as assessable income. Eumeralla is permitted to pay franked dividends to the proprietors. AMTG: ¶3-550, ¶3-810

¶1-140 Worked example: Mutuality principle; taxable income on apportionment of expenses Issue The Pankhurst Panthers are a licensed AFL women’s football club operating since 1903. They have an active social club that provides food and beverages to members after training and game days. With the introduction of the AFL women’s league in 2017, there has been more interest in women’s football and they regularly have guests being signed in by members to various functions. The club’s financial records for the 2019/20 income year show the following: Income

$ Membership fees

 60,000

Trading

675,000

Investment

175,000

Sponsorship by the local independent grocery store

250,000

Expenses

$ Uniforms, training equipment, insurance and AFL fees

157,500

Food and beverage expenses

425,000

Investment

 17,500

The club cannot directly identify the food and beverage income or expenses that relates to members and non-members. The club had 120 members for the year. There were 80 non-members that signed in for functions during the year of which 60 were member guests and 20 were visitors. On average 50 members attended each game day and recovery session. The club was open each Saturday and Sunday for 25 weeks. What is the taxable income of the Pankhurst Panthers for the 2019/20 income year? Solution A club whether incorporated or not is treated as a company for tax purposes. Taxable income is defined as the difference between assessable income (ITAA97 s 6-5) and allowable deductions (ITAA97 s 8-1). Income Clubs are owned by their members and provide funds for a common purpose. The principle of mutuality recognises that a person’s income consists only of moneys derived from external sources, so any money supplied by a member to the club would not be considered income (Taxation Ruling TR 2015/3). As a general principle, where a number of people contribute to a common fund created and controlled by them for a common purpose, any surplus arising from the use of that fund for the common purpose is not income (Colonial Mutual Life Assurance Society Ltd v FC of T (1946) 73 CLR 604, The Social Credit Savings & Loans Society Ltd v FC of T 71 ATC 4232). As a mutual receipt cannot be treated as “income”, it does not form part of “exempt income”. Accordingly, a club would only be assessable on the trading income relating specifically to non-members and on income received from sources outside its general trading activities (Bohemians Club v Acting FC of T (1918) 24 CLR 334). Deductions Under ITAA97 s 8-1, expenditure incurred in gaining or producing assessable income is an allowable deduction, except to the extent that it relates to gaining exempt income or is of a capital, private or domestic nature. Accordingly, expenses incurred by a club can be classified for income tax purposes as follows: a) Non allowable: expenses relating specifically to members. b) Wholly allowable: expenses relating specifically to non-members and expenses relating to wholly assessable income (eg investment expenses). c) Partly allowable: expenses which are apportionable between members and non-members. The allowable proportion may be determined by applying the non-member percentage to the expenses incurred. The following formula, from the decision in “The Waratahs” Rugby Union Football Club v FC of T 79 ATC 4337 (the Waratahs’ Formula) is used for providing clubs with a basis for calculating the non-member percentage: (B × 75%) + C / ((R × S × T) + A) × 100 / 1 Where: A = total visitors for the year of income B = members’ guests, ie those visitors who are accompanied to the club by a member and signed in by that member C=A−B R = the average number of subscribed members in the year of income S = the percentage of members who attended the club on a daily basis T = the number of trading days in the year of income.

Applying these rules to the Pankhurst Panthers, the non-member percentage is: (60 × 75%) + (80 − 60) / (120 × 50/120 × 50) + 80 × 100/1 = 65 / (2,500 + 80) × 100/1 = 2.52% (the “non-member percentage”). The mixed taxable income that cannot be identified is $250,000, that is $675,000 (trading income) less $425,000 (food and beverage expenses). The taxable income attributed to non-members and treated as taxable income by the club is calculated by applying the non-member percentage to the mixed taxable income, ie $250,000 × 2.52% = $6,300. The amounts that are considered mutual are the membership fees, and accordingly, the uniforms, training equipment, insurance and AFL fee amounts are non-deductible as they have not been incurred in producing assessable income. The remaining amounts are from external sources and should be treated as taxable income. The taxable income for the 2019/20 income year is $413,800 calculated as follows: Income

$ Investment

175,000

Sponsorship by the local independent grocery store

250,000

Non-member attribution based on Waratah’s ratio

 6,300 431,300

Less: Expenses Investment TAXABLE INCOME

  17,500 413,800

AMTG: ¶3-810, ¶3-820, ¶3-830

¶1-160 Worked example: Excess superannuation contributions Issue Liz Masselli is aged 41 and runs her own landscaping business. Her taxable income from business activities is $101,000 for 2019/20. Liz is an Australian resident with sufficient private health insurance. For the 2019/20 financial year, Liz contributes $33,000 to her superannuation fund and claims a tax deduction for all of the contributions. What are the tax consequences for Liz of the $33,000 contribution? Solution If an individual claims a tax deduction for contributions made on their own behalf to a superannuation fund, the contributions are “concessional contributions”. An individual also has concessional contributions if an employer makes contributions for that individual. An individual has excess concessional contributions for a year if their concessional contributions exceed their concessional contributions cap for the year (ITAA97 s 291-20). For an individual, the concessional contributions cap is $25,000 for 2019/20. The consequences for an individual of having excess concessional contributions are: • the excess concessional contributions are included in assessable income and taxed at ordinary tax rates (s 291-15(a))

• a non-refundable tax offset equal to 15% of the excess concessional contributions reduces the tax liability (s 291-15(b)) • excess concessional contributions charge may be payable (TAA Sch 1 s 95-10), and • the excess concessional contributions retained in the superannuation fund are treated as nonconcessional contributions. An individual may elect to release from superannuation up to 85% of their excess concessional contributions for the year (TAA Sch 1 s 96-5). The amount is capped at 85% because the remaining 15% represents the tax liability that the fund incurred when it received the contributions. The amount would be paid by the individual’s superannuation fund to the Commissioner (TAA Sch 1 s 96-20) who would credit the amount against the individual’s tax liability (TAA Sch 1 s 96-50). The released amount is nonassessable non-exempt income (ITAA97 s 303-15). Tax consequences for Liz from the excess concessional contributions The tax consequences for Liz when she has taxable income of $101,000 and concessional contributions of $33,000 for 2019/20 are as follows: 1. Liz has excess concessional contributions of $8,000 because the concessional contributions cap for an individual is $25,000. 2. The $8,000 excess concessional contributions are included in Liz’s assessable income and taxed at her ordinary tax rates. 3. The tax on $109,000 (ie $101,000 + $8,000) is $27,827. 4. Liz is entitled to a non-refundable tax offset equal to $1,200 (ie 15% of $8,000), which reduces her tax liability to $26,627 (ie $27,827 − $1,200). Medicare levy is $2,180 (ie 2% of $109,000), meaning that her total tax payable is $28,807. 5. Liz is liable to pay excess concessional contributions charge because her tax liability exceeds what would have been her tax liability if the excess contributions had not been included in her assessable income. As a result of the excess concessional contributions, Liz’s taxable income has increased by $8,000 and her additional tax is $1,920 (ie $8,000 × 37% + $8,000 × 2% − $1,200). Excess concessional contributions charge is payable on $1,920. The charge is calculated daily and the rate is based on the monthly average yield of 90-day Bank Accepted Bills published by the Reserve Bank plus a 3% uplift factor (Superannuation (Excess Concessional Contributions Charge) Act 2013 s 4). Liz may elect to release from superannuation up to $6,800, that is up to 85% of her excess concessional contributions for the year. The amount would be paid by Liz’s superannuation fund to the Commissioner who would credit the amount against Liz’s tax liability. The released amount is non-assessable nonexempt income. Where an amount is released from Liz’s superannuation fund, that amount (grossed-up for the contributions tax) is no longer counted as a non-concessional contribution. If Liz elected to release the full amount of $6,800, then the full $8,000 would no longer be counted as a non-concessional contribution. AMTG: ¶13-777, ¶13-780

¶1-180 Worked example: Income or capital; mere realisation or carrying on a business Issue In 1975, Joe Messina purchased five hectares of land 40 km from Sydney’s CBD. The land was used for agricultural pursuits, with produce sold through Sydney markets.

In the year 2000 the government proposed construction of an airport adjacent to Joe’s land. Subsequently, in 2005 Joe sold the land for $700,000 and used this entire amount to acquire a large block of land closer to Sydney with the intention of keeping the land as a retirement nest-egg. In 2017, Joe was approached by a real estate developer to construct eight townhouses on the land. Joe accepted the proposal and employed architects, builders and obtained development approval from the local council. Joe oversaw the development and engaged real estate agents to market the townhouses for sale upon completion. During the course of the 2019/20 income year seven townhouses were sold for $650,000 each. Joe retired to the remaining townhouse. Advise Joe Messina on whether the proceeds from his land and building transactions constitute assessable income and the basis on which they may be assessed. Solution Sale of the five hectares; income or capital Assessable income consists of ordinary income and statutory income (ITAA97 s 6-1(1)). Ordinary income is assessable under ITAA97 s 6-5(1), whereas statutory income is assessable under specific provisions, such as those relating to capital gains, that is ITAA97 Pt 3-1 and 3-3. An amount may be assessable as both ordinary and statutory income, in which case the specific provisions will apply (ITAA97 s 6-25). An example may be the disposal of an asset, such as land. The amount received may be assessed as ordinary income where the taxpayer is carrying on the business of land development (see FC of T v Whitfords Beach Pty Ltd 82 ATC 4031) or statutory income, for example capital gain where the taxpayer is merely disposing of a parcel of land (see Statham & Anor v FC of T 89 ATC 4070). Joe Messina’s original five hectares of land is a pre-CGT asset and can be disposed of free of CGT. However, a further issue must be considered, that is whether the sale of the land was a mere disposal of an asset or the proceeds from carrying on a business. Proceeds from the mere disposal of an investment are not assessable income (Scottish Australian Mining Co Ltd v FC of T (1950) 81 CLR 188), whereas the proceeds from carrying on a business are assessable as ordinary income. Even an isolated transaction or an extraordinary transaction may be assessable (FC of T v Whitfords Beach Pty Ltd 82 ATC 4031; FC of T v The Myer Emporium Ltd 87 ATC 4363). In Joe’s case the purchase and sale of the land does not meet the indicia for carrying on a business (Californian Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904) 5 TC 159). Joe did not enter into the transaction to sell the land with the intention to make a profit (Whitfords Beach; Myer Emporium). The factors the Commissioner considers in determining whether an isolated transaction amounts to a business are set out in Taxation Ruling TR 92/3. Hence, the $700,000 proceeds from the sale of the land are not assessable income. They are exempt from CGT and do not result from carrying on a business or constitute an isolated or extraordinary transaction on the authority of Whitfords Beach and Myer Emporium. The amount is not assessable on the principle that the proceeds from the mere realisation of a capital asset are not assessable as ordinary income (Statham & Anor v FC of T 89 ATC 4070; Casimaty v FC of T 97 ATC 5135; McCorkell v FC of T 98 ATC 2199). Sale of the townhouses The acquisition of the large block of land constitutes a post-CGT asset, with a cost base of $700,000. The sale of the seven townhouses constitutes the disposal of an asset and prima facie attracts CGT. However, it may be argued that the proceeds are normal proceeds from carrying on a business. The distinction between capital gains and carrying on a business is important because the amount of tax payable may differ. For example, capital gains may attract a 50% discount and some deductions against income from carrying on a business may not add to the cost base for CGT purposes. The tax-free proceeds from the mere disposal of a pre-CGT asset/investment do not apply in the case of post-CGT assets/investments. Had Joe Messina not been involved in the design, council approval, building and marketing of the completed townhouses it could not be said that he was carrying on a residential construction business —

in which case the profit on the sale of the townhouses would be assessable as a capital gain and the gain, discounted by 50% would be added to Joe’s assessable income for the year or years in which the sales took place. The capital proceeds would be $4,550,000. The first element in the cost base, the $700,000 purchase price for the land would need to be apportioned because Joe is retaining one of the eight townhouses for his own use. However, on the facts, Joe Messina took an active role in the development and sale of the seven townhouses and this reflects a number of the indicia applicable to carrying on a business, including profit motive, scope of the activity, personal effort and involvement, employing or sub-contracting staff and the commercial nature of the project. Consequently, it is likely that Joe will be held to be carrying on a business and the normal proceeds from carrying on a business are assessable income (Taxation Ruling TR 97/11). AMTG: ¶10-000, ¶10-020, ¶10-105, ¶10-110, ¶10-112, ¶10-120

¶1-200 Worked example: Non-cash business benefits Issue Quantum Appliances manufactures electrical appliances which can be purchased direct from Quantum or from various large retailers. The appliances have a five-year warranty, but the warranty is only valid if installation, servicing and repairs are carried out by accredited Quantum sub-contractors. In March 2019, Quantum contacted all of its sub-contractors with news that there would be a prize given to the most valuable sub-contractor. This would be the individual who, by their work from July to December 2019, was judged to have made the greatest contribution to Quantum’s reputation and its business. In February 2020, George was judged to be the winner and his prize comprised: 1. a cash prize of $10,000 2. a family membership package for the Western Bulldogs Football Club, worth $600 3. a $1,000 voucher for work tools from a hardware outlet, and 4. a free consultation with a financial planner on structuring his business to maximise its tax benefits, worth $3,000. Advise George on how he would be taxed on the prizes he received? Solution As a general principle, the value of the prizes received by George from Quantum Appliances would be included in his assessable income (ITAA97 s 6-5). They would be treated as ordinary income derived from an earning activity or as a reward for services. Or they could be ordinary income because the receipt of the prizes is “incidental” to his normal income-earning activities — like the professional footballer in Kelly v FC of T 85 ATC 4283 whose cash prize, when he was voted best and fairest player for the year, was ordinary income because it was incidental to his employment as a professional footballer. To be ordinary income, however, the prize must be cash or capable of being converted into cash. In FC of T v Cooke and Sherden 80 ATC 4140, holidays provided by a manufacturer to retailers who sold the manufacturer’s goods were held not assessable as ordinary income because they were not cash or convertible into cash. The Cooke and Sherden decision showed that non-cash business benefits could escape tax if structured so that they were not convertible into cash, and s 21A was introduced into ITAA36 in 1988 to overcome the loophole. Section 21A provides that, in determining a taxpayer’s income, a “non-cash business benefit” (ie property or services provided in respect of a business relationship) that is not convertible into cash is to be treated as if it is convertible into cash. The benefit may then be included in the taxpayer’s assessable income at

its arm’s length value. Section 21A does not apply in three cases: (i) where the cost of the benefit is nondeductible entertainment expenditure to the provider of the benefit (ITAA36 s 21A(4)), (ii) to the extent the taxpayer would have been entitled to a once-only deduction if the taxpayer had incurred expenditure on the benefit rather than it being provided by someone else (ITAA36 s 21A(3)), and (iii) where the value of non-cash business benefits received in the year does not exceed $300 (ITAA36 s 23L(2)). How would George be taxed on the prizes he receives? The cash prize of $10,000 would be ordinary income. If the other benefits are convertible into cash, they would be assessable at their money value (ITAA36 s 21). If they are not convertible into cash, the three non-cash business benefits may be treated as if they are convertible into cash and included in George’s assessable income at their arm’s length value — unless one of the exceptions to s 21A applies. The consequence for George from receiving the benefits would be: 1. the arm’s length value of the football membership package would not be included in George’s assessable income because it would be non-deductible entertainment expenditure (s 21A(4)) 2. the arm’s length value of the voucher for tools would not be included in George’s assessable income on the assumption that, if the cost of the tools had been incurred by George, he would have been entitled to a once-only deduction as a business expense (s 21A(3)), and 3. the arm’s length value of the consultation would be included in George’s assessable income because it is capital expenditure (being paid for advice on “structuring” his business) and would not entitle George to a once-only deduction if he incurred the expense himself. AMTG: ¶10-030, ¶10-895

¶1-220 Worked example: Lease incentive payments Issue Southfield Limited, a shopping mall developer, opened a new shopping complex in June 2019. To attract business Southfield offered Big M, a national supermarket retailer, a lease incentive package to become a tenant in the complex. Big M accepted the offer in July 2019. The incentive package comprised a $50,000 payment to compensate Big M for surrendering the lease at their then current location and $75,000 to enter into the lease in the new complex. In addition, Big M was offered the first month’s tenancy rent-free (saving Big M $30,000); provision of motor vehicles for four senior executive staff; the gift of computer hardware and software; and free-fit out of furnishings and fittings (with Southfield retaining ownership of the furnishings and fittings). Southfield also agreed to provide an all-expenses paid holiday for senior executives of Big M at the end of the first year of the lease on the condition that Big M renewed the lease for a further year. Advise Big M on whether the lease incentive package constitutes assessable income and, if so, the tax treatment of components in the package. Solution In advising Big M on whether lease incentive payments constitute assessable income it is necessary to distinguish between cash and non-cash payments or incentives. Non-cash incentives may or may not be convertible into cash. For some types of lease incentive payments the recipient would be entitled to a tax deduction had the recipient incurred the expense. The application of the otherwise deductible rule may also have a bearing on the tax treatment of lease incentive payments. Payment of $50,000 to compensate Big M for surrendering the lease at their current location A lease surrender payment is assessable income and taxed under the ordinary income provision, ITAA97 s 6-5(1), because it is either a receipt in the ordinary course of carrying on a business of trading in leases or an ordinary incident of business activity, even though it may be an unusual or extraordinary transaction.

If s 6-5(1) is found not to apply, the payment may be assessable as a profit or gain from an isolated business transaction and taxed under ITAA97 s 15-15(1) (see Rotherwood Pty Ltd v FC of T 96 ATC 4203 and Taxation Ruling TR 2005/6). Payment of $75,000 to Big M to enter into a lease in the new complex This is also a cash incentive payment and is assessable income on a similar basis as the lease surrender payments. In FC of T v Cooling 90 ATC 4472, where a firm of solicitors was offered a lease incentive payment to move into new premises, the Full Federal Court held that: “Where a taxpayer operates from leased premises, the move from one premises to another and the leasing of the premises occupied are acts of the taxpayer in the course of its business activity just as much as the trading activities that give rise more directly to the taxpayer’s assessable income.” The High Court endorsed the Cooling decision in FC of T v Montgomery 99 ATC 4749. First month tenancy rent-free The rent-free incentive is a non-cash benefit that is not convertible into cash. Given that Big M would qualify for a tax deduction had Big M paid the rent, the otherwise deductible rule applies and the taxing provision for non-cash business benefits, in ITAA36 s 21A, does not apply. The rent-free saving of $30,000 is tax-free. Provision of motor vehicles for senior executive staff The motor vehicles constitute non-cash benefits that are convertible into cash and are assessable to tax at their full monetary value, under ITAA36 s 21 and 21A. Gift of computer hardware and software If Big M is given plant or articles such as a computer, the arm’s length value of those items will be assessable to it by virtue of s 21A(2), but Big M will be entitled to deductions for depreciation. Free-fit out with Southfield retaining ownership of the furnishings and fittings The free fit-out of the furnishings and fittings is a non-cash, non-convertible incentive or benefit and is taxfree to Big M because ownership of the furnishings and fittings remains with Southfield. The issue of a lease incentive fit-out benefit was considered by the Federal Court in Lees & Leech Pty Ltd v FC of T 97 ATC 4407, where the court distinguished Cooling and Rotherwood and held that s 21A was not applicable. All expenses paid holiday for senior executives of Big M A complete holiday package comprising travel, accommodation, meals and recreation will effectively be tax-free to Big M, as the cost will not be deductible to the landlord. The taxable value of a non-cash business benefit is reduced to the extent to which any expenditure incurred in providing the benefit is nondeductible entertainment expenses (ITAA36 s 21A(4)). The Commissioner’s opinion on the tax assessment of non-cash lease incentive payments or benefits is summarised in Taxation Ruling IT 2631. AMTG: ¶10-030, ¶10-116

¶1-240 Worked example: Australian resident or non-resident Issue Adam Collins was born in Australia and works as an international airline pilot. He is married to Narelle and they have two school aged children. Adam and Narelle own a house in Sydney and receive interest on savings from their joint Australian bank account. Adam pays for Australian private health insurance for the family and has share investments in the airline on which he receives dividends. From 1 November 2018 until 1 April 2019, Adam was based at the airline’s hub in Dubai and lived in an apartment leased by the airline. The airline paid five months of Adam’s $500,000 annual salary directly into a bank account that he established in Dubai. Adam took annual leave in December and returned to Australia to spend Christmas with the family.

In May 2019, Adam accepted an offer to relocate with Narelle to Dubai for an indefinite period. The couple flew to Dubai on 1 July 2019. They established a joint bank account with a local bank and in November 2019 purchased an apartment close to Dubai airport. The children moved to a boarding school in Sydney. Adam and Narelle maintained their joint bank account and private health insurance in Australia and rented out their Sydney home. Adam took six weeks of annual leave during December 2019 and January 2020 and returned to Australia with Narelle to spend time with their children and inspect their home. Advise Adam Collins as to whether he is an Australian resident or non-resident for tax purposes for the 2018/19 and 2019/20 years. Solution Residency status will have a bearing on Adam’s assessable income from various sources. The determination of a taxpayer’s residence is a question of fact based on the particular circumstances and determined on a year by year basis (Taxation Ruling TR 98/17). There are both common law and statutory tests for determining the resident status of a taxpayer. The common law test, based on ordinary concepts, was derived from Levene v Inland Revenue Commissioners [1928] AC 217 and Inland Revenue Commissioners v Lysaght [1928] AC 234, whereas the statutory tests are found in ITAA36 s 6(1). Factors to consider in the common law test include: • where the taxpayer is physically located during the year of income • the frequency and regularity of the taxpayer’s visit to the country concerned • whether the taxpayer maintains a place of abode in Australia • any business and family ties the taxpayer has with Australia, and • the taxpayer’s daily habits and way of life. Further factors to consider include: • the taxpayer’s intention or purpose of presence • family and business/employment ties • maintenance and location of taxpayer’s assets, and • social and living arrangements. (See Taxation Ruling TR 98/17.) Section 6(1) provides the following statutory tests to determine residency. 1. The domicile test: A person whose domicile is in Australia is a resident of Australia, unless the Commissioner is satisfied that the person has a “permanent” place of abode outside Australia. Permanent here means something less than everlasting. The test was applied in FC of T v Applegate 79 ATC 4307, FC of T v Jenkins 82 ATC 4098 and Harding v FC of T 2019 ATC ¶20-685. 2. The 183-day rule: A person who is actually in Australia continuously or intermittently during more than half the year of income is a resident of Australia unless the Commissioner is satisfied that: i. the person’s usual place of abode is outside Australia, and ii. the person does not intend to take up residence in Australia. In applying this test a distinction needs to be drawn between a person initially in Australia and then moving overseas and a person from overseas coming to Australia. See Case S19 85 ATC 225 for an illustration of the application of this rule.

For the 2018/19 year Adam is away from Australia for five months. However, his domicile is in Australia and he has not established a permanent place of abode outside Australia as evidenced by his established ties in Australia and his temporary residence in Dubai. Further, on the basis of the 183-day rule, Adam’s usual place of abode is not outside Australia. Applying the common law factors, Adam has maintained his family, home and financial ties with Australia and has re-visited Australia during his overseas deployment. For the 2018/19 year it can be concluded that Adam Collins is an Australian resident. Adam’s residency status may have changed in the 2019/20 year. The facts suggest that Adam’s permanent place of abode may be outside Australia. His employment in Dubai is for an indefinite period, he has purchased an apartment in Dubai (although according to Harding, the answer may be the same if he merely leased an apartment) and he has established an account with a bank in Dubai. Also, the fact that Narelle has joined him to live in Dubai and that he has rented out their Australian property suggests that Adam has severed ties with Australia. Although Adam has not severed all ties with Australia, that is he has maintained ownership of the family home, retained Australian private health insurance and continued to school his children in Australia, it may still be reasonable to conclude that Adam Collins was a non-resident for the 2019/20 year of income. AMTG: ¶21-000, ¶21-010, ¶21-020

¶1-250 Worked example: Residence: meaning of permanent place of abode Issue Richard Barton was born in Australia and lived here until February 2017. Shortly before that date, he was offered a position working for a major international bank in Dubai, United Arab Emirates. Richard moved to Dubai in February 2017. His wife, Jane, and 14-year-old son initially remained in their family home in Adelaide, South Australia with the intention of joining Richard once the school year had ended and alternative schooling had been found in Dubai. Richard sold his car and boat, and took his remaining personal possessions to Dubai with him. He did not intend to return to Australia. Richard moved into a two-bedroom fully furnished apartment at Khalifa Towers, near Dubai Marina, of a type much frequented by expats working in Dubai. The intention was that the apartment would provide an initial base for Richard and that his wife could then join him there whilst they searched for a permanent residence more suitable to their family situation. In November 2017, Jane took the decision to remain in Australia and in February 2019, Jane and Richard divorced. Following Jane’s decision not to relocate to Dubai, Richard moved into a one-bedroom fully furnished apartment in the same complex in January 2018. In June 2019, he began a new relationship with Heather, a journalist based in Dubai and in March 2020, they decided to co-habit, moving into a twobedroom fully furnished apartment at a different complex near the airport. Richard returned to Australia for 28 days from 8 December 2017 to try to persuade his wife to reconsider her decision and for a further 26 days from 14 December 2018 in order to spend time with his son. Richard has not submitted tax returns for the 2018/19 or 2019/20 income years and wishes to understand whether he needs to declare his income from his Dubai employment — the equivalent of about $250,000 per year — to the ATO. Solution Australian tax residents are assessed on their worldwide income, whilst foreign residents are only assessed on income derived from sources in Australia (ITAA97 s 6-5 and 6-10). Therefore, the key to determining whether or not Mr Barton’s Dubai employment income is assessable in Australia or not is his residency status. A very similar situation was considered by the Full Federal Court (the Full Court) in Harding v FC of T 2019 ATC ¶20-685; [2019] FCAFC 29. In that case, Mr Harding took up residence in Bahrain as a result of an employment-related move to the Middle East. Like Mr Barton, he moved between a series of furnished apartments as a result of changes to his personal circumstances (including the failure of his marriage), without ever leaving Bahrain or returning to Australia, except for short family visits.

The starting point to determine an individual’s residency is to consider the place they actually reside — the “resides” test. The dictionary definition of “reside” is “have one’s settled abode, dwell permanently or for a considerable time, live in or at a particular place”. Whilst physical presence alone may be insufficient evidence of residence, it does seem to be a prerequisite to a finding of residence in a particular place. Certainly, in the Harding case, there was no doubt that the taxpayer did not “reside” in Australia for the purposes of the “resides” test. Therefore, on the basis that Mr Barton was in Dubai throughout the tax years in question (with the exception of two visits of less than a month each to Australia for family reasons), it seems clear that Mr Barton would also not be regarded as resident in Australia under the “resides” test. However, having failed the “resides” test, it is then necessary to consider the three statutory tests set out in ITAA36 s 6(1). Of these, the only relevant test is the “domicile” test which states that a person who was born in Australia is domiciled in Australia — and therefore resident here — unless the Commissioner is satisfied that the person’s “permanent place of abode” is outside Australia. Throughout the period in question, Mr Barton lived in Dubai but in three different apartments. Can it therefore be said that his permanent place of abode was Dubai throughout the period? If not, he would be domiciled in Australia and therefore resident in Australia for tax purposes. The Federal Court’s decision in Harding v FC of T 2018 ATC ¶20-660; [2018] FCA 837 held that a permanent place of abode must be a particular dwelling. However, Mr Harding appealed. The Full Court rejected the Federal Court’s construction of the phrase “permanent place of abode” as a reference to a specific permanent dwelling (such as a particular house or apartment), finding that the Federal Court’s focus on Mr Harding’s specific accommodation (his fully furnished apartment) was too narrow a construction of a “place” of abode. The Full Court held that the reference to “place” in the “permanent place of abode test” was not strictly a reference to a person’s specific dwelling, but could instead be to the town or country in which a person is permanently residing. The Full Court found that if a person has definitely abandoned their residence in Australia, there should be no distinction between someone who buys an apartment overseas and someone who lives in a series of temporary flats in the same country (as Mr Harding did in the Harding case and as Mr Barton does in this example). Therefore, the fact that Mr Harding’s specific type of accommodation in Bahrain was somewhat “temporary” or “transitory” (because it was fully furnished and Mr Harding intended to move once his family circumstances were resolved) did not prevent the Full Court from concluding that his “place of abode” was Bahrain. Because that place was outside of Australia, Mr Harding was not a resident of Australia for tax purposes. Applying those principles to Mr Barton, it can be said that his permanent place of abode was Dubai, not Australia. Accordingly, Mr Barton is not domiciled in Australia and is not therefore a resident of Australia for tax purposes for the purposes of the “domicile” test. The other two statutory tests — the “183-day” test and the “superannuation” test — are not relevant. Mr Barton is not a resident of Australia for tax purposes for the 2018/19 and 2019/20 tax years and the income arising from his employment in Dubai is not therefore assessable in Australia. AMTG: ¶10-000, ¶21-010, ¶21-020

¶1-260 Worked example: Source of income for resident or non-resident Issue Yvonne Merrick, the holder of a British passport and a relevant working visa, arrived in Australia from the UK in January 2009 and started work as an administrator in a Brisbane hospital. On 10 July 2018 she travelled back to the UK for personal reasons and worked in odd jobs until 1 April 2019 when she returned to Brisbane and resumed her position at the hospital. While in the UK she continued to maintain the apartment she had bought in Brisbane and her Australian bank account. She was on “leave without pay” from her job at the hospital.

During the 2018/19 year Yvonne was paid $25,000 for her work in the UK and $15,000 for her work as an administrator in Australia. UK tax of $3,000 was deducted from her salary. She was paid a bonus of $12,000 on 15 February 2019 for her work in 2018. She also received $2,000 interest on the savings in her Australian bank account and a fully franked dividend of $700 from her share investments in the Australian company HAL Corporation Ltd. On 1 July 2019 Yvonne left Australia indefinitely to take up a full-time position as a senior administrator in a UK hospital. In the 2019/20 income year, she was paid a salary of $70,000 for her work in the UK hospital. Tax amounting to $7,000 was deducted from her UK salary. For the 2019/20 year Yvonne received interest of $2,400 on her Australian bank account and a fully franked dividend of $900 on her shares. Upon leaving Australia, Yvonne sold all of her furniture and leased the apartment she owns for $600 per week. For the 2019/20 year she received $23,400 rental income. Advise Yvonne as to her Australian assessable income and tax payable for the 2018/19 and 2019/20 tax years. Solution An Australian resident is assessed on both their Australian and foreign source income, whereas a nonresident is only assessed on their Australian source income (ITAA97 s 6-5(2) and 6-5(3)). Each financial year is considered in isolation. So it is first necessary to determine whether Yvonne is a resident or non-resident for each year in question, and then determine the source of the income under consideration. The source of income is “what a practical man would regard as a real source of income” and the ascertainment of the real source of income is a “practical hard matter of fact” (Nathan v FC of T (1918) 25 CLR 183). The courts have established principles that apply to various categories of income, such as, wages and salaries, rent, interest and dividends. Australia is not Yvonne’s domicile of origin but has been her domicile of choice since her arrival in January 2009. From 10 July 2018 until 1 April 2019 Yvonne was absent from Australia. Under the domicile test (ITAA36 s 6(1)), Yvonne would be deemed to be a resident of Australia unless the Commissioner is satisfied that her permanent place of abode is outside Australia. In Yvonne’s case there is no evidence that her permanent place of abode was outside Australia as she maintained her residence, employment situation and bank account in Australia. It can be concluded therefore that Yvonne was a resident for the 2018/19 income year and would be assessed on both her Australian and foreign source income. It is apparent that in 2019/20 Yvonne is no longer a resident. On the domicile test her permanent place of abode is outside Australia, even though she has not sold her apartment and maintains her bank account and share investments in Australia. Yvonne has taken on a new role in her industry in the UK and has left the Australian hospital, by contrast with doing odd jobs in the previous year. On the authority of FC of T v Applegate 79 ATC 4307, Yvonne would be held to be a non-resident for 2019/20 and would only be assessed on her Australian source income. 2018/19 assessable income As an Australian resident Yvonne will be assessed on both her Australian and foreign source income. $ UK salary Add back foreign tax

22,000 3,000

Australian salary

15,000

Australian bonus

12,000

Bank interest Fully franked dividend

2,000 700

Gross-up dividend

 300

Assessable income

55,000

Income tax payable

9,422

Less tax offsets  Foreign tax offset

3,000

 Dividend imputation credit

 300

NET TAX PAYABLE*

6,122

*Assume there are no tax deductions and exclude the Medicare levy.

2019/20 assessable income As a non-resident Yvonne is only assessed on her Australian source income. $ Income subject to withholding Bank interest Withholding rate per UK DTA Tax payable

2,400 10% 240

Income subject to non-resident rates Income from rent

26,000

Tax payable

8,450

TOTAL TAX PAYABLE*

8,690

*Assume there are no tax deductions and exclude the Medicare levy.

As Yvonne is a non-resident her fully franked dividend is excluded from her assessable income under ITAA36 s 128D. It is regarded as non-assessable non-exempt income under ITAA97 s 6-23. In FC of T v French (1957) 98 CLR 398 and FC of T v Mitchum (1965) 113 CLR 401, the courts held that the source of wages and salary income is the place where the work is performed. In Yvonne’s case, the place where she performed the work to receive her salary (after tax) of $63,000 was the UK. That salary income has a non-resident source and therefore does not form part of Yvonne’s Australian assessable income. Proceeds received by Yvonne from the sale of her furniture would not be included in her assessable income. The proceeds are not ordinary income and would not be caught by the CGT provisions (ITAA97 s 108-20). AMTG: ¶21-000, ¶21-010, ¶21-020, ¶21-060, ¶21-670

¶1-280 Worked example: Alienation of personal services income Issue Robert Richmond was employed by Roads North Ltd (RN) as an engineer to assist in the development of a major road infrastructure project. In July 2019 Robert’s employment was terminated and he was subsequently re-engaged as an independent contractor. In September 2019 Robert incorporated a company named Richmond Engineering Pty Ltd (REPL). Robert and his wife Vivien are the company’s directors and shareholders. REPL purchased a car and contracted with RN to provide the services previously supplied by Robert as an employee. During the 2019/20 income year RN was the only client of REPL. The income and expenditure of REPL for 2019/20 was as follows:

• fees from RN for engineering services — $180,000 • wages paid to Robert for working part-time as a draftsman — $25,000 • salary paid to Robert by REPL — $50,000 • salary paid to Vivien by REPL for accounting and secretarial services — $30,000 • car expenses (after reducing for personal use) — $6,000, and • superannuation contributions made by REPL on behalf of both Robert and Vivien — $30,000 ($15,000 each). Advise Robert as to his income tax position for 2019/20 and how he should manage his affairs in order to avoid the operation of the personal services income (PSI) regime in future years. Solution The PSI regime contained in ITAA97 Div 84 to 87 was enacted to prevent individuals reducing their assessable income and tax payable by alienating PSI to an associated entity (company, partnership or trust) or another individual and/or claiming deductions for certain losses and outgoings not available to employees. For tax purposes, “personal services income” is mainly a reward for an individual’s personal skill and effort, regardless of whether it is income of a personal services entity (PSE) (s 84-5), for example wages and salaries paid under a contract principally for the labour or services of an individual. Whether income is PSI is a question of fact depending on the circumstances (Taxation Ruling TR 2001/7). An individual’s PSI derived through a PSE is included in the assessable income of the individual, that is it is “attributed to” the individual (s 86-15(1)). A PSE is a company, partnership or trust whose ordinary or statutory income includes the PSI of one or more individuals (s 86-15(2)). The PSI attribution provisions do not apply if the income of the PSE is derived from conducting a “personal services business” (PSB) (s 86-15(1)). Since Robert is providing professional services through a PSE, that is REPL, he is subject to the PSI tax regime. Although, on face value, he received during 2019/20 the salary of $50,000 paid by REPL and draftsman’s wages of $25,000, the PSI provisions would apply. As a result, the income of $180,000 derived by REPL would be attributed to Robert and constitute his assessable income, subject to any deductions that he would be entitled to. Robert’s PSI will be reduced by losses or outgoings to which REPL would be entitled had Robert been entitled to the deductions as an employee (Div 85). On the facts stated, the allowable deductions are: • $6,000 — car expenses, and • $15,000 — superannuation contributions made by REPL on behalf of Robert Section 86-60 places Robert in the shoes of the PSE, that is REPL, and disallows a deduction if Robert could not claim a deduction in identical circumstances to REPL. Per s 85-20, a payment or an amount incurred arising from an obligation to an associate is not deductible to the extent the payment or amount relates to gaining or producing the individual’s personal services income, unless the payment made or the amount incurred is in relation to the performance of principal work. In this instance, “principal work” would be the provision of engineering services. Payments for accounting and secretarial work are not principal work and therefore the $30,000 paid to Vivien is not an allowable deduction (but nor is it taxable income to Vivian). Similarly, where an associate is engaged in producing assessable income that is personal services income, and the work performed is solely non-principal work, and the contribution is wholly in respect of that work, then no deduction is allowable for superannuation contributions (s 85-25). In this case, the provision of accounting and secretarial services is non-principal work so a deduction for the $15,000 superannuation contributions made by REPL on Vivien’s behalf is not available.

Therefore, Robert’s assessable income would include the PSI of REPL, that is $180,000, less the allowable deductions of $21,000 = $159,000. To avoid the operation of the PSI regime in 2020/21, Robert would need to carry on a PSB. A PSB exists if: • the “results test” is satisfied (s 87-18) • the 80% rule and any of the PSB tests (unrelated client, employment or business premises tests) are satisfied, or • a PSB determination is obtained from the Commissioner (s 87-60). (See Taxation Ruling TR 2001/8.) Results test Robert will satisfy the three conditions of the results test if: • in relation to at least 75% of his PSI during the year the income is for producing a result • he supplies his own equipment and any other necessary plant and equipment, and • he is or would be liable for the cost of rectifying any defects in the work performed. Note that an ordinary passenger motor vehicle, although a substantial asset, will not satisfy the requirement in the results test to supply plant and equipment or tools of trade. Vehicles potentially meeting this requirement include commercial vehicles or those specifically adapted or purpose built for the relevant work (TR 2001/7 para 88). 80% rule Robert will satisfy the 80% rule if less than 80% of the PSI is from one source and he satisfies any of the following tests: • the unrelated client test • the employment test, or • the business premises test. The unrelated client test would require Robert to make offers or invitations for his professional services to the public and provide those services to two or more unrelated clients (s 87-20). The employment test would require that Robert ensure that at least 20% of the market value of his work is performed by entities that are not his associates. The test could be met by employing unrelated persons to provide engineering services but it is not met by engaging a spouse or other family member to do nonprincipal work such as bookkeeping and secretarial services (s 87-25; TR 2001/8). The business premises test could be satisfied if Robert owned or leased premises for the conduct of his business that are physically separate from premises used for private purposes (s 87-30). PSB determination In some cases, the Commissioner may make a PSB determination if satisfied that although the entity did not meet one of the PSB tests during the year, this was only because of unusual circumstances applying to the entity in that year. To make the determination the Commissioner must be satisfied that the conditions in one or more of s 87-60(3A), (3B), (5) and (6) are met (s 87-65(3)). To avoid the operation of the PSI regime in 2020/21, Robert would be advised to ensure that the contract with RN included the three conditions to satisfy the results test. In addition he should consider structuring his business or operations so as to satisfy one or more of the 80% rule tests. AMTG: ¶30-600, ¶30-610, ¶30-620, ¶30-630, ¶30-660, ¶30-665, ¶30-670, ¶30-680, ¶30-690

¶1-290 Worked example: Personal services income: unrelated clients test; personal services business Issue Damien Deakin is a cyber security expert who is the sole director of Mondas Pty Ltd. Damien provides his services through the company to various large organisations such as government departments, universities, banks and utilities. The shares in Mondas Pty Ltd are owned by the Deakin Family Trust whose beneficiaries are Damien, his wife Stella, and the couple’s two children. Damien undertakes consultancy work with his clients to advise them on the security of their IT systems including finding the most efficient way to protect their systems, networks, software, data and information systems against any potential attacks. Mondas charges clients on an hourly basis for Damien’s consulting work. All of the company’s work to date has been obtained through agencies that match specialist IT experts with clients seeking IT solutions. He has undertaken assignments for eight end-user clients during the course of the year. In addition, the company maintains and regularly updates a LinkedIn profile to highlight the company’s services and Damien’s skills in cyber security. No clients have to date engaged the company’s services as a result of its exposure on LinkedIn. During the year ended 30 June 2020, the company has not paid Damien any remuneration. Damien wishes to pay the profits of the company to the Deakin Family Trust as “management fees” that will reduce the company’s taxable income to nil. He wishes to obtain tax advice on the feasibility of such a proposal. Mondas Pty Ltd does not employ any staff, other than Damien. Although much of the business of the company is conducted on the premises of clients, the management and administration of the company are done from a home office located in the attic of the Deakin’s home in Adelaide. Solution Personal services income (PSI) is income that is mainly a reward for an individual’s personal efforts or skills. As the income earned by Mondas is all derived from the specialist skills and knowledge of Damien, it is PSI. A special tax regime for PSI applies to prevent individuals from reducing their tax by deriving income through a business entity where the nature of the relationship between the individual and the ultimate customer is broadly similar to an employee relationship. Where it applies, the PSI regime has the following main effects: • PSI is included in the assessable income of the individual whose personal efforts or skills generated the income, notwithstanding that it was actually earned in some other entity (Mondas in this case) • there are restrictions on the deductions that may be claimed by the business entity, such that they broadly correspond to the deductions available to employees • the business entity may have additional PAYG withholding obligations. Income from the conduct of a genuine personal services business (PSB) is exempt from the PSI regime. There are various tests for determining whether a PSB is being conducted (ITAA97 s 87-15). There will be a PSB if: • the “results” test is satisfied • less than 80% of the PSI is from one source and any of three additional tests (the unrelated clients test, the employment test and the business premises test) are satisfied, or • a PSB determination is obtained from the Commissioner.

For an entity to satisfy the results test in a particular income year, it must satisfy the following three conditions in relation to at least 75% of PSI received during the year: • the income is for producing a result (eg delivering a completed software component, by contrast with performing a week of programming work) • there is a requirement to supply the plant and equipment or tools of trade needed to perform the work, and • the business is liable for the cost of rectifying any defect in the work performed or, where physical rectification is not possible, is liable for damages in relation to the defect. Based on the information provided, Mondas does not pass the results test as none of the revenue earned by the company is for producing a result. The company provides consulting services that are charged on an hourly basis and the client is free to act or not act on the basis of any advice that Damien provides on behalf of the company. It is therefore necessary to consider the other three tests, which are relevant because less than 80% of the PSI earned by the company is from one source (he had eight clients during the year). Regarding the other three tests, the employment test applies to work out if others were employed or contracted to help to complete the work that generates the PSI and the business premises test is applied to work out whether the business premises meet certain location and usage criteria. One of those is that the business premises must be physically separate from any premises used for private purposes (such as the home). As Mondas does not employ any other staff and operates from the home of Damien Deakin, neither test is met. This leaves the unrelated clients test to consider. An individual or a personal services entity meets the unrelated clients test under s 87-20(1) in an income year if: • the individual or personal services entity produces income from supplying work or services to two or more entities that are not associates of each other, and are not associates of the individual or entity, and • the services are provided as a direct result of the individual or personal services entity making offers or invitations, to the public at large or to a section of the public, to provide the services. An individual or personal services entity must fulfil both conditions to pass the unrelated clients test. For the purposes of s 87-20(1)(b), an offer or invitation is not made by an individual or personal services entity who is merely available to provide services through an entity that conducts a business of arranging for persons to provide services to its clients (s 87-20(2)). In practice, this means that individuals or personal service entities that obtain clients merely through registration with services such as employment agencies or labour hire firms (but do not otherwise advertise their services) are not regarded as having made an offer or invitation to provide services to the public at large or to a section of the public and would therefore fail the unrelated clients test. In Fortunatow v FC of T 2018 ATC ¶10-486; [2018] AATA 4621, similar facts were considered by the Federal Court which found that s 87-20(2) does not require an analysis of how services actually come to be provided (entirely through recruitment agencies in the case of Mondas). Instead, even though the work was obtained and carried out through an intermediary or recruitment agency, the Court found that the exclusion in s 87-20(2) does not apply where there is evidence of advertising to the public or a segment of the public (for instance, through online platforms such as LinkedIn). This judgment was overturned on appeal in FC of T v Fortunatow 2020 ATC ¶20-758; [2020] FCAFC 139, where the Full Federal Court stated that that the provision of services must be the “direct result” of making offers or invitations to satisfy the unrelated clients test. On the facts, none of the clients made their decisions to engage the services of the taxpayer as a direct result of any offer or invitation constituted by the taxpayer’s LinkedIn profile. In these circumstances, on a correct application of s 87-20(1)(b), the “unrelated clients test” was not satisfied. On the basis of the Fortunatow appeal, it appears that the unrelated clients test is not satisfied by Mondas

Pty Ltd, meaning that the PSI rules apply and the company is not treated as a PSB. The PSI earned within the company must therefore be attributed to Damien personally. In practice, whether or not the income is treated as PSI may be less significant than it seems to Damien, particularly with regard to his plan to divert the profits of the company to his family trust. Specifically, if the PSI rules did not apply to include the income of the company in Damien’s assessable income, there is still an expectation on the part of the Commissioner that PSI is ultimately taxed in the hands of the business principle even where the business is a PSB. If the PSI rules will not achieve that, ITAA36 Pt IVA can be applied to achieve a similar end (TR 2001/8, para 102). In particular, IT 2503 states that a professional practice company should have no taxable income. The total income for a year, after expenses, should be fully paid out to the professional person by way of a salary in the financial year (or where this is not possible, by way of a dividend paid as soon as possible after the end of the financial year). So, paying the income of the company to a family trust would risk the Commissioner invoking Pt IVA on the grounds that the diversion of income to the trust is a “scheme”. AMTG: ¶30-600, ¶30-670

¶1-300 Worked example: Allowances and reimbursements Issue Gordon Haddad is employed by Hardware and Software Technologies Ltd (HSTL) as an information technology engineer. The company’s head office is in Melbourne City and Gordon’s employment requires him to travel to regional areas and interstate. Gordon has negotiated a salary package comprising: • an annual salary of $95,000 • an entertainment allowance of $7,500 • a mobile phone and internet allowance of $10,000 • a living away from home allowance of $12,000 • reimbursement of car expenses for use of his own vehicle (based on kilometres travelled) at $1.20 per kilometre, and • a car parking space at the company’s head office in the city. Advise Gordon on the tax treatment of each component of the salary package and the items that are included in Gordon’s assessable income. Solution Gordon Haddad’s salary package includes a combination of ordinary income, allowances, reimbursements and fringe benefits. Apart from the ordinary income taxing provision in ITAA97 s 6-5, allowances or reimbursements may be assessable, or may be exempt under other taxing provisions. A distinction should be drawn between allowances and reimbursements (Taxation Ruling TR 92/15). Allowances are generally included in assessable income, under s 6-5, where they have a nexus with income-earning activities. Allowances may also be included in assessable income under ITAA97 s 15-2, if they are not caught by s 6-5 (ITAA97 s 15-2(3)(d)). Further, s 15-2 does not apply where the benefit to the employee constitutes a fringe benefit. A fringe benefit in the hands of the employee is non-assessable non-exempt income (ITAA97 s 6-23 and ITAA36 s 23L). A reimbursement is compensation for expenses incurred by the employee. The reimbursement is not included in the employee’s assessable income but may attract fringe benefits tax liability for the employer. Exceptions to the distinction apply to reimbursement of car expenses, which would normally be an expense payment fringe benefit. However, where the reimbursement is based on kilometres travelled the

reimbursement is an exempt fringe benefit and is made assessable, as an allowance, to the employee under ITAA97 s 15-70. From 1 July 2018, withholding obligations apply for payments in excess of 68 cents per kilometre (rising to 72 cents per kilometre from 1 July 2020), or where the total number of kilometres exceeds 5,000. This would apply to HSTL and Gordon as he is receiving $1.20 per kilometre. The living away from home allowance (LAFHA) is not treated as an allowance assessable to the employee but rather as a fringe benefit (FBTAA s 30). Gordon’s salary package The salary is ordinary income and is assessable to income tax under ITAA97 s 6-5. The entertainment allowance of $7,500 and mobile phone and internet allowance of $10,000 would be additions to Gordon’s assessable income, either as ordinary income under s 6-5 or specifically as an allowance under s 15-2. Being allowances rather than reimbursements they are not expense payment fringe benefits on which HSTL would be liable for fringe benefits tax. Gordon may be entitled to deductions in relation to the allowances expended on work-related activities. The $12,000 LAFHA, although an allowance, is treated as a fringe benefit (FBTAA s 30). It would not form part of Gordon’s assessable income. HSTL would be liable for fringe benefits tax. Although HSTL is liable for FBT on expense payment fringe benefits (FBTAA s 20), the reimbursement of car expenses based on distance travelled are exempt fringe benefits (FBTAA s 22). Rather, the reimbursement of Gordon’s car expenses will be included in his assessable income (s 15-70). Provision of a car parking space at the company’s head office in the city is a car parking fringe benefit (FBTAA s 39A) on which HSTL would be liable for fringe benefits tax. For Gordon it would be nonassessable non-exempt income and not included in his assessable income. AMTG: ¶10-050, ¶10-060, ¶16-390, ¶35-252, ¶35-340, ¶35-460

¶1-320 Worked example: Derivation; agreement for right to use proprietary software and related services Issue Apps Plus Pty Ltd (Apps) is an Australian software developer. On 1 July 2019, Apps entered into an agreement which provides a customer with the right to use a proprietary software product for a period of four years in consideration for the payment of a licence fee of $20,000. Under the terms of the agreement, Apps is only required to provide the customer with a copy of the software product. The company must also provide technical support for a period of 24 months in consideration for $5,000. Once the proprietary software is delivered to the customer, Apps has fulfilled its full contractual obligations. There is no scope for a refund and neither is there a policy of the company providing one as commercial practice. With respect to the additional services, there is no contractual obligation for Apps to make a refund in the event of non-use of those services or for any other reason. Again, there is no commercial practice for Apps of giving a refund in any circumstances. However, Apps may have contractual exposure to damages in the event that the technical support services are not provided upon request. Apps uses an accruals basis of recognising income for tax purposes. Advise Apps as to how the receipt of $20,000 for the license and the receipt of $5,000 for the provision of technical support should be accounted for in the 2019/20 year. Solution Taxation Ruling TR 2014/1 provides the Commissioner’s guidance with respect to derivation of income from agreements for the right to use proprietary software and the provision of related services. The ruling states that where an amount properly attributable to a contractual obligation is subject to a “contingency of repayment”, the amount is derived for the purposes of ITAA97 s 6-5 when the obligation is fully performed or the contingency of repayment otherwise lapses.

In particular, the amount properly allocated to the obligation converts from “unearned income” to “earned income” when the underlying obligation is fully performed, or the contingency of repayment otherwise lapses (see Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314). Therefore, where there is no “contingency of repayment”, the amount is derived when a recoverable debt arises in respect of the contractual fee. However, TR 2014/1 notes that a “contingency of repayment” does not arise where there is a potential exposure to damages pursuant to consumer protection law or damages in tort. In the present case, there is no contingency of repayment in respect of the software licence fee of $20,000. Apps has undertaken all that is required under the contract with its customer upon delivery of the software and, therefore, the licence fee is derived at the time a recoverable debt arises in respect of the contractual fee in the 2019/20 year. In contrast, with respect to the fee for technical services to be provided over 24 months, a contingency of repayment does exist in relation to the amount payable under the agreement (ie $2,000). In these circumstances, the point of derivation for the amount will occur progressively as the contingency of repayment lapses. As a general rule, TR 2014/1 states that the quantum of exposure to contractual damages in such instances might be expected to diminish progressively on a straight line basis over the terms of the agreement. Therefore, to reflect this, the amount of income that should be recognised for the 2019/20 year by Apps is $2,500 (which is referrable to the first 12 months of the service agreement). The balance of the fee would be assessed in the 2020/21 year. The total amount assessed to Apps under the agreement for the 2019/20 year is $22,500 (ie $20,000 + $2,500). AMTG: ¶9-030, ¶9-050, ¶10-010

¶1-340 Worked example: When is income derived; cash basis Issue Belinda Choy is a doctor previously employed by State Wide Medical (SWM) and currently working in sole practice. On 25 June 2017, while Belinda was employed by SWM, a bonus was declared for all employees. Belinda’s bonus was $7,500 which was paid to her bank account on 1 July 2017. For the 2017/18 year of income Belinda received an annual salary of $75,000 from SWM. She requested that she be paid $50,000 over the course of 2017/18 and the remaining $25,000 in September 2018. On 1 June 2018 Belinda qualified for long service leave and received a lump sum payment of $18,000. On 1 July 2018 Belinda resigned from SWM and established her own sole medical practice. Belinda employed a receptionist and a nurse. Belinda’s income and expenditure for 2018/19 and 2019/20 were as follows: 2018/19 Cash payments received from patients — $80,000 Unpaid patient accounts and Medicare reimbursements as at 30 June 2019 — $45,000 Medicare reimbursements — $30,000 Salary and wages for receptionist and practice nurse — $65,000 Sundry expenses — $8,500 2019/20 Cash payments received from patients — $120,000 Unpaid patient accounts and Medicare reimbursements as at 30 June 2020 — $34,000 Medicare reimbursements — $48,000

Receipt of unpaid patient accounts and Medicare reimbursements as at 30 June 2019 — $45,000 Salary and wages for receptionist and practice nurse — $72,000 Sundry expenses — $9,800 Advise Belinda Choy on her assessable income for the 2017/18, 2018/19 and 2019/20 income years. Solution It is necessary to determine whether a particular receipt is assessable income and also the relevant time period in which to bring it to account, that is the time at which income is derived. There are two recognised accounting methods for determining the year ordinary income should be brought to account. The cash or receipts method brings income to account when it is received or dealt with by the recipient (ITAA97 s 6-5 and s 6-5(4)), regardless of when it is earned, either before or after payment. The accruals or earnings method brings income to account when it is derived, regardless of when it is received. The year in which statutory income is brought to account is dictated by the specific rules pertaining to the particular type of transaction. Guidelines for choosing which method of tax accounting is likely to provide a substantially correct reflex of income in a given income year are set out in Taxation Ruling TR 98/1. The cash basis is appropriate for income derived by an employee, or for business income, derived from the application of the knowledge and skill of the business proprietor (C of T (SA) v Executor, Trustee & Agency Co of South Australia Ltd (1938) 63 CLR 108 (Carden’s case)). Where a business employs staff and/or equipment to produce income, the accruals method is more appropriate (Henderson v FC of T 70 ATC 4016). For professionals in sole practice, such as, accountants, solicitors or doctors, the cash basis is the correct method of tax accounting (see FC of T v Firstenberg 76 ATC 4141 and FC of T v Dunn 89 ATC 4141). On the other hand, for large professional practices where a number of employees or partners bring in the practice income the accrual basis is appropriate (Henderson). Belinda’s assessable income for 2017/18 Belinda’s salary of $75,000 is ordinary income and is included in her assessable income (ITAA97 s 65(1)). Even though $25,000 is not received until September 2018, it was derived in 2017/18 because it was dealt with as she directed (s 6-5(4)). Returning income on a cash basis requires Belinda to include the long service lump sum payment of $18,000 in her assessable income in the year in which it is received, that is 2017/18 rather than the year in which the leave is actually taken. The long service leave payment is assessable under ITAA97 s 83-80. The bonus of $7,500 although declared on 25 June 2017 was not paid until 1 July 2017. The amount is assessable in the year in which it is received and not when it is declared. The bonus would therefore be included in Belinda’s 2017/18 assessable income and not her assessable income for the 2016/17 year. Belinda’s assessable income for 2018/19 A sole practitioner in professional practice will return income on a cash basis (see Carden’s case and Firstenberg). Belinda will be assessed on the cash payments of $80,000 received from patients and the Medicare reimbursements of $30,000. Employing the cash accounting basis, the unpaid patient accounts and Medicare reimbursements of $45,000, as at 30 June 2019, are not included in Belinda’s assessable income for 2018/19. They will be included in the year in which they “come in” to Belinda, that is in 2019/20. Belinda will be entitled to a deduction for the salary paid to the receptionist and nurse of $65,000 and sundry expenses of $8,500. Belinda’s assessable income 2019/20 Belinda will be assessed on the cash payments of $120,000 received from patients and the Medicare reimbursements of $48,000. The receipt as at 30 June 2019 of the unpaid patient accounts and Medicare reimbursements of $45,000 from the previous financial year will be included in Belinda’s assessable income. The unpaid patient accounts and Medicare reimbursements as at 30 June 2020 of $34,000 are not

included in Belinda’s assessable income for 2019/20. They will be included in the year in which they “come in” to Belinda which is likely to be 2020/21. Belinda will be entitled to a deduction in 2019/20 for the salary paid to the receptionist and practice nurse of $72,000 and sundry expenses of $9,800. Summary of Belinda’s assessable income for 2017/18, 2018/19 and 2019/20 2017/18

2018/19

2019/20

$

$

$

Cash payments received from patients

80,000

120,000

Medicare reimbursements

30,000

48,000

Salary

75,000

Lump sum long service leave

18,000

Salary bonus

7,500

Receipt of unpaid patient accounts and Medicare reimbursements as at 30 June 2019

ASSESSABLE INCOME

45,000          

    

100,500

213,000

110,000

AMTG: ¶9-000, ¶9-030, ¶9-035, ¶9-050, ¶9-080, ¶10-050

¶1-360 Worked example: When is income derived; accruals basis Issue Multimedia Systems Pty Ltd (MSPL) is the manufacturer and supplier/retailer of home media and entertainment systems. MSPL not only manufactures and sells home media and entertainment systems but is also available to install the systems in customers’ homes. For the 2018/19 income year MSPL’s financial position was: Cash sales revenue

$260,000

Credit sales — accounts receivable as at 30 June

$85,000 (included in sales revenue for 2018/19)

For the 2019/20 income year MSPL’s financial position was: Cash sales revenue

$290,000

Credit sales — accounts receivable as at 30 June $95,000 During 2019/20, MSPL received instalment payments in advance that amounted to $40,000, although installations completed by the end of the year totalled $25,000. MSPL is required to provide a one-year guarantee/warranty. Industry experience has shown that guarantee/warranty claims amount to 5% of sales revenue. Calculate the assessable income for MSPL for the 2018/19 and 2019/20 income years. Solution There are two recognised accounting methods for determining the year ordinary income should be brought to account. The cash or receipts method brings income to account when it is received or dealt with by the recipient (ITAA97 s 6-5 and s 6-5(4)), regardless of when it earned. The accruals or earnings method brings income to account when it is derived, regardless of when it is received. Guidelines for choosing the appropriate tax accounting method are set out in Taxation Ruling TR 98/1.

The accruals basis is generally appropriate for manufacturing or trading businesses (see C of T (SA) v Executor, Trustee & Agency Co of South Australia Ltd (1938) 63 CLR 108 (Carden’s case) and J Rowe & Son Pty Ltd v FC of T 71 ATC 4001 and 71 ATC 4157), particularly when the following factors are present: • the taxpayer’s activities involve the sale of trading stock • the taxpayer’s outgoings in the day-to-day conduct of the business relate directly to income derived • the taxpayer relies on circulating capital or consumables to produce income, or • the taxpayer relies on staff and/or equipment to produce income. These factors apply to MSPL, which is a manufacturing and trading business. Two further issues must be considered, namely the treatment of instalment payments received in advance of installation and the provision for meeting guarantee or warranty claims. For MSPL operating on an accruals basis, the amount received as prepayment for installation of the home media systems can be treated as unearned income and included in assessable income, particularly if the unearned amounts are included in a suspense account (see Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314). If there is no provision for a refund of the outstanding installation amounts, as at 30 June 2020, then it would be appropriate to include the entire $40,000 in assessable income. However, if customers would be entitled to a refund should the installation not take place, then it would be appropriate to include in assessable income only the amount attributed to installations carried out, that is $25,000. The issue in relation to the guarantee/warranty is whether the total sales revenue should be brought to account or whether the estimated guarantee/warranty amount should be excluded from assessable income. The situation is to be contrasted with the facts in Arthur Murray (NSW) Pty Ltd v FC of T. Here there is only a contingent liability, so the entire sales revenue is brought to account as assessable income (Taxation Ruling IT 2648). MSPL would then be entitled to a deduction, under ITAA97 s 8-1(1), for any guarantee/warranty expense subsequently incurred (see FC of T v James Flood Pty Ltd (1953) 88 CLR 492 and New Zealand Flax Investments Ltd v FC of T (1938) 61 CLR 179). 2018/19 assessable income Sales revenue — $260,000 Add credit sales — accounts receivable as at 30 June 2019 — $85,000 Deduction guarantee/warranty — $17,250 (in the year in which it is incurred) 2019/20 assessable income Sales revenue — $290,000 Less credit sales — accounts receivable as at 30 June 2019 — $85,000 (included in sales revenue for 2017/18) Add credit sales — accounts receivable as at 30 June 2020 — $95,000 Instalment payments in advance — $40,000 Deduction guarantee/warranty — $15,000 (5% × $300,000) (in the year in which it is incurred) Assessable income summary for 2018/19 and 2019/20 2018/19

2019/20

$

$

Sales revenue

260,000

290,000

Credit sales

85,000

(85,000)

Credit sales

95,000

Instalment payments

40,000

Guarantee/warranty — a deduction in the year it is incurred

(17,250)

(15,000)

ASSESSABLE INCOME

327,750

325,000

AMTG: ¶9-000, ¶9-030, ¶9-035, ¶9-050, ¶9-090, ¶16-040

¶1-380 Worked example: Employee share scheme Issue Luxury Vehicles Limited (LVL) sells luxury motor vehicles through its Australia-wide dealership network. In January 2018 the company instituted an employee share acquisition scheme in which all employees were given the opportunity to acquire shares in the company at a discount of 10% on the market value of the company’s shares. Stan Moore, one of the company’s car salesmen, accepted the offer on 15 January 2018 acquiring 5,000 shares at which time the share price was $4 per share. In September 2019 LVL introduced another employee share acquisition scheme offering shares in the company at a 20% discount but restricted to directors and senior executives of the company and subject to forfeiture provisions. Employees acquiring the shares were not permitted to dispose of the shares within five years of acquisition. Stephanie Wu, the company’s finance director, accepted the offer acquiring 500 shares on 1 October 2019 when the share price was $5 per share. Advise Stan Moore and Stephanie Wu on the tax implications of their share acquisitions and the tax implications of any future disposal of their shares. Solution Since 1 July 2009, the taxation of employee share scheme (ESS) interests has been governed by ITAA97 Div 83A which applies where an employee (which includes a director, an officer and an associate of an employee) acquires an ESS interest in an ESS at a discount. An ESS is defined as a scheme under which ESS interests in a company are provided to employees (s 83A-10(2)). An ESS interest is defined as a beneficial interest in a share in a company (s 83A-10(1)). There are two alternative taxing rules for ESSs that might be offered at a discount by employers to employees: • a scheme where the discount is taxed up front, and • a scheme where taxation of the discount is deferred. Where an employee is assessable on a discount received on an ESS interest upfront, a $1,000 exemption applies, provided the conditions in s 83A-35 and s 83A-45 are satisfied, including: • the taxpayer’s income is $180,000 or less • the scheme is offered on a non-discriminatory basis • the shares are not at real risk of forfeiture, and • the shares are held for three years or until the employee ceases employment, subject to a minimum holding period. The deferred taxing provisions apply where the ESS interests are subject to a real risk of forfeiture. In that case the tax on the ESS interest is deferred until the earliest taxing point occurs, according to the rules in s 83A-115. Because the ESS rules in Div 83A are intended to be the primary taxing regime for ESS interests, the discounts are exempt from being taxed as a fringe benefit (s 83A-5; FBTAA s 136(1)) or under the CGT provisions (ITAA97 s 130-75). However, once the shares are disposed of any gain or loss may attract the CGT provisions.

Stan Moore: acquisition of shares in the ESS Stan acquired 5,000 shares at a discount of 10% on the market value of $4 per share. The discount of $0.40 on 5,000 shares amounts to $2,000. This will be included in his assessable income in 2017/18 (s 83A-25(1)). Stan will be entitled to an exemption of $1,000, if the conditions in s 83A-35 are satisfied, in which case only $1,000 will be included in his assessable income. The conditions in s 83A-35 are satisfied if: • the sum of the taxpayer’s taxable income, reportable fringe benefits total, reportable superannuation contributions and total investment loss for the income year is $180,000 or less • the scheme is only offered in a non-discriminatory way to at least 75% of Australian resident permanent employees of the company with three or more years of service • the shares are not at risk of forfeiture, and • the shares are held by the employee for three years or until the employee ceases employment, provided the Commissioner approves and Stan satisfies the minimum holding period rule (as per s 83A-45 for shares acquired from 1 July 2015). Stan Moore: disposal of shares in the ESS If Stan disposed of the shares within three years of acquisition he would not qualify for the $1,000 exemption on acquisition. At whatever time Stan disposes of his shares he will be subject to CGT on the difference between the sale proceeds and the market value of the shares at the date of acquisition. If he holds the shares for more than 12 months he will be entitled to the 50% CGT discount. Only 50% of the capital gain would be added to his assessable income (ITAA97 s 115-5 and s 115-25). If Stan disposes of the shares after 15 January 2020 at the market value of $7 per share, the capital gain addition to his assessable income in 2019/20 would be $7,500 calculated as follows: Capital proceeds

5,000 shares at $7 each = $35,000

Less cost base

5,000 shares at $3.60 each = $18,000

Capital gain

$35,000 − $18,000 = $17,000

Applying the 50% CGT discount

50% × $17,000 = $8,500

Addition to assessable income

$8,500

Stephanie Wu: acquisition and disposal of shares in the ESS As there is a restriction on the right to dispose of the shares within five years of acquisition there is a real risk of forfeiture in that Stephanie may forfeit or lose interest in the shares (other than by disposing of them). The deferred taxation provisions will therefore apply to Stephanie (Subdiv 83A-C) and she will not be entitled to the $1,000 exemption on her acquisition of the shares. The taxation on the acquisition of the shares by Stephanie is deferred until the taxing point occurs. The earliest time that this taxing point could occur is (s 83A-120): • when there is no real risk that Stephanie will forfeit or lose the shares (ie five years after acquisition of the shares) • when Stephanie ceases employment with LVL, or • 15 years after Stephanie acquires the shares. Assuming Stephanie remains in employment with LVL, the taxing point for Stephanie will be 1 October 2024. That is, five years after acquisition of the shares when the forfeiture condition will be lifted. Assume Stephanie disposes of the shares after that date at a price of $12 per share. Under the deferred taxation provision (ITAA97 s 83A-110(1)) the amount to be added to her assessable income in the 2024/25 year, applying current CGT provisions, would be the market value of $12, reduced by the cost base of the ESS

interest, that is, $4 per share on 500 shares. This amount would be calculated as follows: Capital proceeds at taxing point (1/10/24)

$12 per share × 500 shares = $6,000

Cost base at time of acquisition (1/10/19)

$4 per share (ie $5 per share × 20% discount) × 500 shares = $2,000

Capital gain

$6,000 − $2,000 = $4,000

Application of 50% discount

$4,000 × 50% = $2,000

Addition to assessable income in 2024/25

$2,000

AMTG: ¶9-050, ¶10-080, ¶10-085, ¶10-087, ¶10-089, ¶12-630

¶1-400 Worked example: Employee share scheme offered by start-up company Issue Vlad Kozlinski is employed by Solo Pty Ltd, an Australian resident company that was incorporated five years ago and is not listed on any stock exchange. Solo had an annual turnover of $7.3m in 2018/19. Solo does not have a holding company or any subsidiaries but it has an affiliate, Doel Pty Ltd, which had an annual turnover of $12.6m in 2018/19. Solo Pty Ltd operates an employee share scheme (ESS) for its employees and in 2019/20 Vlad is provided with 2,500 shares in Solo Pty Ltd under the company scheme. The market value of each Solo share acquired by Vlad is $1.00 and he pays $0.85 per share. After acquiring the shares, Vlad holds a 2.3% interest in the shareholding and voting rights of Solo Pty Ltd. Explain the tax consequences for Vlad and Solo Pty Ltd. Solution Typically, when a company establishes an employee share scheme for employees, an “ESS interest” in the company may be offered at a discount to market value. An ESS interest is a beneficial interest in a share in the company or a right to acquire a beneficial interest in a share in the company (ITAA97 s 83A10). As a general rule, the discount amount is assessable income for the employee and: • may be taxed up front, in the year the ESS interest is acquired (s 83A-25), but with a reduction of $1,000 if certain conditions are met, or • the taxation of the discount may be deferred until a later time, for example where the ESS interest was at real risk of forfeiture and the risk has been lifted (s 83A-35). From 1 July 2015, special concessions are available for “eligible start-up companies” that reward their employees by offering an ESS interest at a discount to market value. Instead of the discount being included in assessable income, any future increase in the value of the share is taxed as a capital gain when the share is disposed of, with 50% CGT relief being available if the employee has held the share for at least 12 months (s 83A-33). A company is an eligible start-up company if it satisfies various conditions including: • it is an Australian resident taxpayer that has been incorporated for less than ten years and its equity interests are not listed on an approved stock exchange • it has an aggregated turnover not exceeding $50m • the scheme is operated so that employees must hold the ESS interests for at least three years or until

their employment ceases, and • for an ESS interest that is a share, the discount is no more than 15% of the market value. As Solo Pty Ltd is not listed on any stock exchange, was incorporated less than 10 years ago and has an aggregated turnover of less than $50m, it is an eligible start-up company. The market value of each of the 2,500 Solo shares acquired by Vlad is $1.00 and he pays $0.85 per share, which means he has acquired them at a 15% discount. Vlad’s ESS interests will qualify for the start-up concession if he meets any conditions relevant to his own circumstances, for example holding the shares for at least three years or until his employment ends. If Vlad chooses the start-up concession, he does not need to report an ESS discount amount in 2019/20, the year he acquired the shares, but he needs to report the capital gain or capital loss he makes in the later year when he sells the shares. In calculating the capital gain or capital loss, the cost base of Vlad’s shares is set at market value ($1.00 per share), and a 50% CGT discount is available if he holds the shares for at least 12 months. AMTG: ¶10-085, ¶10-087, ¶10-090

¶1-420 Worked example: Employment termination and genuine redundancy payments Issue Barbra Purcell began her employment with the Republic Bank of Australia (RBA) in January 2005 and was made redundant on 1 April 2020, at the age of 58 years. Barbra received a termination lump sum of $75,000, which included a lump sum annual leave payment of $5,000. Advise Barbra on the taxation implications of her redundancy. Solution Employment and other payments on termination of employment are dealt with in ITAA97 Div 82 and 83. The relevant factors include: • some kinds of lump sum payments on termination of employment do not qualify as employment termination payments (s 82-135) • ETPs may attract concessional tax treatment • lump sum annual and long service leave payments are taxed separately (ITAA97 Subdiv 83-A) • genuine redundancy payments and early retirement scheme payments also attract concessional tax treatment (ITAA97 Subdiv 83-C), and • the tax free component of a life benefit termination payment includes the pre-July 83 segment of the payment (s 82-140). From 1 July 2012, a whole-of-income cap amount ($180,000 non-indexed) applies in conjunction with the indexed ETP cap amount for ETPs that are not “excluded payments” (s 82-10(4)). Excluded payments include genuine redundancy and early retirement scheme payments. The requirements for a payment to qualify as an ETP include the following (s 82-130): • the payment must be received “in consequence of the termination of the person’s employment”. See Dibb v FCT of T (2004) 55 ATR 786 and Taxation Ruling TR 2003/13 for the Commissioner’s views on the expression, and • the payment must be received not later than 12 months after that termination, and • it is not a payment mentioned in s 82-135.

The payment received by Barbra meets the first two requirements but not the third, in that it includes an unused annual leave payment and it may qualify as a genuine redundancy payment. The $5,000 lump sum annual leave payment can be severed from the redundancy payment. The entire amount will be assessable under s 83-10(2) at Barbra’s marginal rate, unless it is made in connection with a genuine redundancy payment, in which case it will be taxed at a maximum rate of 30%. A genuine redundancy payment is so much of a lump sum payment received by an employee who is dismissed from employment, because the employee’s position is genuinely redundant, as exceeds the amount that could reasonably be expected to be received by the employee in consequence of their voluntary termination (s 83-175(1)). For the $70,000 payment to Barbra to qualify as a genuine redundancy payment the following additional conditions must be satisfied (s 83-175(2)): • the employee must be dismissed before turning 65 years of age • if the dismissal is not at arm’s length, the payment must not exceed the amount that could reasonably be expected to be made if the dismissal was at arm’s length, and • at the time of the dismissal there was no arrangement between the employer and employee for reemployment of the employee. Taxation Ruling TR 2009/2 provides guidelines on the conditions to be met for a payment to qualify as a genuine redundancy payment. Barbra satisfies the age requirement and providing that Barbra’s dismissal is because her position has become redundant there was no arrangement for her to be re-employed by the RBA then Barbra’s payment of $70,000 qualifies as a genuine redundancy payment. A genuine redundancy payment comprises a tax free amount and an assessable amount (s 83-170). The tax free amount is non-assessable non-exempt income. The amount in excess of the tax free amount is assessable as an ETP, if it qualifies as such under s 82-130. The tax free amount is calculated using the formula: Base amount + (service amount × years of service) The tax free portion of the $70,000 received by Barbara would be calculated as follows: $10,399 + ($5,320 × 15) = $90,199 Since the tax free amount exceeds the total redundancy payment there is no excess to be taxed as an ETP. Finally, neither the pre-July 83 tax free component nor the whole-of-life cap apply to Barbra. AMTG: ¶14-000, ¶14-600, ¶14-610, ¶14-620, ¶14-630, ¶14-700

CAPITAL GAINS TAX Elements of the cost base

¶2-000

Rental property; reduced cost base

¶2-020

CGT losses; indexation of cost base

¶2-040

Main residence exemption; absence rule; first used to produce income rule

¶2-060

Main residence exemption: foreign residents

¶2-070

Death; main residence exemption; dwelling held as joint tenants

¶2-080

Death; CGT assets including personal assets

¶2-100

Relationship breakdown: Rollover relief

¶2-110

Timing of CGT events

¶2-120

Granting a lease; lease variation

¶2-140

Sale of property; settlement in following income year

¶2-160

Disposal of residence; business with a restrictive covenant

¶2-180

Demolition; subdivision of land; construction of units

¶2-200

CGT implications on establishment and dissolution of partnership

¶2-220

CGT consequences of share and bonus shares transactions

¶2-240

Share options

¶2-260

Small business CGT concessions

¶2-280

Small business CGT concessions; meaning of active and excluded assets

¶2-300

Active asset test; use in a business

¶2-303

CGT small business concessions on the sale of shares or units

¶2-305

Digital currencies: personal use exemption

¶2-310

Changing a business structure: small business restructure rollover and small business CGT concessions

¶2-315

Unit trust; interaction between ITAA97 Subdiv 115-C and CGT event E4

¶2-320

Indirect value shifting

¶2-340

Foreign income; CGT discount and foreign tax offset

¶2-360

¶2-000 Worked example: Elements of the cost base Issue Ted and Alice Ritchie own their main residence as well as a holiday home and a rental property. The holiday home and the rental property, located on adjacent blocks, were both purchased in 2009. Ted and Alice spent two years, from 2009 to 2011, living in their holiday home and rented out their main residence. During 2019, taking advantage of an increase in property prices, Ted and Alice decided to dispose of both the holiday home and rental property, acquired in 2009. During the ten-year ownership the holiday home was never rented out. Ted and Alice provided the following financial information in relation to their holiday home and rental

property over their period of ownership, noting that the same figures apply to each property: Capital proceeds from sale of each property (ITAA97 s 116-20(1))

$460,000

Five elements in the cost base in acquiring and owning each property: 1.

Purchase price for each property (ITAA97 s 110-25(2))

$325,000

2.

Incidental costs incurred in acquiring the properties (ITAA97 s 110-25(3))

3.

Costs incurred in relation to owning each of the properties (ITAA97 s 110-25(4))

$37,000

$ Annual interest on loans to acquire each property

1,200

Annual rates and taxes

3,400

Annual insurance premiums

1,500

Repairs and maintenance

  8,900 TOTAL

4.

15,000  

Capital expenditure to increase properties value (ITAA97 s 110-25(5)) Construction of garage and car port

5.

$26,000

Capital expenditure incurred in defending title to the properties (ITAA97 s 110-25(6)) Legal costs incurred opposing re-zoning and resumption of the properties

$14,000

Advise Ted and Alice on the CGT consequences relating the disposal of the two properties. Solution Ted and Alice’s main residence is exempt from CGT if it is disposed of (ITAA97 s 118-100). Although Ted and Alice have vacated and rented out their main residence for two years, it still qualifies as their main residence. They could be absent for up to six years. However, their holiday home cannot qualify as their main residence while their original home remains their main residence. Calculation of capital gain on disposal of the rental property Capital proceeds and cost base

Amount $

Capital proceeds

460,000

Cost base: Purchase price

325,000

Incidental costs

37,000

Capital expenditure

26,000

Legal defence costs

  14,000

Cost base

402,000

Capital gain

58,000

Application of 50% capital gains discount

29,000

Net capital gain addition to assessable income

29,000

Calculation of capital gain on disposal of the holiday home Capital proceeds and cost base

Amount

$ Capital proceeds

460,000

Cost base: Purchase price

325,000

Incidental costs

37,000

Ownership costs

15,000

Capital expenditure

26,000

Legal defence costs

     14,000

Cost base

417,000

Capital gain

43,000

Application of 50% capital gains discount

21,500

Net capital gain addition to assessable income

21,500

For each property the capital gain is discounted by 50% (ITAA97 s 115-100). Ted and Alice do not have the option of choosing to index the cost base in respect of properties that were acquired after September 1999. The difference in the net capital gain for the holiday home ($21,500) and the rental property ($29,000) is because costs incurred in relation to owning the rental property are tax deductible against the rental income. AMTG: ¶11-033, ¶11-250, ¶11-550, ¶11-730, ¶11-740

¶2-020 Worked example: Rental property; reduced cost base Issue Ryan Saunders purchased an apartment from Anna Lowe in April 2013 for use as an investment property. The property was acquired by Anna off-the-plan in 2004 and was used as her main residence. Anna left for overseas soon after the sale to Ryan. Ryan rented the apartment to tenants until he sold it in March 2020. As the relevant information was not available to him, Ryan did not claim deductions for capital works deductions under ITAA97 Div 43 for the income years in which the property was used to produce assessable income. Ryan also did not obtain a building cost estimate from a quantity surveyor as he did not want to incur the expense. Ryan has become aware that broadly, the CGT provisions require a taxpayer to reduce the cost base or reduced cost base of a CGT asset to the extent that the taxpayer has deducted or can deduct expenditure in an income year under Div 43. Advise Ryan if he is still required to reduce the cost base or reduced cost base of the property in working out his capital gain or loss, even though he is unable to obtain the relevant information to do so? Solution The Commissioner accepts as administrative practice that due to a lack of sufficient information, Ryan does not need to reduce the cost base or reduced cost base for any capital works deductions that can be claimed in respect of the property (see Practice Statement PS LA 2006/1 (GA)). Broadly, ITAA97 110-45(2) and 110-50(2) require that a taxpayer must reduce the cost base or reduced cost base of a CGT asset where they have deducted or can deduct expenditure in an income year under the capital works provisions contained in Div 43. These provisions apply to CGT assets acquired after 7.30 pm (ACT time) on 13 May 1997, although they may apply to expenditure on land or a building acquired before that time, provided the expenditure is incurred after 30 June 1999 and forms part of the

fourth element of the cost base of the asset (s 110-45(1A) and 110-50(1A)). However, Practice Statement PS LA 2006/1 (GA) outlines the circumstances where the Commissioner will accept that the taxpayer cannot deduct such an amount, and so is not required to reduce their cost base and reduced cost base in respect of their property. This is primarily the case where the taxpayer cannot obtain sufficient information. This typically happens where the taxpayer: • does not have sufficient information to determine the amount and nature of the construction expenditure for an asset, and • does not seek to deduct any amount in relation to the construction expenditure under Div 43 (or any other provision). Note that the previous owner is required to provide a notice which includes the undeducted Div 43 expenditure if they had previously deducted an amount for capital works (ITAA36 s 262A(4AJA)). PS LA 2006/1 (GA) also outlines when a taxpayer does not have sufficient information to deduct under Div 43. Specifically, this will occur where the previous owner was not entitled to a deduction under Div 43 but the new owner will be, for example if the capital works were acquired from a speculative builder or a previous owner who used the capital works as a private residence. In this case, Ryan would not have been able to obtain the relevant information from Anna as she had used it as a private residence. Even if the information was available, this difficulty is further compounded by the fact that Anna left for overseas shortly after she disposed of the property. In addition, the fact that Ryan did not obtain a valuation from a quantity surveyor does not prevent him from relying on the Commissioner’s administrative practice. PS LA 2006/1 (GA) acknowledges that the cost of obtaining such an estimate can impose a significant burden on taxpayers, so there is no need to do so if sufficient information is not capable of being obtained and deductions for capital works have not previously been claimed by the taxpayer. AMTG: ¶11-550, ¶11-560, ¶20-470

¶2-040 Worked example: CGT losses; indexation of cost base Issue On 1 April 1997 Brenda and Derek Watson, both Australian residents, sold their real estate investment, they had purchased in 1965, for $2m. The couple split the proceeds 50-50 and on 11 November 1997 they both invested the proceeds in share portfolios as follows: Share acquisitions by both Brenda and Derek Watson Company

Number of shares

Share price

Investment

$

$

Mega Mining Ltd

125,000

4

500,000

Global Media Ltd

62,500

8

500,000

Brenda acquired the shares in her own name whereas Derek had his company Derek Watson Investments Pty Ltd acquire his share portfolio. On 20 September 2019 both Brenda and Derek made a decision to dispose of their shares. The proceeds of sale were as follows: Company

Number of shares

Share price

Proceeds of sale

$

$

Mega Mining Ltd

125,000

10

1,250,000

Global Ltd

62,500

6

375,000

Advise both Brenda and Derek on the CGT consequences of their share sales. Solution Shares are an asset for CGT purposes (ITAA97 s 100-25) and the acquisition and disposal of shares, acquired after 19 September 1985, attracts CGT. Any capital gain on disposal is added to the taxpayer’s assessable income while any capital loss, not able to be offset against capital gains, is carried forward to be offset against future capital gains (ITAA97 Div 102). For assets, including shares, acquired before 21 September 1999 and disposed of one or more years later the taxpayer is entitled to index the cost base and so reduce the taxable capital gain on disposal of the shares (ITAA97 Div 114). For assets, including shares, acquired after 21 September 1999 the taxpayer may be able to discount the taxable capital gain by 50% (ITAA97 Div 115). For assets, including shares, acquired before 21 September 1999 and disposed of at least one year later certain categories of taxpayers have the option of indexing the cost base or discounting the capital gain in calculating the taxable capital gain. The taxpayer is entitled to choose the option that gives the lower tax liability. In Brenda’s case, she has made both a capital gain and capital loss on the disposal of her share portfolio. Because she acquired the shares before 21 September 1999 and disposed of the shares some twenty years later she is entitled to index the cost base or apply the 50% discount in calculating any taxable capital gain. However, in Derek’s case, because his shares were acquired by his company he can index the cost base but he cannot apply any capital gains discount in calculating any taxable capital gain (s 115-10). Any capital losses are offset against capital gains before applying the discount percentage. Further, in the case of capital losses the cost base is not indexed (ITAA97 s 100-40, s 100-45 and s 100-50). CGT consequences in relation to Brenda’s share transactions — applying the 50% discount: Mega Mining Ltd

$

Capital proceeds from sale

125,000 shares @ $10 per share 1,250,000

Cost base

125,000 shares @ $ 4 per share

Capital gain

500,000 750,000

Global Media Ltd Capital proceeds from sale

62,500 shares @ $6 per share

375,000

Cost base

62,500 shares @ $8 per share

500,000

Capital loss

125,000

Capital gain on Mega Mining Ltd shares

750,000

Less capital loss on Global Media Ltd shares

125,000

NOMINAL CAPITAL GAIN

625,000

Application of the 50% capital gains discount

312,500

NET CAPITAL GAIN

312,500

CGT consequences in relation to Brenda’s share transactions — indexing the cost base: Mega Mining Ltd

$

Capital proceeds from sale

125,000 shares @ $10 per share 1,250,000

Cost base

125,000 shares @ $ 4 per share

500,000

Indexed cost base

$500,000 cost base × 1.028*

514,000

CAPITAL GAIN Global Media Ltd

736,000

Capital proceeds from sale

62,500 shares @ $6 per share

375,000

Cost base

62,500 shares @ $8 per share

500,000

Capital loss

125,000

Capital gain on Mega Mining Ltd shares

736,000

Less Capital loss on Global Media Ltd shares

125,000

NET CAPITAL GAIN

611,000

*Indexation calculation:

CPI for September Qtr 1999 CPI for December Qtr 1997

68.7 66.8

=

1.028

CGT consequences in relation to Derek’s share transactions — applying the 50% discount: Derek’s shares are held by his company, therefore he cannot apply the 50% capital gains discount because the discount is not available for companies. CGT consequences in relation to Derek’s share transactions through his company Derek Watson Investments Pty Ltd — indexing the cost base: Mega Mining Ltd

$

Capital proceeds from sale

125,000 shares @ $10 per share 1,250,000

Cost base

125,000 shares @ $4 per share

500,000

Indexed cost base

$500,000 cost base × 1.028*

514,000

Capital gain

736,000

Global Media Ltd Capital proceeds from sale

62,500 shares @ $6 per share

375,000

Cost base

62,500 shares @ $8 per share

500,000

Capital loss

125,000

Capital gain on Mega Mining Ltd shares

736,000

Less Capital loss on Global Media Ltd shares

125,000

NET CAPITAL GAIN

611,000

The preferred option for Brenda is to apply the 50% discount and incur a net capital gain of $312,500 rather than the indexation option, which results in a net capital gain of $611,000. Derek does not have a choice of methods and is bound by the indexation option and he incurs a net capital gain of $611,000. The net capital gain of $312,500 is added to Brenda’s assessable income and the net capital gain of $611,000 is added to the assessable income of Derek Watson Investments Pty Ltd. AMTG: ¶11-030, ¶11-033, ¶11-036, ¶11-610

¶2-060 Worked example: Main residence exemption; absence rule; first used to produce income rule Issue Stella Rose acquired a dwelling in February 2004 which she used as her main residence. The dwelling has a cost base of $300,000 for CGT purposes. On 1 July 2010, Stella vacated the dwelling and started renting it to tenants. At that time, the dwelling had a market value of $400,000. Stella made a choice under ITAA97 s 118-145 to treat the dwelling as her main residence during the time that the dwelling was being rented. On 30 June 2020 Stella disposed of the dwelling for $1m.

What is the capital gain or loss to Stella (if any) on the disposal of the dwelling? Solution The main residence provisions contained in ITAA97 Subdiv 118-B allow an individual to disregard a capital gain or capital loss relating to the disposal of a dwelling which was that person’s “main residence”. Specifically, a capital gain or loss is disregarded if the taxpayer is an individual, the dwelling was the taxpayer’s main residence throughout the ownership period, and the interest did not pass to the taxpayer as a beneficiary in, or a trustee of, the estate of a deceased person (s 118-110). A taxpayer can choose to continue to treat the dwelling as their main residence even if they stop using it as such as a result of the “absence rule” (s 118-145). Under the absence rule, if the dwelling is not being used for income-producing purposes during the taxpayer’s absence, this choice can apply indefinitely. Otherwise, the maximum period that the dwelling can be treated as a main residence is six years. The taxpayer would be subject to a capital gain if the six-year period is exceeded — that is, a partial main residence exemption would be available. In addition, a special rule under s 118-192 applies where a main residence is first used for incomeproducing purposes after 7.30 pm EST on 20 August 1996 (commonly referred to as the “first used to produce income” rule). In respect of the dwelling, the rule is triggered if the following apply: • only a partial main residence exemption would be available under Subdiv 118-B because the dwelling was used for the purpose of producing assessable income during the taxpayer’s ownership period • the income-producing use started after 7.30 pm (by legal time in the ACT) on 20 August 1996, and • the taxpayer would have been entitled to a full main residence exemption if a CGT event happened to the dwelling just before the first time it was used for the income-producing purpose during the taxpayer’s ownership period. If these conditions are satisfied, the taxpayer is taken to have acquired the dwelling (with a cost base and a reduced cost base equal to its market value) at the time they first started using it for income-producing purposes. Note that expenditure incurred prior to that time is ignored. This rule however does not apply where a taxpayer, who makes a choice under the absence rule in s 118-145 is entitled to the full main residence exemption. If a dwelling has been rented for more than a sixyear period, only a partial main residence exemption would be available and so s 118-192 would apply. This is because the absence rule under s 118-145(2) limits the period of the exemption to six years. (See ATO online publication “Using your home to produce income (QC 17193)”.) In this case, Stella’s capital gain happens in the 2019/20 year, that is when CGT event A1 is triggered as a consequence of the disposal. The capital gain is calculated as follows: $ Capital proceeds

1,000,000

Less: Cost base (market value as at 1 July 2010)1, 4

(400,000)

Capital gain

600,000

Reduce by main residence days (6 years / 10 years2 × $600,000) Adjusted capital gain CGT general discount NET CAPITAL GAIN Notes:

(360,000) 240,000

(50%)3

(120,000) 120,000

1. The first used to produce income rule under s 118-192 applies. The first element cost base and reduced cost base is $400,000 as at 1 July 2010. 2. Under s 118-192 the dwelling is deemed to have been acquired on 1 July 2010. The dwelling was disposed of on 30 June 2020. The total ownership period is 10 years. The main residence exemption is limited to six years. 3. The CGT general discount applies as the dwelling has been held for at least 12 months (since the deemed acquisition date of 1 July 2010) (ITAA97 Div 115 Subdiv 115-A). 4. It is assumed during the period of rental that no reductions of the cost base have occurred due to the operation of Div 40 and Div 43. AMTG: ¶11-033, ¶11-730, ¶11-740, ¶11-750, ¶11-760

¶2-070 Worked example: Main residence exemption: foreign residents Issue Richard Gregory is a senior executive with a multinational technology company, MyWeb. Born and raised in Australia, in early 2017 Richard was offered the opportunity to move to MyWeb’s global headquarters in Seattle, United States. He moved to Seattle on 1 July 2017 with the intention of remaining permanently in the United States. He retained his home in Melbourne, which was originally acquired on 1 July 2010. He commenced renting out the property on 1 July 2017 and has rented it out ever since. On 1 June 2020, Richard was diagnosed with a life-threatening form of cancer and has commenced treatment in the United States. Richard wishes to understand his potential exposure to CGT should he sell his Melbourne property and also the potential exposure to CGT of his estate in the event that his cancer treatment is unsuccessful, resulting in his death. Under the terms of his Will, the property is to pass to his father, David, who lives in Australia. Michael Wilson is also a senior executive with MyWeb. Born and raised in Australia, he has also taken up the offer of a permanent transfer to head office in Seattle. He left Australia on 1 January 2020 and does not intend to return. He purchased his main residence in Melbourne on 1 August 2017 for $900,000 and now wishes to sell this property, which has been empty since he left Australia. On 1 June 2020, he accepted an offer to sell the property for $1.15m and contracts were signed on the same date. Settlement has not yet occurred. He also wishes to understand his potential exposure to CGT. Solution A capital gain or loss from a dwelling is disregarded (the “main residence exemption”) if the taxpayer is an individual, the dwelling was the taxpayer’s main residence throughout the ownership period and the interest did not pass to the taxpayer as a beneficiary in, or as the trustee of, the estate of a deceased person (ITAA97 s 118-110). If a dwelling that was a taxpayer’s main residence stops being the taxpayer’s main residence, the taxpayer may choose to continue to treat it as a main residence (s 118-145). If the dwelling is not used for income-producing purposes during the taxpayer’s absence, this choice can apply indefinitely. However, if the property is used for income-producing purposes, the maximum period the dwelling can be treated as the taxpayer’s main residence is six years. The main residence exemption can also apply where a trustee or beneficiary of a deceased estate disposes of a property that was either the main residence of the deceased or the main residence of certain beneficiaries (s 118-195). With effect from 7.30 pm (AEST) on 9 May 2017, the main residence exemption is not available to individuals who, at the time a CGT event happens, are either: (a) an “excluded foreign resident” — being a foreign resident that has been a foreign resident for a continuous period of more than six years, or (b) a foreign resident that does not satisfy the “life events test” (s 118-110(3) and (4)). A taxpayer will satisfy the life events test in (b) if the taxpayer has been a foreign resident for six years or

less and satisfies one of the following: • the taxpayer or taxpayer’s spouse or child under 18 years has had a terminal medical condition during that period of foreign residency • the death of either the taxpayer’s spouse or child under 18 years at the time of death during that period of foreign residency • the CGT event happens because of the taxpayer’s divorce or separation (s 118-110(5)). A property held by a foreign resident prior to 7:30 pm on 9 May 2017 will still be eligible for the exemption for a CGT event occurring on or before 30 June 2020 under transitional provisions. The effect of these rules is that for Australians going overseas who sell their main residence at the time they are a foreign resident, the main residence exemption will not be available: • where a “life event” does not occur • after six continuous years as a non-resident, even where a life event occurs, or • do not qualify for the transitional relief because they acquired their main residence after 7:30 pm on 9 May 2017 or sold it after 30 June 2020. Foreign residents will no longer benefit from the “absence rule” rule if the property is sold when they are a foreign resident. As the rules apply only to those who trigger a CGT event whilst a foreign resident, where an individual returns to Australia and resumes Australian tax residency before entering into a contract of sale, they may still be able to claim the main residence exemption (and apply the absence rule) in relation to the entire period of ownership, including the period of foreign residence. In relation to deceased estates, the trustee or beneficiary of a deceased estate will be denied the main residence exemption: • for the deceased’s ownership period, if the deceased had been a foreign tax resident for a continuous period of six years or more immediately before their death (and therefore an “excluded foreign resident”, s 118-195(1)(c)), and • for the trustee or beneficiary’s ownership period, if the relevant beneficiary had been a foreign tax resident for a continuous period of six years or more immediately before the CGT event (and therefore an “excluded foreign resident”, s 118-195(1A)(b)). Applying the above, Richard and Michael can be advised as follows: Richard Gregory As Richard has not yet disposed of the property, a number of scenarios are available: • If Richard enters into a contract for the sale of the property by 30 June 2020, he will be entitled to the full main residence exemption in relation to the sale of the property. This is because he will be entitled to take advantage of the transition provisions that apply to properties acquired before 7:30 pm on 9 May 2017. Richard acquired the property on 1 July 2010, lived in it as his main residence until 30 June 2017 and then rented it out from 1 July 2017. The absence rule therefore applies to continue to treat the property as his main residence from 1 July 2017 to the date of sale. • If Richard enters into a contract for the sale of the property from 1 July 2020, Richard will not be entitled to the main residence exemption at all in relation to the CGT event unless the sale arises as a result of a qualifying life event. It is noted that Richard is suffering from a life-threatening cancer. The main residence exemption may therefore be available to him on the basis that he has had a terminal medical condition during the period of foreign residency. A person has a terminal medical condition if, among other things, two medical practitioners have certified that the illness or injury that the person suffers from is likely to result in his or her death within 24 months of the certification.

• If Richard’s cancer treatment is successful and he ultimately returns to Australia, he may once again be entitled to the main residence exemption if the sale occurs at a point where Richard is a tax resident of Australia. If Richard re-establishes Australian residency and enters into a contract to sell the property before 30 June 2023, he will be entitled to a full main residence exemption as the sixyear absence rule will cover the entire period of foreign residence (assuming the property continues to be rented out throughout the period). If he re-establishes Australian residency and enters into a contract to sell the property from 1 July 2023 onwards, he will be entitled to a partial main residence exemption as the six-year absence period will have ended. • If Richard dies as a result of the cancer, the property will pass to his Australian resident father, David. If the death occurs before 1 July 2023, David may be entitled to apply the main residence exemption on the sale of the property as Richard has not been a foreign tax resident for a continuous period of six years or more immediately before his death. If the death occurs from 1 July 2023 onwards, the main residence exemption will not be available as Richard would be an “excluded foreign resident”. Michael Wilson Michael Wilson is not entitled to apply the main residence exemption as he is an excluded foreign resident at the date of the CGT event, being 1 June 2020, and he has not disposed of the property as a result of a qualifying life event. He is not able to take advantage of the transition provisions that permit access to the main residence exemption where the CGT event occurs by 30 June 2020 as he originally purchased the property on 1 August 2017. Properties acquired after 7:30 pm on 9 May 2017 are excluded from the transition provisions. Michael’s gross capital gain is $250,000 (excluding potential sale and purchase costs), being sale proceeds of $1.15m less the original cost of the property, $900,000. As Michael has owned the property for more than 12 months, he would normally be entitled to discount the gain by 50%. However, the 50% CGT discount allowed for gains made by individuals is reduced for any periods in which the taxpayer has been a foreign resident during the period of ownership (ITAA97 s 115-105). As the ownership period is 1,035 days and the days Michael was an Australian resident were 883, the discount percentage is: 50% × 883/1035 = 42.66% Michael’s net capital gain is therefore: $ Gross gain Discount (42.66%) Net capital gain

250,000 (106,650) 143,350

The purchaser of the property is required to withhold 12.5% of the consideration paid to acquire the property and remit the amount to the Commissioner at the time of acquisition (ITAA97 s 855-20) as a nonfinal withholding tax. This amount ($143,750) will be available as a credit to Michael when he completes his 2019/20 Australian tax return. AMTG: ¶11-036, ¶11-730, ¶11-770

¶2-080 Worked example: Death; main residence exemption; dwelling held as joint tenants Issue Robert and Dennis Brown owned a dwelling as joint tenants. The dwelling, which had been used as the family home, was purchased on 1 July 2010 with a CGT cost base of $400,000. Robert passed away on 15 April 2017 and Dennis continued to live in the dwelling until he moved into a nursing home on 1 February 2019. The dwelling was left vacant after Dennis’s move. In May 2020, it was sold for $1m including agent’s fees of $10,000.

Advise Dennis of the CGT consequences arising from the disposal of the dwelling. Solution Joint interest for CGT purposes For CGT purposes, individuals who own a CGT asset as joint tenants are treated as if they each own a separate CGT asset constituted by an equal interest in the asset, and as if each of them hold that interest as a tenant in common (ITAA97 s 108-7). CGT and death Where an asset is held jointly with another person, an individual’s joint interest in the asset passes to the surviving owner of the asset upon their death. That is, the asset does not form part of the deceased taxpayer’s estate. ITAA97 Div 128 outlines the CGT rules that apply when a taxpayer dies. The general rule is that a capital gain or loss from a CGT event relating to a CGT asset that the taxpayer owned just before death is disregarded (s 128-10). Upon Robert’s death, his interest in the main residence dwelling that he shared with Dennis automatically transfers to him as the surviving joint tenant. The transfer triggers CGT event A1 which relates to the disposal of a CGT asset (ITAA97 s 104-10). Any capital gain or loss on transfer of the interest in the dwelling to Dennis as a consequence of Robert’s death is disregarded (s 128-10). However, special rules under s 128-50 apply if a CGT asset is owned by joint tenants and one of them dies. Under these rules Dennis is taken to have acquired Robert’s interest in the dwelling at the date of his death (ie 15 April 2017) (s 128-50(2)). Further, the cost base and reduced cost base of the deceased taxpayer’s interest in the asset is divided equally between the surviving tenants. Specifically, where the asset is a post-CGT asset (ie acquired after 20 September 1985), the general rule is that the first element of cost base (and reduced cost base) of the interest to each survivor is worked out by using the cost base of the deceased’s interest (at the date of their death) divided by the number of survivors. In this case, the cost base of Robert’s interest at the date of his death is $200,000 (ie $400,000 × 50%). For CGT purposes, Dennis is taken to have acquired Robert’s interest in the dwelling for that amount at the time of his death (ie $200,000 ÷ 1). With the interest having passed to him, Dennis is taken to hold two separate interests in the dwelling comprising of: (i) his original 50% interest in the dwelling, and (ii) Robert’s 50% interest which passed to him following Robert’s death. The main residence exemption The main residence exemption provisions contained in ITAA97 Subdiv 118-B allow an individual to disregard a capital gain or capital loss relating to the disposal of a dwelling which was that person’s “main residence”. In particular, a capital gain or loss is disregarded if the taxpayer is an individual, the dwelling was the taxpayer’s main residence throughout the ownership period, and the interest did not pass to the taxpayer as a beneficiary in, or a trustee of, the estate of a deceased person (s 118-110). Special rules apply where a dwelling is acquired from a deceased estate by way of the operation of s 118195. This provision allows a beneficiary or an executor of a deceased estate to disregard a capital gain or loss on the disposal of a main residence if certain conditions are satisfied. Specifically, for an interest in a dwelling that was a post-CGT asset, a capital gain or loss will be disregarded if: • the dwelling was the deceased’s main residence just before their death and was not then used to produce assessable income, and • either: – the beneficiary’s ownership interest in the dwelling is disposed of within two years of the deceased taxpayer’s death, or – the dwelling was, from the deceased taxpayer’s death until the beneficiary’s ownership interest ends, the main residence of one or more of:

a. the spouse of the deceased taxpayer immediately before death (except a spouse living permanently and separately apart from the deceased taxpayer) b. an individual who has the right to occupy the dwelling under the deceased taxpayer’s will, or c. the individual disposing of the dwelling who obtained the interest as a beneficiary. It is important to note that where an ownership interest in a dwelling passes to an individual as a joint tenant, the change in ownership is taken, for the purposes of Subdiv 118-B, to be as if the dwelling has passed to the individual as a beneficiary of a deceased estate (s 118-197). CGT calculation The capital gain that Dennis makes on the disposal of his original interest in the dwelling on 1 May 2020 is calculated as follows: $ Capital proceeds on original interest ($1m × 50%)

500,000

Cost base of interest — including selling costs ($400,000 + $10,000) × 50%)

205,000

CAPITAL GAIN

295,000

As Dennis has lived in the dwelling since it was acquired, he is entitled to the main residence exemption under s 118-110. The exemption applies notwithstanding that Dennis had vacated the dwelling to live in a nursing home. In such cases, Dennis would be entitled to the full exemption by relying on the absence rule contained in s 118-145. The rule allows a taxpayer to choose to treat the dwelling as their main residence even though they have stopped using it as such. If the dwelling is not being used for incomeproducing purposes during the taxpayer’s absence, this choice can apply indefinitely. Otherwise, the maximum period that the dwelling can be treated as a main residence is six years. In this case, as Dennis had not used the dwelling for income-producing purposes, he can treat it as his main residence indefinitely during his period of absence (ie from 1 February 2019 until 1 May 2020). As the dwelling was Dennis’s main residence throughout his ownership period, the capital gain of $295,000 is fully disregarded. Dennis’s interest in the dwelling which he acquired from Robert The capital gain which Dennis makes on the disposal of the interest which he acquired from Robert is: $ Capital proceeds on acquired interest ($1m × 50%) Cost base of interest (including selling costs) CAPITAL GAIN

500,000 205,000* 295,000

Note: *Dennis assumes the cost base for Robert’s interest of $200,000 + selling costs of $5,000 (ie $10,000 × 50%). To minimise his capital gain, Dennis can use the main residence exemption under s 118-195 because: • the interest in the dwelling was Robert’s main residence before his death and was then not being used to produce assessable income, and • the dwelling was Dennis’s main residence, as a spouse immediately before Robert’s death, from the time of his death until the disposal of the interest in the dwelling. The two-year requirement does not apply in this case as the dwelling was automatically transferred to Dennis following Robert’s death.

As the conditions under s 118-195 are satisfied, the capital gain of $295,000 on the disposal of the interest is fully disregarded. AMTG: ¶11-250, ¶11-730, ¶11-740, ¶11-770, ¶12-570, ¶12-580

¶2-100 Worked example: Death; CGT assets including personal assets Issue Gladys Kravitzski died in September 2019 and in her will she left her entire estate to her son Edward. At the time of her death, Gladys’s estate consisted of: 1. Her family home Purchased in 1965 for $65,000 Market value at date of death was $650,000 2. An investment property Purchased in 1987 for $275,000 Market value at date of death was $425,000 3. Collectable assets — all purchased in February 1989 Artworks Purchased for $6,000 Market value at date of death was $9,500 Antique furniture Purchased for $13,000 Market value at date of death was $5,000 Jewellery Purchased for $24,000 Market value at date of death was $26,000 4. Personal use asset — purchased in 1992 Caravan purchased for $17,000 Market value at date of death was $4,000 Edward decided to live in the family home and to keep the investment property but to dispose of the collectable and personal use assets immediately upon acquiring ownership. Edward received the full market value on the disposal of each collectable and personal use asset. Advise Edward on the CGT consequences resulting from his mother’s death and the disposal of the assets that have passed to him as the sole beneficiary. Solution The general rule is that when a taxpayer dies, capital gains or losses made by the deceased are disregarded (ITAA97 s 128-10). There will be no CGT issues for Gladys upon her death. Her assets pass to her beneficiary, Edward, at the date of her death. Any CGT in respect of Gladys’s assets will fall upon Edward. Any CGT liability will arise on the disposal of the assets by Edward. The following issues must be considered: • how Edward has dealt with the family home/main residence • capital gains and losses treatment for collectable assets

• capital gains and losses treatment for personal use assets • the cost base for the assets inherited, and • indexation and discounting in calculating capital gains. Family home or main residence Because the family home lived in by Gladys as her main residence is a pre-CGT asset, a full CGT exemption is available to Edward if he disposes of it within two years of Gladys’s death or if he has a right of occupancy under Gladys’s will to use the dwelling as his main residence (ITAA97 s 118-195). Investment property The investment property is a post-CGT asset and Edward acquires the property at the original cost base at the date of death (ITAA97 s 128-15(4)). In this case the cost base is $275,000. If Edward elects to dispose of the property at any time after acquisition he would have the option of indexing the cost base or applying the 50% capital gains discount in calculating the net capital gain. Sale of collectable assets A collectable asset includes artwork, jewellery and antiques (ITAA97 s 108-10(2)). In calculating the net capital gain or loss on the disposal of collectables, capital losses can only be used to reduce capital gains from collectables (s 108-10(1)). Net capital losses can be carried forward to offset against future capital gains on collectables. In calculating any capital gains, Edward has the option of indexing or discounting the cost base and choosing the option that gives the lesser capital gain. There is no indexing of the cost base where capital losses are incurred. Further, the third element in the cost base, which includes the non-capital costs of ownership, such as insurance, is not counted in the cost base (ITAA97 s 108-17). Since all the collectables are post-CGT assets, Edward acquires them at their cost base at date of death and given that they were all acquired prior to September 1999 Edward has the option of indexing the cost base or applying the 50% capital gains discount factor. Artworks Capital proceeds

$9,500

Cost base at date of death

$6,000

Indexed cost base

$6,000 × 1.328* = $7,968

Net capital gain

$9,500 − $7,968 = $1,532

Capital gain less non-indexed cost base:

$9,500 − $6,000 = $3,500

Net capital gain less 50% capital gain discount:

$3,500 − 50% × $3,500 = $1,750

For the disposal of the artworks, Edward should choose the indexed cost base for a net capital gain of $1,532. *September 1999 68.7  =  March 1989     51.7 Antique furniture Capital proceeds

$5,000

Cost base at date of death $13,000 Capital loss

$5,000 − $13,000 = $8,000

Where there is a capital loss the cost base is not indexed and the 50% discount does not apply.

Jewellery Capital proceeds:

$26,000

Cost base at date of death $24,000 Indexed cost base

$24,000 × 1.328* = $31,872

When indexing the cost base gives rise to a capital loss the cost base is not indexed. There is no capital loss because the capital proceeds exceed the cost base. The capital loss on collectables of $8,000 is offset against the net capital gain on collectables of $1,532 giving a net capital loss of $6,468 that can be carried forward and offset against future capital gains on collectables. Sale of personal use asset A personal use asset is one that is used or kept mainly for personal use or enjoyment of the taxpayer (ITAA97 s 108-20(2)). The caravan acquired by Edward is a post-CGT asset and is acquired at the cost base at date of Gladys’s death, that is $17,000. A capital gain on a personal use asset is exempt if it is acquired for $10,000 or less. Edward disposed of the caravan for $4,000 and incurred a capital loss of $13,000. Capital losses on the disposal of personal use assets are disregarded (ITAA97 s 108-20(1)). The disposal of the caravan does not give rise to any capital gain or loss tax liability. AMTG: ¶11-380, ¶11-390, ¶11-400, ¶11-770, ¶12-570, ¶12-580, ¶12-590

¶2-110 Worked example: Relationship breakdown: Rollover relief Issue On 30 October 2019, as part of a property settlement arising from the breakdown of their marriage, the Family Court made an order requiring Geoffrey Hedges to transfer to his spouse, Judith Hedges, 1 million shares in Lucky Pty Ltd. On 5 November 2019, Geoffrey sought instructions from Judith as to whom the Lucky shares should be transferred to. The following day, Judith replied that the shares should be transferred to a trust which she controlled. On 8 November 2019, the transfer of the Lucky shares was executed in accordance with Judith’s wishes. Geoffrey wishes to apply CGT rollover relief to the transfer and thereby disregard the capital gain that otherwise arises on him from the transfer of shares to Judith’s trust. Is Geoffrey able to take claim CGT rollover relief? What are the CGT implications of the transfer for Geoffrey, Judith and the trust controlled by Judith? Solution Where personal assets are transferred as a result of a marriage breakdown, automatic CGT rollover relief will be available under Subdiv 126-A where certain conditions are met. Where CGT rollover applies, any capital gain or loss made by the transferor spouse (or entity) on the transfer of the asset is disregarded and, assuming the asset is a post-CGT asset, its cost base to the transferor spouse becomes the cost base of the transferee spouse (s 126-5(5)). The practical effect of this is that the effects of CGT are deferred until the transferee spouse ultimately disposes of the asset. If the conditions for rollover relief are not met, the transfer will be considered to be a normal disposal and acquisition and the usual CGT rules will apply. The conditions for obtaining CGT marriage breakdown rollover are: • the asset is disposed of by a person to his or her spouse or former spouse, and • the disposal is pursuant to: 1. an order of a court under the Family Law Act 1975 (FLA) or a corresponding foreign law, including consent orders (Taxation Determination TD 1999/47) 2. a binding financial agreement under the FLA or a corresponding written agreement that is

binding because of a corresponding foreign law 3. an arbitral award under the FLA or a corresponding arbitral award under a corresponding state, territory or foreign law, or 4. a written agreement made under a state, territory or foreign law relating to relationship breakdowns where the agreement is equivalent to a binding financial agreement under the FLA (s 126-5 ITAA 97). The roll-over applies only if, at the time of the disposal: • the spouses or former spouses are separated, with no reasonable likelihood of cohabitation being resumed, and • the disposal happened because of reasons directly connected with the breakdown of the relationship (s 126-25 ITAA 97). The rollover applies to de facto relationships (including same-sex partner relationships). A CGT rollover may also apply where the asset is transferred by a company or trust, instead of directly by a spouse (s 126-15; 126-20). Crucially, the CGT rollover only applies in relation to assets transferred from a spouse, company or trust to the other spouse. Where the asset is transferred to an entity (eg a company or trust) other than the receiving spouse, the rollover relief is not available. On the face of it, therefore, Geoffrey is not entitled to apply rollover relief to the transfer of his shares. In Ellison v Sandini Pty Ltd; FC of T v Sandini Pty Ltd 2018 ATC ¶20-651, the taxpayers had sought a declaration that a transfer of shares brought about by Mr Ellison pursuant to orders of the Family Court of Western Australia attracted rollover relief in circumstances very similar to those facing Mr and Ms Hedges. Mr Ellison argued that the Family Court caused CGT event A1 to happen (as required by s 126-5(2)) as it provided his former spouse with beneficial ownership of the shares, which in turn amounted to a change of ownership for the purposes of CGT event A1, as required by s 104-10(2), notwithstanding that the shares were actually transferred to a trust controlled by Ms Ellison. He contended that his former spouse had received the shares as she directed Mr Ellison to transfer the shares to her specified trust. The Full Federal Court rejected this argument, concluding that the Family Court order did not effect a change in the ownership of the shares for the purposes of CGT event A1. Instead, the CGT event occurred either on the execution of the transfer of ownership to the trust or at the date the trust became the registered owner of the shares. In addition, the transfer did not arise “pursuant to” the Family Court orders, meaning the basic conditions in s 126-15 were not met. Applying the judgement of the Full Federal Court in the Sandini case, Geoffrey would not be entitled to apply the rollover relief. A capital gain will arise to Geoffrey based on the difference between the market value of the shares at the date of transfer (being 8 November 2019, the date the transfer was executed) and their original cost, which may be reduced by the 50% general CGT discount assuming the shares have been held for more than 12 months. The trust controlled by Judith will be deemed to have acquired the shares for their market value at the date of transfer. There are no tax implications arising from the transfer with regards to Judith personally. AMTG: ¶11-750, ¶12-460, ¶12-470

¶2-120 Worked example: Timing of CGT events Issue Harrison Carter, an Australian resident, seeks advice on the CGT consequences of the following events. 1. He exchanged contracts for the acquisition of an investment property, at market value, on 24 January 1999, paying a 10% deposit of $80,000. Property settlement was deferred until 5 December

2001, when the balance of $720,000 was paid, title transferred, and his name was recorded as the registered proprietor. At the time of settlement the market value of the property was $1m. He sold the property on 14 July 2018 for $1.3m. 2. He acquired 10,000 shares in Star Entertainment Ltd in October 1985, paying $4 per share. He decided to sell his entire shareholding, for $12 per share, and signed a share transfer document and handed the transfer and share script to the Stock Exchange on 20 June 2019. The transfer was not registered with Star Entertainment Ltd until 10 July 2019. 3. He incurred a capital loss in 2019/20 amounting to $65,000. Solution The timing of a CGT event is important for a number of reasons: • Assets acquired before 20 September 1985 are generally exempt from CGT. • The CGT discount only applies to disposal by some taxpayers after 21 September 1999. • Indexation of the cost base was applicable up to 21 September 1999 and the indexation factor is determined quarterly. • The market value of an asset may be relevant at the date of acquisition and disposal. A CGT event A1 happens if a taxpayer disposes of a CGT asset (ITAA97 s 104-10(1)). The taxpayer disposes of a CGT asset when there is a change in ownership. However, a change in ownership does not occur if there is a change in legal ownership of the asset but not a change in its beneficial ownership (ITAA97 s 104-10(2)). The time at which CGT event A1 happens is when the contract for the disposal is entered into or, if there is no contract, when the change of ownership occurs (ITAA97 s 104-10(3)). The most common situations where CGT event A1 happens involve the sale of an asset, however there are many other circumstances involving CGT event A1, such as: • An asset transferred by way of gift. • An asset is transferred from a trustee to a beneficiary of the trust. There are other circumstances where CGT event A1 does not apply, such as: • Where a CGT asset is split or changed (eg land sub-division or amalgamation). • Conversion of a property holding from joint tenancy to a tenancy in common in equal shares. In general, a taxpayer acquires a CGT asset at the time when the taxpayer becomes the owner of the asset (ITAA97 s 109-5(1)). Specific rules on the timing of acquisition of CGT assets, including CGT event A1, are detailed in ITAA97 s 109-5(2). The timing of CGT events was in issue in FC of T v Sara Lee Household & Body Care (Aust) Pty Ltd 2000 ATC 4378, McDonald v FC of T 98 ATC 4306, Elmslie & Ors v FC of T 93 ATC 4964 and Case V156 88 ATC 1005. The issue in FC of T v Sara Lee Household & Body Care (Aust) Pty Ltd was whether a capital loss was available to offset a capital gain on the sale of a business. A contract for the sale of a business was entered into in 1991 and was varied in 1992 and generated a capital gain. A capital loss was incurred in 1992. The question was whether the capital gain was made when the contract was entered into in 1991 or the year in which it was varied, that is 1992. The court held that the contract, which generated the capital gain, from the sale of the business was made in 1991. There was no capital gain in 1992 to offset against the capital loss made in 1992. In the case of a gift of shares, the handing over of a signed share transfer form and the share script would constitute a disposal of the shares by the donor, even though the transfer is not registered (Case V156 88

ATC 1005). Capital gain on the disposal of the investment property For CGT purposes, Harrison acquired the property on 24 January 1999 when contracts were exchanged and not at the time of settlement on 5 December 2001. The contract purchase price is $800,000. The market value at the time of settlement is $1m. Had Harrison acquired the property on 5 December 2001 he would not have the option of indexing the cost base or discounting the capital gain. However, because he acquired the property on 24 January 1999 he has the option of indexing the cost base or applying the 50% capital gain discount. Calculating the capital gain: Applying the 50% capital gain discount:

$

Capital proceeds

1,300,000

Cost base

800,000

Capital gain

500,000

Application of the 50% discount

250,000

NET CAPITAL GAIN

250,000

Indexation of the cost base Capital proceeds

1,300,000

Indexed cost base*

810,400

CAPITAL GAIN

489,600

*September 1999  March 1999 

68.7 = 1.013  67.8 

Harrison is advised to choose the 50% capital gain discount, resulting in a capital gain of $250,000 which is less than the capital gain resulting from use of the indexed cost base method ($489,600). Capital gain on the disposal of shares in Star Entertainment Ltd Again Harrison has the option of either indexing the cost base or applying the 50% capital gain discount in calculating the net capital gain. Calculating the capital gain:

$

Applying the 50% capital gain discount: Capital proceeds

120,000

Cost base

40,000

Capital gain

80,000

Application of the 50% discount

40,000

NET CAPITAL GAIN

40,000

Indexation of the cost base Capital proceeds

120,000

Indexed cost base*

67,840

CAPITAL GAIN

52,160

*September 1999  December 1985 

68.7  40.5 

= 1.696

Harrison is again advised to choose the 50% capital gains discount method resulting in a net capital gain of $40,000. Net capital gain or loss for 2018/19 and 2019/20 years Harrison’s total capital gain for 2018/19 is $290,000. The capital loss of $65,000 incurred in 2019/20 cannot be offset against the capital gain of $290,000 in 2018/19. AMTG: ¶11-033, ¶11-240, ¶11-250, ¶11-440, ¶11-460, ¶11-550, ¶11-610

¶2-140 Worked example: Granting a lease; lease variation Issue Metro Service Station is an independent petrol retailer. On 1 April 2016 the proprietor of Metro Service Station granted a five-year lease to United Petroleum Ltd to use the Metro Service Station as an outlet for the exclusive supply of its petrol. The annual rent was set at an initial $2,000 with a 5% annual rent escalation clause. In addition, United Petroleum Ltd paid Metro Service Station a lease premium of $50,000. Metro Service Station incurred legal and stamp duty costs of $3,500 in executing the lease. On 1 December 2018 Metro Service Station approached United Petroleum with a request to vary the term of the lease from five to four years. United Petroleum agreed to the lease variation on that date in return for the payment to United Petroleum of $10,000. The lease then continued in effect until its end date of 1 April 2020. Advise both Metro Service Station and United Petroleum on the CGT consequences of these lease transactions. Solution Rental income The annual rental payments received by Metro Service Station are assessable income to Metro Service Station as ordinary income from property (ITAA97 s 6-5(1)). United Petroleum would be entitled to a deduction for the rental payment under ITAA97 s 8-1(1). CGT and leases A CGT asset is any kind of property or a legal or equitable right that is not property (ITAA97 s 108-5(1)). ITAA97 categorises CGT events, which include granting and varying leases CGT events F1 to F5 (ITAA97 Subdiv 104-F). A lease is a proprietary interest carved out of property. The granting of a lease gives rise to a CGT asset and event (F1), created by its disposal. The asset is disposed of by the lessor and simultaneously acquired by the lessee (Gray & Anor v FC of T 89 ATC 4640). CGT event F1 granting a lease The payment of lease premium is to be distinguished from other CGT events, such as goodwill (FC of T v Krakos Investments Pty Ltd 96 ATC 4063) and lease incentive payments (FC of T v Cooling 90 ATC 4472) which may give rise to CGT event D1 (ITAA97 s 104-35). The lease premium of $50,000 paid by United Petroleum to Metro Service Station constitutes CGT event F1 (ITAA97 s 104-110(1)) and gives rise to a capital gain of $46,500 for Metro Service Station for the 2015/16 income year, calculated as follows (ITAA97 s 104-110(3)): Capital proceeds less cost base (element 2) = $50,000 − $3,500 = $46,500 A capital gain from CGT event F1 is not a discount capital gain (ITAA97 s 115-25(3)). CGT event F3 lessor pays lessee to have the lease changed The variation of the lease on 1 December 2018 by reducing the term of the lease from five to four years constitutes CGT event F3 (ITAA97 s 104-120) where the lessor, Metro Service Station, pays the lessee, United Petroleum, the sum of $10,000 as consideration for accepting a shorter term lease. The payment constitutes a capital loss of $10,000 for Metro Service Station.

CGT event F4 lessee receives payment for changing the lease CGT event F4 also occurs where the lessee receives a payment for changing the lease (ITAA97 s 104125). The receipt of the $10,000 by United Petroleum, from Metro Service Station, results in a capital gain and a reduction of the cost base of $50,000, paid to Metro Service Station as a lease premium, to $40,000. Expiration of the lease on 1 April 2020 At the expiration of the lease United Petroleum has experienced CGT event C2 (ITAA97 s 104-25), namely the cancellation, surrender and similar ending of a CGT event, that is, the lease premium. This results in a capital loss to United Petroleum of $40,000. AMTG: ¶11-240, ¶11-270, ¶11-300, ¶11-380

¶2-160 Worked example: Sale of property; settlement in following income year Issue Sam Williams entered into a contract for the disposal of land on 25 June 2020. It was agreed with the purchaser that settlement be delayed by 180 days, with settlement to take place on 22 December 2020. The sale of the land gave rise to a capital gain of $400,000. Sam’s tax return for 2019/20 is due on 31 October 2020. He intends to lodge his tax return before the due date. Is Sam required to include the capital gain in his 2019/20 income tax return notwithstanding that settlement is delayed until after the tax return is due? As an alternative, can Sam’s capital gain be included in the tax return in respect of the year of settlement instead, that is the 2020/21 income year? Solution Sam is required to include the capital gain in his 2019/20 income tax return (ie the year that the contract of sale was entered into). He can however lodge his tax return by 31 October 2020 without including the capital gain and later amend his tax return once settlement occurs, that is once there is a change in ownership (Taxation Determination TD 94/89). CGT event A1 happens when a taxpayer disposes of a CGT asset (ITAA97 s 104-10). The time of the event happens when the contract of disposal is entered into. Where there is no contract, then the event happens when there is a change of ownership. Where the contract is settled in a later year of income, a taxpayer is required to include a capital gain or loss in the year of income in which the contract is made, not in the year of income in which the contract is settled. For Sam, this would be the 2019/20 income year. TD 94/89 states however, that a taxpayer is not required to include any capital gain or loss in the appropriate year until an actual change of ownership occurs. Settlement effects a change of ownership and a disposal which then triggers the operation of CGT event A1. When settlement occurs, the taxpayer is then required to include any capital gain or loss in the year of income in which the contract was made. The taxpayer may need to have their assessment amended if an assessment has already been made for that income year. Where an assessment is amended to include a net capital gain, and a liability for interest arises, the remission of general interest charge will be dealt with in each case on its own merits. However, the ATO would expect that discretion would ordinarily be exercised to remit the interest in full where requests for amendment are lodged, and where relevant, self-amendments are made, within a reasonable time after the date of settlement. In most cases, a period of one month after settlement is considered to be reasonable. Sam should amend his 2019/20 tax return shortly after settlement to include the capital gain and to avoid any interest charges. Although not required, Sam can lodge his return for the income year in which the contract was made by the due date and as a matter of convenience include in the return any (net) capital gain arising from the sale of the land, or offset any capital loss arising from the sale of the land against a capital gain. AMTG: ¶11-250

¶2-180 Worked example: Disposal of residence; business with a restrictive covenant Issue Mike and Carol Bradley purchased a one-hectare property on 1 May 1995 for a purchase price of $345,000 and incidental acquisition costs of $20,000. The property supported a residence and a veterinary practice. It was estimated that one-third of the purchase price was attributable to the residential premises and the remaining two-thirds to the veterinary practice. Mike and Carol resided at the property and ran the veterinary practice until September 2019 when Mike and Carol decided to sell-up and retire. The property sold for $660,000 and $10,000 incidental costs were incurred in its disposal. It was determined that the increase in value of the residential premises and veterinary practice was in the same proportion as the original purchase price. The contract for the sale of the property also contained a clause that an additional payment of $50,000 would be made on the condition that neither Mike nor Carol would open a veterinary practice within 100 km for the next three years. Advise Mike and Carol on the CGT consequences of the acquisition and disposal of the property and the restrictive covenant. Solution The disposal of a person’s main residence is exempt from CGT (ITAA97 s 118-110). However, the sale of a business constitutes the disposal of an asset (ITAA97 s 108-5) and will attract CGT. For the purpose of calculating any capital gain it is first necessary to apportion the cost base attributable to the main residence and the cost base attributable to the veterinary practice (ITAA97 s 112-30). Since any capital gain on the sale of the residential premises is exempt from CGT it is only necessary to calculate the capital gain attributable to the veterinary practice. This is done as follows: Cost base of property

Capital proceeds attributable to the veterinary practice  Capital proceeds from the sale of the property 

×

$375,000

×

$440,000  $660,000 

=

$250,000

Where the cost base of the one-hectare property includes the purchase price (ITAA97 s 110-25(2)) of $345,000 and the incidental costs of acquisition and disposal (s 110-25(3)), totalling $30,000 ($20,000 plus $10,000). The share of the cost base attributable to the veterinary practice is $250,000 and the share of the capital proceeds attributable to the veterinary practice is $440,000. Because Mike and Carol are resident individuals and because they satisfy the conditions for either CGT indexation or the 50% CGT discount (because their ownership spans a time period prior to and subsequent to 21 September 1999), Mike and Carol have the option to either index the cost base or discount the capital gain in order to minimise their CGT liability (ITAA97 Div 114 and Div 115). Indexation of the cost base in calculating the capital gain Capital proceeds attributable to the veterinary practice

$440,000

Indexed cost base attributable to the veterinary practice

$250,000 × 1.062* = $265,500

*Where the indexation factor is: CPI September 1999  CPI June 1995 

68.7 64.7

= 1.062

Capital gain:$440,000 − $265,500=$174,500 Application of the 50% capital gains discount in calculating the capital gain

$ Capital proceeds attributable to the veterinary practice

440,000

Cost base attributable to the veterinary practice

250,000

Nominal capital gain

190,000

Application of 50% discount (ITAA97 s 115-100)

95,000

NET CAPITAL GAIN

95,000

Mike and Carol would be advised to apply the 50% discount option in calculating the capital gain on the sale of the property because it results in a net capital gain of $95,000 rather than $174,500, which is the net capital gain derived using the indexed cost base method. Further, as Mike and Carol are joint owners of the property, the capital gain is split between the two of them and constitutes a $47,500 addition to each of Mike and Carol’s assessable income. Small business relief The ITAA97 provides a range of tax concessions for CGT small business entities. An entity is a CGT small business entity if it carries on a business and has an aggregate turnover for the previous year or likely turnover for the current year of less than $2m (ITAA97 s 152-10(1AA)). The four CGT small business concessions are (ITAA97 s 152-1): • the 15-year exemption (Subdiv 152-B) • the active asset 50% reduction (Subdiv 152-C) • the retirement concession (Subdiv 152-D) • the roll-over (Subdiv 152-E). The basic conditions that need to be satisfied in order to qualify for the CGT concessions are (ITAA97 s 152-10): • a CGT event happens in relation to a CGT asset of the business in the income year • the event would (apart from ITAA97 Div 152) have resulted in the gain • the business satisfies the CGT small business entity criterion for the income year or the maximum net asset value of the business does not exceed $6m (s 152-15). The application of these concessions can result in the capital gain being ignored or reduced for CGT purposes. If the 15-year exemption applies, the capital gain is ignored (s 152-105). If the 15-year exemption concession does not apply but the active asset 50% reduction applies in conjunction with the 50% CGT discount, then, the capital gain is reduced by 75% (s 152-205). If the retirement concession and/or the roll-over provisions apply the capital gain is further reduced or ignored for CGT purposes (s 152-210). Given that the relevant CGT asset, the veterinary practice, satisfies the basic conditions for CGT small business relief (s 152-10) up to four CGT concessions may be available to Mike and Carol. Entering into the restrictive covenant Mike and Carol have entered into a restrictive covenant not to open a veterinary practice within 100 km for the next three years, in return for $50,000. Mike and Carol have disposed of an asset created by its disposal. Such actions constitute CGT event D1 and a capital gain arises where the capital proceeds, the $50,000, exceed the costs associated with the agreement (ITAA97 s 104-35). Mike and Carol will be liable for CGT on the $50,000 received for disposing of an asset, namely their right to work. Once the three years have expired the asset no longer exists and the beneficiary of the covenant incurs a capital loss (ITAA97 s 104-25(3)).

AMTG: ¶7-110, ¶11-033, ¶11-038, ¶11-270, ¶11-280, ¶11-380, ¶11-410, ¶11-550, ¶11-570, ¶11-610, ¶11-730, ¶12-005

¶2-200 Worked example: Demolition; subdivision of land; construction of units Issue On 1 July 2008 Bob Harley purchased a block of land with a dwelling on it for $400,000. The dwelling was used as a rental property until he decided to demolish it in July 2017. Bob did not receive any consideration with respect to the demolition of the existing dwelling. On 1 August 2017, the vacant block was subdivided into two equal-sized blocks on which two new units were built (Unit A and Unit B). Construction of the units was completed on 1 October 2018 at a total cost of $600,000 ($300,000 for each unit). Bob used both Unit A and Unit B as investment properties and each of them was rented out on 1 December 2018. Due to financial difficulties, Bob decided to sell Unit B. On 30 April 2020 he entered into a contract for sale. The sale price was $750,000 with settlement on 30 June 2020. Selling costs, that is agent fees amounted to $10,000. What are the CGT consequences of the subdivision, demolition and construction of Units A and B? Solution Demolition of dwelling The block of land and dwelling is taken to be one CGT asset at the time of its acquisition on 1 July 2008 (ITAA97 s 108-55). Note however, that a building or structure is treated as a separate CGT asset if a balancing adjustment can apply to the building or structure under the relevant provisions for depreciating assets and R&D (ITAA97 s 108-55). The demolition of the existing dwelling on the land triggered CGT event C1 (ITAA97 s 104-20). CGT event C1 happens if a CGT asset owned by a taxpayer is lost or destroyed (see also Taxation Determination TD 1999/79). The event occurred when the dwelling was demolished. A capital gain arises from CGT event C1 if the capital proceeds from the loss or destruction of the asset are more than its cost base. In this case there is no capital gain in the 2017/18 year with respect to the dwelling because no capital proceeds were received from the demolition. Note that the market value substitution rule does not apply to CGT event C1 (ITAA97 s 116-25) (see Interpretative Decision ATO ID 2002/633). As a CGT event has happened to only part of the asset, Bob is required to apportion the cost base or reduced cost base between the land and the dwelling using the apportionment rules (ITAA97 s 112-30(2), (3) and (4)). Because Bob did not receive any capital proceeds, the effect of these provisions is that no amount is apportioned to the cost base/reduced cost base of the dwelling (see Interpretative Decision ATO ID 2002/633). The vacant land retains a cost base of $400,000 with no value attributed to the demolished dwelling. Subdivision of vacant land The subdivision of the vacant block of land did not trigger a CGT event (ITAA97 s 112-25(2)). However, each of the blocks is treated as a new asset (s 112-25(1)). Special cost base rules apply if a CGT asset is split into two or more assets, but only if the taxpayer remains the beneficial owner of the new asset after the split (s 112-25(3)). Broadly, Bob is required to apportion each element of the cost base and reduced cost base of the original asset in a reasonable way to each new asset. The Commissioner accepts any basis of attribution which is appropriate in the circumstances, for example based on area or relative market value (Taxation Determination TD 97/3). The cost base of a CGT asset comprises five elements (ITAA97 s 110-25). In brief, these elements are: 1. First element: money paid or property given for the CGT asset. 2. Second element: incidental costs of acquiring the CGT asset or that relate to the CGT event (such as

agent’s fees in relation to selling property). 3. Third element: costs of owning the CGT asset. 4. Fourth element: capital costs to increase or preserve the value of the asset or to install or move it. 5. Fifth element: capital costs of preserving or defending title or rights to the CGT asset. As the area of the land was subdivided equally, splitting the original cost base of the land (ie $400,000) on a 50/50 basis would be a reasonable way to allocate the first element of cost base to the new blocks. Each block would have a first element of cost base of $200,000. As there is no CGT event triggered by the subdivision, each asset is still taken to have been acquired on 1 July 2008 for CGT purposes. The construction costs are included in the fourth element of cost base and reduced cost base as an enhancement cost to the land (ITAA97 s 110-25(5)). As the costs are split evenly between Unit A and Unit B, $300,000 is included in the fourth element of cost base for each unit. The total cost base for each unit is $500,000 ($200,000 for the first element of cost and $300,000 for the fourth element of cost base — see below). Disposal of Unit B The sale of Unit B would be on capital account. Bob’s intention was to build the unit for investment purposes however financial difficulties have necessitated its sale. The disposal of Unit B would trigger CGT event A1 (ITAA97 s 104-10). This event occurs when the contract of disposal is entered into by the taxpayer or if there is no contract, when the change of ownership occurs (s 104-10(3)). As the contract of sale is entered on 30 April 2020, the event is taken to have happened in the 2019/20 year. The capital gain to Bob on disposal of Unit B is calculated as follows: $ Capital proceeds

$ 750,000

Less: First element cost base — purchase price*

200,000

Second element cost base — selling costs

10,000

Fourth element cost base — construction*

300,000 (510,000)

Capital gain

240,000

General discount (50%)**

120,000

NET CAPITAL GAIN

120,000

*For the purposes of this example, Bob did not claim any plant and equipment items or building costs for any property under Div 40 and Div 43 respectively. **Unit B is taken to have been acquired on 1 July 2008. The CGT discount applies as the asset has been held for at least 12 months (ITAA97 s 115-5 to 115-50). AMTG: ¶11-033, ¶11-270, ¶11-410, ¶11-510, ¶11-550, ¶11-570

¶2-220 Worked example: CGT implications on establishment and dissolution of partnership Issue Frank Martin and Jenny Finn, Australian residents, both owned and operated storage units businesses. Frank commenced his business Self Storage (SS) in 1980 while Jenny commenced her business Universal Storage (US) on 15 May 1990. The businesses were located in close proximity to each other

and on 1 August 1995 Frank and Jenny entered into a partnership agreement to merge their businesses and share profits and losses equally. Each business comprised land and buildings, being the storage units and these were the only assets of the businesses. At the commencement of the partnership, on 1 July 1995, the asset valuations were: Assets

Valuation $

Frank — SS Land and buildings: 1980

500,000

Land and buildings: 1 July 1995

2,000,000

Jenny — US Land and buildings: 1990

1,000,000

Land and buildings: 1 July 1995

1,500,000

In March 2020 Frank contemplated retirement and it was agreed to dissolve the partnership. In May 2020 the partnership land and building asset was sold for $6m. Frank and Jenny seek your advice on the CGT consequences resulting from establishing their partnership and its subsequent dissolution. Solution A capital gain or loss arising from a CGT event that happens in relation to a partnership or to one of its assets is made by the partners individually and not the partnership (ITAA97 s 106-5). The outcome for each partner will vary according to the timing and costs involved in the acquisition and disposal of the partner’s fractional interest in the partnership or its assets. If a partner is admitted to a partnership, the new partner acquires a part of each partnership asset and the existing partners are treated as having disposed of part of their interest in each partnership asset to the extent that the new partner has acquired it. If a partner leaves a partnership, the capital proceeds received by the outgoing partner must be broken down into separate amounts, representing the partner’s fractional interest in each of the partnership assets. At the same time, each continuing partner acquires a separate asset to the extent that the partner acquires a part of the outgoing partner’s interest in a partnership asset. CGT consequences on commencement of the partnership Asset

Transaction

Capital gains consequences

Acquisition

½ share in US for $750,000

Cost base

Disposal

½ share in SS for $1,000,000

Capital proceeds

Share in SS

½ share in SS at $250,000

Cost base

Share in US

½ share in US at $750,000

Cost base

Acquisition

½ share in SS for $1,000,000

Cost base

Disposal

½ share in US for $750,000

Capital proceeds

Frank — SS

Asset Holdings:

Jenny — US

Asset Holdings: Share in US

½ share at $500,000

Cost base

Share in SS

½ share in SS at $1,000,000

Cost base

Frank — SS Capital proceeds on disposal of ½ share in SS

$1,000,000

As this is a pre-CGT asset there is no CGT liability on disposal. Jenny — US $ Capital proceeds on disposal of ½ share in US 750,000 Cost base ½ share in US

500,000

Indexed cost base*

524,500

CAPITAL GAIN

225,500

*September 1999 September 1995

68.7 65.5

= 1.049

Application of the 50% capital gain discount: $250,000 × 50% = $125,000 NET CAPITAL GAIN $125,000 Jenny has the option of choosing the method that yields the lesser capital gain. In this case Jenny would choose the 50% discount method as it results in a taxable capital gain of $125,000 rather than $225,500 using the indexed cost base method. However, the partnership satisfies the requirements for the small business CGT concessions in ITAA97 Div 152. Jenny can apply the active asset 50% reduction (ITAA97 Subdiv 152-C) and reduce the taxable capital gain to $62,500. CGT consequences on dissolution of the partnership Frank — SS Half share of capital proceeds on disposal of partnership land and building asset

$3,000,000

Capital proceeds attributable to ½ share in SS

$1,500,000

As this is a pre-CGT asset there is no CGT liability on disposal. Frank — US

 $

Capital proceeds on ½ share in US

1,500,000

Cost base ½ share in US

750,000

Indexed cost base*

786,750

CAPITAL GAIN

713,250

*September 1999 September 1995

68.7 65.5

= 1.049

Application of the 50% capital gain discount: [Capital proceeds − cost base] × 50% [$1,500,000 − $750,000] × 50% = $375,000

Frank has the option of choosing the method that yields the lesser capital gain or a capital loss. Frank should choose the 50% capital gain discount option yielding a capital gain of $375,000 rather than $713,250 using the indexed cost base method. However, the partnership meets the requirements to qualify for the small business CGT concessions in ITAA97 s 152-5, in that the net value of the assets of the partnership do not exceed $6m. Given that Frank intends to retire he can disregard the entire capital gain if he is 55 years of age (or older) and retires (ITAA97 Subdiv 152-B). Alternatively, the active asset 50% reduction is also available to him, further reducing his capital gain to $187,500. Jenny — US

$

Half share of capital proceeds on disposal of partnership land and building asset

3,000,000

Capital proceeds attributable to ½ share in SS

1,500,000

Cost base ½ share in US

500,000

Indexed cost base*

524,500

CAPITAL GAIN

975,500

*September 1999 September 1995

68.7 65.5

= 1.049

Application of the 50% capital gain discount: [Capital proceeds − cost base] × 50% [$1,500,000 − $500,000] × 50% = $500,000 Jenny has the option of choosing the method that yields the lesser capital gain. In this case she would choose the 50% discount method as it results in taxable capital gain of $500,000 rather than $975,000 using the indexed cost base method. However, the partnership satisfies the requirements for the small business CGT concessions in ITAA97 s 152-5, in that the net value of the assets of the partnership do not exceed $6m. Jenny can apply the active asset 50% reduction (ITAA97 Subdiv 152-C) and reduce the taxable capital gain to $250,000. Jenny — SS

$

Capital proceeds attributable to ½ share in SS

1,500,000

Cost base ½ share in SS

1,000,000

Indexed cost base*

1,049,000

CAPITAL GAIN *September 1999 September 1995

451,000 68.7 65.5

= 1.049

Application of the 50% capital gain discount: $500,000 × 50% = $250,000 Jenny has the option of choosing the method that yields the lesser capital gain or a capital loss. The 50% discount method in this case yields the lesser capital gain of $250,000. However, the partnership satisfies the requirements for the small business CGT concessions in ITAA97 Div 152. Jenny can apply the active asset 50% reduction (ITAA97 Subdiv 152-C) and reduce the taxable capital gain to $125,000. The end result is that Jenny has a net capital gain of $375,000. Jenny could consider application of the remaining two small business CGT concessions, namely the lifetime $500,000 retirement exemption (ITAA97 Subdiv 152-D) and the replacement asset concession (ITAA97 Subdiv 152-E) further reducing or deferring the CGT liability. AMTG: ¶5-000, ¶11-000, ¶11-030, ¶11-033, ¶11-200, ¶11-250, ¶11-610, ¶12-005

¶2-240 Worked example: CGT consequences of share and bonus shares transactions Issue David Jones is a self-funded retiree resident in Australia who lives off the income and capital gains from his real estate and share investments. David Jones has accumulated the following portfolio of shares since he started as a share trader and investor: Company

Date of purchase

Number of shares

Purchase price/share

Cost base

$

$

AGL Ltd

1 April 1980

2,000

4

8,000

TEL Ltd

15 May 1987

3,000

6

18,000

IBM Ltd

20 August 1995

5,000

10

50,000

CSR Ltd

10 September 2004

6,000

2

12,000

WBC Ltd

14 December 2019

4,000

15

60,000

Over the years the following transactions took place in relation to David Jones’s share investments: Company

Date of transaction Transaction

AGL Ltd

1995

1 for 10 bonus issue from capital reserve account

1 June 2020

Sale of 1,000 shares @ $6

2000

1 for 20 bonus issue from share premium account

1 June 2020

Sale of 1,500 shares @ $20

12 October 1990

1 for 5 bonus issue out of share premium account

1 June 2020

Sale of 2,000 shares @ $5

1 April 2019

1 for 3 bonus issue paid out of profits

1 June 2020

Sale of 2,000 shares @ $1

8 May 2019

1 for 4 bonus issue from capital reserve account

1 June 2020

Sale of 1,000 shares @ $20

TEL Ltd

IBM Ltd

CSR Ltd

WBC Ltd

Advise David Jones of the income and CGT liability arising from his share transactions for 2019/20. Solution CGT liability arises on the happening of a CGT event, which includes the disposal of an asset (ITAA97 s 104-5). A CGT asset is any kind of property or a legal or equitable right that is not property (ITAA97 s 108-5) and includes shares in a company. The difference between the cost base on acquisition of shares and the capital proceeds on the disposal of shares constitutes a capital gain where the capital proceeds exceed the cost base, or a capital loss where the cost base exceeds the capital proceeds. Any resulting taxable capital gain is added to the taxpayer’s assessable income, while any capital loss is carried forward to be offset against future capital gains. It is common for companies to issue bonus shares to existing shareholders and the CGT treatment of bonus shares depends on: • the date of acquisition of the original shares, and • whether the bonus shares are treated as dividends.

The critical date in relation to the acquisition of shares is 20 September 1985. Shares acquired prior to that date are pre-CGT assets, whereas shares acquired after that date, are post-CGT assets. In general, bonus shares out of company profits will be dividends, while bonus shares derived from the company’s capital account will not be dividends. The capital gains treatment of bonus shares is outlined in ITAA97 Subdiv 130-A. Section 130-15 deals with the acquisition time and cost base of bonus shares where the original shares are either pre-CGT assets or post-CGT assets. CGT treatment of bonus shares Where the bonus share is a dividend and included in assessable income, the cost base of the bonus share includes the amount of the dividend (ITAA97 s 130-20(2)). Where the original shares were acquired before 20 September 1985 and the bonus shares are fully paid, the bonus shares are deemed to have been acquired at the time the original shares were acquired. The bonus shares are treated as having been acquired before 20 September 1985 and will not attract CGT (ITAA97 s 130-20(3)). Where the original shares were acquired on or after 20 September 1985 the bonus shares are deemed to be acquired at the time the original shares were acquired. The first element of the cost base for the original shares is apportioned in a reasonable way over both the original and bonus shares. CGT consequences in relation to AGL Ltd share transactions The AGL Ltd shares are a pre-CGT asset. The 200 bonus shares are deemed to be acquired at the time of acquisition of the original shares (ITAA97 s 130-20(3)). The 2,200 shares maintain their status as preCGT assets. The disposal of 1,000 shares (apportioned between original and bonus shares) is exempt from CGT (ITAA97 Div 104). However, any gain on disposal of the shares may be assessable as an extraordinary transaction on the basis of Myer Emporium 87 ATC 4363, or as a profit-making undertaking or plan (ITAA97 s 15-15). CGT consequences in relation to TEL share transactions The TEL Ltd shares are a post-CGT asset. The 150 bonus shares are deemed to be acquired at the date of acquisition of the original shares, that is 15 May 1987 (ITAA97 s 130-20(3)). The cost base of the shares is spread over both the original and bonus shares: $18,000 = $5.71  3,000 + 150  Since the shares were acquired prior to September 1999, in calculating any capital gain David Jones has the option of indexing the cost base or applying the 50% capital gains discount and choosing the option yielding the lesser CGT liability. Capital gain when indexing the cost base Element

Transaction

Amount $

Capital proceeds

1,500 shares @ $20

Cost base

1,500 shares @ $5.71

Indexed cost base

$8,565 × 1.493*

CAPITAL GAIN *September 1999  June 1987 

30,000 8,565 12,787.55 17,212.45

68.7 = 1.493  46.0 

Capital gain applying the 50% capital gain discount Element

Transaction

Amount

$ Capital proceeds

1,500 shares @ $20

Cost base

1,500 shares @ $5.71

30,000 8,565

Capital gain

21,435

Capital gain 50% discount

10,717.50

NET CAPITAL GAIN

10,717.50

David Jones should rely upon the 50% capital gain discount as it yields the lesser capital gain of $10,717.50. CGT consequences in relation to IBM Ltd share transactions The IBM Ltd shares are a post-CGT asset. The 1,000 bonus shares are deemed to be acquired at the date of acquisition of the original shares, that is, 20 August 1995. The cost base of the shares is spread over both the original and bonus shares, that is: $50,000  5,000 + 1,000 

= $8.33

Since the shares were acquired prior to September 1999, in calculating any capital gain David Jones has the option of indexing the cost base or applying the 50% capital gains discount and choosing the option yielding the lesser CGT liability. However, in the case of a capital loss the cost base is not indexed. Capital gain or loss when indexing the cost base Element

Transaction

Amount $

Capital proceeds

2,000 shares @ $5

10,000

Cost base

2,000 shares @ $8.33

16,660

(Capital loss)

 6,660

David Jones has experienced a capital loss of $6,660 with the disposal of his IBM Ltd shares. Given this capital loss, the cost base is not indexed and the 50% capital gain discount does not apply. As David Jones has made both a monetary and real capital loss, the capital loss can be offset against capital gains or carried forward to offset against future capital gains. CGT consequences in relation to CSR Ltd share transactions Since the bonus issue by CSR Ltd was paid out of profits, it constitutes a dividend. ITAA97 s 130-20(2) provides that the cost base of the bonus shares would include any part of the shares that are a dividend, and that the date of the acquisition would be the date the bonus shares were issued, that is 1 April 2020. The cost base of the original shares would not be affected (ie it remains at $2 per share, being $12,000/6,000). On a subsequent partial sale of shares (on 1 June 2020), if the first-in-first-out (FIFO) basis is adopted then 2,000 of the original shares would be taken to have been sold (Taxation Determination TD 33). Capital gain or loss on disposal of original shares Element

Transaction

Amount $

Capital proceeds

2,000 shares @ $1

2,000

Cost base

2,000 shares @ $2

4,000

(Capital loss)

2,000

CGT consequences in relation to WBC share transactions The WBC Ltd shares were acquired on 14 December 2019 and disposed of on 1 June 2020. It is not permissible for David Jones to index the cost base in calculating any capital gain (ITAA97 s 114-1), nor is it permissible to apply the 50% capital gain discount because David Jones has not held the shares for more than 12 months (ITAA97 s 115-25). The WBC Ltd shares are a post-CGT asset. The 1,000 bonus shares are deemed to be acquired at the date of acquisition of the original shares, that is, 14 December 2019. The cost base of the shares is spread over both the original and bonus shares, that is:  $60,000  = $12.00  4,000 + 1,000  Capital gain on the disposal of shares in WBC Ltd Element

Transaction

Amount $

Capital proceeds

1,000 shares @ $20

20,000

Cost base

1,000 shares @ $12

12,000

CAPITAL GAIN

 8,000

The $8,000 capital gain will be added to other capital gains derived by David Jones in the 2019/20 year. Summary In working out his net capital gain for 2019/20, David Jones needs to follow the steps in ITAA97 s 1025(1). This allows David Jones to deduct capital losses from relevant capital gains before applying the 50% capital gains discount. The steps are as follows: $ Capital gain on disposal of WBC Ltd (neither indexing nor discounting)

8,000

Less capital loss on disposal of IBM Ltd shares

(6,660)

Less capital loss on disposal of CSR Ltd shares

(2,000)

Net capital loss

(660)

Add capital gain on disposal of TEL Ltd shares

21,435

Net capital gain

20,775

Application of capital gains 50% discount

10,387.50

Total capital gain for 2019/20

10,387.50

AMTG: ¶11-000, ¶11-030, ¶11-036, ¶11-240, ¶11-250, ¶11-380, ¶11-500, ¶11-550, ¶11-610, ¶12-600

¶2-260 Worked example: Share options Issue In February 1980 Annette Monroe acquired 1,000 shares in Targette Pty Ltd from Anthony Neal for $5 per share. On 1 March 2019 Anthony offered Annette the right or option to acquire 1 share for each 5 shares held. The cost of the right or option was $1 per share. Annette exercised the option on 11 November 2019 and acquired 200 shares at $15 each. At the end of January 2020, Annette disposed of her entire shareholding in Targette Pty Ltd for $18 per share. Advise both Annette Monroe and Anthony Neal on the CGT consequences of the share option transactions.

Solution CGT event D2 happens if a taxpayer grants an option to an entity, even if the grantor of the option does not own the property at the time of grant. The time of CGT event D2 is when the option is granted (ITAA97 s 104-40). The capital gain is the capital proceeds from granting the option less the cost base, consisting of expenditure incurred in the grant of the option. A capital gain from CGT event D2 cannot be a discount capital gain (ITAA97 s 115-25(3)). In the case of rights or options to acquire shares, the rights or options are taken to be acquired at the time of acquisition of the original shares. However, if the original shares are a pre-CGT asset and the rights or options are granted after 20 September 1985, the rights or options are a post-CGT asset. When an option is exercised any capital gain or loss resulting from CGT event D2 is disregarded (ITAA97 s 104-40(5)). Instead, the amount paid for or received for the grant of the option is added to the capital proceeds and cost base on the disposal of the underlying property. The cost base and reduced cost base of the option are modified under ITAA97 s 134-1. CGT consequences for Annette Monroe The original 1,000 shares are pre-CGT assets and do not attract CGT on disposal. The 200 shares acquired in November 2019 are post-CGT assets and attract CGT. The cost base for the 200 shares comprises the cost of the rights or options at $1 per share and the price paid for acquisition of the shares, namely $15 per share. Annette Monroe’s capital gain for the 2019/20 year is: $ Capital proceeds:

200 shares @ $18

3,600

Cost base*:

200 shares @ $16

3,200

CAPITAL GAIN

400

*Cost base: cost of rights $1 × 200 plus cost of shares $15 × 200 = $3,200 Indexation of the cost base does not apply here because the transactions took place after September 1999 and the capital gain is not discounted by 50% since the shares were not held for at least 12 months. CGT consequences for Anthony Neal CGT event D2 occurred at the time Anthony granted the right or option to Annette to acquire the 1 for 5 shares in Targette Pty Ltd, for $1 per share. Assuming a zero cost base, this yields a capital gain of $200 for the 2018/19 year. Once the option is exercised in November 2019 the CGT event D2 is disregarded. However, for the 2019/20 year Anthony makes a capital gain, calculated as follows: $ Capital proceeds from the disposal of 200 shares @ $15 per share

3,000

Capital proceeds from grant of option on 200 shares @ $1 per share

  200

Capital proceeds

 3,200

Cost base (assuming Anthony acquired the 200 shares for $2 per share)

  400

CAPITAL GAIN for 2019/20

2,800

Anthony Neal is further advised that: • He will be entitled to a credit in 2019/20 for the $200 CGT paid in the 2018/19 year. • The 50% capital gains discount does not apply to CGT event D2. • Whether Anthony is entitled to index the cost base or apply the 50% discount to the disposal of the 200 shares will depend on when he acquired the 200 shares.

AMTG: ¶11-240, ¶11-280, ¶12-700

¶2-280 Worked example: Small business CGT concessions Issue Neil Swan is an engineer who owns and manages a marine boat and yacht repair business. He acquired the business as a going concern in 2001 for $700,000 and in 2020 it is valued at $3.8m. Revenue has increased over the years and in 2018/19 it amounted to $1.1m and in 2019/20 it rose to $1.2m. The business assets comprise land and buildings on which the business operates; a slipway for winching boats and yachts out of the water; and plant and equipment for repairing the marine craft. The value of the business includes the intangible assets goodwill and the benefit of a restrictive covenant limiting competition from adjacent businesses. In April 2020 Neil Swan turned 54 years of age. For personal reasons he may need to sell his marine boat and yacht repair business. At the same time he has an opportunity to acquire an engineering and manufacturing business for $2.5m. Neil Swan is contemplating whether or not to dispose of his business in 2020 and seeks your advice on the options or strategies available to him and the CGT consequences of the various options or strategies. Solution The issues outlined above raise questions as to whether Neil Swan’s business satisfies the basic conditions for a CGT small business entity and whether the CGT concessions for small business are available to him. Requirements for small business CGT relief Provided certain conditions are satisfied, there are four CGT concessions that may be available to small business, which have the effect of reducing or even eliminating CGT on the disposal of certain assets. The basic conditions for relief in ITAA97 Subdiv 152-A, s 152-5 include: • the entity must be a CGT small business entity or the net value of assets that the entity and related entities owned must not exceed $6m, and • the CGT asset must be an active asset. A CGT small business entity is a business where aggregated turnover is less than $2m for the previous income year or is likely to be less than $2m for the current financial year (ITAA97 s 152-10(1AA)). A taxpayer satisfies the maximum net asset value test if, just before the time of the CGT event, the net value of the CGT assets of the taxpayer, its connected entities, its affiliates and the entities connected with those affiliates is no more than $6m (s 152-15). It excludes liabilities of the entity that are related to those assets and provisions for annual or long service leave and unearned income and tax liabilities (s 152-20). A CGT asset satisfies the active asset test if the asset was an active asset of the taxpayer: • for a total of at least half of the period from when the asset was acquired until the CGT event, or • if the asset is owned for more than 15 years, for a total of at least 7½ years during that period (ITAA97 s 152-35). A CGT asset is an active asset if: • the taxpayer owns the asset and it is used or ready for use in the course of carrying on a business that is carried on by the taxpayer, an affiliate or another entity connected with the taxpayer, or • if the asset is an intangible asset (such as, goodwill or a restrictive covenant) the taxpayer owns it and it is inherently connected with the business that is carried on (ITAA97 s 152-40).

The four small business CGT concessions 1. The CGT 15-year exemption (ITAA97 Subdiv 152-B) A CGT small business entity can disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met, namely: • the basic conditions for relief in Subdiv 152-A are satisfied • the entity continuously owned the asset for the 15-year period leading up to the CGT event • if the entity is an individual, the individual is 55 or over and the CGT event happens in connection with their retirement, or is permanently incapacitated (ITAA97 s 152-105). This concession does not impact on the $500,000 lifetime retirement exemption. 2. The CGT active asset 50% reduction (ITAA97 Subdiv 152-C) This concession does not apply to the extent that the CGT 15-year exemption has eliminated the capital gain (s 152-215). Providing the conditions in ITAA97 Subdiv 152-A are satisfied, then a capital gain can be reduced by 50% (s 152-205). This applies after the 50% capital gains discount (if applicable) has been applied, thereby reducing the taxable capital gain by 75%. The capital gain may be further reduced by the small business retirement exemption or a small business roll-over, or both (s 152-210). Alternatively, the individual may choose not to apply the active asset 50% reduction and instead apply the small business retirement exemption or a small business roll-over, or both (s 152-220). 3. The CGT retirement exemption (ITAA97 Subdiv 152-D) A small business taxpayer can disregard a capital gain from a CGT event happening to an active CGT asset if the proceeds from the event are used in connection with the taxpayer’s retirement (s 152-305). A lifetime limit of $500,000 applies (ITAA97 s 152-320). To qualify for this concession: • the basic conditions in Subdiv 152-A must be satisfied, and • if the individual is under 55 years, the amount equal to the asset’s CGT exempt amount is contributed to a complying superannuation fund or retirement savings account (RSA). This concession usually applies after the CGT active asset 50% reduction. 4. The CGT roll-over exemption (ITAA97 Subdiv 152-E) The small business roll-over allows a taxpayer to defer the making of a capital gain from a CGT event that happens in relation to one or more small business active assets (s 152-415), providing the basic conditions in Subdiv 152-A are satisfied (ITAA97 Subdiv 152-E). Where no replacement asset is acquired the taxpayer can choose to defer the capital gain on the disposal of the active asset for two years. Where a replacement asset is acquired, the capital gain on the disposal of the active asset is deferred until the replacement asset is disposed of. The possible application of CGT events J5 (ITAA97 s 104-197), J6 (ITAA97 s 104-198) and J2 (ITAA97 s 104-185) need to be taken into account. Neil Swan’s marine boat and yacht repair business satisfies the basic conditions for a CGT small business entity. The annual turnover and net value of its assets are both within the current thresholds and the business assets qualify as active CGT assets. Consequently, the four small business CGT concessions are potentially available to Neil Swan. If Neil was to hold off selling his business for one year, until he reached 55 years of age, the CGT 15-year exemption would apply and any capital gain on the disposal of his business would be disregarded. On the other hand, if Neil wishes to dispose of his business in 2020, because of personal reasons or the opportunity to acquire the engineering manufacturing business, as he is only 54 years of age, the CGT 15-year exemption is not available. However, the other three small business CGT exemptions may be available.

Application of the CGT active asset 50% reduction The capital gain on the disposal of the business, being the difference between the capital proceeds and the cost base, would be $3.8m less $700,000, that is $3.1m. Because the business is owned by Neil, a resident individual, and was acquired in 2001, Neil is entitled to apply the 50% CGT discount (ITAA97 s 115-100). This reduces the capital gain to $1.55m. Application of the CGT active asset 50% reduction further reduces the capital gain to $775,000. Application of the CGT retirement exemption Neil Swan could apply the net capital gain of $775,000 against his $500,000 lifetime retirement exemption. The outstanding capital gain would be reduced to $275,000. Being under 55 years of age, Neil would be required to contribute the $500,000 into a complying superannuation fund or RSA. Neil is also advised that, subject to a lifetime limit of $1.480m in 2019/20, amounts associated with the CGT small business concessions can be contributed to superannuation without being counted towards the individual’s non-concessional contributions cap (ITAA97 s 960-285). The remaining $275,000 capital gain, after tax, could also be contributed to superannuation as a non-concessional contribution. CGT roll-over exemption A final option Neil should consider is to roll-over the capital gain on the disposal of his business and acquire the engineering manufacturing business for $2.5m. Any outstanding capital gains in respect of the disposal of the marine boat and yacht repair business would be deferred until disposal of the engineering manufacturing business. AMTG: ¶7-001, ¶7-110, ¶7-120, ¶7-130, ¶7-145, ¶7-165, ¶7-175, ¶7-185, ¶7-195

¶2-300 Worked example: Small business CGT concessions; meaning of active and excluded assets Issue Victoria Adams owns residential premises in which she runs a bed and breakfast in rural New South Wales. The property contains six bedrooms and has been operated as a bed and breakfast since its acquisition. Victoria is responsible for the bookings, checking guests in and out and cleaning the rooms. She also provides clean linen and meal facilities to guests. She does not enter into any lease agreements with guests staying at the apartments. The rooms are collectively advertised as a bed and breakfast and are booked for periods ranging from one night to one month. The majority of bookings are from one to seven nights. Victoria also owns two commercial properties in the area which she leases to local businesses. The properties have been leased since acquisition under formal lease agreements to various commercial tenants. They have used them as office and warehouse spaces. The terms of the leases have ranged from one year to three years with a three-year option; they are provided for exclusive possession. Victoria has not engaged a real estate agent to act on her behalf and manages the leasing of the properties by herself. Due to financial difficulties, Victoria is considering disposing of one of her commercial properties. Alternatively, she is also considering disposing of the residential premises from which the bed and breakfast business is being carried on from and cease trading altogether. She wishes to reduce the capital gain on the disposal of the relevant properties by way of access to the small business CGT concessions. Advise Victoria as to whether any of the relevant properties that is the subject of disposal is taken to be an “active asset” for the purposes of the small business CGT concessions. Solution Pursuant to ITAA97 s 152-35, a CGT asset satisfies the active asset test for the purposes of the small business CGT concessions if:

• the taxpayer has owned the asset for 15 years or less and the asset was their active asset for at least half of the period specified in s 152-35(2), or • the taxpayer has owned the asset for more than 15 years and the asset was the taxpayer’s active asset for a total of at least 7½ years during the period specified in s 152-35(2) (s 152-35(1)). The period specified in s 152-35(2) begins when the taxpayer acquired the asset and ends at the earlier of: • the CGT event, and • if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows — the cessation of the business. Generally, a CGT asset is an “active asset” if: • the taxpayer owns the asset (whether it is tangible or intangible) and it is used, or held ready for use in the course of carrying on a business that is carried on (whether alone or in partnership) by the taxpayer, the taxpayer’s affiliate or another entity that is connected with the taxpayer, or • if the asset is an intangible asset — the taxpayer owns it and it is inherently connected with a business that is carried on (whether alone or in partnership) by the taxpayer, the taxpayer’s affiliate or another entity that is connected with the taxpayer (s 152-40(1)). There are however some specific exclusions from the asset being an active asset. One of these exclusions relates to an asset whose main use in the course of carrying on a business is to derive interest, an annuity, rent, royalties or foreign exchange gains (ITAA97 s 152-40(4)(e)). Taxation Determination TD 2006/78 provides guidance on whether there are any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test notwithstanding the exclusion for assets whose main use is to derive rent. According to the TD 2006/78 and the decision in Tingari Village North Pty Ltd v FC of T 2010 ATC ¶10-131, a key factor in determining whether the income from premises constitutes rent is whether the occupier has a right to exclusive possession and quiet enjoyment. In the present case, the commercial premises held by Victoria which are leased to commercial tenants for use as office space and as a warehouse under formal lease agreements would not be an “active asset” on the basis that the properties main (only) use is to derive rent; that is, the exclusion in s 152-40(4)(e) applies. This applies regardless of whether Victoria is carrying on a business of leasing properties. The approach adopted is consistent with the views of the Commissioner in TD 2006/78 (see Example 1) and in accordance with Tingari; each tenant in the present case are entitled to exclusive possession and quiet enjoyment of their respective properties; that is, there is a landlord/tenant relationship. Therefore, as the premises are not active assets, Victoria would not be entitled to the small business CGT concessions if she were to sell either of these properties. In contrast, the exclusion in s 152-40(4)(e) does not apply with respect to the residential premises from which Victoria operates her bed and breakfast. The Commissioner in TD 2006/78 (see Example 4) considers that a bed and breakfast is operated in a similar way to a motel. In the present case, the guests do not have exclusive possession of the apartment they are staying in but rather only a right to occupy the apartment on certain conditions. Further, the usual length of stay by guests is very short term and room cleaning, linen and meals are also provided to guests. These factors indicate that the relationship between Victoria and the guests at her bed and breakfast is not that of a landlord/tenant under a lease agreement (in contrast to the relationship she has with the tenants of her commercial properties). Accordingly, the income derived is not “rent”. As the activities of running a bed and breakfast amount to carrying on a business, the exclusion in s 152-40(4)(e) would not apply and the dwelling would be an active asset. In order to access the small business CGT concessions, Victoria would need to ensure that all conditions under the active asset test in s 152-35 are satisfied (ie the asset must be an active asset for the

prescribed period) and that the basic conditions in s 152-10 are satisfied if she intends on disposing of this asset. AMTG: ¶7-110, ¶7-120, ¶7-145

¶2-303 Worked example: Active asset test; use in a business Issue Wendy Simpson owns a four-hectare block of land south of Perth. The block consists of scrubby bushland and is adjacent to the premises of Simpson Construction Pty Ltd, a building contractor whose shares are wholly owned by Wendy and her husband, Peter. Simpson Construction Pty Ltd uses the part of Wendy’s block that is directly adjacent to its premises — about one hectare in total — to store building materials and to park vehicles owned by the company when not in use on construction jobs. The block of land has been owned by Wendy for 20 years and has been used in this way by Simpson Construction Pty Ltd throughout the period of ownership. There is no business signage on the block of land. The other three hectares are vacant. Wendy has received an offer to sell the block of land to a property developer who wishes to build townhouses on the block. Due to increasing land prices in the area, she stands to make a substantial profit on the sale and is keen to understand if she can claim the small business concessions to reduce or eliminate her potential CGT liability. Advise Wendy on this point. Solution There are a number of conditions that must be met before the small business CGT concessions can apply to a taxpayer. Relevantly, the fourth condition in the basic conditions set out in s 152-10(1) states that the CGT asset giving rise to the capital gain must be an “active asset”. If the active asset test is not satisfied, no small business CGT relief is available, even where the taxpayer satisfies the other conditions, such as the small business turnover or maximum net asset value tests. The active asset test in s 152-35 states that a CGT asset satisfies the active asset test if: • the taxpayer has owned the asset for 15 years or less and the asset was an active asset of the taxpayer for a total of at least half of the relevant period, or • the taxpayer has owned the asset for more than 15 years and the asset was an active asset of the taxpayer for a total of at least 7½ years during the relevant period. According to s 152-40, a CGT asset is an “active asset” at a given time if: • the taxpayer owns the asset (whether the asset is tangible or intangible) and: – the taxpayer uses it, or holds it ready for use, in the course of carrying on a business, or – it is used, or held ready for use, in the course of carrying on a business by: i. the taxpayer’s affiliate, or ii. an entity connected with the taxpayer, or • if the asset is an intangible asset — the taxpayer owns the asset and it is inherently connected with a business carried on by the taxpayer, the taxpayer’s affiliate or an entity connected with the taxpayer. So, an asset is an active asset if it is used in a business (or inherently connected with a business, if the asset is intangible) carried on by the taxpayer, an affiliate of the taxpayer or an entity connected with the taxpayer. The question of what is meant by “use in the course of carrying on a business” has been particularly troublesome in the context of land, particularly in relation to otherwise vacant land that has had some business use. The Commissioner has traditionally taken the view that whilst an asset does not need to be used

exclusively for business purposes, the use of the land must be “integral to the process by which the business is carried on”. This, in the Commissioner’s view, is what is meant by being used “in the course of” the business. So, the activities undertaken on the land must not be merely incidental to the business operations; there must be a direct connection to the business. In FC of T v Eichmann 2019 ATC ¶20-728; [2019] FCA 2155, the taxpayer carried on a business of building, bricklaying and paving. The taxpayer and his wife purchased the property next door to their matrimonial home. On the property were two sheds measuring 4 metres × 3 metres each. The taxpayer used the sheds for the storage of work tools, equipment and materials. The open space on the property was used to store materials that did not need to be stored under cover, including bricks, blocks, pavers, mixers, wheelbarrows, drums, scaffolding and iron. Work vehicles and trailers were also parked there. The property would be visited a number of times a day in between jobs depending on what each job required. Although most of the work of the business was done on worksites, some preparatory work was done at the property in a limited capacity. There was no business signage on the property. The Federal Court found that the usage of an asset — land in this case — must be a constituent part or component of the day-to-day business activities, and might in that way be described as “integral” to the carrying on of the business. The Court also found that for an asset to be “used” in the course of carrying on a business, it must be wholly or predominantly so used, such that any other use can only be minor or incidental. The land in the Eichmann case was not so used. The Federal Court further noted that the land use was preparatory to undertaking activities in the ordinary course of business of the taxpayer. It was for the storage of materials for use by the company which were used when it engaged in its business activities if those materials were required. However, the storage itself was not an activity in the ordinary course of the taxpayer’s business. While it might have been a use of the land “in relation to” the carrying on of the business, it was not, of itself, an activity in the course of carrying on the business. There was no direct connection between the uses and the business activities and the uses had no functional relevance to those business activities. Therefore, in this instance, the vacant land used for storage was found not to be an active asset. Applying the principles of this case to Wendy, it can be seen that she will not be entitled to claim the small business CGT concessions in relation to the capital gain arising on the sale of the land. The land is not an active asset. This is because the land is not integral to the business of Simpson Construction Pty Ltd. Although it is convenient for the company to use the land to store materials and equipment, it is not a constituent part of the day-to-day business activities of the company. In addition, only part of the land — about a quarter — is used in the business at all. It is not wholly or predominantly used in the course of carrying on the business of the company. The use to which Wendy’s land is put is preparatory to the undertaking of activities in the ordinary course of the company’s business, that is for the storage of materials and equipment for use by the company when it engages in its business activities. The storage itself is not an activity in the ordinary course of the taxpayer’s business of construction. AMTG: ¶7-110, ¶7-120, ¶7-145

¶2-305 Worked example: CGT small business concessions on the sale of shares or units Issue Bumble Pty Ltd is a business that manufactures and sells toys for children. Its annual turnover in the 2019/20 year was less than $2m and it does not own any interests in other entities and nor does it have any affiliates. The company has two equal shareholders; Freddy Bee and the Buzz Family Trust (BFZ). On 14 May 2020, each shareholder agreed to sell their 50% share of Bumble Pty Ltd for $1.5m each. Settlement occurred on 27 June 2020. The shareholders have owned Bumble since it was formed in 2008. Throughout that period, the total market value of the company’s active assets and cash/financial instruments inherently connected with

Bumble’s business has amounted to at least 80% of Bumble’s total assets. BFZ satisfies the $6m Maximum Net Asset Value test. During the 2019/20 income year, the trustees of BFZ distributed all of the trust income of BFZ, in equal proportions, to Rod and Jane. Freddy does not satisfy the MNAV test but he carried on an unrelated business just before the CGT event and is a CGT Small Business Entity for the 2019/20 income year. Can BFZ and Freddy claim the small business concessions in relation to the disposal of their shares in Bumble? Solution If a CGT asset is a share in a company or an interest in a trust (the object entity), the taxpayer must satisfy additional basic conditions relating to the CGT asset, the taxpayer, the object entity and CGT concession stakeholders if the CGT event happened on or after 8 February 2018 (s 152-10(2)). • The shares or units in the object entity must satisfy the new “modified active asset test” that looks through shares in companies and units trusts to the activities and assets of the underlying entities, if any (s 152-10(2)(a)). The modified active asset test is applied after the regular active asset test. Where the object entity does not hold any shares or units in another company or trust, the two tests will almost always achieve the same result. However, where the object entity does hold such shares or units, the share or unit held by the object entity is “looked through” (ie ignored) and assets held by that other company or trust (the “later entity”) are taken into account. • If the taxpayer triggering the CGT event (ie the share or unit holder) does not satisfy the MNAV test, they must have been carrying on a business just before the CGT event (s 152-10(2)(b)). • The object entity must either: – be a CGT SBE, or – satisfy a modified MNAV test (s 152-10(2)(c)) using a modified rule to determine whether entities are “connected with” other entities under s 328-125 with the following assumptions: (1) the turnover or assets of entities that may control the object entity are disregarded (2) an entity is treated as a controlling another entity if it has 20% (instead of 40%) or more, and (3) any determination by the Commissioner under s 328-125(6) to treat certain entities as not controlling others are disregarded. The basic condition that has always existed in relation to the disposal of shares and units (s 152-10(2)) must also be satisfied, namely: • The individual who triggers the CGT event must be a CGT concession stakeholder of the company or trust (the object entity) just before the CGT event. A CGT concession stakeholder is an individual who is either: – a significant individual in the object entity. This is an individual with a “small business participation percentage” (SBPP) in the object entity of at least 20%. Broadly the SBPP equates to the taxpayers direct or indirect ownership interest in the entity, or – a spouse of a significant individual (with a SBPP or more than 0% in the object entity). • Where a company or trust triggers the CGT event, it must satisfy the “90% test”, meaning that just before the CGT event, CGT concession stakeholders of the object entity have a SBPP of at least 90% in the company or trust that made the capital gain. Buzz Family Trust

The BFZ satisfies the basic conditions for the application of the small business concessions. It meets the MNAV test and the shares in Bumble satisfy the regular active asset test. In respect of the additional basic conditions that apply on the sale of a share or unit: • The shares in Bumble satisfy the modified active asset condition since Bumble does not own any interests in “later entities” (meaning that the two tests are effectively the same). • The BFZ satisfies the MNAV test so does not need to consider whether it was carrying on a business just before the CGT event. • Bumble is a CGT SBE. It does not own any interests in (and therefore does not control) other entities and has no affiliates and therefore only needs to consider its own annual turnover (which is less than $2m). • The BFZ satisfies the 90% test just before the CGT event. This is because Rod and Jane each have a SBPP in Bumble of 25% (being a 50% interest in BFZ multiplied by BFZ’s 50% interest in Bumble). They are significant individuals (each has a SBPP of at least 20%) and therefore are CGT concession stakeholders in Bumble. So, CGT concession stakeholders in Bumble together have a SBPP in BFZ of 100% (in excess of the 90% test). Accordingly, BFZ satisfies both the basic and additional conditions in relation to the disposal of its shares in Bumble and the CGT small business concessions can be applied. Freddy Freddy satisfies the basic conditions for the application of the small business concessions. He is a CGT SBE for the year and the shares in Bumble satisfy the regular active asset test. In respect of the additional basic conditions that apply on the sale of a share or unit: • the shares in Bumble satisfy the modified active asset condition as above • Freddy does not satisfy the MNAV test but he was carrying on a business just before the CGT event • Bumble is a CGT SBE, as above • Freddy is a CGT concession stakeholder in Bumble just before the CGT event. He has a SBPP of 50% in Bumble (well in excess of the required 20%). He is a significant individual in Bumble, and therefore a CGT concession stakeholder. Accordingly, Freddy satisfies both the basic and additional conditions in relation to the disposal of his shares in Bumble and the CGT small business concessions can also be applied. AMTG: ¶7-120, ¶7-124, ¶7-130, ¶7-145, ¶7-156, ¶10-105

¶2-310 Worked example: Digital currencies: personal use exemption Issue Donald Drake has been a long-term investor in shares and has a range of holdings in various public companies in a balanced portfolio of high- and low-risk investments. Some of his holdings are income producing and some not, and he adjusts his portfolio frequently at the advice of his adviser. Recently, Donald’s adviser told him that he should invest in digital currency. On 16 December 2019, he bought one unit of the digital currency for $4,435. By 21 June 2020, the value of his unit had increased to $14,100 and, fearing the price rise was unsustainable, he decided to sell, making a profit of $9,665 (excluding fees). Prior to purchasing his unit of digital currency, Donald was told by a friend that profits on digital currencies are tax free provided the cost of the investment is $10,000 or less. What are the tax implications of Donald’s digital currency transactions? Is he correct that the profit could

be tax free? Solution Digital currency, or cryptocurrency, is a form of currency that is created and held electronically. It is produced by people and businesses running computers all around the world using software that solves mathematical problems. It isn’t printed like dollars or euros and nobody controls it — there is no support from any central bank. The best-known digital currency is Bitcoin. The disposal of digital currency will give rise to a tax liability. Examples include the sale, trade or exchange of digital currency, conversion to a currency like Australian dollars, or use to obtain goods or services. If the disposal is part of a business, the profits on disposal will be assessable as ordinary income and not as a capital gain. Per TD 2014/26 (CGT: Is bitcoin a CGT asset?), the disposal of digital currency acquired for the purposes of investment to a third party gives rise to CGT event A1 under s 104-10(1). A taxpayer will make a capital gain from CGT event A1 if the capital proceeds from the disposal of the digital currency are more than the digital currency’s cost base. The capital proceeds from the disposal are, in accordance with s 116-20(1), the money or the market value of any other property received (or entitled to be received) by the taxpayer in respect of the disposal. The money paid or the market value of any other property the taxpayer gave in respect of acquiring the digital currency will be included in the cost base of the digital currency in accordance with s 110-25(2). A capital gain will arise if the capital proceeds from the disposal of the digital currency are more than its cost base. If the capital proceeds from the disposal of the digital currency are less than its cost base, a capital loss arises. If the digital currency is held for 12 months or more, the CGT discount should be available. While a digital wallet can contain different types of digital currencies, each digital currency is a separate CGT asset. Under s 118-10(3), a capital gain made from a personal use asset is disregarded if the first element of the cost base (broadly speaking, the amount paid to acquire the digital currency in the context of this question) is $10,000 or less. In addition, any capital loss made from a personal use asset is disregarded under s 108-20(1). Digital currency may be a personal use asset if it is acquired and kept or used mainly to purchase items for personal use or consumption. Digital currency is not a personal use asset if it is acquired, kept or used: • as an investment • in a profit-making scheme, or • in the course of carrying on a business. Per TD 2014/26, an example of where digital currency would be considered to be a personal use asset is where an individual taxpayer purchased the digital currency from an exchange and uses the digital currency to make online purchases for their personal needs, for example clothing or music. If the digital currency is instead purchased to facilitate the purchase of income-producing investments, it would not be a personal use asset. Another example of where digital currency would not be a personal use asset is where an individual taxpayer mines the digital currency and keeps it for a number of years with the intention of selling at opportune times based on favourable rates of exchange. In Donald’s case, there is no evidence that he acquired the digital currency for personal use. He acquired the digital currency as part of his overall diversified investment strategy and sold it in order to realise the favourable rate of exchange that existed in June 2020. Therefore, even though he spent $10,000 or less acquiring the digital currency, he cannot take advantage of the personal use exemption. The full profit (less purchase and sale fees) of $9,665 will be subject to CGT. As he retained the digital currency for less than 12 months, he is not entitled to the 50% CGT discount.

AMTG: ¶11-400, ¶11-640

¶2-315 Worked example: Changing a business structure: small business restructure rollover and small business CGT concessions Issue Marcus Hearn, an Australian resident for tax purposes, is a qualified dentist who acquired his own dental practice in 2010, together with the consulting rooms from which he operates his practice as a sole trader. He is 48 years old. The turnover of his business in both the 2018/19 and 2019/20 income years was less than $2m. Marcus is concerned that both his personal assets and his business premises may be exposed in the event of claims from disgruntled patients or creditors. He wishes to restructure his business so as to protect his assets. He also wishes to boost his superannuation savings since he is conscious that in recent years, he has tended to invest surplus funds back into his practice rather than making superannuation contributions. He therefore wishes to transfer his business and all its assets into a discretionary trust, the Marcus Discretionary Trust (MDT), which has a family trust election in place naming Marcus as the primary individual. He also wishes to transfer the consulting rooms into a newly established SMSF, the Marcus SMSF, which will then lease the premises to the MDT for a commercial rent. He wishes to undertake the transfers on 30 June 2020. The active assets of his business are the goodwill of the practice, the consulting rooms, the stock of medical and dental products on hand and various depreciating assets. The market value and cost base/adjustable value of those assets as at 30 June 2020 is: Market value

Cost base

Consulting rooms

700,000

350,000

Goodwill

400,000

100,000

Stock of dental/medical products 80,000

75,000

Depreciating assets

25,000 (adjustable value)

70,000

What are the capital gains tax and other taxation implications of the proposed restructuring? What reliefs and concessions are potentially available to Marcus to reduce his tax liability? Solution In the absence of any further planning, Marcus will make a capital gain in relation to the transfer of the consulting rooms of $350,000 and a further capital gain in relation to the transfer of the goodwill of $300,000. In addition, he will make an assessable profit of $5,000 on the transfer of stock and $45,000 on the transfer of depreciating assets. Transfer of the business assets to the MDT Marcus can choose to apply the Small Business Restructure Rollover in relation to the transfer of the assets to the MDT. This relief is available for the transfer of assets as part of a change of legal structure without a change in the ultimate legal ownership of the assets (Subdiv 328-G). The roll-over relief is available for gains and losses that arise on the transfer of CGT assets, trading stock, revenue assets and depreciating assets. The roll-over is available where the conditions set out in s 328-430 are satisfied: • an entity transfers an asset to one or more other entities • the transaction is, or is part of, a genuine restructure of an ongoing business • each of the parties to the transaction falls within one of the following categories:

– it is a small business entity (SBE) for the year in which the transfer occurred – it is connected with an entity that is a SBE for the year in which the transfer occurred – it has an affiliate that is a SBE for the year in which the transfer occurred – it is a partner in a partnership that is a SBE for the year in which the transfer occurred • the transaction does not have the effect of materially changing the individuals who have the ultimate economic ownership of the asset transferred and their respective share of that ultimate economic ownership • at the time of the transfer the asset is an active asset of the vendor (or is an active asset of the relevant connected entity, affiliate or partnership that is a SBE if the vendor is not a SBE in its own right) • the transferor and transferee each choose to apply the rollover relief • the entities involved in the transaction are both Australian residents • none of the entities involved in the transaction are complying superannuation funds or exempt entities. The following features may indicate the transaction is part of a genuine restructure (see LCR 2016/3): • It is a bona fide commercial arrangement undertaken in a real and honest sense to facilitate growth, innovation and diversification, adapt to changed conditions, or reduce administrative burdens, compliance costs and/or cash flow impediments. • It is authentically restructuring the way in which the business is conducted as opposed to a “divestment” or preliminary step to facilitate the economic realisation of assets. • The economic ownership of the business and its restructured assets is maintained. • The small business owners continue to operate the business through a different legal structure. • It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business. In addition, there is a safe harbour rule that provides the transaction will be a genuine restructure where in the three-year period after the transaction takes effect: • there is no change in ultimate economic ownership of any of the significant assets of the business (other than trading stock) that were transferred under the transaction • those significant assets continue to be active assets, and • there is no significant or material use of those significant assets for private purposes (s 328-435). The effect of applying the rollover is that a restructure is capable of being achieved in a tax-neutral way with regard to income tax. The CGT effect of applying the roll-over is as follows: a) the CGT asset is treated as being transferred for an amount equal to the transferor’s cost base of the asset just before the transfer, thereby preventing any capital gain or loss from arising (s 328-455(2) (a)) b) any pre-CGT asset transferred maintains its pre-CGT status (s 328-460) c) for the purpose of determining whether there will be a discount capital gain in the future, the transferee will be treated as having acquired the CGT asset at the time of the transfer.

Effective roll-over relief also applies to the trading stock, revenue assets and depreciating assets (s 328455). Asset protection is specifically noted as a reason for a genuine restructure in LCR 2016/3. Therefore, Marcus can justifiably claim that the transfer of assets to the discretionary trust is part of a genuine restructure. Alternatively, or in addition, he can also rely on the three-year safe harbour provision. The other relevant conditions noted above are also satisfied based on the information provided. No gain or loss therefore arises on the transfer of the assets to MDT since the assets are transferred at their rollover cost. The MDT is taken to have acquired each asset at the time of transfer for its rollover cost, being the cost base of the goodwill ($100,000), the cost of the trading stock ($75,000) and the adjustable value of the depreciating assets ($25,000). Transfer of the consulting rooms to the Marcus SMSF One of the basic conditions for applying the SBRR is that neither the transferor nor the transferee can be a superannuation fund. Therefore, the SBRR is not available in relation to the transfer of the consulting rooms. However, Marcus may be able to apply the small business CGT concessions to the capital gain arising on the transfer. In particular, Marcus may be able to: • reduce the capital gain by 50% using the general discount (reducing the gain to $175,000) • further reduce the capital gain by using the 50% small business active asset reduction (so the total gain is reduced to $87,500 at this stage) • reduce the balance of the gain to nil using the small business retirement exemption. As Marcus is under 55, he would be obliged to make a contribution of $87,500 into a complying super fund in order to meet the conditions for applying the retirement exemption. This will be treated as a nonconcessional contribution unless Marcus elects to apply it against his lifetime CGT cap ($1,515,000 for 2019/20). Marcus could in addition pay further amounts from the sale proceeds into super up to his nonconcessional contributions cap. Note: Neither the SBRR nor the CGT small business concessions will protect Marcus from other taxation issues, such as GST and Stamp Duty, which will need to be considered separately. AMTG: ¶7-050, ¶7-120, ¶7-175, ¶7-185, ¶12-380

¶2-320 Worked example: Unit trust; interaction between ITAA97 Subdiv 115-C and CGT event E4 Issue Rebecca Samson owns one unit in the Blueberry Unit Trust with another unitholder (ie 50/50). The cost base of the unit is $20,000 and Rebecca has held the property since April 2005. The Blueberry Unit Trust operates a hardware store in a building that has been held by the trust since May 2005. In the 2019/20 year, the Blueberry Unit Trust disposed of the building. A capital gain of $800,000 was derived, with the capital proceeds received being $1m. The cost base of the building was $200,000. The Blueberry Unit Trust is eligible to apply for the small business CGT concessions under ITAA97 Div 152. Applying the 50% general discount and the CGT active asset 50% reduction the net capital gain from the sale is $200,000; no other small business CGT concessions have been applied. With no other income or deductions, the net income of the Blueberry Unit Trust for the 2019/20 year is $200,000. Under the trust deed, the trustee of the Blueberry Unit Trust distributes the capital proceeds of $1m in accordance with the legal interest held by Rebecca and the other unitholder (ie 50/50). Assuming Rebecca is eligible for the small business CGT concessions and that she only wishes to apply the CGT active asset 50% reduction, what are the tax consequences of the distribution made to her by

the trustee? Would CGT event E4 arise with respect to Rebecca’s unit in the Blueberry Unit Trust? Solution ITAA97 Subdiv 115-C sets out the rules for dealing with the net income of a trust that has a net capital gain. The rules will treat parts of the net income attributable to the Blueberry Unit Trust’s net capital gain as capital gains made by the beneficiaries entitled to those parts (ie Rebecca and the other unitholder). Rebecca’s net income from the trust for the 2019/20 year under ITAA36 s 97 is $100,000 (ie $200,000 × 50% interest). This amount is attributable to Rebecca as a capital gain (as there was no other income derived or deductions incurred by the Blueberry Unit Trust during the year). Rebecca’s capital gain for 2019/20 under s 115-215 is calculated as follows: $ Gross-up trust gain under (s 115-215(3)(c) ($100,000 × 4))

400,000

Less: CGT discount reduction (s 115-215(4)(a))

(200,000) 200,000

Less: CGT active asset 50% reduction under s 115-215(4)(b)

(100,000)

CAPITAL GAIN

 100,000

CGT event E4 (ITAA97 s 104-70) arises for a unitholder in a trust if the trustee makes a payment to the unitholder in respect of their unit and some or all of the payment is not included in the unitholder’s assessable income. CGT event E4 generally occurs just before the end of the income year in which the trustee makes the payment, unless another CGT event happens to the interest before the end of the income year (s 10470(3)). In this case, the event is taken to have occurred at the end of the 2018/19 year. A non-assessable part under CGT event E4 may include amounts associated with the CGT active asset 50% reduction, frozen indexation, building allowance and accounting differences in income (ITAA97 s 104-71). However, an amount referrable to the CGT general discount in ITAA97 s 115-5 is not included as a non-assessable part under CGT event E4. Taxation Determination TD 2006/71 provides guidance on determining the non-assessable amount where part of the payment contains a CGT active asset 50% reduction amount and CGT general discount. Rebecca’s non-assessable part under CGT event E4 for the 2019/20 year is $200,000, calculated as follows: $ Payment of capital proceeds made by trustee ($1m × 50%)

500,000

Less: trust net capital gain assessed under ITAA36 s 97

(100,000) 400,000

Less: CGT discount adjustment (s 104-71(4) table item 1)

(200,000)

Non-assessable part

 200,000

Given that the non-assessable part of the payment is more than the $20,000 cost base of her unit, Rebecca must reduce the cost base of her unit to nil and makes a capital gain under CGT event E4 for the 2019/20 year (s 104-70): $ Non-assessable part of payment

200,000

Less: cost base

(20,000)

Capital gain under CGT event E4

180,000

As the unit in the Blueberry Unit Trust was acquired in April 2005, Rebecca satisfies the conditions for the 50% general discount. The calculation for the 2019/20 year is: $ Capital gain under CGT event E4 Less: 50% CGT discount

180,000 90,000 90,000

Less: CGT active asset 50% reduction

45,000

Reduced capital gain

45,000

The net tax result for Rebecca is that she is taxed on a net capital gain of $145,000 (comprised of the $100,000 capital gain under Subdiv 115-C plus $45,000 from the CGT event E4 capital gain). AMTG: ¶7-175, ¶11-033, ¶11-060, ¶11-290

¶2-340 Worked example: Indirect value shifting Issue Lagrande Pty owns five million shares in a wholly owned subsidiary Merkel Pty Ltd. The cost base is $5 per share and the market value is $4 per share. In the 2018/19 income year, Merkel sells an asset with a market value of $4m to Justin Pty Ltd a subsidiary of Lagrande in return for $1m cash. In the 2019/20 income year, Lagrande sells five million shares in Merkel for $3 per share, realising a loss of $2 per share. The shares are held on capital account. What tax consequences arise from these arrangements? Solution A value shift occurs when something is done that results in the value of one asset decreasing and the value of another increasing (or being issued at a discount). An indirect value shift arises where there is a net shift of value from one related entity to another, for example transferring assets for less than or more than market value. It involves a reduction in the value of equity or loan interests in one entity (the losing entity) and a corresponding increase in the value of interests in another entity (the gaining entity). Indirect value shifting rules deal with the consequential effects on the values of interests that are held directly or indirectly by the entities involved (ITAA97 Div 727). In this case, the arrangement has resulted in an indirect value shift of $3m based on the difference between market value and the cash offered for the asset that was transferred from Merkel to Justin. Assuming all the conditions in Div 727 have been satisfied. The market value in the interests in Merkel have fallen by $0.60 per share ($3m/$5m) to $3.40 ($4.00 − $0.60). The indirect value shifting does not give rise to assessable gains or losses. Instead, adjustments are made for the consequential or indirect effects of the value shift. The consequences are limited to either reducing capital losses or capital gains that would otherwise arise when the interests are realised or, where a choice is made, varying the adjustable values of interests held by affected owners. There are two methods that can be applied to work out the consequences of an indirect value shift, that is the “realisation time method” or the “adjustable value method”. The realisation time method applies unless a choice is made to use the adjustable value method (s 727-455). Prima facie, the sale of the shares in Merkel (the losing entity) by Lagrande triggered a capital loss of $2 per share. Based on the indirect value shift that occurred in the 2018/19 income year, the $2 per share loss is

required to be adjusted. Adopting the realisation time method, $0.60 per share is attributed to the indirect value shift. The impact of the indirect value shift reduces the loss of $2 per share by $0.60 per share to $1.40 per share. AMTG: ¶12-800, ¶12-840, ¶12-850

¶2-360 Worked example: Foreign income; CGT discount and foreign tax offset Issue On 4 January 1998, Michael Simpson acquired an investment property in Florida, United States for US$250,000 (A$410,000), including purchase costs. He lived in the property for approximately four weeks each year and rented the property to holidaymakers for the remainder of the year. On 16 October 2019, Michael signed a contract to sell the property, with settlement occurring on 1 December 2019. The sales price was agreed to be US$1,000,000 (A$1,430,000), after selling costs. Michael is advised that the profit on sale of US$750,000 will be subject to United States income tax on capital gains, partly at a rate of 15% and partly at a rate of 20%. On 16 September 2020, Michael pays United States tax amounting to US$135,000 (A$205,000). Michael wishes to understand the Australian CGT implications of his transactions, including whether he can claim a credit for the United States tax paid. Michael was an Australian resident for tax purposes throughout the period of ownership. He has no other CGT events in the years 2018/19 or 2019/20 and no capital losses brought forward from earlier years. His other income for the year exceeds $180,000. Solution The disposal of the property in the United States will give rise to CGT event A1. The capital gain is calculated by deducting the asset’s cost base (in Australian dollars) from the capital proceeds (in Australian dollars). This gives a capital gain of A$1,020,000. Where a capital gain results from a CGT event happening to a CGT asset owned by the taxpayer for at least 12 months, the gain can be discounted by 50% where it is made by an individual (ITAA97 s 115-25). This reduces the amount of the capital gain to $510,000. Per s 102-5, this is the net capital gain that is included in Michael’s assessable income for the 2019/20 income year (the date the contract of sale is signed). This amount is subject to income tax at Michael’s marginal tax rate, being 45%, plus 2% Medicare levy. His total income tax liability in relation to the transaction is $239,700 ($510,000 × 47%). In order to avoid double taxation, Michael is entitled to a foreign tax offset (FITO) in relation to the United States tax paid. This will reduce his tax liability calculated above. A FITO is only available where an amount of foreign income tax is actually paid (s 770-10). In many cases, including this one, foreign tax is actually paid in a different income year from that in which the income or gain is included in the tax return. In this case, the capital gain is reported in the 2019/20 Australian tax return but the United States tax is paid in 2020/21. If Michael lodges his Australian tax return before the United States tax is paid on 16 September 2020, he cannot claim the FITO. He will need to claim the offset in the 2019/20 return by lodging an amended return for 2019/20 after the United States tax has been paid. If he has not lodged his 2019/20 tax return by 16 September 2020, he can include the FITO in that return without the need for an amendment. If a taxpayer pays foreign tax on a foreign capital gain, the offset is available provided that the gain is taken into account in determining the taxpayer’s net capital gain for the year. What this means was considered in the case of Burton v FC of T 2019 ATC ¶20-709; [2019] FCAFC 141. As Michael paid United States tax of A$205,000 in relation to the disposal of the property, the principles set out in that case are vital to understanding whether he can claim the entire $205,000 as a FITO against his Australian tax liability. In Burton, the taxpayer derived capital gains from investments made in the United States. Those gains were taxed at source under the United States income tax law. Mr Burton paid the applicable United States

tax. By virtue of Mr Burton’s residence, the gains were also taxable in Australia as capital gains but were subject to a 50% discount as the investments had been held for more than a year. The taxpayer claimed a FITO under ITAA97 Div 770 for the full amount of the tax paid in the United States, but the Commissioner argued that since only 50% of the net gain was included in the taxpayer’s assessable income, only 50% of the amount of the United States tax paid should count towards the FITO. The reasoning behind this was that Div 770 aims to relieve double taxation that arises where assessable income is subject to both foreign tax and Australian tax. An amount not included in assessable income (namely, 50% of the capital gain) could not be doubly taxed. According to the Commissioner, the taxpayer had not suffered double taxation to the extent of 50% of the capital gain, a view that was upheld by the Full Federal Court with Logan J observing “the amount in respect of which foreign tax is paid has to be the same as all or part of an ‘amount included in your assessable income’”. Per s 102-5, there is no doubt that the amount that is included in assessable income is the net capital gain, not the gain before the discount. As the taxpayer was only entitled to a FITO for the United States tax paid in respect of the amount included in his assessable income, that is the net capital gain, he was only entitled to a FITO for 50% of the United States tax paid. The taxpayer also argued that Art 22(2) of the Australia–United States DTA allowed a full credit of foreign tax paid and that the provisions of the DTA override domestic Australian law, namely Div 770 discussed above. The first sentence of the DTA provides that “tax paid under the law of the United States ... in respect of income derived from sources in the US by a person who ... is a resident of Australia shall be allowed as a credit against Australian tax payable in respect of the income”. The third sentence states that the credit “shall be in accordance with ... the law of Australia”. The Full Federal Court held that only half of the United States tax paid could be said to be “in respect” of the income as taxed in Australia. Because the purpose of Art 22(2) was the allowance by Australia of a credit against tax payable, the starting point was the identification of what income Australia taxed. Due to the operation of the CGT 50% discount, Australia did not tax all of the gain; it taxed 50% of it. That was the income, for Art 22(2) purposes, in respect of which Australian tax was payable. Only half of the United States tax paid could be said to be in respect of the income taxed in Australia. Applying these principles to Michael’s case, he is not entitled to a FITO in respect of the entire amount of the United States tax paid (A$205,000). Recognising that only half of the gain is included in Michael’s assessable income, he is entitled to a FITO of $102,500. This will reduce his Australian income tax liability in relation to the disposal of the property to $137,200 ($239,700 − $102,500). AMTG: ¶11-033, ¶12-780, ¶21-680

FRINGE BENEFITS TAX Benefits to employees, former employees and customers

¶3-000

Car fringe benefit

¶3-020

Car fringe benefits; fleet vehicles; operating cost method

¶3-040

Exempt car benefits and exempt residual benefits: Minor private use of cars ¶3-050 Exempt benefits

¶3-060

Entertainment; minor benefits exemption

¶3-080

Loan fringe benefit

¶3-100

Housing fringe benefits

¶3-120

Housing fringe benefits; provision of onsite accommodation

¶3-140

Living-away-from-home allowances

¶3-160

Living-away-from-home allowance; fly-in, fly-out

¶3-180

Travel expenses: fly-in, fly-out workers

¶3-190

Farming benefits

¶3-200

Meal entertainment fringe benefits

¶3-220

Entertainment, travel and education benefits

¶3-240

In-house property fringe benefits

¶3-260

Private company providing loans and assets for personal use

¶3-280

Exempt FBT employer; salary sacrificed meal entertainment benefits

¶3-300

Reportable fringe benefits amount; payment summary

¶3-320

Various manager’s and employee’s benefits

¶3-340

Sundry benefits

¶3-360

¶3-000 Worked example: Benefits to employees, former employees and customers Issue Mate Co Ltd, is a manufacturer of electronic equipment. During the FBT year ending 31 March 2020, Mate Co provided the following items: (a) Shares in an employee share scheme (ESS) to a current employee. (b) Superannuation contributions paid into a former employee’s complying fund pursuant to a salary sacrifice arrangement. (c) A brief case for a potential employee as an enticement to join the organisation. (d) A holiday package costing $5,500 to a customer as part of a competition. (e) The payment of an employee’s personal credit card expenses of $10,000 under a salary sacrifice arrangement. Mate Co is not entitled to any FBT concessional treatment.

Advise Mate Co as to which of these items do not fall within the meaning of “fringe benefit”. For any items that constitute a fringe benefit, calculate the taxable value and the FBT payable. Solution (a) Shares Shares issued to an employee under an “employee share scheme” (ESS) in which ITAA97 Subdiv 83A-B or 83A-C applies are specifically excluded from being a fringe benefit under item (h) of the definition of a fringe benefit in FBTAA s 136(1). Broadly, an ESS for this purpose is defined under ITAA97 s 83A-10 as a scheme under which ESS interests (eg shares in a company) are provided to employees, or associates of employees (including past or prospective employees) of: (a) the company, or (b) subsidiaries of the company. (b) Superannuation contributions Superannuation contributions paid to a complying superannuation fund are specifically excluded from being a fringe benefit under item (j) of the definition of a fringe benefit in s 136(1). (c) Brief case A brief case is an exempt fringe benefit under FBTAA s 58X(2)(d). An exempt fringe benefit is specifically excluded from being a fringe benefit under item (g) of the definition of a fringe benefit in s 136(1). (d) Holiday package The holiday package does not constitute a fringe benefit as it is not provided to an employee or an associate of the employee (s 136(1)). (e) Payment of employee’s personal credit card expenses The payment of an employee’s personal expenses falls within the definition of a fringe benefit under s 136(1) and the exclusions listed in that section do not apply. The fact that the benefit is provided under a salary sacrifice arrangement does not alter the outcome. The payment of an employee’s personal credit card bill constitutes an expense payment fringe benefit pursuant to FBTAA s 20. This arises where an employer pays or reimburses expenses incurred by an employee. The FBT liability is calculated as follows: Taxable value = $10,000 Grossed-up taxable value = $10,000 × 1.8868* FBT payable = $18,868 × 47% = $8,868 *Grossed-up using the lower Type 2 gross-up rate as Mate Co Ltd is not entitled to claim input tax credits for GST purposes as a credit card statement by itself is not a tax invoice. AMTG: ¶35-025, ¶35-070, ¶35-080, ¶35-330, ¶35-350, ¶35-645

¶3-020 Worked example: Car fringe benefit Issue On 1 April 2019, Bourke Pty Ltd, a Melbourne based company, purchased a new company car at a cost of $50,000 including GST. The car was registered and insured on that date and was to be used exclusively by Tom Grant, Bourke’s Business Manager. The total distance travelled by the car in 12 months was 22,000 km, 8,000 km of which was for business purposes. The car was garaged at Tom’s residence. The following costs (GST inclusive) relate to the car’s use: $ Registration and insurance

1,300

Petrol and oil for car

3,000^

Repairs

500

Service and maintenance

400

^Tom contributed $1,500 towards the cost of the petrol and oil for the car. Calculate the FBT liability using both the statutory formula and the operating cost methods. Which method would you recommend to Bourke Pty Ltd? Solution The employer, Bourke Pty Ltd has provided a company car for Tom’s exclusive use. The car will be treated as being available for Tom’s private use as it is garaged at his home. A fringe benefit therefore arises even though the car is also used by Tom for business or work-related travel. Bourke Pty Ltd can use either the statutory formula method (FBTAA s 9(1)), or the operating cost method (FBTAA s 10(2)) to work out the taxable value of the car fringe benefit. However, in order to use the operating cost method the appropriate substantiation records must be kept, for example log books. Statutory formula method The taxable value of a car fringe benefit under the statutory formula method is calculated as follows: ABC − E  D 

where

A=

$50,000, the base value of the car

B=

20%, the statutory fraction, regardless of the number of kilometres travelled (FBTAA s 9(2)(c))

C=

366, the number of days when the car was used or available for private use

D=

366, number of days in the FBT year, and

E=

$1,500, the employee’s (recipient’s) contribution.

$50,000 × 0.20 × 365  365 

Taxable value

=

–

$1,500 = $8,500

FBT payable

=

Taxable value × Type 1 gross-up factor† × FBT rate

=

$8,500 × 2.0802 × 47%

=

$8,310.40

† The Type 1 gross-up factor has been used because in this scenario as the employer would be able to claim GST input tax credits. Operating cost method (assume substantiation requirements are met) The taxable value of a car fringe benefit under the operating cost method is calculated as follows: [C × (100% − BP)] − R where C = operating cost of the car BP = percentage of business use, and R = employee’s (recipient’s) contribution

C — operating costs of the car $ Registration and insurance

1,300

Petrol and oil for car

3,000 (includes Tom’s contribution of $1,500)

Repairs

500

Service and maintenance

400

Deemed depreciation

12,500 ($50,000 × 25%*)

Deemed interest**

 2,685 ($50,000 × 5.37%)

Total operating costs

20,385

*The deemed depreciation rate is 25%. **Deemed interest is the base value of the car multiplied by the statutory benchmark interest rate, which is 5.37% for the 2019/20 FBT year. BP — the business percentage The business percentage is calculated using the formula: Business kilometres  Total kilometres 

Taxable value

=

 8,000 km   22,000 km 

=

36.36%

= [C × (100% − BP)] − R = [$20,385 × (100% − 36.36%)] − $1,500 = $11,473 (rounded)

FBT payable

= Taxable value × Type 1 gross-up factor × FBT rate = $11,473 × 2.0802 × 47% = $11,217

The statutory method in this case produces a lower taxable value, therefore Bourke Pty Ltd should be advised to use that method rather than the operating cost method. AMTG: ¶35-150, ¶35-180, ¶35-210, ¶35-240

¶3-040 Worked example: Car fringe benefits; fleet vehicles; operating cost method Issue MediPlus Pty Ltd is in the business of selling medical equipment and prostheses to surgeons. During the 2019/20 FBT year, the company has a fleet of 25 vehicles which it provides to its employees to carry equipment for sales calls and to provide on-call assistance to surgeons at hospitals. The cars are normally garaged at the employees’ homes overnight and are primarily used for work purposes. The cars are Toyota hatchbacks which are chosen by MediPlus Pty Ltd due to fleet discounts available and their ability to carry and transport the equipment. They were purchased for a cost of $35,000 (incl GST) each during the 2018/19 income year as part of an update to the company’s fleet. All expenses in relation to the running of the vehicles, such as fuel, insurance and maintenance, are met by the company. MediPlus Pty Ltd uses the operating cost method for calculating the taxable value of its car fringe

benefits. Employees of the company are required to maintain valid log books to determine the extent of any private use for the log book year. However, only 20 employees have undertaken this requirement in the log book year. The average of the business percentages of these log books is 80% for the 2019/20 FBT year. The company is concerned that in the absence of valid log books it cannot apply the operating cost method. For the 2019/20 FBT year, advise MediPlus Pty Ltd whether it can apply the operating cost method for determining the taxable value of the car fringe benefits for its entire fleet. Solution FBTAA s 10 allows employers to elect to apply the operating cost method to work out the taxable value of car fringe benefits provided to their employees. One aspect of the operating cost method requires the employer to work out the business use percentage applicable to each of the cars provided. To work out the business percentage of a car, an employer must ensure that log books and odometer records showing the business use of the car are maintained (s 10A). This requirement must be completed on or before the date on which the employer’s FBT return for the year is due to be lodged. An employer must retain odometer and log book records for five years from the assessment date of the last year to which they relate (FBTAA s 123; 136(1)). An employer is required to keep a log book for the first year the operating cost method is used and then every five years. The log book must be kept for a minimum of 12 weeks. As noted in the facts, while MediPlus Pty Ltd has a policy of requiring that all its employees maintain log books, this requirement has been satisfied by only 20 employees. Prima facie, in the absence of valid log books to determine the business percentage for five of the cars provided, a choice cannot be made for the company to apply the operating cost method in working out the taxable value of these vehicles. The statutory formula method is the default method which would apply in calculating the taxable value for those cars. However, Practical Compliance Guideline PCG 2016/10 allows employers who manage large car fleets to rely on a representative average business use percentage to calculate car fringe benefits for the fleet under the operating cost method. This simplified approach applies if: • it is an employer with a fleet of 20 or more cars • the cars are “tool of trade” cars (ie the cars are subject to extensive business use) • the employees are required to maintain log books in a log book year • the employer holds valid log books for at least 75% of the cars in the log book year • the cars are of a make and model chosen by the employer, rather than the employee • each car in the fleet had a GST-inclusive value less than the luxury car limit applicable at the time the car was acquired, and • the cars are not provided as part of an employee’s remuneration package (eg under a salary packaging arrangement), and employees cannot elect to receive additional remuneration in lieu of the use of the cars. If an employer meets the above criteria, it can apply an average business use percentage to all tool of trade cars held in the fleet in the log book year and the following four years. In the present case, MediPlus Pty Ltd satisfies all these criteria, as: • it has a fleet of 25 cars (which exceeds the 20-car threshold)

• the cars are “tools of trade” as they are car provided to sales representatives and therefore, used extensively in the business • the employees are required to maintain a log book in the log book year • it holds log books for 80% of the cars in the log book year (ie 20 out of 25 cars); which exceeds the 75% threshold • it chooses the make and model of car to be used, rather than the employee • each car in the fleet had a GST-inclusive value of $35,000 (which is less than the luxury car limit relevant for the 2018/19 income year of $66,331), and • it would be reasonable to conclude that the cars are not provided as part of an employee’s remuneration package and employees cannot elect to receive additional remuneration in lieu of the use of the cars. As the company is eligible, it can calculate the average business use percentage by: • gathering all log books kept for each car in the fleet • determining which of those log books are valid • confirming that it has valid log books for at least 75% of the cars in the fleet, and • calculating the average of the business use percentages determined in accordance with each of the valid log books. In the present case, assuming that this methodology has been adopted, the average business use percentage is calculated as being 80% for the 2019/20 FBT year. PCG 2016/10 states that this simplified record-keeping approach can be applied for a period of five years in respect of the fleet (including replacement and new cars) provided the fleet remains at 20 cars or more, and subject to there being no material and substantial changes in circumstances. PCG 2016/10 contemplates that a substantial change in such circumstances would be a change in location of the employer’s depot that would substantially alter the business use percentage of the fleet. Further, the simplified approach may also be used as a basis for determining individual fringe benefits amounts for employees, although such amounts would be excluded fringe benefits for these purposes if a fleet car is made available to more than one employee for private purposes in the same FBT year. AMTG: ¶35-170, ¶35-180, ¶35-210, ¶35-230, ¶35-240, ¶35-690

¶3-050 Worked example: Exempt car benefits and exempt residual benefits: Minor private use of cars Issue Meglos Pty Ltd provides an employee, Tom, with a new utility vehicle designed to carry a load of less than 1 tonne. The ute is provided to Tom so that he can carry bulky tools and equipment to and from work sites. The ute is not provided as part of a salary packaging arrangement, and was acquired for a value below the applicable luxury car tax threshold. The ute is garaged at Tom’s home and he uses the van to travel between home and his place of employment. Meglos Pty Ltd has a strict policy in place about limiting the private use of the vehicle. Tom usually stops at a local bakery to buy a sandwich for his lunch on his way to work. The diversion to the bakery adds 1.5 km to the total trip from home to work. On 14 occasions during the FBT year, Tom also took his son to school in the van during the morning journey to work. Each of these journeys added 5 km to the commute. In addition, Tom also used the ute

to travel to the beach with his son on a public holiday. The return journey to the beach was 275 km. Can Meglos Pty Ltd take advantage of the exemption from FBT for employee use of an eligible vehicle that is limited to work-related travel, and other private use that is “minor, infrequent and irregular“ in relation to Tom’s use of the ute? Solution Employee use of certain commercial vehicles will be an exempt benefit where the only private use, apart from minor, infrequent and irregular use by an employee or an associate of an employee, is for “workrelated” travel by the employee (not by an associate of the employee) (s 8(2)). Work-related travel is home/work travel by an employee, or travel by an employee that is incidental to travel in the course of performing employment duties. The exemption applies to: • taxis, panel vans or utilities designed to carry a load of less than 1 tonne, and • other vehicles that are designed to carry a load of less than 1 tonne and that are not designed mainly to carry passengers. A similar exemption applies to commercial vehicles that would otherwise give rise to a residual benefit where used for private purposes (s 47(6)). This exemption applies essentially to vehicles that are designed to carry a load of 1 tonne or more, or nine or more passengers. Practical Compliance Guideline PCG 2018/3 provides guidance on the ATO’s compliance approach to the exemption in s 8(2) for private use of a commercial vehicle that is minor, infrequent and irregular. Employers who meet the requirements and who rely on the Guideline do not need to keep records about employee’s minor private use of the vehicle and the Commissioner will not devote compliance resources to review the exemption for that employee. An employer may rely on the Guideline if: (a) it provides an eligible vehicle to a current employee (b) the vehicle is provided to the employee for business use to perform their work duties (c) the vehicle had a GST-inclusive value less than the luxury car tax threshold at the time the vehicle was acquired (d) the vehicle is not provided as part of a salary packaging arrangement and the employee cannot elect to receive additional remuneration in lieu of the use of the vehicle (e) it has a policy in place that limits private use of the vehicle and obtain assurance from its employee that their use is limited to use as outlined in subparagraphs (f) and (g) (f) the employee uses the vehicle to travel between their home and their place of work and any diversion adds no more than 2 km to the ordinary length of that trip, and (g) for journeys undertaken for a wholly private purpose, the employee does not use the vehicle to travel more than 1,000 km in total and a return journey that exceeds 200 km. In giving assurance to his employer at the end of the FBT year, Tom can state that: • in driving to and from work, no diversions were undertaken that exceeded 2 km, the diversions to the bakery adding only 1.5 km to the journey • although multiple journeys were undertaken in the FBT year for a wholly private purpose (including the trip to the beach and the trips to drop his son at school), these journeys did not exceed 1,000 km in total. Unfortunately, the return trip to the beach was 275 km. As no return journey can exceed 200 km, the beach trip would fall outside the Commissioner’s Guidelines. Accordingly, Tom’s private use of the vehicle

would not be “minor, infrequent and irregular” and Meglos Pty Ltd would not be able to take advantage of the FBT exemption. AMTG: ¶35-150, ¶35-160, ¶35-580

¶3-060 Worked example: Exempt benefits Issue During the FBT year ending 31 March 2020, Barb’s IT Solutions Pty Ltd, which is not a small business entity, provided the following benefits to Josephine Lim, an employee of the company: (a) Payment of Josephine’s gym membership fees of $50 per month. (b) A bouquet of flowers on her birthday (valued at $80). (c) A laptop computer for Josephine’s child (valued at $800). (d) Payment of her airport lounge membership (valued at $500). (e) Reimbursement of the portion of Josephine’s mobile phone bill for work-related calls. Advise Barb’s IT Solutions Pty Ltd as to which of the above are not exempt benefits and calculate the FBT payable. Solution (a) Gym membership The payment on the gym membership fees is an expense payment fringe benefit. The minor benefit exemption under FBTAA s 58P is not available as the benefit is not provided on an irregular or infrequent basis (see Taxation Ruling TR 2007/12). (b) Birthday flowers The provision of flowers is a property fringe benefit. However, as the benefit is less than $300 in value and provided on an irregular and infrequent basis, that is on Josephine’s birthday, the benefit is an exempt minor benefit under s 58P (see TR 2007/12). (c) Laptop computer This benefit is a property fringe benefit, as it is provided to an associate of the employee. FBTAA s 58X allows the provision of a portable electronic device acquired after 13 May 2008, such as a laptop computer, to be exempt for FBT purposes provided that it is “primarily for use in the employee’s employment” and only one is provided per FBT year. As the laptop is used by Josephine’s child, it is not used in her employment and therefore, the benefit is subject to FBT. (d) Airline membership FBTAA s 58Y provides that eligible memberships provided or reimbursed by employers are exempt benefits. Airline lounge memberships are “eligible” and therefore exempt. (e) Reimbursement of mobile phone costs The reimbursement of work-related phone costs is an expense payment fringe benefit under FBTAA s 20. As the employee would have been entitled to a tax deduction had she incurred the cost herself, the taxable value of the benefit would be reduced to nil under the “otherwise deductible rule” pursuant to FBTAA s 24; provided appropriate documentation and declarations are maintained. AMTG: ¶35-330, ¶35-360, ¶35-645

¶3-080 Worked example: Entertainment; minor benefits exemption Issue

John Maguire is employed by HortiSupplies Ltd (HSL) as a sales representative. During 2019/20, HSL sponsors a corporate golf day once a month for the benefit of its staff and valued customers. John attends each monthly golf day so he can create opportunities for gaining extra business for HSL. HSL pays for John’s golf club entry fee, the food and drink John consumes, and his taxi fares between his home and the club. It costs HSL approximately $1,000 each year to send John to the golf days. Advise HSL whether it is liable for FBT in respect of the costs of John attending the golf days and calculate any fringe benefits tax liability. Solution When HSL pays for John’s entry fee to the golf club, the food and drink John consumes while at the club as well as his taxi fares between his home and the club, it is providing a benefit to John. The word “benefit” for FBT purposes includes any right, privilege, service or facility (FBTAA s 136(1)). It includes entertainment by way of food, drink or recreation, or accommodation or travel to do with providing entertainment by way of food, drink or recreation (s 136(1); ITAA97 s 32-10(1)). The Commissioner considers that attending a golf day is a social event (see the ATO’s publication Fringe benefits tax (FBT) and entertainment for small business). The purpose of the golf day is considered to be entertainment and paying for John to attend is a benefit in the form of entertainment. The benefits are “fringe benefits” as defined because HSL provides them to John in respect of his employment (FBTAA s 136(1) and s 148). The payment of the expenses for the golf days would be an expense payment benefit. They would come within the provisions of FBTAA Div 5. Under s 20, an expense payment benefit arises where the employer makes a payment on behalf of the employee. The taxable value is the amount paid in respect of the expense benefit. The minor benefits exemption (FBTAA s 58P) is not likely to apply to John’s benefits. However, benefits provided with a value of less than $300 that are “infrequent or irregular” may be exempt. However, taken together, the value of the benefits is more than $300 and it could not be said that they are “infrequent or irregular”. While there is an FBT exemption for taxi travel between home and work (FBTAA s 58Z), this does not apply to John’s taxi travel to or from the golf day because it does not start or end at his place of work. As HSL has provided an expense payment fringe benefit to John in respect of his employment and the minor benefits FBT exemption does not apply, HSL will be liable for FBT in respect of the amount it paid for John to attend the corporate golf days. The taxable value is $1,000. As GST will be payable on the benefit, it is a Type 1 benefit and the grossed up taxable value is: $1,000 × 2.0802 = $2,080.20 and the FBT = $2,080.20 × 47% = $977.69. AMTG: ¶35-000, ¶35-617, ¶35-645

¶3-100 Worked example: Loan fringe benefit Issue James Mason has worked for 22 years for Fincomp Pty Ltd, a finance company. On 1 April 2019, James requested a loan of $100,000 to undertake renovations on his home and build up his share portfolio. James spent $60,000 on the home renovations and the balance on purchasing shares. He holds no shares in the finance company. The loan was offered on commercial terms. This type of loan was available to all other long serving employees with an interest rate of only 3.45%, which is less than that provided to the public. Calculate the FBT liability for the loan for the 2019/20 FBT year. Solution The provision of the loan to James constitutes a benefit by his employer referred to as a loan fringe benefit (FBTAA s 16). The loan would not be exempt (FBTAA s 17) as the finance company is a

moneylender that is offering loans to employees that are different to those offered to the public (Taxation Determination TD 95/18). James Mason is an employee of the finance company and not a shareholder, and the circumstance would not render the loan a dividend under ITAA36 s 109D. James has used the loan in two ways: 60% for a private purpose to renovate his home and 40% for a taxable purpose to purchase shares (interest is deductible against dividend income). In relation to the $40,000 spent on shares, the otherwise deductible rule applies (FBTAA s 19). This rule reduces the taxable value of the loan so that none of the interest relating to the share purchase amount is brought to account in calculating the taxable value of the loan benefit, because the interest on the shares purchased for investment would be deductible to James. The taxable value of the loan is based on the difference between the notional amount of interest (based on the benchmark rate) and the actual amount of interest accrued (FBTAA s 18). The notional interest rate or benchmark rate for 2019/20 is 5.37% (Taxation Determination TD 2019/6). Therefore, the taxable value of the $100,000 loan is $1,920, calculated as follows: Notional amount of interest

 $

Loan amount ($100,000) × notional interest rate (5.37%)

5,370

Less Amount of interest accrued Loan amount ($100,000) × amount of interest accrued* (3.45%)

3,450

Taxable value

1,920

*This calculation is based on a fixed rate of interest, as the facts do not refer to any variable rate changes. The reduced taxable value of the loan (FBTAA s 19) is the taxable value less the notional deduction. The notional deduction is $768 and is calculated using the formula: GD − RD where GD is the gross deduction, ie the amount allowable for gross loan interest $5,370 × 40% = $2,148, and RD is the allowable deduction for interest that accrued on the loan $3,450 × 40% = $1,380 $ Taxable value Less Notional deduction Reduced taxable value

 1,920    768 1,152

The loan is a Type 2 benefit as it is a financial arrangement and GST could not be claimed as an input tax credit. The gross-up factor is 1.8868 with the grossed-up taxable value calculated as follows: $1,152 × 1.8868 = $2,174. The FBT liability is $2,174 × 47% = $1,021.78 AMTG: ¶35-270, ¶35-290, ¶35-300

¶3-120 Worked example: Housing fringe benefits

Issue Jacqueline Suzanne is single with no dependents and leases an apartment in the city of Adelaide. She is employed by a national vegetable processing company. On 1 June 2019, Jacqueline accepted a promotion to a management position with the company and terminated the lease giving four weeks’ notice. The promotion involved a three-year secondment to Barmera, a regional town in South Australia starting 1 July 2019. As part of her salary packaging arrangement, the employer leased a modest threebedroom home for $350 per week for Jacqueline. Under the arrangement, Jacqueline contributes $50 each week to the rent. Calculate the taxable value of the housing fringe benefit for the 2019/20 FBT year. In the alternative, assume Jacqueline accepted the promotion as outlined above however, she was married with two children, she owned a house in Adelaide with her husband that was rented to tenants while she and her family lived in Barmera, and she did not make any rental contributions to the house in Barmera. How would this change the taxable value of the housing fringe benefit? Solution Scenario 1 Jacqueline is receiving a housing fringe benefit (FBTAA s 25) as she has been granted a “housing right” (FBTAA s 136) by her employer through the leasing of a unit of accommodation, that is the three bedroom house. She is using the accommodation as her usual place of residence, given her three-year stay in Barmera would be habitual and she has abandoned her leased apartment in Adelaide. The taxable value of a housing fringe benefit depends on whether the accommodation is outside Australia, in a non-remote region in Australia, or a remote region in Australia. Barmera is a small country town in South Australia with a population of approximately 4,000. However, it is not considered a remote region as defined by ITAA36 Sch 2, as it is not located within Zone A or Zone B (Taxation Ruling TR 94/27). The taxable value of the housing fringe benefit for a non-remote region (FBTAA s 26) is the market value of the rental accommodation less any “recipients rent”. In this case, the taxable value of the accommodation from 1 July 2019 to 31 March 2020 would be $11,700, calculated by taking the market value of the rental accommodation for 39 weeks and subtracting Jacqueline’s contribution for that period: $ $350 per week × 39 weeks Less $50 × 39 weeks Taxable value

13,650   1,950 11,700

Note that the supply of residential premises is input taxed with no GST included. A Type 2 gross-up factor therefore applies in calculating the fringe benefits tax payable. Scenario 2 It is assumed that Jacqueline would sign the lease as the employee receiving the housing fringe benefit, and would therefore receive the “housing right” — although her family share this benefit. An important issue to consider is whether the unit of accommodation that has been offered would be a usual place of residence given that Jacqueline and her husband continue to own a house in Adelaide. The fact they have rented their house to tenants would indicate they have abandoned that home as their usual place of residence. This would mean that they no longer have the intention to return to Adelaide in the short-term and that their Adelaide home would no longer qualify as their usual place of residence. The only significant difference therefore from the facts in Scenario 1 is that no contribution to the rent has been paid by Jacqueline. In this second scenario, the taxable value of the accommodation from 1 July 2019 to 31 March 2020 would be $13,650, that is the market rental value of the accommodation for 39 weeks.

If Jacqueline and her husband did not rent out their Adelaide home and the family returned to live in it on a number of occasions throughout the 2019/20 FBT year, then it is arguable that the family has maintained that home as a usual place of residence. This situation could qualify as an exempt residual fringe benefit under FBTAA s 47(5). For a s 47(5) benefit to apply, the Commissioner would require a declaration by the employee in the approved form on or before the time that the employer lodges an FBT return (Miscellaneous Taxation Ruling MT 2021 (withdrawn)) advising on the following three requirements of s 31F(1)(a): • the address of their usual place of residence • that their usual place of residence is available for immediate use and enjoyment and so satisfies the requirements of s 31C, and • the address where they actually reside. AMTG: ¶35-400, ¶35-420, ¶35-430

¶3-140 Worked example: Housing fringe benefits; provision of onsite accommodation Issue Beryl McMasters works as an onsite duty manager at HiLo Motel. The motel is in the central business district of Perth. Beryl is provided with accommodation in the form of a residential unit behind the motel. Under the terms of her employment agreement, HiLo requires Beryl to reside in the unit so that she is available onsite 24 hours. Beryl lives in the unit as her private residence; however, the unit is also used for occasional work-related purposes; such as meetings. Outside of the motel, Beryl does not have her own place of residence. The accommodation is provided by HiLo Motels free of charge with no rent being paid by Beryl. This is taken to be part of her compensation in addition to her salary. As Beryl is required to be on call for her role, HiLo Motels is considering whether the provision of the accommodation would warrant the imposition of any FBT, and if so, the type of fringe benefit provided and whether there are any exemptions available. Advise Hi Lo Motels. Solution A fringe benefit will arise where: • a benefit is provided to an employee, an associate of an employee, or some other person at the direction of an employee or an associate of an employee • the benefit is provided by the employee’s employer, by an associate of the employer, or by a third party under an arrangement with the employer or with an associate of the employer, and • the benefit is provided in respect of employment of the employee (FBTAA s 136(1), 148(2)). A “benefit” is broadly defined to include any right, privilege, service or facility. Some benefits are expressly excluded, for example exempt benefits, salary and wages and termination payments. In considering whether a fringe benefit has been provided, the following applies to HiLo Motels: • A “benefit” is provided to an employee: The provision of the right to occupy onsite accommodation (ie the residential unit) to Beryl constitutes the provision of a “benefit” for FBT purposes. • The benefit is provided by an employer, an associate of the employer or a third party: HiLo Motels is Beryl’s current employer (s 136(1)). The provision of the right to occupy the onsite accommodation (ie the residential unit) is made to Beryl in that capacity. • The benefit is provided in respect of the employee’s employment: Beryl has been provided with onsite accommodation which allows her to discharge her duty manager responsibilities as defined in her

employment contract. Given this connection between the onsite accommodation provided and her duties, it is clear that the accommodation was provided in respect of employment. The connection between the benefit received by Beryl and her employment is material and sufficient, and not merely causal. If it were not for the employment arrangement, Beryl would not have received the onsite accommodation. Therefore, the accommodation has been received in respect of Beryl’s employment and would be taken to have been received as part of an arrangement relating to the performance of her work. Having established that a fringe benefit has been provided, it is then necessary to consider the type of fringe benefit provided. In this case the most likely fringe benefit would be a housing fringe benefit. A housing fringe benefit arises when an employer grants an employee a “housing right” — a right to occupy or use a unit of accommodation as a usual place of residence — which must be for more than one day (FBTAA s 25 and 149). Taxation Ruling TR 2017/D6 discusses the meaning of “usual place of residence”. The main principles from the ruling include: • Whether an employee is living away from their “usual place of residence” usually involves a choice between two places of residence — where the employee is living at the time and the location of the work. • An employee is only living away from home where it is reasonable to conclude that they intend to return to their previous location after work at the new location ceases. • Indicators that an employee has a usual place of residence at a previous location include the employee’s ownership or possession of premises at that location and occupation of the premises by members of the employee’s family. In the present case, Beryl is required to be close to where she is working (ie to reside onsite and be oncall 24 hours a day, seven days a week). In that sense, she is living in accommodation which is in close proximity to her workplace. This indicates that Beryl’s usual place of residence is the accommodation to which she was given the right to occupy. Further, Beryl’s employment is permanent; the employment is not temporary or for a finite duration. She would also arguably spend the majority of her time in the unit of accommodation when she is not working. Therefore, it is considered that the onsite accommodation provided by HiLo Motels is Beryl’s usual place of residence and, as such, all the conditions of a “housing benefit” have been satisfied. The onsite accommodation provided to Beryl will be a treated as a “housing benefit” provided by HiLo Motels, unless otherwise exempted. An exemption is available under FBTAA s 58ZC in respect of a housing fringe benefit if the accommodation is provided in a remote area. Specifically, in order for the accommodation to be in a remote area, it must not be in, or adjacent to, an “eligible urban area”. An “eligible urban area” is an area that is either: • situated in Zone A or Zone B for income tax purposes and is an urban centre with a 1981 census population of not less than 28,000, or • not situated in Zone A or Zone B for income tax purposes and is an urban centre with a 1981 census population of not less than 14,000. The onsite accommodation provided to Beryl is in the Perth central business district and therefore is not provided in a remote area (ie an “eligible urban area”). Therefore, the onsite accommodation benefit provided does not qualify as an exempt remote area housing benefit. There are also no other exemptions for housing benefits under which the benefit could qualify. As a consequence, HiLo Motels would be subject to FBT on the provision of this benefit. AMTG: ¶35-000, ¶35-060, ¶35-070, ¶35-080, ¶35-380, ¶35-400, ¶35-420

¶3-160 Worked example: Living-away-from-home allowances Issue John Johnson is an architect who worked for a boutique architectural firm in Adelaide where he owns a home. In April 2019, he was offered and accepted a consultant’s position with XYZ Pty Ltd, a company designing and assisting in the building of a Melbourne hospital. John was hired to provide on-going advice to the architects, builders and planning board. He received an increase in his annual salary in addition to a weekly allowance of $850 to cover additional food and accommodation costs incurred in his relocation to Melbourne. The relocation was temporary as the design and building project was estimated to take only one year to complete. John is single and is renting an apartment in Melbourne city for $650 per week for the term of the project. Outline the fringe benefits consequences of this arrangement. Solution A benefit paid to employees in the form of an allowance for additional expenses for accommodation and food because the employee is required to live away from their normal residence, is considered a livingaway-from-home allowance (LAFHA) fringe benefit (FBTAA s 30). The weekly allowance of $850 paid to John would be such a benefit. The additional expenses of food and accommodation are not tax deductible to John, as an employee (Hancox v FC of T 2013 ATC ¶20-401; Taxation Determination TD 93/230). The taxable value of the benefit where an employee maintains a home in Australia (FBTAA s 31) is reduced by the exempt food and exempt accommodation amounts, which are the expenses incurred by the employee. Section 31 also requires that: • the employee must maintain an Australian home (FBTAA s 31C) • the employee receives a benefit for the first 12 months only (FBTAA s 31D), and • the employee must make a declaration in the form approved by the Commissioner (FBTAA s 31F). John maintains a home in Adelaide, and his employment arrangement requires John to live away from his usual place of residence. However, his home must be available for his immediate use while he is in Melbourne. If John rents his home to tenants, he will not be eligible for LAFHA benefits. As mentioned, the LAFHA receives concessional treatment, as it is reduced by the exempt food and exempt accommodation amounts. The concessional fringe benefit is limited to the first 12 months of stay in Melbourne, after which time the employer will have to pay FBT on the whole allowance. However, this 12-month period need not be continuous and may be paused by the employer, in which case John would be free to return to his Adelaide home, and then resume the duties required by his employer when called upon again. If this happens, the period continues to accrue. John must sign a declaration in the form approved by the Commissioner prior to the employer lodging their FBT return. John would need to declare: • his home address • where he lived in Melbourne, and • that he is required by his employer to live away from home and that his home is available for immediate use. The exempt accommodation and food must be substantiated and the employee is required to either provide relevant documentation before the employer lodges the FBT return or provide a declaration about the expenses and retain the documentation for a period of five years (FBTAA s 31G). However, substantiation is not required if the expenses are reasonable.

In this case, John receives $850 each week as an additional accommodation and food allowance. The accommodation component no longer needs to be considered “reasonable” as it is exempt where the actual accommodation cost is substantiated (s 31), that is through receipts or John’s declaration. As John’s accommodation costs $650 per week this leaves $200 each week for the additional food. The Commissioner has set out reasonable amounts for additional food in Taxation Determination TD 2019/7. For example, in the 2019/20 FBT year, the Commissioner considers $269 per week for a single adult in Australian locations to be reasonable. Therefore, both the additional food and accommodation amounts would be reasonable and not excessive. The amounts would be exempt and therefore the costs incurred by John would reduce the taxable value of the LAFHA fringe benefit to nil. AMTG: ¶35-460, ¶35-470

¶3-180 Worked example: Living-away-from-home allowance; fly-in, fly-out Issue Pat Newman is to be employed during the 2019/20 FBT year as a fly-in, fly-out worker by a mining company, Emerald Ltd. Pat will be required to work seven days on, six days off in a remote mining town in Queensland. When he is not working, Pat lives in Brisbane with his family. Emerald Ltd intends to pay Pat an allowance to cover accommodation and meals totalling $700 per week. The total accommodation cost to be incurred by Pat per week will be $500, with the balance to cover Pat’s total food costs while he is away at the mine site on duty (ie this allowance will cover food which he would have otherwise consumed at home). Advise Emerald Ltd on the tax consequences of these arrangements. Solution The provision of the accommodation and meal allowance by Emerald Ltd to Pat constitute a living-awayfrom-home allowance (LAFHA) benefit under FBTAA s 30(1). A LAFHA benefit arises where an employer pays an employee an allowance to compensate for additional expenses or disadvantages suffered because the employee (with or without family) has to live away from home for employment purposes. Pat’s employment with Emerald Ltd requires him to live away from his usual place of residence (see Taxation Ruling TR 2017/D6). Emerald Ltd is subject to FBT on the provision of the benefit. Provided that certain general conditions are satisfied, the taxable value of the LAFHA benefit is calculated as amount of the fringe benefit reduced by any exempt accommodation and any exempt food components (FBTAA s 31). Note however, the special requirements that must be satisfied when calculating the taxable value for employers who provide a LAFHA benefit to fly-in fly-out or drive-in drive-out workers (FBTAA s 31A). Under s 31A, the requirements which Emerald Ltd must satisfy include: • the requirement that Pat, as an employee, has residential accommodation at or near his usual place of employment • the fly-in fly-out and drive-in drive out requirement (FBTAA s 31E) — broadly, this requires that: – Pat work on a regular and rotational basis, works for a number of days on and off, returns to his normal place of residence (ie Brisbane) and on completion of the days off returns to his usual place of employment on the mine site – it is customary for Pat to undertake such duties in his industry – it would be unreasonable to expect Pat to travel daily on work days between the mine site and his residence, and – it is reasonable to expect that Pat will resume living at his normal place of residence when his duties no longer require him to live away from it.

• the declaration requirement (FBTAA s 31F), that is Pat is required to give Emerald Ltd a specific declaration for fly-in fly-out, drive-in drive-out workers. On the basis that the above requirements are satisfied, the taxable value, calculated for each week that Pat is away from home on duty, is as follows: Total allowance

$700

Less: Exempt accommodation component^

$500

Exempt food component*

$158 ($658)

Taxable value

   $42   

^Amount taken to be spent on accommodation. Pat must substantiate all accommodation expenses. *Amount taken to be spent on food less statutory food amount, ie $200 − ($42 − $0) = $158. The statutory food amount is $42 per adult. The food allowance paid to Pat by Emerald Ltd is to cover for his total meal costs while he is working away from home. In addition, because the food component paid is $200, which is less than the Commissioner’s reasonable food amount of $269 per adult (see Taxation Determination TD 2019/7), the full amount of the food component is accepted as having been spent. Otherwise, Emerald Ltd would be required to request written evidence from Pat to support his expenditure. FBT is payable by Emerald Ltd based on the statutory food component — this represents the amount covering the costs of food that Pat would have otherwise consumed if he was not working. The allowance currently covers Pat’s total food cost which includes the statutory food component. However, the amount of FBT may be minimised if it is agreed between Emerald Ltd and Pat that the food allowance is to cover the additional food that Pat consumes while he is working (ie in addition to the statutory amount). As the LAFHA paid is a fringe benefit, it is non-assessable non-exempt income in the hands of Pat (ITAA36 s 23L) and he is not assessed on the allowance. As noted, Pat is required to provide a specific declaration to Emerald Ltd in the approved form. The declaration must be given to Emerald Ltd before the lodgment date of the company’s FBT return. Pat is also required to substantiate the cost of his accommodation costs with written evidence to be provided to Emerald Ltd. AMTG: ¶10-060, ¶35-460, ¶35-470, ¶35-645

¶3-190 Worked example: Travel expenses: fly-in, fly-out workers Issue Patrick and Ian live next door to each other in suburban Perth. Patrick works on a fly-in, fly-out basis for Superstrong Engineering Pty Ltd overseeing equipment maintenance at a mine site in remote Western Australia. Ian also works on a fly-in, fly-out basis for Omega Minerals Pty Ltd at a different mine in Western Australia. Both work 20 days on and seven days off. Both Patrick and Ian travel at their own cost to Perth airport to catch flights to their respective mine sites. Superstrong Engineering Pty Ltd pays for Patrick’s flights to the nearest airport to the project location and for bus transportation to his accommodation near the mine site. His employer then pays for the costs associated with Patrick’s return journey, being another bus journey and a flight back to Perth. Patrick’s rostered period starts when he arrives at the work site and ends when he leaves the worksite on day 20. During the outward and return journeys, Patrick is not required to undertake any duties on behalf of Superstrong Engineering Pty Ltd. He normally relaxes with a book, or listens to some music. Omega Minerals Pty Ltd also pays for Ian’s flights to the nearest airport to the project location and then provides bus transport to the mine site. His employer also pays for the cost of the return bus journey and

flight back to Perth. Unlike Patrick, Ian is rostered on duty from the time he arrives at Perth airport on the outbound journey to the time he arrives back at Perth airport on day 20. Omega Pty Ltd has determined that the demands of Ian’s role require that he be paid for the periods spent travelling between Perth airport and the work location. Throughout the journey, Ian is expected to remain contactable, dealing (where possible) with work calls, emails and texts. He typically spends his time in-flight catching up with administrative paperwork. Will Superstrong Engineering Pty Ltd and Omega Minerals Pty Ltd be subject to FBT for the travel expenses incurred in relation to Patrick and Ian, respectively? If Patrick and Ian had paid the cost of their travel expenses from Perth airport to their respective worksites personally, would they be entitled to an income tax deduction for the expense? Solution The “otherwise deductible” rule permits the gross taxable value of certain fringe benefits to be reduced by the amount of the notional income tax deduction that an employee would “otherwise” have been entitled to if the employee had incurred the expense. So, in general terms, if an employee would have been entitled to a deduction for an expense, an employer incurring the expense instead would be exempt from FBT in relation to the amount incurred. As an example, in John Holland Group Pty Ltd & Anor v FC of T 2015 ATC ¶20-510, the Full Federal Court found that travel costs incurred periodically by an employer to transport fly-in fly-out employees from Perth to Geraldton (WA) for a rail upgrade project and back again would have been an allowable deduction to the employees under ITAA 97 s 8-1 if the costs had been incurred by them. As a result, the “otherwise deductible” rule in FBTAA s 52(1) applied to reduce the taxable value of the residual fringe benefits to nil. Per TR 2019/D7, a transport expense is not deductible where the travel is to start work or depart after work is completed. In contrast, a transport expense is deductible where it can be said that the employment is the occasion for the expense. To determine whether travel is undertaken in performing an employee’s work activities, the following factors need to be considered: • whether the travel occurs on work time • whether the travel occurs when the employee is under the direction of the employer • whether the travel fits within the duties of employment • whether the travel is relevant to the practical demands of carrying out the work duties, and • whether the employer asks for the travel to be undertaken. Although home to work travel is generally not deductible, such journeys may be deductible where they meet the criteria outlined above. The need for a transit point (such as Perth airport in this example) must fit within what would be reasonably expected by the duties of employment and not by the private characteristics of the employee, such as where they live in relation to where they report for work. For instance, in the John Holland case, the remoteness of the project location provided an explanation for the travel being part of the employment. In determining whether an employee is subject to the direction and control of the employer, consideration needs to be given as to whether the employee is subject to their employer’s orders or directions, and whether or not those orders or directions are exercised during the period of the travel. However, direction and control alone is not sufficient to establish the relevant connection with employment. The need to be under the direction and control must be established by the duties of employment and the need to travel for work. In relation to Patrick, the travel is to and from work and is not undertaken in performing his duties. Accordingly, the travel would not be deductible to Patrick if he incurred the cost. The transport costs are not therefore “otherwise deductible” to Superstrong Engineering Pty Ltd, which will incur an FBT liability in relation to the costs incurred.

By contrast, Ian’s travel is undertaken in performing his work activities and reflects the practical demands of carrying out his work duties. In addition, he is under the direction and control of his employer throughout the journey between Perth airport and the work location. Accordingly, Ian would be able to claim an income tax deduction for the costs associated with the journey between Perth airport and the mine site if he incurred them himself. As a result, the costs as actually incurred by Omega Minerals Pty Ltd are “otherwise deductible” and hence exempt from FBT. In both Ian and Patrick’s case, the costs incurred in travelling between their respective homes and Perth airport are non-deductible home to work travel. AMTG: ¶35-680, ¶16-220, ¶16-230

¶3-200 Worked example: Farming benefits Issue Scenario 1: Joseph Phillips — station manager On 1 April 2019, Joseph Phillips was hired as a station manager to work on a sheep farm. His employer, Merino Pty Ltd leased a two bedroom house for him in Maitland, NSW which is 40 km from the farm. The market value of the rented house was $300 per week, and Joseph made a weekly contribution of $50 to the rent. Joseph also negotiated that his electricity bill be paid by Merino ($2,000 for the period 1 April 2019 to 31 March 2020). Joseph’s previous employer had paid for such costs while he was employed in a remote location and that company had received an FBT concession. As part of Joseph’s salary packaging arrangement, Joseph’s credit card debt of $15,000 was paid off by Merino. Scenario 2: Jeremy Pike — shearer Jeremy Pike is a shearer and spent four weeks in late 2019 working at Merino’s farm as he travels a shearing circuit in Australia. He was provided with free food and lodging. The standard of the living quarters was equivalent to three-star accommodation with a market value of $120 per night. On the day that he arrived at the farm, Jeremy was provided with the benefit of using the unregistered jeep to explore the large station property. This vehicle is used by the business on the farm only. Should FBT be imposed on any of the benefits provided and if so, what would be the taxable value? Solution Scenario 1: Joseph Phillips — station manager Provision of housing to Joseph The provision of a housing benefit in a remote area is an exempt benefit (FBTAA s 58ZC). However, Maitland NSW is not classified as a remote area for FBT housing fringe benefit purposes. Maitland NSW is an urban centre with more than 60,000 people. Therefore, the provision of accommodation to Joseph in Maitland constitutes a housing fringe benefit (FBTAA s 25). The taxable value of that benefit is the market value of the rental of $300 per week less Joseph’s contribution of $50 per week (FBTAA s 26). Taxable value is 52 weeks × $250 = $13,000 for the FBT year. Note that GST does not apply to private rentals, and accordingly the Type 2 gross-up factor of 1.8868 is used in calculating the fringe benefits tax payable for the 2019/20 FBT year. Residential fuel In the situation where an employee receives a remote area housing benefit and the employer pays for the employee’s residential fuel (which is any form of fuel and includes electricity), the expense of the fuel paid by the employer is an expense payment fringe benefit. However, the taxable value is reduced by 50% providing that the arrangement is at arm’s length (FBTAA s 59). In this situation, this is not a remote area and the payment for electricity would therefore be an external expense payment fringe benefit (FBTAA s 23). The taxable value would be the cost of $2,000. Joseph’s credit card payments

The direct payment to discharge Joseph’s credit card debt would be an external expense fringe benefit. The expense payment is paid to a third party and such expenditure is external to the employer’s business. The taxable value is the amount of the expense paid, whether by reimbursement or paid directly less any of the recipient’s contribution (s 23). Assuming that none of the expenditure was deductible, the taxable value would be $15,000, being the amount of the credit card balance that has been paid off (FBTAA s 24). Note: GST does not apply to finance expenses, and accordingly the Type 2 gross-up factor of 1.8868 applies. Scenario 2: Jeremy Pike — shearer Provision of meals and living quarters for Jeremy Shearers, because of their itinerant occupation, would be eligible to claim deductions for their accommodation and food (see Taxation Ruling MT 2029). Although, Jeremy would be receiving a benefit from living quarters, the accommodation would not constitute a housing fringe benefit (FBTAA s 25). This is because being itinerant, the provision of living quarters would not constitute a usual place of residence. The living quarters are a residual benefit (FBTAA s 45). However, the taxable value would be reduced to nil as the otherwise deductible rule could apply (FBTAA s 52). Similarly, the provision of food could be a board fringe benefit (FBTAA s 35) or alternatively a property fringe benefit (FBTAA s 40). In either case the taxable value would be reduced to nil as the otherwise deductible rule could also apply (FBTAA s 37 and s 44). Note that meals for primary production employees are exempt benefits (FBTAA s 58ZD) providing the farm is not located in or adjacent to an urban area. Meals for primary production employees do not qualify as meal entertainment fringe benefits (FBTAA s 37AC). Private use of an unregistered motor vehicle Jeremy has used an unregistered motor vehicle for a private purpose to explore the farm. The use of an unregistered motor vehicle that does not travel on roads is a residual benefit but it is exempted when used principally for business purposes (FBTAA s 47(6A)). Although Jeremy has used the vehicle for private purposes, in this case no FBT would be imposed due to the small amount of private use. AMTG: ¶35-330, ¶35-340, ¶35-350, ¶35-360, ¶35-380, ¶35-400, ¶35-420, ¶35-430, ¶35-570, ¶35-580, ¶35-630, ¶35-650

¶3-220 Worked example: Meal entertainment fringe benefits Issue ABC Finance Co leased a corporate box at the Brisbane Cricket Ground for $150,000 during the 2019/20 FBT year. This cost included advertising of $60,000 which entitled the company logo to be displayed on the corporate box at all times during entertainment events including displays on the electronic perimeter ring. During the year, the company spent $20,000 providing food and drinks to staff and clients using the corporate box during events. Cab charges vouchers totalling $10,000 were issued to staff and clients to attend these events and return home safely. Accommodation and airfares for VIP interstate clients to attend entertainment events totalled $5,000. No contributions to these costs were made by staff or clients. ABC also maintained a 12-week register and determined that 40% of the value of the meal entertainment was a fringe benefit. Calculate the taxable value of the meal entertainment fringe benefit. Which concessional method would you recommend that ABC elect under FBTAA Div 9A? Solution If no Div 9A election is made, meal entertainment expenses could be classified variously as expense payment fringe benefits, property fringe benefits, residual benefits and could even be a tax-exempt body entertainment benefit. Each of these different methods have different valuation rules, exemptions and

reductions, resulting in complexity. However, an employer can elect to treat these costs as meal entertainment fringe benefits. This election provides an administrative advantage given special rules reduce compliance costs. The provision of the corporate box and meals, cab charges, flights and accommodation are all benefits that have been provided by the employer ABC to their employees and clients during the 2019/20 FBT year. These benefits may be characterised as meal entertainment fringe benefits under Div 9A because: • the meals provided are food and drink by way of entertainment (FBTAA s 37AD(a)) • the leasing cost of the corporate box is accommodation in connection with the purpose of providing entertainment by way of the food and drink (s 37AD(b)) • the cab charges are travel in connection with the purpose of providing entertainment by way of the food and drink (s 37AD(b)), and • the airline flights and accommodation expenses for interstate clients are accommodation or travel in connection with the purpose of providing entertainment by way of food or drink (s 37AD(b)). Despite the cost of the corporate box including a portion of $60,000 for advertising, a deduction for advertising signs is only partially allowable under s 8-1. The Commissioner accepts that the extent to which advertising is deductible is 5% of the total cost, per Taxation Determination TD 92/162. As a result, an amount of $7,500 would be deductible from the corporate box lease of $150,000. The meal entertainment fringe benefit pertaining to the leasing cost is therefore $142,500. The total cost of the benefit is calculated as follows: $ Corporate box leasing cost

142,500

Food and drink costs

20,000

Cab charge costs

10,000

VIP client airfares and accommodation

 5,000

Total cost of benefit

177,500

The concessional methods available for determining the taxable value of a meal entertainment fringe benefit are the 50/50 split method and the 12-week register method. If ABC elects to use the 50/50 split method (FBTAA s 37BA election), the taxable value is 50% of the cost of the benefit, ie $177,500 × 50% = $88,750. If ABC elects to use the 12-week register method (FBTAA s 37CA election), the taxable value is 40% of the cost of the benefit, ie $177,500 × 40% = $71,000. Therefore, ABC should elect the 12-week register method as it yields a lower taxable value. An added advantage of this method is that the 12-week register can be used for the 2019/20 year, and the following four FBT years (FBTAA s 37CD). AMTG: ¶16-390, ¶35-617

¶3-240 Worked example: Entertainment, travel and education benefits Issue Healey Chocolates Pty Ltd (Healey Chocolates) is a small family company in Hobart managed by its directors Ben and Sharon Healey, who are also employees. The following events occur during the 2019/20 FBT year. Sharon is paid an allowance of $20,000 to entertain clients as she travels locally and interstate to promote

the company. Healey Chocolates also reimburses her for her $100 frequent flyer program joining fee and $1,000 airport lounge membership fee. Sharon accumulated 300,000 frequent flyer points in her name and she used her points to purchase free overseas tickets in February 2020. Ordinarily, Sharon would have had to pay $8,000 for the same tickets for her family holiday. Ben, the company’s book-keeper attended a CPA conference in Sydney to maintain and update his technical accounting skills and this involved travelling to Sydney and two nights’ accommodation. Healey Chocolates paid $1,500 directly to the organisers of the conference and $3,500 directly to the travel agent for the airfare and accommodation. Justin (Ben and Sharon’s son) helped out in the business on weekends and nights at no cost to the company. The family company paid Justin’s private school fees of $20,000, directly to the college. Jane their daughter studied in Canberra at ANU. Jane’s Higher Education Loan Programme (HELP) debt of $10,000 was reimbursed by Healey Chocolates. Jane assumed no FBT applied as the costs would be fully deductible to her as a self-education expense. Advise Ben and Sharon on the FBT implications of these events. Solution Sharon’s entertainment allowance The entertainment allowance is not a fringe benefit. It is ordinary income and is assessable to Sharon under ITAA97 s 6-5 and s 15-2. Accordingly, the entertainment allowance forms part of Sharon’s salary and wages. Salary and wages are specifically excluded from the definition of a fringe benefit (FBTAA s 136). It is important to distinguish an allowance from a reimbursement, the former is income and the latter can be a fringe benefit (see Taxation Ruling TR 92/15). Sharon’s frequent flyer and airport lounge fees If Sharon pays to join the frequent flyer program and/or the airport lounge membership, she may be able to claim a deduction, given travel would be work-related. Given that Healey Chocolates reimbursed Sharon for the cost of joining the frequent flyer program, the fee would be an expense payment fringe benefit (FBTAA s 23) that could be reduced to nil by the otherwise deductible rule (FBTAA s 24). Further, it would also qualify as a minor and infrequent benefit and would be exempt given the cost was less than $300 (FBTAA s 58P). Reimbursement of an airport lounge membership is an external expense payment fringe benefit given that the benefit is provided by a third party that is external to the business of Healey Chocolates. The taxable value is the amount of the expense paid, whether by reimbursement or paid directly less any of the recipient’s contribution (s 23). However, airport lounge membership fees are exempt benefits under the FBTAA Div 13 exemptions (FBTAA s 58Y). Sharon’s use of frequent flyer points to purchase airfare tickets Frequent flyer points can provide a benefit when purchasing gifts and travel (at little or no cost) but in general, such benefits are not ordinary income and not considered income to an employee under s 15-2. Flight rewards are also generally not subject to FBT. This is because the points and resulting benefits arise from a personal contractual relationship between the airline and the recipient and not from an employment relationship, despite the points having accumulated because of work-related travel (see Taxation Ruling TR 1999/6). An exception arises, and FBT will apply where the employer and employee have a family relationship and the flight reward is received in connection with the employment. In this case, the employer, Healey Chocolates, and the employee, Sharon, have a family relationship. Sharon’s duties require that she undertake business travel, and the points arising from that travel have been converted to a benefit for herself, her husband and children (who are associates). Alternatively, where there is an “arrangement” (such as in this case where travel points have accrued from the company paying for Sharon’s travel) and a reward to an employee or their associate arises from business expenditure, FBT may apply. Under the arrangement, there is a sufficient and material connection between the accrued travel points redemption and Sharon’s employment and accordingly FBT would apply.

The benefit of cheap or free reward flights for Sharon’s airline travel by redeeming points would be considered a residual fringe benefit (FBTAA s 45). The taxable value would be the amount that Sharon would reasonably be expected to pay for the reward, which according to the facts is $8,000 (FBTAA s 50 and s 51). Ben’s CPA conference fees, travel and accommodation The amount paid by Healey Chocolates to cover the conference fees and Ben’s travel and accommodation would be the taxable value of an external expense payment fringe benefit (s 23). However, Ben would be able to claim these expenses as a tax deduction given he is updating his professional knowledge and the taxable value would be reduced to nil under the otherwise deductible rule (s 24). Justin’s private school fees Justin is an associate of either Sharon or Ben. Justin’s parents have the legal obligation to pay his school fees. School fees whether reimbursed, or as in this case, paid directly to the college on behalf of an employee (or their associate), would be an external expense payment fringe benefit (s 23). The taxable value would be the amount of the college fees, that is $20,000. Note that GST does not apply to school fees, and accordingly the Type 2 gross-up factor of 1.8868 applies in calculating the fringe benefits tax payable for the 2019/20 FBT year. Jane’s HELP debt Jane is an associate of Sharon and Ben, who are both employees, therefore payment of the debt is an external expense payment fringe benefit (s 23). The full amount of $10,000 would be the taxable value (s 24). Note that GST does not apply to the HELP debt, and accordingly the Type 2 gross-up factor of 1.8868 applies in calculating the fringe benefits tax payable for the 2019/20 FBT year. Jane is mistaken that FBT does not apply as the otherwise deductible rule does not extend to associates of employees (Taxation Determination TD 93/90). Further, the otherwise deductible rule could not reduce the taxable value, as HELP debts are specifically denied as a deduction under ITAA97 s 26-20. See Taxation Ruling TR 98/9 for further discussion regarding self-education expenses. AMTG: ¶2-380, ¶16-450, ¶35-070, ¶35-330, ¶35-350, ¶35-360, ¶35-590, ¶35-645, ¶35-680

¶3-260 Worked example: In-house property fringe benefits Issue Jenny Wong and her manager, Joshua Smith are employed by Johnsons Electronics Pty Ltd (Johnsons), a national electronics retailer. Jenny is provided with a desktop computer which retails for $4,000. Jenny uses this computer equally for both business and private purposes. Joshua is provided with a laptop computer which also retails for $4,000. Joshua uses this computer 90% of the time for business purposes only. Johnsons purchases televisions for $1,000 each, which are sold to the public for $2,000. In December 2019 Jenny and Joshua both purchased a television under the employee discount scheme for $1,800 each. Johnsons also purchases sound bars for $1,000 each, which are sold to the public for $1,200. In January 2020 Jenny and Joshua purchased one sound bar each for $600 under the employee discount scheme. Outline the fringe benefits consequences in terms of the taxable value of these arrangements. Solution Desktop and laptop computers The computers are a property fringe benefit as Johnsons has provided property to Jenny and Joshua (FBTAA s 40). Further, the computers would be an in-house property fringe benefit as the computers are sourced from Johnson’s business which buys and sells computers. The taxable value is determined according to in-house property fringe benefits rules (FBTAA s 42). The taxable value is 75% of the lowest amount paid by the public, ie 75% × $4,000 = $3,000.

The otherwise deductible rule allows certain fringe benefits to be reduced by the amount of a notional once-only income tax deduction that the employee would “otherwise” have been entitled to claim. In Jenny’s case, the otherwise deductible rule cannot apply to reduce the taxable value, as Jenny could claim depreciation over a number of years on the laptop computer, which does not meet the requirement of a once-only deduction (FBTAA s 44). In addition, the amount of expenditure involved is not less than $300 (a minor benefit) and therefore is not exempted (FBTAA s 58P). However, Joshua’s laptop computer is used 90% for employment-related purposes therefore it would be treated as an exempt benefit (FBTAA s 58X). This is because it is an eligible work-related item used primarily for use in the employer’s employment. Other common work-related items that fall into this category include a mobile phone, calculator, electronic diary, portable printer — which are office items designed as complete units that are portable, small, light and, can operate on battery supply (Interpretative Decision ATO ID 2008/133). Staff discount on televisions and sound bars If Jenny and Joshua purchased goods from Johnsons at arm’s length prices, then this would not give rise to a fringe benefit because the benefit must be provided in respect of their employment. This is so even if Jenny and Joshua purchased their goods at the full price that was offered to the public, or where the goods were discounted to the public. In either case, these are sales in the ordinary course of business where the goods would be sold above cost (Miscellaneous Taxation Ruling MT 2022). In the situation where a benefit arises because of Jenny and Joshua’s employment, such as through staff discounts, this benefit is not a property fringe benefit. This is because the law establishes that a benefit only arises where the sale price to Jenny and Joshua would be lower than the cost price of the goods to Johnsons (FBTAA s 42(1)(b)). Miscellaneous Taxation Ruling MT 2022 provides that staff discounts are generally not subject to FBT and retailers do not need to keep records of such sales to individual employees. In the case of Jenny and Joshua’s purchase of a television, no fringe benefit arises from the staff discount. However, in relation to the sound bar, which was sold below cost, a fringe benefit arises for each of the purchases for Jenny and Joshua. The taxable value for each sound bar is therefore $400, that is the cost of purchase by Johnsons ($1,000) less the price paid by Jenny and Joshua under their employee discount ($600). Reduction of aggregate taxable value of in-house fringe benefits Johnsons has in-house fringe benefits and can reduce the aggregate taxable value of these benefits by $1,000 for each employee (up to a maximum nil value) (FBTAA s 62). Jenny

$

Taxable value of television

0

Taxable value of sound bar

400

Taxable value of desk top computer

3,000

Total aggregate taxable value

3,400

Less s 62 reduction

1,000

Taxable value

2,400

Joshua

$

Taxable value of television

0

Taxable value of sound bar

400

Taxable value of lap top computer Total aggregate taxable value

    0 400

Less s 62 reduction

1,000  Nil*

Total taxable value

2,400

*Note that the s 62 reduction of $1,000 is limited to each employee. Where the aggregated taxable value for that employee is less than $1,000, the s 62 reduction can only reduce that employee’s taxable value to nil. It cannot be applied to other employees. AMTG: ¶35-490, ¶35-520, ¶35-530, ¶35-645, ¶35-660

¶3-280 Worked example: Private company providing loans and assets for personal use Issue Panda Pty Ltd is in the business of selling antique furniture. The company is owned in equal shares by two brothers, John and Robert Ng. Panda Pty Ltd is a private company under ITAA36 s 103A. John is the director of the company and undertakes an active role in overseeing the operations of the business while his brother Robert is a passive shareholder who has no active role either as a director or as an employee. During the 2019/20 income year, Panda Pty Ltd purchased two luxury cars for John and Robert’s personal use. Each car cost $100,000 including GST. John was provided with his car in his capacity as an employee of Panda Pty Ltd while the other car was provided to Robert in his capacity as a shareholder. During the 2019/20 year, Panda Pty Ltd also provided interest-free loans of $50,000 each to John (in his capacity as a director) and Robert (in his capacity as a shareholder). The loans were not repaid at year end. What tax consequences arise from the provision of the cars and interest-free loans? Solution Luxury cars (i) John’s car The provision of the luxury motor vehicle by Panda Pty Ltd to John, in his capacity as a director, would constitute a fringe benefit. The benefit provided would be a car fringe benefit for the purposes of calculating the taxable value. A director of a company is taken to be an employee for FBT purposes (see Miscellaneous Tax Ruling MT 2019). The provision of a luxury car may also trigger the operation of ITAA36 Div 7A. Broadly, Div 7A treats certain payments, loans and debts forgiven to a shareholder (or their associate) as a dividend. The provision of an asset for use (other than a transfer of property) by a shareholder or shareholder’s associate falls within the meaning of a “payment” for Div 7A purposes (ITAA36 s 109CA). A tie-breaker test in ITAA36 s 109ZB however applies in situations where both the FBT and Div 7A provisions apply with respect to the provision of a loan, payment or debt forgiveness to a person who is both an employee and a shareholder of a private company. Broadly, s 109ZB(3) provides that Div 7A does not apply to a payment made to a shareholder, or an associate of a shareholder, in their capacity as an employee or an associate of such an employee. The provision of the luxury car to John for his personal use is therefore not subject to Div 7A due to the exclusion in s 109ZB(3). Rather, the provision of the car would be subject to FBT to Panda Pty Ltd and the taxable value determined as a car fringe benefit (FBTAA s 7). John can calculate the taxable value of the car fringe benefit using either the statutory formula method or the operating cost method (FBTAA s 9 and 10). In the absence of a log book, the business use percentage will be 0%. (ii) Robert’s car The provision of the luxury car to Robert for his personal use would not be subject to FBT because the car was not provided “in respect of the employment of an employee”. Robert is not an employee of Panda

Pty Ltd; he is only a passive shareholder of the company. However, the car would constitute a “payment” under s 109CA and as such trigger the operation of Div 7A. The time that the payment is made is the time that Robert first uses the asset or has the right to use the asset (s 109CA(2)). In working out the amount of the dividend, the amount of the payment is the amount that would have been paid for the transfer by parties dealing at arm’s length less any consideration given by Robert (as transferee). Note that if the consideration given by the transferee equals or exceeds the arm’s length value of the property, the amount of the payment is nil. Section 109ZB will not apply as the provision of the car by Panda Pty Ltd does not constitute a fringe benefit. Interest-free loans (i) John’s loan The $50,000 interest-free loan provided by Panda Pty Ltd to John, as an employee, constitutes a fringe benefit. Specifically, it is a loan fringe benefit for the purposes of calculating its taxable value. John is an employee of Panda Pty Ltd in his capacity as a director of a company. The interest-free loan is also subject to the operation of Div 7A, as John is a shareholder of Panda Pty Ltd (ITAA36 s 109D). Again, the tie-breaker test in s 109ZB applies where a loan is made to a person who is both a shareholder and employee of a private company. Broadly, s 109ZB(1) provides that Div 7A applies to the loan of an amount to an entity by a private company, even if the loan is made to the individual in his/her capacity as an employee (or an entity who is an associate of such an employee) for FBT purposes, or in respect of the employment of an employee. A “dividend” under Div 7A by way of a loan to a shareholder is excluded from being a fringe benefit under FBTAA s 136. The provision of the interest-free loan to John is subject to Div 7A as a “loan” and is not subject to FBT due to the operation of s 109ZB(1). Panda Pty Ltd is taken to have paid a dividend to John at the end of the 2019/20 income year (s 109D(1)). The amount of the dividend is the amount of the loan that has not been repaid before the company tax return lodgment day for the 2019/20 year — that is $50,000 (s 109D(1AA)) unless a written loan agreement in accordance with s 109N is in place by that time. The amount is also subject to the amount of the distributable surplus for 2019/20 under ITAA36 s 109Y — the dividend would be less if the distributable surplus calculated is below the loan amount. (ii) Robert’s loan The $50,000 interest-free loan provided by Panda Pty Ltd to Robert does not constitute a fringe benefit as he is not an employee of the company (see above). The interest-free loan however, would be subject to the operation of Div 7A; as Robert is a shareholder of the company. Panda Pty Ltd is taken to have paid a dividend to Robert at the end of the 2019/20 year. The amount of the dividend is $50,000 if it is not repaid by the lodgment day of the company tax return unless a written loan agreement in accordance with s 109N is in place by that time (however the amount could be less subject to the distributable surplus of Panda Pty Ltd for 2019/20 under s 109Y). AMTG: ¶4-200, ¶4-205, ¶4-230, ¶4-249, ¶35-150, ¶35-170, ¶35-210, ¶35-230

¶3-300 Worked example: Exempt FBT employer; salary sacrificed meal entertainment benefits Issue Melbourne Children’s Public Hospital, a not-for-profit employer, provides Dr Joshua Taylor with benefits under a salary sacrifice arrangement for the 2019/20 FBT year comprising of: • a private use of a car with a taxable value of $5,000 • reimbursement of child care fees with a taxable value of $4,000 • reimbursement of restaurant meals with a taxable value of $2,000, and

• reimbursement of holiday accommodation with a taxable value of $1,500. However, food and drink provided to Dr Taylor while he was attending a corporate event of the hospital was not provided under a salary sacrifice arrangement. The food and drink provided had a taxable value of $450. Calculate any FBT amount payable by Melbourne Children’s Public Hospital in relation to the benefits provided to Dr Taylor for the 2019/20 FBT year. Also determine any reportable fringe benefits to be included in his PAYG payment summary. Solution An employer’s fringe benefits taxable amount is calculated by “grossing-up” the taxable values of fringe benefits provided during the FBT year. The gross-up has the effect that FBT is calculated as if the employer provided fringe benefits with a taxable value that included the FBT paid by the employer. An employer’s fringe benefits taxable amount is calculated using two gross-up methods: • one for benefits for which the employer is entitled to GST input tax credits on the acquisition price (Type 1; which is 2.0802 for the 2019/20 FBT year), and • the other for benefits for which there is no entitlement to GST input tax credits (Type 2; which is 1.8868 for the 2019/20 FBT year). An “employer’s fringe benefits taxable amount” (FBTAA s 5B) represents the total of the Type 1 and Type 2 aggregate fringe benefit amounts plus any aggregate non-exempt amount. An employer’s aggregate non-exempt amount is calculated according to s 5B(1E) to 5B(1L). Only employers that are qualifying public or non-profit hospitals, public ambulance services, health promotion charities or public benevolent bodies and that provide benefits exempted by s 57A have aggregate nonexempt amounts. Such an employer’s aggregate non-exempt amount is the sum of the grossed-up value of an employee’s individual fringe benefits amounts and most excluded fringe benefits provided to the employee that exceeds the relevant threshold. This sum is basically all fringe benefits other than entertainment facility leasing expenses and meal entertainment (except if provided as part of a salary packaging arrangement — see below) and car parking. The relevant threshold is $17,000, if the employee is engaged in duties connected with qualifying public or non-profit hospitals or public ambulance services. $5,000 cap for salary packaged meal entertainment and entertainment facility leasing expenses Salary packaged meal entertainment and entertainment facility leasing expenses are not considered to be excluded fringe benefits. To provide a $5,000 threshold before such benefits become taxable, the aggregate non-exempt amount is reduced by the lesser of $5,000 and the total grossed-up taxable value of salary packaged meal entertainment and entertainment facility leasing expense benefits. The $5,000 cap for meal entertainment and entertainment facility leasing expenses provided under a salary sacrifice arrangement is available to each employee of an employer in an FBT year. The $5,000 cap is the grossed-up amount. The lower Type 2 gross-up rate of 1.8868 is used where the employer is a public benevolent institution, public or private hospital, public ambulance service or a health promotion charity that is registered for GST and the employer is not entitled to GST input tax credits for the entertainment provided. For such an employer, if the salary packaged meal entertainment and entertainment facility leasing expenses provided to an employee exceeds the $5,000 cap, the excess over the $5,000 is added together with the other fringe benefits provided to that employee to determine if the $17,000 general exemption cap has been exceeded. Calculating the FBT liability In the present case, the FBT liability which arises to Melbourne Children’s Public Hospital from the benefits provided to Dr Taylor for the 2019/20 FBT year is as follows:

Type 1 benefits Car benefits Melbourne Children’s Public Hospital is entitled to GST input tax credits for the car fringe benefits so they are grossed-up using the Type 1 gross-up rate of 2.0802: $5,000 x 2.0802 = $10,401 Type 2 benefits Meal entertainment and entertainment leasing facility benefits The reimbursement of the restaurant meals and holiday accommodation are meal and other entertainment benefits provided under a salary packaging arrangement so they are included in the $5,000 cap. Melbourne Children’s Public Hospital is not entitled to GST input tax credits for the meal and other entertainment benefits so they are grossed-up at the Type 2 rate of 1.8868: $3,500 × 1.8868 = $6,603.80 The excess over the $5,000 cap ($1,603.80) is included in Dr Taylor’s general exemption cap of $17,000. The food or drink with a taxable value of $450 that is not provided under a salary packaging arrangement is excluded from the cap and from the reportable fringe benefits amount. It is effectively exempt from FBT. Expense payment benefit — reimbursed child care fees Melbourne Children’s Public Hospital is not entitled to GST input tax credits for the reimbursed child care fees so they are grossed-up at the Type 2 rate of 1.8868: $4,000 × 1.8868 = $7,547.20 FBT payable The grossed-up amounts for the car fringe benefits, excess over the $5,000 cap and the child care fees are added together to determine whether Dr Taylor’s cap of $17,000 is exceeded: $10,401 + $1,603.80 + $7,547.20 = $19,552 Dr Taylor’s general exemption cap of $17,000 has been exceeded by $2,552, as a consequence the FBT payable by Melbourne Children’s Public Hospital is: $2,552 × 47% = $1,199.44 Reportable fringe benefits Employers are required to record on PAYG payment summaries the grossed-up taxable value of certain fringe benefits (other than excluded fringe benefits) provided to employees during the FBT year where the taxable value of the benefits provided to an employee exceeds $2,000. To calculate the reportable fringe benefits amount for Dr Taylor, all the benefits except the ones not provided through a salary sacrifice arrangement are considered and grossed up at the Type 2 gross-up rate: $5,000 + $4,000 + $2,000 + $1,500 = $12,500 $12,500 × 1.8868 = $23,585 $23,585 is reported on Dr Taylor’s payment summary for the year ended 30 June 2020. AMTG: ¶35-025, ¶35-055, ¶35-057, ¶35-100, ¶35-170, ¶35-330, ¶35-617

¶3-320 Worked example: Reportable fringe benefits amount; income statement Issue Joe Glugner is employed by R-Byte Ltd. Joe’s salary package in the FBT year ended 31 March 2020 includes his company car (FBT taxable value $10,000), parking in the company car park (taxable value

$2,000), reimbursed private parking fees (taxable value $500), laptop computer (an exempt fringe benefit), superannuation contributions (an exempt fringe benefit) and private health insurance (taxable value $600). Other benefits provided in the year are food and drink at a staff Christmas party (exempt minor fringe benefit), use of the R-Byte Ltd corporate box at a football venue (taxable value $1,000), reimbursement of restaurant meals (taxable value $500) and reimbursement of tickets to several sporting events (taxable value $600). None of the benefits have been provided to Joe as part of a salary packaging arrangement. What is the reportable fringe benefits amount that should be shown in Joe’s income statement for the year ended 30 June 2020? Solution When R-Byte Ltd prepares Joe’s income statement information for the year ended 30 June 2020, it must show his reportable fringe benefits amount which is the grossed-up taxable value of certain fringe benefits provided to him in the FBT year ended 31 March 2020. An amount must be reported if Joe’s individual fringe benefits amount is more than $2,000 (FBTAA s 135M to 135Q). Benefits

Taxable value $

Car (car benefit)

10,000

Car parking (FBTAA Div 10A car parking benefit)

2,000

Car parking fees (expense payment benefit)

500

Laptop computer (exempt benefit)

Nil

Superannuation contributions (exempt benefit)

Nil

Christmas party — food & drink (exempt benefit)

Nil

Corporate box — used by all employees (residual benefit)

1,000

Tickets to sporting events (expense payment benefit)

600

Reimbursement of restaurant meals (expense payment benefit)

500

Private health insurance (expense payment benefit) Taxable value

    600 15,200

The benefits which are excluded from reporting are: Car parking

(2,000)

Corporate box

(1,000)

Meal entertainment

 (500) 11,700

Individual fringe benefits amount Gross-up factor: 1.8868

      

Reportable fringe benefits amount (FBTAA s 135P)

22,076

Joe’s individual fringe benefit amount does not include the following fringe benefits (FBTAA s 5E(3)): • car parking on the employer’s business premises • meal entertainment, and • benefits that are “attributable to” entertainment facility leasing expenses, such as the hiring of a

corporate box. If the meal entertainment and corporate box had been provided under a salary packaging arrangement, then they would not have been excluded from Joe’s individual fringe benefits amount. AMTG: ¶35-055, ¶35-252, ¶35-617

¶3-340 Worked example: Various manager’s and employee’s benefits Issue Martin Lee is a young, talented manager who has been head hunted to join a new local baking company, Cupcakes Pty Ltd. In negotiating Martin’s employment contract, Martin and Cupcakes come to the following salary packaging arrangement for the 2019/20 FBT year: • $100,000 salary • $20,000 bonus • $5,000 clothing allowance • $50,000 superannuation benefits, paid by Cupcakes to Martin’s choice of superannuation fund • $35,000 mortgage payments reimbursed by Cupcakes • $24,000 childcare reimbursement by Cupcakes paid to an external childcare provider directly for Martin’s twins — being net costs of $24,000 for 48 weeks after government subsidy • $5,500 — for the provision of various electronic products, that is a tablet ($1,700), a smartphone ($1,500) a digital camera ($900), and a laptop ($1,400) — none of which were for employment use • $598 for annual gym memberships, one each for Martin ($299) and his wife ($299), and • $5,500 holiday voucher — providing a family Gold Coast holiday with all airfares, accommodation, breakfast meals and entry tickets paid for three theme parks. What is the taxable value of the salary packaging arrangement? Solution Salary, bonus, clothing allowance and superannuation benefits The salary, bonus and clothing allowance are not fringe benefits. They are all assessable income and would be considered a component of salary and wages. Paragraph (f) of the definition of a fringe benefit in FBTAA s 136 specifically excludes salary and wages. In addition, the payment of superannuation contributions directly to Martin’s superannuation fund is also not a fringe benefit. Paragraph (j) of the definition of a fringe benefit in s 136 specifically excludes contributions paid to a superannuation fund on behalf of an employee. Mortgage payments The reimbursement of home mortgage payments would be an external expense payment fringe benefit. The taxable value is the amount of the expense paid, whether by reimbursement or paid directly less any of the recipient’s contribution (FBTAA s 23). Accordingly, the taxable value would be $35,000 being the amount of the reimbursement (FBTAA s 24). GST does not apply to mortgage payments, so the Type 2 gross-up factor of 1.8868 applies in calculating the fringe benefits tax payable. Childcare Martin receives reimbursement for his external provider childcare fees and this is an external expense payment fringe benefit. The taxable value is the amount of the expense paid, whether by reimbursement

or paid directly less any of the recipient’s contribution (s 23). The taxable value is the cost paid for the childcare, that is $24,000 (s 24). In the case of employer-based childcare situated on the employer’s business premises and managed by the employer, such childcare benefits are exempt under FBTAA s 47(2) (Taxation Ruling TR 2000/4). GST does not apply to childcare expenses, and accordingly the Type 2 gross-up factor of 1.8868 applies in calculating the fringe benefits tax payable. Electronic equipment An FBT obligation in the form of a property fringe benefit arises where the value of any property is provided free or at a discount to the employee (FBTAA s 40). The taxable value of the property fringe benefit is $5,500 being the total cost of the electronic equipment (FBTAA s 43). The portable electronic equipment is not used by Martin for his employment, therefore the FBT exemption under FBTAA s 58X will not apply. Annual gym memberships totalling $598 This would be an external expense payment paid directly to the gym ($299 for Martin and $299 for his wife) (s 23). The amount would be an “exempt benefit” being a minor, infrequent benefit valued at less than $300 (FBTAA s 58P). Paragraph (g) of the definition of fringe benefits in s 136 specifically excludes exempt benefits. Holiday voucher The holiday for Martin’s family is an entertainment expense to Cupcakes because it provides for recreation in theme parks and the associated travel and accommodation, including breakfast meals (food and drink). Entertainment expenses are not deductible under ITAA97 s 32-5, however the entertainment is deductible to the employer if the employer pays FBT. Where Cupcakes has provided a holiday voucher, Martin receives an external residual fringe benefit when the voucher is redeemed. The food and drink could be a property benefit but most of the cost pertains to a travel and accommodation and theme park entrance tickets, which are residual benefits (FBTAA s 45). The taxable value would be $5,500, that is the cost of the voucher given the transaction was at arm’s length (FBTAA s 50 and s 51). If Cupcakes had simply paid or reimbursed the expense rather than purchased a voucher in the name of the employee, this would be an external expense payment fringe benefit (s 23), however the taxable value would be the same. As this is a personal expense the otherwise deductible rule does not apply. In calculating the FBT payable the Type 1 gross-up factor of 2.0802 will apply to the taxable value of $11,000 for the electronic products and holiday voucher. The Type 2 gross-up factor applies to the taxable value of $59,000 for the mortgage and childcare payments. AMTG: ¶10-060, ¶35-070, ¶35-350, ¶35-360, ¶35-490, ¶35-530, ¶35-580, ¶35-590

¶3-360 Worked example: Sundry benefits Issue On 25 November 2019, Jason Brightman flew return from Adelaide to Melbourne for a job interview with Orange Taxis. He provided Orange Taxis with a copy of his e-ticket so that he could be reimbursed for his return airfare of $450. Jason was successful in the interview. On 12 December 2019, Jason relocated by car from Adelaide to Melbourne to start his new job. Orange Taxis advised Jason that they would reimburse him for the $650 travel costs of his relocation on a cents per kilometre basis. On 14 December 2019, Jason started work. During induction he was taken on a tour of the office and shown the staff bathroom and the staff room that is equipped with coffee and tea making facilities, a television and vending machines. He was told that only the manager enjoys the benefit of an Orange Taxi

service transporting him from home to work in the morning and then back home in the evenings. He was also told that Christmas committee had agreed on a small bottle of cologne as a Christmas gift for each employee. The cologne normally retails for $150, but would only cost Orange Taxis $100 per gift — a total of $1,000 for all staff including Jason. Later that day Jason fell ill and was provided with an Orange Taxi to take him home. The cost of the fare was $55 and Jason made no contribution. Advise Orange Taxis as to whether any of the benefits provided to Jason and its staff have FBT implications? Solution Reimbursement of Jason’s interview travel costs The interview travel costs of $450 are exempt under FBTAA s 58A. This provision provides an exemption for applicants and current employees attending interviews and selection tests. Documentary evidence is required as a condition of the exemption. Jason has provided the documentary evidence for the travel by submitting a copy of his e-ticket. Reduction of taxable value of relocation — transport by employee’s car The relocation costs are a miscellaneous fringe benefit, and the taxable value may be reduced to nil (FBTAA Div 14). Orange Taxis may reimburse Jason for the cost of relocating to a new residence where he is required to leave home and uses his own car for transport. This also applies where an employee moves from a new residence and returns home. Where Orange Taxis reimburses Jason using the cents per kilometre basis (ITAA97 Div 28), the taxable value of $650 can be reduced to nil. However, it is a condition that the employee signs and provides the employer a relocation declaration in a form approved by the Commissioner (FBTAA s 61B). Similar rules apply where an employee uses their own car and is reimbursed for travel to an employment interview (FBTAA s 61E). Also, in relation to relocation, a reduction in taxable value applies for temporary accommodation (FBTAA s 61C). Use of business premises facilities The use of the business premise facilities such as the staff room, vending machine, television and bathroom facilities are exempt residual benefits (FBTAA s 47). Manager’s taxi fees The taxi fees for transporting the manager are exempt residual benefits under s 47(1). The taxi transportation fees qualify as exempt residual benefits because: • the manager is an employee of Orange Taxis • Orange Taxis is in the business of providing transport (not aircraft) to members of the public, and • the transport is between the manager’s home and the office. Christmas gift Orange Taxis has provided its staff with a gift of cologne at Christmas time. This is an external property fringe benefit rather than an in-house one as the employer is not a retailer or manufacturer of the goods, that is cologne. However, because the cost of the gift to each employee is less than $300 and has only been given at Christmas time it may qualify as minor exempt benefit under FBTAA s 58P (also see Taxation Ruling TR 2007/12). Taxi transporting Jason home In the situation where Orange Cab Taxis is the employer, the travel to transport Jason home would be an exempt benefit under s 47 for the same reasons discussed above in relation to the manager’s taxi fees from home to work and back again. If the employer was not a taxi company, and a cab-charge voucher was used to take a sick employee home, a general residual fringe benefit would arise (see National Australia Bank v FC of T 93 ATC 4914).

However, taxi travel between work or home or another necessary place is specifically made exempt for travel due to an employee’s sickness or injury (FBTAA s 58Z). AMTG: ¶35-530, ¶35-580, ¶35-645

DEDUCTIONS Deductions for car parking expenses

¶4-000

Deductions for car expenses

¶4-020

Travel expenses for residential rental property

¶4-030

Costs of repairs to investment rental property

¶4-040

Vacant land

¶4-050

Repairs and improvements

¶4-060

Bad debts

¶4-080

Work-related expenses

¶4-100

Working from home expenses

¶4-110

Legal expenses

¶4-120

Tax losses of earlier years

¶4-140

Costs of borrowing for business purposes

¶4-160

Interest expenses after income-producing activity ceases and loan refinanced ¶4-180 Deductibility of interest on loans

¶4-200

Self-education and home office expenses

¶4-220

Work-related travel; home to work travel

¶4-230

Deductions for travel expenses

¶4-240

Work-related meal expenses and the substantiation exception

¶4-260

Deductions for employer and individual’s superannuation contributions

¶4-280

Prepaid expenditures; non-deductible non-cash business benefits

¶4-300

Business-related capital expenditure; preservation of value of goodwill

¶4-320

Capital expenditure for proposed business

¶4-340

Capital works; demolition; environmental protection activities

¶4-360

Club fees; boating; leisure facilities and activities

¶4-380

Deductions; partnership and service trust

¶4-400

¶4-000 Worked example: Deductions for car parking expenses Issue Rachel Jones works as an employee in an office building in Melbourne’s central business district. This is her primary place of employment. She travels to work by car each day from her home and parks in a commercial car park situated below her building from between 9 am to 5 pm (eight hours). Rachel personally incurs the costs of parking her car. Advise Rachel as to whether she is entitled to claim an income tax deduction for her car parking costs. Would the outcome be different if Rachel was entitled to a valid disabled person’s car parking permit? Solution

Rachel is not allowed to claim a deduction for her car parking costs in her personal tax return. The amount is specifically denied under ITAA36 s 51AGA. Broadly, s 51AGA denies a tax deduction for cost incurred in relation to car parking for a particular day if: • the employee has a primary place of employment • the car is parked for more than four hours during the day between the hours of 7 am and 7 pm at, or in the vicinity of, that primary place of employment • the expenditure is in respect of the provision of the parking facilities to which that parking relates • the car was used in connection with travel by the employee between: – the place of residence of the employee, and – that primary place of employment • the provision of parking facilities for the car during the period or periods is not taken, under the regulations, to be excluded. The car parking costs incurred by Rachel to park in the commercial car park near her workplace are not deductible to her as she parks there for eight hours during the 7 am to 7 pm period and her parked car is used by her for travel between her home and her primary place of employment. The outcome would be different however if Rachel was entitled to use a valid disabled person’s car parking permit. Specifically, a deduction for car parking expenses is not denied to Rachel if she was the driver of, or a passenger in the car and she is entitled under state or territory law to use a disabled person’s parking space and a valid disabled person’s car parking permit is displayed on the car (Income Tax Assessment (1936 Act) Regulation 2015 reg 8). AMTG: ¶16-310

¶4-020 Worked example: Deductions for car expenses Issue Robyn Lewis is an interior design consultant operating from premises in a suburban shopping centre. During 2018/19 and 2019/20, Robyn leased a car which she used for business purposes, for visiting clients to advise on interior design and installation of furnishings and fittings, and also for private use. Robyn has provided the following details of her car expenses for both 2018/19 and 2019/20 and seeks your advice on which method for claiming deductions for her car expenses would yield the greatest deduction. Car expense items 2018/19 2019/20 $

$

Car lease rental

6,900

6,900

Petrol and oil

3,600

4,800

600

800

1,520

1,550

12,620

14,050

Repairs and maintenance Registration and third party insurance Total car expense Information for calculating car expenses deductions Prescribed rates per kilometre

68 cents

68 cents

Total kilometres travelled

32,000

45,000

Work-related kilometres

19,200

24,750

Private use kilometres

12,800

20,250

Business percentage

19,200  32,000 

= 60%

24,750  45,000 

= 55%

Solution An individual can claim a deduction for car expenses in relation to a car owned or leased by the individual where the vehicle is used for income-producing purposes (ITAA97 s 8-1). ITAA97 Div 28 is concerned with car expenses, including the meaning of car expenses and the two methods for calculating the deduction. Substantiation requirements, in ITAA97 Subdiv 900-C apply to the log book method. A car expense is a loss or outgoing to do with a car or operating a car and the decline in value of the car (ITAA97 s 28-13). Car expenses include interest on a car loan, fuel and oil costs, depreciation, maintenance, registration and insurance costs. Leasing charges are also deductible as rent only and any payments representing private use or towards the ultimate purchase price are not deductible. For the 2018/19 and 2019/20 income years, two methods (the “cents per kilometre” method and the “log book” method) are available for calculating the deduction for car expenses. Cents per kilometre method — Subdiv 28-C The amount of the deduction is determined by multiplying the number of business kilometres travelled in the year by a prescribed rate of cents per kilometre for the income year (s 28-25(1)). The deduction is limited to 5,000 km of business travel but can still be used where business travel is more than 5,000 km (s 28-25(2)). Business kilometres are kilometres the car has travelled in producing assessable income or travelling between work places (s 28-25(3)). Substantiation is not required (s 28-35). Log book method — Subdiv 28-F The deduction using the log book method requires multiplying each car expense by the business use percentage (s 28-90(1)). The business use percentage is calculated by dividing the number of business kilometres the car has travelled during the income year by the total number of kilometres the car travelled during that period and expressing the result as a percentage (s 28-90(3)). To use this method, the taxpayer must keep records to substantiate their car expenses (Subdiv 900-C), including: • keeping a log book for estimating the number of business kilometres (s 28-100(2)), and • keeping odometer records documenting the total kilometres the car has travelled during the income year (s 28-100(3)). The requirements for keeping a log book are contained in Subdiv 28-G and the requirements in relation to odometer records are in Subdiv 28-H. It is permissible to choose different methods for the same car for different income years and different methods for different cars in the same income year (s 28-20(3)). Division 28 car expenses methods 2018/19

2019/20

Cents per kilometre

5,000 km × 68 cents = $3,400 5,000 km × 68 cents = $3,400

Log book method

$12,620 × 60% = $7,572

$14,050 × 55% = $7,727

Robyn is advised to use the log book method for both 2018/19 and 2019/20 as this method yields the greatest deduction; $7,572 in 2018/19 and $7,727 in 2019/20. However, if Robyn has not kept proper records to substantiate the log book method claim, she must fall back on a cents per kilometre claim. AMTG: ¶16-310, ¶16-320, ¶16-324, ¶16-340, ¶16-350, ¶16-360, ¶16-370, ¶16-375, ¶42-170

¶4-030 Worked example: Travel expenses for residential rental property Issue William has been a longstanding client of your accountancy practice. He is a professional self-employed electrician who lives in Melbourne and owns two residential rental properties in the Melbourne metropolitan area that are rented on long-term leases. He also owns a holiday apartment on the Gold Coast that he lets out on short-term leases through the Airbnb platform. He occasionally visits his two Melbourne properties to undertake repairs requested by his tenants, but otherwise his properties are managed by a firm of real estate agents. He also visits the Gold Coast twice a year, once to attend a meeting of the Body Corporate and once to inspect the property and undertake routine maintenance. He employs a locally based individual to clean the property at the end of guest bookings and to prepare the property for the next booking. This individual is also on call to deal with minor issues arising during guest stays but forwards more serious issues (such as repair requests) to William to deal with, which he does by contacting a relevant tradesperson in the Gold Coast area. William looks after all booking enquiries and other administrative tasks himself from his home office in Melbourne. Prior to 1 July 2017, William used to claim a tax deduction for all his travel expenses associated with visiting his three properties. He was disappointed to learn that he was no longer able to claim a deduction for these costs. Attending a summer barbeque in January 2020, William was told by a friend that if he claimed to be in the business of providing residential accommodation, he would still be able to claim deductions for his travel costs. When he visits your office to complete his tax return for the year ended 30 June 2020, he asks for your advice as to whether he can make such a claim. What would your advice to William be? Solution ITAA97 s 26-31 denies a deduction for travel costs incurred from 1 July 2017 in connection with a residential rental property investment, subject to certain exceptions. Examples of such costs include travel for the purposes of collecting rent, visiting a property manager, and organising or performing maintenance and repairs of the property. The key features of this rule are: • a deduction is denied for any travel expenses incurred to generate rental income from residential property • the rule applies to individuals and closely held entities (including SMSFs) with interests in residential investment properties • companies and other institutional investors are exempted • the rule does not apply if the expense is incurred in connection with earning business income • the rule is restricted to travel costs so does not extend to fees paid to a property management services provider, even though the fees charged by the property manager may include disbursements of travel costs incurred by the manager • travel expenses incurred for more than one purpose can be apportioned and so may be deductible to the extent they are not related to rental income from residential investment property (for instance, the taxpayer may own a building with commercial premises on the ground floor and a residential apartment on the first floor; travel expenses would be deductible to the extent they related to the

commercial premises on the ground floor) • expenses denied a deduction under s 26-31 also cannot form part of the property’s cost base or reduced cost base (s 110-38(4A) and s 110-55(9J)), and • expenses denied a deduction under s 26-31 also cannot be deducted as blackhole expenditure (s 40880(5)(g) and (h). William wishes to take advantage of the exemption for business income noted above. The Commissioner has issued LCR 2018/7 addressing this question. In that Ruling, the Commissioner notes that the question of whether a business is carried on is a question of fact and depends on the circumstances of each case. Some of the factors that the Commissioner may consider can include: • the total number of residential properties that are rented out • the average number of hours per week spent actively engaged in managing the rental properties • the skill and expertise exercised in undertaking these activities, and • whether professional records are kept and maintained in a business-like manner. The Commissioner also notes that “generally, it is more difficult for an individual to demonstrate that they are carrying on a business of property investing than it is for a company. The receipt of income by an individual from the letting of property to a tenant, or multiple tenants, will not typically amount to the carrying on of a business as such activities are generally considered a form of investment rather than a business”. Although the Ruling itself does not contain many practical examples, further guidance can be found in a series of examples set out in SMSF Ruling 2009/1: • A couple own two holiday flats in a popular holiday destination which they manage and maintain (including the cleaning and repair of the flats, and financial tasks, such as banking). The ATO says that the scale of the operation is such that no business is being carried on. • An individual owns 20 residential units that are leased to long-term tenants. The individual manages and maintains the flats on a full-time basis, living on the income generated from the leases. The ATO says that the scale of the operation, together with the element or repetition and purpose, indicate that the individual is carrying on a property investment business. • An individual owns 10 residential units that are leased to long-term residents and uses the services of an agent to manage the premises. The ATO says that the individual does not carry on a property investment business as they use an agent to manage the properties. Applying all the above to William, he should be advised that he is not able to take advantage of the exemption for earning business income. The starting point for the ATO is that he is an individual who own properties and therefore, prima facie, the income he derives is considered investment income rather than business income. There is nothing in William’s particular circumstances to suggest that this view can be challenged, for example: • the number of properties owned by William is not substantial • two of the three properties are managed by a letting agent • management of the Gold Coast property is split between William and a local individual but there is no evidence that the time and effort spent by William in managing the administration side of his Airbnb activity is considerable • William exhibits no particular skill or expertise in the minimal management that he undertakes of his portfolio

• William runs a full-time business as an electrician; he does not live on the income generated by the rental properties. As William is not undertaking a business of renting properties, he cannot claim his travel expenses in relation to visits to his three properties. AMTG: ¶10-105, ¶16-650

¶4-040 Worked example: Costs of repairs to investment rental property Issue Cecil Jackson purchased a home unit in Brisbane in December 2016 with the intention of renting it out as an investment property. At that time, he undertook some repairs to ensure that the property was suitable to be rented out. This included repainting some walls, replacing broken light fittings and repairing wardrobe doors in some of the bedrooms. The costs of the repairs were incurred shortly after acquisition and the property was tenanted by January 2017. In May 2019, Cecil decided to sell the unit. After his tenant vacated the property and he was no longer receiving rental income, Cecil discovered that one of the heaters did not work and the laundry window was broken. He also found a hole in the living room wall that had been covered with a painting. Cecil incurred costs of repairing the heater and laundry window to their original condition in June 2019. In August 2019, he paid for a handyman to repair the hole in the wall to its original condition. The property was subsequently sold in September 2019 at auction. Is Cecil entitled to claim a deduction for repair costs which he incurred in December 2016, June 2019 and August 2019 in his personal tax return for the relevant income years? Solution Non-capital expenditure incurred on repairs to plant or premises held or used to produce assessable income is specifically made deductible under ITAA97 s 25-10. A repair involves a restoration of a thing to a condition it formerly had without changing its character. Note however that substantial improvements, additions, alterations, modernisations and reconstructions are not repairs. Initial repairs before tenancy — December 2016 The costs incurred by Cecil in December 2016 to remedy defects in the property after its acquisition and to make it suitable for renting are capital in nature and not deductible under s 25-10 (also see The Law Shipping Company Ltd v Inland Revenue Commissioners (1924) 12 TC 621). Such repairs are referred to as “initial repairs”. A repair is an initial repair if it is needed when the property is acquired in the sense that the property has defects, damage or deterioration or is not in good order and suitable for use in the way intended (Taxation Ruling TR 97/23). Although, the costs of the initial repairs are not deductible they can be included in the cost base of the property when calculating the capital gain on sale (as the property is a CGT asset). Heater and window repairs — June 2019 In the 2018/19 tax year, Cecil is entitled to claim a deduction under s 25-10 for the costs incurred in repairing the heater and laundry window. Fixing the heater and window are repairs for tax purposes because each item has been restored to its respective former condition. The expenditure is not capital in nature; it does not constitute an improvement, alteration, modernisation or reconstruction (Taxation Ruling IT 180; TR 97/23). Cost of handyman — August 2019 The cost of the repair to the wall would ordinarily be capital expenditure and not deductible under s 25-10. Further, a deduction is not allowed for the repair in August 2019 under the approach in Taxation Ruling IT 180. This ruling provides the ATO’s guidance on the deductibility of repair costs after a property ceases to be used for an income-producing purpose. Specifically, the cost of repairs may be deductible if: (a) the necessity for the repairs can be related to the period of time during which the premises were producing assessable income; and (b) the premises have been used for the production of assessable income during the income year in which the expenditure is incurred.

In Cecil’s case, it is reasonable to conclude that the defects to the property related to the period to which it was tenanted. However, deductions for the costs of the relevant repairs incurred are limited to the 2018/19 year only as this was the last income year that the property was used to produce assessable income. Therefore, Cecil is not allowed to claim a deduction for the cost of fixing the hole in the wall as it was incurred during the 2019/20 year when the property was no longer being used to produce assessable income. AMTG: ¶16-700, ¶44-107

¶4-050 Worked example: Vacant land Issue Agnes Grey owns four blocks of land located in the outer suburbs of Sydney. She acquired all four blocks prior to 1 July 2019. She has previously claimed deductions in her tax return for various costs associated with holding the land, including interest on bank loans taken out to acquire the land, insurance and council rates. Details of the blocks are as follows: • Block One: Acquired 1 July 2016. Agnes intends to build a residential investment property on the block but has had difficulty in obtaining the required permissions from the local Council. Construction finally commenced on 1 September 2019 and was completed on 1 May 2020. An occupancy certificate was issued on 1 June 2020; however, she did not appoint an agent to market the property until 1 July 2020. • Block Two: Acquired 1 July 2015. Agnes intends to build a residential investment property on the block but has had difficulty in obtaining finance for the build. She commenced construction on 1 August 2019 and a free-standing double garage was completed on the site before financial difficulties forced her to suspend construction for the remainder of the year. Construction on the rest of the house commenced on 1 August 2020. • Block Three: Acquired 1 July 2010. Agnes’s husband, Richard, owns and operates an earth-moving business. In 2010, Agnes purchased Block Three, which is adjacent to the premises from which Richard runs his business. Although her intention is to ultimately build a residential investment property on the block, since she first acquired it she has allowed Richard to store his earth-moving equipment on the block. Richard does not pay Agnes rent for the use of the block. • Block Four: Acquired 1 July 2016. This block is an empty field that was acquired with a view to building a series of townhouses. No construction work has been undertaken and, due to contractual difficulties with the developer, Agnes has chosen to lease out the land to a neighbouring farmer who intended to use the land to graze sheep. The farmer pays a nominal rent of $250 per month, approximately a quarter of the market rental, but due to a downturn in demand is not currently using the field. Agnes has been advised that when she completes her 2019/20 tax return, she will not be able to claim deductions for any of her holding costs and wishes to understand if this is correct and, if so, at what point it will become possible to claim deductions relating to the land. Solution With effect from 1 July 2019, ITAA97 s 26-102 operates to deny deductions for losses or outgoings incurred that relate to holding vacant land. For the operation of the section, it is immaterial when the land was acquired, that is whether it was acquired before or on or after 1 July 2019. Any such outgoings can be added to the CGT cost base of the property as “costs of owning” a CGT asset. These costs are included as part of the third element of the cost base of the property (s 110-25(4)). Section 26-102 applies to individuals, self-managed superannuation fund (SMSF) trustees, private trusts and partnerships comprised of any of these, but not to companies, superannuation funds (other than SMSFs), managed investment funds and public unit trusts. The costs that are likely to be impacted are those incurred in holding vacant land such as:

• ongoing borrowing costs, including interest payments on money borrowed for the acquisition of land • land taxes • council rates • maintenance costs • insurance. Land is considered vacant under the new law if there is no substantial and permanent building or other structure on the land which is in use, or available for use, with an independent purpose that is not incidental to another structure (s 26-102(1)). So, for land to be excluded from the restriction on deductions, any structure on it must be substantial (being significant in terms of size, value or some other criteria of importance to the particular property) and permanent (being fixed and enduring) and have an independent purpose. All three criteria must be met. For a loss or outgoing to be deductible, the relevant land must generally contain a structure at the time the loss or outgoing is incurred. Where land contains residential premises, the land is treated as remaining vacant until the residential premises are: • able to be occupied under the law (ie an occupancy certificate has been issued), and • leased, hired or licensed or available for lease, hire or licence. This means that deductions cannot be claimed until the premises can be legally rented and the taxpayer is actively seeking to derive rental income by placing the premises on the rental market. There are a number of exemptions from the restrictions where the land is used in a business context. The primary exemption states that deductions can still be claimed by the holder of the land to the extent that the land is in use, or available for use, in carrying on a business at the time the loss or outgoing is incurred by: • the taxpayer • an entity connected with the taxpayer • the spouse or child under 18 years of the taxpayer (where the taxpayer is an individual) • an affiliate of the taxpayer or an entity of which the taxpayer is an affiliate (s 26-102(1) and (2)). In addition, the vacant land deduction provision does not apply if, at the time the loss or outgoing is incurred: • the land to which the loss or outgoing relates was leased, hired or licensed to another entity • the entity holding the land or (broadly) an affiliate, spouse or child under 18 years, or an entity connected with that entity, is carrying on a primary production business (not necessarily on the land) • the land does not contain residential premises, and • residential premises are not being constructed on the land (s 26-102(8)). Finally, the vacant land deduction provision does not apply if, at the time the loss or outgoing is incurred: • the land was leased, hired or licensed to another entity on an arm’s length basis • the land was in use, or available for use, in carrying on a business • the land did not contain residential premises, and

• residential premises were not being constructed on the land (s 26-102(9)). Applying the above to Agnes, we can conclude as follows: • Block One: Agnes cannot claim a deduction for holding costs incurred in relation to Block One for the 2019/20 year. By 1 May 2020, the land contained a substantial and permanent structure, being residential premises, which was constructed while Agnes held the land. In addition, by 1 June 2020, the premises were lawfully able to be occupied. Despite this, the land is still regarded as vacant land and hence deductions cannot be claimed. This is because the property has not yet been rented or made available for rent. An agent was appointed on 1 July 2020 and, assuming the active marketing of the property begins immediately, that is the date from which Agnes will be able to commence claiming deductions for holding costs. • Block Two: Agnes cannot claim a deduction for holding costs incurred in relation to Block Two for the 2019/20 year. Although the double garage constructed during the year is both substantial and permanent, it does not have a purpose that is independent of another structure (in this case, the unbuilt house that the garage will eventually serve). Accordingly, despite there being a structure on the land, it is still regarded as vacant and accordingly no deduction for holding costs can be claimed. Holding costs will become deductible once the house is constructed, legally able to be occupied and made available for rent. • Block Three: Agnes can claim a deduction for holding costs incurred in relation to Block Three for the 2019/20 year. Block Three is used in the earth-moving business owned and operated by her husband and hence Agnes is able to take advantage of the “carrying on a business” exclusion. This exclusion enables deductions to be claimed for holding costs in relation to vacant land where the land is used in a business operated by, amongst others, the spouse of the taxpayer. Although Richard does not pay rent to Agnes for the use of the land, this does not affect her position. To rely on this exclusion, there is no requirement that the entity that uses the land, or has it available for use, in a business pays the landowner rent. • Block Four: Agnes can claim a deduction for holding costs incurred in relation to Block Four for the 2019/20 year. Block Four is rented by a neighbouring farmer and she is therefore able to take advantage of the exclusion for primary producers. This exclusion applies even though the land is not currently being used in the relevant primary production business and even though the rental agreement is not at arms-length (the question tells us that Agnes could rent out the land for four times the amount she is actually receiving). Note that the primary production exclusion does not apply where residential premises are being constructed on the land. Although Agnes intends to build residential premises on the land, she is not currently doing so. AMTG: ¶13-150, ¶16-650

¶4-060 Worked example: Repairs and improvements Issue On 17 July 2019, Ken Fong acquired a restaurant as a going concern, paying $850,000 for the land and buildings, plant and equipment and goodwill. Upon taking possession Ken realised that the plumbing and electrical systems required repairing. In August 2019, he spent $27,000 for the repairs so that the restaurant could open for business. Shortly after opening, the tiles in the kitchen cracked and fell off the walls. Ken had them replaced, restoring them to their original condition, costing $6,400. In November 2019 Ken decided to replace all the kitchen cooking equipment in order to reduce the likelihood of having to replace it in the future. The cost was $30,000. At the same time Ken entered into a contract to have the equipment regularly inspected and serviced. The contract fee was $1,500 per year. At that time he also decided to pay a pest control company $2,000 a year to rid the restaurant of pests and ensure health and safety standards were maintained. In January 2020, a violent summer hail storm caused damage to the roof of the restaurant. Instead of

making repairs, Ken decided to replace the entire roof along with the roofing insulation and ducted air conditioning. The roof replacement cost $32,000 and the insulation and air conditioning added another cost of $7,400. At that time Ken contracted builders to construct an additional room to cater for increased patronage. The cost of the addition was $26,800. Advise Ken on the deductibility of the expenditure incurred on repairs and improvements to his restaurant in 2019/20. Solution Non-capital expenditure on repairs to plant or premises held, or used for the production of assessable income, is specifically made deductible under ITAA97 s 25-10. This position is supported by case law and the Commissioner’s views expressed in Taxation Ruling TR 97/23. The essential features for work on an item or asset to qualify for a deduction under s 25-10 are that: • the repair involves the restoration of an item or asset to its previous condition (W Thomas & Co Pty Ltd v FC of T (1965) 115 CLR 58) • the item or asset must be in need of restoration before it can be repaired, and • the repair involves replacement or renewal of part of an item or asset, rather than the entirety (The Law Shipping Company Ltd v Inland Revenue Commissioners (1924) 12 TC 621). There are additional principles that deny a deduction for what would otherwise be repairs. For example: • there is no deduction for notional repairs (FC of T v Western Suburbs Cinemas Ltd (1952) 86 CLR 102) • there is no deduction for capital expenditure constituting additions or improvements — such expenditure may be taken into account in the depreciable cost of an asset, or cost base for capital gains tax purposes, and • there is no deduction for initial repairs. Rather, the cost of initial repairs may be taken into account in the depreciable cost of an asset, or cost base for capital gains tax purposes. Other provisions may allow a deduction for expenditure that does not qualify as a repair, including: • deductions for depreciating assets under ITAA97 Div 40 • deductions for capital works under ITAA97 Div 43, and • deductions for maintenance expenditure under the general deduction provision ITAA97 s 8-1(1). Repairs to the plumbing and electrical systems This work constitutes initial repairs and would not be deductible under s 25-10 (The Law Shipping Company Ltd v Inland Revenue Commissioners (1924) 12 TC 621) even if the need for the repairs was unknown at the date of acquisition of the restaurant (W Thomas & Co Pty Ltd v FC of T (1965) 115 CLR 58). Replacement of the kitchen tiles The tiles were in need of replacement and were restored to their original condition and the replacement qualifies as a repair. The cost of $6,400 is deductible under s 25-10. Replacement of the kitchen cooking equipment Current expenditure of $30,000 to replace kitchen equipment, in order to avoid future expenditure does not qualify as a deduction for repairs under s 25-10 because the equipment was not in need of restoration or repair and amounted to replacement of a capital asset and would be dealt with under the depreciation provisions in ITAA97 Div 40. Service contract for the kitchen equipment

The service contract annual fee of $1,500 would be deductible under the general deduction provision, that is s 8-1(1) as a loss or outgoing incurred in gaining assessable income or carrying on a business for that purpose. Pest control contract The pest control contract annual fee of $2,000 would also be deductible under s 8-1(1) as a loss or outgoing incurred in gaining assessable income or carrying on a business for that purpose. Replacement of damaged roof and installation of insulation and air conditioning The cost of replacing the roof would be deductible under s 25-10. In determining whether a repair is deductible, it is necessary to consider whether the work restores the efficiency of function of the property without changing its character. Replacing the roof restored the function of the roof following severe storm damage but did not change its character; the roof still functioned as a roof, even though more modern materials may have been used. TR 97/23 indicates that expenditure for repairs to property is of a capital nature where the extent of the work carried out represents a renewal or reconstruction of the entirety. Paragraph 40 of TR 97/23 specifically states that a roof is only a part of a building and does not constitute an “entirety”. The building itself is the entirety. The replacement of the roof is therefore not capital. W Thomas & Co Pty Ltd v FC of T (1965) 115 CLR 58 involved a claim for general repairs to a building. In that case, it was said that the question was not whether the roof, looked at in isolation, was repaired as distinct from being wholly reconstructed, but whether what was done to the roof was a repair to the building of which it was a part. There is no evidence provided in the question that the insulation and air conditioning was damaged by the storm. Accordingly, the costs of adding insulation and air conditioning would be an improvement as they go beyond what would normally be covered by a repair and restoration. This element is capital expenditure and not deductible. The deductible amount, being the costs associated with replacing the roof, would be $32,000. The nondeductible amount, being capital costs associated with the insulation and air conditioning, would be $7,400. Construction of additional room to cater for increased patronage This constitutes capital expenditure and is not deductible under s 8-1(2)(a). A depreciation deduction of 2.5% is allowed under ITAA97 Div 43 which deals with deductions for capital works. The $26,800 adds to the cost base for CGT purposes. Capital expenditure which the taxpayer can deduct, for example under the capital works provisions of Div 43, reduces the cost base of the asset. AMTG: ¶16-060, ¶16-105, ¶16-700, ¶20-470

¶4-080 Worked example: Bad debts Issue Parker Bros own and operate a hardware business offering both cash and credit sales. They also conduct a money-lending business making loans to tradesmen and builders to finance their development projects. During the 2019/20 year, the hardware business had cash sales of $87,000 and credit sales of $75,000. The money-lending business made loans to tradesmen and builders amounting to $480,000. Parker Bros acquired Home Hardware, a competitor hardware business run by an individual. The amount paid for the business included trade debtors of $52,000. Towards the end of the year, Parker Bros took stock of their financial position. They doubted that $20,000 of their credit sales would be paid and they wrote off 25% of these credit sales as bad debts. Parker Bros also determined that 10% of outstanding loans would not be repaid and wrote off those amounts as bad debts. After acquiring their competitor’s business, Parker Bros assigned the $52,000 of debts to Factors Financing Pty Ltd (Factors). Under the financing agreement, Factors acquired the debts for their face value, less a 10% fee. Factors paid Parker Bros $46,800. During the year, Parker Bros collected $30,000 of the assigned debts and paid it to Factors. However, the balance of the debts remained uncollectable

and were considered to be bad debts. Advise Parker Bros on the tax deductibility of the debts incurred by their businesses during 2019/20. Solution Provided certain conditions are satisfied, a deduction for bad debts may be claimed under ITAA97 s 2535 or, alternatively under ITAA97 s 8-1. The conditions that must be satisfied under s 25-35 are: • There must be a debt in existence. If the debt is released (Point v FC of T 70 ATC 4021) or otherwise extinguished by an act of the creditor (GE Crane Sales Pty Ltd v FC of T 71 ATC 4268) there will be no debt in existence to be written off as a bad debt. • The debt must have gone “bad”. The test of whether a debt is bad is a practical commercial one where a reasonable business person would regard it as unlikely that the debt will be paid or be recoverable. Taxation Ruling TR 92/18 provides examples of when a debt may be considered to be bad. • The debt must have been written off as a bad debt in the year of income. There is no formal writing off requirement, any written entry clearly disclosing the taxpayer’s intention to treat the debt as bad will suffice (see Taxation Ruling TR 92/18). • The debt must have been included in the taxpayer’s assessable income, except in the case of money lent in the ordinary course of a money lending business (FC of T v Bivona Pty Limited 90 ATC 4168; FC of T v BHP Billiton Finance Ltd 2010 ATC ¶20-169). Therefore, bad debt deductions do not apply to businesses operating on a cash receipts accounting basis. If the requirements of s 25-35 are not satisfied a bad debt may still be deductible under s 8-1(1) provided it is a loss incurred in gaining or producing the taxpayer’s assessable income. This could apply to a normal business loan or factoring discount fees. Further, it is not necessary for the amount to have been brought to account as assessable income for s 8-1(1) to apply. To prevent “trafficking” in companies with bad debts, ITAA97 Subdiv 165-C requires a company to satisfy either a same ownership and control test or the business continuity test to be eligible to claim a deduction for a bad debt. The recoupment of an amount deductible in respect of a debt written off as bad gives rise to an assessable amount (see ITAA97 Subdiv 20-A). Advice As Parker Bros is not incorporated, the company bad debt trafficking provisions in Subdiv 165-C do not apply. Being a retail business the accruals or earnings method of accounting is appropriate, so the bad debt provisions do apply. Doubtful debts and bad debts There is no deduction for doubtful debts so the $15,000 of credit sales considered as doubtful debts would not be deductible. However, the $5,000 treated as bad debts would be deductible under s 25-35. The amount would have been included in Parker Bros assessable income operating on an accruals or earnings accounting basis. And providing Parker Bros came to the decision that it was unlikely the amount would be recovered and took appropriate written action to write the debt off. Loans written off as bad debts Whether Parker Bros are carrying on a money lending business is a question of fact. Guidance provided by Taxation Ruling TR 92/18 would confirm that Parker Bros are carrying on a money lending business. Given that the loans were made in the ordinary course of carrying on a money lending business a deduction for the $48,000 bad debts is available to Parker Bros, even though the amount had not previously been brought to account as assessable income — provided the other requirements in s 25-35 are satisfied (FC of T v Bivona Pty Limited 90 ATC 4168; BHP Billiton Finance Ltd v FC of T 2010 ATC ¶20-169). Debts assigned to Factors Financing Pty Ltd

On assignment of the $52,000 of debts to Factors, the amount assigned would be included in the assessable income of Parker Bros. Parkers Bros would be entitled to a deduction under s 8-1 for the 10% fee ($5,200). There are no tax consequences for Parker Bros of the $30,000 of debt collected. Parker Bros does not derive this as income but is only collecting it and paying it to Factors under the financing agreement. The unpaid balance of the assigned debts ($16,800) is not deductible by Parker Bros. Because they assigned the debts they did not have any debts to write off as bad (see Point v FC of T 70 ATC 4021 and GE Crane Sales Pty Ltd v FC of T 71 ATC 4268). AMTG: ¶16-580, ¶16-582, ¶16-584

¶4-100 Worked example: Work-related expenses Issue Marilyn Murphy is a primary school teacher at a local school. During the 2019/20 tax year she incurred the following expenses: • Expenses for car travel from her home to school and also from school to a teachers’ retreat, then from the retreat to her home. Marilyn did not keep a log book. She estimates that the distance travelled from school to the retreat and then to her home was 400 km. • The cost of a new blouse and skirt which Marilyn wears exclusively for teaching at school. Marilyn also incurred dry-cleaning costs for these clothes. • Stationery, paper and sundry material costs. These items were purchased by Marilyn for use at work. The cost for each item is less than $10 with total costs being $180. Advise Marilyn Murphy whether she is entitled to claim deductions for any of the costs incurred. If the costs are deductible, what are the substantiation requirements? Solution Travel and car expenses A deduction is typically available for the costs of travel from the place of employment to the conference venue and from the venue to home under the general deduction provisions (ITAA97 s 8-1). A deduction is not available for travel from home to the place of employment as this is considered to be private in nature. Further, the nature of Marilyn’s work is not itinerant, and does not warrant consideration as to whether a deduction under ITAA97 s 8-1 is available for travel costs which she incurred for travel from her home to her place of employment. A deduction in some cases may be available where travel is a fundamental part of the employee’s work (see Taxation Ruling TR 95/34). In calculating her car expense deductions, Marilyn can choose between the cents per kilometre method and the log book method (ITAA97 s 28-15). As Marilyn travelled less than 5,000 km and did not maintain a log book, she can use the cents per kilometre basis for calculating her deductions (ITAA97 s 28-25(2)). As she has travelled 400 kilometres during 2019/20 tax year — the deduction available to her is: 400 km × 68 cents = $272 Note that the cents per kilometre method can still apply if Marilyn travels more than 5,000 km. The deduction however is capped at 5,000 km. No written evidence (eg receipts) is required, however Marilyn must be able to demonstrate that the travel was attributable to income-producing activities, and the kilometres travelled have been reasonably estimated (ITAA97 s 28-25(3)). Work-related clothing and laundry expenses A deduction is not available under s 8-1 for the blouse and skirt purchased by Marilyn as it is private and

domestic in nature and is not protective clothing, an item of work uniform or occupation specific clothing; even though it is worn by her in the course of performing her duties. Further, a deduction would not be allowed for any dry cleaning costs incurred as a consequence. As the costs are non-deductible, there is no need to consider any substantiation requirements. However, note that if the item of clothing was protective clothing, a work uniform or occupation specific clothing and allowed as a deduction (under s 8-1 or some other provision); a receipt would be required to substantiate the deduction. The costs of laundry and dry cleaning for deductible items of clothing are also available as deductions (see Taxation Ruling TR 97/12). For dry cleaning costs, written evidence (eg receipts) will need to be kept as substantiation. However, special rules apply for laundry costs under ITAA97 s 900-40 (see also Taxation Ruling TR 98/5). These rules include: • Where the total amount of deductible laundry expenses incurred in the income year is up to $150, there is no need to retain written evidence of each laundry expense. However, a taxpayer may calculate their laundry expenses by keeping written evidence. • Where a taxpayer does not keep written evidence of their laundry expenses, the Commissioner will allow a claim of $1 per load (which covers washing, drying and ironing) where only work-related clothing is being laundered, and 50 cents per load where both private and work-related clothing is being laundered at the same time. If this approach is used, a taxpayer should keep details of the number of washes that were done during the year, and what type of clothes (work-related, private or both) were included in each wash. • Where the total amount of work expenses incurred in the income year is $300 or less, there is no need for written evidence to be kept for laundry or other work expenses even if the laundry expenses are more than $150 (ITAA97 s 900-35). A taxpayer may use the Commissioner’s estimate of laundry expenses or calculate their laundry expenses by keeping written evidence. However, where the total amount of work expenses is more than $300, then to claim laundry expense that total more than $150, a taxpayer must keep written evidence of all their laundry expenses (not just the amount above $150). Stationery costs A deduction is available under the general deduction provisions (s 8-1) for the stationery purchased as this is used by Marilyn in the course of her producing her assessable income (ie for work purposes). For such expenses, Marilyn can either retain the receipts or record the relevant information in a document (eg a diary). This is on the basis that the individual items of expenditure are less than $10 and the total costs do not exceed $200 (ITAA97 s 900-125). The information must be in English and recorded as soon as possible after the expense is incurred (see also Taxation Ruling TR 97/24). AMTG: ¶16-180, ¶16-210, ¶16-220, ¶16-230, ¶16-370

¶4-110 Worked example: Working from home expenses Issue Renee Gardiner is employed as a senior lawyer with a legal practice based in Melbourne CBD. As a result of COVID-19, her office is closed on 23 March 2020 and her employer instructs all staff to work from home for the remainder of the financial year. Renee records her working hours by completing daily timesheets. These show that during the period 23 March 2020 to 30 June 2020, she worked 550 hours in total. Renee converted a spare bedroom in her home into a home office. This room was not used for any other private purpose during the period. Based on her house plans, she estimates that the home office accounts for 10% of the total floor area of her home.

She incurred the following expenses during her period working from home: • cost of office desk — $270 • cost of office chair — $149 • cost of office storage cabinet — $225 • electricity — $1,100 • gas — $270 (used for home heating) • home phone/internet — $380 (estimated 50% work use) • mobile phone — $450 (estimated 65% work use) • cleaning products — $80 (10% work-related) • tea, coffee, milk and toilet paper — $40 • stationery — $110 (100% work use) • repairs to non-functioning heating vent in home office — $240. In addition, she was provided with a laptop and printer by her employer. She wishes to understand the tax deductions she can claim in relation to her period working from home and also the substantiation requirements for her claim. Solution Where an individual works from home, a deduction can be claimed for expenses relating to the area used for work. Generally, additional costs — costs over and above those associated with the use of the house as a home — arising as a result of the use of the home workspace will be deductible. Practice Statement PS LA 2001/6 sets out the ATO views on what principles usually apply in regard to verification of a taxpayer’s claims for deductions for home office running expenses and electronic device usage expenses. The ATO has also released Practical Compliance Guideline PCG 2020/3, which provides a simpler alternative for claiming deductions for additional running expenses incurred while working from home due to COVID-19. From 1 March 2020, the ATO allows working from home claims to be calculated using three methods: The shortcut rate As a result of COVID-19, the Commissioner has introduced a special “shortcut” rate to simplify working from home claims for eligible taxpayers. The shortcut rate is 80 cents per hour. This rate can be claimed for every hour that is worked at home. The hourly rate covers all possible deductible expenses relating to working from home. If a taxpayer uses the shortcut rate to claim a deduction for their additional running expenses, they cannot claim a further deduction for any other working from home expense. To claim the shortcut rate, the taxpayer must keep a record of the hours they have worked at home. This could be in the form of timesheets, rosters, a diary or similar document that sets out the hours worked. The shortcut rate covers all taxpayers working from home during this period, whether as a result of COVID-19 or not. The shortcut rate commences on 1 March 2020 and is stated to cease to apply on 30 September 2020. However, if the situation regarding COVID-19 remains unchanged at that date, its application is likely to be extended. The shortcut rate does not cover occupancy costs, which are not claimable in relation to working from home but are potentially claimable where a business is run from home. Renee commenced working from home on 23 March and can therefore use the shortcut method if she wishes. She worked 550 hours from home and her claim is therefore $440 (550 hours × 80 cents). Her timesheets will be sufficient substantiation for this claim.

52 cents per hour fixed rate Alternatively, the existing fixed rate of 52 cents per hour can be used to work out a claim. This covers home office electricity (lighting and cooling/heating, running electrical items such as a computer), gas (heating), cleaning and the decline in value of home office items such as furniture and furnishings. It does not cover other expenses such as computer consumables, stationery, phone and internet expenses or the decline in value of a computer, laptop or similar device. Hence, a record of the hours worked at home (as per the shortcut method) along with full written evidence to substantiate the expenses that are not covered by the 52 cents per hour rate must be kept when using this methodology. Renee can claim the 52 cents per hour method in relation to her 550 hours worked from home. Her claim is $286 (550 hours × 52 cents). In addition, she can make separate claims for: • home phone/internet costs — $190 ($380 × 50%) • mobile phone — $293 ($450 × 65%), and • stationery — $110. She cannot claim a deduction for the decline in value of the laptop and printer as the expense was incurred by her employer. Her total deduction is $879 ($286 + $190 + $293 + $110). The only substantiation required in relation to her fixed-rate claim is her timesheet. In relation to the other expenses, she will require written proof of the expense such as a receipt, invoice or bill. For the home phone/internet and mobile phone costs, she will also need to be able to demonstrate that her work usage percentage is a “reasonable estimate”, for instance by working out actual work usage based on itemised bills. She can prepare a reasonable estimate based on work use over a four-week representative period and then apply this to the whole period spent working from home. In relation to home phone and internet costs, she needs to be careful to take into account usage of the service by other household members such as her spouse and children. Actual costs The third available method is to claim a deduction for actual costs incurred including: • electricity (lighting, cooling/heating and electronic items used for work, for example, a computer) and gas (heating) expenses • the decline in value and repair of capital items such as home office furniture and furnishings • cleaning expenses • phone expenses including the decline in value of a phone handset • internet expenses • computer consumables • stationery, and • the decline in value of a computer, laptop or similar device. Such a claim must be substantiated by keeping records and written evidence to determine the workrelated proportion of each expenses incurred. If she chooses the actual method, Renee’s claim can be calculated as follows: • cost of office desk — $270

• cost of office chair — $149 • cost of storage cabinet — $225 • electricity — $110 ($1,100 × 10%) • gas — $27 ($270 × 10%) • home phone/internet — $190 ($380 × 50%) • mobile phone — $293 ($450 × 65%) • cleaning products — $8 ($80 × 10%) • stationery — $110 • repairs — $240. The office desk, chair and cabinet are capital items but as the cost of each item is less than $300, the entire cost can be immediately deducted (s 40-80(2)). She cannot claim a deduction for the tea, coffee, milk and toilet paper; these items are private and domestic in nature, even though her employer would previously provide these at work. Her total deduction is $1,622 (the sum of all the items above). In relation to substantiation, she will require written proof of the expense such as a receipt, invoice or bill. She will also need to be able to demonstrate that her split between work and private usage is reasonable. For mobile phone and home phone/internet costs, the issues are the same as for the fixed-rate claim (above). For her utility bills and cleaning expenses, she must demonstrate that the use of a work proportion of 10% (based on the floor area of the home office as a proportion of the total floor area of the property) is reasonable. In particular, she should bear in mind that the home office is only used for roughly one-third of each day, and is otherwise unused. Offset against that is the fact that whilst the home office is in use, electricity and gas consumption (at peak daily rates) may be heavily focused on the home office, rather than the rest of the house. As the actual method produces the largest deduction ($1,622 compared to $879 for the fixed-rate method and just $440 for the shortcut method), Renee should use the actual method provided she can meet the potentially onerous substantiation requirements. AMTG: ¶16-400, ¶16-480, ¶16-700

¶4-120 Worked example: Legal expenses Issue Bling & Harvey Pty Ltd (B&H) is a discount wholesaler and retailer of consumer durable whitegoods. On 1 September 2019 B&H entered into a lease of commercial premises and paid a solicitor $1,375 to prepare the lease documentation. On the same day B&H incurred borrowing expenses of $12,000 on a loan of $180,000 from Australian Finance Corporation for a ten-year term at 7.8% per annum. The purpose of the loan was to fund the acquisition of trading stock. During the 2019/20 year, B&H initiated legal proceedings against a competitor, Ross Norman Pty Ltd, for infringing B&H’s trademark. B&H was successful in the action but legal costs for the court proceedings amounted to $63,000. Also during the year the local council sought to rezone the area as heavy industrial and acquire the premises from which B&H was trading. B&H, along with other adjoining retailers, was successful in opposing Council’s proposed rezoning of the land in the Land and Environment Court. However, the legal proceedings cost B&H $71,000. Towards the end of 2019/20, B&H received notification of a tax shortfall penalty from the ATO for making

a false and misleading statement on a tax matter relating to GST (TAA Sch 1, s 284-70(a) and s 28490(1)). The penalty or fine was for $8,250. Advise B&H on the tax deductibility of the above costs and expenses. Solution There are no specific deduction provisions pertaining to legal expenses in the taxation legislation. Rather, deductibility is determined by the application of the general deduction provision ITAA97 s 8-1. However, there are specific deduction provisions relating to expenditures bordering on legal expenses, such as: • ITAA97 s 25-20 — lease document expenses • ITAA97 s 25-25 — borrowing expenses, and • ITAA97 s 26-5 — penalties. The underlying issue with legal expenses is whether the expenditure is of a revenue nature (deductible under s 8-1(1)) or of a capital nature and made non-deductible by s 8-1(2). Further, legal expenses are not deductible if they: • constitute a loss or outgoing of a private or domestic nature, or • are incurred in gaining or producing exempt or non-assessable non-exempt income, or • are specifically denied deductibility by a provision in the legislation that prevents the deduction. Numerous decisions provide examples of legal expenses that have been held to be deductible and examples of legal expenses held to be of a non-revenue nature and non-deductible, for example FC of T v Snowden & Willson Pty Ltd (1958) 11 ATD 463; (1958) 99 CLR 431 (legal costs to defend business); Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 (legal costs to prevent competition); and Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542 (legal cost incurred to defend business practices). Some legal expenses held to be of a capital nature and not deductible under s 8-1 may qualify for deductibility, over five years, under the black-hole provisions in ITAA97 s 40-880. Other legal expenses may be an addition to the fifth element of the cost base of an asset for CGT purposes (ITAA97 s 11025(6)). Preparation of lease documentation The $1,375 paid to a solicitor to prepare the lease documentation for premises to be used for the sale of whitegoods and generating assessable income is deductible for B&H, as a legal expense, under the specific lease documentation expenses provision in ITAA97 s 25-20. Borrowing expenses in relation to the loan to acquire trading stock Borrowing expenses in relation to a loan (such as, procurement fees, loan establishment fees, stamp duty and legal expenses) are deductible to the extent that the borrowed money is used for the purpose of producing assessable income. Hence the $12,000 borrowing expenses incurred by B&H are deductible under s 25-25. However, under s 25-25, the expenses are deductible over the period of the loan or five years, whichever is the shorter period — in this case five years. The calculation of the deduction for 2019/20 is: $12,000 × 304/1,826 = $1,997 Where 304 is the number of days of the loan term in 2019/20 and 1,826 is the number of days in five years (taking into account leap years) and the allowable deduction is $1,997. Legal expenses in relation to trademark infringement proceedings Legal expenses incurred in relation to the profit yielding business structure are generally of a capital nature and are made non-deductible by s 8-1(2) (see Sun Newspapers). However, there have been cases where legal expenses incurred in protecting trade secrets (FC of T v Consolidated Fertilizers Ltd 91 ATC

4677) and in preventing a competitor from using a similar trade name (FC of T v Duro Travel Goods Pty Ltd (1953) 10 ATD 176; (1953) 87 CLR 524) have been held to be on revenue account and deductible. On this basis, it is arguable that the $63,000 legal expenses incurred by B&H in successfully undertaking trademark infringement proceedings against a competitor are deductible under s 8-1(1) on the basis that the infringing trade mark could impact on B&H’s sales and revenue. On the other hand, if it was argued that the competitor’s trade mark impacted on B&H’s business reputation and goodwill, then the $63,000 could be held to be non-deductible capital expenditure (although see, Snowden & Willson). Legal costs in opposing Council’s proposed rezoning of the land Had the land on which B&H carried on its business been rezoned and resumed by the Council, B&H’s profit yielding asset would have been destroyed or sterilised (The Glenboig Union Fireclay Co Ltd v Inland Revenue Commissioners (1922) 12 TC 427) and the $71,000 cost of legal proceedings in opposing Council’s proposed rezoning of the land in the Land and Environment Court would be held to be a nondeductible legal expense of a capital nature. Costs incurred by the owner of a shopping centre in seeking to overturn the rezoning of nearby land that would have allowed a larger shopping centre to be built were held to be a non-revenue legal expense in Case 37/97 97 ATC 385. For CGT purposes, the $71,000 capital legal expenses would add to the fifth element of the cost base, being expenditure incurred to establish, preserve or defend the taxpayer’s title to or right over the asset, that is B&H’s business premises (ITAA97 s 110-25(6)). The effect is to reduce any capital gain on the subsequent disposal of the premises. Deductibility of the tax shortfall penalty Penalties or fines imposed for breaches of the law are specifically excluded from deduction under ITAA97 s 26-5. A tax shortfall penalty is similarly non-deductible (see Interpretative Decision ID 2001/221). Consequently, B&H would not be able to claim a deduction for the $8,250 tax shortfall penalty imposed for making a false and misleading statement on a tax matter relating to GST. AMTG: ¶11-550, ¶16-010, ¶16-060, ¶16-640, ¶16-800, ¶16-830, ¶16-840, ¶16-842, ¶16-844, ¶16-845

¶4-140 Worked example: Tax losses of earlier years Issue Fred Pattel is self-employed and turned 58 in 2019. Fred has owned and operated a landscape gardening business trading as “Keep Australia Beautiful” for the past 25 years. Jim Gee, an employee of Fred’s for 20 years, decided to retire in August 2019. Fred paid Jim a gratuity of $15,000 on the basis of Jim’s past service and dedication to the business. Fred has his own complying self-managed superannuation fund and made personal concessional contributions of $25,000, in both October 2018 and October 2019. Fred’s landscape gardening business income for 2018/19 was $34,000 and his losses and outgoings incurred in conducting the business amounted to $48,000. For 2019/20 the figures were $43,000 and $49,000 respectively. As a member of the Australian army reserve, Fred receives $3,000 in pay and allowances on 1 July 2018 and on 1 July 2019. Advise Fred as to his taxable income for both the 2018/19 and 2019/20 income years. Solution A loss is incurred if the taxpayer’s allowable deductions exceed their assessable income and net exempt income in a given year (ITAA97 s 36-1). The steps in calculating a tax loss are outlined in ITAA97 s 3610. Such losses can be carried forward indefinitely and offset against assessable income in future years. The rules for the deduction of tax losses from earlier income years contain certain limitations, for example: • the losses are offset against assessable income and net exempt income (s 36-15(3), (4)), if any

• the taxpayer cannot choose the year in which to claim the tax losses, in an attempt to avoid wasting tax losses when the taxpayer derives net exempt income • if there are two or more losses, they are deductible in the order in which they were incurred (s 3615(5)), and • deductions for certain outgoings are not allowed to the extent that they would create or add to a tax loss (ITAA97 s 26-55), namely: – payments of pensions, gratuities or retiring allowances (ITAA97 s 26-50) – gifts (ITAA97 Div 30) – conservation covenants (ITAA97 Div 31) – personal superannuation contributions (ITAA97 s 290-150). Fred Thompson’s taxable income 2018/19 $ Business income

 34,000

Business deductions

 48,000

Australian army reserve pay and allowances

 3,0001  25,0002

Superannuation contribution Tax loss:

$

Business income

 34,000

Add net exempt income

 3,000  37,000

Less business deductions

  48,000 11,0003

Tax loss for 2018/19 carried forward Fred Thompson’s taxable income 2019/20 $ Business income

43,000

Business deductions

49,000

Australian army reserve pay and allowances

3,0001

Gratuity

15,0004

Superannuation contribution

25,0002

Tax loss: Business income Add net exempt income

$ 43,000   3,000 46,000

Less business deductions

  49,000

Tax loss for 2019/20 carried forward

3,0005

Notes: 1. Australian army reserve pay The Australian army reserve pay and allowances of $3,000 received by Fred in both 2018/19 and 2019/20 are exempt income under ITAA97 s 51-5. The exempt income is added to Fred’s business income in calculating the tax loss for the relevant income year. The effect is to reduce the carried forward loss from $14,000 to $11,000 in 2018/19 and from $6,000 to $3,000 in 2019/20. 2. Personal concessional superannuation contribution Fred can make personal concessional contributions to his complying superannuation fund of $25,000 in 2018/19 and 2019/20. Fred is entitled to claim a deduction for contributions to his superannuation fund under ITAA97 s 290-150. However, he is denied the deduction in both income years because they will give rise to, or add to, a tax loss (ITAA97 s 26-55). 3. Tax loss for 2018/19 carried forward to be offset against future income Fred’s tax loss of $11,000 can be carried forward indefinitely to offset against future income. 4. Gratuity The gratuity paid to Jim, a former employee would be deductible, provided the requirements of s 25-50 are satisfied. However, the deduction is denied because it will give rise to, or add to, a tax loss (s 26-55). 5. Tax loss for 2019/20 carried forward for offset against future income Fred’s tax loss of $11,000 for 2018/19 cannot be offset against income in 2019/20 because there is a tax loss in that year as well. Fred’s 2019/20 tax loss of $3,000 is added to his $11,000 loss from the previous year and is available to be offset against future income. The two losses are deductible in the order in which they were incurred (ITAA97 s 36-15(5)). AMTG: ¶10-760, ¶16-880, ¶16-895

¶4-160 Worked example: Costs of borrowing for business purposes Issue When Ben Sadiq decided to start his own business, he needed to borrow a large sum. He was able to borrow the money from a bank at a 5% interest rate over a four-year loan period starting on 1 September 2019. Ben also incurred other costs amounting to $3,600 associated with the loan. These costs related to the loan establishment fee, valuation fees and stamp duty. All of the money borrowed from the bank is used for carrying on his business. Is Ben entitled to a tax deduction for the outgoings he incurs in relation to the loan? Solution Ben has incurred two types of expenditure: (i) the interest, and (ii) the borrowing costs. Interest Interest is deductible to the extent that it is expenditure incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income (ITAA97 s 8-1). In determining the deductibility of interest, significance is placed on the use to which the borrowed money is put. Under this “use test”, interest may be deductible if the money is used to acquire income-producing assets such as business premises or shares or to meet current business expenses. Under s 8-1, an outgoing may be deductible “to the extent” it is incurred for the appropriate purpose, and the outgoing may be apportioned if there is both an income-producing purpose and a private purpose in

the use of the borrowed money. Because Ben uses the borrowed money wholly in carrying on his business, the interest outgoing would be deductible in the year the interest expenditure is incurred, generally when it becomes due and payable. Borrowing expenses Expenditure incurred in borrowing money is normally a capital outgoing that would not be deductible under s 8-1 because of the exclusion of capital expenditure in s 8-1(2)(a). A deduction for the borrowing expenses may, however, be available under ITAA97 s 25-25 to the extent that the money is used for the purpose of producing assessable income. Section 25-25 allows a deduction for certain borrowing expenses that would ordinarily be regarded as capital in nature and therefore not deductible under s 8-1. Expenditure that may fall within s 25-25 includes establishment fees, legal, valuation and survey fees, stamp duty and loan guarantee insurance. Borrowing expenses do not include interest payable on the money borrowed. Beginning in the year in which they are incurred, borrowing expenses are deductible over whichever is the shortest period: (i) the period of the loan specified in the loan contract, (ii) the actual loan period if the loan terminates early, or (iii) five years. The deductible amount for a year is calculated by dividing the undeducted expenditure by the number of days remaining in the loan period and multiplying the result by the number of days in the loan period that are in the income year. If the amount of borrowing expenses incurred in a year is less than $100, the amount may be deducted in full in that year. Calculation of Ben’s deductions for the borrowing expenses Ben incurred borrowing expenses of $3,600 on 1 September 2019. The total period of the four-year loan is 1,461 days and the number of relevant days in 2019/20 (ie 1 September 2019 to 30 June 2020) is 304. The borrowing expenses would be deductible as follows: $3,600 2019/20

$749

(ie

1,461 days

× 304 days)

$3,600 – $749 = $2,851 $2,851 2020/21

$899

(ie

1,157 days

× 365 days)

$2,851 – $899 = $1,952 2021/22

$900

$1,952

(ie

792 days

× 365 days)

$1,952 – $900 = $1,052 $1,052 2022/23

$899

(ie

427 days

× 365 days)

$1,052 – $899 = $153 2023/24

$153

(ie

$153 62 days

× 62 days)

AMTG: ¶16-740, ¶16-800

¶4-180 Worked example: Interest expenses after income-producing activity ceases and loan refinanced Issue Mary and Harry Stark, who are married, operated the Ironbark Café as a partnership. They jointly obtained an interest bearing loan from the bank to fund the acquisition of the café’s business assets. The Ironbark Café business failed to make a profit during its years of operation. On 1 February 2019, Mary and Harry sold the business at a loss. The proceeds and other amounts which they had on hand were not sufficient to fully repay their loan to the bank. They continued to make minimum repayments and incur interest costs because they did not have any other assets which they could liquidate or cash in the bank which they could use to fully repay the loan. On 1 July 2019, Mary and Harry decided to refinance their loan with another bank because they were able to obtain a lower interest rate. Given their financial position, they continued to incur interest expenses under the refinanced loan for the remainder of the 2019/20 year. Advise Mary and Harry whether they are entitled to claim interest deductions for: 1. Interest expenses incurred after they sold their business during the 2018/19 year. 2. Interest expenses incurred following the refinancing of the loan during the 2019/20 year. Solution Taxation Ruling TR 2004/4 provides guidance on the deductibility of interest expenses incurred prior to the commencement of, or after cessation of, income-earning activities. The ruling states that the deductibility of interest is typically determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put. Further, interest expenses are recurrent expenses and where the interest is on revenue account, the fact that the borrowed funds may be used to purchase a capital asset does not alter this conclusion. The loan obtained by Harry and Mary to fund the purchase of business assets for the Ironbark Café would be a deductible expense as it would be reasonable to conclude that there is a nexus between the interest expense incurred and the derivation of income from the use of the assets in the business pursuant to general deduction provisions contained in ITAA97 s 8-1. However, whether such interest remains deductible under s 8-1 may be impacted where the incomeproducing activity of the taxpayer ceases. The decisions of the Full Federal Court in FC of T v Brown 99 ATC 4600 and FC of T v Jones 2002 ATC 4135 are instructive in determining whether interest incurred after the income producing ceases is deductible. Specifically, the circumstances encountered by Harry and Mary are similar to that of Jones’ case. In Jones, the taxpayer, together with her husband, borrowed money to fund a trucking and equipment hire business. After her husband’s death, the taxpayer sold the assets of the business but the proceeds (plus other amounts on hand) were insufficient and she was unable to fully repay the loan. Subsequently, the taxpayer refinanced the loan because she was able to obtain a lower rate of interest through an alternative lender. The Federal Court concluded that interest incurred on the loan continued to be deductible despite the cessation of the relevant income-earning activities. The occasion of interest expenditure can be found in the relevant income-earning activities even where those activities are now defunct and all the borrowed funds (or assets representing those funds) are lost. While the deductibility of interest is premised on the question of whether there is a nexus between the interest expense incurred and the income-earning activities, the Commissioner in Taxation Ruling TR 2004/4 indicates that interest will not fail to be deductible merely because:

• the loan is not for a fixed term • the taxpayer has a legal entitlement to repay before maturity the principal with or without penalty, or • the original loan is refinanced, whether once or more than once. However, the nexus will be broken if the taxpayer: • keeps the loan on foot for reasons unassociated with the former income-earning activities, or • makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income with respect to the debt that was originally incurred. In particular, the Commissioner considers a legal or economic inability to repay suggests that the loan was not kept on foot for purposes other than the former income-earning activities. Not too dissimilar to the decision in Jones, Harry and Mary had valid reasons for keeping the loan on foot as they lacked the financial capability of being able to fully repay it after they sold the business. Therefore, it would be reasonable to conclude that the interest costs incurred for the 2018/19 year would be deductible to Harry and Mary for that year. This is consistent with the Commissioner’s view that the less the financial resources and liquid assets the taxpayer has on hand, the more likely it is that an inference could be drawn that the existence of a continuing obligation to pay interest is a burdensome legacy of the taxpayer’s past rather than a result of the taxpayer choosing to keep the loan on foot for reasons unassociated with the former income-earning activities. The refinancing of the loan to an alternative bank should not impact the deductibility of interest costs incurred by Harry and Mary for the 2019/20 year. The Commissioner indicates in TR 2004/4 that refinancing of a loan does not of itself break the nexus between outgoings of interest under the loan and the prior income-earning activities. However, the Commissioner considers that the decision to refinance may, in all the circumstances, lead to the inference being drawn that the taxpayer has made a conscious decision to extend the loan, and has done this in order to derive an ongoing commercial advantage. Mary and Harry’s decision to refinance the loan in this case would arguably not break the nexus and limit their ability to claim deductions for interest costs incurred during 2019/20. Their lack of cash and other asset holdings coupled with their financial circumstances would therefore indicate that their decision to refinance the loan was not to derive an ongoing commercial advantage. Similar to the decision in Jones, Mary and Harry had not been in a position to repay the loan, although they had been attempting to do so as best that they could from the resources available. The failure to repay the loan over the relevant income years since the disposal of the business is attributable to their financial position and not to any decision to keep the loan on foot for other reasons. AMTG: ¶16-010, ¶16-015, ¶16-740

¶4-200 Worked example: Deductibility of interest on loans Issue Olga Retton lives in her own apartment in Sydney and owes $270,000 on her mortgage. Olga carries on a clothing and accessories business and in February 2018 negotiated a three-year $200,000 interest only loan at 10% interest. The loan proceeds were used to acquire trading stock of clothing and accessories ($44,000) and to meet the 9.5% superannuation guarantee contribution requirement in respect of an employee ($6,000). Half of the loan proceeds ($100,000) were applied to acquire shop premises from which to conduct the business. The remaining $50,000 was on-lent by Olga to her share trading business, Retton Pty Ltd, to acquire shares in technology company, HAL Ltd. Retton Pty Ltd agreed to pay interest on the loan, from dividends received, at the rate of 5%. In February 2019 the clothing and accessories business failed. However, Olga remained liable to pay

interest on the loan for the remaining two-year term of the loan. Following the business failure, Olga obtained employment with Ventilo Pty Ltd, as a retail clothing manager, but was obliged to move from Sydney to Melbourne. Olga purchased an apartment in Melbourne by taking out another loan of $280,000. At the same time Olga leased her Sydney apartment to tenants for $400 per week. However, the rent received by Olga fell short of her interest payments by $6,000 per year. Olga has received advice that she should refinance her two apartment property loans into one loan but split into two accounts, one for each of the properties and that she should direct all repayments to paying down the principal and interest on the Melbourne apartment loan and allowing the interest to accrue and be capitalised on the Sydney apartment loan, until the Melbourne apartment loan is fully repaid. Olga seeks advice on the deductibility of interest incurred on the various loans she has entered into. Solution The deductibility of interest on loans is governed by ITAA97 s 8-1(1), where interest will generally be deductible when it is incurred in gaining or producing assessable income or carrying on a business for that purpose. Interest will not be deductible if the negative limbs of ITAA97 s 8-1(2) apply. That is, if the interest is of a capital nature or of a private or domestic nature. There is a need to establish a nexus between the incurring of the interest expense and the generation of assessable income. However, a deduction may still be allowable even if the interest expense happens before or after the generation of income. Tests have been devised by the courts to determine whether interest on loans is deductible in various circumstances. The leading test is the “use” or “purpose” test where the deductibility of interest is determined according to the use to which the borrowing is put. Interest may be incurred on loans for more than one purpose, in which case it may be necessary to apportion the interest payments for calculating deductibility of the interest. One of those uses or purposes may be to acquire a capital asset. Another purpose may be to take advantage of negative gearing. Where more than one use or purpose is involved, a loan may be structured so that it is split into different accounts and repayments and the interest adjusted to take advantage of interest deductibility. Deductibility of interest incurred on loans for the Sydney and Melbourne apartments On the basis of the “use” or “purpose” test, the interest incurred by Olga on the loans taken to purchase her home would not be deductible because the loans were for a private or domestic purpose (s 8-1(2)(b)). Olga’s lease of her Sydney apartment Once Olga begins to lease her Sydney apartment the rent constitutes assessable income and the interest on the outstanding loan would be deductible from that time. This is so even if the interest on the loan exceeds the annual rental income. It is another example of the legally acceptable practice of negative gearing. Deductibility of interest on the $200,000 loan Because the loan proceeds are employed for or put to use for a number of purposes it is necessary to apportion the interest payments across the various uses or purposes (Taxation Ruling TR 95/33). i. Acquisition of trading stock The proportion of interest incurred on the loan for the purchase of trading stock is deductible as the proceeds are being used to gain or produce assessable income or carry on a business for that purpose (s 8-1(1); FC of T v Munro (1926) 38 CLR 153). ii. Funding the superannuation guarantee requirement The proportion of interest incurred on the loan for funding the superannuation guarantee requirement in relation to an employee would also be deductible because the proceeds are being used to gain or produce assessable income or carry on a business for that purpose. Further, on the basis that the superannuation contribution made for the employee is deductible under ITAA97 Subdiv 290-B, s 26-80 permits a deduction for the interest on a loan to finance the superannuation contribution. iii. Acquisition of business premises

Although the use to which this half of the loan is put is to acquire a capital asset, the interest incurred would be deductible as it is incurred in acquiring an income-producing asset and is not a capital outgoing. Interest is a recurrent expense that secures the use of borrowed money during the term of the loan (Steele v DFC of T 99 ATC 4242; Travelodge Papua New Guinea Ltd v Chief Collector of Taxes 85 ATC 4432). As explained by the Full Federal Court in Australian National Hotels Ltd v FC of T 88 ATC 4627: “The cost of securing and retaining the use of the capital sum for the business, that is to say, the interest payable in respect of the loan, will be a revenue item. It creates no enduring advantage, but on the contrary is a periodic outgoing related to the continuance of the use by the business of the borrowed capital during the term of the loan.” iv. On-lending $50,000 to Retton Pty Ltd for (dividend) income-producing purposes In Ure v FC of T 81 ATC 4100, the taxpayer entered into loans at commercial rates of up to 12.5% and on-lent the funds to associates, who used the funds for non-income-producing purposes. The associates agreed to pay interest on the on-lent funds at 1%. The Full Federal Court reduced the taxpayer’s deduction for interest incurred on the loans to the extent of the 1% interest on the on-lent amounts returned as assessable income. Olga’s situation however, can be distinguished as she on-lent the money to a private company controlled by her for income-producing purposes. It is arguable on the basis of FC of T v Total Holdings (Australia) Pty Ltd 79 ATC 4279 and Economedes v FC of T 2004 ATC 2353 that Olga would be entitled to a deduction for interest incurred on the loan at 10% even though she only returns interest at 5% on the onlent funds. This type of negative gearing arrangement has been accepted by the Commissioner (see Taxation Ruling TR 95/33). Olga still liable for interest on the $200,000 loan after business failure For deductibility under s 8-1, some nexus is required to be established between the loss or outgoing and the gaining or production of assessable income or carrying on a business for that purpose. Issues arise when the loss or outgoing precedes the production of assessable income or is incurred after the incomeproducing activities have ceased. In a series of cases (Steele v DFC of T 99 ATC 4242; FC of T v Brown 99 ATC 4600 and FC of T v Jones 2002 ATC 4135) the courts have held that interest incurred on a loan taken out for income-producing purposes is deductible even after the income-producing activity has ceased (see also Taxation Ruling TR 2004/4). Given that all the uses to which the $200,000 loan proceeds were put were for income-producing purposes, Olga would be entitled to deduct the interest on the outstanding loan even though all the uses of the funds had ceased, except for the amount on-lent. What if Olga borrowed money to purchase her Melbourne apartment and to repay the loan on the Sydney apartment? In this case the interest on the loan attributable to the purchase of the Melbourne apartment would not be deductible but the interest attributable to the loan to pay off the outstanding loan on the leased Sydney apartment would be deductible (Case B11 70 ATC 46; Case 12/95 95 ATC 175 and Case 29/95 95 ATC 284). What if Olga re-negotiated her two apartment loans into a split loan? Assume Olga re-negotiated her $270,000 Sydney apartment loan and her $280,000 Melbourne apartment loan into a single $550,000 loan split into two accounts, one for each apartment. Would Olga be entitled to a full deduction for the interest, including the accrued and capitalised interest, on the Sydney apartment loan if she: • directed repayments to the account relating to the Melbourne apartment (for which she gets no interest deduction) until the loan is fully re-paid, and • continued to accrue interest, and capitalise the interest, on the loan relating to the Sydney apartment, for which she can claim a deduction for interest? A similar situation arose in FC of T v Hart & Anor 2004 ATC 4599 where the High Court held that the interest was deductible, except for the compound interest (ie interest on interest accruing on the loan), which was not deductible, as it was caught by the anti-avoidance provisions in ITAA36 Pt IVA.

Along the lines of Hart, Olga would not be entitled to a full deduction of the interest on the Sydney apartment loan. The portion of interest that is compound interest may not be deductible where the Commissioner considers it caught by the anti-avoidance provisions. While the ATO accepts that the principles governing the deductibility of compound interest are the same as ordinary interest (Taxation Determination TD 2008/27), it takes the view that the ITAA36 Pt IVA antiavoidance provisions apply to certain arrangements (see Taxation Determination TD 2012/1). See also Taxation Ruling TR 2000/2. AMTG: ¶16-010, ¶16-740, ¶16-742, ¶16-744, ¶16-746, ¶16-748

¶4-220 Worked example: Self-education and home office expenses Issue Arnold Joyce is a flight attendant with an international airline while his partner, Dianne Morcombe, is a qualified hairdresser and small business owner. They both seek advice regarding a number of tax deductions that were denied by the Commissioner. Arnold While working as a flight attendant Arnold enrolled in a Bachelor of Aviation degree course which would qualify him as a pilot. Arnold also enrolled in a Bachelor of Management degree. Arnold had the opportunity to complete some of the subjects for the Bachelor of Aviation in France and some of the subjects in the Bachelor of Management in New York. His airline employer funded the cost of flights for the purpose of overseas study. Arnold incurred course fees and purchased textbooks, a computer and mobile phone. He also had to pay for his accommodation while studying overseas. In his tax return for 2019/20, Arnold claimed a tax deduction for all the expenses he incurred in gaining his two degrees on the basis that they were self-education expenses related to his income-earning activity as a flight attendant. The Commissioner denied the deductions. Dianne Dianne manages and owns a hair-dressing salon in a local shopping centre. Dianne travelled overseas to Paris to attend a conference on new developments and products in hair care. Dianne had a few days to spare in Paris before her return flight to Australia. Dianne also sees customers for hair-dressing at her home. She has set aside a room in the house and installed hair-dressing equipment. Customers can enter the room via a side door to the house. Dianne, also visits aged-care homes and attends to the hair for residents residing in those premises. She uses her own vehicle for this purpose and has to transport hairdressing equipment in the vehicle. In her tax return for 2019/20, Dianne claimed a tax deduction for the total cost of the trip to Paris and conference fees. She also claimed tax deductions for all the expenses in operating her home based hairdressing business. The Commissioner denied the claim for the deductions claimed for the Paris trip and only allowed a partial deduction for the running costs incurred in relation to the home-based business. Solution Deductions for self-education expenses Deductions are available for self-education expenses under the general deduction provision, ITAA97 s 81(1), as expenses incurred in gaining or producing assessable income, provided there is a nexus between the self-education expense and income-earning activity. Self-education expenses may include: • tuition or course fees • cost of textbooks, professional and trade journals and photocopying • fares incurred on overseas study tours or attending work-related conferences

• motor vehicle expenses in travelling between home and an educational institution, and • interest on money borrowed to pay for the above expenses. (Taxation Ruling TR 98/9) Self-education expenses are defined as expenses necessarily incurred by a taxpayer in connection with a prescribed course of education. “Prescribed course of education” and “course of education” are defined in TR 98/9, as are the Commissioner’s views on the principles governing the deductibility of self-education expenses. In addition, some self-education expenses may be claimable under specific deduction provisions, such as repairs and depreciation. There are restrictions or limitations imposed on claims for self-education expenses, for example: • For certain types of self-education expenses, the maximum amount deductible under s 8-1 is limited to the excess of self-education expenses over $250 (ITAA36 s 82A). • Deductions cannot be claimed for self-education expenses to the extent they are incurred in gaining or producing rebatable benefits, such as, Youth Allowance (ITAA97 s 26-19 and FC of T v Anstis 2010 ATC ¶20-221). • Deductions are not available for student contributions to various student assistance programs, such as, HELP (ITAA97 s 26-20). Where an employer pays an employee’s HELP, the employer will be entitled to a deduction but will also be liable for FBT in respect of the value of the benefit. Arnold’s Bachelor of Aviation degree course Arnold would rightly be denied a deduction for the costs associated with his Bachelor of Aviation degree course if his purpose in undertaking the course was to allow him to become an airline pilot. The expenses would be seen as being incurred to obtain new employment. There would be no nexus between the expenditure and his current income-earning activities (FC of T v MI Roberts 92 ATC 4787). However, the expenses would be deductible as self-education expenses if Arnold could establish a relevant connection to his current employment as a flight attendant. He could argue that they were incurred in order to better discharge his current duties as a flight attendant, for example by understanding how aircraft fly and respond under different conditions in the air, and to be able to explain the situation to passengers or being able to offer assistance to the pilots should they experience difficulties. Deductions, under analogous circumstances have been allowed in FC of T v Studdert 91 ATC 5006 and FC of T v Wilkinson 83 ATC 4295. Arnold’s Bachelor of Management degree course Similarly, the expenses for this degree course would be seen as incurred by Arnold in obtaining new employment and not having a nexus to his current income-earning activities. Arnold would need to argue that the degree would better enable him to do his existing job as a flight attendant. He could do this by arguing that the degree would give him management and leadership skills and enhance his prospects of being promoted to cabin manager or flight supervisor and receiving increased remuneration. On the basis of these arguments all of Arnold’s degrees self-education expenses would be deductible, including: course fees, textbooks and materials and computers. However, Arnold would need to prove that the mobile phone was used wholly or partly for study purposes (or for work-related purposes). To the extent he could not do that, the cost would not be deductible. Meals and accommodation expenses would be deductible but not the airfares paid for by Arnold’s airline employer. The airfares would constitute a fringe benefit for which the employer would be liable for fringe benefits tax. For Arnold they would be classified as non-assessable non-exempt income. Further, the first $250 of self-education expenses would also not be deductible (ITAA36 s 82A). Dianne’s home operated business

Dianne satisfies the criteria relied upon by the Commissioner in Taxation Ruling TR 93/30 for claiming deductions for both the occupancy and running costs attributable to her hair-dressing business. A room is set aside and set up for hair-dressing and is not available for private or domestic use. She attends to customers at home and they enter via a side door separate from the normal residential entry. Dianne would be entitled to claim occupancy expenses for home loan interest or rent, insurance, council and water rates and land tax, apportioned on the basis of floor area for the room relative to the home as a whole. Dianne would also be entitled to claim running expenses directly attributable to the business, such as, heating, lighting, cleaning and insurance. She could also claim for repairs (ITAA97 s 25-10) and depreciation of the hairdressing equipment under ITAA97 Div 40. Dianne’s use of motor vehicle Dianne is entitled to claim car expenses relating to the use of her motor vehicle when attending to the hair of customers in aged-care premises, including travel to and from the premises, on the basis that her home is her place of business and she is travelling on business (ITAA97 s 25-100). See FC of T v Vogt 75 ATC 4073 and Case U29 87 ATC 229. Dianne’s trip to Paris The expenses incurred in travelling to Paris and attending the hair-dressing conference are deductible as they satisfy the Commissioner’s principles for deductibility of self-education expenses in TR 98/9. The costs incurred were for the purpose of improving her knowledge and skills and keeping up-to-date in her current hair-dressing trade, and therefore has a relevant connection to her current income-earning activity. The deductions would relate to conference fees, books and materials and the cost of travel, meals and accommodation (FC of T v Finn (1961) 106 CLR 60 and FC of T v Highfield 82 ATC 4463). The expenses would be deductible in full provided the additional days spent in Paris were only incidental to the main purpose of travelling to Paris or if it was not possible to catch an earlier flight back to Australia. These self-education expenses are not affected by the limitation in ITAA36 s 82A as attendance at a conference is not a prescribed course of education for the purposes of that section. AMTG: ¶16-220, ¶16-450, ¶16-452, ¶16-460, ¶16-480

¶4-230 Worked example: Work-related travel; home to work travel Gillian works for a large accountancy firm based in Melbourne, which has several offices across Victoria. She lives in Frankston and works as a manager at the Melbourne CBD office. Her role requires her to deal with work issues outside of ordinary office hours and this is reflected in the salary that she is paid. Gillian travels to and from work by train. She will often deal with work-related emails before she leaves home, over breakfast or in the evening, after returning from work, after dinner. She also typically deals with further emails, sends work-related texts and makes work-related calls on the train to and from Melbourne. In October 2019, Gillian is given the opportunity to provide eight weeks holiday cover for a senior manager at the firm’s Geelong office. Gillian opts to drive to and from Geelong, approximately a two-hour drive from her home. Under the terms of the holiday cover engagement, Gillian is required to make her own way to and from the Geelong office in her own time in order to attend the office during standard working hours (9 am to 5:30 pm). In recognition of the additional travel commitment, she is paid an allowance of $250 per week to cover the extra costs and inconvenience. In February 2020, Gillian is offered the role of temporary practice manager covering the firm’s five offices in northern Victoria for three months while the full-time owner of the role recovers from a serious operation. She is required to spend one day a week at each of the five offices in Wodonga, Echuca, Bendigo, Swan Hill and Mildura. She leaves Melbourne early on Monday morning, driving between the five offices on consecutive days, spending each night in a hotel before returning to Melbourne on Friday evening. In recognition of the amount of travelling involved, her working day includes travelling time and she is paid overtime for travel hours undertaken outside normal business hours. She is expected, where

possible, to deal with work-related matters such as emails and calls whilst travelling. Is Gillian able to claim deductions for any of the following travel costs? • Return train fares from Frankston to Melbourne incurred as part of her normal role • Motor vehicle expenses incurred in travelling between Frankston and Geelong as part of her first temporary assignment • Motor vehicle expenses incurred in travelling between home and the five northern Victorian offices as part of her second temporary assignment Solution Taxation Ruling TR 2019/D7 sets out the ATO’s view as to when deductions are allowed for employee’s travel expenses. Generally speaking, a transport expense is not deductible where the travel is to start work or depart after work is completed. Travel to start work is not required by the work activity but is preliminary to the work. In contrast, a transport expense is deductible where the travel is undertaken in performing the employee’s work activities. These principles apply to travel between: • home and a work location • a work location and another work location, and • another place (ie neither home nor a work location) and a work location. To determine whether travel is undertaken in performing an employee’s work activities, it is necessary to consider the following factors: • the travel occurs on work time • the travel occurs when the employee is under the direction of the employer • the travel fits within the duties of employment • the travel is relevant to the practical demands of carrying out the work duties, and • the employer asks for the travel to be undertaken. Applying these principles, Gillian cannot claim a tax deduction for the train fares from Frankston to Melbourne. This is normal home to work travel, even though she undertakes work at home in both the morning and evening and on the return train journey, and her salary is set to cover the expectation that she will do so. The trip between Frankston and Melbourne is a normal daily commute, reflecting her choice about where to live. In addition, she is not required to work from home or on the train; she chooses to do so. Gillian can claim a tax deduction for the motor vehicle expenses incurred driving to and from Geelong. According to TR 2019/D7, private travel to a regular place of work is not deductible but travel to a location other than a regular place of work (for instance, an alternative work location such as another office of their employer) is deductible. It is essential to deductibility in such cases that the travel fits within the duties of employment and is relevant to the practical demands of carrying out the work duties. In this case, Gillian is required by her employer to travel to Geelong and can only undertake her duties by being present in that office. The travel to Geelong is a necessary consequence of Gillian’s employment duties needing to be performed in more than one location. In other words, the distance or remoteness of the assignment causes the need for the travel to be part of that for which Gillian is employed. Note that according to the ATO’s previous ruling on this subject (TR 2017/D6, now superseded by TR 2019/D7), a deduction would not be available for this travel; see example 2 of that ruling. The allowance will be taxable as assessable income. Gillian can claim a tax deduction for the motor vehicle costs incurred in her second temporary

assignment, working from the five northern Victorian offices. Although the journeys at the start of the week from Frankston to Wodonga and at the end of the week from Swan Hill to Frankston are notionally at least home to work journeys, they are also journeys undertaken because of the special demands of her role. The journeys are included in the activities for which she is paid under the terms of her employment in the role and the travel is reasonable because of the practical demands of the role, including the remoteness of the work locations. She is also under the direction and control of her employer during those travel hours, with her working day on Monday commencing when she leaves Frankston and ending on Friday when she returns to Frankston. The other journeys between the offices, undertaken during the week, are not home to work travel. She has a requirement to move continuously between different work locations and a requirement, because of the practical demands of the job, to stay away from home during the week. Accordingly, all her motor vehicle costs incurred during the second temporary assignment are deductible. Gillian can either claim using the cents per kilometre method (68 cents per kilometre up to 5,000 km) or she can apply the log book method, provided she keeps a logbook and all supporting receipts. AMTG: ¶16-220, ¶16-230, ¶16-240

¶4-240 Worked example: Deductions for travel expenses Issue Max Conway is a management consultant. He is employed by Foresearch Associates and he also runs his own marketing consultancy business from his residential premises. Max is also undertaking an MBA degree part-time at the University of Australia. Max travels to Foresearch Associates, where he has an office, for consulting with clients three days each week. He also travels to university either from home or from his office at Foresearch Associates. Two days a week Max travels from his home to consult with clients on marketing research and sales issues. He would normally see up to five clients each day, either travelling from client to client or from home to client then home and then off to see the next client. For these visits Max has to transport his own audiovideo equipment for making presentations. Max uses his own vehicle for these journeys and he seeks advice on which journeys qualify for tax deductions. During 2019/20, Max was invited to be a guest lecturer at an international marketing and management conference held in Berlin. His wife accompanied him on the trip and he also took his research assistant with him. His research assistant did the research and analysis for the paper to be delivered by Max at the conference. She was also present during the question and answer session. Max would like to claim a tax deduction for the total cost of the trip, including airfares of $11,000, accommodation of $7,000, conference registration fees and dinner costs of $4,800 (which he attended along his wife and research assistant) local travel costs of $260, meal costs of $940 and sightseeing cost of $2,750. Solution Travel expenses Travel expenses are deductible under ITAA97 s 8-1 where the purpose of the travel has a nexus with the gaining or producing of assessable income or carrying on a business for that purpose. The Commissioner has stated in TR 2019/D7 that an employee’s travel expenses are deductible where the travel is undertaken in performing the employee’s work activities. The factors the Commissioner considers relevant to determine this are: • whether the travel occurs on work time • whether the travel occurs when the employee is under the direction of the employer • whether the travel fits within the duties of employment

• whether the travel is relevant to the practical demands of carrying out the work duties, and • whether the employer asks for the travel to be undertaken. Substantiation requirements apply to claims for travel expenses (ITAA97 Div 900) and apportionment is necessary where the travel is partly for business and partly for private purposes or where relatives accompany the taxpayer (ITAA97 s 26-30). The situations in which a claim for travel expenses might be made include: • travel between home and work (in very limited circumstances) • travel between two places of employment with the one business • travel between unrelated workplaces • travel between a number of different workplaces in the same job • travel to a client’s premises • travel to and from an educational institution, and • domestic and international travel. Claims for travel expenses are more complicated where journeys embody a number of the above situations. The cost of travel between home and work is generally not deductible. It is a cost incurred in travelling to work not on work (FC of T v Payne 2001 ATC 4027). However, there are exceptions to the rule where, for example, the taxpayer has to transport heavy or bulky equipment from home to work (FC of T v Vogt 75 ATC 4073 and Case U 29 87 ATC 229) or the taxpayer is an itinerant worker whose home is a base and the worker visits a number of workplaces on a given day (FC of T v Wiener 78 ATC 4006). In some circumstances where a worker is on call 24/7 it has been held that they have two workplaces, that is their home and their place of employment and a deduction for travel expenses from home to work has been allowed (FC of T v Collings 76 ATC 4254). However, if the worker does not commence incomeproducing activities until arrival at the workplace, a deduction for travel costs from home to workplace will be denied (FC of T v Pitcher 2005 ATC 4813). The costs of travel between two places of employment as part of the same job are deductible on the basis that the travel is undertaken in performing an employee’s work activities (Taxation Ruling TR 2019/D7). So are the costs of travel between one place of business and another for the purposes of the one business. Also deductible are the costs of travelling between two unrelated workplaces. Travel between workplaces occurs where a taxpayer travels directly between two places where income-producing activities are carried on and neither place is the taxpayer’s residence (ITAA97 s 25-100 and see FC of T v Payne 2001 ATC 4027). The cost of a journey from an employee’s home to a client’s premises and then on to the office, or a journey from the office to see a client and then travelling home, rather than back to the office, is deductible (Miscellaneous Taxation Ruling MT 2027). It is not uncommon for an employee or persons in business to travel from home or their workplace to an educational institution and then either to their workplace or home. In these situations the following journey costs are deductible:

(Taxation Ruling TR 95/8) Apportionment of travel costs applies where another person accompanies the taxpayer or where the travel is partly for pleasure or private purposes. In the case of another person accompanying the taxpayer, the Commissioner normally applies a 50/50 apportionment. Where travel is for both business and pleasure, if the private purpose is only incidental, the expenses will be fully deductible under s 8-1. However, if the income-producing activities are merely incidental, then only those expenses directly related to income-producing activities will be deductible. Where both purposes are equal 50/50 apportionment is acceptable. Travel expenses for an accompanying relative are not deductible (ITAA97 s 26-30(1)) unless the relative performs substantial duties on the trip and it is reasonable to conclude that the relative would still have gone on the trip even in the absence of the personal relationship with the taxpayer (s 26-30(2)). Substantiation requirements apply to claims for both domestic and overseas travel expenses including obtaining written evidence and maintaining travel records in accordance with ITAA97 Div 900: • Subdiv 900-D — substantiating business travel expenses • Subdiv 900-E — written evidence, and • Subdiv 900-F — travel records. Tax deductibility for work and education journeys Travel by Max from home to work at Foresearch Associates and returning home is not deductible. Journeys by Max to the University from either home or Foresearch Associates and back home or to work, respectively, are deductible. However, if Max travelled from home or work to University and then on to work or home respectively, the journeys would not be deductible (Taxation Ruling TR 95/8). The various journeys taken by Max in relation to his marketing consulting business will generally be deductible. His home can be considered as his “base of operations” and he may qualify as an “itinerant worker”. So the trips from home to visit a number of clients and back home would be deductible (FC of T v Wiener 78 ATC 4006). In addition, the fact that Max has to transport heavy, bulky and fragile equipment allows him to claim a deduction for travel costs in visiting clients — see FC of T v Vogt 75 ATC 4073 and Case U 29 87 ATC 229. The journeys from one client to another are also deductible as Max is travelling on work not to work (FC of T v Payne 2001 ATC 4027). Max’s situation can be distinguished from Payne in that Max’s residential premises are his base of operations (s 25-100). Deductibility of overseas travel costs Max’s overseas travel costs are deductible as they satisfy the requirements of s 8-1. However, apportionment of the expenses is required because his wife and research assistant accompanied him on the trip and because some of the expenses were of a private nature. Max would also need to be able to produce written evidence of the expenses and keep a travel diary in order to satisfy the substantiation provisions. The airfares for Max and his research assistant would be deductible but not the cost of his wife’s airfare. The cost of conference registration and conference dinners would be deductible for Max and his research assistant provided the dinners were regarded as work-related activities. Otherwise they may be treated as non-deductible entertainment expenses (ITAA97 s 32-5). In any case the wife’s dinner expenses would not be deductible. The cost of accommodation, for Max and his wife, would need to be apportioned, either on a marginal cost basis or 50/50% split (Case R2 84 ATC 106 and Case V39 88 ATC 335). The accommodation cost for the research assistant would be deductible. The cost of local travel relevant to the conference such as, travel to and from the conference venue, would be deductible on the basis shown in the travel diary. The cost of meals for Max and his research assistant in relation to the conference would be deductible. The expenditure on sightseeing would not be deductible but rather would be treated as non-deductible entertainment expense (s 32-5).

AMTG: ¶16-220, ¶16-230, ¶16-240, ¶16-260, ¶16-270, ¶16-280, ¶16-290, ¶16-300

¶4-260 Worked example: Work-related meal expenses and the substantiation exception Issue Patrick Healey is employed by a human resources company, Human Capital Pty Ltd. His duties require him to travel to see various clients in the major capital cities throughout Australia. His trips normally last at least three days and he is required to stay overnight. To cover his travelling cost, his employer provides him with a daily meal allowance of $140 to cover meals consumed each day (ie breakfast, lunch and dinner). All accommodation costs in relation to Patrick’s travel are either reimbursed or paid for by Human Capital Pty Ltd. During the 2019/20 year, the total for Patrick’s daily meal allowance is $14,000 (ie $140 per day for 100 days where he consumes breakfast, lunch and dinner). Human Capital Pty Ltd discloses the allowance paid on his PAYG income statement for 2019/20. Patrick’s income statement also shows that his gross salary for the year was $150,000. Patrick has not maintained all his receipts in respect of his meal expenditure while travelling. The total value of receipts only amounts to $5,500. However, Patrick has maintained a travel diary of the appointments and locations that he has travelled to during the 2019/20 income year. Advise Patrick on whether the cost of meals is deductible to him and the total amount which he can claim in his tax return in relation to this meal expenses for 2019/20. Solution Travel expenses which are incidental and relevant to a taxpayer’s derivation of assessable income, including salary and wages, are generally deductible under ITAA97 s 8-1. Travel expenses not only cover transport costs (such as taxis or airfares) but also include the cost of meals, accommodation and travel between the accommodation and the place (or places) of business visited while away. Therefore, it is relatively clear that the travel costs incurred by Patrick while he is travelling to visit clients (including any overnight meals and accommodation) would be deductible under s 8-1. There is a nexus between the travel costs incurred and the derivation of Patrick’s salary and wage income. In order to claim a deduction, special substantiation rules apply to expenses which relate to overseas and domestic travel (ITAA97 Div 900). It would be necessary for written evidence of the expenditure to be kept and travel records (such as a travel diary) to be maintained. Ordinarily, Patrick can only claim a deduction for his meal expenditure to the extent that he has maintained the relevant receipts and travel diary. In this case, his poor record keeping means, prima facie, he can only claim $5,500 in his 2019/20 tax return. However, a substantiation exception is available where the taxpayer receives a travel allowance relating to work-related travel in Australia. Specifically, if the Commissioner considers that the amount of travel expenses claimed for travel covered by the allowance are reasonable, then the relevant expenses may be deductible without written evidence or a diary (ITAA97 s 900-50). Domestic travel allowance claims are considered reasonable if they do not exceed certain daily rates set out by the Commissioner (see Taxation Ruling TR 2004/6 on the substantiation exception and Taxation Determination TD 2019/11 for rates for the 2019/20 year). According to TD 2019/11, the reasonable amount for an employee (who is on a salary between $124,481 to $221,550) for daily food and drink consumed while travelling to Australia’s major capital cities is $134.60. The meal allowance of $140 per day paid to Patrick by Human Capital Pty Ltd exceeds the reasonable amount. Taxation Ruling TR 2004/6 states that where the allowance paid by the employer is greater than the reasonable amount the taxpayer may still use the exception from substantiation if the claim for deduction is not greater than the reasonable amount. In such cases, the allowance must be shown as assessable

income and written evidence is not required to support the claim — however, Patrick can only claim the amounts he actually spent and therefore must be able to verify his costs (eg by reference to diary entries, bank records and receipts that he kept for some of the trips). Patrick can only verify costs amounting to $5,500, for which receipts exist. He cannot verify his other expenditure. Although he is not required to produce detailed substantiation, such as receipts, he must at the least be able to show how much he spent. The travel diaries may not be sufficient for this purpose unless he wrote down the amount spent on each meal within the diary. He is therefore entitled to claim a deduction of only $5,500 since he is unable to prove the amounts he spent for which receipts have not been kept. He cannot claim the Commissioner’s reasonable amount (ie $134.60 × 100 days) since he cannot verify that he actually spent $134.60 per day and he can claim only the amount he did actually spend. He also cannot claim the entire allowance of $14,000 unless he can fully substantiate his expenses with written evidence (ie receipts). Patrick would also be required to include the travel allowance of $14,000 as assessable income in his 2019/20 tax return. However, he can only claim a deduction for work-related travel up to the provable amount of $5,500. If he had noted in his travel diary the costs incurred on other meals for which receipts were not kept, he would be able to claim those costs also to the extent that the total amount spent did not exceed the Commissioner’s reasonable amount of $134.60 per day. While written evidence is not required, the Commissioner does note in TR 2004/6 that a taxpayer may still be required to show the basis for determining the amount of their claim and that the expense was actually incurred for work-related purposes. AMTG: ¶16-210, ¶16-240, ¶16-300

¶4-280 Worked example: Deductions for employer and individual’s superannuation contributions Issue Dr Su, aged 62 years, is a specialist medical practitioner conducting a private practice in which he employs a receptionist. Dr Su is also an adjunct professor at the Royal Prince Charles (RPC) teaching hospital. Dr Su’s receptionist is Carol. She is 45 years of age and is paid $60,000 per annum. Dr Su contributes the mandatory 9.5% superannuation guarantee to the Health Employees (complying) Superannuation Fund (HESF). Carol also enters into a salary sacrifice arrangement contributing $14,300 from her salary into her superannuation fund. As adjunct professor, Dr Su trains medical students at the RPC for which he is paid $50,000 per annum, as a salary package with a salary of $30,000 and grossed-up fringe benefits amounting to $20,000. The hospital also makes the 9.5% superannuation guarantee to Dr Su’s complying SMSF. Dr Su’s patient fees income for 2019/20 totalled $300,000 out of which Dr Su made a concessional contribution to his SMSF of $25,000. Dr Su claimed a deduction for the $25,000 contribution. During the year Dr Su made a capital gain of $15,000 from the sale of shares in Medibank Private, which he had held for six months. Dr Su seeks your advice as to whether: 1. He can claim a tax deduction for the contributions made on behalf of Carol to the HESF. 2. He can claim a tax deduction for his $25,000 contribution to his SMSF. Solution The deductibility of superannuation contributions by an employer on behalf of employees or by individuals making personal contributions is governed by ITAA97 Subdiv 290-B and Subdiv 290-C, respectively. The general deduction provision, ITAA97 s 8-1, has no role to play. The Commissioner’s views on the deductibility of superannuation contributions is set out in Taxation Ruling TR 2010/1. Section 290-60 allows an employer a deduction for a contribution made for the purpose of providing superannuation benefits for another person who is an employee of the employer. There is no limit to the

amount that an employer can contribute. However, amounts in excess of the employee’s concessional contribution cap have additional tax consequences for the employee. The requirements in s 290-60 that need to be satisfied for the employer to claim a deduction are: • The contribution must be made to a complying superannuation fund. • The contribution must be made for the purpose of providing superannuation benefits (Raymor Contractors Pty Ltd v FC of T 91 ATC 4259). • The contribution is made for another person who is an employee of the employer. That is, the employee and the taxpayer claiming the deduction must be different people (Harris v FC of T 2002 ATC 4659). • The contribution is made for an employee whose age is within the prescribed limits. If an employee enters into an effective salary sacrifice arrangement with their employer, the superannuation contributions for the employee are treated as employer contributions and are deductible to the employer. Under s 290-150, personal concessional contributions to superannuation are deductible provided the requirements in s 290-155 to 290-170 are met, namely: • The contribution is made to a complying superannuation fund. • The contribution must be made not later than 28 days after the end of the month in which the contributor turns 75 years (s 290-165(1)). • The contributor must notify the fund of the intention to claim a deduction for the contribution (s 290170(1)). • The contribution is not an amount previously released under the First Home Super Saver (FHSS) scheme (s 290-168). • The contribution is not a downsizer contribution (s 290-169). Tax deduction for contributions on behalf of Carol to the HESF Carol has a concessional contributions cap of $25,000 for the 2019/20 year. Her employer, Dr Su, has made the mandatory superannuation guarantee 9.5% contribution to Carol’s complying superannuation fund of $5,700 ($60,000 × 9.5%). Carol has entered into an effective salary sacrifice arrangement with her employer contributing a further $14,300 on Carol’s behalf. Her employer is entitled to claim a tax deduction for both the superannuation guarantee and salary sacrifice contribution amounts. Tax deduction for $25,000 contribution to Dr Su’s SMSF As an adjunct professor at the RPC, Dr Su is an employee with a salary package of $50,000 comprising salary of $30,000 and grossed-up fringe benefits of $20,000. The hospital, as his employer, is required to make superannuation guarantee contributions on behalf of Dr Su based on his salary of $30,000 amounting to $2,850 to his complying SMSF. Dr Su has patient fee income of $300,000 which is derived from being self-employed in private practice. Dr Su made a concessional contribution to his complying SMSF of $25,000. Assuming Dr Su has given the trustee of his SMSF notice of his intention to claim a tax deduction for his $25,000 concessional contribution, he is entitled to claim a tax deduction for his $25,000 concessional contribution to his complying SMSF. An individual’s concessional contributions to a superannuation fund are subject to a concessional contributions cap of $25,000 in 2018/19. Combining his own contribution to his SMSF of $25,000 with the $2,850 paid by RPC, this cap has been breached in the 2018/19 year. Breaching this cap generally results in additional tax payable for the individual, but this does not, by itself, affect the deductibility of the contributions under s 290-150.

AMTG: ¶13-700, ¶13-705, ¶13-710, ¶13-730, ¶16-575

¶4-300 Worked example: Prepaid expenditures; non-deductible non-cash business benefits Issue Brian Benton is in the business of manufacturing and selling wine. On 2 December 2018, Brian contracted with Veritas Wines Pty Ltd (Veritas), a wine production company, to manage the production of wine on Brian’s vineyard. The services of Veritas would be supplied from 1 January 2019 for a period ending on 15 May 2020. Brian paid Veritas $200,000 in advance on 12 December 2018, in accordance with the contract. Brian does not expect to derive any income from the wine produced from the grapes until 2021. On 14 July 2019, Brian purchased plant and equipment, from Australian Manufacturing Industries Pty Ltd, for processing the grapes, storing and bottling wine and ultimate sale of wine, at a cost of $190,000. As part of this arrangement, Brian’s sister Anne was to be given a sports car costing $45,000. Brian is not a small business entity as defined in ITAA97 s 328-110. Advise Brian on the following: 1. The deductibility of the $200,000 paid under the supply contract. 2. The deductibility of the $190,000 paid for the purchase of plant and equipment. Solution Deductibility of prepaid expenditure Where expenditure qualifies for a deduction under ITAA97 s 8-1, the deduction is generally allowable in full in the year the expenditure is incurred (Taxation Ruling TR 94/25). However, special rules apply to affect the timing of deductions for certain prepaid expenditures (under ITAA36 Pt III, Div 3, Subdiv H). Where expenditure is for services that are not to be wholly provided within the income year in which the expenditure is incurred, an apportionment of the deduction is required (ITAA36 s 82KZMA). In Brian’s case, the expenditure incurred in the 2018/19 income year is for services provided by Veritas during both the 2018/19 and 2019/20 income years. Therefore, apportionment of the deduction is required over the income years covered by the “eligible service period” (ITAA36 s 82KZL). The eligible service period under an agreement begins on the first day on which the thing under the agreement commences to be done or on the day the expenditure is incurred, if that is a later day. It continues until the end of the last day the thing under the agreement ceases to be done. The eligible service period is however always limited to 10 years. In Brian’s case, the eligible service period is 1 January 2019 to 15 May 2020. Apportionment of the deduction is required according to the formula in s 82KZMD: Expenditure

×

Number of days of eligible service period in the year of income  Total number of days of eligible service period 

Deduction for income year 2018/19: $200,000 × 182 / 501 = $72,655 Deduction for income year 2019/20: $200,000 × 319 / 501 = $127,345 Brian can claim a deduction for the entire $200,000 expenditure, but the deduction is apportioned over the two income tax years. Deductibility of expenditure which includes non-cash business benefits Brian would be entitled to deduct the depreciation on the plant and equipment purchased. However, a deduction allowable to a business taxpayer may be reduced where non-cash business benefits are provided to induce the taxpayer to purchase the plant or equipment (ITAA36 s 51AK(1)). A “non-cash business benefit” is property or services provided wholly or partly in connection with a business relationship (ITAA36 s 21A(5) and s 51AK(4)). If the non-cash business benefit is for private use and not for the purpose of deriving assessable income, then, the taxpayer will be treated as having paid the full

arm’s length price for the benefit and the cost of the main item is reduced accordingly. In other words, the value of the benefit is deducted from the expenditure incurred on plant and equipment for the purpose of calculating depreciation on the plant and equipment. The sports car given to Anne would be regarded as a non-cash business benefit. Therefore, for depreciation purposes, its value of $45,000 is deducted from the $190,000 expended by Brian in purchasing the plant and equipment because the sports car was not associated with gaining or producing assessable income or carrying on the business for that purpose. It was of a purely personal or private nature and not deductible under ITAA97 s 8-1(2)(b). Had the car been for use in the business it could have been claimed as a separate asset of the business. The cost for calculating the annual depreciation of the wine-making plant and equipment will be $190,000 − $45,000 = $145,000. AMTG: ¶16-045, ¶16-157

¶4-320 Worked example: Business-related capital expenditure; preservation of value of goodwill Issue Fernando Torres and Louise Baker carried on a business together in partnership in Mosman, NSW. The partnership — Pets R Us — provided dog washing services. Fernando decided to leave the partnership and start his own dog washing business as a sole trader. In May 2020, Louise paid Fernando $50,000 to secure agreement not to operate a similar business within a 10 km radius of Mosman. The payment was to preserve the goodwill of Pets R Us. How should Louise treat the payment of $50,000 to Fernando for income tax purposes? Solution An agreement where there is restraint of trade is commonly referred to as a “restrictive covenant”. The general deduction provision in ITAA97 s 8-1 allows a deduction for a loss or outgoing to the extent that it is incurred in gaining or producing the taxpayer’s assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing the taxpayer’s assessable income. However, a deduction is not permitted under s 8-1 to the extent that the loss or outgoing is capital or of a capital nature. In Sun Newspapers Ltd v FC of T (1938) 61 CLR 337, the High Court held that a payment made by the taxpayer for an interest in a competing newspaper and for the competitor not to be associated for a period of three years with the publication of any other newspaper in the region was capital in nature. It would be reasonable to conclude in this case that the payment by Louise is capital or capital in nature as it was in relation to the restrictive covenant to protect the profit-yielding structure of Pets R Us, that is the goodwill. As the payment is on capital account, it would typically form part of the cost base of the CGT asset to which it relates, in this case, the goodwill of the business. However, as the expenditure is to preserve the goodwill of Pets R Us, it does not form part of the cost base of the goodwill of the business due to a specific exclusion in ITAA97 s 110-25(5A). There is nothing to prevent the amount from forming part of cost base of another CGT asset. Arguably, the expenditure incurred by Louise could instead relate to the acquisition of a right to enforce restrictions on Fernando from operating a similar business in Mosman NSW. As such, it could be argued that the expenditure relates to the first element of cost base — being the money paid in respect of acquiring the right (s 110-25(2)). Notwithstanding this, there is scope for the expenditure incurred by Louise to be business-related capital expenditure, which can be claimed over five years (provided that the deduction is not denied by some other provision) under ITAA97 s 40-880. An amount is not deductible under s 40-880 if, among other things, apart from s 40-880, it could be taken

into account in working out the amount of a capital gain or capital loss from a CGT event (s 40-880(5)(f)). As noted, the expenditure incurred would form part of the first element of the cost base in working out a capital gain or loss from a CGT event happening to the right. While there does not appear to be a deduction available, there is an exception under s 40-880(6) which provides that s 40-880(5)(f) does not apply to expenditure the taxpayer incurs to preserve (but not enhance) the value of goodwill if the expenditure incurred is in relation to a legal or equitable right and the value to the taxpayer of the right is solely attributable to the effect that the right has on goodwill. Section 40-880(6) ensures that expenditure in relation to a right which has no value of itself and does not increase the value of goodwill from what it was before the expenditure took effect is not excluded from a deduction under s 40-880 (see Taxation Ruling TR 2011/6). Example 40 in TR 2011/6 is similar to the situation encountered by Louise. It would be reasonable to conclude that the expenditure in this case relates to a right which provides a restraint on trade and merely prevents the goodwill of Pets R Us from being damaged. In itself it does not carry with it any value except to preserve the value of goodwill. On this basis, Louise is entitled to deduct the $50,000 business-related capital expenditure equally over five income years at $10,000 each year, beginning from the 2019/20 income year. AMTG: ¶11-550, ¶16-010, ¶16-156

¶4-340 Worked example: Capital expenditure for proposed business Issue After Jonah Salinger had been employed as a mathematics teacher in Queensland for 20 years, he decided to set up a coaching college business in Sydney. When he arrived in Sydney, he spent some time getting his personal affairs in order, and then set to work organising the coaching college business. Jonah engaged experts to advise him on what kind of college was needed, where it should be located, what staff should be hired and what regulations had to be complied with. After six months, Jonah’s expenditure on the venture amounted to nearly $60,000, but he was then forced to abandon the project when he was diagnosed with a severe illness. Is Jonah entitled to a tax deduction for the expenditure he incurred? If a tax deduction is not available, can the expenditure be taken into account in any other way? Solution It is necessary to decide if Jonah’s expenditure on the proposed business was a capital or revenue outgoing, because this will be critical in determining its tax treatment. The guidelines for distinguishing between capital and revenue outgoings were laid down in Sun Newspapers v FC of T (1938) 61 CLR 337. It was pointed out in that case that expenditure in establishing, replacing and enlarging a profit-yielding (ie business) structure is capital, whereas working or operating expenses relating to the business are revenue. Applying the capital/revenue test set out by Dixon J in Sun Newspapers, Jonah’s expenditure would be classified as capital because it was directed at establishing his business, rather than being day-to-day outgoings in the running of a business. The expenditure would therefore not be deductible under s 8-1 pursuant to s 8-1(2)(a). Treatment of capital expenditure under the tax law A taxpayer who has incurred capital expenditure relating to a business may determine the tax treatment of the expenditure according to the following steps: 1. Can the expenditure be included in the cost of a depreciating asset for the purposes of the capital allowance provisions in ITAA97 Div 40? The answer is no in this case as there is no relevant depreciating asset. 2. Can the expenditure be included in construction expenditure for the purposes of the capital works provisions in ITAA97 Div 43? The answer is no in this case as there is no relevant construction

expenditure. 3. Is there any other specific deduction provision that applies? The answer is no in this case. 4. Can the expenditure be included in the cost base of a CGT asset for the purposes of calculating the capital gain or capital loss when the CGT asset is disposed of (ITAA97 Pt 3-1 and 3-3)? The answer is no in this case as there is no relevant CGT asset. 5. Can the expenditure be deducted under ITAA97 s 40-880 which allows an immediate deduction for certain business capital expenditure incurred on start-up expenses for a small business that would not be deductible or taken into account in any other way under the tax law? The answer may be yes. Immediate deduction for business start-up expenditure Under s 40-880, taxpayers can immediately deduct capital expenditure relating to a proposed business. Such expenditure is sometimes called “blackhole expenditure” because, in the absence of a specific deduction provision, it would generally be non-deductible despite being a genuine business expense. The section only applies if the expenditure would not already be deductible (or specifically made nondeductible), capitalised or capped in some way under another provision. Expenditure may be deductible under s 40-880 to the extent that it is incurred for a taxable purpose, and could include pre-business expenditure on feasibility studies, market research or establishing a business structure. To qualify, the capital expenditure must relate to a proposed business. It needs to be incurred in obtaining advice or services for the proposed structure or operation of the business. Alternatively, it must be a fee, tax or charge paid to an Australian Government agency relating to the set up or operating structure of the business. In addition, the taxpayer must be a small business entity for the income year the expense was incurred. Alternatively, for the year the expense was incurred, the taxpayer must neither: (i) carry on a business; nor (ii) be connected or affiliated with a non-small business entity that carries on a business. Because Jonah’s expenditure related to a business that he proposed to carry on, he would need to demonstrate that, when the expenditure was incurred: (i) he demonstrated a commitment of some substance to commence to carry on the business, (ii) there was sufficient identity about the business proposed to be carried on, and (iii) it was reasonable to conclude the business was proposed to be carried on within a reasonable time (ATO Interpretative Decision ID 2009/42). Provided the requirements of s 40-880 are satisfied, Jonah would be entitled to immediately deduct the $60,000 in the year it is incurred. AMTG: ¶16-156

¶4-360 Worked example: Capital works; demolition; environmental protection activities Issue Bob McKnight owns a rental property that includes a garden shed. The property is currently tenanted. A recent inspection of the property by a builder friend of Bob’s coincidentally found that the shed at the rear of the property was constructed of asbestos. To prevent any pollution of the property and eliminate the risk of his tenants being exposed to potentially harmful asbestos fibres, Bob engaged a licensed asbestos removalist to demolish the shed and safely remove the asbestos from the property. The demolition and removal cost was $8,000. What deductions (if any) could Bob claim in respect of the demolition of the shed and the safe removal of the asbestos? Note that just before demolition, the shed had an undeducted construction expenditure amount of $17,000. Solution

The general deduction provisions contained in ITAA97 s 8-1, in broad terms, allow a taxpayer to claim a deduction in relation to an outgoing incurred to the extent that it relates to the taxpayer producing their assessable income. A deduction is denied however if the expenditure incurred is capital or capital in nature. The costs incurred by Bob in respect of the demolition of the shed and removal of the asbestos is of a capital nature. The expenditure secured a lasting benefit for the profit-yielding subject, that is the property (Sun Newspapers Ltd v FC of T (1938) 61 CLR 337; FC of T v The Broken Hill Proprietary Company Ltd 69 ATC 4028). Therefore, a deduction would not be available under s 8-1. Deduction for demolition of capital works ITAA97 s 43-10 provides a deduction for “construction expenditure” incurred for the construction of certain assessable income-producing capital works. However, expenditure on demolishing an existing structure does not contribute to a capital works deduction because such works are specifically excluded from the meaning of “construction expenditure” (s 43-70). Therefore, the $8,000 incurred with respect to the demolition and asbestos removal does not form part of the “construction expenditure” and is not eligible for a deduction under s 43-10. As an aside, ITAA97 s 43-40 allows a taxpayer to deduct an amount, in the income year in which capital works are destroyed, for the remaining construction expenditure incurred on the capital works that has not yet been deducted, subject to certain conditions being satisfied. Broadly, the amount of the deduction for the remaining construction expenditure is calculated by reducing amounts received by the taxpayer for: • the destruction of the capital works such as insurance proceeds (ITAA97 s 43-255(a)), and • disposing of the capital works less any demolition expenditure incurred on the capital works (s 43255(b)). In the present case, the remaining construction expenditure of the shed is $17,000 for ITAA97 Div 43 purposes. Bob did not receive any amount for the demolition of the shed. Therefore, the demolition expenditure incurred, that is $8,000 cannot be taken into account under item s 43-255(b) to reduce the proceeds from disposal of the capital works. Neither can the expenditure be used to offset any amount such as insurance proceeds received for the destruction of the capital works under s 43-255(a). As a result, the amount of the deduction for the remaining construction expenditure due to the demolition is $17,000. Specific deduction for repairs under ITAA97 s 25-10 Section 25-10 generally allows a deduction for the costs of repairs to plant or premises held or used for the production of assessable income. The demolition of the shed however, does not qualify as a repair for the purposes of s 25-10 as the work does not remedy or make good defects in, or damage to, or deterioration (in a mechanical or physical sense) of the rental property (Taxation Ruling TR 97/23). A repair also contemplates the continued existence of the property. Further, in this case, the expenditure is capital in nature; capital expenditure is not deductible under s 25-10 (s 25-10(3)). Deduction for environmental protection activities Bob should also consider ITAA97 s 40-755 (contained in ITAA97 Subdiv 40-I) which allows a deduction for expenditure incurred by a taxpayer for the sole or dominant purpose of carrying on “environmental protection activities”. A deduction is not allowed under s 40-755 to the extent the expenditure can be deducted under another provision outside Subdiv 40-I. One class of environmental protection activity relates to preventing pollution of or from the site of the taxpayer’s earning activity (s 40-755(2)(a)(ii)). An “earning activity” ’, among other things, includes an activity that the taxpayer carries on for the purpose of producing assessable income (except a net capital gain) (s 40-755(3)). The site of the taxpayer’s earning activity includes leasing a site that the taxpayer owns (s 40-755(4)). The expenditure incurred by Bob in demolishing and removing the shed was for the sole or dominant

purpose of carrying on environmental protection activities, that is to prevent pollution of the property. Further, no amount can be deducted for the expenditure under another provision outside Subdiv 40-I. Therefore, under s 40-755 Bob can claim an immediate deduction for the $8,000 expenditure incurred with respect to the demolition of the shed and removal of the asbestos. AMTG: ¶16-700, ¶19-110, ¶20-470, ¶20-480, ¶20-530

¶4-380 Worked example: Club fees; boating; leisure facilities and activities Issue The Southern Ocean Yacht Club Pty Ltd (SOYC) owns and operates club premises which provides food, drink, entertainment and car parking for members and guests. The club is managed by Mitch Walker, who receives an annual salary package comprised of; salary and superannuation guarantee — $52,000, salary sacrifice into superannuation, Club membership — $3,000 and personal use of the yacht Lady Jane when it is not on commercial hire. The SOYC operating profit for the 2019/20 income year was $125,000 from a turnover of $340,000 with losses and outgoings amounting to $215,000. SOYC premises also embodies a marina for the berthing of yachts and other boats owned by club members. Berths are leased for an annual fee of $5,000. Two of the berths are occupied by yachts owned by SOYC, the Fair Winds and Lady Jane which are regarded as “boat” entities separate from SOYC. Income from the lease of marina berths, for the 2019/20 income year amounted to $26,000 and the losses and outgoings for maintenance, repairs and depreciation totalled $34,000. The Fair Winds is leased long term to charter operator — Scenic Cruises Pty Ltd (SC). SC is responsible for the day-to-day operating expenses as well as promotional activities. Repairs and depreciation of the yacht are the responsibility of SOYC. The annual lease premium is $50,000. Repairs and depreciation incurred by SOYC, for the 2019/20 year amounted to $70,000. The Lady Jane was let on short term hire during the 2019/20 income year, generating hire fees of $33,000. Mitch Walker and other members of the club and guests made use of the yacht on various occasions over the course of the year. Losses and outgoings incurred by SOYC in relation to the Lady Jane for 2019/20 totalled $48,000. Are the losses and outgoings incurred by SOYC’s club, marina and boating activities deductible? Solution The general deduction provision in ITAA97 s 8-1(1) allows a deduction against assessable income for losses or outgoings incurred in gaining or producing assessable income or carrying on a business for the purpose of gaining or producing assessable income. However, s 8-1(2)(d) states that the taxpayer cannot deduct a loss or outgoing to the extent that a provision in the Act prevents the taxpayer from claiming a deduction. ITAA97 Div 26 is one such set of provisions. It sets out amounts a taxpayer cannot deduct or cannot deduct in full (ie apportionment may be required). In particular, s 26-45 denies a deduction for recreational club expenses; s 26-47 denies a deduction for non-business boating expenses; and s 26-50 denies a deduction for expenses in relation to a leisure facility. However, there are exceptions where the expenditure is incurred in providing a fringe benefit or if the taxpayer is carrying on a business. Deductibility of Mitch Walker’s salary package The salary paid to Mitch Walker and superannuation guarantee contribution are deductible under s 8-1(1) and ITAA97 s 290-60, respectively. Generally, a taxpayer cannot deduct a loss or outgoing to the extent that it is incurred to obtain or maintain a membership of a recreational club or rights to enjoy facilities provided by a recreational club (otherwise than as a member) for the use or benefit of its members (ITAA97 s 26-45(1)). However, the provision of Club membership and personal use of the yacht Lady Jane when it is not on commercial hire are both fringe benefits (the former an expense payment fringe benefit and the latter a property fringe benefit). SOYC would be liable for fringe benefits tax but would be entitled to a tax deduction for the value

of the benefits. The Club membership of $3,000 is therefore deductible (ITAA97 s 26-45(3)). Deductibility of club-operating and marina activity expenses Generally, a taxpayer cannot deduct a loss or outgoing to the extent that it is incurred to use, operate, maintain or repair a leisure facility or in relation to any obligation associated with ownership of a leisure facility (ITAA97 s 26-50(1)). A leisure facility is defined as land, a building, or part of a building or other structure that is used (or held for use) for holidays or recreation (s 26-50(2)). Recreation includes amusement, sport or similar leisure-time pursuits (ITAA97 s 995-1(1)). A leisure facility includes a boat (Athineos v FC of T 2006 ATC 2334). However, the deduction is permitted where employed in the ordinary course of the taxpayer’s business of providing leisure facilities for payment (s 26-50(3)(b)(i)); or in the receipt of rents or lease premiums (s 2650(3)(b)(ii)); or if the expenditure is incurred in providing a fringe benefit (s 26-50(8)). For SOYC, the issue is therefore whether a business is being carried on such that the above exception applies in relation to a leisure facility (s 26-50). There are well established indicia for assessing whether a business is being carried on, such as, the commercial character of the activities and the prospect of making a profit (Taxation Rulings TR 97/11; TR 2003/4 and TR 2003/4A). On the basis that SOYC satisfies the profit criteria for carrying on a business, its losses and outgoings are deductible under the exception to expenses in owning and operating a leisure facility (s 26-50(3)(b)(i)). If the marina was an entity separate from the SOYC, then its losses and outgoings exceed its revenue for 2019/20 by $8,000. However, there is an intention to make a profit and the prospect of doing so in the future, and given that it is a commercial operation, the losses and outgoings would be deductible under the exception to expenses in owning and operating a leisure facility (s 26-50(3)(b)(i)). The loss may be carried forward and offset against income in future years (ITAA97 s 36-15). Deductibility of boating activities The object of ITAA97 s 26-47 is to prevent deductions from boating activities that are not carried on as a business being offset against other assessable income (ie a form of negative gearing). ITAA97 Div 35 — Deferral of losses from non-commercial business activities may also be relevant. Accordingly, s 26-47(2) allows a deduction for losses or outgoings in relation to using or holding boats up to the income for the income year derived from boating activities. The amount of any loss and outgoing in the income year in relation to using or holding boats in excess of income derived from those boating activities is quarantined and may be offset against income from the boating activities in future years. Exceptions to this rule apply to permit the deductions from boating activities where the boat is used or held for letting or hire in the ordinary course of a business carried on by the taxpayer (s 26-47(3)) or where it is incurred in providing a fringe benefit (s 26-47(4)). For SOYC, each yacht needs to be considered separately in determining whether s 26-47(2) or s 26-47(3) applies (see Athineos). If for each yacht, it is established that a business is being carried on, the losses and outgoings are deductible. If not, then the loss is quarantined and carried forward to offset against income from the “boat” activity in future years (Taxation Rulings TR 2003/4 and TR 2003/4A). If the Fair Winds is treated as a “boat” entity separate from SOYC, given that it is leased to a charter boat operator and the “boat” entity merely receives annual lease premiums, then the entity is in receipt of income from property and is not carrying on a business. Hence, it would not be entitled to a deduction for its loss of $20,000 in excess of its annual income. Rather, the loss would need to be carried forward to offset against future income, unless, there was a degree of control over the yacht by the “boat” entity during the course of the year sufficient to satisfy the indicia for carrying on a business (TR 2003/4 and TR 2003/4A). The situation for Lady Jane is different. There is a direct contractual dealing between the “boat” entity and the hirer of the yacht. The activities throughout the year have the hallmark of carrying on a business. The $15,000 loss would not need to be quarantined but could be claimed under the non-deductibility exception provision in s 26-47(3)(b). However, because the yacht is used by Mitch Walker, other members of the club and guests on various occasions over the course of the year, the losses and outgoings would need to be apportioned between business and private use (s 8-1(1) deductions for losses or outgoings in gaining assessable income are deductible “to the extent that” they are incurred in carrying on a business

for the purpose of gaining or producing your assessable income). Deductions for losses or outgoings in relation to boating activities were denied in Athineos v FC of T 2006 ATC 2334; Ell & Anor v FC of T 2006 ATC 4098 and Phippen & Anor v FC of T 2005 ATC 2336 on the grounds that either a business was not being carried on and/or there was no prospect of making a profit. AMTG: ¶10-105, ¶10-110, ¶16-410, ¶16-420

¶4-400 Worked example: Deductions; partnership and service trust Issue Adrienne and Bonny Riley own and manage a sports clothing and accessories retail store, in partnership (the Partnership). Charlotte Powers is employed as a sales assistant. Adrienne and Bonny established the Adrienne and Bonny service trust (the Service Trust) to supply the furniture and fittings for the sports store and to provide accounting, finance and IT services to the business. Adrienne and Bonny were the trustees and beneficiaries of the Service Trust. During the 2019/20 income year, the following transactions and activities took place: • equal share of profits distributed to the partners Adrienne and Bonny — $40,000 • salary paid to Charlotte — $25,000 • superannuation guarantee, at 9.5% paid to Charlotte’s nominated complying superannuation fund — $2,375 • annual royalty paid to a high-profile American footwear manufacturer to use its trademark in their promotion brochures — $5,000 • payment to the Service Trust for the supply of furniture and fittings for the sports store — $10,000 • payment to the Service Trust for the provision of accounting, finance and IT services — $35,000 • payment to the Service Trust for removal and storage of trading stock off site — $6,000 • interest charges on a two-year fixed interest and fixed term loan of $8,000 per annum (to purchase trading stock) for 2019/20 and 2020/21, should Adrienne and Bonny liquidate the business at the end of 2019/20 year. At the beginning of the year the trading stock (sports clothing and accessories) was valued at $180,000 and at the end of the year it was valued at $110,000. Advise Adrienne and Bonny on the deductibility of the losses and outgoings incurred during 2019/20. Solution Deductions are available either under the general deduction provision (ITAA97 s 8-1(1)) or under a specific deduction provision in ITAA97 Div 25, or both. However, s 8-10 prevents double deductions. The deduction is to be claimed under the most appropriate provision. ITAA97 Div 26 covers a list of items that are not deductible or not deductible in full. Under ITAA97 s 8-1(1) the taxpayer can deduct from assessable income any loss or outgoing, to the extent that it is incurred in gaining or producing the taxpayer’s assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing the taxpayer’s assessable income. However, the taxpayer cannot deduct a loss or outgoing under this section, to the extent that, it is a loss or outgoing of capital, or of a capital nature (ITAA97 s 8-1(2)). The categorisation of expenditure as capital or capital in nature, or otherwise as revenue expenditure is based on various tests formulated by decided cases. The widely accepted test is the “business entity” test formulated by Dixon J in Sun Newspapers Ltd v FC of T (1938) 61 CLR 337. Losses or outgoings on capital account relate to the business entity structure and organisation established for profit making

activities, whereas losses or outgoings on revenue account relate to the processes by which the business entity operates to generate income. A factor to consider in making the distinction is the lasting quality of the expenditure on capital account rather than regular recurrence of the expenditure on revenue account (see British Insulated & Helsby Cables v Atherton [1926] AC 205). Share of profits distributed to Adrienne and Bonny and payment of salary to Charlotte There is no deduction to the Partnership for the distribution of profits to Adrienne and Bonny. Rather Adrienne and Bonny include the distributions in their individual tax returns, as income (ITAA36 s 92). However, the salary paid to Charlotte, as an employee is deductible to the Partnership under s 8-1(1). Superannuation guarantee paid into Charlotte’s superannuation fund The superannuation guarantee contribution paid to Charlotte’s superannuation fund is deductible to the Partnership under ITAA97 s 290-60. Royalty paid for use of manufacturer’s trademark A deduction would be available for the payment of the royalty under s 8-1(1) provided the relevant withholding obligations have been complied with. A deduction is prohibited if the Partnership was required to withhold an amount from the royalty payment under TAA Sch 1 Div 12 and failed to do so, or failed to pay any amount so withheld to the Commissioner (ITAA97 s 26-25(1)). Broadly, Div 12 applies to royalty payments to non-residents. Payment to the Service Trust for the supply of furniture and fittings Deductibility would depend on the substance of the arrangement between the Partnership and the Service Trust. If the Partnership acquired ownership of the fixtures and fittings the outlay would be of a capital nature and non-deductible, but the cost would form the basis for claiming depreciation under ITAA97 Div 40. On the other hand, if the Partnership is a mere lessee of the fixtures and fittings, it would be able to claim a deduction for the payments to the Service Trust (see Lees & Leech Pty Ltd v FC of T 97 ATC 4407). Payment to the Service Trust for accounting, finance and IT services Payments to the Service Trust for services out-sourced are deductible provided that the payments are reasonable and in-line with commercial rates (see Phillips v FC of T 77 ATC 4169; FC of T v Phillips 78 ATC 4361; and Taxation Ruling TR 2006/2). Payment to the Service Trust for removal and storage of trading stock off site The cost of acquiring trading stock is deductible under the general deduction provision s 8-1(1), being an ordinary revenue expense. Further, it has been held that the costs incurred in moving trading stock from old premises to new premises is of a non-capital nature and is deductible (Lister Blackstone Pty Ltd v FC of T 76 ATC 4285). Therefore, the cost incurred in removal and storage of trading stock off site will be deductible. Interest on two-year fixed interest and fixed term loan The general rule is that losses or outgoings incurred while a business is being carried on may be deductible. If the business has not yet commenced or has ceased being carried on, losses or outgoings would not be deductible. However, it has been held in a series of cases that interest due on business loans that continue after the business has ceased may still be deductible provided there is a nexus between the interest and the ceased business activities (see FC of T v Brown 99 ATC 4600; Steele v DFC of T 99 ATC 4242; FC of T v Jones 2002 ATC 4135 and TR 2004/4). Decrease in the value of trading stock from opening stock of $180,000 to valuation of closing stock of $110,000 The costs of acquiring trading stock is deductible and the deduction is offset by bringing to account the revenue derived from the sale of trading stock as assessable income. Adjustments are made for the change in the value of trading stock over the course of the year. Where the value of trading stock at the end of the year is less than the value of trading stock at the beginning of the year, the difference is deductible against assessable income. The Partnership will be entitled to a deduction for the decrease in

the value of trading stock in the amount of $70,000 (ITAA97 s 70-35(3)). AMTG: ¶5-090, ¶9-170, ¶9-190, ¶13-700, ¶13-710, ¶16-005, ¶16-010, ¶16-060, ¶16-070, ¶16-100

TRADING STOCK Meaning of trading stock

¶5-000

Consignment stock

¶5-020

Demonstration stock

¶5-040

Valuation method for similar items

¶5-060

Non-arm’s length dealing in trading stock and stock “on hand”

¶5-080

Trading stock taken for personal consumption; stock written-off due to obsolescence

¶5-100

Choice of stock valuation methods; obsolescence

¶5-120

Transfer of property to or from trading stock

¶5-140

Live stock valuation; private use

¶5-160

Disposal not in ordinary course of business

¶5-180

Stock in-transit; disposal outside ordinary business; closing balance

¶5-200

Trade incentives offered by sellers to buyers

¶5-220

Valuation of closing stock to minimise taxable income

¶5-240

Reasonable valuation of trading stock; special circumstances

¶5-260

Partial change in ownership of stock

¶5-280

¶5-000 Worked example: Meaning of trading stock Issue The Manny Group is primarily in the business of manufacturing, selling, repairing and hiring out equipment used by landscape gardeners. As a secondary business, it is involved in the acquisition of land for development and sale as residential blocks and it also owns a property in the Southern Highlands that is used as a tourist resort. The Manny Group requires guidance on whether the following items should be treated as its trading stock for 2019/20: 1. Land that it purchases, develops and sells as residential blocks. 2. Animals such as goats, horses, sheep and hens that are held to entertain tourists on its property in the Southern Highlands. 3. Raw materials used in the manufacture of equipment. 4. Spare parts acquired for use in its business of repairing equipment. 5. Materials used to package equipment sent to purchasers. 6. Shares that are sold during the year in anticipation of a falling share price. 7. Equipment held for hire to landscape gardeners. 8. Guard dogs that patrol the Manny Group business premises.

9. Apricots that grow in an orchard situated on the Southern Highlands property. Solution Trading stock is defined in ITAA97 s 70-10 as including anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business. Trading stock is basically the things in which a business trades. This statutory definition of trading stock is not intended to be exhaustive, and anything that is trading stock in the ordinary meaning would also be included unless it is specifically excluded. The intrinsic nature of a particular item does not determine if it is trading stock, and a particular item may be trading stock in the hands of one taxpayer but not in the hands of another. Whether an item is held for the purpose of manufacture, sale or exchange by the taxpayer in the ordinary course of business is a primary consideration. The definition in s 70-10 specifically includes live stock, but animals used as beasts of burden or working beasts in a non-primary production business are specifically excluded from being “live stock” (ITAA97 s 995-1(1)). These matters must be taken into account in determining whether the listed items are or are not trading stock for the Manny Group. Only guidance can be given in some cases because more extensive information would be required to be definitive. (1) Land that the Manny Group purchases, develops and sells as residential blocks Land may be trading stock in the hands of a land dealer (FC of T v St Hubert’s Island Pty Ltd 78 ATC 4104), and can be trading stock even if it is not yet in the condition in which it is intended to be sold. To be trading stock, the land must be held for resale and a business activity that involves dealing in land must have commenced. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose leads to the land being trading stock (Taxation Determination TD 92/124). Where the Manny Group purchases land for subdivision and sale, it is only when the individual subdivided blocks of land become marketable that each block can be valued as an item of trading stock. Before such time, the entire unsubdivided land will be an item of trading stock (Barina Corporation Ltd v DFC of T 85 ATC 4186). (2) Animals held to entertain tourists on its property in the Southern Highlands To be live stock (and therefore trading stock), an animal must generally be used in a primary production business and animals that are primarily kept for domestic purposes, such as to entertain tourists, would not be trading stock. The Commissioner states, for example, in Interpretative Decision ID 2009/25 that birds for display in a tourist park are not trading stock. (3) Raw materials used in the manufacture of equipment In its ordinary meaning, trading stock includes raw materials to be incorporated into manufactured products that are the taxpayer’s trading stock (All States Frozen Foods Pty Ltd v FC of T 90 ATC 4175). (4) Spare parts acquired for use in its business of repairing equipment Spare parts acquired to carry out repairs on equipment that is hired out to customers would not be trading stock, but spare parts may be trading stock if a separate charge is levied for the parts when they are supplied in the course of providing repair services (Taxation Ruling TR 98/8). The spare parts would not be trading stock if the supply of the parts is only a minor aspect of the service being provided to the customer. (5) Materials used to package equipment sent to purchasers Packaging materials come within the ordinary meaning of trading stock if the taxpayer is in business trading in “core” goods and the packaging materials are closely associated with the core goods sold, for example they bring the core goods into the state in which they are sold, and the packaging materials are disposed of by the taxpayer when the core goods are sold (Taxation Ruling TR 98/7). (6) Shares that are sold in anticipation of a falling share price Shares may be trading stock in the hands of a dealer or trader in shares (Investment & Merchant Finance

Corporation Ltd v FC of T 71 ATC 4140), but otherwise they are treated as a capital asset when disposed of. (7) Equipment held for hire to landscape gardener Trading stock is property that is held for manufacture, sale or exchange to a customer, and does not include goods held for hire to customers (Cyclone Scaffolding Pty Ltd v FC of T 87 ATC 4021). (8) Guard dogs that patrol the Manny Group business premises Dogs used for security purposes are working beasts, which, according to the definition of live stock in s 995-1(1), are not trading stock unless they are used in a primary production business. (9) Apricots that grow in an orchard situated on the Southern Highlands property The apricots are not trading stock while they are on the trees, but may be trading stock if they have been harvested for sale (Taxation Ruling TR 95/6). AMTG: ¶9-150

¶5-020 Worked example: Consignment stock Issue SS Home Improvements is a hardware store. The store acquires its paint stock on consignment; that is, the stock is not legally owned by SS Home Improvements but rather is owned by the paint manufacturer who provides the stock. The stock is delivered to SS Home Improvements on an “on sale or return” basis. Upon sale of the stock, the manufacturer is notified of the sale by SS Home Improvements and an invoice is issued to the store on a monthly basis during the financial year. The manufacturer does not have control over the sale of the consignment stock once it is received and it can be returned to the manufacturer. During the 2019/20 income year, the paint manufacturer delivered stock with a cost of $1.2m on consignment. Of that amount, $150,000 of paint stock remained unsold at year end. Advise SS Home Improvements of the income tax implications of the paint stock that is acquired on consignment for the 2019/20 year. Solution Generally, a taxpayer can deduct an outgoing incurred in relation to acquiring trading stock under the general deduction provisions contained in ITAA97 s 8-1 (ITAA97 s 70-15(1)). A deduction is available for the relevant income year provided that the stock becomes part of the taxpayer’s trading stock “on hand” (s 70-15(2)). The generally accepted proposition is that goods are trading stock on hand where the taxpayer is in a position to dispose of the goods. This is the case notwithstanding that they have not been physically delivered to the taxpayer’s business premises or outlet (see Taxation Ruling IT 2670). This is referred to as having “dispositive power”. This proposition is supported by the Full Federal Court decision in All States Frozen Foods Pty Ltd v FC of T 90 ATC 4175. In that decision, the taxpayer was found to be the owner of goods en-route even though it did not have physical possession because they were on board vessels at sea at the time. For income tax purposes, a taxpayer can be taken to have dispositive power over stock notwithstanding that they do not have legal ownership of the stock under a consignment stock arrangement. Such arrangements typically have the following characteristics: • the stock on consignment is held among other trading stock until sold in the ordinary course of business • payment by the purchaser is not required for the stock until after its sale • the seller is notified of the sale and an invoice is issued, and

• the seller has no control over the sale of the consignment stock once it is received by the purchaser. In FC of T v Suttons Motors (Chullora) Wholesale Pty Ltd 85 ATC 4398, the taxpayer, a motor vehicle dealership, held vehicles which it offered for sale to the public on its floor. These vehicles were for sale in its ordinary course of business. They were supplied by General Motors Holden (GMH). The taxpayer was entitled to, but was not legally obliged to purchase these vehicles from GMH at wholesale prices at the time that it took delivery. Despite not having legal ownership, the High Court concluded that the vehicles were “on-hand” as they were in possession and at the risk of the taxpayer at the time of delivery. Further guidance with respect to consignment stock is contained in Taxation Ruling IT 2472. Some general principles outlined include: • Goods never become part of the trading stock of a consignee where stock on consignment refers to the delivery of goods to an agent for its sale on behalf of the consignor as principal. The goods remain the trading stock of the consignor with the consignee being paid commission for any sales made on behalf of the consignor. • A consignee is effectively committed to the ultimate purchase of the particular goods from the time of their delivery where goods are delivered to the consignee “on approval” or “on sale or return” and a sale to the consignee is contemplated. This is similar to the arrangement that was adopted in the Sutton Motors decision. The paint stock was acquired by SS Home Improvements on an “on sale or return” basis. As such, the paint stock delivered is taken to be “on hand” for tax purposes as the business is committed to the ultimate purchase of the goods. As a result, SS Improvements is entitled to claim a deduction for the $1.2m of paint stock delivered in the 2019/20 income year. The stock of $150,000 remaining at year end is included in the $1.2m deduction amount as it is also considered to be on-hand for tax purposes. AMTG: ¶9-150, ¶9-170

¶5-040 Worked example: Demonstration stock Issue Ultimate Wheelchairs Pty Ltd is a manufacturer of motorised wheelchairs. The company sells its wheelchairs to either customers directly at retail prices or through retail stores at wholesale prices. The cost of each wheelchair to manufacture is $1,000. The company has a policy of valuing its trading stock at the end of the income year at cost for income tax purposes under ITAA97 s 70-45. Wheelchairs are provided to prospective customers on a trial basis as demonstrators and are also provided as demonstrators to retailers in their stores. At the end of the 2019/20 income year, Ultimate Wheelchairs Pty Ltd had 15 motorised wheelchairs trialled with prospective customers (at a cost of $15,000) and 35 wheelchairs as demonstrators with retailers (with a cost of $35,000). The company retains ownership of the stock at the time that they are provided as demonstrators and they are not placed on consignment. During the weeks prior to the end of the 2019/20 income year, 10 of the motorised wheelchairs are purchased by the prospective customers. The company also enters agreements with the retailers to dispose of 15 of the demonstrator wheelchairs. Advise Ultimate Wheelchairs Pty Ltd of the income tax implications of the remaining motorised wheelchairs being used as demonstrator stock at the end of the 2019/20 year. Solution Generally, a taxpayer can deduct an outgoing incurred in relation to acquiring trading stock under the general deduction provisions contained in ITAA97 s 8-1 (ITAA97 s 70-15(1)). A deduction is available for the relevant income year provided that the stock becomes part of the taxpayer’s trading stock “on hand” (s 70-15(2)).

Taxation Determination TD 95/48 confirms that, as a general rule, where stock is provided as demonstrators to prospective customers or to retailers for display purposes only, such stock is considered to remain on hand with the taxpayer at year end to the extent that: • the prospective purchasers are still yet to contractually agree to the purchase of the demonstrators, or • the retailers still hold them for display purposes only. In contrast, stock will not be on hand at year end where the prospective purchasers have agreed to purchase the demonstrators or once the retailer has dispositive power. This ordinarily arises from the wholesaler/manufacturer having entered into a contract of sale or consignment for the demonstrators and therefore no longer having the dispositive power. The 10 motorised wheelchairs that the prospective purchasers and the 15 demonstrator wheelchairs that the retailers have respectively agreed to purchase are taken not to be on hand at the end of the 2019/20 year. Instead, the balance of the demonstrators; that is, five wheelchairs being used by the prospective purchases and 20 wheelchairs being held by retailers where there has not been an agreement to sell are taken to be on hand at year end. Therefore, Ultimate Wheelchairs Pty Ltd has 25 wheelchairs on hand at year end since the company has retained dispositive power over the demonstrators. On the basis that the company has a policy of valuing its year-end stock for tax purposes at cost under s 70-45, the deduction available to the company under s 70-15(2) is $25,000 (ie $1,000 for each wheelchair × 25). AMTG: ¶9-170, ¶9-180, ¶9-190

¶5-060 Worked example: Valuation method for similar items Issue Bill Kovacs purchased a block of land with a house on it (the property) in January 2020. He rented the house out to Klaus and Margarita for six months during which time he decided to redevelop the property for sale. When the six-month lease ended, Bill commenced development activities by demolishing the existing house and began constructing four new townhouses. The construction of the townhouse complex was incomplete at the end of the 2019/20 income year. (1) Can Bill elect to value each townhouse as closing stock at the end of the 2019/20 income year using different methods of valuation (ie cost or market selling value or replacement value)? (2) Is each townhouse a separate item of trading stock or must all the townhouses be valued collectively? Solution (1) Where items of property owned by a taxpayer but not held as trading stock start being held as trading stock, the change is treated as a disposal and re-acquisition at cost or market value at the taxpayer’s election (ITAA97 s 70-30). Accordingly, the cost or market value of the property (whichever is chosen by Bill Kovacs) is its cost for trading stock purposes. However, in valuing trading stock at the end of the 2019/20 income year for tax purposes, irrespective of the basis Bill used for valuing trading stock for accounting purposes, he may adopt any one of the cost, market selling value or replacement value bases of valuing trading stock (ITAA97 s 70-45). Bill can adopt a different basis of valuation for each class of stock and even for each individual townhouse. He can change, at will, the basis adopted for any townhouse each year. (2) In Bill’s circumstances, it is only when the individual townhouses in the subdivision become marketable that each townhouse, rather than the whole area of the land on which the townhouse development is constructed, is an item of trading stock in its own right and valued as such (Barina Corporation Ltd v DFC of T 85 ATC 4186). However, where the taxpayer is in the business of land development, the whole area of the land (excluding the area of any infrastructure land) may be

trading stock before its subdivision (FC of T v Kurts Development Limited 98 ATC 4877) and must be valued as such. AMTG: ¶9-180, ¶9-190, ¶9-245

¶5-080 Worked example: Non-arm’s length dealing in trading stock and stock “on hand” Issue The relevant trading stock accounts for Jensens Co Pty Ltd (Jensens) reveal the following for the year ended 30 June 2020: $ Sales

$ 3,000,000

Less cost of goods sold Opening stock

200,000

Add purchases

1,200,000

Less closing stock

330,000 1,070,000

GROSS PROFIT

1,930,000

Some purchases were made through one of the director’s associated companies and $80,000 was paid for stock even though it only had a market value of $45,000. On 30 June 2020, $100,000 was paid to the same associated company for stock that was not delivered until 31 July 2020. Normally deliveries only take one week. The director advised that he had authorised this purchase as his other company was having temporary solvency issues. He saw no issue with this course of action as the excess market price would be reversed in August or September 2020 when his other company was financially more buoyant and would buy a similar quantity of stock below market price. Calculate the taxable income of Jensens for the year ended 30 June 2020. Solution All legislation references are to ITAA97. Calculation of taxable income $ Sales Add excess of closing stock (s 70-40)

3,000,000 (s 6-5) 130,000 (s 70-35(2)1)

over opening stock (s 70-45, s 70-50) Assessable income

3,130,000

Less allowable deductions: Purchases3

1,065,000 (s 8-1, s 70-252)

Taxable income

2,065,000 (s 4-15)

1. As the value of closing stock is greater than the value of opening stock, the excess is included as Jensen’s assessable income. If the value of opening stock figure was greater than the value of closing stock, the excess would be treated as a deduction under s 70-35(3). 2. Section 70-25 provides that costs incurred in connection with acquiring trading stock are not capital or of a capital nature. 3. As some trading stock was acquired for more than its market value, the arm’s length price of $45,000 is

imposed under s 70-20 to reduce the level of allowable deduction under s 8-1 to its market value. In addition, s 70-15 requires that the trading stock be recognised only when it forms part of the company’s trading stock on hand. This occurs when the company has the power to dispose of the trading stock (Taxation Ruling IT 2670). Although stock in transit can be goods on hand even though a taxpayer does not have physical possession (All States Frozen Foods Pty Ltd v FC of T 90 ATC 4175), in this case, as stock costing $100,000 had not been delivered until 31 July 2020 and normal delivery terms are only one week, Jensens did not have the rights and obligations to the trading stock at the 30 June 2020 balance date. Therefore, the $100,000 prepayment cannot form part of stock on hand for the 2019/20 year. Accordingly, the deduction for purchases of $1,200,000 is reduced by the excess over market value of $35,000 (s 70-15) and the prepayment of $100,000 (s 70-20) to arrive at $1,065,000. AMTG: ¶9-150, ¶9-160, ¶9-170, ¶9-180, ¶9-210

¶5-100 Worked example: Trading stock taken for personal consumption; stock written-off due to obsolescence Issue Susan Ellis is a sole trader and the owner of the Captain Cook Fish and Chips take-away food shop. She prepares her meals using the freshest available seafood which she purchases from a local wholesaler. Occasionally, Susan will take some of the seafood for personal consumption. She takes the seafood to feed herself and her two children who are aged 10 and 12 years respectively. During the 2019/20 year, Susan took seafood on numerous occasions but she failed to properly account for the quantum and the amount taken; nonetheless, she estimates the cost of seafood taken for personal consumption to be $6,000 (excl GST) for the year. However, she is unsure that this is the correct amount. At times, there are also items of seafood that have passed their expiration date. Susan dumps these items. The cost of the seafood which has been written-off in the books for the 2019/20 year is $5,000 (excl GST). Advise Susan of the income tax implications of taking the seafood for her own personal use and for the seafood which has been written-off for the 2019/20 year. Solution The income tax treatment of trading stock is governed by ITAA97 Div 70. “Trading stock” is defined as including anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business (s 70-10(1)). The seafood used by Susan for the purposes of her take-away food shop is taken to be trading stock of her business. Stock taken for personal use Where an item of property stops being held as trading stock but continues to be owned by the taxpayer, it is treated as if it has been sold to someone else so that the cost of the item is included in the taxpayer’s assessable income. At the same time, the item is taken to be immediately reacquired by the taxpayer at cost (s 70-110). The taking of seafood for personal consumption by Susan would trigger the operation of s 70-110 because it is no longer being used in her business as trading stock. Prima facie, she is taken to have disposed of the trading stock for an estimated cost of $6,000 (excl GST), which is to be included in her assessable income. Susan is also taken to have reacquired the seafood at its cost. However, records which are ordinarily required to be kept by Susan to support the assessed amount and re-acquisition for her private use include the date the item is taken from stock, the reason the item is taken, a description of the item, and the cost of the item. Susan’s estimate of the cost of the stock taken is not sufficient under the tax law to support her claim and re-acquisition. Notwithstanding this, the Commissioner in Practice Statement PS LA 2004/3 (GA) recognises that for certain businesses or industries it is difficult to determine the value of an item of trading stock taken for private use. For these taxpayers, a ruling is issued for each income year providing a schedule of values of goods that may be used as a guide to the amounts that the ATO will accept as estimates of the total value

of items taken. For the 2019/20 year, Taxation Determination TD 2020/1 outlines amounts that the Commissioner will accept as estimates of the value of goods taken from trading stock for private use by taxpayers in named industries. One of the industries listed is “Takeaway food shop”. TD 2020/1 states the relevant amounts for this industry to be: • $3,440 (excl GST) for an adult/child over 16 years, and • $1,720 (excl GST) for a child 4 to 16 years. As Susan has taken seafood from her take-away shop business for personal consumption (ie for herself and her two children who are both between 4 and 16 years), the amount which she is taken to include in her assessable income for the 2019/20 year is $6,880 (ie $3,440 + $1,720 + $1,720). She is also taken to have reacquired the seafood for this amount. As noted, Susan can use a different amount if this could be substantiated by written evidence (eg if she could prove that the amount taken was actually at a cost of $6,000). Stock written-off due to obsolescence As a general rule, the closing value of trading stock for income tax purposes can be valued using one of three bases being either cost, market selling value or replacement value (s 70-45). Notwithstanding these three bases, the Commissioner has issued guidance in Taxation Ruling TR 93/23 for trading stock valuations where the stock has become obsolete or other special circumstances apply. For stock to be obsolete the ruling states that a taxpayer must be able to show that there is no reasonable prospect of future sales of the stock. Further, the ruling states that a nil valuation for stock is acceptable if the stock is to be “dumped” or destroyed within a reasonable amount of time after the end of the income year in which it is written down (usually six months). Clearly, the seafood dumped by Susan because it had expired is taken to be obsolete stock. Therefore, it would be appropriate for her to adopt a nil valuation for the $5,000 worth of stock that expired as long as it was dumped during the 2019/20 year or within a reasonable amount of time after year end. AMTG: ¶9-150, ¶9-180, ¶9-240, ¶9-245

¶5-120 Worked example: Choice of stock valuation methods; obsolescence Issue Bernini Pty Ltd (Bernini) is a fresh produce importer. For the tax year ending 30 June 2020 sales were $7,500,000 and purchases were $4,000,000. Bernini’s allowable deductions were $2,000,000. Closing stock valuations were as follows: Closing stock at 30 June 2019

$700,000 (replacement value)

Closing stock at 30 June 2020

$600,000 (cost)

Closing stock at 30 June 2020

$580,000 (market selling value)

Closing stock at 30 June 2020

$560,000 (replacement value)

The accounts show that a late blueberries order was not included by a manager in purchases or closing stock as advised, however the bill of lading indicated that title had passed on 24 June 2020, even though the goods were not delivered by 30 June 2020. The manager had misstated the order and requested too many berries. The cost of the berries was $400,000. The shipment arrived on 1 July 2020 from China but only about 25% of the delivery could be sold while the balance had rotted. Calculate the taxable income and describe how the relevant trading stock provisions impact upon the calculation. Solution All legislation references are to ITAA97.

Opening stock The value of opening stock as at 1 July 2019 is $700,000 because opening stock must be the same value as closing stock from the prior year (s 70-40). Closing stock and obsolescence Closing stock is to be valued on the basis of one of three methods which a taxpayer must choose, that is cost, market selling value and replacement cost. Cost relates to full absorption costing (Phillip Morris Ltd v FC of T 79 ATC 4352). The Commissioner accepts first in, first out (FIFO), average cost, retail inventory and standard cost methods. The Commissioner does not accept last in, first out (LIFO) or base stock methods. Market selling value involves no forced sale, and is the market value in the company’s own selling market (Australasian Jam Co Pty Ltd v FC of T (1953) 88 CLR 23). Replacement value relates to the cost price to the company to obtain substantially the same item on the last day of the year, including freight, insurance and any other costs (Parfew Nominees Pty Ltd v FC of T 86 ATC 4673). Bernini can elect whichever method it wishes to apply to each and every product / item of trading stock (s 70-45). Bernini wants to make a choice that yields the lowest taxable income. This occurs where there is the smallest closing stock figure — in this case, the replacement value of $560,000. Late purchase of blueberries Stock in transit can be goods on hand even though a taxpayer does not have physical possession (All States Frozen Foods Pty Ltd v FC of T 90 ATC 4175). In this case, the berries arrived on 1 July 2020, that is after the balance date of 30 June 2020, however the bill of lading shows that title had passed prior to that date, on 24 June 2020. In this case therefore, the late trading stock order is an allowable deduction because s 70-15 requires that the trading stock be recognised when it forms part of the company’s trading stock on hand. However, the order can be valued at a different method to the other goods providing it is different stock (s 70-45). The large purchase of berries cost $400,000 but only $100,000 (25%) was sold. The remaining $300,000 (75%) rotted and were thrown out. Because of obsolescence or special circumstances, the stock may be valued at $100,000 (s 70-50). Therefore, the total value of closing stock as at 30 June 2020 will be $560,000 + $100,000 = $660,000. Calculation of taxable income $ Assessable income Sales

7,500,000 (s 6-5)

Less deductions Various allowable deductions

2,000,000 (s 8-1 or specific deduction)

Purchases (includes late order)

4,400,000 (s 8-1)

Excess of opening stock (s 70-40) over closing stock (s 70-45) TAXABLE INCOME

40,000 ($700,000 − $660,000) (s 7035(3)) 1,060,000 (s 4-15)

AMTG: ¶9-170, ¶9-180, ¶9-190, ¶9-200, ¶9-220, ¶9-225

¶5-140 Worked example: Transfer of property to or from trading stock Issue

Elite Cars Pty Ltd (Elite) sells prestige cars to the public. During the 2019/20 tax year, the manager changed his company car which was usual practice in the company. The car was used exclusively for business to visit customers and attend meetings at various locations with sales representatives. The manager used his own car for private purposes. On 1 July 2019, Elite transferred the manager’s existing company sedan to their car yard to be sold to the public. The car remained unsold for 12 months. The original cost price of the car was $80,000. The market value at 30 June 2019 was $55,000 and its adjustable value at 30 June 2019 was $45,000 (based on the depreciation limit of $57,581 from the prior year). Also on 1 July 2019, Elite transferred a new sports car from the car yard to be used as a company car by the manager for 100% business use. The closing stock value of the sports car at 30 June 2019 was valued at the replacement cost of $55,000. The sports car cost $65,000 and its sale price (market selling value) to the public was $75,000. The sports car has an effective life of eight years. Outline the income tax consequences of this arrangement to Elite. Solution All legislation references are to ITAA97. Transfer car from plant to trading stock Elite has taken a car from its depreciation schedule and transferred it to trading stock. This is a regular practice and would be considered in the ordinary course of business. Both trading stock and depreciation will need to be considered. There are no CGT consequences. A deemed disposal has occurred, and Elite is treated as having made an arm’s length sale and simultaneously a re-acquisition (s 70-30). Elite has the option to elect to make the sale value either the cost of the car or its market value just before it becomes trading stock, and the re-acquisition will be recorded at the same value. Elite would elect to treat the sale value as its cost price of $80,000 which is greater than the market value of $55,000. This would maximise the deduction under s 8-1 for re-acquisition. The other matter to consider is depreciation. No depreciation expense would be calculated as the car was notionally sold on 1 July 2019. However, it would be necessary to calculate the balancing adjustment given there is a disposal of a depreciating asset. The balancing adjustment to be included in the assessable income is the excess of the termination value of the car over the adjustable value of the car. Balancing adjustment

=Termination value − Adjustable value (s 40-285) =$57,581* − $45,000 =$12,581

*The termination value of the car is adjusted under s 40-325 to take into account the car limit for the year in which the car was first used for any purpose: Termination value

=Termination value × (Car limit + second element  costs / Total cost of car ignoring car limit) =$80,000 × ($57,581 + 0 / $80,000) =$57,581

There are no CGT consequences as the motor vehicle was a depreciating asset held by Elite and any capital gain is disregarded in relation to a balancing adjustment event (s 118-24). Further, cars are exempt assets (s 118-5) and no capital gain can arise. As a result of the transfer of the car from plant to trading stock, Elite’s taxable income is decreased by $67,419, ie $80,000 − $12,581. Transfer of car from trading stock to plant Elite has also taken a car out of its trading stock and transferred it into its depreciation schedule as plant.

This is also a regular practice and would be considered in the ordinary course of business. Both trading stock and depreciation provisions will need to be considered. There are no CGT consequences. A deemed disposal of the trading stock has occurred, and Elite is treated as having made an arm’s length sale and simultaneously a re-acquisition (s 70-110). Unlike s 70-30, under s 70-110, Elite has no option to make an election. The sale value of the trading stock (sold at arm’s length in the ordinary course of business) is the cost just before it stops being trading stock, and the re-acquisition price is recorded at the same value. Accordingly, the sale price of $65,000 (based on stock cost) is included in assessable income. The disposal will also be recognised in the trading stock year end stock take valuation because the closing stock will be $55,000 lower due to the disposal. In effect, the disposal of the car increases Elite’s taxable income by $10,000. As to the acquisition, the purchase price of the asset is the re-acquisition price of $65,000. However, the depreciation for the income year using the diminishing value method is based on the maximum car limit for the 2019/20 income year of $57,581 (and not the re-acquisition price of $65,000). $57,581 ×

365  365 

×

200%  8 

=

$14,395

(s 40-72)

There are no CGT consequences for the disposal of trading stock (s 118-25). As a result of the transfer of the car from trading stock to plant, Elite’s taxable income is decreased by $4,395, ie $14,395 − $10,000. AMTG: ¶9-245, ¶11-700, ¶17-485, ¶17-500, ¶17-630, ¶17-640, ¶43-110

¶5-160 Worked example: Live stock valuation; private use Issue Hendersons is an established farming partnership that sells its natural cattle produce. It bases the value of its live stock on the average cost method. Hendersons provides the following information in relation to their live stock for the 2019/20 financial year. • Closing stock as at 30 June 2019: 2,500 head of cattle valued at $400,000 ($160 per head) • 1,000 head of cattle sold for $300,000 • 500 head of cattle purchased for $65,000 • Natural increase of 600 head of cattle valued at the cost prescribed by ITR97 reg 70-55.01 (s 70-55(1) (b)) • Death of 100 head of cattle • 50 head of cattle killed for private use, including rations for employees that were sourced from stock on hand at 1 July 2019 • Allowable deductions — $95,000. Calculate the value of: • the closing balance of the live stock • the rations / goods for private use, and • the taxable income. Solution

All legislation references are to ITAA97. Closing balance — number and value of live stock The closing balance of stock can be calculated by first preparing a live stock account. $ Stock on hand at start of year Purchases

2,500 400,000 500

65,000

Natural increase

 600 12,0001

Total

3,600 477,000

Gross sales

1,000 300,000

Deaths Killed for rations Total

100

02

 50

8,0003

1,150 308,000

1. The natural increase in live stock value can be based on amounts under ITR97 (reg 70-55.01). This is $20 for each head of cattle for 2020. 2. No value is ascribed to the cattle that have died as there has been no receipt of money in regard to these outgoings. If insurance money was received for these types of losses, such compensation would be included in the value of the deaths. 3. The value of 50 rations is based on the opening stock value from which the cattle rations were sourced, 50 × $160. The closing balance in number of live stock is the opening number of live stock and its increases (through purchases and natural increase) less any reductions in the number of live stock (through sales, deaths and rations), ie 3,600 − 1,150 = 2,450 cattle. The value of the closing stock is based on the average cost of stock on hand at the start of the year, purchases and the increase in live stock. The average cost per head is therefore $477,000 / 3,600 = $132.50 The closing stock value of the cattle is therefore: 2,450 × $132.50 = $324,625 Goods for private use Goods for private use by Hendersons, family members or rations for employees must be valued and brought to account. This includes graziers who kill live stock for personal consumption. Hendersons uses 50 head of cattle for private use and rations. The value of the 50 head of cattle is included as assessable income and is based on cost (s 70-110). The amount for private use/rations to be included in calculating assessable income is based on the number of cattle sourced from stock on hand, ie 50 × $160 = $8,000. However, if the stock were sourced from purchases, the value of the purchases would be applied. If the stock were sourced from natural increase, the value of natural increase would be applied. If the source of the stock was not able to be determined, the average cost would be applied. Calculation of taxable income $ Assessable income Sales

300,000 (s 6-5)

Private use / rations

  8,000 (s 70-110)

308,000 Less allowable deductions Purchases

65,000 (s 8-1)

Excess of opening stock over closing stock ($400,000 − $324,625)

75,375 (s 7035(3))

Other allowable deductions

 95,000 (s 8-1) 235,375

TAXABLE INCOME

 72,625 (s 4-15)

AMTG: ¶9-170, ¶9-180, ¶9-190, ¶9-245, ¶9-250, ¶9-260

¶5-180 Worked example: Disposal not in ordinary course of business Issue Plasteel Pty Ltd (Plasteel) is a manufacturer of children’s gym equipment. It received the following valuation from a licensed valuer commissioned to value its stock on hand as at 30 June 2019: $ Cost

650,000

Market selling value

800,000

Replacement price

700,000

Plasteel elected to value its trading stock at 30 June 2019 at cost. Owing to liquidity difficulties, Plasteel decided it must sell all of its stock to its competitor Jumpingym Pty Ltd (Jumpingym) which wants to expand their market share. Jumpingym purchased all of Plasteel’s stock on 2 July 2019 for only $550,000. In retiring its playground stock, Plasteel had simultaneously decided to change its manufacturing activities to gardening and household items made from plastics and steel items, which its plant is substantially capable of doing. What are the income tax consequences of the disposal? Solution All legislation references are to ITAA97. This is a sale that is not in the ordinary course of business, that is an unwanted complete sale of all of Plasteel’s stock owing to liquidity difficulties. The sale was to its competitor, and not another distributor. In this situation, s 70-90(1) applies, and the market value of the goods must be brought to account on the day of disposal. The ordinary meaning of market value applies. Prima facie, the amount that needs to be brought to account could be the market selling value of $800,000. However, the market selling value is not the same as market value. The market selling value is based on sales made in the ordinary course of business, not a forced sale. Therefore, the market selling value of $800,000 is not the market value. The market value under these circumstances would probably be best exemplified by the replacement cost. The replacement cost is the amount that it would cost Plasteel to obtain very similar if not identical items in the market at year end. This is reasonable and would be a good representation of market value as this would also be the amount the competitor would have to pay in their market to purchase such assets under similar circumstances. The value that should be brought to account as assessable income for Plasteel is therefore the replacement cost of $700,000 (s 70-90(1)). Similarly, the value that must be brought to account as a purchase is $700,000 for Jumpingym (s 70-95), despite the fact that they only paid $550,000.

The amount of $550,000 actually received not in the ordinary course of business is not included in Plasteel’s assessable income nor is it exempt income (s 70-90(2)). Lastly, the difference between the value of opening and closing stock needs to be calculated. The value of the opening stock is $650,000 (s 70-40). Given Plasteel no longer manufactures children’s gyms, the closing stock is assumed to be nil (s 70-45). The deduction is therefore an excess of opening stock over closing stock, ie $650,000 − nil = $650,000 (s 70-35(3)). Taxable income is therefore increased by $50,000, ie $700,000 − $650,000. AMTG: ¶9-180, ¶9-290

¶5-200 Worked example: Stock in-transit; disposal outside ordinary business; closing balance Issue Flyover Pty Ltd operates a business selling drones. The company imports its stock from overseas and sells the drones through its website to local customers. Flyover reports the following information about its trading stock for the year ended 30 June 2020. • On 25 March 2020 — ten drones were given away as gifts to support fund raising for the local children’s hospital. The cost of the stock was $100,000 with the market value being $150,000. • On 29 June 2020 — an order and payment of $100,000 was made for drones from a supplier in Malaysia. The bill of lading having passed to Flyover at that time with the stock arriving in Australia on 10 July 2020. • The opening value of the company’s trading stock for tax purposes was $400,000. Trading stock in Flyover’s warehouse at year end was: $ Cost

700,000

Market selling value

770,000

Replacement value

650,000

What tax consequences arise from this information about Flyover’s trading stock? Solution Gifting Where trading stock is disposed of outside the ordinary course of business, the transaction is brought into account as assessable income at the market value of the stock at the date of disposal (ITAA97 s 70-90). Flyover is deemed to have disposed of its trading stock to the hospital for its market value of $150,000 and it will be assessed on this amount. Further, on the assumption that the local children’s hospital is a deductible gift recipient, then, in the year of the donation, Flyover can claim a gift deduction for the market value of the trading stock on the day they donate it (if the deduction does not add to or create a tax loss). Stock on hand For an item to be considered trading stock, it must be held for the purposes of manufacture, sale or exchange (ITAA97 s 70-10). Items can be considered “trading stock on hand” notwithstanding that they have not been physically delivered to the taxpayer’s business premises or outlet, provided the taxpayer is in a position to dispose of the goods. In All States Frozen Foods Pty Ltd v FC of T 90 ATC 4175, the court held that goods en route to Australia on a cargo ship at midnight 30 June 1985 constituted trading stock on hand at year end as the bill of lading for the goods had been delivered to the taxpayer before year end and gave the taxpayer the right to dispose of the goods.

Given that the drones were ordered on 29 June 2020 (arriving in Australia on 10 July 2020), they are considered trading stock for the year ended 30 June 2020 as the bill of lading for the drones had passed to Flyover on the date they were ordered and paid for, and Flyover had the right to dispose of them. These drones should be included in the value of trading stock at year end. Closing value of trading stock Where the value of trading stock at year end exceeds the opening value, the excess is included in the taxpayer’s assessable income (ITAA97 s 70-35(2)). Trading stock can be valued at year end at either cost, market selling value, replacement cost, or some lower value due to obsolescence (ITAA97 s 70-45, 70-50). To minimise the company’s tax liability, Flyover has the choice to use the replacement value of $650,000 as this produces the lowest assessable amount (ie $650,000 − $400,000 = $250,000). The replacement value of the drone in-transit would need to be included in the closing stock amount, so an additional $100,000 would increase the closing stock value to $750,000. AMTG: ¶9-170, ¶9-180, ¶9-290, ¶31-270

¶5-220 Worked example: Trade incentives offered by sellers to buyers Issue Barney Co sells items to Connor Poulos under the following terms of trade. Situation 1 Connor is entitled to receive a volume rebate of 5% for all purchases of 5,000 or more items of trading stock. Connor purchases 10,000 items of trading stock with a cost price of $20 per item subject to the 5% rebate. Situation 2 Connor is entitled to receive a volume rebate of 2% on his purchase of a particular item of trading stock subject to his purchasing 100,000 items in an income year. Barney Co and Connor initially proceed on the basis that the rebate is uncertain and treat the purchases as undiscounted at the time of purchase, and the undiscounted purchase price of $20 per item is paid by Connor. By the end of six months Connor has purchased 80,000 items and the parties conclude that it is certain that the volume rebate level will be achieved. From the seventh month Connor pays the discounted price of $19.60 per item. Connor has purchased 100,000 items by the end of the eighth month, and Barney Co credits the volume rebate of $32,000 attributable to the first 80,000 items purchased by Connor. The rebate is shown as a credit due to Connor on the sales invoice for the eighth month. Throughout the year, including after the volume rebate threshold is considered certain and after it is actually achieved, the undiscounted price is shown on invoices and other documentation as the trading stock price and the volume rebate is shown separately. Explain the tax consequences of these transactions for Barney Co and Connor. Solution Trade incentives may be treated in either of the following ways, according to Taxation Ruling TR 2009/5. For the buyer Trade incentives that relate directly to the purchase of trading stock, so as to reduce the purchase price, are treated as a reduction in the cost of acquiring the trading stock for the buyer for the purposes of ITAA97 s 8-1 and Div 70. Trade incentives that are subject to a condition that has not been satisfied at the time of the purchase do not relate directly to the purchase of trading stock and do not reduce the cost of acquiring trading stock for the buyer. For the seller Trade incentives that relate directly to the sale of trading stock, so as to reduce the sale price, are treated as a reduction of the sale proceeds for the seller for the purposes of ITAA97 s 6-5 and Div 70.

An incentive that is subject to a condition that has not been satisfied at the time of the sale does not generally relate directly to the sale of trading stock and does not reduce the proceeds of sale for the seller. The exception is where there is virtual certainty at the time of sale that the condition will be satisfied, for example a settlement discount that is always taken by the buyer will reduce the sale price for the seller. Similarly, a volume rebate subject to a rebate threshold that has not been met but is certain to be met will reduce the sale price for the seller. In both cases, the seller’s assessable income from the sale is the reduced amount. Whether a trade incentive relates directly to trading stock Factors relevant to whether a trade incentive reduces the cost of acquiring trading stock for a buyer and the proceeds of disposal for the seller include: • the terms of trade between the parties and other sales and transaction documentation, such as invoices, incentive claim forms and credit notes • an objective assessment of the intention of the parties, and • other relevant circumstances surrounding the payment of the incentive. Situation 1 The volume rebate received by Connor is intended to reduce the selling price of the goods and is treated as a reduction in the cost of the purchase of trading stock by Connor. The volume rebate reduces the acquisition cost of the trading stock for income tax purposes to $190,000. Similarly, the volume rebate reduces the sale proceeds of Barney Co for income tax purposes to $190,000. Situation 2 The rebates applicable to the first 80,000 items do not reduce the cost of acquiring trading stock for Connor and the proceeds of sale for Barney Co. This is because the rebates are subject to a condition that has not been satisfied at the time of sale and it is not certain at that time that it will be satisfied. The rebates applicable to the next 20,000 items do not reduce the cost of acquiring trading stock for Connor but do reduce the proceeds of sale for Barney Co. While the rebates are subject to a condition that has not been satisfied at the time of sale, it is certain in a practical sense at that time that the condition will be satisfied. The rebates applicable to all items purchased and sold after the 100,000 items threshold is achieved reduce the cost of acquiring trading stock for Connor and the proceeds of sale for Barney Co because the rebates are no longer subject to a condition that has not been satisfied at the time of sale. The rebate of $32,000 applicable to the first 80,000 items is derived as ordinary income (s 6-5) by Connor and incurred as an expense (s 8-1) by Barney Co when Barney Co credits Connor’s account with the $32,000, that is when Connor has purchased 100,000 items. AMTG: ¶9-170

¶5-240 Worked example: Valuation of closing stock to minimise taxable income Issue Taurus Pty Ltd manufactures and sells bicycle chains and bicycle brakes, and its trading stock at 30 June 2019 and 30 June 2020 was as follows: 30 June 2019 30 June 2020 $

$

Cost — bicycle chains

30,000

35,000

Cost — bicycle brakes

15,000

10,000

Market selling value — bicycle chains

40,000

30,000

Market selling value — bicycle brakes

30,000

20,000

Replacement value — bicycle chains

35,000

40,000

Replacement value — bicycle brakes

20,000

15,000

For tax purposes, Taurus Pty Ltd valued its entire closing trading stock at 30 June 2019 at replacement value. During the 2019/20 income year, Taurus Pty Ltd’s only transactions were purchases that amounted to $60,000 and sales proceeds that amounted to $140,000. Calculate Taurus Pty Ltd’s taxable income for 2019/20 on the basis that it valued trading stock for tax purposes to give the smallest possible taxable income. Solution Taurus Pty Ltd valued its entire closing trading stock at 30 June 2019 at replacement value, so that is the value of its opening stock for 2019/20 (ITAA97 s 70-40(1)). In order to give the smallest possible taxable income, Taurus Pty Ltd needs to choose the lowest value of closing stock for the bicycle chains and the bicycle brakes, and ITAA97 s 70-45 allows Taurus Pty Ltd to choose one method for one and another method for the other. The correct approach therefore is to choose the market selling value for closing stock for the bicycle chains and cost for closing stock for the bicycle brakes — because this is the lowest value in each case. The calculation of Taurus Pty Ltd’s taxable income would be as follows: $

$

$

Sales 140,000 Less cost of goods sold: Opening stock (replacement value)

55,000

Purchases

60,000 115,000

Less closing stock: Bicycle chains at market selling value

30,000

Bicycle brakes at cost

10,000

40,000

TAXABLE INCOME

75,000 65,000

This equates to the calculation of taxable income under the ITAA97: Assessable income (s 6-5)

$140,000

Allowable deductions • s 8-1 and 70-15

$60,000

• s 70-35(2)

$15,000

TAXABLE INCOME

$75,000 $65,000

AMTG: ¶9-180, ¶9-190, ¶9-200, ¶9-220, ¶9-225

¶5-260 Worked example: Reasonable valuation of trading stock; special circumstances

Issue Ollie Garson owns a hardware store in a country town. In September 2017 he was persuaded by an offer that seemed too good to ignore to purchase a large supply of household items that had just been released onto the market. Sales of these household items were slow right from the beginning and lively criticism on social media from disgruntled purchasers brought sales to a virtual halt by early 2019. The consumer regulator’s attention was drawn to the items and intervention to limit sales seemed a possible outcome. At the end of the 2019/20 income year, Ollie still had 5,500 of the household items on hand and he believed he was unlikely to ever sell them. The household items that Ollie still held cost $2 each, had a market selling value of $3 each and a replacement value of $2.50 each. Assuming that Ollie wants to minimise his tax liability for the 2019/20 income year, how should he value the household items that he holds as stock on hand at the end of the year? Solution To minimise his tax liability for the 2019/20 income year, Ollie should value the household items at the lowest value that is available to him. A taxpayer is generally required to value each item of trading stock on hand at the end of an income year at its cost, its market selling value or its replacement value (ITAA97 s 70-45). As an exception, a taxpayer may elect to value an item of trading stock below all the values in 70-45 if: • that is warranted because of obsolescence or any other special circumstances relating to the item, and • the value that the taxpayer elects is reasonable (ITAA97 s 70-50). Special circumstances The meaning of “special circumstances” in this context was considered by the Commissioner in Taxation Ruling TR 93/23, where it is stated that special circumstances exist if stock becomes less marketable because of changed circumstances. Situations that are considered to be special circumstances include: • a loss of market which spans more than one income year • an error in over-ordering stock where the stock is not likely to be sold in the foreseeable future, and • the inability to sell a substantial amount of stock due to damage or physical deterioration. In Ollie’s case, the lowest value that can be chosen under s 70-45 is the cost price of $2 per unit, but he may be able to argue that a lower value should reasonably be allowed because of the special circumstances that exist. In particular, he could point to the slow sales of the product from the time they were purchased, the loss of market because of the antagonistic social media campaign and the possibility that the consumer regulator’s intervention will permanently prevent further sales. Where special circumstances have been shown to exist, the Commissioner accepts, as an alternative to the values available under s 70-45, “any fair and reasonable value” provided adequate documentation supporting the calculation is maintained. The fair and reasonable value should be calculated taking into account factors such as: • the quantities of the stock on hand which, according to the operating and sales budgets, are expected to be used or sold during the year and in the future • the length of time since the last sale of the stock • industry experience/taxpayer expertise in relation to the same kind or class of trading stock, and • the price at which the last sale of the stock was made, the price of the stock on the taxpayer’s price

list, and the price at which the taxpayer is prepared to sell the stock. Ollie can choose the value that is reasonable, and this value may even be nil if in fact the items are unsaleable and cannot be sold for scrap. AMTG: ¶9-180, ¶9-240

¶5-280 Worked example: Partial change in ownership of stock Issue Pat Lee and Nora Jones are equal partners in a retail business. At 30 June 2020, they admit Zach Smith as a full partner, and Pat and Nora each sell one-third of their interest in the partnership assets to Zach. At 30 June 2020, the closing value at cost of the trading stock on hand of the partnership was $150,000 and its market value was $230,000. The partners seek advice on the tax consequences when ownership of the trading stock moves from the two partners to the three partners. Solution When the partnership of Pat and Nora ceased to own the partnership assets on 30 June 2020 and the partnership of Pat, Nora and Zach took up ownership of the partnership assets, there was a partial change in ownership of the trading stock. A partial change in the ownership of trading stock occurs if, after the change, a new owner and at least one of the old owners have an ownership interest in the trading stock (ITAA97 s 70-100). In such a case, the partial change in the ownership of the trading stock is treated as a notional disposal of the trading stock by all the old owners to all the new owners. As a general rule, the assessable income of the old owners (the transferor) includes the market value of the trading stock on the day it is transferred, and the new owners (the transferee) are treated as having bought the item for market value on the same day (ITAA97 s 70-100(1) to (3)). In some circumstances, the old owners and the new owners may elect to treat the trading stock as having been disposed of for what would have been its value in the hands of the transferor at the end of the income year if the income year had ended on the date of the change of ownership (s 70-100(4)). If the election is made, this value is included in the transferor’s assessable income, and the transferee is treated as having bought the item for that same value (s 70-100(5)). The election can only be made if: • the item becomes an asset of the business carried on by the new owners • after the notional disposal from the old to the new owners, the old owners retain at least a 25% interest in the item, and • the value elected is less than the market value of the item (s 70-100(6)). Application of s 70-100 to the disposal by the old partnership to the new partnership In the new partnership of Pat, Nora and Zach, there is a 66⅔% continuity of interest of Pat and Nora, and the three partners (Pat, Nora and Zach) can therefore make an election for s 70-100(4) to apply. If the election is made, the old partnership is deemed for tax purposes to have sold, and the new partnership is deemed to have purchased, the trading stock for $150,000 (ie its value in the hands of Pat and Nora when the ownership changed) and there is no assessable profit on the transaction. The assessment of profit is deferred until the stock is sold at a later time in the ordinary course of the business of the new partnership. If an election is not made, the old partnership is deemed for tax purposes to have sold, and the new partnership is deemed to have purchased, the trading stock for its market value of $230,000. Pat and Nora, as equal partners in the old partnership, are each assessed on 50% of the $80,000 profit ($230,000 − $150,000).

AMTG: ¶9-295

DEPRECIATION Decline in value and other deductions

¶6-000

Apportioning deduction for decline in value of depreciating assets

¶6-020

Deduction for capital works

¶6-040

Decline in value deductions and balancing adjustment on disposal

¶6-060

Balancing adjustments; disposal of depreciating assets; instant asset write-off

¶6-080

Balancing adjustments; disposal of business and non-business assets; capital gains

¶6-100

Disposal of depreciable asset used for private purposes

¶6-120

Purchase of intangible business assets; calculating decline in value

¶6-140

Depreciating assets; intangible assets; plant

¶6-160

Commercial website development expenditure

¶6-180

Pooling low cost and low value depreciating assets

¶6-200

Small business entity assets; general small business pool

¶6-220

Small business entity assets: temporary changes to immediate deduction

¶6-240

Composite assets

¶6-260

Primary producers; accelerated depreciation rates

¶6-280

Second-hand depreciating assets in residential premises

¶6-300

¶6-000 Worked example: Decline in value and other deductions Issue Angela Codak runs a studio photography business. On 1 September 2019, Angela decided to extend her business and purchased audio-visual equipment. The equipment cost $12,000 plus $400 for installation and $1,800 for a one-year contract for two hours’ training each month for the first six months. Angela was advised that the equipment had an effective life of four years. She also commissioned the development of film editing software for $3,500. Advise Angela on tax deductions available in relation to the purchase and use of the audio-visual equipment. Solution The audio-visual equipment is a capital expense and not deductible under ITAA97 s 8-1 (see also British Insulated & Helsby Cables v Atherton [1926] AC 205; and Sun Newspapers Ltd v FC of T (1938) 61 CLR 337). In British Insulated & Helsby Cables Viscount Cave formulated the test for characterising a capital outgoing: “When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or advantage for the enduring benefit of a trade … there is very good reason … for treating such expenditure as properly attributable not to revenue but to capital.” In Sun Newspapers, Dixon J formulated the business entity test: “The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between [on the one hand] the business entity, structure, or organisation set up or established for the earning of profit and [on the other hand] the process by

which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss …” However, the audio-visual equipment is a depreciating asset (ITAA97 s 40-30) and a capital allowance deduction is available to Angela. The first element of cost is the $12,000 purchase price (ITAA97 s 40-180) and the second element is $400, that is the amount incurred in having the equipment installed ready for use (ITAA97 s 40-190). The capital allowance deduction will be based on the cost figure of $12,400. The costs towards developing the film editing software may be allocated to a software development pool (ITAA97 s 40-450) and depreciated over five years. The deduction in year one is nil and 30% in years two, three and four and the remaining 10% in year five. Angela will not be entitled to a capital allowances deduction for the software in 2018/19 (ITAA97 s 40-455). The expense of $1,800 incurred in entering into the training contract is a revenue expense rather than a capital one and is deductible under ITAA97 s 8-1. Calculation of depreciation of the audio-visual equipment: Depreciable cost

$12,400

Apportionment

1 September 2019 to 30 June 2020 = 304 days / 366* days

Effective life

Four years

Diminishing value method for calculating the decline in value (ITAA97 s 40-72): Base value  Asset’s effective life 

×

Days held  Days in year 

× 200%

Applied to Angela: $12,400  4 years 

×

304  366* 

× 200%

= $5,150

Angela has the choice of using the prime cost method for calculating the decline in value. However, the deduction for 2019/20 would only amount to $2,575, calculated using the following formula (ITAA97 s 4075): Prime cost deduction

Prime cost deduction

Cost  Effective life 

=

=

$12,400  4 years 

×

×

Days held  Days in year  304 = $2,575  366* 

*Adjusted for leap year Angela is advised to apply the diminishing value method over the prime cost method as it results in a greater capital allowance deduction for 2019/20. Once this method is chosen for the particular asset, it applies to that asset in later income years. AMTG: ¶16-010, ¶17-280, ¶17-370, ¶17-480, ¶17-490, ¶17-500

¶6-020 Worked example: Apportioning deduction for decline in value of depreciating assets Issue Doug Johnson resigned from his employment as a bus driver and established a learner driver training school. On 1 July 2019, Doug purchased a Subaru Liberty sedan for $37,000 incurring dealer delivery charges of $2,000 and registration and insurance costs amounting to $4,000. Doug had the vehicle

modified by installing dual controls, at a cost of $2,500. During the year the vehicle was used for both private and driver learner training purposes. At 30 June 2020, the log book registered 48,000 km as the total distance travelled of which 30,000 km were for learner driver training. Doug estimates the vehicle has an effective life of 240,000 km. On 1 March 2020, Doug added another vehicle to his driver training school. This second car, a Honda Accord, cost $45,000 with dealer delivery charges of $1,800 and registration and insurance amounting to $3,600. The vehicle was modified with the installation of dual controls at a cost of $2,400. The vehicle was used entirely for learner driver training purposes and travelled 6,000 km up to 30 June 2020. Doug estimated the vehicle has an effective life of 90,000 km. Advise Doug Johnson on the tax deductions available to him in relation to his learner driver training business. Solution A deduction is available for losses or outgoings incurred in gaining or producing assessable income or carrying on a business for the purpose of gaining or producing assessable income (ITAA97 s 8-1(1)). However, a taxpayer cannot deduct a loss or outgoing under s 8-1(1) to the extent that it is a loss or outgoing of capital, or of a capital nature (s 8-1(2)(a)). A capital allowance is available for depreciating assets, provided the taxpayer is the holder of the asset (ITAA97 s 40-1). A depreciating asset has a limited effective life (ITAA97 s 40-30). The taxpayer can deduct the decline in value of the depreciating asset held during an income year (ITAA97 s 40-25(1)). The deduction is reduced if the asset is only partly used for a taxable purpose (s 40-25(2) and 40-25(7)). The deduction is also apportioned if the asset is used for only part of the year. The process for calculating the deduction involves determining the cost of the depreciating asset and its effective life, then choosing either the prime cost or diminishing value method for calculating the annual deduction. The closing value at the end of the year is the opening value for calculating the deduction in the next year. Capital allowance in relation to the Subaru Liberty As the legal owner of the vehicle, Doug is entitled to claim the depreciation deduction. The cost of the vehicle has two elements. The first is the purchase price of $37,000 (ITAA97 s 40-180). The second element includes costs incurred in bringing the asset to its present condition (ITAA97 s 40-190). For Doug, this would include the dealer delivery charge of $2,000 as well as the dual controls modification costing $2,500. The registration and insurance would not be included in the cost but would be deductible under s 8-1(1). Doug can estimate the effective life of the vehicle or rely on the Commissioner’s determination (ITAA97 s 40-95). Doug estimates that the vehicle has an effective life of 240,000 km which at 48,000 km per year translates into an effective life of five years. Doug then has the choice of using the prime cost method (ITAA97 s 40-75) or the diminishing value method (ITAA97 s 40-72) for calculating the annual depreciation deduction. Calculation of depreciation deduction: $ Cost element 1: cost of Subaru Liberty

37,000

Cost element 2: cost of bringing vehicle to its present condition

 4,500

Total cost

41,500

Apportionment for business purposes: 30,000 km / 48,000 km

0.625

Diminishing value method (s 40-72): Base value  Asset’s effective life 

×

Days held  Days in year 

×

200%

× Business purposes

$41,500  5 years 

366  366* 

×

×

200%

× 0.625

Capital allowance deduction for Subaru Liberty for 2019/20 = $10,375 Prime cost method (s 40-75): Cost  Effective life  $41,500  5 years 

Days held  Days in year 

×

×

366  366* 

×

0.625

×  Business purposes

= $5,188

*Adjusted for leap year The diminishing value method is preferred, yielding a deduction of $10,375 compared to the prime cost method which yields a deduction of only $5,188. Capital allowance in relation to the Honda Accord The cost element 1 for the Honda Accord is $45,000. Cost element 2 is $4,200 making the total cost for capital allowance purposes $49,200. Doug estimated the effective life is 90,000 km. The vehicle travels 6,000 km in four months which equates to 18,000 km per year. This translates into an effective life of five years. Calculation of depreciation deduction $ Cost element 1: cost of Honda Accord

45,000

Cost element 2: cost of bringing vehicle to its present condition

 4,200

Total cost

49,200

Apportionment: days vehicle held in 2019/20 (1 March to 30 June 2020) = 122 days Diminishing value method (s 40-72): Base value  Asset’s effective life 

×

Days held  Days in year 

×  200%

$49,200  5 years 

×

122  366* 

×  200%

*Adjusted for leap year Capital allowance deduction for Honda Accord for 2019/20 = $6,560 The prime cost method results in a capital allowance deduction for the Honda Accord for 2019/20 of $3,280 ($49,200 / 5 years × 122/366 days). Doug is advised to apply the diminishing value method over the prime cost method as it results in a greater capital allowance deduction for 2019/20. AMTG: ¶17-015, ¶17-080, ¶17-105, ¶17-270, ¶17-480, ¶17-500, ¶17-560, ¶17-570

¶6-040 Worked example: Deduction for capital works Issue Clive Randle is a property developer and in 1995 he decided to diversify his activities by constructing hotels, residential apartment blocks and factory units for industrial activities. During 1995/96 the following

contracts were entered into: Hotel Contract date: 1 October 1995 Construction commenced: 1 February 1996 Construction completed and hotel operating: 1 March 1997 Construction cost: $1.5m Residential apartment block Contract date: 1 December 1995 Construction commenced: 1 April 1996 Construction completed and all apartments occupied: 1 January 1997 Construction cost: $2m Factory units Contract date: 1 May 1996 Construction commenced: 1 July 1996 Construction completed and factory units leased for industrial activities: 1 January 1997 Construction cost: $1m On 15 April 2020, Clive accepted an offer on the apartment block and sold it to an investor for $3.5m. Advise Clive on the tax deductions available to him in relation to his hotel, apartment block and factory units for the 2019/20 year. Solution Tax deductions are available for depreciating assets (ITAA97 s 40-25, 43-30). The deduction does not apply to capital works for which a deduction is available under ITAA97 Div 43 (s 43-10). A deduction is available for capital works, which include buildings begun in Australia after 21 August 1979. The rate of deduction is either 2.5% or 4%, depending on the type of capital works and the date on which construction commenced (s 43-25). However, the deduction cannot be claimed until construction is complete and the building is used for income-producing purposes (s 43-30). For capital works started before 1 July 1997, the capital work must have been intended for use for a certain purpose at the time of completion. Clive Randle’s three construction projects all come within intended uses described in the table at ITAA97 s 43-90. The rate of deduction for capital works is contained in s 43-25. For capital works begun after 26 February 1992: • there is a basic entitlement to a rate of 2.5% for uses described in the Table in s 43-140 (current year use) • the rate increases to 4% for uses described in Table 43-145. For capital works begun before 27 February 1992 and used as described in the Table in s 43-140, the rate is: • 4% for capital works begun after 21 August 1984 and before 16 September 1987, or • 2.5% in any other case. The deduction is calculated according to the steps in:

• ITAA97 s 43-210 for capital works begun after 26 February 1992, or • ITAA97 s 43-215 for capital works begun before 27 February 1992. A balancing adjustment is taken into account on the disposal of a depreciating asset (ITAA97 s 40-285). However, there is no balancing adjustment on the disposal of capital works. Rather, the undeducted construction expenditure over the remaining life of the capital works carries over to the new owner of the capital works. For post-26 February 1992 undeducted construction expenditure the calculation is according to the steps in ITAA97 s 43-235. The period over which deductions can be claimed for capital works is 40 years, where the rate of deduction is 2.5%, and 25 years for those works for which the rate is 4%. It is not permissible to recover more than 100% of the capital expenditure of the capital works (ITAA97 s 43-15). Capital works deduction for hotel for 2019/20 Construction of the hotel commenced on 1 February 1996. Construction was completed and the hotel started operation on 1 March 1997. The deduction rate is 4% and is available for the entire 2019/20 year. Calculation of the hotel capital works deduction $1,500,000 × 4% = $60,000 Capital works deduction for apartment block for 2019/20 Construction of the apartment block commenced on 1 April 1996. Construction was completed and all of the apartments were occupied on 1 January 1997. The deduction rate is 2.5%. However, the apartment block was disposed of on 15 April 2020. The capital works deductions claimed by Clive Randle up to the date of disposal are calculated as follows: Deduction for the period 1 January 1997 – 30 June 1997 $2,000,000 × 181 / 365 × 2.5% = $24,795

Deduction for the five leap years (2000, 2004, 2008, 2012, 2016) $2,000,000 × 366 / 366 × 2.5% × 5 = $250,000

Deduction for 17 years of 365 days $2,000,000 × 365 / 365 × 2.5% × 17 = $850,000

Deduction for the period 1 July 2019 – 15 April 2020 $2,000,000 × 290 / 366 × 2.5% = $39,617 Total capital works deduction for Clive’s apartment block over the period of ownership = $1,164,412. Undeducted construction expenditure that may be claimed by investor purchasing the apartment block: $2,000,000 − $1,164,412 = $835,588. Given that Clive received $3.5m for the sale of the apartment block, CGT issues will also apply. Capital works deduction for factory units for 2019/20 Construction of the factory units commenced on 1 July 1996. Construction was completed and all units were leased for industrial activities and in operation on 1 January 1997. The deduction rate is 4% (ITAA97 s 43-150) and is available for the entire 2019/20 year. Calculation of the factory units’ capital works deduction $1,000,000 × 4% = $40,000

AMTG: ¶17-015, ¶17-030, ¶20-470, ¶20-480, ¶20-490, ¶20-500, ¶20-520, ¶20-530

¶6-060 Worked example: Decline in value deductions and balancing adjustment on disposal Issue Jackie Anderson is a qualified hire car driver and on 1 September 2017 she purchased a new BMW for $80,000, which was to be used in her hire car business as well as for private purposes. Jackie’s log books indicate that 80% of the kilometres travelled in a year relate to her hire car business. Jackie estimates that the effective life of the BMW will be 10 years, with a total of 20,000 km driven each year. On 1 March 2020, Jackie traded-in her BMW for a Jaguar. The trade-in on the BMW was $43,212 and the cost of the Jaguar was $51,000. Jackie estimated that the effective life of the Jaguar would be four years and that the hire car business usage would be 45,000 km each year. Jackie has chosen the diminishing value method for calculating the decline in value and has chosen to self-assess the effective life of her vehicles. Advise Jackie on the depreciation deductions she would be entitled to for her hire car business or additions to her assessable income in the 2019/20 tax year. Solution Tax deductions are available for losses or outgoings incurred in gaining assessable income or carrying on a business for the purpose of gaining assessable income (ITAA97 s 8-1(1)), unless the loss or outgoing is of capital or a capital nature (s 8-1(2)(a)). However, a deduction is available for depreciating assets (ITAA97 s 40-25) under the capital allowances regime. Jackie’s motor vehicles qualify as depreciating assets. The cost (ITAA97 s 40-180) of the asset is the starting point in calculating depreciation. However, there is a cost limit for cars (ITAA97 s 40-230), currently $57,581, for 2019/20 (Per the ATO website. Note: Annual Taxation Determinations for the car limit are no longer published). It is then necessary to determine the effective life of the asset. Jackie can self-assess the effective life of her hire cars (ITAA97 s 40-105). There is a choice of two methods in calculating the annual decline in value of depreciating assets (ITAA97 s 40-65). Jackie has chosen to use the diminishing value method (ITAA97 s 40-72). The formula makes provision for assets held for only part of the year. The concepts of adjustable value and opening adjustable value (ITAA97 s 40-85) are also relevant to the calculation of depreciation and the balancing adjustment on disposal of an asset. The opening adjustable value for an income year is the adjustable value of the asset at the end of the previous income year. An additional adjustment is required where, as in Jackie’s case, the asset is used for both incomeproducing and private purposes (s 40-25(2)). The extent to which the asset is used for private purposes will impact on the calculation of depreciation and the amount of any balancing adjustment on disposal of the asset. When a depreciating asset is disposed of, such as Jackie’s disposal of her BMW, a balancing adjustment is required (ITAA97 s 40-295), where there is a difference between the termination value (ITAA97 s 40300) and the adjustable value at the time of disposal (s 40-85). If the termination value is more than the adjustable value, the excess is assessable (ITAA97 s 40-285(1)) whereas, if the termination value is less than the adjustable value, the difference is deductible (s 40-285(2)). Where a balancing adjustment event happens for a car subject to the car limit, the termination value is adjusted for the purpose of calculating any balancing adjustment. A further complication arises in Jackie’s case because her BMW was used for both business and private use. The balancing adjustment amount is reduced to the extent that the vehicle is used for private purposes, according to the formula in ITAA97 s 40-290. Depreciation of the BMW

$ Cost of BMW on 1 September 2017

80,000

Car depreciation limit in 2017/18 (Taxation Determination TD 2017/18)

57,581

$57,581 10 years

Less decline in value:

×

303 days 365 days

×

9,560

200%

Opening adjustable value on 1 July 2018 $48,021 10 years

Less decline in value:

48,021 ×

365 days 365 days

×

9,604

200%

Opening adjustable value on 1 July 2019 $38,417 10 years

Less decline in value:

38,417 ×

244 days 365 days

×

 5,136

200%

Adjustable value on 1 March 2020

33,281

Adjusted termination value (trade-in) on 1 March 2020

31,102

Recognising that the cost of the car exceeded the car limit, the termination value for the purpose of calculating any balancing adjustment is adjusted (ITAA97 s 40-325) as follows: sale price

×

car limit actual cost of vehicle

ie $43,212

×

$57,581 $80,000

adjusted sale price (termination value) = $31,102 As the termination value ($31,102) is less than the adjustable value of the car ($33,302), Jackie is entitled to a balancing deduction of $2,200 (ie $33,302 − $31,102) for 2018/19. However, an adjustment needs to be made to take account of non-business use, by applying the formula: Balancing deduction amount ×

Sum of reductions Total decline

Balancing adjustment on disposal of the BMW in 2019/20 Tax year

Decline in value $

Deduction: 80% Business use $

Reduction $

2017/18

9,560

7,648

1,912

2018/19

9,604

7,683

1,921

2019/20

 5,136

 4,109

1,027

TOTAL

24,300

19,440

4,860

Balancing deduction amount

$2,200 ×

$4,856  $24,279 

×

Sum of reductions Total decline

= $440

For 2019/20, the balancing adjustment deducted from Jackie’s assessable income, on the disposal of the BMW is reduced by $440 from $2,200 to $1,760 to take into account the 20% private use of her BMW. Depreciation of the Jaguar in 2019/20

Purchase price of Jaguar on 1 March 2020 = $51,000

Hire car business use: 45,000 km per year Effective life: 4 years

Less decline in value:

$51,000  4 years 

×

122 days × 200% = $8,500  366 days 

Apportionment of decline in value to take into account the 20% non-business use: $8,500 × 80% = $6,800 Opening adjustable value on 1 July 2020 = $42,500 Summary of depreciation deductions or additions to assessable income for Jackie in 2019/20 Balancing adjustment, from disposal of the BMW, deduction from assessable income

$1,760

Depreciation deduction for the BMW to 1 March 2020

$4,109

Depreciation deduction for the Jaguar from 1 March 2020

$6,800

AMTG: ¶17-080, ¶17-200, ¶17-270, ¶17-485, ¶17-500, ¶17-560, ¶17-570, ¶17-630, ¶17-640, ¶17-660

¶6-080 Worked example: Balancing adjustments; disposal of depreciating assets; instant asset write-off Issue Rene Richards owns and manages a business, trading as Alpine Printing. This business prints and publishes lifestyle, real estate and financial magazines and journals. The turnover of Alpine Printing in all relevant years is less than $500m. During the 2019/20 year, the following transactions took place relating to the business’s printing presses. Printing press 1: Opening value 1 July 2019:

$150,000

Effective life:

10 years

Depreciated using diminishing value method Sold on 1 November 2019, for:

$65,000

Printing press 2: Opening value 1 July 2019:

$100,000

Effective life:

10 years

Depreciated using diminishing value method Sold on 1 February 2020, for:

$125,000

Printing press 3: Opening value 1 July 2019:

$100,000

Effective life:

10 years

Depreciated using diminishing value method

Destroyed by fire on 1 April 2020 Insurance pay-out:

$132,000

Printing press 4: Replacement printing press: Purchased on 1 May 2020, for:

$180,000

Effective life:

10 years

Depreciated using diminishing value method Rene would like to know what deductions are available in relation to the capital transactions concerning his printing presses during 2019/20. Solution The printing presses qualify as depreciating assets (ITAA97 s 40-30) and the owner, Rene, is entitled to claim deductions for the decline in value of the printing presses used during 2019/20 (ITAA97 s 40-25). He is free to estimate the effective life of the printing presses (ITAA97 s 40-105) and apply the diminishing value method in calculating the decline in value over the year (ITAA97 s 40-65(1)). When depreciating assets are disposed of a balancing adjustment must be taken into account. If the termination value of a depreciating asset on disposal is less than its adjustable value, the difference is deductible in the year of the disposal (ITAA97 s 40-285(2)). If the termination value is more than the adjustable value on disposal, the excess is assessable in the year of the disposal (s 40-285(1)). The termination value is usually the selling price or amount received on disposal of the asset (ITAA97 s 40300 and s 40-305) — this can be an insurance payout from the destruction of the asset. The adjustable value of a depreciating asset is initially its cost, and subsequently its opening value at the commencement of the year, having deducted depreciation over the previous year (ITAA97 s 40-85). Balancing adjustments may be subject to balancing adjustment relief and offset against the cost of a replacement asset. Conditions must be met in order to make this choice (ITAA97 s 40-365). A gain on the disposal of a depreciating asset would normally give rise to a capital gain however this gain is specifically disregarded under ITAA97 s 118-24. Note that CGT event K7 applies to capture gains relating to the non-business use of depreciating assets. Printing press 1 balancing adjustment Diminishing value method (ITAA97 s 40-72): Opening adjustable value  Asset’s effective life  $150,000  10 years 

×

×

Days held ×  200%   Days in year 

123 × 200% = $10,082  366* 

*Adjusted for leap year Adjustable value on 1 November 2019: $150,000 − $10,082 = $139,918 Since the adjustable value at the time of disposal of $139,918 is greater than the termination value of $65,000, the difference of $74,918 is deductible for Alpine Printing in the 2019/20 year. Printing press 2 balancing adjustment Diminishing value method (s 40-72): Opening adjustable value  Asset’s effective life  $100,000  10 years 

×

×

Days held  Days in year 

× 200%

215 × 200% = $11,749  366* 

*Adjusted for leap year Adjustable value on 1 February 2020: $100,000 − $11,749 = $88,251 Since the adjustable value at the time of disposal of $88,251 is less than the termination value of $125,000, the difference of $36,749 is assessable income for Alpine Printing in the 2019/20 year. Printing press 3 balancing adjustment Diminishing value method (s 40-72): Opening adjustable value  Asset’s effective life  $100,000  10 years 

×

×

Days held  Days in year 

× 200%

275 × 200% = $15,027  366* 

*Adjusted for leap year Adjustable value on 1 April 2020: $100,000 − $15,027 = $84,973 Since the adjustable value at the time of destruction of the printing press of $84,973 is less than the termination value of $132,000, the difference of $47,027 is assessable income for Alpine Printing in the 2019/29 year. Printing press 4 depreciation for 2019/20 year Because Alpine Printing’s press 3 was involuntarily destroyed/disposed of, the balancing adjustment of $47,027 that would be added to assessable income for the 2019/20 year may be used as balancing adjustment relief in conjunction with the purchase of printing press 4 (s 40-365). The balancing adjustment amount can be deducted from the opening adjustable value of the replacement asset, namely, printing press 4. Assuming that Alpine Press made the choice to offset the balancing adjustment against the replacement press, the opening adjustable value for printing press 4 would be: $180,000 − $47,027 = $132,973. A medium-sized business entity can immediately write off the cost of an eligible asset in the income year in which it starts to use it or has it installed ready for use for a taxable purpose if the cost of the asset at the end of that year is less than the applicable threshold (s 40-82(1)). Between 12 March 2020 and 31 December 2020, the applicable threshold is $150,000 (between the start of the income year and 11 March 2020, it was $30,000). Generally, an entity is a medium-sized business in an income year if it carries on a business with a turnover of $10m or more (and so is not a small business entity), but has a turnover of less than the applicable higher threshold. Between 12 March 2020 and 31 December 2020, the higher threshold is $500m (previously $50m between the start of the income year and 11 March 2020). The cost of the asset for depreciation purposes is $132,973 and it was acquired on 1 May 2020. Accordingly, Alpine Printing is entitled to a deduction for the cost of printing press 4 of $132,973 for the 2019/20 year. Summary: Alpine Printing assessable income and deductions for 2019/20 Assessable income Balancing adjustment — printing press 2 $36,749 Balancing adjustment — printing press 3 $47,027 Deductions Balancing adjustment — printing press 1

$74,918

Instant write-off — printing press 4 (assuming that the balancing adjustment for printing press 3 is offset against purchase price of printing press 4)

$132,973

AMTG: ¶17-485, ¶17-500, ¶17-630, ¶17-640, ¶17-710

¶6-100 Worked example: Balancing adjustments; disposal of business and nonbusiness assets; capital gains Issue Larry Mellor is the managing director of Construction Machinery Pty Ltd. The company’s assets comprise machinery for excavations and constructions on building sites. Over the course of 2019/20, the company disposed of three of its machines. The company self-estimates the effective life of each of the machines and chooses to calculate the decline in value using the diminishing value method. The details in relation to the disposals are: 1. Excavator Opening adjusted value: 1 July 2019

$21,000

Effective life

Four years

Percentage taxable purpose/business use

100%

Date of disposal

30 September 2019

Termination value — sold for scrap

$20,000

2. Crane Opening adjusted value: 1 July 2019

$25,000

Effective life

Four years

Percentage taxable purpose/business use

60%

Date of disposal

26 January 2020

Termination value — sale

$20,813

3. Generator Purchase price — 1 July 2017

$40,000

Effective life

Eight years

Percentage taxable purpose/business use

80%

Date of disposal

31 March 2020

Termination value — sale

$30,282

Advise Construction Machinery Pty Ltd as to the taxation consequences arising in 2019/20 from the disposal of the three pieces of machinery. Solution Deduction for decline in value of depreciating assets A taxpayer can deduct an amount equal to the decline in value, for an income year, of a depreciating asset, to the extent that the asset is used for a taxable purpose (s 40-25(1), (2)). A depreciating asset is an asset that has a limited effective life and that is reasonably expected to decline in value over the time that it is used (ITAA97 s 40-30). In general, taxable purpose equates with business purpose and nontaxable purpose equates with private use or purpose. The taxpayer is free to estimate the effective life of the asset (ITAA97 s 40-105) and has a choice of applying the diminishing value (ITAA97 s 40-72) or prime cost method (ITAA97 s 40-75) in calculating the annual decline in value. Apportionment is necessary where the asset is used for only part of a year (s 40-72) or is used for both

taxable and non-taxable purposes (s 40-25(2)). The concepts of adjustable value and opening adjustable value (ITAA97 s 40-85) are also relevant to the calculation of the decline in value of a depreciating asset and balancing adjustments for the asset. The opening adjustable value for an income year is the adjustable value of the asset at the end of the previous income year. Balancing adjustment on disposal of depreciating assets The disposal of an asset, for example, by sale or trade-in may give rise to a balancing adjustment event. The effect of a balancing adjustment event is: • if the termination value of the depreciating asset is less than its adjustable value on disposal, the difference is deductible in the year of the event (ITAA97 s 40-285(2)), and • if the termination value of the depreciating asset is more than its adjustable value on disposal, the excess is assessable income (s 40-285(1)). The general rule is that the termination value of an asset is the amount the taxpayer is taken to have received for the balancing adjustment event (ITAA97 s 40-305). If the deduction for the decline in value of a depreciating asset held by the taxpayer is reduced because the asset was used for non-taxable purposes, any balancing adjustment amount that would otherwise be assessable or deductible is reduced by the following fraction (ITAA97 s 40-290): Sum of reductions  Total decline  CGT events and balancing adjustments A capital gain or loss on the disposal of a depreciating asset which gives rise to a balancing adjustment is ignored (ITAA97 s 118-24(1)) unless CGT event K7 applies (s 118-24(2)). A capital gain or loss can only arise if a CGT event takes place (ITAA97 s 102-20). CGT event K7 happens where a balancing adjustment event happens to a depreciating asset that has been used or installed ready for use, wholly or partly for a non-taxable purpose (ITAA97 s 104-235). Consistency in treatment between CGT rules and capital allowance rules To ensure consistency of treatment between the capital allowance rules and the CGT rules, a capital gain or loss under CGT event K7 is calculated on the basis of the asset’s cost and termination value, instead of the usual CGT basis of cost base and capital proceeds (ITAA97 s 104-240). There are three possible situations that could apply on the disposal of a depreciating asset: • If the use of the asset is 100% taxable, CGT event K7 does not apply, but there is a balancing adjustment under the capital allowances system (s 40-285, s 118-24). • If the use of the asset is 100% non-taxable, there will be a capital gain or loss under CGT event K7 based on the difference between the asset’s termination value and its cost (ITAA97 s 104-240) and there will be no balancing adjustment. • If there is both business and non-business use of the asset, there may be both a balancing adjustment and a capital gain or loss. The capital gain or loss will be based on the difference between the termination value and the cost apportioned to reflect the taxable component of the decline in value (s 104-240). Under CGT event K7, if the cost of the asset exceeds its termination value, the excess multiplied by the percentage of non-business use is a capital loss. If the termination value of the asset exceeds its cost, the excess multiplied by the percentage of nonbusiness use is a capital gain. A capital gain made as a result of CGT event K7 can be a discount capital gain but is not eligible for the CGT small business concessions.

Calculating capital gains and losses In working out capital gains and losses, if the capital proceeds exceed the cost base or indexed cost base, the difference is a capital gain. If there is no capital gain, the capital proceeds are subtracted from the reduced cost base (ITAA97 s 11055) of the asset and if the reduced cost base exceeds the capital proceeds, the difference is a capital loss. If the capital proceeds are less than the cost base but more than the reduced cost base, there is neither a capital gain nor a capital loss. In other words, the taxpayer has made a monetary capital gain but a real capital loss. Disposal of excavator $ Opening adjustable value — 1 July 2019

21,000

Decline in value to 30 September 2018: $21,000 / 4 × 92 / 366* × 200% Adjusted value at time of disposal: $21,000 − $2,639

2,639 18,361

Balancing adjustment: Termination value less adjusted value: $20,000 − $18,361

1,639

*Adjusted for leap year Since the termination value ($20,000) exceeds the adjusted value on disposal ($18,361), the excess of $1,639 is included in the company’s assessable income for 2019/20. Disposal of crane $ Opening adjustable value — 1 July 2019

25,000

Decline in value to 26 January 2019: $25,000 / 4 × 210 / 366* × 200%

7,172

Adjusted value at time of disposal $25,000 − $7,172

17,828

Deduction for 60% taxable purpose/business use: $7,172 × 60%

4,303

Termination value

20,813

*Adjusted for leap year Balancing adjustment: Termination value less adjusted value: $20,813 − $17,828

2,985

Adjusted balancing charge: $2,985 × 60% taxable purpose/business use

1,791

The balancing adjustment, being the difference between the termination value ($20,813) and the adjusted value at the date of disposal ($17,828) of $2,985 has to be restricted to the 60% business use of the crane. The balancing adjustment adjusted amount of $1,791 ($2,985 × 60%) is included in the company’s assessable income for 2019/20. A capital gain or capital loss will apply to the 40% non-business use of the crane, under CGT event K7, depending on whether the termination value exceeds or is less than the cost of the crane, adjusted for the 40% non-business use. Disposal of generator $ Purchase price Decline in value: 1 July 2017 – 30 June 2018

40,000

$40,000 / 8 × 365 / 365 × 200%

10,000

Closing adjustable value — 30 June 2018

30,000

Decline in value: 1 July 2018 – 30 June 2019 Opening adjustable value:

30,000

$30,000 / 8 × 365 / 365 × 200%

7,500

Closing adjustable value — 30 June 2019

22,500

Decline in value: 1 July 2019 – 31 March 2020 Opening adjustable value:

22,500

$22,500 / 8 × 274 / 366* × 200%

4,226

Adjustable value at date of disposal

18,274

*Adjusted for leap year The balancing adjustment, being the difference between the termination value ($30,282) and the adjustable value at the date of disposal ($18,274) of $12,008 has to be restricted to the 80% business use of the generator. The balancing adjustment adjusted amount of $9,606 ($12,008 × 80%) is included in the company’s assessable income for 2019/20. The 20% non-business use of the generator also needs to be taken into account. CGT event K7 applies to the difference between the cost of the generator and its termination value. 20% of the difference will constitute a capital gain or loss: Cost of generator

$40,000

Termination value

$30,282

Excess of cost over termination value

$9,718

Non-business 20% use of the generator $1,944 The amount of $1,944 constitutes a capital loss, on the application of CGT event K7, and can be offset against capital gains made by the company or carried forward to offset future capital gains. Had the termination value exceeded the cost of the generator CGT event K7 would have given rise to a capital gain. The capital gains discount would not apply because the capital gain was made by a company (ITAA97 s 115-10). Further, it would not be possible to index the cost base in order to reduce or eliminate the CGT liability because the generator was acquired after September 1999. AMTG: ¶11-000, ¶11-030, ¶11-240, ¶11-350, ¶11-700, ¶17-480, ¶17-500, ¶17-640, ¶17-660, ¶17-670

¶6-120 Worked example: Disposal of depreciable asset used for private purposes Issue Barry Riley is a sole trader who acquired a tractor on 1 July 2018 for use in his farming business. The tractor was acquired for $24,000 (excluding GST). It was subsequently sold for $21,000 (excluding GST) on 30 June 2020. Throughout the period of ownership, Barry used the tractor 10% of the time for private purposes. The tractor had an adjustable value (ie tax written-down value) on sale of $20,000. The prime cost method was used for calculating the decline in value of the asset using an effective life of 12 years. Barry is registered for GST. Calculate the balancing adjustment arising from the disposal of the tractor for the 2019/20 income year under the capital allowance provisions contained in ITAA97 Div 40. Also determine whether CGT event K7 applies to Barry because of the disposal and calculate any capital gain or loss arising. Solution

Depreciation of tractor in 2018/19 $ Opening adjustable value — 1 July 2018 Depreciation in 2018/19 income year; prime cost method: $24,000/12 × 365/365 Adjusted value at 30 June 2019

24,000 2,000 22,000

As Barry used the tractor for income-producing purposes for 90% of the time, the amount of depreciation that he can claim in 2018/19 is reduced by the private use portion (10%), to $1,800. Depreciation of tractor in 2019/20 $ Opening adjustable value — 1 July 2019

22,000

Depreciation in 2019/20 income year; prime cost method: $24,000/12 × 366/366*

2,000

Adjusted value at 30 June 2020 (date of disposal)

20,000

*Adjusted for leap year As Barry used the tractor for income-producing purposes for 90% of the time, the amount of depreciation that he can claim in 2019/20 is reduced by the private use portion (10%), to $1,800. Balancing adjustment A balancing adjustment is typically required when a taxpayer stops “holding” a depreciating asset because of a “balancing adjustment event” (ITAA97 s 40-285). Typically, a balancing adjustment event happens when a taxpayer disposes of a depreciating asset. An assessable balancing adjustment happens if the asset’s “termination value”, that is the amount received or taken to have been received, is more than its “adjustable value” (tax written down value) just before the event occurred (s 40-285(1)(b)). A deductible balancing adjustment happens if the asset’s termination value is less than its adjustable value just before the time that the event occurred (s 40-285(2) (b)). In this case, the balancing adjustment is calculated as follows: $ Termination value

21,000

Adjustable value

(20,000)

Assessable balancing adjustment

  1,000

If the taxpayer’s depreciation deduction is reduced because the asset was used for a non-taxable purpose, the balancing adjustment is reduced by the following fraction (s 40-290): sum of reductions  total decline  Where: • sum of reductions is the sum of the depreciation deductions for the asset in the hands of the taxpayer, or an earlier transferor (if there is a roll-over) or a deceased taxpayer (if the asset is now held by a legal personal representative), and • total decline is the maximum potential depreciation claim for the asset while being held by the taxpayer, an earlier transferor or a deceased taxpayer. The assessable balancing adjustment ($1,000) is adjusted for private use of the tractor as follows:

$1,000 × 3,600/4,000 = $900 This amount is included in Barry’s assessable income for the 2019/20 income year. CGT event K7 As the depreciating asset was partially used for private purposes, Barry must consider the application of CGT event K7 (s 104-235 and 104-240). The CGT event is triggered when the balancing adjustment event happens, for example a disposal. A separate calculation would be required to work out the capital gain or loss. Under CGT event K7, if the termination value of the asset exceeds its cost (as defined for CGT purposes), the excess, multiplied by the percentage of non-business use, is a capital gain. In contrast, if the cost of the asset exceeds its termination value, the excess, multiplied by the percentage of nonbusiness use, is a capital loss. Barry’s capital gain/loss is calculated as follows: $ Cost Termination value Loss Capital loss

 24,000 (21,000)  3,000  300

The capital loss is calculated by multiplying the excess by the sum of reductions relating to private use, ie $3,000 × ($400 / $4,000) = $300. The balancing adjustment amount included in Barry’s assessable income for 2019/20 is $900. Barry also incurred a capital loss of $300 which can be applied against current year capital gains or carried forward to be offset against future capital gains. For GST purposes, only a partial input tax credit is available on acquisition of an asset where there is private use. A GST adjustment may be required in some instances where there is a change in intended use of the asset. AMTG: ¶11-350, ¶17-630, ¶17-660, ¶17-670, ¶34-110, ¶34-145

¶6-140 Worked example: Purchase of intangible business assets; calculating decline in value Issue Small Co Pty Ltd is in the business of developing video game apps for smartphones. Big Co Pty Ltd acquired the business assets of Small Co Pty Ltd on 1 July 2019. The following intangible assets were acquired by Big Co Pty Ltd as part of the business sale: • a standard patent for a new hardware design • copyright for a smartphone app • trade mark for the smartphone app’s logo, and • license for “off-the-shelf” programming software. All assets are used wholly in the business of Small Co Pty Ltd. Advise Big Co Pty Ltd whether it can claim a deduction for the decline in value of these intangible assets and if so, the relevant method and effective life of the asset under the uniform capital allowance provisions contained in ITAA97 Div 40. Solution

The cost of a “depreciating asset” is generally of a capital nature and is, therefore, not immediately deductible as an ordinary business expense. However, deductions may be available for the decline in value of a depreciating asset to the extent that the asset is being used for a taxable purpose (ie in producing the taxpayer’s assessable income). A depreciating asset is defined as an asset that has a limited effective life and that is reasonably expected to decline in value over the time that it is used (ITAA97 s 40-30). An asset is something that is capable of being put to use in the business of the holder (ie owner of the asset). Intangible assets Certain assets are specifically excluded from being depreciating assets. One such category of excluded assets are “intangible assets” (s 40-30(1)(c)). An exception however is allowed for certain types of assets which include, among other things, intellectual property and in-house software. Intellectual property includes the rights that an entity has under Commonwealth or foreign law as patentee, or as an owner of a registered design or a copyright, or as a licensee of any of those items (ITAA97 s 995-1(1)). That is, a patent, a registered design or a copyright (or a license thereof). A trade mark is not included in the meaning of intellectual property and, therefore, is not a depreciating asset (Interpretative Decision ATO ID 2004/858). In the present case, the patent for new hardware design and the copyright for the smartphone app acquired by Big Co Pty Ltd would be depreciating assets of the company. The trade mark for the smartphone app’s logo is an intangible asset which is not a depreciating asset; instead it is treated as a CGT asset. A CGT asset is defined as any kind of property; or a legal or equitable right that is not property (ITAA97 s 108-5). As noted, “in-house software” is not excluded from being a depreciating asset. In-house software is defined as being computer software, or a right to use such software, that is acquired, developed or commissioned, and that is mainly for the taxpayer to use in performing the functions for which the software was developed, which does not include resale. The license to use off-the-shelf programming software acquired by Big Co Pty Ltd satisfies the meaning of “in-house software”; as it will be used in the business for app development purposes. Methods for calculating decline in value There are two methods available for working out the decline in value of a depreciating asset: the prime cost method (ie straight line) and the diminishing value method (ie reducing balance). Generally, the taxpayer must choose which method to use before lodging their tax return. The choice is exercised on an asset-by-asset basis and on a year-by-year basis. However, the decline in value of intellectual property and in-house software must be calculated using the prime cost method. Under the prime cost method, the annual decline in value of a depreciating asset is calculated by allocating the cost of the asset over its effective life in accordance with the following formula (s 40-75):    cost   effective life

 ×

 days held  days in year

Generally, the decline in value of a depreciating asset is based on the effective life of the asset as selfassessed by the taxpayer or as determined by the Commissioner. However, intangible assets have statutory effective lives prescribed for the relevant asset type (s 40-95(7)). For patents, the effective life depends on whether it is a standard patent, innovation patent or petty patent. In this case, the patent for the hardware design acquired is taken to be a standard patent which has a statutory effective life of 20 years (s 40-95(7), item 1). For the copyright relating to the smartphone app, the statutory effective life is the shorter of 25 years and the period until the copyright ends (s 40-95(7), Item 5). For the in-house software, the statutory effective life is five years (s 40-95(7), item 8). In addition, where an intangible asset is acquired from a former holder, it would be necessary to

determine whether the statutory effective lives apply or whether another life applies. For assets such as patents, the cost of the asset must be spread over the number of years remaining in the effective life of the asset as at the start of the income year in which Big Co Pty Ltd acquires the asset (s 40-75(5) and s 40-75(6)). Therefore, Big Co Pty Ltd can only claim the decline in value of its standard patent over its remaining effective life. It would be necessary for Big Co Pty Ltd to ascertain the remaining years from Small Co Pty Ltd to calculate the decline in value of the patent. Note that the requirement under s 40-75(5) only applies to a patent (whether a standard, innovation or petty patent), registered designs, license (other than one relating to a copyright or in-house software), spectrum license or datacasting transmitter license acquired from a former holder. The cost of copyrights (other than film copyright), license relating to copyrights and in-house software acquired from a previous holder is spread over the statutory effective life applied as from the time of acquisition. As a consequence, Big Co Pty Ltd can claim a deduction for the decline in value for the copyright and its off-the-shelf programming software using the statutory effective life prescribed above. It would be necessary for Big Co Pty Ltd to ascertain from Small Co Pty Ltd whether the copyright has a life with a period shorter than 25 years. AMTG: ¶17-005, ¶17-010, ¶17-015, ¶17-270, ¶17-280, ¶17-370, ¶17-480, ¶17-490

¶6-160 Worked example: Depreciating assets; intangible assets; plant Issue Advanced Technologies Pty Ltd (ATPL) is a company that creates intellectual property products, including sound recordings, cinematograph films, computer games and industrial and commercial computer programs. In 2016, ATPL moved into a purpose built building with sound proofing, dust proofing and temperature control panels in the walls, floor and ceiling. The building accommodated furniture and fittings, computers and sound and video recording equipment. ATPL asserts ownership of copyright in the sound recordings and cinematograph films and has obtained patents for the computer programs. ATPL commissioned the development of computer software for the purpose of the design and production of intellectual property materials. In 2017, ATPL invested in a residential property that was constructed in 2017. The premises have electrical wiring and wiring for communication (phone and internet), plumbing and ducted air-conditioning. The premises are furnished with fixtures and fittings, stove, dishwasher, refrigerator and a washing machine. ATPL seeks advice on the tax deductions available in relation to its building, intellectual property activities and its investment property. Solution Depreciating assets including intangible property and plant A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used (ITAA97 s 40-30(1)). Intangible assets, such as intellectual property and in-house software also qualify as depreciating assets (s 40-30(2)). Under the pre-1 July 2001 capital allowance system the definition of depreciating asset implicitly covered plant. Plant included articles, machinery, plumbing fixtures and fittings and tools of trade. A common law definition was given by Lindley LJ in Yarmouth v France [1887] 19 QBD 647: “… in its ordinary sense, [plant] includes whatever apparatus is used by a business man for carrying on his business … all goods and chattels, fixed or moveable, which he keeps for permanent employment in his business”. Buildings and plant attached to buildings Buildings are not included as depreciating assets under ITAA97 Div 40 but may be depreciated as capital works under ITAA97 Div 43. However, an issue arises where items of plant are “attached to” a building. If the plant is merely attached to the building, the capital allowances under Div 40 apply to the plant.

However, if the plant is integrated into the building (see Wangaratta Woollen Mills Ltd v FC of T 69 ATC 4095 and Taxation Ruling TR 2007/9) or merged with the building, Div 40 capital allowances do not apply and Div 43 deductions for capital works apply. Residential premises and items contained in residential premises The issue of the application of Div 40 or Div 43 also arises for the residential premises, that is for items such as wiring, cabling, plumbing, hot-water, solar panels, stoves and air-conditioning. The test for deciding whether an item is part of residential premises or plant includes (see Taxation Ruling TR 2004/16): • whether the item appears visually to retain a separate identity • the degree of permanence with which the item has been attached • the incompleteness of the structure without the item, and • the extent to which the item was intended to be permanent or whether it was likely to be replaced within a relatively short period. The decline in value of a depreciating asset is calculated on the basis of the effective life of the asset. The taxpayer can self-assess the effective life of depreciating assets (s 40-105) or rely upon the effective life determined by the Commissioner (s 40-95). However, a statutory figure for effective life applies for some assets such as intellectual property (s 40-95(7)). For standard patents the effective life is 20 years and for copyright it is the shorter of 25 years from acquisition of copyright and the period until copyright ends. Further, there is no choice of method in calculating the decline in value of intellectual property and inhouse software, only the prime cost method (s 40-75) can be used (s 40-70(2)). Computer hardware and software Computer hardware qualifies as a depreciating asset and its decline in value is deductible under the Div 40 provisions. In-house computer software also qualifies as a depreciating asset and may be allocated to a software development pool (s 40-450(1)) or treated separately for claiming a deduction for its decline in value. In-house software is computer software acquired, developed or commissioned and used by the taxpayer in performing the functions for which the software was developed. Once an in-house software development pool is created all in-house software must be allocated to that pool. In addition, expenditure on in-house software can only be allocated to the pool if it is used entirely for a taxable purpose (s 40-450(3)). Balancing adjustments are also required for pooled software disposed of. The deduction for in-house software in a software development pool is nil in the first year, 30% in each of the next three years and the remaining 10% in year five (s 40-455). Business premises building The building is not a depreciating asset for which its decline in value can be claimed under Div 40 (s 4030(1)(a)). However, the building can be depreciated at 4% per year under the capital works provisions in Div 43. On the authority of Wangaratta Woollen Mills Ltd v FC of T 69 ATC 4095, ATPL may argue that the cost of sound proofing, dust proofing and temperature controlling the building should be included in the cost of the building in claiming for its decline in value under Div 43. Building premises plant The plant within the building, including fixtures and fittings, computers and recording equipment qualify as depreciating assets, under s 40-30 and the annual decline in value of these assets is deductible over their effective life using either the prime cost or diminishing value methods. Intellectual property created by ATPL Creating intellectual property (ie sound recordings, cinematograph films, video games and computer programs) in the way that ATPL does suggests that the intellectual property is not trading stock (s 4030(1)(b)); as these types of intellectual property are used as tools of trade, they qualify as depreciating assets. The decline in value of the copyright in the sound recordings, cinematograph films, video games

and computer programs is to be calculated based on an effective life of the shorter of 25 years from acquisition of copyright and the period until copyright ends. For computer programs over which the company has a standard patent, the decline in value will be calculated on the asset having an effective life of 20 years (s 40-95(7)). In-house software ATPL has the choice of either allocating its commissioned in-house computer software used in its business to an in-house software development pool or to claim a deduction for its decline in value independent of the pool over five years. If pooled, and if the cost of the in-house software is incurred in 2015/16 or later years, the cost is depreciated over five years, but with none claimed in the first year, three years at 30% each and the final year at 10%. Investment in the residential premises Applying the opinion of the Commissioner in Taxation Ruling TR 2004/16, ATPL may be required to accept that the electrical and communications wiring, plumbing, ducted air-conditioning, fixtures and fittings are not plant and not depreciating assets under s 40-30(1). However, the dishwasher, stove, refrigerator, washing machine and the power unit for the air-conditioner are plant and their annual decline in value is deductible to ATPL. The items that do not qualify as plant are added to the cost of the building and will be depreciable, at 2.5%, under Div 43. AMTG: ¶17-015, ¶17-040, ¶17-280, ¶17-370, ¶17-490, ¶20-510

¶6-180 Worked example: Commercial website development expenditure Issue Jenny Fowler operates a florist business which trades as Blossoming Flowers. On 1 May 2018, Jenny engaged Spider Web Pty Ltd, a web developer, to help her create a website for her business to sell bouquets and flower arrangements online and attract new customers. The total costs for the development of the website was $5,000 (excl GST) and was conducted in two phases. A payment of $2,500 (excl GST) was required to be made after each phase is completed. Phase 1 was to develop the website with content about the business, which included the following features: • business and contact details • opening hours • promotional text identifying the types of occasions and flowers used • a subscription facility for promotion and sales emails, and • links to the business’s social media pages. Phase 1 was completed on 1 June 2018 and website went live on that date. Payment was made before the end of the 2018/19 year. Phase 2 was to develop an online sales facility, which included the following features: • a product catalogue • a shopping cart • a payment facility • a back-end stock database and a back-end customer database. Phase 2 was completed on 1 August 2019 and went live on the website on that date. Payment was made

before the end of August 2019. In the 2019/20 income year, Jenny also incurred the ongoing yearly costs of domain name registration — $50 (excl GST); and server hosting — $500 (excl GST). Jenny, trading as Blossoming Flowers, is not a “small business entity” under ITAA97 Div 328 and she is registered for GST. What is the tax treatment of the expenditure incurred in having the website developed and the yearly costs of domain name registration and server hosting to Jenny? Solution The tax treatment of commercial website development expenditure is set out by the Commissioner in Taxation Ruling TR 2016/3. A website is an intangible asset consisting of software, and includes software integrated into the website for online use by a website user. Whether expenditure on a commercial website is deductible under the general deduction provisions contained in ITAA97 s 8-1 depends on whether the expenditure is on capital or revenue account. If the expenditure is taken to be on capital account, the expenditure may constitute “in-house software” and be deductible pursuant to the capital allowances regime contained in ITAA97 Div 40. Expenditure which is incurred in acquiring or developing a commercial website for a new or an existing business is on capital account. Such expenditure, which includes the cost of labour, would ordinarily relate to enhancing the profit-yielding structure of the business. TR 2016/3 provides that expenditure incurred in relation to development of a commercial website is “inhouse software” if the following are satisfied: • the expenditure relates directly to the commercial website • the commercial website is mainly used by the business for interaction with customers (ie any copyright in the website is not itself exploited for profit), and • the expenditure is not deductible under a provision outside Div 40 and 328. In the present case, the expenditure incurred engaging Spider Web Pty Ltd to develop the website for Blossoming Flowers is a capital expense on the basis that it is an enduring feature of the business with the objective of promoting the business and attracting new customers. The website is a depreciating asset; it is software used by the business to establish an online profile, increase brand awareness and allows customers to transact. It is “in-house software” and depreciable under Div 40. Expenditure incurred on in-house software can be treated under Div 40 as follows: • deducted over five years using the prime cost method from the time the in-house software is first used or installed ready for use, or • alternatively, if the expenditure is incurred on developing computer software, the expenditure may be allocated to a software development pool and deducted in accordance with the pool rules. The simpler compliance approach would be for the in-house software to be deducted over five years using the prime cost method (ie straight-line basis) — rather than to maintain a pool which requires a separate pool to be maintained for each income year that expenditure is incurred. If Jenny, trading as Blossoming Flowers, was a small business entity under Div 328, she would be eligible to claim an immediate deduction under the instant asset write-off for the in-house software or failing that, it could be depreciated under the general small business pool. The fact that the payments for the completion of the website are to be made in two instalments relating to each phase of the website’s development does not change the outcome that it is expenditure relating to in-house software. The cost of a depreciating asset — which is relevant to calculating the decline in value of an asset —

comprises a first element and a second element of cost (s 40-175). As the website went live on 1 June 2018 following Phase 1, it is reasonable to conclude that this is when the in-house software was installed and ready for use. The amount incurred, that is $2,500, to implement the website (including basic content) as part of Phase 1 would form part of the first element of the cost of a depreciating asset. Generally, this represents the amount the taxpayer has paid or is taken to have paid to hold the asset, and it is worked out when the taxpayer begins to hold the asset (s 40-180). The decline in value is determined from that date (ie 1 June 2018) using the prime cost method. The decline in value using the prime cost method is worked out using the following formula:    cost  

 ×

effective life

 days held  days in year

The decline in value for the 2018/19 income year is: $2,500 5

×

30

= $41.10

365

The second element of cost of a depreciating asset is the amount the taxpayer is taken to have paid from time-to-time to bring the asset to its present condition (s 40-190). This would typically include the cost of modifications, alterations or improvements made to the asset by the taxpayer during the relevant income year. The expenditure incurred to add an online sales facility enlarges the profit yielding structure of the business. The cost of the upgrade is a capital expense and is expenditure incurred on in-house software. Therefore, the amount of $2,500 incurred by Jenny in relation to the website would form part of the asset’s second element of cost — it is a modification to the website and does not constitute a separate asset. The decline in value of the asset is calculated using the remaining effective life of the asset from when it was first installed and ready for use. However, instead of using the asset’s cost, the “opening adjustable value” plus any second element costs for the year is used instead if second element costs are incurred after the year in which the asset was first used or installed ready for use for any purpose. The opening adjustable value for an income year is the adjustable value of the asset at the end of the previous year. The adjustable value at a particular time is the opening adjustable value for the year plus any second element cost for the year, less its decline in value for the year up to that time. In the year the asset is first used or installed ready to be used for any purpose, the adjustable value of an asset at a particular time is its cost less its decline in value. The opening adjustable value for the 2019/20 year is $4,958.90 (ie $2,500 − $41.10 + $2,500). The decline in value for the 2019/20 year is:

opening adjustable value effective life   

 ×

$4,958.90 4    

days held days in year  ×

366 366*

= $1,239.73

*Adjusted for leap year A domain name is a unique name registered with a domain name registrar. Periodic registration fees for a domain name, including initial registration fees, are revenue expenses and are deductible when paid (see TR 2016/3). The annual registration fee of $50 would be deductible to Jenny. The registration fee should be contrasted to the right to use the domain name — which would be a CGT asset. The cost of hosting the server of $500 would also be on revenue account as it is a cost of running and

maintaining the website. The total deduction available to Jenny for 2019/20 with respect to the costs of establishing and maintaining her website is $1,789.73 (ie $1,239.71 + $500 + $50). AMTG: ¶17-100, ¶17-105, ¶17-370, ¶17-485, ¶17-490

¶6-200 Worked example: Pooling low cost and low value depreciating assets Issue Spotless Cleaning Services operates a chain of dry cleaning and laundry outlets. The business does not qualify as a small business entity under ITAA97 s 328-110 but does conduct a low-value pool for both low-cost and low-value assets (ITAA97 s 40-420 and 40-425). Spotless provides the following information in relation to its low-value pool for 2019/20. • Opening balance of pool as at 1 July 2019 — $12,800. • Purchase of 10 washing machines for $950 each. Eight machines were used 100% of the time for commercial/taxable purposes. The other two machines were only used 50% of the time for commercial/taxable purposes. • The written down value of $600 each for 16 washing machines was added to the pool. All of these machines were used 100% of the time for commercial/taxable purposes. • Disposal of the two washing machines that were acquired earlier in the year and only used 50% of the time for commercial/taxable purposes. The amount received for each machine was $750. Calculate the decline in value of the low-cost and low-value assets added to the low-value pool for 2019/20 and the closing value of the pool as at 30 June 2020. Also, advise Spotless on the consequences of disposing of the two washing machines acquired during the year. Solution Taxpayers can establish a low-value asset pool for depreciating low-cost assets (ITAA97 s 40-425(2)) costing less than $1,000 and low-value assets with an adjustable value of less than $1,000 calculated using the diminishing value method (s 40-425(5)). This does not apply to assets costing less than $300, where an immediate write-off is available (ITAA97 s 40-80(2)). The low-value asset pool is not available for small business entities (ITAA97 s 328-110), rather assets may be allocated to a general small business pool (ITAA97 s 328-185). Nor is the low-value asset pool available for R&D assets that qualify for an R&D offset under ITAA97 s 355-100. A taxpayer that pools a low-cost depreciating asset must pool all low-cost assets acquired during the year and all subsequent years (ITAA97 s 40-430), but this does not apply to low-value assets. Once an asset is allocated to a low-value pool, it must remain in the pool. It is also necessary to estimate the percentage of taxable purpose and non-taxable or private purpose that applies to each asset allocated to the pool (ITAA97 s 40-435). It is only the proportion of taxable or business use that is included in the pool. An adjustment needs to be made for pool assets disposed of during the year. The effect is to reduce the pool closing value for the year. A balancing adjustment arises for assets disposed of that were used for both taxable and non-taxable purposes (ITAA97 s 40-445) — this may give rise to a capital gain or loss depending on the difference between the cost of the asset and its termination value. The decline in value of depreciating assets in a low-value pool for an income year is worked out in the following way (ITAA97 s 40-440): Step 1: Calculate the total of the low-value pool at the end of the year Closing pool balance for the previous income year — 30 June 2019 Add: Cost of low-cost assets allocated to the pool during the year, and the written down value of low-

value assets allocated to the pool Less: Termination value of pool assets disposed of during the year Step 2: Calculate the decline in value of pooled assets for the year Closing pool balance for the previous income year — 30 June 2019, depreciated at 37.5% Cost of low-cost assets allocated to the pool during the year, depreciated at 18.75% Written down value of low-value assets allocated to the pool, depreciated at 37.5% Step 3: Calculate the closing value of the low-value pool at the end of the year Total pool value at the end of the year less decline in value of pool over the year. Decline in value of low-value pool for 2019/20 Step 1: Assets in the low-value pool 2019/20 $ Closing pool balance — 30 June 2019

12,800

Add: Low cost assets — washing machines allocated to the pool: Eight washing machines used 100% for taxable purposes: 8 × $950

7,600

Two washing machines used 50% for taxable purposes: 2 × $950 × 50%

950

16 washing machines used 100% for taxable purposes: written down value of $600 each

9,600

Less: Disposal of two washing machines used 50% for taxable purpose: $750 × 2 × 50%

 (750)

Total value of assets in the low-value pool:

30,200

Step 2: Calculation of decline in value of low-value pool 2019/20 $ Closing pool balance — 30 June 2019: $12,800 × 37.5%

4,800

Low cost assets — washing machines allocated to the pool: Eight washing machines 100% taxable purpose: 8 × $950 × 18.75%

1,425

Two washing machines 50% taxable purpose: 2 × $950 × 50% × 18.75%

178

16 washing machines with written down value of $600 each: $9,600 × 37.5%

 3,600

Total decline in value of assets in the low-value pool:

10,003

Step 3: Closing balance of low-value pool as at 30 June 2020 $ Total value of assets in the low-value pool 2019/20

30,200

Less: decline in value of assets in the low-value pool 2019/20

(10,003)

Closing balance of assets in low value pool as at 30 June 2020

 20,197

Consequences of disposing of two washing machines during 2019/20 The termination value of the taxable purpose proportion of the two washing machines disposed of during 2019/20 reduces the closing balance of the low-value pool. Had the termination value exceeded the closing pool balance, the difference would have been added to Spotless Cleaning Services’ assessable income for the year. As for the 50% non-taxable usage, the balancing adjustment may trigger CGT event K7. If the termination value exceeded the cost of the washing machines a capital gain arises, whereas, if the termination value

is less than the cost a capital loss is incurred. Given that the termination value of 50% of $750 is less than the 50% of $950 cost of the washing machines, Spotless Cleaning Services has incurred a capital loss on the disposal of the two washing machines. AMTG: ¶17-330, ¶17-420, ¶17-670, ¶17-810

¶6-220 Worked example: Small business entity assets; general small business pool Issue Ashley Cooper is a sole proprietor manufacturing furniture and trading as Furniture Fantastic. His annual turnover is $1.4m and he qualifies as a small business entity. At the commencement of the 2016/17 year, the opening balance of his general small business pool was $28,000. Ashley seeks advice on the taxation treatment of the following transactions in his small business pool for the 2016/17, 2017/18, 2018/19 and 2019/20 tax years. On 1 August 2016, Ashley purchased a new Lexus motor vehicle at a cost of $35,000 with 70% business usage and an effective life of five years. Its decline in value will be calculated using the diminishing value method. On 12 September 2016, Ashley purchased a new machine for assembling furniture. The machine was used 100% in the business and was estimated to have an effective life of eight years. The cost of the machine was $200,000. On 11 November 2017, Ashley made an addition to a woodworking machine, purchased some years ago, at a cost of $75,000. On 15 March 2018, Ashley installed a 3D printer to assist in the design of the furniture that he manufactures. The printer cost $24,000. On 1 April 2019, Ashley sold the Lexus motor vehicle for $26,000. On 1 July 2019, Ashley purchased an additional assembling machine for $15,000 which was used 100% in the business. Solution The small business entity (SBE) regime in ITAA97 Subdiv 328-D provides concessional and simpler depreciation rules for SBEs. The current requirements to qualify as an SBE are that businesses aggregate turnover must be less than $10m (ITAA97 328-110). The provisions provide for immediate write-offs, a general small business pooling arrangement and simplified balancing adjustments on the disposal of assets. An immediate deduction is available for a low-cost asset in the income year in which it was first used, or installed ready for use for a taxable purpose. An immediate deduction can be applied to: • an asset costing less than $20,000 — where the asset was acquired on or after 7.30 pm on 12 May 2015 and first used or installed ready for use between 7.30 pm on 12 May 2015 and 28 January 2019 (Income Tax (Transitional Provisions) Act 1997 s 328-180(4)) (where the depreciating asset was acquired before 12 May 2015 but first used after this time the $1,000 threshold applies) • an asset costing less than $25,000 — where the asset was acquired on or after 29 January 2019 and first used or installed ready for use between 29 January 2019 and 7:30 pm on 2 April 2019 • an asset costing less than $30,000 — where the asset was acquired on or after 7:30 pm on 2 April 2019 and first used or installed ready for use between 7:30 pm on 2 April 2019 and 11 March 2020 • an asset costing less than $150,000 — where the asset was acquired on or after 12 March 2020 and first used or installed ready for use between 12 March 2020 and 31 December 2020, or • an asset costing less than $1,000 — in any other case (s 328-180(1)). Apportionment is required where assets are used for both business and private use. It is only the

business proportion that is considered in calculating the decline in the assets value and termination value on disposal of the asset. Assets added to the general small business pool during the income year are depreciated at 15% (s 328190(2)), while the opening pool balance is depreciated at 30% (s 328-190(1)). The opening pool balance at the commencement of one year is the closing pool balance from the previous year. The closing pool balance (ITAA97 s 328-200) is calculated by starting with the opening pool balance equal to the closing pool balance from the previous year and: • adding to that figure, the business use proportion of the adjustable value of each new asset or asset improvement that was first used in that year, then • subtracting from that figure the: i. business use proportion of the termination value of any pooled depreciating asset that has been disposed of during the year ii. deductions allowed for the pool’s depreciation for the year (s 328-190(1)), and iii. deductions allowed for depreciation on an asset or improvement allocated to the pool used or installed ready for use for a taxable purpose during the year. Where the general small business pool is between $0 and $1,000, the balance is written-off immediately, instead of claiming the 30% deduction (s 328-210(1) and 328-210(2)). If the pool balance would be less than $0 due to balancing adjustment events, the negative amount is added to assessable income (s 328215(2)) and the pool’s balance reverts to zero (s 328-215(3)). However, for an income year that ends during the period 12 May 2015 to 30 June 2018, a deduction for the pool balance can be claimed in the income year where the balance of the pool, prior to the calculation of the depreciation for that income year is less than $20,000. For the income year that ends on 30 June 2019, a deduction for the pool balance can be claimed in the income year where the balance of the pool prior to the calculation of the depreciation for that income year is less than $30,000. For the income year that ends on 30 June 2020, a deduction for the pool balance can be claimed in the income year where the balance of the pool prior to the calculation of the depreciation for that income year is less than $150,000. Taxation treatment of transactions in Ashley Cooper’s general small business pool in 2016/17 Depreciation deductions: Asset

Depreciation calculation

Deduction $ 

Opening pool balance: $28,000

$28,000 × 30%

8,400

Purchase of Lexus: $35,000

($35,000 × 70%) × 15%

3,675

Purchase furniture machine $200,000

$200,000 × 15%

Total depreciation deductions: 2016/17

30,000 42,075

Closing balance of the general small business pool: Transaction

Calculation

Amount $ 

Opening pool balance: 1 July 2016

$28,000

28,000

$35,000 × 70%

24,500

Additions during the year: Lexus motor vehicle Furniture machine

200,000

Less: Total depreciation deductions (s 328-190)

 (42,075)

Closing balance of general small business pool: 30 June 2017

210,425

Taxation treatment of transactions in Ashley Cooper’s general small business pool in 2017/18 Depreciation deductions: Asset

Depreciation calculation

Deduction $ 

Opening pool balance: $210,425

$210,425 × 30%

63,127

Cost addition amount: (s 328-190(3))

$75,000 × 15%

11,250

Purchase of 3D printer: $24,000

$24,000 × 15%

3,600

Total depreciation deductions: 2017/18

77,977

Closing balance of the general small business pool: Transaction

Calculation

Amount $

Opening pool balance: 1 July 2017

$210,425

210,425

Additions during the year: 3D printer

$24,000 × 100%

24,000

Cost addition amount

75,000

Less: Total depreciation deductions (s 328-190)

(77,977)

Closing balance of general small business pool: 30 June 2018

231,448

Taxation treatment of transactions in Ashley Cooper’s general small business pool in 2018/19 Depreciation deductions: Asset

Depreciation Calculation

Deduction $

Opening pool balance: $231,448

$231,448 × 30%

69,434

Total depreciation deductions: 2018/19

69,434

Closing balance of the general small business pool: Transaction

Calculation

Amount $

Opening pool balance: 1 July 2018

$231,448

231,448

Less: Total depreciation deductions (s 328-190) Disposal proceeds (termination value) of Lexus

(69,434) $26,000 × 70%

(18,200)

Closing balance of general small business pool: 30 June 2019

143,814

Taxation treatment of transactions in Ashley Cooper’s general small business pool in 2019/20 Closing balance of the general small business pool: Transaction

Calculation

Amount $

Opening pool balance:

143,814

Immediate deduction of pool balance (s 328-210)

(143,814)

Closing pool balance of the general small business pool at 30 June 2020 Depreciation deductions

0 Deduction

Total depreciation deductions: 2019/20 Immediate deduction of opening pool balance

143,814

Purchase of furniture assembling machine $15,000 $15,000 × 100% (immediate deduction)

 15,000

Total

158,814

Advice Ashley Cooper is advised that he is entitled to depreciation deductions in relation to assets in his general small business pool of $42,075 (2016/17), $77,977 (2017/18), $69,434 (2018/19) and $158,814 (2019/20). He is further advised that the opening value for his general small business pool on 1 July 2020 is $0. AMTG: ¶7-250, ¶17-325, ¶17-330, ¶17-810

¶6-240 Worked example: Small business entity assets; temporary changes to immediate deduction Issue Matt Eames is a sole proprietor manufacturing furniture and trading as Furniture Edge. The annual turnover of his business is $1.4m. At the beginning of the 2017/18 year, the opening balance of his general small business pool was $28,000. During the year Furniture Edge disposed of pool assets and the pool balance at 30 June 2018 was $980 which was written-off and the pool closed. To take advantage of the more generous accelerated depreciation provisions effective from 12 May 2016, Furniture Edge acquired new assets during 2019/20. On 1 August 2019 Furniture Edge purchased a furniture delivery van for $19,250 and a timber cutting and shaping machine for $44,000. On 29 May 2020, Furniture Edge purchased a furniture assembly machine for $48,000. On 24 August 2019 Furniture Edge commissioned an IT company to develop in-house software to program the machines cutting and shaping the timber and constructing the furniture. This development project cost Furniture Edge $17,400. Advise Matt on the taxation consequences of Furniture Edge’s asset acquisitions over the course of 2019/20. Solution The small business entity (SBE) regime in ITAA97 Subdiv 328-D provides concessional and simpler depreciation rules for small business entities. The current requirements to qualify as an SBE are that a business’s aggregate turnover must be less than $10m (s 328-110). The provisions provide for immediate write-offs, a general small business pooling arrangement and simplified balancing adjustments on the disposal of assets.

Temporary changes to accelerated depreciation for small business assets came into effect on 12 May 2015 and continue until 31 December 2020. The changes necessitate changes to Subdiv 328-D. In particular, the addition of s 328-180 and additions to s 328-175(1), 328-180(1)(b), 328-180(2)(a) and 328180(3)(a), 328-210(1), 328-250(1) and (4) and 328-253(4). The substance of the changes allows for an immediate deduction for assets, acquired or installed ready for use, costing less than $20,000, after 12 May 2015 and before 29 January 2019. From 29 January 2019 to 7:30 pm on 2 April 2019, an immediate deduction is available for assets costing less than $25,000 and from 7:30 pm on 2 April 2019 to 11 March 2020, an immediate deduction is available for assets costing less than $30,000. From 12 March 2020 to 31 December 2020, an immediate deduction is available for assets costing less than $150,000. Assets costing more than the relevant instant write-off amount can be allocated to a general small business pool. Assets allocated to the pool are depreciated at 15% during the year they are allocated to the pool. The general small business opening pool balance is depreciated at 30% using the diminishing value method. Once the pool balance falls below $150,000 (or $30,000 for the income year ended 30 June 2019 and $20,000 for income years up to 30 June 2018), it can be written-off in that year. The changes also apply to software costing less than the instant asset write-off amount, which attracts an immediate write-off. Software costing the instant asset write-off amount or more may be allocated to a software development pool. The five-year lock-out rule does not apply to the temporary changed accelerated depreciation provisions (ITAA97 s 328-175(10)). Immediate write-off/deduction for depreciating assets for 2019/20 Furniture Edge is an SBE with an annual turnover of $1.4m. The business therefore qualifies for the accelerated depreciation provisions effective from 12 May 2015 and can immediately claim a deduction for the $19,250 furniture delivery van in the 2019/20 year. In addition, the business can also claim an immediate deduction for the $48,000 furniture assembly machine acquired in May 2020 (after the instant asset write-off amount had increased to $150,000 per asset). Establishment of a general small business depreciation pool The cost of the timber cutting and shaping machine ($44,000) exceeds the immediate write-off threshold (which was $30,000 at the date of acquisition) and can be allocated to a general small business depreciation pool. The asset allocated to the pool during 2019/20 would normally be depreciated at 15%, using the diminishing value method, for the 2019/20 tax year. However, under s 328-210, a deduction for the pool balance can be claimed in the income year where the balance of the pool prior to the calculation of the depreciation for that income year is less than instant asset write-off threshold. Because of the COVID-19-related increase to the threshold from 12 March 2020, this is $150,000. The balance of the pool before depreciation is $44,000 due to the acquisition of the machine earlier in the year and therefore this amount can be immediately written off. The increased threshold for immediate write-off of assets is a temporary measure. From 1 January 2021, the threshold is scheduled to return to $1,000. Although Furniture Edge disposed of its general small business depreciation pool assets by 30 June 2018, the five-year “lock-out” provisions do not apply to the temporary measures introduced on 12 May 2015 (s 328-175(1)). “In-house software” commissioned by Furniture Edge Under the new temporary arrangements, an immediate deduction is available to Furniture Edge for the $17,400 paid for the development of computer software to co-ordinate the operation of their machines, because the amount is below the instant asset write off threshold ($30,000 at the date the software was commissioned). That is provided Furniture Edge is not currently operating a software development pool, in which case the $17,400 software would have to be added to the pool. AMTG: ¶17-325, ¶17-330, ¶17-810

¶6-250 Worked example: Instant asset write-off; accelerated depreciation; expensive

cars Issue Baxter’s Bulldozers Pty Ltd is an earth-moving company based on the south coast of New South Wales. In January 2020, the premises of Baxters Bulldozers were extensively damaged when a bushfire burned through the area. Several significant items of earth-moving equipment were destroyed in the fire. Following the receipt of insurance proceeds in May 2020, several asset purchases were made: • On 5 May 2020, a new bulldozer (bulldozer 1) was acquired for $188,000, delivered on and first used on the same day. The bulldozer has an effective life of five years. • On 12 May 2020, a further new bulldozer (bulldozer 2) was acquired for $135,000, delivered on 14 May 2020 and first used on 21 May 2020. The bulldozer has an effective life of five years. • On 19 May 2020, a new Alfa Romeo Giulia was acquired for the use of the Managing Director at a cost of $100,000, delivered on 26 May 2020 and first driven by the Managing Director on the same day. • On 24 May 2020, a new Mercedes Benz X-Class dual cab utility vehicle was acquired for the Operations Director at a cost of $87,500. The claimed payload of the vehicle according to the manufacturer is 1,010 kg. The vehicle was delivered on the same day and first driven the following day. Both the Alfa Romeo and the Mercedes Benz will be used for a mixture of business and private use. The turnover of Baxter’s Bulldozers Pty Ltd was expected to be $65m for the year to 30 June 2020. Ronald Baxter, the Managing Director, has requested your advice on the depreciation deductions available in relation to these asset purchases. The company depreciates assets using the diminishing value method. Solution Instant asset write-off For a limited period, entities that qualify as “medium-sized businesses” can immediately deduct the cost of certain depreciating assets, similar to the concession available to small business entities under Div 328. Under ITAA97 s 40-82, this temporary “instant asset write-off” is available for businesses that meet the $500m aggregated turnover test, where the depreciating asset was both acquired and first used or installed ready for use between 12 March 2020 and 31 December 2020 and where the asset costs less than $150,000. From 1 January 2021, the instant asset write-off will only be available for small businesses with an aggregated turnover of less than $10m and the threshold will be $1,000. Backing Business Investment (BBI) — accelerated depreciation Also known as accelerated depreciation, BBI is one of the government’s measures to support business investment following the COVID-19 pandemic, introduced in Sch 2 of the Coronavirus Economic Response Package Omnibus Bill 2020 effective from 12 March 2020. The measure provides accelerated depreciation rates for assets that are first held, and first used or installed ready for use, for the purpose of producing assessable income (taxable purpose) between 12 March 2020 and 30 June 2021 (inclusive) by businesses with aggregated annual turnovers of less than $500m. The measure is contained in s 40-120 of the Income Tax (Transitional Provisions) Act 1997. To be eligible for accelerated depreciation: • the business must have an aggregated turnover of less than $500m • the asset must be a new depreciable asset acquired and first used or installed ready for business use

from 12 March 2020 to 30 June 2021 • the business must have not applied other depreciation deductions or the instant asset write-off. Eligible assets do not include: • second-hand depreciating assets • some specific Div 40 assets subject to low value and software development pools • certain primary production assets • buildings and other capital works deductible under Div 43 • assets that the entity was committed to acquiring before 12 March 2020. For small businesses (those with an aggregated turnover of less than $10m) using the simplified depreciation rules, those assets over the instant asset write-off threshold which are eligible for the BBI are added to the general small business pool. A deduction can then be claimed for an amount equal to 57.5% (rather than 15%) of the business portion of a new depreciating asset in the year the asset is added to the pool. In later years the asset will be depreciated under the general small business pool rules. For an entity with an aggregated turnover of less than $500m in the income year that does not use the simplified depreciation rules, the amount deductible in the income year the asset is first used or installed ready for use is 50% of the cost (or adjustable value where applicable) of the depreciating asset plus the amount of the usual depreciation deduction that would otherwise apply but calculated as if the cost or adjustable value of the asset were reduced by 50%. Effectively, together with the instant asset write-off rules, the accelerated depreciation deduction applies to assets with a cost (or adjustable value if applicable) of: • $150,000 or more for assets acquired and first used or installed ready for use before 1 January 2021 • $1,000 or more for assets acquired and first used or installed ready for use from 1 January 2021 to 30 June 2021. Motor vehicles Section 40-230(1) limits the depreciation deduction in relation to the cost of a “car” (s 995-1(1)) to the “car limit” for the “financial year” in which the taxpayer started to “hold” it, if the cost would otherwise exceed that limit. The car limit applies to passenger vehicles designed to carry a load of less than one tonne or fewer than nine passengers and is $57,581 for the 2019/20 year. In practice, this caps the cost on which depreciation deductions can be calculated. The excess cost over the car limit cannot be claimed under accelerated depreciation, the instant asset write-off or under any other depreciation rules. If a new vehicle carries a load of one tonne or more or carries nine passengers or more, the car limit does not apply and the actual cost of the vehicle can be used for the purpose of calculating depreciation. The one tonne limit relates to the maximum load a vehicle can carry, also known as the payload capacity. It is usually specified by the manufacturer of the vehicle. It does not include the weight of fuel, goods or occupants. Solution Applying the above, Baxters Bulldozers can claim the following depreciation deductions in relation to the year ended 30 June 2020: • Bulldozer 1: An immediate deduction of $98,856 can be claimed under s 40-130 of Income Tax (Transitional Provisions) Act 1997. The remaining balance of the cost ($88,144) will be deprecated over the balance of the asset’s effective life using the diminishing value method. The deduction of $98,856 consists of two elements: – an immediate deduction of 50% of the cost of the asset ($188,000 × 50%) — $94,000

– a depreciation deduction calculated using the diminishing value method based on the remaining cost of $94,000 and an effective life of five years (apportioned for the number of days of ownership in the year): 94,000 ×  5 

×

57  366 

×

200% = $5,856

• Bulldozer 2: An immediate deduction of $135,000 can be claimed under s 40-82(1) in the 2019/20 income year as the cost of the asset is less than $150,000 and it is acquired and first used after 12 March 2020. • Alfa Romeo Giulia: an immediate deduction of $57,581 can be claimed under s 40-82(1) in the 2019/20 income year as the cost of the asset is less than $150,000 and it is acquired and first used after 12 March 2020. The depreciation limit that applies to cars which cost more than the expensive car limit restricts the depreciation deduction to $57,581. This applies to the instant asset write-off and other forms of depreciation deduction. The excess of cost over the expensive car limit ($42,419) cannot be depreciated, either in the current year or any other. However, when the car is sold or otherwise disposed of, the termination value (usually the sale proceeds) of the car is reduced by the ratio of the car’s actual cost to the car limit (s 40-325) for the purposes of calculating the balancing adjustment. • Mercedes Benz X-Class: an immediate deduction of $87,500 can be claimed under s 40-82(1) in the 2019/20 income year as the cost of the asset is less than $150,000 and it is acquired and first used after 12 March 2020. The restriction on depreciation for cars does not apply as the Mercedes Benz X-Class is not a “car” for tax purposes. As its payload capacity is over one tonne, it is classified as a commercial vehicle. Other assets purchased by Baxters Bulldozers Pty Ltd during the income year but before 12 March 2020 cannot access the instant asset write-off and have to be calculated under normal Div 40 rules, usually based on the effective life of the asset. Note that the depreciation deduction for the two motor vehicles is not reduced for private use of the vehicle. Where an employer incurs expenditure on a depreciating asset in connection with the provision of benefits to employees and those benefits would be private in nature if provided by the employees for themselves on their own behalf, then the employer is still entitled to deduct an amount for the full decline in value of the asset on the basis that, from the employer’s perspective, the benefits are provided in respect of the employment relationship. Private use of the vehicles is taken into account by imposing a fringe benefits tax liability on the company. AMTG: ¶17-200, ¶17-330, ¶17-430

¶6-260 Worked example: Composite assets Issue SmallCo has setup a new branch office, installing two stand-alone desktop personal computers (PC), each comprising a base unit, monitor, keyboard and mouse, and a printer. The business expanded and six months later, SmallCo purchased three additional PCs and set-up a local area network linking the five PCs. One PC has a server and the other PCs share the same software. Users can access a shared database, however these computers can also operate independently, running their own software. SmallCo also purchased a new printer, and a keyboard and mouse to replace those belonging to one of the original two PCs. To what extent should these purchases be treated as separate assets for depreciation purposes for SmallCo? Solution

Whether a set of assets purchased together is depreciable as one item or whether its components are separate depreciating assets will depend on the application of the “functionality” test (see Ready Mixed Concrete (Vic) Pty Ltd v FC of T 69 ATC 4038; FC of T v Tully Co-operative Sugar Milling Association Ltd 83 ATC 4495; Monier Colourtile Pty Ltd v FC of T 84 ATC 4846). In practice, the Commissioner will treat an asset as a separate unit for depreciation purposes if it can be regarded as a whole in itself, is capable of being separately identified, and has a separate function of its own (Taxation Determination TD 93/159). Each of the two initially-purchased PCs, comprising the base unit, monitor, keyboard and computer mouse is a single depreciating asset because the components are intended to function as a whole (ie whether purchased as a single PC package from one retailer or as separate items from different retailers). The two printers are separate depreciating assets (Taxation Ruling TR 94/11). The three additional PCs and the server are separate depreciating assets, as are the new printer, keyboard and mouse purchased separately at a later time. If SmallCo is a small business entity (SBE) it will be able to utilise the SBE depreciation provisions (ITAA97 Subdiv 328-D). This allows for the immediate write-off of assets up to a certain value ($20,000 for the period to 28 January 2019, $25,000 from 29 January 2019 to 7:30 pm on 2 April 2019, $30,000 from 7:30 pm on 2 April 2019 and $150,000 from 12 March 2020) or the adding of the assets to the SBE general pool otherwise. If SmallCo is not an SBE and buys depreciating assets costing less than $1,000, it may elect to claim depreciation using a low-value pool (ITAA97 s 40-420 to 40-445). A low-value pool is easier to maintain than calculating depreciation based on individual assets. AMTG: ¶7-250, ¶17-015, ¶17-810

¶6-280 Worked example: Primary producers; accelerated depreciation rates Issue Phil and Jill Masters are certified organic farmers operating their business through the Masters Family Trust (MFT). In January 2020, they started irrigation works to channel surface water into the crops grown on their farm. The works, which included the construction of a small dam and the purchase and installation of water pumps, cost $100,000 and were completed in time for the start of winter on 1 June 2020. On 3 April 2020, Phil and Jill ordered and paid $60,000 for a silo to store the special organic grain they use to feed their goats and rabbits. The silo was installed on 4 July 2020. Outline the tax treatment of the costs of the irrigation works and organic grain silo for the MFT for the 2019/20 tax year. Solution Cost of irrigation works Capital expenditure on water facilities for primary production land qualifies for an immediate deduction where it is incurred after 7.30 pm on 12 May 2015 (ITAA97 s 40-515 to 40-575). For the deduction to apply, the following conditions must be satisfied: 1. the taxpayer must incur capital expenditure on the construction, manufacture, installation or acquisition of a depreciating asset that is a water facility 2. the expenditure must be incurred primarily and principally to conserve or convey water, and 3. the water must be for use: • in a primary production business conducted by the taxpayer on land in Australia, or • if the expenditure is incurred by an irrigation water provider, the water must be for use in primary production businesses conducted by other entities on land in Australia, to whom water is supplied by the irrigation water provider.

MFT can claim the cost of their irrigation works of $100,000 as an immediate deduction in the 2019/20 income year. Cost of silo for organic grain feed Primary producers may claim a deduction for expenditure on fodder storage assets in the year in which the expenditure is incurred for fodder storage assets first used or installed ready for use on or after 19 August 2018 (ITAA97 s 40-515 to 40-575). The term “fodder” takes its ordinary meaning and refers to food for livestock, usually dried, such as grain, hay or silage including silos, liquid feed supplement storage tanks, bins for storing dried grain, hay sheds, grain storage sheds and above-ground bunkers for silage. MFT’s grain silo meets the definition of a fodder storage asset, and MFT is permitted to immediately deduct the cost. However, the silo is not installed until the 2019/20 income year. The general depreciation rules under s 40-25 state that to claim a deduction the asset must be installed and ready for use. However, in this case where special provisions apply to water facilities, fodder storage assets, fencing assets, the general depreciation rules do not apply. The immediate deduction is available when the amount is incurred and pro-rating is not required. MFT can therefore deduct the full cost of the silo ($60,000) in the 2019/20 tax year. AMTG: ¶17-030, ¶18-080

¶6-300 Worked example: Second-hand depreciating assets in residential premises Issue On 1 June 2019, Marilyn acquired a five-year-old two bedroom house in Melbourne for $400,000. The house was rented out from 3 June 2019. Included in the house at the date of purchase were a number of assets including carpets, window coverings and an air-conditioning unit. The cost allocated to those assets in the purchase price was $10,000. Before she rented the property, Marilyn installed a number of additional depreciating assets including: • curtains that were purchased second hand on eBay — cost $2,000 • second-hand shelving and racking for the garage — cost $2,000 • a second-hand washing machine — cost $500, and • a dishwasher, originally acquired on 1 June 2015, that was previously installed in Marilyn’s own kitchen at the house where she lived elsewhere in Melbourne — value $500. On 28 June 2023, Marilyn decides to sell the apartment for $800,000, which includes $9,000 in respect of assets included as fixtures within the property including: • assets already within the property on purchase — $5,500 • curtains purchased in June 2018 — $1,000 • shelving and racking — $2,000 • washing machine — $250, and • dishwasher — $250. What depreciation deductions can Marilyn claim in respect of the above assets? What is Marilyn’s capital gain on the disposal of the property in June 2023? Solution ITAA97 s 40-27 prohibits a deduction for the decline in value of a depreciating asset in residential

premises used to generate rental income where the asset was previously used, that is the asset is not newly used for that purpose. The limitation applies to individuals, SMSFs and closely held trusts, for example family trusts and closely held partnerships. It does not apply to companies and superannuation funds other than SMSFs. The limitation also does not apply where an entity generates rental income in the course of carrying on a business (s 40-27(2)(b)). The limitation therefore targets those investors in residential investment properties, including situations where owner-occupiers subsequently rent out their home. Where assets in the home were previously used, or installed ready for use, by the landlord in a personal capacity, the deduction for the decline in value is not available to the landlord for such depreciating assets after the change of use. The restriction applies to income years starting on or after 1 July 2017. It applies to assets acquired at or after 7.30 pm (AEST) on 9 May 2017 unless the asset was acquired under a contract entered into before this time. Depreciating assets acquired before this time which are moved from a taxpayer’s home into a rental property are also subject to this rule. For s 40-27 to apply, firstly, the depreciating asset must be used or installed ready for use in residential premises to earn rental income (s 40-27(2)(a)). Secondly, the limitation only applies to second-hand or previously used assets (s 40-27(2)(c)). It does not apply to an asset that the entity (seeking to claim the deduction) acquired new for use or installation in a residential investment property. Assets already used or installed in a residential property when an investor acquires the property are therefore caught. Assets previously used by an entity in their residence, or for some other purpose which meant they were not entitled to a deduction for decline in value, are also caught (s 40-27(2)(d)). Accordingly, Marilyn is not able to claim depreciation deductions for any of the items listed. The carpets, window covering and air-conditioning unit that were already in the property at the date it was acquired are pre-existing assets and therefore a deduction for decline in value is not available. Similarly, the curtains, shelving and racking, and washing machine were all acquired second hand and therefore are “previously used”, meaning that a depreciation deduction is not available. Although Marilyn has owned the dishwasher since new, it was previously used for a non-taxable purpose (ie for her own personal use) and is therefore also excluded from a depreciation claim. The sale of the property in 2023 together with the associated depreciating assets will, assuming the legislation remains the same, trigger a balancing adjustment event in relation to the depreciating assets. Per s 104-235(1)(b), where depreciation deductions are denied due to the application of s 40-27, CGT event K7 happens. This will typically give rise to a capital loss since the termination value of a secondhand asset will almost always be less than its cost. A capital gain will arise in the unusual situation where the termination value exceeds the cost of the asset. In either case, the excess is multiplied by the percentage of the total decline in value that was denied to determine the capital gain or loss. In Marilyn’s case, the property was used for rental purposes throughout the period of ownership so apportionment of the capital gain/loss is not required. In relation to the disposal of her depreciating assets, as Marilyn has not been able to claim any depreciation deductions, her balancing adjustment will be nil. As the cost of the assets ($15,000) exceeds their termination value ($9,000), Marilyn made a capital loss of $6,000 arising from CGT event K7. She will also trigger CGT event A1 on the sale of the property itself. Her sale proceeds (excluding the depreciating assets) were $791,000 and the original cost (excluding the depreciating assets) was $390,000. This gives a capital gain arising from CGT event A1 of $401,000. Her total capital gain is $395,000 (arrived at by offsetting the K7 capital loss against the A1 capital gain). AMTG: ¶17-012

INDIVIDUALS Resident individual; calculating tax liability

¶7-000

Taxable income; tax payable

¶7-020

PAYG instalments; tax offsets

¶7-040

Taxable income; tax offsets

¶7-060

Small business income tax offset; trust distributions

¶7-080

Primary producers; non-commercial losses

¶7-100

Tax concessions; personal superannuation contributions

¶7-120

Salary packaging; tax effectiveness

¶7-140

Salary packaging; company car

¶7-160

Salary sacrifice and super guarantee charge

¶7-170

Income averaging scheme applied to sportsperson

¶7-180

Personal services income

¶7-200

Termination payments

¶7-220

Superannuation funds

¶7-240

Superannuation death benefit paid to family members

¶7-260

Downsizer contributions

¶7-265

First Home Super Saver Scheme

¶7-270

Carry-forward concessional superannuation contributions

¶7-275

Total superannuation balance and the bring-forward of non-concessional superannuation contributions

¶7-278

COVID-19: Early access to superannuation

¶7-279

CGT small business retirement exemption

¶7-280

Foreign salary; wages income

¶7-300

Exempt foreign income

¶7-320

Foreign income tax offset amendment period

¶7-340

Temporary residents; taxation of income

¶7-360

Working holiday makers

¶7-380

Taxation of minors

¶7-400

Recovery of HELP debts

¶7-420

Sharing economy; ride-sourcing service; Uber drivers

¶7-440

Medicare levy surcharge; foreign health insurance policy

¶7-460

¶7-000 Worked example: Resident individual; calculating tax liability Lina Chua arrived in Australia on 1 June 2019 to take up a position with a bank and was a resident for tax purposes from that time. Before coming to Australia, Lina was a full-time student in Singapore. She is

single and took out private health insurance when she arrived in Australia. During 2019/20, Lina earned the following amounts: • $120,000 salary — $43,000 tax was withheld by her employer during the year and remitted to the ATO • fully franked dividends of $11,000 with franking credits of $4,714 • unfranked dividends of $800 • rent of $18,000 from an investment property • interest of $750, and • a net capital gain on sale of investments of $170. Lina’s expenditure during 2019/20 is: • self-education expenses $3,800 • gifts to deductible gift recipients $6,500 • investment property repairs $700 • bank fees $120 • brokerage fees on the sale of investments $600, and • work expenses $300. Calculate Lina’s tax liability for 2019/20. Solution An individual’s tax liability for a financial year is calculated according to the following formula in ITAA97 s 4-10(3): Income tax = (taxable income × rate) − tax offsets. The amount of income tax payable is calculated by following five steps: (1) Calculate the individual’s taxable income for the income year. (2) Calculate the gross tax payable on the taxable income according to the applicable tax rates. (3) Calculate the individual’s tax offsets for the income year. (4) Subtract the tax offsets from the gross tax payable — the result is the amount of net tax payable for the financial year. Levies, charges and surcharges may need to be added. Step 1 Lina’s taxable income is calculated according to the formula in ITAA97 s 4-15(1) as: Taxable income = assessable income − deductions Lina’s assessable income is $155,434 (ie $120,000 + $11,000 + $4,714 + $800 + $18,000 + $750 + $170). Franking credits on dividends from Australian companies are assessable per ITAA36 s 44(1). Lina’s employer made $11,400 superannuation guarantee contributions for her during the year ($120,000 × 9.5%). These are not taken into account in calculating her assessable income.

Lina has allowable deductions of $11,170 (ie $3,550 + $6,500 + $700 + $120 + $300). The self-education expenses of $3,800 is reduced by $250 to $3,550 due to the operation of ITAA36 s 82A. As the gifts were made to deductible gift recipients, the amount is deductible under ITAA97 s 30-45. Brokerage fees on the sale of investments would form part of the second element of the cost base of the investment under ITAA97 s 110-35. They would therefore be included as part of the net capital gain listed in assessable income. Lina’s taxable income is $144,264 (ie $155,434 assessable income − $11,170 allowable deductions). Step 2 Lina’s gross tax payable on taxable income of $144,264, using the 2019/20 tax rates for a resident individual, is $36,160.68, calculated as follows: $  Tax on $18,200

0

Plus ($37,000 − $18,200) × 19%

3,572.00

Plus ($90,000 − $37,000) × 32.5%

17,225.00

Plus ($144,264 − $90,000) × 37%

20,077.68 40,874.68

Step 3 Lina is entitled to a tax offset for the $4,714 franking credits. Step 4 Lina’s gross tax payable is reduced to $36,160.68 when the tax offset is subtracted. Step 5 Lina is liable to Medicare levy of $2,885.28 ($144,264 taxable income × 2%). She is not liable to Medicare levy surcharge because she has private health insurance. The low and middle income tax offset (LMITO) is not available to Lina since her taxable income of $144,264 exceeds the upper qualifying threshold of $126,000. Payment of income tax Lina’s net tax payable is $39,045.96 ($36,160.68 gross tax payable + $2,885.28 Medicare levy). When she lodges her income tax return for 2019/20, credit is given for the $43,000 tax withheld by her employer from her salary during the year. As the tax withheld exceeds her tax liability, she is entitled to a $3,954.04 refund ($43,000 − $39,045.96). AMTG: ¶2-090, ¶11-550, ¶16-460, ¶16-950, ¶42-000, ¶42-010

¶7-020 Worked example: Taxable income; tax payable Issue The expenditure and receipts for Ted Jones for 2019/20 comprise the following: Receipts Salary

$ 92,000

Car expenses reimbursed by the employer (cents per kilometre basis)

3,400

Entertainment allowance from employer

2,000

Employer paid holiday

5,000

Expenses

$

Work-related car expenses (using cents per kilometre rate)

3,400

Entertainment expenses incurred on employer’s business

1,000

Interest paid on bank loan used to buy shares in a listed company

750

Donation made to the Arthritis Foundation

250

Dental expenses on behalf of self and family (self: $700, wife: $1,100)

1,800

Medical expenses included an electronic walker for his disabled son

6,700

Jones maintains the following dependants during 2019/20: • his wife Mary, aged 41 years, who received $880 in interest income only, and • his disabled son Paul, aged 20 years, a full-time student who is in receipt of a disability support pension of $1,450 and requires Mary’s full-time care. Ted maintained private patient hospital insurance and neither he nor his spouse were in receipt of any family tax benefits for the 2019/20 tax year. Based on the above information and assuming Ted Jones resides in Ordinary Zone B, determine his taxable income for the 2019/20 tax year and calculate his tax payable including any Medicare levy. Solution Ted Jones taxable income 2019/20 tax year (all legislation references are to ITAA97 unless otherwise stated) Assessable Income Salary (s 6-5)

$

$

92,000

Car reimbursement (s 15-70)

3,400

Entertainment allowance (s 6-5)

2,000 97,400

Deductions Car expenses (s 8-1; 28-25)

3,400

Interest (s 8-1)

750

Donations (s 30-15 — designated gift recipient)

250 4,400

Taxable income

93,000

Tax payable on $93,000 at 2019/20 rates

21,907.00

Less: DICTO1 Zone rebate2

2,474.00 627.00

Medical expenses rebate3 Low and middle income tax offset4

  0.00 990.00 4,091.00

17,816.00 Add Medicare levy (2% × taxable income in 2019/20) TOTAL TAX PAYABLE

1,860.00 19,676.00

The employer paid holiday is neither assessable nor exempt income for the employee under ITAA36 s 23L. It is an expense payment fringe benefit and would be subject to FBT (FBTAA s 20). The entertainment expenses are not deductible (s 32-5). Notes: (1) Dependant invalid carer tax offset (DICTO) The taxpayer and their spouse have an adjusted taxable income for offsets (ATIO) of less than $100,000 and are therefore entitled to a DICTO (s 61-10). Mary is genuinely unable to work due to her carer obligations (ie she is wholly engaged in caring for Paul who is in receipt of a disability support pension).      DICTO (2019/20): $2,766 − [1/4 × (ATIO of the eligible dependent − $282)] = $2,766 − [1/4 × ($1,450 − $282)] = $2,474.00 (2) Zone rebate — Ordinary Zone B (s 79A) Relevant rebate amount = maximum DICTO available + notional dependent rebate (one student, ie $2,474 + $376 = $2,850). Ordinary Zone B is $57 + (20% × $2,850) = $627 (3) Medical expenses rebate (s 159P(4)) A rebate in respect of medical expenses is no longer available from the 2019/20 year of income. The 2018/19 year of income was the final year of the phase-out period in which a rebate was available under ITAA36 s 159P to a taxpayer whose net medical expenses related to disability aids, attendant care or aged care. (4) Low and middle income tax offset (s 61-100 ITAA 1997) The amount of the LMITO is: • for taxpayers with income exceeding $90,000 — $1,080 less 3% of the amount of the income that exceeds $90,000. Ted’s taxable income is $93,000 so he is entitled to a LMITO of $990 ($1,080 – (3000 x 3%)). Ted has adequate private health insurance (hospital cover) and therefore avoids the Medicare levy surcharge. AMTG: ¶2-090, ¶10-060, ¶15-100, ¶15-190

¶7-040 Worked example: PAYG instalments; tax offsets Issue Victoria Jackson is a self-employed interior decorator who advises households and business in the Sydney region of their furnishing needs. Victoria is aged 55 years, single and not registered for GST. After lodging her 2018/19 income tax return, Victoria’s notional taxable income (adjusted for inflation) for the 2019/20 tax year was $48,000, which included a $2,000 donation and a $500 tax agent’s fee. Victoria also paid $1,850 to a private health fund from 1 December 2019 for hospital cover and claimed $250 for TFN amounts withheld from interest. Calculate Victoria’s PAYG instalments for the 2019/20 tax year. Solution

As an individual with investment or business income, Victoria Jackson will have to pay tax by PAYG instalments. The legislation is found in TAA Sch 1 Pt 2-10. Victoria has lodged her tax return for the 2017/18 tax year and her PAYG for the 2018/19 tax year can now be determined. Victoria may be an annual payer if the following conditions are satisfied (TAA Sch 1 s 45-140(1)): • the taxpayer’s most recent notional tax notified by the Commissioner is less than $8,000 • the taxpayer is not required to be registered for GST • the taxpayer is not a partner in a partnership that is registered or required to be registered for GST • if the taxpayer is a company the company is not a participant in a GST joint venture under GST Act Div 51 • if the taxpayer is a company, it is not part of an instalment group (as defined in s 45-145) or participating in GST joint ventures. Victoria meets all these conditions, and can consequently pay an annual instalment at the end of the first quarter of the following year. If she has come into the PAYG system for the first time during the income year, she can pay at the end of the first quarter for which an instalment would normally be due. Taxpayers who cease to be eligible to pay PAYG on an annual basis will commence paying PAYG instalments from the first quarter of the following income year. Pursuant to TAA Sch 1 s 45-325(1), notional tax is the adjusted tax on adjusted taxable income for the base year, reduced by the adjusted tax on adjusted withholding income. (1) Adjusted taxable income = total assessable income less allowable deductions from the most recent assessment: $ Total assessable income

50,500

Less: Donation

2,000

Tax agent’s fee

   500

ADJUSTED TAXABLE INCOME

48,000*

*Note: The interest that was subject to TFN withholding does not count as adjusted withholding income. It is noted that Victoria is entitled to a tax offset for private health insurance pursuant to ITAA97 s 61-205, subject to Subdiv 61-G conditions being met. These include the requirement that the premium be paid in respect of a “complying health insurance policy”, such as one that provides hospital cover and/or ancillary cover, and also that the premium is paid in the same income year that it is claimed as an offset. The private health insurance rebate is reduced for individuals earning more than $90,000, or families earning more than $180,000. The offset cuts out completely for singles earning more than $140,000 and families earning more than $280,000. An individual’s entitlement to the offset is now tested against their income for Medicare levy surcharge purposes. Therefore Victoria is entitled to a private health insurance rebate of $137.70 calculated as follows: $1,057  × $793 ×

122 ×    366  25.059%^

= $88.29

91 ×  25.059%  366 

= $49.41

Total $137.70 ^A rebate of 25.059% applies as Victoria is aged less than 65 years, single and has an income of less than $90,000 for the period 1 December 2019 to 31 March 2020. The rebate percentage from 1 April

2020 to 30 June 2020 is also 25.059%. Victoria is also entitled to a low income rebate of $280 under ITAA36 s 159H calculated as follows: $  Maximum rebate amount

445

Less: reduction in rebate [($48,000 − $37,000) × 0.015]

165

Low income tax offset entitlement on assessment

280

In addition, Victoria is entitled to a low and middle income tax offset (LMITO) under ITAA97 s 61-100 amounting to $1,080 2) Adjusted tax on adjusted taxable income at 2019/20 rates: $      Tax payable on $48,000 (2019/20 rates)

7,147

Less: Private health insurance tax offset

138

Low income tax offset

280

LMITO

1,080 5,649

  Plus: Medicare levy ($48,000 × 2%) 2019/20 NOTIONAL PAYG TAX INSTALMENT

   960 6,609

AMTG: ¶15-300, ¶15-330, ¶27-120, ¶27-200, ¶27-260

¶7-060 Worked example: Taxable income; tax offsets Issue Ian Jacobs, aged 67 years, is married with children. Ian derived $56,000 in salary, $3,000 in bonuses, $800 in bank interest and $5,400 in fully franked dividends during the 2019/20 income tax year. His deductions, which all relate to earning his salary, totalled $2,342. Ian’s wife Mandy does not work and is in receipt of a disability support pension. She had an adjusted taxable income of $730 (including the pension) for the 2019/20 tax year and was not entitled to, nor claimed any family tax benefits. Ian had adequate private hospital health insurance cover for the year and the tax paid on Ian’s salary totalled $12,167 during the 2019/20 tax year. Based on the above information, calculate Ian Jacobs’s taxable income and tax payable/refund including Medicare levy for the tax year ended 30 June 2020. Solution Calculation of Ian’s tax liability for 2019/20 (all legislation references are to ITAA97 unless otherwise stated) Assessable Income Salary (s 6-5) Bonuses (s 15-2) Bank interest (s 6-5) Dividends (ITAA36 s 44)

$

$

56,000 3,000 800 5,400

Gross up for franking credit ($5,400 × 30 / 70) (s 207-20)

       2,314

Total income

67,514

Less: Deductions

        2,342

TAXABLE INCOME

   65,172

Tax payable on $65,172 (2019/20 tax rates)

12,727.90

Less: Offsets Dependant invalid carer tax offset (DICTO)^ (s 61-10)

2,654.00

Low income tax offset (LITO)† (s 159H, 159N)

22.42

Low and middle income tax offset* (s 61-100)

1,080

Franking credit (s 207-20)

  2,314.28 6,070.70 6,657.20

Add: Medicare levy ($65,172 × 2%)

  1,303.44 7,966.64

Less: Credit for PAYG withheld from salary

12,167.00

TAX REFUND

 4,206.36

^DICTO calculation

$

Maximum tax offset available (2019/20)

 2,766

Reduced for Mandy’s adjusted taxable income for offsets less ¼ of ($730 − $282) (ignore cents)

  112

DICTO

2,654

†LITO calculation

$

Maximum tax offset available Reduction for taxable income [($65,172 − $37,000) × 0.015] LITO

     445    (422.58)       22.42

*LMITO calculation Australian resident individuals (and certain trustees) with relevant income that does not exceed $126,000 are entitled to the low and middle income tax offset (LMITO) for the 2019/20, 2020/21 and 2021/22 income years. The amount of the LMITO is: • for taxpayers with income not exceeding $37,000 — $255 • for taxpayers with income exceeding $37,000 but not exceeding $48,000 — $255 plus 7.5% of the amount of the income that exceeds $37,000 • for taxpayers with income exceeding $48,000 but not exceeding $90,000 — $1,080, and • for taxpayers with income exceeding $90,000 but not more than $126,000— $1,080 less 3% of the amount of the income that exceeds $90,000. As Ian’s taxable income is $65,172, he is entitled to the maximum offset of $1,080. AMTG: ¶2-090, ¶2-320, ¶4-800, ¶15-100, ¶15-300

¶7-080 Worked example: Small business income tax offset; trust distributions Issue The Kent Family Trust (KFT) carries on a business in the food industry and is a small business entity in relation to its business activities. The discretionary beneficiaries of the KFT include Dominic and Rebecca Kent, and their two children, Sally and Thomas who are both under 18 years of age. Dominic and Rebecca are employed and jointly own some passive investments. Their taxable income for 2019/20, disregarding any distributions from the KFT, is $130,000 each. For the 2019/20 income year, KFT’s net income is $62,000 comprising of: $       Gross trading income Deductible business expenses related to trading operations

80,000 (22,000)

Franked dividends — $14,000 and $6,000 franking credits

20,000

Net rental income from an investment property

15,000

Net capital gain from the sale of a business asset

3,000

Professional tax adviser fees

(3,000)

Expenses related to managing the share portfolio

(1,000)

Prior year losses

(30,000)

NET INCOME

 62,000

According to the trust deed, the distributable income of the trust is equal to its net income for tax purposes. Rebecca, as trustee of the KFT, will distribute all of the income of the trust for 2019/20. She is making trust distributions for the first time because the trust was settled in 2017/18 and it was in losses in that year and 2018/19. Advise Rebecca on how to effectively distribute the income of the trust. Solution Net small business income Only an individual taxpayer is eligible to claim the small business income tax offset. A taxpayer’s small business income tax offset will be equal to 8% of tax payable on “total net small business income” up to a maximum of $1,000 (ITAA97 s 328-360). The taxpayer’s total net small business income is the sum of (s 328-360(1)): • the “net small business income” they make from their sole trader small business entity (SBE) • their share of the “net small business income” of an SBE (other than a company) that is included in their assessable income (which would include net small business income that forms part of a distribution from the KFT). An entity’s “net small business income” is defined in ITAA97 s 328-365 as assessable income (with some exceptions) that relates to the entity carrying on a business, less allowable deductions (with some exceptions) that are attributable to that income. Income included in net small business income For the KFT, its $80,000 gross trading income is the only item of income that is included in its net small business income. The dividends and rental income are not included as those amounts do not relate to the SBE’s business. The legislation specifically excludes the net capital gain from the calculation of KFT’s net small business income (s 328-365(1)(a)(i)). Treatment of deductions

To calculate its net small business income, KFT must reduce its net small business income by the deductions that are attributable to the assessable income. This amount is the $22,000 deductions that are attributable to the derivation of the trading income (s 328-365(1)(b)). The $1,000 share portfolio expenses are not included as they are not attributable to the trading income. In addition, the tax adviser expenses that are deductible under ITAA97 s 25-5 are specifically excluded (ITAA97 s 328-370). KFT’s net small business income is therefore $58,000, that is trading income less attributable deductions ($80,000 − $22,000). Distributions to Thomas and Sally Minors are not eligible for the small business income tax offset unless the income is derived from: • a small business that they are carrying on themselves (ie as a sole trader), or • a partnership distribution from a small business entity partnership of which they are a partner (ITAA97 s 328-375). Accordingly, Thomas and Sally cannot access the offset in relation to small business income that is distributed to them from a family trust that is an SBE. Rebecca, as trustee of the KFT, should distribute $416 to each minor. Any distribution exceeding that amount will be taxed at punitive minors’ rates. Because the minors cannot access the small business income tax offset, it would be advisable to stream $832 of the net capital gain ($416 each) to them. Note that the low income tax offset and LMITO are not available in relation to family trust distributions. Any trust distribution from KFT in excess of $416 will be taxed at punitive rates with no reprieve available from either offset. Distributions to Dominic and Rebecca After the distributions to Thomas and Sally, there remains $61,168 of trust income for distribution to Dominic and Rebecca ($2,168 net capital gain and $59,000 other net income). Distribution to each of Dominic and Rebecca: • $1,084 net capital gain, and • $29,500 other net income, including $29,000 small business net income of the trust. Steps to calculate their entitlement to the offset (s 328-360): Step 1: Determine the proportion of basic income tax liability that relates to small business activities: = $29,000 / $160,584 (being $130,000 + $1,084 + $29,500) = 0.18 Step 2: Calculate the tax payable on total net small business income: Basic income tax liability on $160,584 = $46,913* × 0.18 = $8,444 *Applying 2019/20 tax rates

Step 3: Calculate the small business tax offset: The offset for each taxpayer is calculated as the lesser of 8% of $8,444 (ie $676) and $1,000. Therefore, Dominic and Rebecca can each claim a tax offset of $676. AMTG: ¶2-160, ¶6-130, ¶7-210

¶7-100 Worked example: Primary producers; non-commercial losses Issue In April 2018, Jay Mitchell, an accountant from Melbourne, purchased a farm for $320,000. Apart from the farm house he has no other farm assets. Jay uses the farmland to agist some horses for the local pony club. In the 2019/20 income year he earned $10,000 in agistment fees. Jay is also considering running the property as a children’s farm on weekends. Jay has a large mortgage over the farm with interest payments in excess of the agistment fees earned. Jay’s farm backs onto Alex and Sydney West’s farm and he has agreed to share the $30,000 cost of a fence between the two properties. Building of the fence started on 1 February 2020 and was finished on 28 February 2020. During the time that Jay has owned the farm he has seen very little capital growth. He keeps good records and operates in a business-like manner. Advise Jay as to whether he can claim an immediate write-off for his share of the cost of the fence between the properties under the primary producers accelerated depreciation regime for the 2019/20 tax year. Can Jay offset any loss from the farm against his accountant’s salary? Solution Immediate write-off for fence With effect from 12 May 2015 primary producers may claim an immediate write-off for capital expenditure on fencing assets in the year in which the expenditure is incurred (ITAA97 s 40-515 to 40-575). The deduction applies to capital expenditure incurred on the construction, manufacture, installation or acquisition of a fencing asset if that expenditure was incurred primarily and principally for use in a primary production business conducted on land in Australia. A primary production business is defined in ITAA97 s 995-1 and includes a business of income from the short-term hiring of equipment to other primary producers or the granting of short-term agistment rights (but not where a substantial part of the property is used solely for agistment). Where a property, or substantial part of property is used solely for agistment, a taxpayer would not be considered to be carrying on a primary production business (Taxation Ruling IT 225). Accordingly, Jay cannot avail himself of the primary producers accelerated depreciation regime, as agistment is the only activity that he is conducting on his farm. Jay cannot claim the cost of his share of the fence of $15,000 as an immediate write-off in the 2019/20 income year. Jay would need to treat the fence as a depreciating asset under ITAA97 Div 40. The effective life for agricultural fencing is 30 years (Taxation Ruling TR 2018/4), so Jay would need to apportion the fence cost of $15,000 over this time period or choose to self-assess the effective life of the asset. Non-commercial losses Special measures apply to prevent a loss from a non-commercial business activity carried on by an individual taxpayer being offset against other assessable income in the year in which the loss is incurred (ITAA97 Div 35). Under these measures, a loss cannot be offset against other income in the year in which it arises (ie the loss is quarantined). Instead, the loss may be carried forward and offset against assessable income from the business in the next year that the business is carried on (future year). A loss from a non-commercial activity can be deducted against other income if the taxpayer’s “adjusted taxable income” for the income year is less than $250,000 and one of the four tests outlined below is satisfied for the year. If one of the four tests is not satisfied, such taxpayers may offset a non-commercial loss against other assessable income if the Commissioner’s discretion is exercised or an exception applies for the year. The four tests are as follows: 1. Assessable income test: the assessable income (including capital gains) for that year from the activity must be at least $20,000 (s 35-30). 2. Profits test: the particular activity must have resulted in taxable profit in at least three out of the last five income years, including the current year (s 35-35).

3. Real property test: the total reduced cost bases of real property or interests in real property used on a continuing basis in carrying on the activity (other than privately used dwellings and tenant’s fixtures) must be at least $500,000 (s 35-40). 4. Other assets test: the total value of other assets (other than motor vehicles) used on a continuing basis in the activity must be at least $100,000 (s 35-45). Applying these four tests to Jay’s circumstances: i. Assessable income test: Jay’s income from his agistment activities is $10,000, that is less than $20,000, so this condition is not satisfied. ii. Profits test: Jay has not made a profit from his agistment activities as he incurred mortgage interest expenses greater than the fees and also the fence costs. This condition is not satisfied. iii. Real property test: Jay’s property cost base is less than $500,000 so this condition is not satisfied. iv. Other assets test: Jay does not have any other assets in this category so this condition is not satisfied. Jay does not satisfy any of the conditions under the non-commercial losses regime and accordingly is not permitted to deduct the loss from the farm against his taxable income from his job as an accountant. These losses are quarantined. Jay would need to satisfy one of the above four tests to allow these losses to be used against his other taxable income. Alternatively, if Jay’s accounting job and income from any other sources drops below $40,000, and he develops his business to meet the definition of a primary production business, he will be permitted to offset the prior year losses from this activity. AMTG: ¶16-020, ¶18-010, ¶18-090

¶7-120 Worked example: Tax concessions; personal superannuation contributions Issue Jake Woodward is aged 34 years and works part-time as an employee of a suburban travel agency. He also runs his own business arranging educational tours for small groups of travellers and escorting them on those tours. During 2019/20, Jake earns $45,000 from employment and $23,000 from his own business. His travel agency employer makes superannuation guarantee contributions of $4,275 (9.5% of his ordinary time earnings) to a complying superannuation fund on behalf of Jake. Jake also makes a personal contribution of $10,000 to the superannuation fund, and contributes $3,000 on behalf of his wife to her superannuation fund. His wife, also aged 34 years, is a full-time student and has no income for 2019/20. What tax concessions, if any, are available to Jake for the superannuation contributions he makes on behalf of himself or his wife? Solution For 2019/20, individuals who make contributions to a complying superannuation fund may be entitled to any of the following tax concessions for the contributions: (a) a deduction (b) a government co-contribution if the individual makes undeducted personal contributions (c) a low income superannuation tax offset, and (d) a tax offset if the individual makes contributions for a low income spouse.

Deduction for the $10,000 personal contribution Jake can claim a tax deduction for the $10,000 personal contribution against his income for the year. An individual taxpayer is entitled to a deduction for personal superannuation contributions if the conditions in ITAA97 Subdiv 290-C are satisfied. An individual taxpayer’s personal superannuation contributions are deductible if the contributions are made to a complying superannuation fund or RSA for the purpose of providing superannuation benefits for the taxpayer (ITAA97 s 290-150). A deduction is allowed only for the year in which the contribution is made (ITAA97 s 290-150(3)). An individual must satisfy the age-related condition to qualify for a deduction under s 290-150 for personal superannuation contributions, namely: • if the person is under 18 years of age at the end of the income year in which the contributions were made — the person must have derived income from the carrying on of a business, or is an employee under the SGAA, and • in any other case — the person made the contributions before the 28th day after the end of the month in which he or she turned 75 (ITAA97 s 290-165). To qualify for a deduction for the whole or a part of personal contributions, a taxpayer must give a notice in the approved form to the superannuation fund trustee or RSA provider stating their intention to claim a deduction for the whole or a part of the contributions covered by the notice, and the trustee must have given the taxpayer an acknowledgment of the notice (ITAA97 s 290-170(1)). The notice must be given before: • if the taxpayer has lodged an income tax return for the income year in which the contribution was made on a day before the end of the next income year — the end of that day, or • otherwise — the end of the next income year. A taxpayer cannot deduct more than the amount stated in the notice (ITAA97 s 290-175). The income tax return for individuals includes a tick box for those with personal superannuation contributions to confirm that they have complied with the requirements to submit a “notice of intent” (NOI) where they intend to take a tax deduction for the contributions. A deduction for personal superannuation contributions under Subdiv 290-C is limited to an individual’s adjusted assessable income for the year (before taking into account the contribution deduction) (ITAA97 s 26-55(2)). The deduction cannot create or increase a loss to be carried forward. Government co-contribution for the $10,000 personal contribution A government co-contribution (up to $500) may be made to match an individual’s personal contributions where a deduction has not been claimed for the contributions, and the individual’s total income for the year is less than the “higher income threshold” (Superannuation (Government Co-contribution for Low Income Earners) Act 2003). For 2019/20, the higher income threshold is $53,564. Jake’s total income of $68,000 for 2019/20 exceeds the $53,564 higher income threshold and he is not therefore entitled to a government co-contribution. Low income super tax offset (LISTO) Individuals whose adjusted taxable income for a year is below $37,000 may be entitled to a LISTO (Superannuation (Government Co-contribution for Low Income Earners) Act 2003). The LISTO amount payable is 15% of the individual’s concessional contributions for the year up to a maximum of $500 and is non-refundable. The LISTO is intended to compensate the low income earner for the 15% tax on contributions made on their behalf, usually by an employer. In calculating an individual’s eligibility for the offset, their adjusted taxable income includes not only ordinary income from employment or carrying on a business, but also the value of fringe benefits provided

to them in the year, their total net investment losses and employer superannuation contributions made for them under a salary sacrifice arrangement. Jake’s $68,000 adjusted taxable income for 2019/20 exceeds $37,000, and he is not therefore eligible for a low income superannuation contribution. Tax offset for spouse contributions For 2019/20, an individual who contributes to a superannuation fund on behalf of a spouse is entitled to a tax offset if the spouse’s income is less than $40,000 (ITAA97 s 290-230). The spouse must be aged less than 65 years, or aged less than 70 years and gainfully employed on at least a part-time basis during the year, that is has worked at least 40 hours in a 30-day period. There is no income or age test for the individual making the spouse contributions. The maximum offset for 2019/20 is $540, based on 18% of maximum contributions of $3,000. The $540 offset is reduced if the spouse’s income for the year exceeds $37,000 and is not available at all if the spouse’s income is $40,000 or more (ITAA97 s 290-235). Jake is entitled to a tax offset of $540 for the contributions he makes for his spouse because she has no income for 2019/20. AMTG: ¶13-730, ¶13-760, ¶13-770, ¶35-070

¶7-140 Worked example: Salary packaging; tax effectiveness Issue James Brown is an accountant working for a company named Benefits R Us Pty Ltd. James has been interested in the salary packaging options the firm has offered its staff. In particular, James would like to salary package a laptop with a retail cost $4,400 (GST inclusive) so that his children have a computer to use for their school work. Benefits R Us is prepared for James to package the item provided the total remuneration cost (TRC) remains unchanged. His current annual package is $90,000 salary and $8,550 superannuation (9.5%). Assuming Benefits R Us Pty Ltd is a full tax paying entity that is registered for GST purposes what is the tax effectiveness of James receiving a laptop if provided on a salary sacrifice basis for the FBT year ended 31 March 2020? Solution The pre- and post-salary package positions for Benefits R Us are as follows: Benefits

Pre-package Post-package

R Us

$

$

Salary

90,000

 82,418

Laptop

   4,400

FBT

  4,302*

Superannuation

8,550

   7,830

GST input tax credit

         

 – 400

TRC

98,550

98,550

*Note: FBT on the laptop which is used exclusively for private purposes Expense payment fringe benefit (FBTAA s 20) Taxable value = $4,400 × 2.0802 (Type 1 GST inclusive 2019/20) = $9,152.88 × 47% (FBT rate) = $4,302 The pre- and post-salary package positions for James are as follows: James Brown

Pre-package

Postpackage

Salary Net (tax and Medicare) at 2019/20 rates After tax and Medicare Less: Laptop NET CASH

$

$

90,000

82,418

  22,597

   19,981

67,403

62,437

 (4,400)

        0

63,003

62,437

Salary packaging results in James being $566 worse off. It is noted that in this case James is on marginal tax rate of 32.5%% and that generally packaging provides an advantage for employees on the top marginal rate of 45% tax as the after tax saving is greater. AMTG: ¶35-057, ¶35-070, ¶35-330

¶7-160 Worked example: Salary packaging; company car Issue Judy Line is an employee of Tel Co Holdings Pty Ltd earning a gross salary of $100,000. Judy entered into a salary sacrificing arrangement with her employer to salary package a company car. The car, which was used exclusively for private purposes, was purchased on 1 April 2019 and cost $44,000 (including GST) and was financed under a four-year lease. Tel Co Holdings will take ownership of the vehicle after the four-year lease, where Judy has an option to purchase from her employer. The monthly lease payments are $1,500 ($18,000 per year). The running costs of the car for the first year came to $12,000. Under the salary sacrifice agreement, Tel Co will pay the lease payments and the running costs of the car on Judy’s behalf and also any FBT associated with the provision of the car. These costs are passed on by Tel Co Holdings to Judy and subsequently deducted from her pre-tax gross salary. In addition, the agreement provides that Tel Co Holdings will pass on to Judy any GST input tax credits it receives associated with the transaction — this results in an addition to Judy’s salary. Assuming Tel Co Holdings uses the statutory formula method for calculating car fringe benefits and Judy has maintained adequate private health insurance what is the tax effectiveness of receiving the car for Judy as provided on a salary sacrifice basis for the FBT year ended 31 March 2020? Solution The pre- and post-salary package positions for Judy are as follows: Judy Line

Salary

Pre-package

Postpackage

$ 

$ 

100,000

Less motor vehicle costs ($18,000 + $12,000)

100,000 (30,000)

Less FBT payable1

(8,604)

Add input tax credits2

   

   5,090

Remaining cash salary

100,000

66,486

Net (tax and Medicare) at 2019/20 rates

  26,497

  14,485

73,503

52,001

After tax lease and running costs

  30,000

       0

NET CASH

  43,503

52,001

After tax and Medicare

Packaging results in Judy being $8,498 better off.

Notes: 1. FBT on the car which is used exclusively for private purposes. Taxable value: (20% × $44,000 − 0) = $8,800 × 2.0802 (Type 1 GST inclusive 2019/20) = $18,305.76 FBT = $18,305.76 × 47% = $8,604 2. GST input tax credit = car cost $44,000 / 11 = $4,000 + running costs $12,000 / 11 = $1,090 = $5,090. The lease is a financial supply which is not subject to GST. AMTG: ¶35-057, ¶35-150, ¶35-180, ¶35-190, ¶42-000

¶7-170 Worked example: Salary sacrifice and super guarantee charge Issue Rosalind and Peter Russell are keen to boost their retirement savings and accordingly each has determined to contribute an additional $1,000 per month into their super fund by way of a salary sacrifice arrangement with their respective employers, commencing 1 March 2020. Rosalind Russell earns $60,000 per annum. Her employer paid $1,425 per quarter into her super prior to the salary sacrifice arrangement coming into effect; however, when Rosalind checks her superannuation account at the end of the financial year, Rosalind is disappointed to observe that the superannuation contributions paid into her fund by her employer remained at $1,425 for the March to June 2020 quarter. Peter Russell also earns $60,000 per annum. His employer also previously paid $1,425 per quarter into his super prior to the salary sacrifice arrangement coming into effect; however, when Peter checks his superannuation account at the end of the financial year, he notices that the superannuation contributions paid into his fund by his employer were $2,330 for the quarter, about $95 less than he expected. Rosalind and Peter have asked for your advice as to why their employer’s super contributions are less than expected for the March to June 2020 quarter and what action they can take in the event that their employers have underpaid super. Solution Both Rosalind and Peter earn $15,000 per quarter. In the absence of the salary sacrifice arrangements, each of their employers would contribute $1,425 per quarter into their super funds on their behalf ($15,000 × 9.5%) as superannuation guarantee (SG) payments. In Rosalind’s case, by salary sacrificing $1,000 per quarter into super, her expectation is that the quarterly contribution her employer makes on her behalf will increase to $2,425 per quarter. However, it appears that her employer has used the $1,000 in salary sacrificed contributions to count towards the employer’s mandated SG obligation. As such, they have continued to make a contribution of $1,425, mostly consisting of Rosalind’s $1,000 salary sacrificed amount. Peter also expects the quarterly contribution made by his employer to increase to $2,425. However, it appears that Peter’s employer has calculated SG liability on his post-salary sacrifice wage ($14,000 instead of $15,000 per quarter). The employer contributed $2,330 per quarter ($1,330 mandated employer contribution + $1,000 salary sacrifice amount) instead of $2,425 ($1,425 + $1,000). From 1 January 2020, the way in which Rosalind and Peter’s SG contributions have been made by their employers is no longer lawful. From that date, SG contributions must be paid on the pre-salary sacrifice base. In addition, salary sacrificed amounts cannot be used to reduce the employer’s required minimum level of SG contributions. The Treasury Laws Amendment (2019 Tax Integrity and Other Measures No 1) Act 2019 closes a loophole that was used by some employers to reduce the level of SG contributions made for their employees. Amounts that an employee salary sacrifices to superannuation cannot reduce an employer’s SG charge.

So, under the new amendments, Rosalind’s $1000 sacrificed contribution can no longer reduce the charge. The employer has actually made a contribution amounting to 2.83% ($425/$15,000 × 100). As the employer is required to contribute 9.5% of the ordinary time earnings (OTE) base, they must contribute an additional 6.67% to meet their minimum SG obligations. The employer has a shortfall of approximately $1,000 (6.67% × $15,000). As sacrificed contributions no longer reduce the charge, Rosalind’s employer will need to contribute $1,425 (the mandatory employer contributions) in addition to the $1,000 employee sacrificed amount, to avoid a shortfall and liability for the SG charge. The total payment of $2,425 is in line with the amount that Rosalind expected to see contributed. In relation to Peter’s situation, to avoid a shortfall an employer must contribute at least 9.5% of an employee’s OTE base — which specifically includes any salary sacrificed amount. When calculating the amount to be contributed, Peter’s employer must (under the new law) include sacrificed OTE amounts in the OTE base. The OTE base is the sum of OTE and sacrificed OTE amounts. Peter’s employer’s charge percentage is currently 8.86% ($1,330/$15,000 × 100) as a result of the incorrect method of calculating SG contributions. Since 8.86% is less than the required 9.5%, the employer will have a charge percentage of 0.64% under s 19 of the Superannuation Guarantee (Administration) Act 1992 and a shortfall of $95. To avoid the shortfall, Peter’s employer must contribute $2,425 each quarter (consisting of $1,425 in mandated employer contribution and $1,000 in sacrificed amounts) which is the amount that Peter expected to see in contributions. In order to take action to address the situation, Rosalind and Peter should first speak to their employers to see if the underpayments can be resolved. If that fails, they should lodge a complaint with the ATO, which can order the employers to make retrospective catch-up payments. An online form can be found at www.ato.gov.au. In addition, the ATO itself may be able to identify the underpayments through Single Touch Payroll (STP). STP is a new way of reporting tax and superannuation information to the ATO. One of the specific purposes of STP was to identify, in real time, underpayment or non-payment of employer SG contributions. Using STP-enabled software, employers send details of employees’ salary and wage, tax withheld and super information to the ATO each time they pay their employees. STP reporting began on 1 July 2019 for all employers so Peter and Rosalind’s employers should now be using STP-enabled software. AMTG: ¶26-620, ¶39-100, ¶39-250, ¶39-530

¶7-180 Worked example: Income averaging scheme applied to sportsperson Issue Bradley Goodman is an Australian resident and a professional athlete who competes in cycling events in Australia and Europe. Bradley’s taxable professional income derived from competing in cycling events as well as sponsorship, prizes and awards for winning races and commentating on various cycling events for the previous four years was: • $45,000 in 2015/16 • $25,000 in 2016/17 • $20,000 in 2017/18, and • $34,000 in 2018/19. In the 2019/20 income year Bradley derived $60,000 from his professional cycling activities and spent $8,000 on equipment, clothing, travel and medical procedures (massage and manipulation). During 2019/20 Bradley was also paid $15,000 to train and coach junior cyclists.

Calculate Bradley’s tax liability for the 2019/20 income tax year. Solution Significant fluctuations can occur to the income of professional sportspersons. To lessen the impact of these fluctuations on marginal tax rates, special tax rates apply if the professional sportsperson’s income is above their average income (ITAA97 s 405-1). Where the professional sportsperson has above-average professional income, the Income Tax Rates Act 1986 generally sets a special rate so that the amount of income tax the professional sportsperson pays on the top 4/5 of their above-average special professional income is effectively four times what they would pay on the bottom 1/5 of that income at basic rates (ITAA97 s 405-5). In calculating his income for the 2019/20 income year, Bradley Goodman is entitled to take advantage of the income averaging provisions, contained in ITAA97 Div 405. The steps involved in the calculation are as follows: Calculation of Bradley Goodman’s income tax payable for 2018/19 1. Division of Bradley Goodman’s total assessable income into assessable professional income and other assessable income: $ Assessable professional income (s 405-20)

60,000

Other assessable income

15,000

Total assessable income

75,000

2. Division of Bradley Goodman’s total taxable income into taxable professional income and other taxable income: $ Assessable professional income

60,000

Less: Deductions attributable to assessable professional income

 8,000

Taxable professional income (s 405-45)

52,000

Other taxable income from training and coaching

15,000

3. Bradley Goodman’s average taxable professional income This is generally a four-year average (s 405-50) calculated by dividing the sum of Bradley’s taxable professional income for each of the last four years by four, ie $124,000 / 4 = $31,000 4. Division of Bradley Goodman’s total taxable income into above-average special professional income and normal taxable income Whether Bradley has any above-average special professional income and, if so, the amount is determined according to s 405-15. Bradley’s above-average special professional income is $21,000 calculated as follows: $ Taxable professional income

52,000

Less: Average taxable professional income

31,000 21,000

Bradley’s normal taxable income is $46,000 calculated as follows: $ Average taxable professional income

31,000

Taxable income that is not taxable professional income

15,000 46,000

5. Calculate the tax payable on Bradley Goodman’s normal taxable income using ordinary individual income tax rates At 2019/20 income tax rates the income tax on Bradley’s normal taxable income of $46,000 is $6,497. 6. Calculate the tax payable on Bradley Goodman’s normal taxable income plus 1/5 of the sum of the above-average special professional income using ordinary individual income tax rates $ Bradley’s normal taxable income

46,000

1/5 of Bradley’s above-average special professional income is: 1/5 × $21,000

 4,200 50,200

TAX PAYABLE

 7,862

7. Calculate the difference between tax payable on Bradley Goodman’s normal taxable income plus 1/5 of the sum of the above-average special professional income and the tax payable on Bradley Goodman’s normal taxable income plus 1/5 of the sum of the above-average special professional income (ie Step 6 – Step 5) $7,862 – $6,497 = $1,365 8. Calculate the tax payable on above-average special professional income (ie Step 6 – Step 5 × 5) $7,862 – $6,497 = $1,365 × 5 = $6,825 The amount of $6,825 is the tax payable on the above-average special professional income. 9. The total income tax payable is the sum of the tax payable on the normal taxable income and the tax payable on above-average special professional income $ Tax on Bradley’s normal taxable income

6,497

Plus: Tax payable on above-average special professional income  6,825 TOTAL TAX PAYABLE for 2019/20

13,322

Note: Bradley Goodman will also be liable for a 2% Medicare levy on his normal taxable income plus 1/5 of the sum of the above-average special professional income using ordinary individual income tax rates, ie 2% × $50,200, or $1,004. AMTG: ¶2-140, ¶2-142, ¶2-144

¶7-200 Worked example: Personal services income Issue

Peter Simmons is an engineer who provides consulting services through his private company Clean Power Pty Ltd. The company has contracted with the local council for Peter to provide consulting services in relation to their project works. For the year ended 30 June 2020, Clean Power received a fee from the council of $90,000 and paid the following: $ Tax-related expenses Annual engineers registration fee Peter’s salary

2,500 440 60,000

Other income of Clean Power consisted of some investments amounting to $3,300. Peter is based at the council officers when conducting his work where all equipment is supplied by the council who also assumes all responsibility for Peter’s work. Peter charges an hourly rate of $50 to the council for his services. Clean Power Pty Ltd were recently unsuccessful in deriving a personal services business (PSB) determination from the Commissioner and understand that the personal services income (PSI) regime will apply to their operations. Assuming ITAA97 Pt 2-42 applies to Clean Power Pty Ltd and Peter Simmons determine the tax consequences and the amount attributable to Peter under the PSI regime for the 2019/20 tax year. Solution Clean Power’s $90,000 fee revenue is derived from Peter’s personal services as an engineering consultant and therefore is susceptible to the alienation of the PSI regime (ITAA97 s 84-5; Taxation Ruling TR 2001/7). In these circumstances, Clean Power would have to attribute the fee revenue it received to Peter and he will be assessed on the amount attributed (ITAA97 s 86-1). Consequences of the PSI regime applying The PSI received by Clean Power will be attributed to Peter (ITAA97 s 86-15(1)). As Clean Power had already distributed a salary to Peter, the PSI attributed will be reduced by that amount of salary already paid (s 86-15(4)). Clean Power must distribute Peter’s salary before the end of the 14th day of the PAYG payment period and must withhold PAYG from Peter’s gross salary. Clean Power may offset particular allowable deductions against Peter’s PSI. This reduction is derived by applying the method statement in ITAA97 s 86-20. The application of the method statement is as follows: Step 1

PSI deductions

= $440, annual engineer’s registration fee

Step 2

Entity maintenance deductions

= $2,500 of tax-related expenses

Step 3

Clean Powers’ assessable income other than PSI

= $3,300 of investment income

Step 4

Entity maintenance deductions are less than other income (Step 2 minus Step 3)

= ($800)

Step 5

Step 5 does not apply as the amount under Step 4 is less than zero

Step 6

As the amount in Step 4 is less than zero the PSI income is reduced by the amount in Step 1

= $440

Therefore, Step 6 applies and $440 will be offset against the PSI attributed (s 86-20(1)). Where a personal services entity (PSE) is not running a PSB the ability to deduct a loss or outgoing is generally limited to employee type deductions (ITAA97 s 86-60). However, a PSE may also deduct “entity maintenance deductions” (ITAA97 s 86-65). Further outgoings may also be deducted when specifically allowed by ITAA97 Subdiv 86-B (see Taxation Ruling TR 2003/10).

Amount attributable to Peter Simmons (individual) using Clean Power (PSE) Peter includes $29,560 for his personal services in his income tax return as calculated below: $ Peter’s PSI received by PSE

90,000

Less: salary payments already made by the PSE

60,000 30,000

Less: reduction by method statement (s 86-20(1))

     440

PSI attributed to Peter

29,560

The PSI attributed to Peter will be added to his taxable income and taxed at his marginal rate of tax. The implications for Clean Power is that the fees received will not form assessable income or exempt income to the extent that it constitutes Peter’s PSI (ITAA97 s 86-30; Taxation Ruling TR 2003/6). AMTG: ¶30-600, ¶30-610, ¶30-620, ¶30-630, ¶30-680

¶7-220 Worked example: Termination payments Issue Due to a work injury to his right arm, Neil Maggie, aged 62 years, took an invalidity payment and resigned from Pipecoaters Ltd on 31 May 2020. His date of birth is 31 May 1958. He had worked with the company since 1 June 1981 (39 years). He was due to retire on 31 May 2023 at age 65. Other information Number of days of work from 1 June 1981 to 31 May 2020

14,245

Number of days until retirement from 31 May 2020 to 31 May 2023 1,095 Number of days from 1 June 1981 to 30 June 1983

760

As part of his pay-out, Neil received: • $410,000 as an employment termination payment (ETP) • payments for unused long service leave of $12,000 for the period 1/6/81 to 17/8/93 and $8,000 for the period 18/8/93 onwards, and • $2,500 annual leave accrued from 1/7/19. Based on the above information, what are the tax implications for Neil Maggie for the 2019/20 tax year? Solution To determine the tax-free component of the ETP, it is necessary to calculate the amount of the invalidity segment using the following formula in ITAA97 s 82-150(2): Amount of the ETP ×

Days to retirement  Employment days + days to retirement

Neil resigned on 31 May 2020, which is three years earlier than the expected/anticipated date of 31 May 2023. The amount of the termination payment of $410,000 that qualifies as an invalidity payment is $29,267, calculated as follows: $410,000 ×

1,095 days 14,245 + 1,095 days*

*Note: Number of days adjusted for leap years.

= $29,267

No tax is payable on this amount. The other tax-free component of the ETP is the pre-July 1983 segment worked out as follows: Step 1: Subtract the invalidity segment (if any) from the total ETP. $410,000 − $29,267 = $380,733 Step 2: To determine the pre-July 1983 component, multiply the amount in Step 1 by the fraction: Number of days of employment to which the payment relates that occurred pre-1 July 1983 The total number of days of employment to which the payment relates = $380,733 ×

760 14,245

= $20,313   Hence the post-30 June 1983 component is: $380,733 − $20,313 (the pre-July 1983 component) = $360,420 As the post-30 June 1983 component is above the 2019/20 tax threshold of $210,000 and Neil is above the preservation age of 55 years, the tax payable on the post-30 June 1983 component is $99,189 calculated as follows:    $ $210,000 × 15%  =

31,500

$150,420 × 45%  =

67,689

TAX PAYABLE

99,189

It should be noted that the whole-of-income cap of $180,000 does not apply to this life benefit termination payment as an invalidity payment qualifies as an excluded payment under ITAA97 s 82-10(6)(c). Leave payments made in respect of unused long service leave and annual leave accrued from 18 August 1993 onwards are fully assessable, and taxed at the taxpayer’s marginal rate of tax. Consequently, the long service leave of $8,000 and annual leave of $2,500 accrued by Neil from 18 August 1993 to his date of resignation would normally be fully assessable. Due to Neil’s invalidity, the payments are subject to a rebate so that tax payable does not exceed 30% (plus Medicare levy). The long service leave payment of $12,000 accrued from 1 June 1981 to 17 August 1993 is fully assessable, but is also subject to a rebate limiting the maximum rate of tax payable on the leave to 30% (plus Medicare levy). AMTG: ¶14-620, ¶14-630, ¶14-640, ¶14-720, ¶14-730, ¶42-270

¶7-240 Worked example: Superannuation funds Issue Coalstream Superannuation Fund is a complying superannuation fund. During the 2019/20 tax year Coalstream incurred the following transactions: $ •

Received a 100% franked dividend from a listed public company

•

Rental income from a property lease to the Coalstream discretionary trust — a related entity. The lease payment has been determined by an independent valuation

210,000 22,000

•

Sale of shares in a public company. The shares were acquired in December 2011 and had a cost base of $60,000

78,000

•

Interest on term deposits

30,000

•

Employer contributions on behalf of employees

77,000

•

Administration costs

•

Accounting and audit fees

•

Payments to retiring members of the fund:

•

–

lump sums

–

pensions

230,000 28,000

180,000 90,000

Legal costs associated with redrafting of the trust deed to comply with APRA regulations

5,400

Calculate the amount of tax payable/refundable for Coalstream Superannuation Fund for the 2019/20 tax year. Solution To calculate the tax payable by a superannuation fund the assessable income and allowable deductions are determined by taking into account the special rules in ITAA97 Div 295. The taxable income is based on the trustee being an Australian resident. The taxable income can be separated into a low tax component and a non-arm’s length component. Assessable Income

$

$

Dividends1

210,000

Gross-up

90,000

Rent2

22,000

Capital gain3

12,000

Interest4

30,000

Less: Exempt current pension income5 Employer contributions on behalf of employees6

(182,000)   77,000

259,000

Allowable deductions Administration costs7 Accounting and audit fees7 Legal costs8 Less: expenses relating to pension income TAXABLE INCOME

115,000 14,000    2,700 (131,700)

131,700 127,300

All of the income is subject to tax at the 15% rate for a complying fund = $127,300 × 15% = $19,095. The fund is also entitled to tax offset for the imputation credit of $90,000 which results in a tax refund of $70,905. Notes: 1. The dividends from the public company are grossed-up to include the imputation credit of $90,000. The gross-up amount is calculated as follows: $210,000 × 30 / 70 = $90,000. 2. The rental income is taken to be an arm’s length amount despite the parties being related.

3. The sale of the shares will constitute a CGT event. As the shares have been held for more than 12 months, the 1/3 CGT discount will apply to the capital gain. The capital gain is therefore calculated as follows: $78,000 − $60,000 = $18,000 − (1/3 × $18,000) = $12,000. 4. The interest income is fully assessable. 5. As the superannuation fund is paying pensions to members, some of the income is exempt current pension income. In this case, an actuarial certificate was obtained and the determined exempt current pension percentage was 50%: $210,000 + $90,000 + $22,000 + $12,000 + $30,000 = $364,000 × 50% = $182,000. 6. Contributions received by a fund are not considered ordinary income, however under Div 295 assessable contributions include contributions made by a contributor on behalf of someone else. In this case, the contributions of the employers on behalf of the employees would constitute assessable income. 7. In accordance with the actuarial certificate, it is assumed that the administration costs were 50% incurred in producing assessable income as were the accounting and audit fees. Taxation Ruling TR 93/17 may also be used when determining the deductibility of expenditure according to ITAA97 s 8-1 in relation to superannuation funds. For the purposes of this example, the actuarial percentage was used. Payments to retiring members of the fund are not deductible. 8. The cost associated with amending a trust deed would generally not be an allowable deduction unless the change or amendment was required to maintain compliance status (Taxation Ruling IT 2672). Consequently, the legal costs associated with redrafting of the trust deed to comply with APRA regulations are deductible in this case. In accordance with the actuarial certificate, only 50% of the deduction is allowable: $5,400 × 50% = $2,700. AMTG: ¶13-050, ¶13-100, ¶13-120, ¶13-125, ¶13-130, ¶13-140, ¶13-150

¶7-260 Worked example: Superannuation death benefit paid to family members Issue Galina Quest was aged 83 when she died on 1 December 2019. Her superannuation balance at the date of death was $750,000 and this amount passed to the trustee of her estate to be distributed according to the terms of her will. The trustee of the deceased estate is advised by the trustee of Galina’s superannuation fund that 10% of the $750,000 is a tax free component and 90% is a taxable component (ITAA97 s 307-120). Galina had been a widow since 2000 and expressed the wish in her will that her estate be distributed as follows: • 75% to her son Anton aged 56 — Anton has been financially dependent on Galina all his life because of the intellectual and physical disabilities that he suffers, and • 25% to her granddaughter Belle aged 21 — Belle is a university student who supports herself on Youth Allowance payments and part-time work. The trustee of the deceased estate decides that, in accordance with Galina’s wishes, the distribution of the superannuation death benefits would be: (i) $562,500 to Anton, and (ii) $187,500 to Belle. Explain how the superannuation death benefits paid to Anton and Belle would be taxed and the obligations imposed on the trustee of the deceased estate when the payments are made. Solution Where the trustee of a deceased estate receives a superannuation death benefit from a superannuation fund, the trustee of the deceased estate must determine who is to benefit and whether tax is payable. If tax is payable, the trustee must withhold the appropriate amount of tax from each beneficiary’s payment and remit it to the ATO. The taxation of the $750,000 depends on who is a beneficiary and whether that person was, or was not, a dependant of Galina for tax purposes.

As a general rule: • if the beneficiary is a death benefits dependant of the deceased person, no tax is payable (ITAA97 s 302-60), and • if the beneficiary is not a death benefits dependant, tax is payable on the death benefit as follows: (i) no tax is payable on the tax free component of the benefit, and (ii) the taxable component is included in assessable income but a tax offset ensures that the rate of tax does not exceed 15% (ITAA97 s 302-140, 302-145). Payment of $562,500 to Anton A “death benefits dependant” of a person is defined in ITAA97 s 302-195 as the deceased person’s spouse or former spouse, the deceased person’s child aged less than 18, any other person with whom the deceased person had an “interdependency relationship” (ITAA97 s 302-200), or any other person who was financially dependent on the deceased. Anton was a death benefits dependant of Galina at the date of her death because his intellectual and physical disabilities caused him to be financially dependent on her for all his life. As a dependant, no tax is payable on the $562,500 to which Anton is entitled. The trustee may pay the amount to him as a lump sum or as a pension. Payment of $187,500 to Belle Belle does not fit into any of relationships that would make her a death benefits dependant of Galina at the date of death and therefore she is taxed as a non-dependant and can only be paid the benefit as a lump sum. The trustee must withhold the appropriate amount of tax from the benefit and remit it to the ATO, and give Belle the balance. The $187,500 lump sum death benefit is taxed as follows: (a) no tax is payable on the $18,750 tax free component of the benefit (ie 10% × $187,500), and (b) the $168,750 taxable component (ie 90% × $187,500) is taxed up to a maximum rate of 15 per cent. In addition, the 2% Medicare levy will be payable on the full taxable amount. AMTG: ¶14-270, ¶14-280

¶7-265 Worked example: Downsizer contributions Issue Donald purchased his home in 2005. He is married to Doreen, who is 66 years old and has lived with Donald in his home since 2015. On 1 December 2017, Donald passes away and leaves the home to Doreen. The property title is transferred to her through the administration of his estate in April 2018. Doreen sells the property with settlement occurring on 1 May 2020 for $550,000. Doreen wishes to contribute some of the proceeds into her superannuation fund as a downsizer contribution. Is she eligible to do so? Solution From 1 July 2018, an individual who is aged 65 or over may use the proceeds from the sale of their main residence to make superannuation contributions (referred to as “downsizer contributions”) up to a maximum of $300,000 per person (ie up to $600,000 per couple). The main provisions in relation to downsizer contributions are contained in s 292-102 ITAA 1997. A contribution is a downsizer contribution in respect of an individual if the following conditions are

satisfied: • the individual is aged 65 years or older at the time the contribution is made • the contribution must be in respect of the proceeds of the sale of a qualifying dwelling in Australia from contracts entered into on or after 1 July 2018 • a gain or loss on the disposal of the dwelling must have qualified (or would have qualified) for the main residence CGT exemption in whole or part • the 10-year ownership condition is met • the contribution must be made within 90 days of the disposal of the dwelling, or such longer time as allowed by the Commissioner • the individual must choose to treat the contribution as a downsizer contribution, and notify their superannuation provider in the approved form of this choice at the time the contribution is made • the individual cannot have downsizer contributions in relation to an earlier disposal of a main residence (ITAA97 s 292-102(1)(i), (3)). A downsizer contribution is not counted towards the concessional or non-concessional superannuation contribution caps. A downsizer contribution can be made even if an individual has a total super balance above the general transfer balance cap (currently $1.6m). An individual or their spouse must have held an ownership interest in the dwelling for 10 or more years just prior to its disposal (s 292 102(2)). The 10-year ownership period is calculated from the commencement day of ownership of the dwelling to the day it ceased. This would usually be the period from the settlement date of the original contract to purchase the dwelling to the settlement date of the later sale contract. It is not necessary for an individual to hold an ownership interest for the entire 10-year period personally, provided that, at all times during this period, an ownership interest has been held by some combination of the individual, the individual’s spouse, and/or the individual’s former spouse. This allows for changes in ownership between spouses to account for circumstances such as the death of a spouse and relationship breakdown. Where a spouse who held an ownership interest dies, an individual can count the period of ownership of the deceased spouse, including the period the dwelling is held by the trustee of the deceased estate, towards the 10-year ownership test. Doreen meets the 10-year ownership condition because: • from 2005 until 1 December 2017, the ownership interest in the home is treated as being held by Donald, and • since 1 December 2017, the ownership interest is treated as being held by Doreen. In addition, Doreen is entitled to claim the main residence CGT exemption in relation to the disposal of the property. Accordingly, Doreen is eligible to make a downsizer contribution of up to $300,000. She must make the contribution to her super fund within 90 days of the date of disposal and must notify her superannuation provider using the approved form at or before the time the contribution is made. AMTG: ¶13-015, ¶13-795, ¶13-825

¶7-270 Worked example: First Home Super Saver Scheme Issue Paul is saving for the deposit on a first home. He wishes to take advantage of the First Home Super

Saver Scheme and accordingly, between 1 July 2018 and 30 June 2020, he has made voluntary concessional contributions totalling $8,000 for which he has claimed a tax deduction. In addition, he has made voluntary non-concessional contributions totalling $20,000. His eligible contributions have not exceeded $15,000 in either of the two relevant years. Paul requests a First Home Super Saver Determination via his myGov account on 1 July 2020, having identified a property he would like to buy. He has not signed a contract at that date. What process does Paul have to follow in order to release the funds from his superannuation fund and how will he be taxed on the released amounts? Paul had a marginal tax rate of 37% in 2019/20 and has no outstanding Commonwealth debts. Solution Individuals can use the First Home Super Saver (FHSS) Scheme to make voluntary contributions to their superannuation fund from 1 July 2017 (ITAA97 Div 313; TAA Sch 1 Div 138). The Scheme enables individuals to save for their first home through the superannuation system, taking advantage of the concessional tax rates afforded within a super fund, and then withdraw funds to pay a deposit on a first home. ATO guidelines on the operation of the FHSS Scheme are set out in LCR 2018/5 and GN 2018/1. The key features of the FHSS Scheme are as follows: • To be eligible to benefit from the FHSS Scheme, an individual must be at least 18 years old, must have never used the FHSS Scheme before, and must have never owned real property (eg a home, an investment property or vacant land) in Australia unless specific financial hardship circumstances apply. • The maximum voluntary contributions under the Scheme is $15,000 a year, and $30,000 in total. Voluntary contributions can be non-concessional or concessional contributions and are subject to the normal contributions caps. • An individual may apply to the ATO to withdraw up to their “FHSS maximum release amount”, which is the sum of eligible contributions of up to $30,000 and associated deemed earnings, to use as a deposit on a first home. • To initiate the withdrawal, the individual must request a “first home super saver determination” (FHSS Determination) from the Commissioner. In making an FHSS Determination, the Commissioner must identify a “maximum release amount” based on the individual’s past contributions and associated earnings. • Once an FHSS has been received, the individual can request the Commissioner to issue a release authority in respect of their superannuation interests under TAA Sch 1 Div 131. • The maximum FHSS releasable contributions amount is 85% of concessional contributions, plus 100% of non-concessional contributions plus the amount of the associated earnings. • The associated earnings are a notional amount of earnings calculated at the shortfall interest charge rate from the 1st day of the month the contribution is made to the date of the determination. • The individual’s superannuation fund must pay the amount to be released to the Commissioner, who will withhold an amount for the tax payable and pay the balance to the individual. The amount withheld will reflect the best estimate of the tax payable or, if such an estimate cannot be made, 17% of the amount released (FHSS released amount). • An FHSS released amount is subject to concessional tax treatment. Concessional contributions and earnings that are withdrawn will be included in the individual’s assessable income and will be subject to a non-refundable 30% tax offset. For released amounts of non-concessional contributions, only the associated earnings will be taxed, with a 30% tax offset.

• An individual will generally have 12 months after money is released from superannuation to sign a contract to purchase or construct a home. The premises must be occupied as soon as practicable and for at least six months of the first year after it is practicable to do so. • If a home is not purchased, the individual is required to re-contribute an amount into superannuation or pay 20% FHSS tax on the FHSS released amount to unwind the concessional tax treatment when it was released. The FHSS tax is imposed by the First Home Super Saver Tax Act 2017. In Paul’s case, having applied for a FHSS Determination, the Commissioner will advise Paul of his maximum release amount. This is calculated to be $28,500, comprising: • $20,000 (the eligible non-concessional contributions) • $6,800 (85% of the eligible concessional contributions) • $1,700 (associated earnings, calculated by the Commissioner). The Commissioner will use Paul’s previous tax return to estimate his marginal tax rate for 2020/21. His taxable income from the last year plus his assessable FHSS released amount provides an estimated income, which suggests that he will remain in the same marginal tax bracket of 37% for 2020/21. Paul’s estimated withholding rate is determined to be 9%, being: • the estimated marginal tax rate of 37%, plus • 2.0% Medicare levy, less • the 30% tax offset. Paul can sign a contract to purchase his desired property as soon as he receives the FHSS Determination but he must then apply for the release of his funds within 14 days of entering that contract. Alternatively, if Paul is not yet ready to sign the contract, he has up to 12 months from the date he requested the release of his FHSS amounts to sign a contract to purchase or construct a home. Paul can then request a release of the maximum amount in 2020/21. A release authority will be issued to his fund and his fund will release the full amount to the ATO. The ATO will withhold $765 (9% of $8,500) from the released amount, and release the remaining $27,735 to Paul. It will typically take between 15 and 25 business days for the fund to release Paul’s money and for the ATO to pay it to Paul. Paul will then need to include $8,500 in his assessable income in his 2020/21 tax return. He will also receive a tax offset of $2,550, being 30% of the assessable FHSS released amount and a credit for the tax withheld of $765. AMTG: ¶13-790

¶7-275 Worked example: Carry-forward concessional superannuation contributions Issue Roger is aged 55. In the 2019/20 income year, Roger’s employer made concessional superannuation guarantee contributions of $10,000 on his behalf to his superannuation fund. Roger did not make any deductible personal contributions to his fund. Roger’s unused concessional contributions cap amount for the 2019/20 financial year is therefore $15,000. In the 2020/21 income year, Roger’s employer made further concessional contributions of $15,000. He did not make any deductible personal contributions to his fund. His unused concessional contributions cap amount for the 2020/21 financial year is therefore $25,000 (being $15,000 brought forward from 2019/20 and $10,000 from 2020/21). In 2021/22, Roger wishes to use his unused concessional contributions cap amounts to make

concessional contributions of $25,000, on top of his employer’s concessional superannuation guarantee contribution of $25,000. At the end of 30 June 2021, Roger had a total superannuation balance of $506,000. By 30 June 2022, his total superannuation balance had fallen to $490,000 due to a fall in the value of the stock market. Can Roger make an additional concessional contribution of $25,000 in 2021/22, as he wishes? Assume the current concessional contributions cap remains unchanged for all years to 2022/23. Solution Individuals with a total superannuation balance of less than $500,000 just before the start of a financial year may be able to increase their concessional contributions cap in the financial year by applying previously unused concessional contributions cap amounts from one or more of the previous five financial years. The concessional contributions cap amount is $25,000 in 2019/20 for all individuals, regardless of their age (s 291-20). The cap amount is indexed annually to AWOTE, in increments of $5,000 rounded down. Only unused amounts accrued from the 2018/19 financial year onwards can be carried forward so in practice it will be the 2023/24 year before full access to the previous five financial years is available. An individual’s concessional contributions cap for a financial year may be increased if: a) their concessional contributions for the year would otherwise exceed their concessional contributions cap for the year b) their total superannuation balance just before the start of the financial year is less than $500,000, and c) they have previously unapplied “unused concessional contributions cap” for one or more of the previous five financial years (s 291-20(3)). An individual’s “unused concessional contributions cap” for a financial year is the amount by which their concessional contributions for the year falls short of their concessional contributions cap for the year (s 291-20(6)). An individual cannot have unused concessional contributions cap earlier than the 2018/19 financial year (s 291-20(7)). As a result, the first year in which an individual can make additional concessional contributions by applying their unused concessional contributions cap amounts is the 2019/20 financial year. As Roger’s superannuation balance at 30 June 2021, just before the start of the financial year in which he wishes to make the extra contribution, is $506,000 Roger cannot increase his concessional contributions cap by $25,000 using his unused cap amounts from the two previous years. The maximum amount he can pay in concessional contributions is $25,000 (being the concessional contributions cap for that year). This amount will be paid by his employer meaning that he cannot pay any further concessional contributions in 2021/22 using his unused cap amounts from earlier years. By 30 June 2022, just before the start of the next financial year, Roger’s superannuation balance has fallen to $490,000. This means that he is now able to use his $25,000 unused cap amounts in the following financial year (2022/23) and increase his concessional contributions cap for that year from $25,000 to $50,000 (being his normal concessional contributions cap of $25,000 and his unused cap amount brought forward of $25,000). AMTG: ¶13-730, ¶13-775, ¶13-785

¶7-278 Worked example: Total superannuation balance and the bring-forward of nonconcessional superannuation contributions Issue Jane is 55 years old. On 1 March 2020, she sold an investment property she owned in South Africa. She

now wishes to use some of the proceeds of that sale to boost her superannuation. She would like to make a non-concessional contribution of $200,000 into her super fund before 30 June 2020. She then wishes to make a further non-concessional contribution of $100,000 in the year ended 30 June 2021. She has not made non-concessional contributions in any earlier years. As at 30 June 2019, the balance of her super fund stood at $1.3m and at 30 June 2020, it stood at $1.6m. Advise Jane on the feasibility of her plan if she makes the contribution before 30 June 2020. Solution The concept of a “total superannuation balance” applies from 1 July 2017 as a method for valuing an individual’s total superannuation interests at a particular time and for limiting the amount of superannuation contributions that can be made. The concept was introduced by the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (Act No 81 of 2016). An individual’s total superannuation balance (s 307-230) at a particular time is calculated as the sum of: • the accumulation phase value of their superannuation interests that are not in the retirement phase • if the individual has a superannuation income stream that is in the retirement phase, their transfer balance or modified transfer balance, and • the amount of any rollover superannuation benefit not already reflected in the accumulation phase value of their superannuation interests or their transfer balance. An individual is only entitled to make non-concessional contributions in 2019/20 if their total superannuation balance at the end of 30 June 2019 is less than the general transfer balance cap, which is $1.6m for 2019/20 (and will be the same for 2020/21). An individual’s total superannuation balance also affects whether the individual can take advantage of the bring-forward rule for non-concessional contributions. An individual’s non-concessional contributions cap for 2019/20 is either $100,000 or nil (s 292-85(2)). The cap is nil if, immediately before the start of the year, the individual’s total superannuation balance equals or exceeds the general transfer balance cap for the year, being $1.6m (s 292-85(2)). This means the individual cannot make any non-concessional contributions for that year. Individuals who are under 65 at some time in the year may be able to bring forward two years’ worth of entitlements to make non-concessional contributions, and so can make three years’ non-concessional contributions in one year without exceeding their non-concessional contributions cap. For 2019/20, an individual who is eligible to bring forward two years of entitlements would normally have a nonconcessional contributions cap of $300,000, subject to their total superannuation balance. For those whose total superannuation balance is approaching the $1.6m cap, special rules apply whereby the amount of the cap an individual may bring forward is: • three times the annual cap, that is $300,000, over three years if their total superannuation balance is less than $1.4m • two times the annual cap, that is $200,000, over two years if their total superannuation balance is above $1.4m and less than $1.5m, and • nil if their superannuation balance is $1.5m or above, that is no bring-forward period and the general non-concessional contributions cap applies (s 292-85(5)). In this case, as Jane has not previously made any non-concessional contributions, she has a $300,000 (three times the annual figure) cap available. This is because: • she satisfies the age requirement • her superannuation balance was less than $1.6m as at 30 June 2019 • the difference between the general transfer balance cap and her total superannuation balance is greater than $200,000 (ie $1.6m less $1.3m = $300,000).

Jane can therefore make a non-concessional contribution into her super fund of $200,000 for the year ended 30 June 2020. She then has an unused portion of the NCC cap ($100,000) available to be carried forward to the 2020/21 year (in addition to her actual $100,000 cap for 2020/21). In theory, therefore she can make a further NCC of $100,000 in 2020/21. However, immediately before the start of the 2020/21 year (as at 30 June 2020) her total superannuation balance was $1.6m. Accordingly, her cap is reduced to nil and she can make no further NCCs in the 2020/21 year. If the value of her super fund were to fall during that year such that the balance at 30 June 2021 were to be below $1.6m, she may be able to make further NCCs in 2021/22 depending on the level of her balance. AMTG: ¶14-050, ¶14-320

¶7-279 Worked example: COVID-19: Early access to superannuation Issue Richard Milligan owns and operates a small Melbourne restaurant called High Steaks as a sole trader. He is originally from New Zealand and moved to Australia with his New Zealand-born wife in 2010. He has not taken Australian citizenship or applied for permanent residency but resides here on a “Special Category Visa” under s 32 of the Migration Act. As a result of COVID-19, Richard has been forced to close his restaurant operation. Although he still offers takeaway food, his turnover in the period 1 April 2020 to 30 June 2020 is expected to fall by over 70%. On 1 July 2020, as a result of a relaxation in government guidelines, Richard is able to temporarily reopen the restaurant to diners, although turnover in the quarter to the end of September 2020 is still 50% lower than the same quarter in 2019 as a result of restrictions being reimposed later in the quarter. Richard has applied for and received JobKeeper for himself (as an eligible business participant) and his eligible staff. His superannuation balance is $120,000. He employs two apprentice chefs in his restaurant: • Thomas Keegan is an Australian citizen, aged 32. Prior to the COVID-19 crisis, he earned $1,000 per fortnight before tax working part-time at High Steaks. Thomas’s working hours have been cut by 50% as a result of the reduced operations of the business. Nevertheless, as an eligible employee, he has been receiving JobKeeper, meaning that his income has lately actually increased to $1,500 per fortnight before tax. His superannuation balance is $80,000. On 1 July 2020, Richard’s hours are increased back to normal due to the reopening of the restaurant. • Ben Riley is an Irish citizen who came to Australia on a 457 visa in April 2018 to train full-time as a chef at High Steaks. Because of COVID-19, there is now insufficient work for two apprentice chefs and he has been stood down until the crisis recedes. He remains stood down as at 24 September 2020. As he is not eligible for either JobKeeper or JobSeeker, his income has fallen to zero. His superannuation balance is $22,000. Richard, Thomas and Ben have heard that is possible to access their superannuation in order to relieve the financial stress imposed by COVID-19. Advise them if they are eligible, how much they are entitled to withdraw and how they apply. Solution The range of circumstances in which an individual can obtain early access to their superannuation is narrowly defined to include access: • on compassionate grounds • due to severe financial hardship • due to a terminal medical condition • due to temporary or permanent incapacity

• where the balance of the fund is less than $200. In addition, as part of the Coronavirus Economic Response Omnibus Act 2020, the SIS Regulations (SIS Regs) are amended to allow eligible individuals affected by COVID-19 to release up to $10,000 over two financial years from their superannuation on compassionate grounds. Any amount withdrawn is tax-free as non-assessable non-exempt income. Eligible Australian and New Zealand citizens and permanent residents are permitted to access up to $10,000 of their superannuation in 2019/20 (applications to be made before 1 July 2020) and a further $10,000 in 2020/21 (applications to be made from 1 July 2020 to 31 December 2020). To be eligible for this new COVID-19 condition of release (reg 6.19B of the SIS Regs), the following requirements must be met: • the individual is unemployed; or • the individual is eligible to receive a JobSeeker payment, parenting payment, special benefit, farm household allowance or youth allowance (other than on the basis that the person is undertaking fulltime study or is a new apprentice); or • On or after 1 January 2020, either: – the individual has been made redundant – the individual has had their working hours reduced by 20% or more (including to zero) – if the individual is a sole trader, their business was suspended or has suffered a reduction in turnover of 20% or more. The regulations do not specify any minimum documentation or evidentiary conditions for meeting these requirements. The ATO will determine an individual’s eligibility based on self-assessment and will administer this through the application process. Applications must be made to the ATO via myGov from 20 April 2020 to 30 June 2020 in relation to applications for the 2019/20 financial year and from 1 July 2020 to 31 December 2020 in relation to applications for the 2020/21 financial year. The ATO will process applications within four business days and will send an outcome letter to the individual’s myGov inbox and will advise the super fund to make the payment to the bank account specified in the application. Where the individual has an Australian Prudential Regulation Authority fund and the application is approved, the fund will then make the payment to the individual without them needing to contact the fund directly. Under reg 6.19b(1B) and (1C), a temporary resident may apply to access up to $10,000 of their super until 30 June 2020. Temporary residents cannot apply for the second $10,000 payment available to eligible Australian and New Zealand citizens and permanent residents from 1 July 2020. To apply for early release as a temporary resident, the following requirements must be met: • The individual holds a student visa that has been held for 12 months or more and the individual is unable to meet immediate living expenses. • The individual is a temporary skilled work visa holder (subclass 457 and 482) and still employed but is unable to meet immediate living expenses. • The individual is a temporary resident visa holder (excluding student or skilled worker visas) and cannot meet immediate living expenses. Applying the above to Richard, Thomas and Ben, each of them will first need to open a myGov account if they have not already done so. Then: • Richard is entitled to apply to withdraw up to $10,000 in super in 2019/20 by 30 June 2020 and a further $10,000 in super in 2020/21, provided the application is made by 31 December 2020. He is a

sole trader and his business turnover has fallen by 70% in the quarter to the end of June and 50% in the quarter to the end of September (both of which are more than the minimum stipulated fall in turnover of 20%). Although he is not an Australian citizen or permanent resident, New Zealand citizens are included within the terms of the full early release scheme (giving access to both withdrawal opportunities), even though the visa he has is technically a temporary one (TD 2012/18). • Thomas is entitled to apply to withdraw up to $10,000 in super in 2019/20 by 30 June 2020. Although his income has not actually fallen during the April to June quarter — in fact, it has increased due to JobKeeper — his hours of work have been cut by 50%, which is more than the minimum stipulated fall of 20%. Thomas is not eligible to withdraw super in 2020/21. The requirements about reductions in a person’s working hours or in their turnover as a sole trader are determined by reference to changes that have occurred since 1 January 2020. This requires a comparison of a person’s working hours or turnover at the time they make the application and their usual hours prior to 1 January 2020. By the time Thomas is able to make an application to withdraw super in 2020/21 (from 1 July onwards), his working hours have increased back to normal, meaning that he no longer satisfies the 20% reduction test. • Ben is entitled to apply to withdraw up to $10,000 in super in 2019/20 by 30 June 2020 since he is a holder of a temporary working visa (subclass 457) and, although still employed, he has been stood down and is not able to meet his immediate living expenses. He is not eligible to withdraw super in 2020/21. In relation to temporary visa holders, early access to super is only available in 2019/20. The second withdrawal in 2020/21 is not available. AMTG: ¶13-025, ¶13-810

¶7-280 Worked example: CGT small business retirement exemption Issue Bill Smythe is aged 66. Bill is intending to retire and consequently in the 2019/20 income year, he sold his business which he had owned for two years and derived a $400,000 capital gain. Bill’s net assets immediately prior to the sale were less than $6m and his turnover each year has been less than $2m. Bill has always been an Australian tax resident. Advise Bill as to how much of the capital gain can be made as a superannuation contribution without incurring excess contributions tax. Solution 50% general discount As Bill Smythe is an individual, the 50% general discount will apply to reduce his capital gain from $400,000 to $200,000 prior to the application of any CGT small business concessions (see below) because he owned his business for at least 12 months prior to the sale (ie two years), the capital gain was calculated without the benefit of indexation (as the business was purchased and sold postSeptember 1999) (ITAA97 Div 115; s 102-5, method statement — step 2), and Bill was a resident during the whole period that he owned the business (ITAA97 s 115-105). CGT small business concessions Bill can choose to apply the small business retirement exemption from the four CGT small business concessions provided for in ITAA97 Div 152. As Bill has only owned his business for two years and has not acquired further business assets, he cannot choose the small business 15-year exemption (ITAA97 s 152-105), nor can he choose the small business roll-over (ITAA97 s 152-410). Bill should also not apply the small business 50% reduction, as this will allow him to maximise the contributions to his superannuation fund that are tested against his CGT cap rather than the non-concessional contributions cap, that is $100,000 in 2019/20 (ITAA97 s 29285(2)) (see also ITAA97 s 102-5, 152-210, 152-220). As indicated above, the general 50% CGT discount will apply first, which reduces the capital gain of

$400,000 to $200,000. He should then apply the small business retirement exemption (see below), as the business is an active asset, which reduces the net capital gain to nil (ITAA97 s 152-310). Small business retirement exemption Bill can apply the CGT small business retirement exemption: • if he satisfies the basic conditions under Subdiv 152-A, and • if he chooses to contribute an amount up to his CGT exempt amount (see below), and • if the contribution is made at the later of when he chooses to apply the exemption or when he receives the capital proceeds (ITAA97 s 152-305(1)). If Bill was under 55, he would need to contribute the amount to a complying superannuation fund or a retirement savings account in order to apply the small business retirement exemption (ITAA97 s 152305(1)(b)). As he is over 55, he has a choice whether or not to contribute the amount. Bill satisfies the basic conditions because: (1) the sale of his business gives rise to CGT event A1 (s 104-10) which would result in a capital gain of $400,000 (2) he satisfies the maximum net asset value test (ie net assets less than $6m), and (3) his business is an active asset (ITAA97 s 152-10). Bill must choose to apply the small business retirement exemption; it is not automatic. The amount of the capital gain which is disregarded in accordance with s 152-315 is known as the “CGT exempt amount”. The CGT exempt amount for each taxpayer is limited to a lifetime limit of $500,000 (ITAA97 s 152-315(2), 152-320). Bill should specify his CGT exempt amount as $200,000, being the capital gain remaining after the application of the CGT discount. Provided this amount does not exceed the CGT cap (see below), it will not count towards the non-concessional contributions cap. Bill must specify the CGT exempt amount in writing (s 152-315(4)). There is no specified format for the choice but claiming the exemption in his tax return will not constitute the making of the choice of the CGT exempt amount (ITAA97 s 103-25(3)). Superannuation contributions Bill’s contribution into a complying superannuation fund will not be counted towards the non-concessional contribution limit ($100,000 in the 2019/20 year) if he is eligible for, and chooses to apply, the CGT small business retirement exemption (ITAA97 Subdiv 152-D) and the contribution counts towards his CGT exempt amount of $500,000. CGT exempt amount Bill’s superannuation contribution will count towards the CGT exempt amount of $500,000 where it meets all of the following requirements: (1) the contribution is equal to all or part of the capital gain from a CGT event that is disregarded because of the small business retirement exemption (2) the contribution is made on or before the later of the following days (ITAA97 s 292-100(2): • the day Bill is required to lodge his tax return for the income year in which the CGT event happened • 30 days after the day Bill receives the capital proceeds from the CGT event, and (3) Bill chooses to apply the CGT cap amount to that contribution (ITAA97 s 292-100(1), 292-100(7)). Bill will be regarded as having made a choice to apply the CGT exempt amount where he completes the

approved form and provides it to the superannuation provider in relation to the complying superannuation plan on or before the time when the contribution is made (ITAA97 s 292-100(9)). Therefore, to the extent that Bill is eligible for and claims the CGT small business retirement exemption, he will be able to make contributions from the CGT exempt amount into his superannuation fund without the contribution counting towards the non-concessional contributions cap. However, to the extent that the capital gain contributed to his superannuation fund is part of the capital gain disregarded in accordance with the 50% general discount ($200,000), the contribution will count towards Bill’s non-concessional cap ($100,000). Any contribution in excess of this cap will be liable to excess contributions tax of 47% under ITAA97 Div 292, s 292-80 and 292-85(1) (Superannuation (Excess Non-concessional Contributions Tax) Act 2007). As Bill is not under 65, he is not able to utilise the bring forward rule (which would have effectively increased his non-concessional contributions cap to $300,000 — ITAA97 s 292-85(3) and (4)). Effectively, Bill can contribute $300,000 to his superannuation fund without incurring excess contributions tax. That is, $200,000 covered by the CGT cap and $100,000 that is within the non-concessional contributions cap. AMTG: ¶7-110, ¶7-185, ¶13-780

¶7-300 Worked example: Foreign salary; wages income Issue Matt Coates is a sergeant-major with the Australian Defence Force who worked overseas for 13 months on combat duties. Matt left for Afghanistan on 1 July 2019 and returned to Australia on the 6 August 2020. During the tax year ended 30 June 2020, Matt derived the following income: $ Salary paid and taxed in Afghanistan Dividends received in Afghanistan, net of 15% withholding tax Rent received in Australia

77,000 1,700 11,000

Matt incurred expenses of $4,500 in deriving his salary income and $2,300 in deriving rental income. In addition Matt made a deductible contribution of $3,000 to a complying superannuation fund, paid $500 in tax agent fees for preparation of his Australian tax return and also made a donation of $300 to the Red Cross. Withholding tax of $300 was deducted from the overseas dividends and $23,720 of tax was paid on the Afghan salary. Note: Salary earned by Matt Coates while working in Afghanistan is exempt from Australian tax (ITAA36 s 23AG), however it must be included in determining the tax payable by Matt on his Australian taxable income. Assuming the above figures have all been converted into Australian dollars, calculate the tax payable by Matt for the year ended 30 June 2020. Solution Salary income earned by Matt Coates while working in Afghanistan is exempt from Australian tax (ITAA36 s 23AG and 23AG(1AA) as a government employee deployed as a member of a disciplined force but it must be included in determining the tax payable by Matt on his Australian taxable income. Taxable income

$

 $

Gross — assessable income: Rent received in Australia Non-exempt foreign dividends (dividends received $1,700, plus withholding tax

11,000 2,000

13,000

$300) Less: Expenditure incurred exclusively in deriving this income

2,300

Superannuation contributions

3,000

Tax agent’s fees

 500

Less apportionable deductions (donation)

  300

 6,100

Other taxable income after apportionable deductions

 6,900

Exempt foreign income after deductions ($77,000 − $4,500)

72,500

Add other taxable income after apportionable deductions

 6,900

Notional gross taxable income

79,400 Calculation of the apportionable deduction:

Apportionable deduction

Other taxable income

×

Apportionable deductions + Notional gross taxable income

=$300 × $6,900 / $300 + $79,400 =$25.97* Matt’s other taxable income $ Gross assessable income ($11,000 + $2,000) Less: Expenditure incurred exclusively in deriving this income Superannuation contributions Tax agent’s fees

$ 13,000

2,300 3,000  500

Donations

  25*

Other taxable income

5,825 7,175

Tax payable on non-exempt income For the purposes of determining the tax payable on the income which is not exempt under ITAA36 s 23AG, the following formula applies (s 23AG(3)): Notional gross tax Notional gross taxable income

× Other taxable income

Notional gross tax is the tax (in whole dollars) that would be payable (including the Medicare levy, but not including any tax offsets) on the amount that would be total taxable income if the exempt income was also assessable income, ie: Total assessable income = $77,000 + $11,000 + $1,700 + $300 (dividend withholding tax) = $90,000 Less Total allowable deductions = $4,500 + $2,300 + $3,000 + $500 + $300 = $10,600 Notional gross taxable income = $79,400 Notional gross tax = ($79,400 − $37,000) × 32.5% = $13,780 + $3,572 = $17,352 Other taxable income in the formula is $6,900*. This amount differs from the $7,175 taxable income in the calculation above because the gift to the charity is subtracted as an apportionable deduction of $25, rather than as a full deduction of $300. Tax payable on the non-exempt income is calculated as follows:

$17,352 / $79,400 (excluding Medicare levy) × $6,900 = $1,507.92 $ 

$

Less: Credit for dividend withholding tax

300

Low middle income tax offset

255

Low income tax offset TAX PAYABLE ON NON-EXEMPT INCOME

445 1,000.00   507.92

Note: *The gift deduction is excluded from this calculation (Taxation Determination TD 98/15). AMTG: ¶2-090, ¶10-860, ¶10-865

¶7-320 Worked example: Exempt foreign income Issue James Tan works as an aid officer employed with AusAID, a recognised non-government organisation. He is a resident of Australia for tax purposes. During the 2019/20 income year, James is posted overseas to assist with AusAID’s delivery of an aid program in Indonesia. James moved to Indonesia on 1 July 2019 and returned to Australia on 30 June 2020. James paid tax in Indonesia on his income from AusAID. Advise James as to whether his income will be exempt from tax under ITAA36 s 23AG? Solution Income from salary or wages derived overseas by an Australian resident may be exempt from Australian income tax where the period of continuous foreign service is 91 days or more (s 23AG). However, from 1 July 2009, the scope of the exemption has been significantly limited with the introduction of s 23AG(1AA). The exemption is now only available if the foreign service is directly attributable to: • aid or charitable worker employed by a recognised non-government organisation • work as a government aid worker • work as a government employee deployed as a member of a disciplined force. The exemption from Australian tax does not apply where the foreign source income is exempt from income tax in the foreign country only because: • of a double tax agreement • the foreign country does not tax employment or personal services income, or • there is an international agreement dealing with privileges and immunities of diplomats or consuls, or persons connected with international organisations (s 23AG(2)). Continuous period of foreign service To be eligible for the tax exemption, the taxpayer’s period of foreign service must be for at least 91 days. The 91-day period does not have to be all in the one income tax year. The continuous period of service can commence in one income year and end in another (Taxation Determination TD 2012/8). Continuity is not broken by: • leave granted by the employer due to accident or illness • bona fide business trips related to the taxpayer’s service overseas, and • weekends, public holidays, recreation leave or other approved time off.

Continuity of foreign service would be affected by: • long service leave • leave without pay, and • returning to Australia if not associated with foreign service or acceptable temporary absence (eg illness or accident). Continuous service can also constitute two or more periods in which a person has been engaged in foreign service. The continuity is broken at: • the end of the last period, or • a time (if any), since the start of the first period, when the person’s total period of absence exceeds 1/6 of the person’s total period of foreign service, whichever happens sooner (see s 23AG(6A); Taxation Determination TD 2012/8). As James is a resident of Australia and he pays tax in Indonesia on his foreign earnings, the only issue is whether his period of service is one of at least 91 continuous days (s 23AG(1) and (2)). In calculating whether James has completed at least 91 continuous days of foreign service, James can include any period during which he is absent on recreation leave in accordance with the terms and conditions of his foreign service (s 23AG(6)). In calculating the period of foreign service certain temporary absences from the foreign country will also be included in the period of foreign service (see Taxation Determination TD 2012/8). On the basis that James is working for a continuous period in excess of 91 days, given that he has been posted in Indonesia for the full 2019/20 tax year, and he is an aid worker employed by a recognised nongovernment organisation, he will be able to claim a tax exemption for his foreign earnings under s 23AG. AMTG: ¶10-860

¶7-340 Worked example: Foreign income tax offset amendment period Issue Cameron Davis is an Australian tax resident who resides in Sydney. He owned a commercial building in Canada which he decided to sell. The contract date for the sale of the property was 1 June 2017, however because of financing delays settlement did not take place until April 2019. Under the double tax agreement between Australia and Canada Cameron is subject to taxation in both countries in relation to any capital gain arising from the sale of the Canadian property. For Australian tax purposes, CGT event A1 happened on 1 June 2017. No other CGT event happened to Cameron during 2016/17 and a net capital gain of $60,000 was included in Cameron’s 2016/17 tax return. Cameron lodged his own 2016/17 tax return in October 2017. He could not claim any foreign income tax to offset the Australian tax liability as he had not yet paid Canadian tax on the capital gain. It was not until December 2019 that Cameron lodged a Canadian tax return for the 2017 Canadian tax year. The return disclosed a taxable capital gain of $80,000 (in Australian dollars). Cameron paid the Canadian tax on the capital gain in January 2020. Is Cameron entitled to claim a foreign income tax offset (FITO) in relation to the Canadian tax paid on the capital gain even though his amendment period expired in November 2019? Solution As at January 2020, Cameron is entitled to claim a FITO in relation to 75% of the Canadian tax paid on the capital gain, notwithstanding the fact that his standard amendment period of two years expired in November 2019. ITAA97 s 770-190(1) allows taxpayers a special amendment period of four years after an “amendment event” happens. Relevant to Cameron, an “amendment event” includes the payment of foreign tax (ie

Canadian tax) that counts towards the FITO for the year (s 770-190(2)). This amendment period of four years overrides the standard amendment periods in ITAA36 s 170. An amount of foreign tax counts towards the FITO for the year to the extent that it was paid in respect of an amount included in assessable income that year (s 770-10(1)). In Cameron’s case, the capital gain that was assessable in Australia in 2016/17 (ie $60,000) equals 75% of the capital gain that was taxed in Canada (ie $80,000). Therefore, only 75% of the Canadian tax paid in respect of the gain can count towards the FITO for 2016/17. Cameron has until January 2024 to amend his 2016/17 tax return to claim a FITO in relation to the Canadian tax paid on the capital gain. The FITO claimable will equal the lesser of: • 75% of the amount of Canadian tax paid, and • the foreign income tax offset limit calculated under s 770-75. The FITO limit calculated under s 770-75 very broadly represents the Australian tax that would be payable on double taxed foreign source income in the absence of the FITO. Cameron will calculate his FITO limit as follows: Step 1: Calculate his tax payable for the 2016/17 year, including Medicare levy and Medicare levy surcharge, but excluding any tax offsets. Step 2: Calculate his tax payable for the 2016/17 year using the following assumptions: (a) Assessable income does not include: • any assessable amount (whether Australian or foreign sourced) on which foreign income tax has been paid that counts towards his FITO, and • any other foreign source income. (b) The following deductions were not allowable: • debt deductions attributable to an overseas permanent establishment • any other deductions (other than debt deductions) that are reasonably related to any amount covered by (a), and • an amount of the foreign loss component of one or more tax losses deducted in the income year. Subtract the result of Step 2 from the result of Step 1. This is Cameron’s FITO limit for 2016/17. Note, a taxpayer may claim up to $1,000 of foreign tax paid as a FITO without needing to calculate the limit and comparing it to the foreign tax paid on the double taxed income. In Cameron’s case, his FITO limit is likely to be much higher than $1,000 given the size of the capital gain taxed in Canada. However, for taxpayers with smaller foreign tax amounts, the $1,000 limit offers an administrative concession. AMTG: ¶21-710, ¶21-775

¶7-360 Worked example: Temporary residents; taxation of income Issue KoalaKo recruited Caroline Jacobs from the US to work in their Sydney office. On 1 August 2019 Caroline arrived in Australia on a Temporary Work (Skilled) visa (subclass 457). She is expected to remain in her role for at least the four-year term of her visa, with a possibility of an extension. Caroline is a temporary resident for Australian tax purposes. In March and April 2020 Caroline was sent to work in Auckland at

KoalaKo’s New Zealand (NZ) subsidiary, KiwiKo. KiwiKo paid Caroline’s salary for the two months she was in NZ. Caroline owns a rental property in the US and receives monthly rental income. She makes monthly mortgage payments, including interest to a US bank. She also holds less than 10% of all issued shares in a US company (US Co) that is listed on an American stock exchange. During 2019/20, she received dividends from US Co. Dividend withholding tax was withheld at the source. After Caroline arrived in Australia in August 2019, she purchased shares in an Australian company (Auz Co) that is listed on the Australian Stock Exchange. She holds less than 10% of all issued shares in the company. Auz Co did not pay any dividends in 2019/20. In May 2020 Caroline sold her shares in US Co and Auz Co. A gain was made on both sales. Advise Caroline on how each of the items of her income will be treated for Australian tax purposes in 2019/20. Would the working holiday maker legislation apply to income Caroline derived during the 2019/20 year? Solution Employment income Caroline will be taxed on her Australian source salary income received from KoalaKo (ITAA97 s 6-5). Her NZ source salary income is also assessable. Even though foreign income is generally non-assessable non-exempt income to temporary residents, this treatment does not apply to employment income (ITAA97 s 768-910(3)). US rental property The rental income derived from the US rental property is non-assessable non-exempt income under s 768-910(1). This is because the income is foreign source income, and not employment income or personal services income. Since the US rental income is not assessable, Caroline will not be entitled to deduct the mortgage interest paid to the US bank (ITAA97 s 8-1 requires a deduction to have a nexus to assessable income). Any other costs incurred in relation to the rental property will also be non-deductible. Although Caroline pays interest to a foreign entity, her temporary residency status provides an exemption from remitting any Australian interest withholding tax (ITAA97 s 768-980). US dividends The US Co dividends are non-assessable non-exempt income as it is foreign source income (s 768910(1)). There are no Australian tax implications arising from the US dividend withholding tax that was withheld at the source. There are no assessable dividends to be grossed up for the withholding tax paid. The withholding tax cannot be claimed as a foreign income tax offset as the dividends are not assessable. Sale of US Co and Auz Co shares The capital gains arising from the sales of the US Co shares and the Auz Co shares are not assessable on the basis that the shares do not constitute “taxable Australian property”. A temporary resident is subject to tax on a capital gain only if the CGT asset is taxable Australian property (s 768-915(1)). A share in a company is taxable Australian property if it constitutes an “indirect Australian real property interest” (s 855-15, item 2). The share will be an indirect Australian real property interest under s 855-25 if: • the taxpayer holds 10% or more of the company at the time of the share disposal, or throughout a 12month period in the 24 months prior to the share disposal (the non-portfolio interest test), and • more than 50% of the total market value of the company’s assets comprises taxable Australian real property (eg real estate) at the time of the share disposal (the principal asset test). Neither the shares in Auz Co nor the shares in US Co are taxable Australian property to Caroline as she held less than 10% of the shares in each company. As the share do not pass the non-portfolio interest test, the principal asset test does not require consideration. Note, for the taxable Australian property test,

it is irrelevant where the company is listed, incorporated or resident for tax purposes. Working holiday maker tax rates The tax rates that apply to working holiday makers will not apply to Caroline. The rules only apply to taxpayers who hold a visa subclass 417 or 462. Temporary residents holding other types of temporary visas, such as Caroline, are not affected. AMTG: ¶12-725, ¶12-760, ¶21-000, ¶22-020, ¶22-125

¶7-380 Worked example: Working holiday makers Issue Walt Brown owns a mango farm in northern Queensland and wants to employ some working holiday makers during the peak picking season. Walt is concerned about how working holiday makers should be taxed. He is worried that the law is now too complicated and that as an employer he will make mistakes in complying and he will be penalised by the ATO. Explain to Walt the tax rules that apply to working holiday makers and what he, as an employer of working holiday makers, would need to do to comply with the law. Solution Under the Working Holiday Maker program, young adults aged 18 to 30 from eligible countries can work in Australia while having an extended holiday. The Working Holiday Maker program includes subclass 417 (Working Holiday) and 462 (Work and Holiday) visas. Before 1 January 2017, when a working holiday maker started work with an employer they would generally indicate on a TFN declaration that they were either a resident or a non-resident for tax purposes. They would then be taxed according to that status: • if a resident, they would be taxed at resident rates, or • if a non-resident, they would be taxed at 32.5% on their assessable income from the first dollar they earned. The ATO’s view was that working holiday makers should be taxed as non-residents because of the transient pattern of their working and holidaying while in Australia. From 1 January 2017, the taxation of working holiday makers has been simplified — the first $37,000 of their income is taxed at 15% and the balance is taxed at non-resident rates, that is at 32.5%. Duties of employers of working holiday makers An employer who employs working holiday makers must register with the ATO as an employer of working holiday makers, generally by the first day they are required to withhold an amount. This registration process applies in addition to an employer’s obligation to be registered for PAYG withholding. Registered employers will withhold tax from the pay of working holiday makers at 15% on the first $37,000, then at 32.5% on the balance. Employers of working holiday makers who do not register must withhold tax at 32.5% on income up to $90,000. These tax rates only apply if the employee provides their tax file number to their employer — otherwise, the employer must withhold tax at the top rate (45% for 2019/20). When a working holiday maker finishes work, their employer must give them a payment summary showing how much has been earned and how much tax withheld. The same information is sent to the ATO. When an income tax return is lodged by the working holiday maker, there may be a refund of tax if deductions have been allowed, for example for work-related expenses. Working holiday makers are not liable for Medicare levy and are not entitled to the low income tax offset. Superannuation contributions

Employers must make superannuation contributions on behalf of their working holiday maker employees in the same way as they make contributions for other employees. This means that an employer must generally make a contribution equivalent to 9.5% of an employee’s ordinary time earnings to a complying superannuation fund, unless the employee earns less than $450 in a month from the employer. The employee must be allowed to choose the fund into which the contribution is made, but if the employee fails to make a choice the employer will generally make the contribution to a superannuation fund nominated in the award that covers the employee’s employment. After a working holiday maker has left Australia, they can apply to the ATO to have their superannuation money paid to them as a Departing Australia Superannuation Payment. Any such payment is taxed at 65%. AMTG: ¶21-033, ¶26-277, ¶42-125

¶7-400 Worked example: Taxation of minors Issue Allison Miles, aged 17 years, currently lives at home with her mother. While studying for her final year at high school she worked part-time in a retail shop for 15 hours a week and conducted catalogue deliveries three times a week. Allison’s uncle established a bank account with a balance of $9,000 in Alison’s name. Allison’s grandfather who is still alive and is the trustee of the Miles Family discretionary trust, distributed a further $5,300 to assist Allison to cover other school and living expenses during the 2019/20 income tax year. During the year ended 30 June 2020, Allison’s receipts and expenses were as follows: Receipts

$

$

Receipts from the catalogue delivery

3,600

Wages from working at the retail shop

5,100

Interest from bank account established by her uncle

904

Interest from Allison’s other bank account in which she has banked her receipts from her employment activities

240

Dividend received from shares in AMP (fully franked) left to Allison by her deceased father

150

Income received as a beneficiary in the Miles Family trust established by her grandfather

5,300

Expenses Replacement of her walking shoes Bank charges on account established by her uncle Purchase of wet-weather clothing Bank charges on Allison’s bank account Dry cleaning of retail shop uniform Bus fares incurred for travelling from home to the retail shop

138 14 160 3 62 112

Other information No tax had been deducted from the income received as a delivery person or as a shop assistant for Allison. The trustee for the Miles Family inter vivos trust advised that Allison’s share of net trust income was $10,000 but that $4,500 had been withheld for payment of tax. The balance of $5,500 was payable to

Allison. Based on the above information determine the taxable income for Allison Miles for the 2019/20 tax year and calculate her tax payable/refundable including any Medicare levy. Solution Taxable income Allison Miles Statement of taxable income for the year ended 30 June 2020 $

$

Excepted assessable income (ITAA36 s 102AE) Income from catalogue delivery

3,600

Income from working at retail shop

5,100

Interest from Allison’s bank account Dividend from shares in AMP (Includes franking credit)2

240    214

9,154

Less: Deductions1— Dry cleaning of retail shop uniform Bank charges on Allison’s bank account

62          3

Excepted taxable income

  65 9,089

Eligible assessable income Interest from bank account established by uncle Income as beneficiary from an inter vivos trust

904 10,000

10,904

Less: Deductions— Bank charges on account established by uncle

    14

Eligible taxable income

10,890

TOTAL TAXABLE INCOME

19,979

Notes: (1) Claim for expenses The damage to Allison’s shoes although resulting from a work-related activity, is not allowable, as the clothing is of a conventional nature. The cost of wet weather clothing, although perhaps necessary to protect her in adverse conditions, will not be allowable for the same reason. In cases where there are extreme weather conditions, or prolonged periods of time in the elements, the expenses may be deductible (Taxation Ruling TR 2003/16 para 50). In this instance, doing part time catalogue deliveries would not be considered a prolonged period of time, and no evidence of extreme weather conditions exist. The dry-cleaning is fully deductible as a work-related expense under ITAA97 s 8-1 but the bus fare is deemed to be private and not deductible (see Lunney v FC of T; Hayley v FC of T (1958) 100 CLR 478). (2) Dividend Include the gross dividend $150 plus the franking credit ($150 × 30 / 70 = $64) as assessable income. As the dividend is a receipt from a deceased estate it is considered excepted minor’s income under ITAA36 s 102AE(2)(c). Tax payable

$

$

Tax on eligible taxable income $10,890 at 45%

4900.50

Tax on excepted taxable income ($9,089) at ordinary rates

       0 4900.50

Less: Tax offsets Imputation credit (ITAA97 s 207-20) Tax paid by trustee (ITAA36 s 100(2)) TAX PAYABLE

64.29 4,500.00 4,564.29   336.21

As Allison Miles’s taxable income ($19,979) does not exceed the Medicare low income threshold for the 2019/20 tax year ($22,801), no Medicare levy is payable. The low income tax offset cannot be applied against “eligible taxable income”. The low and middle income tax offset is also unavailable against such income. AMTG: ¶2-160, ¶2-170, ¶2-210, ¶2-220, ¶2-250

¶7-420 Worked example: Recovery of HELP debts Issue Eva Simpson and Kelly Connors finished their university studies in December 2018 and had each accumulated a considerable HELP debt — $28,000 for Eva and $49,000 for Kelly. After travelling overseas for a few months, the friends started to look for employment. In the 2019/20 financial year, Eva found work as a teacher in Darwin on a salary of $68,000 and Kelly was involved in research for a pharmaceutical company in Sydney on a salary of $58,000. In January 2020, Kelly was offered a 24-month transfer by the company to their head laboratory in the United States. She left for overseas in February 2020. Explain whether Eva and Kelly would be liable to make repayments of their HELP debts for 2019/20 and, if so, how the repayments would be made. Solution An individual with a HELP debt does not have to make repayments unless their “repayment income” for the year has reached at least the HELP threshold for the year. For 2019/20, the HELP threshold is $45,881. The repayment rate, ranging from 1% to 10%, depends on a taxpayer’s repayment income for the year. An individual’s repayment income is the total of their: (i) taxable income, (ii) exempt foreign employment income, (iii) reportable fringe benefits total, (iv) reportable superannuation contributions, and (v) total net investment losses. HELP debts are collected in either of two ways: • if the individual’s employer knows that the individual has an accumulated HELP debt and their repayment income has reached the HELP threshold for the year, the employer will withhold additional tax, or • when the individual lodges an income tax return and their tax liability for the year is assessed. An employer may be aware that an individual has an accumulated HELP debt because of information provided to the employer on a Tax File Number Declaration when an individual starts a new job or on a Withholding Declaration if the individual acquires a HELP debt after employment commences. HELP repayments are not deductible if they are made by an employee, but may be deductible for an employer if the repayment is made on behalf of an employee and the employer also pays fringe benefits tax on the amount paid (ITAA97 s 26-20).

If a taxpayer with a HELP debt moves overseas for more than 183 days (the assumption being that they are then a foreign resident), the taxpayer is required to repay their HELP debt to the same extent as they would have been required if they continued to reside in Australia. Liability is imposed on overseas debtors as a levy — the “overseas debtors repayment levy” (Student Loans (Overseas Debtorsss Repayment Levy) Act 2015). The HELP debt repayment rules are in the Higher Education Support Act 2003. Eva Assuming she has no assessable income for 2019/20 other than her salary income, Eva has repayment income of $68,000. The repayment rate on $68,000 is 4.0%, so Eva must pay $2,720 ($68,000 × 4.0%) in addition to her income tax liability. This will be paid either by her employer withholding the additional tax from her salary during the year, or when she lodges an income tax return and her tax liability is assessed. Kelly No later than seven days after she goes overseas, Kelly must give notice of her absence to the ATO in the approved form. As a foreign resident, she will be required to make HELP repayments for 2019/20 if she has a HELP debt on 1 June 2019 and her “assessed worldwide income”, that is the sum of her repayment income and her foreign-sourced income, exceeds the repayment threshold for the year. Assuming she has no assessable income for 2019/20 other than her salary income, Kelly has repayment income of $58,000. The repayment rate on $58,000 is 2.5%, so Kelly must pay $1,450 ($58,000 × 2.5%) in addition to her income tax liability. The fact that she went overseas for 24 months in February 2019 does not stop her being liable. To report her income whilst overseas, she must complete a non-resident foreign income schedule and lodge it with her tax return. This can be done through myTax or her tax agent can complete and lodge it on her behalf. AMTG: ¶2-380

¶7-440 Worked example: Sharing economy; ride-sourcing service; Uber drivers Issue Elon Leyland is currently employed as an engineer for Aerospaceco. To help grow his savings for a deposit on a property he decides to become an Uber Partner. He registers with Uber and immediately starts earning income. Elon has never previously supplemented his income. He has always been on salary and wages with PAYG withholding. He has a FEE-HELP debt and a small amount of interest income from his term deposits. He manages his tax compliance obligations using My Gov and the ATO tax return software. He simply pre-fills and lodges his return by 31 October each year. Now Elon is exposed to the sharing economy and he wants to ensure that he continues to meet all of his tax obligations. Advise Elon on the tax consequences and the steps he needs to undertake to ensure he continues to be tax compliant. Solution Taxable income and deductions Elon must declare all the income he receives from his Uber driving along with his salary and wages from Aerospaceco in his annual tax return, as these amounts are assessable as ordinary income (ITAA97 s 65). Any associated expenses directly associated with gaining this income will be allowable deductions for tax purposes (ITAA97 s 8-1). Elon can claim deductions for expenses related to his Uber income. Given that Elon’s car is also used for private purposes, he can only claim expenses based on the proportion that the car is used for Uber

purposes. The list of deductions available to Elon that relate to his Uber driving include: • any amounts paid to Uber as commissions, licensing or service fees • costs for water and mints for Uber Riders • fuel • tolls • parking • vehicle registration and insurance • mobile phone bills, and • costs of cleaning, servicing and repairing the vehicle. Deductions that are considered private and not deductible include: • driver’s licence (Taxation Determination TD 93/108) • any fines such as parking or speeding (ITAA97 s 26-5) • clothing (Taxation Ruling TR 94/22), and • personal meals. The largest of Elon’s expenses that can be claimed as deductions will relate to the car usage costs. The ATO permits two methods to calculate car expenses based on the substantiation required to support these claims, that is the cents per kilometre method and the log book method. Under the cents per kilometre method Elon can claim kilometres travel at 68c per kilometre (72 cents per kilometre from 1 July 2020) for distances up to 5,000 km. This method incorporates all car expenses including petrol, servicing and depreciation. Using the log book method Elon must maintain a log book for a minimum period of 12 weeks to determine the business use percentage for the car expenses. This log book must be updated every five years. Elon can then claim all expenses that relate to the operation of the car, at his percentage of business use (which is based on an estimate of business kilometres travelled using the log book and other factors — see ITAA97 s 28-90(5)). GST obligations As an Uber driver Elon will have GST obligations. Although, enterprises with a turnover of less than $75,000 are not normally required to register for GST, taxi and limousine operators are required to be registered, regardless of turnover (GST Act s 144-5). A person who is carrying on an enterprise is required to be registered for GST purposes if, in carrying on the enterprise, that person supplies taxi travel (s 144-5(1)). “Taxi travel” is defined as meaning “travel that involves transporting passengers, by taxi or limousine, for fares” (GST Act s 195-1). In Uber BV v FC of T 2017 ATC ¶20-608, the courts confirmed that providing uberX services to passengers (uberX Riders), uberX drivers (uberX Partners) are a supply of “taxi travel”. Accordingly, Elon must be registered for GST. Elon must charge GST on all fares and also can claim the GST back on any expenses that he has incurred. Elon must apply for an ABN and register for GST. There are no application fees for this process. These registrations must be in place within 28 days from the end of the first quarter that Elon started receiving income from his Uber activities. This is the deadline for Elon to lodge his first Business Activity Statement (BAS). For example, if Elon started receiving Uber income on 23 July 2019, then he must lodge his first BAS by 28 October 2019. This BAS includes the net GST up until 30 September 2019. Management

To manage his ongoing compliance, Elon should consider setting up a separate bank account for his Uber activities with all the income and expenses debited and credited through that account. This will assist him to keep a record of all expenses as well as income, and manage his quarterly GST liability. PAYG instalments As Elon is now deriving income that is not subject to PAYG withholding, it is possible that Elon may become liable to pay PAYG instalments. This will apply if Elon is not entitled to the senior and pensioners’ tax offset, the balance of his assessment is $1,000 or more, and his business and investment income is $4,000 or more. AMTG: ¶10-105, ¶16-310, ¶16-320, ¶16-350, ¶16-370, ¶27-120, ¶33-105, ¶34-100, ¶34-115, ¶34-220

¶7-460 Worked example: Medicare levy surcharge; foreign health insurance policy Issue Tim Wong is an Australian tax resident who is single with no dependants. His taxable income for the 2019/20 income year is $95,000. Tim has held an Australian health insurance policy for many years with a health fund that is registered under the Private Health Insurance (Prudential Supervision) Act 2015. His policy includes private patient hospital and extras cover and is a complying policy for the purposes of the Private Health Insurance Act 2007 (PHIA). On 1 September 2019 Tim’s Australian employer arranged for him to work in the company’s overseas office for eight months. As part of the arrangement the overseas subsidiary provided Tim with private health insurance with a local foreign insurer who is not registered in Australia. The foreign insurer did not provide any policies that would cover treatment in Australia or treatment in relation to events that happen in Australia. Tim’s foreign health insurance policy included hospital and extras cover for the foreign country only. Tim cancelled his Australian health insurance policy when he left for overseas. Tim remained an Australian tax resident for the duration of his eight months working overseas. When he returned to Australia at the beginning of May 2020, he reinstated his Australian health insurance policy. Is Tim exempt from paying the Medicare levy surcharge (MLS) for the 2019/20 income year? Solution Liability for MLS Under the Medicare Levy Act 1986 (MLA) s 8B Tim is liable to pay the MLS in relation to a period if during the whole of that period: (i) he was not married (ii) he did not have any dependants (iii) he was not a “prescribed person” (as defined in ITAA36 s 251U), and (iv) he was not covered by an insurance policy that provides “private patient hospital cover” for the purposes of the MLA. Note, s 8B can apply to “part of a financial year” so a taxpayer may be subject to the MLS for only part of an income year. Tim meets criteria (i), (ii) and (iii) for the period, that is the whole of the 2019/20 income year. Throughout 2019/20 Tim was unmarried and had no dependants. He was also not a “prescribed person” at any time during 2019/20 as he did not fall within any of the categories listed in s 251U. The remaining question is whether he was covered by “an insurance policy that provides private patient hospital cover” for all or part of the year. MLA s 3(5) defines when a person is covered by “an insurance policy that provides private patient hospital cover”. One of the requirements is that the policy is a “complying health insurance policy” within the meaning of the PHIA that covers “hospital treatment” within the meaning of that Act.

A policy is a complying health insurance policy under PHIA s 63-10 if it meets the requirements in specified divisions of the PHIA (Div 66, 69, 72, 75, 78 and 81) and any requirements set out in the Private Health Insurance (Complying Product) Rules. Note the other requirement under MLA s 3(5) relates to the amount of excess payable in relation to benefits under the policy — assume that Tim’s Australian health insurance policy meets this requirement. The term “hospital treatment” is defined in PHIA s 121-5. Broadly, it is treatment which: • is intended to manage a disease, injury or condition • is provided to a person by a person who is authorised by a hospital, or under such a person’s management or control, and • is provided at a hospital or provided with the direct involvement of a hospital. A business of “undertaking liability, by way of insurance” is a health insurance business for the purposes of the PHIA s 121-1(1)(a). Note the following points: 1. Entities are only permitted to carry on a health insurance business if they are registered under the Private Health Insurance (Prudential Supervision) Act 2015 Pt 2 Div 3 (PHIA s 115-1). 2. For the purposes of the s 121-1 meaning of health insurance business, the liability by way of insurance must relate to: a) loss arising out of a liability to pay fees or charges relating to provision in Australia of such treatment, or b) provision in Australia of such treatment, or c) the happening of an occurrence connected with the provision in Australia of such treatment, or d) the happening of an occurrence in Australia that ordinarily requires the provision of such treatment. Period of four months covered by the Australian health insurer The government website www.privatehealth.gov.au provides a list of health funds registered under the PHIA. The facts state that Tim’s health fund is appropriately registered as a health insurance business. Tim confirms with his health fund that his specific policy is a complying health insurance policy under PHIA s 63-10. The policy provides hospital cover that covers relevant treatment provided in Australia and therefore the cover is hospital cover under PHIA s 121-5. In relation to the periods July to August 2019 and May to June 2020, Tim is not liable to pay the MLS under s 8B because in addition to meeting the criteria in s 8B(i), (ii) and (iii) Tim was covered by a complying health insurance policy issued by a health fund that is appropriately registered as a health insurance business and provides private patient hospital cover and hospital treatment in Australia. Period of eight months covered by the foreign policy Tim’s foreign health fund is not registered under the Private Health Insurance (Prudential Supervision) Act 2015 and therefore the foreign policy cannot be relevant cover that will allow him an exemption from the surcharge. In any case, a health insurance provider that can be registered must broadly provide treatment in Australia or in relation to an occurrence in Australia (PHIA s 121-1). The foreign insurer would not be able to meet this requirement. In relation to the period September 2019 to April 2020, Tim is liable to pay the MLS as he was not covered by an insurance policy that provides private patient hospital cover for the purposes of the MLA — regardless of the fact that the foreign policy provided hospital cover overseas.

AMTG: ¶2-335, ¶42-010

PARTNERSHIPS Net partnership income

¶8-000

Calculation of net partnership income; distribution to partners ¶8-020 Calculation of net partnership income; capital gain

¶8-040

Partnerships; CGT assets

¶8-060

CGT; Admitting a new partner

¶8-080

Retiring partners; distributions

¶8-100

Uncontrolled partnership income; penalty tax

¶8-120

Disposal of partner’s interest

¶8-140

Variation of partnership interests

¶8-160

Assignment of partnership interests

¶8-180

Residence; profit and loss sharing

¶8-200

Work in progress; trading stock

¶8-220

Admission of new partner; ABN/TFN requirements

¶8-240

Tax returns; income; interest; change in partnership

¶8-260

¶8-000 Worked example: Net partnership income Issue T&C Printing is a stationery store operated in partnership by Tim and Caitlin. The partnership agreement provides the following: • an annual salary of $35,000 to Caitlin for working full-time in the business • a superannuation payment for Caitlin equal to 10% of Caitlin’s annual salary • interest to be paid at the rate of 15% on each partner’s capital contribution with Tim contributing $90,000 and Caitlin $30,000 respectively, • apart from the above, Tim and Caitlin otherwise share partnership profits equally, and • interest at the rate of 12% pa to be paid on any loan made to the partnership. Tim contributed $15,000 to the business as working capital on 1 May 2020. The net profit of the partnership after allowing for these particular outlays and other operational expenses was $150,000 for the year ended 30 June 2020. Calculate the net income of the partnership pursuant to ITAA36 s 90 for the year ended 30 June 2020 and the distribution to both Tim and Caitlin. Solution To determine the net income of the partnership pursuant to ITAA36 s 90, the net operating profit of $150,000 must be adjusted. The adjustments take into account outlays that are not expenses of the partnership but are merely a means by which the partners have agreed to distribute partnership profits. Such outlays are not deductible to the partnership under ITAA97 s 8-1 (Taxation Ruling TR 2005/7). These outlays are the partners’ salaries, superannuation payments and interest on capital accounts or

current accounts. Net income of the partnership is:  $ Net operating profit

  150,000

Add: Interest on capital (Tim)

 13,500

Salary (Caitlin)

 35,000

Superannuation (Caitlin)

 3,500

Interest on capital (Caitlin)

  4,500

NET INCOME

206,500

Interest on a loan is deductible to the partnership where it is incurred in borrowing money applied to the use of producing assessable income (ITAA97 s 8-1(1)). Tim had contributed the money as working capital. Although Tim is a partner, on the basis that the money lent is applied as working capital and used in gaining assessable income of the partnership, the interest on the loan is deductible to the partnership. Therefore, the interest on the loan is not added back in calculating the net income of the partnership. In FC of T v JD Roberts; FC of T v Smith 92 ATC 4380, interest paid by a partnership on money borrowed to replace working capital used by the partnership in its business to earn assessable income was deductible. The distribution of the net income of the partnership of $206,500 between the partners is as follows: Tim

$

Interest on capital

13,500

Equal share of residual net income*

75,000 88,500

Caitlin

$

Salary

35,000

Superannuation

3,500

Interest on capital

4,500

Equal share of residual net income*

75,000 118,000

* Share of residual = ($206,500 − $13,500 − $35,000 − $3,500 − $4,500) = $150,000 / 2 = $75,000. The interest on the loan provided by Tim as working capital is included in Tim’s assessable income under ITAA97 s 6-5 as ordinary income and does not form part of his distribution of the net income of the partnership. AMTG: ¶5-070, ¶5-090, ¶5-130, ¶11-200

¶8-020 Worked example: Calculation of net partnership income; distribution to partners Issue James Ney is a retired public servant. Wishing to remain active, he and his wife, Joanne, invested in a clothing shop that is managed by their 25-year-old daughter Lisa in partnership with her parents.

James and Joanne each contributed $50,000 capital to the business. The partnership agreement provides the following: • James and Joanne will each receive interest at the rate of 15% per annum on their capital contribution. • Lisa will receive a salary of $35,000 per annum for the management of the business, and $4,000 per annum will be paid by the business into a superannuation fund for Lisa. • A car will be leased for the business. • All residual profits and losses will be shared equally between the three partners, James, Joanne and Lisa. During the year ended 30 June 2020, the partnership records show: $ Sales

400,000

Cost of goods sold

220,000

Interest on capital contributions — James and Joanne

15,000

Salary — Lisa

35,000

Superannuation — Lisa

4,000

Lease of car

9,000

Other expenses — all deductible

20,000

The leased car has been used solely by Lisa, who has used the car 90% for business and 10% for private use. What is the ITAA36 s 90 net income of the partnership? Solution The net income of the partnership for the year ended 30 June 2020 is as follows: $ Sales

$ 400,000

Less: Cost of goods sold Lease of car — 90% business use Other deductions

220,000 8,100 20,000

NET INCOME

248,100 151,900

The distribution between the partners is: James Interest on capital Share of residual*

7,500 32,633.33 40,133.33

Joanne Interest on capital Share of residual*

7,500 32,633.33 40,133.33

Lisa Salary

35,000

Superannuation

4,000

Share of residual*

32,633.33 71,633.33

*Share of residual = ($151,900 − $7,500 − $7,500 − $35,000 − $4,000) = $97,900 / 3 = $32,633.33 A partner cannot be an employee of the partnership nor can a partner employ himself or herself. Therefore, there is no fringe benefits tax on Lisa’s private use of the partnership car. The cost associated with the private use is not deductible to the partnership. In determining the s 90 net income of the partnership, payments by a partnership to a partner by way of salary, the distribution of interest on capital contributions, or payments to a superannuation fund as contributions on behalf of a partner, are not deductible expenses of the partnership. They are merely a means by which the partners have agreed to distribute partnership profits. AMTG: ¶5-070, ¶5-090, ¶5-130

¶8-040 Worked example: Calculation of net partnership income; capital gain Issue Jack Haufmann and Dustin Nikolai are equal partners in a partnership. Both have contributed equal amounts of capital. Jack is a silent partner while Dustin spends most of the time working in the partnership business. To reflect the extra time that Dustin spends in the business, they have agreed that Dustin should receive an annual salary of $40,000. The book-keeper has provided the following information in relation to the partnership for the 2019/20 tax year: $ Sales

500,000

Cost of sales

200,000

Other expenses (including Dustin’s salary of $40,000)

100,000

Capital gain: profit on sale of land held as an investment

120,000

What is the ITAA36 s 90 net income of the partnership? Solution The s 90 net income of the partnership is calculated as follows: $ Sales

$ 500,000

Less: Cost of sales

200,000

Other expenses

100,000 300,000

Add back non-deductible salaries: Salary — Dustin NET INCOME

40,000 240,000

The salary payable to Dustin is not an expense deductible under ITAA97 s 8-1. It is merely a means of distributing partnership income (Taxation Ruling TR 2005/7).

The net income of the partnership would be distributed between the partners as follows: Jack

Dustin

Total

$

$

$

Salary

Nil

40,000

40,000

Equal share of residual net income* 100,000 100,000 200,000 100,000 140,000 240,000 * Share of residual = ($240,000 − $40,000) = $200,000 / 2 = $100,000. The capital gain on the sale of the land does not form part of the partnership’s net income but is taken to have been made by the partners individually (ITAA97 s 106-5). Therefore, Jack and Dustin must calculate any resulting capital gain by reference to the partnership agreement, and include the gain in their own individual tax return. On the basis that Jack and Dustin are partners who contributed equally into the partnership, and have the same cost base for their fractional interest in the land, they each include a $60,000 capital gain in their tax return. AMTG: ¶5-070, ¶5-090, ¶5-130, ¶11-200

¶8-060 Worked example: Partnerships; CGT assets Issue The Dale partnership is in the business of manufacturing shelters for pets. The partnership was formed by Graham, Martha, Joan and Cate Dale in June 2010 with each partner holding equal shares. At that time the partners made the following contributions: • Graham — a small factory to manufacture the shelters with a market value of $500,000. The factory was acquired by Graham before 20 September 1985. • Martha — a warehouse for storage of the shelters with a market value of $200,000. She also contributed $300,000 in cash. • Joan — registered designs for the pet shelters and $100,000 in cash. • Cate — $500,000 in cash. In July 2011, the partnership purchased a shop for $800,000 to sell the pet shelters. In August 2019, Graham decides to retire from the partnership. At this time the market value of the partnership assets is: Assets Small factory Warehouse

$ 1,000,000 600,000

Pet shelter designs Shop

nil 1,200,000

The value of the trading stock on hand when Graham retires is $3m. Martha, Joan and Cate agree to pay Graham $2.1m ($700,000 each) for his interest in the partnership, with all the assets to remain in the new partnership. What are the capital gains tax (CGT) consequences for Graham upon retiring from the partnership? Solution CGT will only apply in relation to a CGT event that occurs to a CGT asset. A CGT asset is defined to

include: (1) an interest in the asset of a partnership; and (2) an interest in a partnership not covered by (1) (ITAA97 s 108-5(2)). A capital gain or loss from a CGT event happening in relation to a partnership or a partnership’s CGT asset is attributed to the partners individually and not to the partnership. On Graham’s retirement, Martha, Joan and Cate are taken to have acquired a separate CGT asset when they acquire a share of Graham’s interest in a partnership asset (ITAA97 s 106-5). Accordingly, the disposal of Graham’s interest in the assets of the partnership can result in capital gain or capital loss to Graham. The money received by Graham is allocated among various assets to the extent it relates to the assets of the partnership or his interest in the partnership. Based on this application of the law, the CGT consequences arising for Graham upon retiring from the partnership are as follows: Small factory On entering the partnership, Graham has disposed of 3/4 of his interest in the factory (ie 1/4 each to the other three partners). His remaining 1/4 share in the building remains a pre-CGT asset. The 1/4 shares belonging to the other partners are post-CGT assets. By leaving the partnership, the disposal of Graham’s interest in the factory to the remaining partners triggers CGT event A1. The capital proceeds are determined to be $250,000 being 1/4 of the market value. However, as the interest in the factory is a pre-CGT asset in the hands of Graham, the capital gain is disregarded. Warehouse On entering the partnership, Graham acquired 1/4 share in the warehouse from Martha. The cost base of his interest in the warehouse is $50,000. On leaving the partnership, the disposal of his interest in the warehouse to the remaining partners also triggers a CGT event A1 with capital proceeds of $150,000 based on Graham’s 1/4 share at market value. Graham has made a $100,000 capital gain from the disposal of this asset. Since this asset was held for over 12 months, the 50% CGT discount would apply. It is also possible that Graham may qualify for further CGT concessions available to small business entities (see below). Shop The disposal of Graham’s interest in the shop to the remaining partners triggers CGT event A1 and results in a capital gain in the hands of Graham. Graham’s 1/4 share in the asset on acquisition was $200,000. The capital proceeds are $300,000 based on market value, so a capital gain of $100,000 results. Again, since this asset was held for more than 12 months the 50% CGT discount applies. Again, it is also possible that Graham may qualify for further CGT concessions available to small business entities (see below). Design and plans (depreciating asset) and trading stock Changes in the membership of the partnership will give rise to a partial change in the ownership of the depreciating assets and trading stock which is treated as a notional disposal by the old owners to the new owners under specific rules in ITAA97 Div 40 and 70 respectively. The effect of these changes are taken into account in calculating the net income or loss of the partnership. Any capital gains made by the retiring partner from the disposal of his interests in the trading stock and depreciating assets are reduced to the extent that the gains have been taken into account as assessable income under ITAA36 s 92 (ITAA97 s 118-20). On this basis, there is no CGT impact for Graham in relation to the depreciating assets or trading stock. Goodwill Graham has received $2.1m from the other partners — $700,000 of this amount relates to the factory, warehouse and shop. We are not told how the remaining $1.4m has been determined or the terms of the partnership agreement. Prima facie, this residual consideration is for the disposal of his partnership interest and is generally attributable to goodwill, a CGT asset. On the basis that the goodwill has a nil cost base, he will derive a capital gain of $1.4m. However, the capital gain will be reduced to the extent that the $1.4m is assessable as his individual interest in the partnership’s net income under ITAA36 s 92 (ITAA97 s 118-20). If the $2.1m was the only amount Graham received in respect of the partnership for the 2019/20 year, then the capital gain will need to be reduced by his share of the partnership’s net income up to the date of his retirement (which would include any profit on the deemed sale of the trading

stock by the partnership). Again, since Graham held his partnership interest for more than 12 months the 50% CGT discount applies. Again, it is also possible that Graham may qualify for further CGT concessions available to small business entities (see below). If the partnership was a “no-goodwill” partnership then a different result will occur. In a “no-goodwill” partnership, the partners agree that when a new partner is admitted, that partner is not required to pay an amount which reflects a value for any goodwill of the partnership and that when a partner leaves the partnership the partner is not entitled to receive a payment which reflects a value for any goodwill of the partnership. In this scenario, the $1.4m paid to Graham is likely to represent an appropriation of the profits of the partnership and would be assessable under s 92. This is likely to have the effect of reducing the capital gain on the disposal of his partnership interest to nil. CGT concessions for small business Besides the CGT discount, Graham may be entitled to apply the CGT concessions that are available for small businesses. Two of these concessions, the small business active asset 50% reduction and the small business retirement exemption, are potentially applicable. The small business active asset 50% reduction provides an additional 50% reduction of the net capital gain attributable to active assets. The small business retirement exemption allows the net capital gain from active assets to be disregarded where the proceeds are used for retirement purposes (they must be contributed to a complying superannuation fund or approved deposit fund if Graham is under 55). An active asset is an asset actively used in the carrying on of a business; this can include goodwill. For Graham to be eligible for these concessions, the following conditions must be met: 1. A CGT event applies to the asset 2. The event must result in a gain 3. Either: • Graham must satisfy the net asset test, or • The partnership must be a small business entity, and 4. The asset must be an active asset. Conditions 1, 2, and 4 are satisfied for each asset sold by Graham. We do not know the aggregated turnover of the partnership so we cannot determine if it is a small business entity. In order to pass the net asset test, the net value of the CGT assets of Graham and his connected entities must not exceed $6m. There are various exclusions in the calculation of this amount (ITAA97 s 152-20) and it is not known whether Graham will satisfy this test. AMTG: ¶5-070, ¶5-090, ¶7-110; ¶11-200, ¶11-250, ¶16-727

¶8-080 Worked example: CGT; Admitting a new partner Issue Ellen Wong and Madeline Smith form a partnership in which they are equal partners. The partnership acquired business premises to run its business on 1 July 2006 for $306,000. The current market value of the property is $500,000. Ellen and Madeline are considering admitting a third and equal partner, Arron Welsh, into the partnership. Arron is willing to contribute an asset valued at $300,000 into the partnership. What are the CGT consequences to the partnership, Ellen and Madeline of admitting the new partner into the partnership? Solution If there is a change in the composition of a partnership, that is a new partner is admitted, the old partnership is dissolved and a new partnership is generally formed, unless the partnership agreement provides otherwise. Capital gains tax (CGT) legislation is based on the premise that as a partnership is not a separate legal

entity, legal title to partnership assets must remain vested in the partners, even though any one of the partners may not have separate title to any specific asset. Consequently, it is the partners and not the partnership who incur any capital gain or loss on the happening of a CGT event in relation to any partnership CGT asset. Each partner is regarded as owning an interest in each partnership asset (ITAA97 s 106-5 and 108-5(2) (c)). Any capital gain is shown in the individual tax returns of each partner and is not included when determining the net income of the partnership under ITAA36 s 90. Ellen and Madeline will be acquiring a one-third interest in the $300,000 asset contributed by Arron. Ellen and Madeline have a cost base of $100,000 each in relation to the interest acquired in Arron’s asset. Ellen and Madeline are each disposing of one-third of their interest in the property of the old partnership, which has a market value of $500,000. The cost base of that interest, however, will be based on the value of the property previously contributed by them. CGT consequences for Ellen and Madeline in disposing of their one-third individual interest $ Capital proceeds received in disposing of one-third interest in the CGT partnership asset. In this case capital proceeds equal one-third of the $300,000 asset contributed by Arron Less: Individual cost base

100,000 each

51,000 each

Ellen and Madeline are deemed to have disposed of one third of their interest in the property contributed by them (1/3 × $306,000 / 2) Capital gain

49,000 each

Less: General CGT 50% discount (assuming they are Australian residents)

24,500

NET CAPITAL GAIN

24,500 $

Ellen and Madeline will have a remaining cost base of $102,000 in the property: Cost base of original property Less: Cost base of one-third interest sold to Arron Remaining cost base

153,000 each 51,000 102,000 each

AMTG: ¶5-070, ¶11-200

¶8-100 Worked example: Retiring partners; distributions Issue Smith Clarke Petersen is an accounting firm in Perth operating as a partnership. Due to the downturn in the mining sector, one of the partners, Jim Petersen, has decided to retire and return to Tasmania. Jim retires from the partnership in February 2019 and receives a payment of $1.5m from the partnership in October 2019. The partnership accounting profit for the 2018/19 income year was $4.5m. Jim was allocated 33% in

accordance with the partnership deed with a breakdown documented as follows: • base profit share for 2018/19 • unused leave, and • retiring allowance. The partnership retirement deed stated that the payment of $1.5m was in relation to disposal of a partner’s interest in the partnership. How should Jim Petersen treat the $1.5m from the partnership for income tax purposes? Solution An amount received by a partner upon their retirement or exit from the partnership may be considered a disposal of the partner’s interest in the partnership. This amount would appear to have the character of capital and should be treated on capital account. However, the assessable income of a partner in a partnership is defined in ITAA36 s 92, and if the amount satisfies this definition then it will be on revenue account. Under s 92, the assessable income of a partner in a partnership shall include: (a) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident, and (b) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was not a resident and is also attributable to sources in Australia. The amount that Jim has received needs to be identified to the extent that it: • represents the partner’s share of partnership net income • is assessable in the partner’s hands on revenue account or another basis, or • otherwise relates to the disposal of the partner’s interest in partnership assets. (Taxation Determination TD 2015/19). Furthermore, TD 2015/19 concludes that where the amount represents the partner’s individual interest in the partnership income, then the amount should be assessable on revenue account (s 92) and not on capital account regardless of: • how the amount the partner is entitled to is labelled or described (including whether it is expressed to be consideration for something provided or given up by the partner) • the timing of the partner’s retirement (including whether they retire before the end of the income year), and • the timing of any payment. In this case, Jim Petersen’s exit payment is determined by reference to his past service in the partnership, regardless that it is expressed in respect of him disposing of his partnership interest, and is accordingly assessed on revenue account under s 92. Note that most professional partnerships will commonly result in the existing partner being assessable under s 92 as most assets are held by a separate entity (usually a company or trust) that provides “services” to the partnership. Furthermore, the partnership agreement will state that no payment will arise for goodwill on entering and exiting. The conclusion reached in this example where the partner’s exit payment is treated as revenue is contrary to many private rulings issued by the Commissioner where an amount has been considered under the capital gains regime.

AMTG: ¶5-070, ¶5-090, ¶5-130, ¶16-540

¶8-120 Worked example: Uncontrolled partnership income; penalty tax Issue Sam Richardson and his wife Leanne operate a gift shop in partnership. For the year ended 30 June 2020, Sam worked full-time in the business and was paid a salary of $55,000. Leanne was not active in the business as she had a full-time job as a receptionist at the local council paying an annual salary of $40,000. Leanne did however make a sizeable initial capital contribution when the partnership was first established. Leanne received a salary of $12,000 from the partnership and incurred deductions of $2,600 which included a gift to eligible funds of $200 which all related to her partnership income. The partnership made a profit of $50,000 after paying the partners salaries. Profits and losses are to be shared equally. Advise Sam and Leanne of their tax liability for the year ended 30 June 2020. Solution $ Partnership profit after salaries

50,000

Add back salaries to Sam and Leanne

67,000

NET INCOME OF THE PARTNERSHIP

117,000

Distributed as follows: $ Sam (50% of $50,000 + $55,000)

80,000

Leanne (50% of $50,000 + $12,000)

37,000 117,000

Where a partner does not have real or effective control over the disposal of their share of partnership income, this will constitute “uncontrolled partnership income” which may be subject to further tax pursuant to ITAA36 s 94. As Leanne is not involved in the day-to-day decision making of the partnership and has no control as to how the income is derived it would appear that Leanne does not have real and effective control (see Robert Coldstream Partnership v FC of T (1943) 68 CLR 391). Leanne’s partnership income of $37,000 includes $12,000 uncontrolled partnership income. In calculating her taxable income the gift is treated as an apportionable deduction and the calculation becomes: $12,000 − $2,400 +

($200 × ($12,000 − $2,400)) ($40,000 + $37,000)

= $12,000 − $2,400 + $25 = $9,625 which will be liable to a special further tax. For the 2019/20 year, the rate of further tax on uncontrolled partnership income under ITAA36 s 94 is 45% reduced by the average rate of ordinary tax applicable to the taxpayer’s total taxable income. Leanne’s total taxable income is made up of her receptionist salary of $40,000 plus the partnership distribution of $37,000 less deductions ($37,000 − $2,400 − $25) = $74,575. Leanne’s tax liability is calculated as follows: Tax payable at 2019/20 rates on taxable income of $74,575 = $15,783.88

Average rate = $15,783 ÷ $74,575 × 100% = 21.16% Top marginal rate = 45% The uncontrolled income of $12,000 is further taxed at a rate of 23.84%, calculated by deducting the average rate from the top marginal rate, ie 45% − 21.16% = 23.84% The further tax payable is 23.84% × $12,000 = $2,860.80 The tax payable by Leanne is: $ Tax on taxable income of $74,575

15,783.88

Plus: Further tax on uncontrolled partnership income

2,860.80 18,644.68

Plus: Medicare levy (2% × $74,575)

1,491.50

TOTAL TAX PAYABLE

20,136.18

Sam will not be liable to further tax as he has effective control of his share of partnership income. His liability will therefore be tax on $80,000: $17,547.00 + $1,600.00 (Medicare levy) = $19,147.00 AMTG: ¶5-180, ¶5-190, ¶5-200, ¶5-210

¶8-140 Worked example: Disposal of partner’s interest Issue Mark, Richard and Sharon have been in partnership since 1 July 1990, sharing profits and losses equally. For the year ended 30 June 2020, the net income of the partnership was $104,000. The balance sheet at 30 June 2020 showed: Assets

$ Cash at bank

$ 12,000

Debtors

9,900

Less: Provision for doubtful debts

(900)

Trading stock (at cost) (market value is $200,000)

9,000 140,000

Fixed assets

300,000

Less: Accumulated depreciation

160,000

140,000 301,000

Less: Liabilities — Creditors — Loan NET ASSETS

11,000 20,000

(31,000) 270,000

Represented by: Capital— Mark

90,000

— Richard

90,000

— Sharon

90,000 270,000

In July 2020, Sharon indicated that she will sell her interest in the partnership to her brother Theo for $120,000. Mark and Richard have agreed to the sale. For tax purposes, the partners value trading stock at cost and the adjustable value of depreciating assets is $105,000. The partners’ capital represents their initial investment in the business. All profits have been withdrawn yearly by the partners, and all assets introduced into the partnership were acquired on or after 1 July 1990. What are the tax implications of the disposal for Mark, Richard and Sharon? Solution On disposal of Sharon’s interest in the partnership to her brother Theo the old partnership is dissolved and a new partnership is created. (1) Trading stock A change in ownership triggers a notional disposal at market value from the old partners to all of the new partners (ITAA97 s 70-90 and 70-100). The market value of the stock ($200,000) will be included in the assessable income of the old partnership and the new partnership will be deemed to have acquired the stock at that value. To prevent this situation, as Mark and Richard will continue to retain more than a 25% ownership in the new partnership, an election can be made to value trading stock as if there had been a continuing business (ie at the cost price of $140,000 elected for tax purposes). If the trading stock is valued in this way, then s 70-90 will not apply and consequently there will be no difference to account for and any profit on disposal of trading stock will be deferred until the trading stock is sold in the ordinary course of business (s 70-100(4) to (9)). (2) Depreciable assets A balancing adjustment (ie profit or loss on disposal of the old partnership assets) for depreciable assets can arise where there is an actual disposal of the old partnership’s assets to the new partnership. A new value is attributed to the depreciable assets which forms the basis of future depreciation deductions for the new partnership. In this case if the assets are valued at their adjustable value ($105,000) then no adjustments are necessary as it equals the termination value. However, if the assets are valued at their book value ($140,000), this will result in a balancing adjustment of $35,000 under s 40-285(1). Future depreciation deductions will be based on a cost of $140,000. (3) Capital gains Sharon is disposing of her underlying interest in the partnership assets which are all post-CGT assets. Assuming assets are disposed of at their book value, this would result in a share of goodwill of $30,000 being the difference between Sharon’s interest in the assets ($90,000) and the disposal price ($120,000). However, as the disposal occurs after 11.45 am on 21 September 1999 and the assets have been held for more than 12 months, assuming she is an Australian resident she can apply the 50% CGT discount to reduce the capital gain and potentially the small business 50% reduction may also apply. To qualify for the small business reduction, the conditions in ITAA97 s 152-5 must be satisfied which includes the condition that the CGT asset must be an “active asset” (ITAA97 s 152-40) and an interest in an entity is not necessarily an active asset (s 152-40(4)(a)). In this regard a partnership may not be viewed as an entity as it is not a separate legal entity since it is the partners who have an interest in the underlying assets of the partnership. Alternatively, an asset of the partnership that is considered a small business entity must still be an “active” asset to qualify for the 50% CGT discount. Assuming Sharon qualifies for both the 50% CGT discount and 50% small business reduction the potential capital gain would be $30,000 × 50% × 50% = $7,500. (4) Cash vs accrual Whether the partnership operates on a cash or accruals basis is important. In recognising debts that are sold to the new partnership which then go bad prevents the new partnership from obtaining a deduction under s 25-35. This is because the original sale had not been bought to account by the new partnership as income. Consequently, it is suggested that doubtful debts are not sold so that the old partnership

would continue to exist for the purposes of collecting its doubtful debts and generally winding up its affairs. (5) GST Distributions on the dissolution of a partnership are part of the carrying on of a partnership enterprise. The making of an in-kind distribution is treated as a supply in the course of an enterprise that the partnership carries on regardless of whether the partnership is continuing or is under a general dissolution. As there is no winding up of the partnership, the change in membership does not give rise to any supplies or acquisitions from one partnership to another partnership (GST Ruling GSTR 2003/13). AMTG: ¶5-000, ¶11-200, ¶11-210, ¶11-350, ¶34-100

¶8-160 Worked example: Variation of partnership interests Issue Max Caldwell and Sam Robinson operate a dental practice as partners. On 1 April 2020, they admitted a new partner, Kayla Scott into the partnership. The terms of the partnership agreement provided that the profits and losses of the partnership would be shared 40% each to Max and Sam and 20% to Kayla. At 30 June 2020, the partnership accounts for the 2019/20 tax year revealed a profit of $300,000. It was established that the earning capacity of the partnership was heavily weighted to the first three quarters of the year producing 90% of the income and the remaining quarter just 10%. Based on the above information what is each partner’s share of income from the partnership? Assume the following additional facts. Sam’s daughter Mari who is 27 years old was employed as a receptionist for the business in 2019/20 and was paid a salary of $35,000 for the year. After an audit of the partnership accounts the Commissioner disallowed $10,000 of this salary under ITAA97 s 26-35(1). What is the adjusted partnership income for the year ended 30 June 2020? Solution The earning of partnership income indicated 90% in the first nine months and 10% in the remaining three months. Therefore: $ Partnership income 1 July 2019 to 31 March 2020

270,000

Partnership income 1 April 2020 to 30 June 2020*

30,000

Partnership income

300,000

*From 1 April 2020, a new partnership would be created which would require a separate tax return. Shares of partnership income $ Max (50% of $270,000 and 40% of $30,000)

147,000

Sam (50% of $270,000 and 40% of $30,000)

147,000

Kayla (20% of $30,000)

6,000 300,000

Mari’s salary partly disallowed The disallowance of part of Mari’s salary means that the partnership net income must be increased by $10,000, which in turn changes the partners’ shares of income for tax purposes. $

Partnership income per accounts

300,000

Add: Mari’s salary disallowed under s 26-35(1) Adjusted partnership income

10,000 310,000

If it is reasonable to assume that Mari’s salary expense was incurred evenly through the 2019/20 income year, then the distribution to the partners will be as described above but based on the amount of $310,000. $ Max (50% of $279,000 plus 40% of $31,000)

151,900

Sam (50% of $279,000 plus 40% of $31,000)

151,900

Kayla (20% of $31,000) TOTAL

6,200 310,000

AMTG: ¶5-070, ¶5-100

¶8-180 Worked example: Assignment of partnership interests Issue Adam North and Sally Marsden have been in partnership since 1 July 1995, sharing profits and losses equally. For the year ended 30 June 2020, the net income of the partnership was $210,000. The balance sheet at 30 June 2020 showed: Assets

$ Cash at bank

$ 15,000

Debtors

11,800

Less: Provision for doubtful debts

(800)

Trading stock (at cost) (market value is $180,000)

11,000 120,000

Fixed assets

230,000

Less: Accumulated depreciation

130,000

100,000 246,000

Less: Liabilities — Creditors — Loan NET ASSETS

10,000 16,000

(26,000) 220,000

Represented by: Capital — Adam — Sally

110,000 110,000 220,000

On 1 June 2020, Adam makes an equitable assignment of half of his partnership interest to his wife, Laura, for consideration of $80,000. This entitles Laura to half of any amounts Adam receives as a partner, but does not make Laura a partner. How does this affect the tax liability of Adam?

Solution An assignment of half of Adam’s interest in the partnership to Laura constitutes a disposal of a post-CGT asset and triggers CGT event A1 for Adam. Each partner has an interest in owning a part of each partnership asset and consequently an assignment of an interest results in a change in ownership (ITAA97 s 106-5 and 108-5(2)). In this case as the capital proceeds of $80,000 exceed $55,000 ($110,000 × 50%), that is Adam’s one-half share of the capital, on face value a taxable gain of $25,000 would arise. However, it is noted that in this case Adam’s assignment was not at arm’s length and consequently the capital proceeds deemed to be received are based on the market value of the assigned assets despite the passing of consideration from Adam’s wife (ITAA97 s 116-30(2)(b)). See also Reynolds v Commissioner of State Taxation (WA) 86 ATC 4528. The assignment will be effective from 1 July 2019 when the partnership commenced as the net income from the partnership is not derived until the end of the year. See FC of T v Galland 86 ATC 4885 and Taxation Ruling IT 2501 which indicates that valid assignments consistent with the decisions in FC of T v Everett 80 ATC 4076 and Galland are acceptable and not subject to the anti-avoidance provisions, a position that was accepted by the ATO for many years. In 2015, the ATO varied its position concluding that an Everett assignment could constitute a tax avoidance arrangement when one of the ATO’s pre-defined benchmarks was not satisfied. In 2017, the ATO announced they were suspending those guidelines on the basis that they were being “misinterpreted in relation to arrangements that go beyond the scope of the guidelines”. The guidelines remain suspended so there remains a risk that assignments such as the one Adam has made could be subject to the antiavoidance provisions. However, recent changes to the law to prevent the application of the CGT small business concessions (see below) may have reduced the chances of the ATO choosing instead to apply the anti-avoidance provisions. A situation that may prevent a valid assignment could be where a revocation clause exists in the relevant deed of assignment and ITAA36 s 102 applies which renders the assignment ineffective (see Taxation Ruling IT 2501). There is no evidence of this in the present case. When considering the deduction available to the assignor partner (Adam) Taxation Ruling IT 2608 should also be taken into account with regard to the allocation of expenses. It is noted that Adam’s capital gain may also be reduced by the 50% CGT discount given the event took place after 21 September 1999 and the asset was held for more than 12 months. This is also based on the assumptions that Adam is an Australian resident and has not elected to employ the indexation method in calculating his capital gain. The CGT small business concessions will not be available. For CGT events that occur after 7.30 pm in the Australian Capital Territory on 8 May 2018, the small business CGT concessions are only available for CGT events involving a right or interest in a partnership if the right or interest would be sufficient to make the entity holding the right or interest a partner (including, for example, the transfer of all or part of a partner’s share in a partnership to another entity, making that other entity a partner or increasing their existing share in the partnership). Other rights and interests are not membership interests within the meaning of the income tax law and cannot satisfy the new condition. In this case, the interest transferred to Laura does not make her partner, which excludes the application of the CGT concessions. AMTG: ¶5-070, ¶5-160, ¶5-170

¶8-200 Worked example: Residence; profit and loss sharing Issue Greg and Livia operate an import/export business of oils and lotions in partnership. Greg is an Australian resident but Livia is a Spanish resident for tax purposes. Greg runs business operations in Perth with sales income having an Australian source. Livia lives in Barcelona, Spain and is responsible for sales there (which have a source in Spain). The partnership business results in 2019/20, split between Australian sourced income and income sourced in Spain were:

Australian source sales $ Total income

17,000

Less: Stock Other business expenses Improvements to premises (capital) incurred 9/9/18 Greg salary

5,000 10,850 3,500 20,000

Subtotal

(39,350)

Loss — Australian business

(22,350)

Spanish source sales $ Total income

7,100

Less: Stock

4,400

Other business expenses

6,760

Livia salary

12,000

Subtotal

(23,160)

Loss — Spanish business

(16,060)

Greg and Livia share profit and losses equally after the payment of salaries to Greg ($20,000) and Livia ($12,000) respectively. Calculate the net income or loss of the partnership for tax purposes and the distribution to partners for the year ended 30 June 2020. Solution To arrive at the net income of the partnership for income tax purposes, it is necessary to adjust the profit and loss results for non-deductible expenses (the improvements to Perth premises which are capital and not deductible) and for the salaries paid to the partners. Assume the improvements to Perth premises qualify for the Div 43 building write-off. The deduction is $70, calculated as $3,500 × 2.5% × 294 / 365. Distribution of partnership loss As indicated in Taxation Ruling TR 2005/7 the payment of partners’ salaries is only a means of allocating partnership profits and consequently cannot result in or even contribute to, a partnership loss. Consequently, it is not an allowable deduction for the purposes of calculating the s 90 partnership income. This was highlighted in the case of Scott v FC of T 2002 ATC 2077 where salaries paid to members of a family partnership were treated as drawings in advance which were not deductible and could not result in a partnership loss. The allocation of a salary to a partner as part of the net income of the partnership is only possible where there are available profits. If current profits are insufficient in meeting salary entitlements as is the case here, a salary may be drawn from future year profits. Where salaries drawn exceed the partners’ interests in the partnership net income the partners will not be assessed on the excess. When sufficient profits become available the salaries will be assessable in a

future income year. It should be noted that agreements of this nature must be entered into before the end of the income year to be effective for income tax purposes. Australian source sales $ Partnership loss — Australian business

(22,350)

Adjust for tax Add improvements to premises (capital)

3,500

Less Div 43 deduction

(70)

Add Greg’s salary

20,000

Section 90 net income — Australian sales

1,080

Spanish source sales $  Partnership loss — Spanish business

(16,060)

Adjust for tax Add Livia’s salary

12,000

Section 90 partnership loss — Spanish sales

4,060

In summary, there is net income from the Australian business and a net loss from the Spanish business and an overall net loss for s 90 purposes of $2,980. Partners’ share of net loss Greg is entitled to a deduction for $1,490, for example 50% of the net loss. However, because the net loss is attributable to a non-Australian source, Livia is not entitled to a deduction for 50% of the loss. For any period that the partner is a non-resident, s 92(1) only includes in assessable income so much of the partner’s interest in the net income of the partnership as is attributable to Australian sources. Similarly, for any period that the partner is a non-resident, s 92(2) only allows the partner a deduction for so much of the partnership loss as is attributable to Australian sources. AMTG: ¶5-070, ¶5-090, ¶5-110, ¶5-150, ¶20-470

¶8-220 Worked example: Work in progress; trading stock Issue Mitch and Carol Groves are in partnership and wish to admit their four adult children into the partnership as equal partners. Immediately before the children are admitted on 1 July 2020 the Groves partnership holds the following assets:

Depreciating assets

Cost

Market value

$

$

100,000

50,000

Work in progress (WIP)

20,000

20,000

Trading stock

20,000

100,000

Tax adjustable value $40,000

In the 2019/20 income year, Mitch and Carol elected to value their trading stock at a replacement cost of $50,000. A $10,000 payment was also made to the old partnership for the WIP. What are the tax implications of admitting the children into the partnership? Solution Depreciating assets, trading stock and WIP impact on the calculation of the partnership’s net income or loss. Depreciating assets The partnership is the owner of the depreciating assets (ITAA97 s 40-40, item 7). On admitting the children into the Groves partnership, there is a disposal and a balancing adjustment event occurs (s 40295(2)). This would result in the depreciating assets being disposed of for market value to the new partnership. The old partnership would have a $10,000 ($50,000 − $40,000) assessable balancing adjustment to declare in the final old partnership return. The tax value of the depreciating assets for the new partnership will be the market value of $50,000. However, if all parties agree, rollover relief is available and no balancing adjustment would arise (ITAA97 s 40-340(3) and (4)). The new partnership would take on the previous partnership’s tax values. Trading stock The admission of the children into the partnership would be considered a change of ownership outside the course of ordinary business (ITAA97 Subdiv 70-D). The deemed disposal of the trading stock would be at market value (s 70-80 to 70-100). However, providing that the old and new partnership agrees in writing, the disposal can be taken to be the tax carrying value (ITAA97 s 70-100(4)). This would result in no taxing impact for the new and old partnership. WIP The value of the WIP does not constitute assessable income until a recoverable debt arises. The WIP is yet to be billed by the partnership and as such there is no recoverable debt. Since the old partnership has been paid $10,000 for the WIP, this is considered assessable to the old partnership (ITAA97 s 15-50). To avoid double taxation, the $10,000 is deductible to the new partnership under ITAA97 s 25-95. AMTG: ¶5-060, ¶5-070, ¶17-630

¶8-240 Worked example: Admission of new partner; ABN/TFN requirements Issue The partnership of HJ Wills and Associates, an accounting firm, is expecting to admit a new partner, Daryl Tims, to form a partnership of four partners. Daryl will have a 20% interest in the partnership. The existing partnership and the new partnership will continue to trade as an accounting firm. Does the new partnership require a new Tax File Number (TFN) and/or a new Australian Business Number (ABN)? Advise as to under what circumstances this would be the case. Solution Where the change in the composition of a partnership amounts only to a “technical dissolution” of the partnership and the partnership continues as a reconstituted continuing entity (a “reconstituted partnership”), then the partnership will not need to change its TFN and ABN, and only one partnership tax return is required at the end of the income year. In particular the return should provide details of the date of reconstitution, the names of all the partners and new partners (see the ATO’s Partnership tax return instructions upon which some of the commentary in this solution is based). Technical dissolution A dissolution that does not result in the winding up of a partnership is called a “technical dissolution”. A technical dissolution occurs where the assets and liabilities of the partnership are taken over by the continuing partners (and any new partners) and the partnership business is continued without any

apparent break. In the case of a technical dissolution, no new partnership will come into existence and the existing partnership will simply continue for tax purposes. A technical dissolution should be contrasted with a “general dissolution”. General dissolution A dissolution leading to the winding up of the partnership is called a general dissolution, and results in the creation of a new partnership and the end of the existing partnership. A general dissolution of a partnership may be brought about in a number of ways, including by mutual agreement between the partners, upon the expiration of time if the partnership is for a fixed period of time, by the death or bankruptcy of a partner, or permanent cessation of the business carried on. If the changes in membership amount to a general dissolution of the partnership, a new partnership is formed. This new partnership requires a new TFN and ABN. Both partnerships will need to lodge a partnership tax return. One tax return should be lodged for the old partnership from the beginning of the income year to the date of its dissolution. Another tax return should be lodged for the new partnership from the date of its formation to the end of the income year. Reconstituted partnership Under general law, any change in the membership of a general law partnership leads to its dissolution. However, the dissolution does not necessarily result in the winding up of the partnership. The continuing partners and any new partner may conduct the business of the partnership without any break in its continuity. This can be referred to as a reconstituted partnership (GST Ruling GSTR 2003/13, para 148). Whether or not there is a reconstituted partnership will depend on the intention of the parties, and the terms and conditions of the partnership agreement (GST Ruling GSTR 2003/13, para 149). The written partnership agreement may expressly provide for the continuation of the business in the event of a change in the membership of the partnership. This provision is often referred to as a “continuity” or “nondissolution clause”. In the absence of a written agreement, such a clause may be implied by the conduct of the partners following the retirement or death of a partner, or introduction of a new partner (GST Ruling GSTR 2003/13, para 150). The Commissioner will treat a changed partnership as a reconstituted continuing entity if the original partnership agreement incorporated a provision for a change in membership or shares, and the following factors apply: • the partnership is a general law partnership • at least one of the partners is common to the partnership before and after reconstitution • there is no period where there is only one “partner” (ie in a two-person partnership, there is a direct transfer of interest from the outgoing partner to a new partner) • the partnership agreement includes an express or implied continuity clause, and • there is no break in the continuity of the enterprise or firm, that is the partnership’s assets remain with the continuing partnership and there are no changes to the nature of the business, the client or customer base, or the business name or name of the firm. At the end of the income year, a reconstituted continuing partnership needs to lodge only one partnership tax return covering the full income year. The tax return must include the distributions made to all persons who were a partner at any time during the income year, including those partners who left the partnership during the year. When lodging the partnership tax return, the following details must also be supplied: • the date of the dissolution • the date of the reconstitution • the names of the new, continuing and retiring partners

• the TFN or address and date of birth of all new partners, and • details of the changes if the persons authorised to act on behalf of the partnership changed. AMTG: ¶5-060, ¶33-000, ¶33-100

¶8-260 Worked example: Tax returns; income; interest; change in partnership Issue Tom Sullivan and Jake Williams jointly own a rental property. They split the rental income equally and each contribute half of any expenses. Tom and Jake have no other joint investments or business interests. Tom’s parents, Michael and Minnie Sullivan, carry on a trading business as a partnership (in general law and in tax law). Annual tax returns are lodged in relation to the partnership. Under the partnership agreement, Michael and Minnie are each entitled to a 50% share of partnership net income or loss. The following partnership information is relevant for the 2019/20 income year: • trading income (all income is assessable for tax purposes) $600,000 • expenses (all expenses are deductible for tax purposes) $720,000, and • accounting capital gain from the sale of a partnership asset worth $180,000 (assume that the accounting capital gain equals the net capital gain that would be calculated under the CGT provisions). In the following income year, Michael and Minnie each make additional capital contributions to the partnership. They are each entitled to interest on their contributions at a rate of 4% per annum. In addition, Michael loans the partnership a sum of money to buy new machinery. The loan terms include interest at a commercial rate. Michael and Minnie are considering admitting Tom as a partner and seek advice on the following: 1. Do Tom and Jake have to lodge a joint tax return in relation to the rental property? 2. In their (Michael and Minnie’s) 2019/20 personal income tax returns, what would be the share of partnership income or loss that they would each include? 3. How are the interest amounts treated in their (Michael and Minnie’s) hands and the partnership for tax purposes? 4. If Tom is admitted as a partner, are there likely to be tax consequences arising? If so, what would be the nature of those consequences? Solution (1) Lodgment of partnership tax return A separate tax return does not need to be lodged in relation to the rental property. Tom and Jake have a tax law partnership in relation to the rental property because they are in receipt of ordinary income jointly (ITAA97 s 995-1). However, there is no general law partnership because Tom and Jake are not carrying on a business in common. See Taxation Ruling TR 93/32. A partnership income tax return is not required to be lodged for partnerships in which the partners derive income jointly. Tom and Jake will instead disclose details of their share of jointly derived rental income and jointly incurred deductible expenditures in their personal tax returns. (2) Share of partnership net income/loss Michael and Minnie would each include a $60,000 loss as his/her share of the partnership net loss. The

total partnership loss is $120,000 ($600,000 less $720,000). The capital gain is not included in the calculation of the partnership net income or loss. Instead, each partner will individually account for the CGT consequences arising from the CGT event happening to their respective shares in the underlying partnership asset in their personal tax returns. Note that there is a possibility of the non-commercial loss provisions applying in this situation as each partner has a net loss of $60,000 from the partnership. However, provided that the capital gain can be considered part of the same business activity, then no loss should arise. (3) Interest expenditure The interest on the capital contributions is not deductible to the partnership and is therefore assessable to Michael and Minnie as part of their shares of the net income of the partnership. That is, the interest on partnership capital is treated as an appropriation of profit. Therefore, the interest is not taken into account in calculating the net income of the partnership and forms part of Michael and Minnie’s respective shares of the partnership net income or loss for the year. This is best illustrated by way of an example: Ignoring the loan from Michael for the new machinery (discussed below), assume that Michael contributes $100,000 in additional capital contributions and Minnie contributes $150,000. Also assume that the trading income was $600,000 and the expenses (other than the interest on partnership capital) were $200,000. The net accounting income is therefore $390,000 ($600,000 − $200,000 − $10,000 interest on partnership capital). For accounting purposes, each partner will receive $195,000 plus his/her interest on partnership capital — Michael will receive a total of $199,000 and Minnie will receive a total of $201,000. For tax purposes, the net income of the partnership is $400,000 ($600,000 − $200,000). Each partner’s share of the net income will be $199,000 (Michael) and $201,000 (Minnie) — all disclosed at the partnership income item of their tax returns. However, the interest on the loan received from Michael is deductible to the partnership (as the loan funds were applied to an income-producing purpose) and reduces the net income or increases the net loss of the partnership to be included in Michael and Minnie’s tax returns. In addition, the interest income is assessable to Michael (Taxation Ruling TR 95/25). (4) Change in partnership Tom’s admittance as a partner would give rise to income tax consequences. Broadly, Michael and Minnie would be deemed to have disposed of a proportion of their respective interests in each partnership asset to Tom (ITAA36 s 92). Partnership assets such as trading stock and depreciable assets will be treated as a disposal from the old partnership to the new partnership, however, rollover relief is available in such cases providing both parties agree. AMTG: ¶5-060, ¶5-065, ¶5-070, ¶16-740, ¶24-010

TRUSTS Division 6E income; trust income of beneficiaries

¶9-000

Net trust income; distributions

¶9-020

Deceased estates; net income of minors

¶9-040

Net trust income; tax payable

¶9-060

Streaming franking credits

¶9-070

Income of a deceased estate; tax payable

¶9-080

Trust gains of foreign residents

¶9-090

Trust losses; income injection test

¶9-100

Trust losses; pattern of distribution test

¶9-120

Revocable trusts

¶9-140

Family trust elections

¶9-160

Family group; family trust election; interposed entity election

¶9-180

Net trust income; trust law distribution

¶9-200

Present entitlement of tax exempt entities

¶9-220

Beneficiary; present entitlement; use of disclaimers

¶9-240

Circulation issues; dividends and distributions; reimbursements agreements; tax avoidance

¶9-260

School fees; reimbursement agreements

¶9-280

COVID-19 stimulus; cash flow boost and JobKeeper

¶9-300

¶9-000 Worked example: Division 6E income; trust income of beneficiaries Issue In the 2019/20 tax year the Telex Family Trust earned the following trust income: $ Trading profits

300,000

Franked dividends

210,000

Capital gain (discountable)

500,000

Trust income

1,010,000

The trust has a carried forward capital loss of $90,000 from 2016/17. The net (taxable) income of the trust is: Trading profits

300,000

Franked dividends

210,000

Franking credits Capital gain (after application of capital loss and CGT discount)

90,000 205,000

Taxable income

805,000

According to the trust deed, capital gains form part of the trust income. The trust deed allows streaming and the trustee resolves as follows: • Specifically entitled to franked dividends: – Joe 100% • Specifically entitled to capital gains: – Adam 100% • Balance of trust Income: – Rosemary 100% What is the ITAA36 Div 6E income and the trust income of each of the beneficiaries? Solution Division 6E provides rules for the tax treatment of capital gains and franked dividends that are streamed through a trust. Income which is subject to Div 6E: $ Taxable income

805,000

Less: Specific entitlements Franked dividends Franking credits

(90,000)

Capital gains

(205,000)

Division 6E income

*300,000

*Defined as trust income to which beneficiaries are presently entitled less capital gains and franked distributions; in this instance Div 6E income and Div 6E net income are the same as there are no deductions. Note that franking credits are excluded from trust income in accordance with the approach adopted in the streaming legislation (see ITAA97 Subdiv 207-B and Draft Taxation Ruling TR 2012/D1). Trust income of beneficiaries

Division 6 s 97** Subdivision 207-B*** Subdivision 115-C**** TAXABLE INCOME

Joe

Adam

Rosemary

Total

$

$

$

$

 0

 0

 300,000

 300,000

 300,000

 0

 0

 300,000

0

205,000

0

205,000

300,000

205,000

300,000

805,000

**Division 6E amount ***Includes attached franking credits ****Takes into account the capital loss AMTG: ¶4-860, ¶6-077, ¶6-107, ¶11-060

¶9-020 Worked example: Net trust income; distributions Issue Rosa and Sam Costello are the only two beneficiaries of a discretionary trust created by their grandfather during his lifetime. Rosa aged 23 years resides in Italy and is a non-resident for Australian tax purposes. Sam aged 16 years is a resident of Australia. During the 2019/20 tax year the trustee received a dividend of $6,300 from a company resident in Italy, on which withholding tax of 10% had been deducted at source, and a fully franked dividend of $8,800 from a resident Australian company that is not a base rate entity. The trustee resolved to distribute the income equally among the two beneficiaries. What is the Australian income tax liability of both the trustee and the beneficiaries on the distributions for the 2019/20 tax year? Solution The net income of the discretionary trust calculated in accordance with ITAA36 s 95 is: $ Australian franked dividends received Gross-up for franking offset ($8,800 × 30/70 × 100%)

8,800 3,771*

(ITAA97 s 207-35(1)) Dividend from Italy Gross-up for withholding tax ($6,300/0.90 − $6,300)

6,300 700

(ITAA97 s 770-10) NET INCOME

19,571

*Assume the small shareholder exemption applies so that franking credit offsets are available to beneficiaries. Distribution as per trustee’s resolution: Sam (aged 16 years) $9,785.50 Rosa (aged 23 years) $9,785.50 Tax liability As Sam is an Australian resident he is a beneficiary presently entitled to trust income but being only 16 years of age he is under a legal disability. Therefore, the trustee is liable to pay tax on Sam’s share of the net income (ITAA36 s 98). Given Sam is a minor and, assuming that he is not an “excepted person” under ITAA36 s 102AC(2), he is a prescribed person receiving eligible income and any tax payable by the trustee will be at ITAA36 Pt III Div 6AA rates (45% × $9,785.50 = $4,403.47). This amount will be reduced by Sam’s half share of the franking credit under ITAA97 s 207-50(1)(b) ($1,885.50) and half share of the foreign income tax offset ($350). The low income tax offset is not available on a minor’s unearned income. Therefore, Sam’s total tax payable is $2,167.97. Rosa is a beneficiary who is presently entitled to trust income and is not under a legal disability. Rosa is a non-resident which means she is only liable for tax on Australian source trust income (ITAA36 s 98A). This will include a distribution of the Australian sourced fully franked dividend. As the dividend is fully franked, there is no withholding tax obligation and it is non-assessable non-exempt income for Australian tax purposes when received by a non-resident (ITAA36 s 128B(3)(ga) and 128D). Rosa’s assessable income of $1,885.50 for her share of the franking credit is reduced to nil and she is not entitled to a tax offset (ITAA97 s 207-95). The remaining income allocated to Rosa is from a foreign source and as such she will not have any liability for Australian tax on this portion as non-resident beneficiaries are only

assessable on Australian sourced trust income. AMTG: ¶4-840, ¶6-080, ¶6-085, ¶6-120, ¶6-170

¶9-040 Worked example: Deceased estates; net income of minors Issue Harry Michaels died on 24 August 2018. Harry’s daughter Siobhan was named as the executor of his estate. Harry’s will states that the beneficiary of all the assets will be Ryder, Siobhan’s son, who was 16 when Harry died. The will also states that Ryder cannot receive any assets until he turns 21, however, expenses for his education can be paid for out of the deceased estate. Harry had a number of income streams and kept poor records. Siobhan decided to wait until all the pre-fill information was available from the ATO and based on this information completed Harry’s final tax return on 31 August 2019. At this time she was also certain of the assets of Harry’s estate, and could determine the net income of the trust. The assets of the estate included cash and a portfolio of listed shares. Income consisted of interest on the cash amounts and a mixture of franked and unfranked dividends from the share portfolio. Income was in excess of $18,200 for all the income years. Probate was granted in September 2019. What are Siobhan’s tax obligations as executor of the deceased estate? Solution A deceased estate is treated as a trust for tax purposes. The executor has the role of trustee. A trustee shall not be liable to pay income tax on the income of the trust estate unless there is a specific provision that requires the trustee to be assessed and to pay tax (ITAA36 s 96). The trustee of the estate of a deceased taxpayer is assessed on amounts received after the death of the deceased that would have been assessable to the deceased had they been received during the deceased’s lifetime with the amounts deemed to be income to which no beneficiary is presently entitled (ITAA36 s 101A). Amounts to which no beneficiary is presently entitled are assessed under ITAA36 s 99A or under ITAA36 s 99 if the Commissioner thinks that it is unreasonable for s 99A to apply. However, where a beneficiary is presently entitled but under a legal disability, the trustee is assessed on the beneficiary’s share of the trust’s net income (ITAA36 s 98(1)). Minors are under a legal disability. The beneficiary of a trust who is not under a legal disability and is presently entitled to a share of the net income of the trust is assessed on their share of the net income (ITAA36 s 97). Net income is the total assessable income of the trust derived during the income year, calculated as if the trustee were a resident taxpayer, less allowable deductions (ITAA36 s 95(1)). Where the income of a trust is distributed to a beneficiary that beneficiary would be taken to be presently entitled to the income of the trust estate. Income that is paid or applied for the beneficiary’s benefit is taken to be distributed to the beneficiary (ITAA36 s 95A(1)). Tax return obligations As executor, Siobhan must lodge a final individual tax return for Harry for the period from 1 July 2018 to the date of death, 24 August 2018, and the return must include all assessable income derived (and all deductible losses or outgoings incurred) by the deceased in that period. Generally, the return should be accompanied by a full and true statement of assets and liabilities valued at the date of death. Siobhan must lodge a tax return for the estate of Harry Michaels, for the period from his death to 30 June 2019. That return would include all assessable income and allowable deductions referable to that period. Lastly, she would be required to lodge a final return for the estate — the 2019/20 tax return — reporting the net income of the estate in the period before it is finalised. During the period between the date of death and the grant of probate (administration), Siobhan as trustee was still identifying assets and liabilities of the deceased. No beneficiaries were presently entitled during that time (FCT v Whiting (1943) 68 CLR 199; Taxation Ruling IT 2622), and accordingly Siobhan as

trustee would be taxed under s 99. Then she would need to determine the net income from 1 July 2019 until September 2019 (ie the date when probate was granted) for the 2019/20 income year. Again Siobhan would be taxed under s 99 for this period. The sole beneficiary, Ryder is presently entitled to the net income of the trust but he is under a legal disability until he reaches 18 years of age in 2020. Therefore, from September 2019 until Ryder turns 18, Siobhan as trustee will be assessed on his share of the net income of the trust (ITAA36 s 98(1)). The amounts that are applied for Ryder’s education will be treated as income to which the beneficiary is presently entitled. However, as Ryder is under a legal disability, the amounts will be assessed to Siobhan as trustee under s 98(1). In 2020, when Ryder turns 18 years of age and is no longer under legal disability, the trust income will be assessed to him directly at resident individual tax rates. This will continue until he reaches the age of 21 in 2023, and gains access to the monies as stipulated in the will. AMTG: ¶6-030, ¶6-180, ¶6-190

¶9-060 Worked example: Net trust income; tax payable Issue Neil Jones is the trustee of an Australian resident trust estate created by a Deed. The Deed names Pauline and Bob as the beneficiaries of the trust neither of whom are related to Neil. Pauline aged 14 years and Bob aged 25 years are both residents of Australia. The following information indicates the trading activities of the trust for the 2019/20 income tax year: $ Receipts Net income from trading activities

80,000

Investment income

25,000

Rental income

65,000

Expenses Interest paid on investments

40,000

Expenses incurred in generating rental income 15,000 The only income earned by Pauline and Bob was as follows. Bob derived a salary of $12,000 while working casually as a waiter and Pauline received interest income of $800 from her savings account. (a) Calculate the net income of the trust estate under the following alternative situations: (i) Assuming the trust is a discretionary trust and the trustee does not exercise any discretion as to the distribution of income during the year. (ii) Assuming the trust is a fixed unit trust under which each beneficiary is entitled to 50% of the trust income during the year. (b) Calculate the tax payable by the trustee and/or each beneficiary under each of the alternatives (i) and (ii). Solution Net income — situations (i) and (ii) $ Income

170,000

Deductions NET INCOME

55,000 115,000

Note that the net income of the trust estate will be the same in both situations. Under ITAA36 s 95, the net income of the trust estate is determined as though the trust is a resident taxpayer and neither the type of trust nor the status of the beneficiaries are relevant in regards to the calculation. The exception is where carry forward losses are subject to trust loss and debt deduction recoupment tests. (i) Tax payable — discretionary trust where discretion not exercised No beneficiary is presently entitled to any of the $115,000 net trust income. Instead, the trustee will be assessed on the entire amount. As the trust is created by a Deed and not a will it will be taxed at the penalty rates under ITAA36 s 99A. Tax payable = $115,000 × 45% = $51,750. In addition, Medicare levy of $115,000 × 2% = $2,300 is payable (ITAA36 s 251S(1)(c)). Bob is assessed on his salary of $12,000. As he is aged over 18 years, ordinary tax rates apply. However, no tax or Medicare is payable as the income is below the tax free threshold of $18,200 for 2019/20 tax year. Pauline is assessed on her $800 of interest income. However, as this constitutes eligible assessable income for a minor under ITAA36 s 102AE, Div 6AA rates apply. Tax payable = ($800 − $416) × 66% = $253.44 Note, there is no entitlement to a low income rebate on Div 6AA income (ITAA36 s 159N(4)) but there is also no Medicare levy payable. (ii) Tax payable — fixed trust Bob is presently entitled to his $57,500 share of trust income. He is not under a legal disability and will be assessed under ITAA36 s 97. $57,500 trust income + $12,000 salary = $69,500 taxable income Tax payable on $69,500 at 2019/20 rates = $14,134.50 + Medicare levy ($69,500 × 2%) = $1,390 Total tax payable = $15,524.50 Pauline is presently entitled to her $57,500 share of the trust income. However, as Pauline is a minor she is under a legal disability. The trustee will be assessed on her $57,500 share under ITAA36 s 98. As it is a trust created by Deed, the entire amount is eligible assessable income (s 102AG) and taxed under Div 6AA. Tax payable by the trustee is $57,500 × 45% = $25,875 + Medicare levy ($57,500 × 2%) = $1,150 Total tax payable by the trustee on behalf of Pauline = $27,025 As Pauline has income from another source she will also be assessed on the $57,500 of her share of the net trust income under ITAA36 s 100(1). When added to her interest income of $800 this gives a total $58,300 all of which is eligible assessable income. Under s 100(2) Pauline is entitled to a credit for the tax paid by the trustee on her behalf. Therefore, the net tax payable by Pauline is $27,491 − $27,025 = $466. AMTG: ¶6-080, ¶6-085, ¶6-110, ¶6-120, ¶6-170

¶9-070 Worked example: Streaming franking credits Issue Liz Michaels is an investor in listed company shares who runs her share market activities through the Michaels Investment Trust. Over the years, she has been very successful in her activities and has made substantial returns on her investments as well as receiving large sums in franked dividends. Liz Michaels now wishes to engage in tax planning to maximise the value of the franking credits attached

to the substantial dividends she has received in the year to 30 June 2019. In the past, dividends and franking credits have been largely streamed to a corporate beneficiary (LM Pty Ltd) with only a small proportion of the dividends and attached franking credits streamed to Liz personally. Liz has retired from her job working for a large investment bank in Sydney and, as a result, her other income for the year ended 30 June 2020 has declined substantially. She believes that she can achieve a better financial outcome by restructuring the distributions from the trust as follows: • The trust will distribute 75% of the dividends received during the year to LM Pty Ltd, and the remaining 25% to Liz. • The trust will separately distribute 25% of the franking credits relating to those dividends to LM Pty Ltd and 75% to Liz. The reasoning behind this plan is that the distribution of 25% of the franking credits will eliminate most, if not all, of the taxable income of LM Pty Ltd. Liz will then be able to claim a large cash refund in relation to the franking credits that are distributed to her. This plan was put to her by her family lawyer, who is not a tax expert, but based on his knowledge of trust law believes that the broad powers contained in the trust Deed give the trustee the ability to deal with franking credits on franked dividends in whatever way the trustee wishes. Studying the trust Deed, you observe that the Deed permits the trustee to record identified categories of income separately in the trust’s books of account. The identified categories include dividends which were fully franked, which were unfranked, to which a foreign tax credit attached, or to which “any other separately identifiable taxation consequence or benefit” attached. Separately, the Deed permits differential distribution of the whole or any part of the income between beneficiaries — commonly referred to as “streaming”. The Deed does not treat franking credits as income. However, the Deed does contemplate that franked distributions could be streamed between beneficiaries in different proportions to the other income of the trust. Liz has come to you for tax advice in relation to the proposed plan. In particular, Liz wants your advice on whether the proposal complies with taxation law. Solution The facts of Liz’s case are similar to those in the case of FC of T v Thomas & Ors 2018 ATC ¶20-663. In that case, the High Court held that a trustee of a trust could not stream franking credits separately from, and in different proportions to, the dividends distributed to the beneficiaries. The High Court found franking credits, as dealt with in Div 207 ITAA 1997, are a notional amount or “tax fiction” attributed to an amount of dividend received by a beneficiary. The Court stated “that the statutory notional allocation of franking credits to beneficiaries follows the proportions which have been established with respect to their notional sharing in franked distributions at the earlier stages”. In addition, “so long as a trust Deed confers power on a trustee to apply classes of income of the trust estate to particular beneficiaries to the exclusion of other beneficiaries (or differentially among beneficiaries), Div 207 recognises that a trustee may stream the franked distribution (or any part of it) to one beneficiary and the other income to another beneficiary. However, Div 207 does not treat franking credits as a separate source of income capable of being dealt with, and distributed, separately from the franked distribution to which they are attached. The scheme’s objective in relation to trusts is to ensure that a beneficiary of a trust will have notionally attributed to it that proportion of the franked distributions received by the trustee that is referable to the amount of the net income distributed to the beneficiary while, at the same time, ensuring that the beneficiary obtains the benefit of the franking credits to the extent of those franked distributions. The franking credits are on, or attached to, the franked distribution”. Accordingly, applying Div 207 and based on the principles set out in the Thomas case, the scheme that Sue is proposing will not comply with taxation law. While the trustees of the Michaels Investment Trust

can exercise their discretion to distribute franked dividends in whatever proportion they wish, they cannot separately distribute the franking credits attached to those dividends in different proportions. AMTG: ¶4-680, ¶6-107

¶9-080 Worked example: Income of a deceased estate; tax payable Issue Tom Werner died four years ago leaving the assets of his estate which only comprised of shares listed on the ASX. The terms of his will provided that these shares were to be held in trust for a period of 25 years by his executor Charles Noble. The terms also provided that any dividend income derived during this 25year period would be accumulated exclusively for his daughter Marilyn Werner until she turns 21 years of age or marries, and then paid to her. If Marilyn dies before attaining 21 years then all the shares would be transferred to his widow Grace Werner’s estate. Marilyn celebrated her 18th birthday on 30 November 2019. She was not married at any time during the 2019/20 tax year. During the 2019/20 year, the trustee of the trust estate received a fully franked dividend of $20,600 and a partly franked (40%) dividend of $7,500 which was paid to Marilyn. Discuss how the income of the trust estate would be taxed in the 2019/20 tax year and calculate the tax payable, assuming Marilyn was not in receipt of any other income. Solution Based on the terms of Tom’s will, the dividends on the shares are to be paid exclusively to Marilyn. However, Marilyn cannot demand immediate payment of any part of the trust income as she is under 21 years and unmarried and, therefore, she is not presently entitled. Likewise, Marilyn is not deemed presently entitled by ITAA36 s 95A(2) as she has no vested or indefeasible interest since, upon her death, the shares will be transferred to the widow’s (Grace Werner’s) estate. Marilyn’s interest is, therefore, a contingent interest. Consequently the amount will be assessed to the trustee under ITAA36 s 99, assuming the Commissioner exercises his discretion to apply s 99 and not ITAA36 s 99A. The net income will be grossed-up to include the imputation credits (ITAA97 s 207-35): $ Franked dividend income

20,600

Dividend gross-up: $20,600 × 30 / 70* × 100%

8,829

Partly franked dividend

7,500

Dividend gross-up: $7,500 × 30 / 70* × 40%

1,286

Assessable amount

38,215

*assuming the dividend is not paid by a base rate entity Consequently, the full $38,215 is assessed to the trustee under s 99 (assuming the Commissioner exercises his discretion not to apply s 99A) as the income is derived under a deceased estate. As it is more than three years since the date of death, no tax-free threshold is available and the income will be taxed as follows: $7,030 + [($38,215 − $37,000) × 32.5%] = $7,424.88 (Income Tax Rates Act 1986, Sch 10 Pt I(2)) The trustee will also be entitled to offset the imputation credits attached to the dividends against the tax liability. Note that neither the low income tax offset (s 159H) nor the Medicare levy (s 251S(1)(c)) applies to s 99 assessments in respect of deceased estates.

AMTG: ¶6-030, ¶6-040, ¶6-077, ¶6-080, ¶6-170

¶9-090 Worked example: Trust gains of foreign residents Issue Pond Family Pty Ltd (PFP), an Australian resident company, is the trustee of the Pond Family Trust, a discretionary family trust. Ms Amy Pond is a beneficiary of the trust and a resident of the United Kingdom. During the year ended 30 June 2019, the trust made capital gains arising from the disposal of shares in a number of Australian listed companies which were held for investment purposes. The trust resolved to distribute 100% of the capital gains to Amy. On the basis that the assets disposed of, being Australian listed company shares, were not Taxable Australian Property and that the capital gains were distributed to a non-resident of Australia, no capital gain has been reported by any parties to the transactions. On 1 June 2020, the ATO issued an assessment to PFP under ITAA36 s 98 on the basis that the capital gains distributed to Amy, being deemed or attributable gains of Amy under ITAA97 Subdiv 115-C, were assessable to PFP. The directors of PFP have approached you for advice on how to respond to the ATO, and specifically whether their original tax treatment of the sale of the shares was incorrect. Solution The basis of PFP’s original treatment of the transactions can be found in ITAA97 Div 855, which exempts non-residents from CGT unless the CGT event arises from something happening to “Taxable Australian Property” (TAP). Section 855-15 lists the categories of CGT assets that are TAP. Listed Australian company shares are not included in that list, except to the extent that the taxpayer has a direct or indirect ownership interest in the company of 10% or more and more than 50% of the market value of the company’s assets is attributable to Australian real property (such as land or buildings). We are advised in the question that the shares are not TAP. Section 855-10 provides that a foreign resident is to “disregard a capital gain or capital loss from a CGT event if… the CGT event happens in relation to a CGT asset that is not taxable Australian property”. Therefore, if the capital gains that were distributed to Amy had been made directly by her (ie she held the shares that were disposed of), she would have been exempt from tax. The tax position of a beneficiary of a discretionary trust is generally to be determined as if they had made the capital gain themselves (ie Amy should be viewed as making the capital gain herself, and because she is non-resident, the gain should be disregarded by s 855-10). However, the ATO position is that s 855-10 does not disregard a capital gain distributed to a foreign resident beneficiary of an Australian discretionary trust (TD 2019/D6). In that draft ruling, the ATO states that a foreign beneficiary presently (or specifically) entitled to a capital gain made by an Australian discretionary trust on an asset that is not TAP is assessable on the capital gain even though that would not occur if the foreign resident made the gain directly rather than through a discretionary trust. This view was supported by the Federal Court in Peter Greensill Family Co Pty Ltd (as trustee) v FC of T 2020 ATC ¶20-742; [2020] FCA 559. In that case, the Court ruled that s 855-10 does not apply so as to disregard a capital gain in such a situation because the capital gain does not arise “from a CGT event” within the meaning of s 855-10. For a gain to arise from a CGT event, there must be a direct connection between the capital gain and the CGT event. Section 855-10 was not intended to apply to an amount which was “attributable to a CGT event” which occurred to another person. In effect, the trustee (who is an Australian resident) generates the gain rather than the beneficiary. The gain in the hands of the beneficiary does not arise “from” a CGT event, but rather, from an amount distributed by the trustee equal to the capital gain. Section 115-220 then operates so that the trustee is assessed under ITAA36 s 98(3) on the beneficiary’s attributable capital gain. This is the reason why the ATO has issued an assessment to PFP in this case. Based on the ATO position in TD 2019/D6 and the outcome of the Greensill case, it appears that the Commissioner was correct to issue an assessment in relation to the transactions and that an objection to the assessment would not succeed.

AMTG: ¶12-725, ¶12-735

¶9-100 Worked example: Trust losses; income injection test Issue The Grapevine Family Trust carries on a profitable winery business in the Hunter Valley region in New South Wales. The trustee is Travis Mason and the beneficiaries include himself, his wife Anna and son Lucas and the Speciality Wines Trust. The Speciality Wines Trust is Lucas’s family trust which commenced its wine wholesaling business in the 2017/18 tax year and of which Lucas is the trustee. The beneficiaries of the Speciality Wines Trust are Travis Mason, Anna and Lucas himself. No interposed election has been made to include the Speciality Wines Trust in the Grapevine Family Trust’s family group. The trust deed of the Speciality Wines Trust defines trust income to be the trust’s taxable income derived during the year. During the 2018/19 tax year the Speciality Wines Trust incurred a loss of $800,000 under ITAA97 s 36-10 which had been carried forward. The Grapevine Family trust is currently profitable and this is expected to continue in future years. Travis Mason as trustee of the Grapevine Family Trust allocated $800,000 of the trust income to the Speciality Wines Trust during the 2019/20 income year. However, the trustees had an informal agreement (not evidenced in writing) that the amount was a loan and that this amount was lent in good faith. The terms of the repayment of the loan was negotiable between the trustees. Discuss whether the trust losses in the Speciality Wines Trust can be recovered? Solution This scenario examines the application of the income injection test with regards to the recovery of losses in the Speciality Wines Trust. Division 270 of the ITAA36 contains provisions designed to prevent income injection schemes that purport to take advantage of tax losses and other deductions. Broadly, under an income injection scheme, income is injected into the trust which has tax losses or other deductions so that less (or no) tax is payable on the income. The purpose of the income injection test is to prevent the use of deductions/losses by the trust to shelter the assessable income. Specifically, ITAA36 Sch 2F Div 270, s 270-10(1) provides certain requirements that need to be satisfied. These requirements include that a trust has a tax loss/allowable deduction (but for the application of the income injection test) and there is a scheme pursuant to which: • the trust derives assessable income • an outsider (a person not connected with the trust: s 270-25) provides a direct or indirect benefit (s 270-20) to the trustee or a beneficiary (or their associate) • the outsider is provided with a return benefit from the trust • it can be reasonably concluded that the benefit was provided or the assessable income derived from the scheme was done so wholly or partly (but not incidentally) because the loss or deduction is allowable • the trust is not an “excepted trust” (s 272-100) Where these tests are satisfied the assessable income will be included in the net income of the trust. However the tax losses/deductions that would have been taken into account (but for the income injection provisions) will be ignored. Applying these conditions to the Speciality Wines Trust the following may be noted: • the Speciality Wines Trust is not an excepted trust and has derived assessable income as a result of the allocation of the net income by the Grapevine Family Trust

• by allocating net income to the Speciality Wines Trust the Grapevine Family Trust (income trust) has provided a benefit to the Speciality Wines Trust (loss trust) with no details of repayment in return. The Grapevine Family Trust is an outsider of the Specialty Wines Trust • the Speciality Wines Trust has provided a benefit to the Grapevine Family Trust by informally agreeing to repay the $800,000 which happens to be equal to its income allocation. As a result, the Grapevine Family trust has effectively alienated $800,000 of income which would have been subject to tax in the 2019/20 income year and thereby satisfied the requirements of s 270-10(1)(c). Despite, the promise of the Grapevine Family Trust being repaid, the terms of the borrowing indicate that it is not commercial. Consequently, the benefits provided by the two trusts to each other, appear to have been solely created as a result of the existence of prior year loss deductions in the Speciality Wines Trust and the desire to generate a tax benefit. In these circumstances, the income injection test negates the tax benefit by increasing the net income of the Speciality Wines Trust to match the $800,000 allocation from the Grapevine Family Trust. As a result, the loss deduction is disallowed against the “scheme assessable income” for the 2019/20 income year (s 270-15). This treatment does not prevent the deductibility of other deductions of the Speciality Wines Trust while losses may continue to be carried forward to future years. Also, the income injection test may still operate in this scenario regardless of whether the terms of the arrangement between the trusts were commercial. Where there is an intention to create a tax benefit (ie a reduction in income and tax payable of the Grapevine Family Trust in this case) this anti-avoidance rule will apply. For instance, the income injection test applied in Corporate Initiatives Pty Ltd & Ors v FC of T 2005 ATC 4392 where losses were provided to a trust estate under a “scheme” (defined broadly), the income injection test applied to deny the tax benefit. AMTG: ¶6-262, ¶6-267

¶9-120 Worked example: Trust losses; pattern of distribution test Issue During the year ended 30 June 2015, the Davidson Family discretionary trust derived trust income of $290,000 and capital of $150,000. Brian Ross acting as trustee of the Davidson Trust distributed income to the Davidson family beneficiaries — Peter 30%, Geraldine 45% and Lenny 25% respectively. The capital beneficiaries comprised Phillip 40%, Colin 40% and Claire 20%. During the year ended 30 June 2016, the trust incurred a trading loss of $350,000 and a capital loss of $200,000 due to a down turn in the economy. Subsequently, the business was restructured and placed under new management which gradually returned it to profitability deriving a profit of $500,000 by the year ended 30 June 2020. The trustee subsequently made income distributions to Peter 20%, Geraldine, 25% and Lenny 55% in the 2019/20 tax year. The trustee also made distributions of capital to Phillip 30%, Colin 60% and Claire 10% during this period. Apply the pattern of distributions test to determine whether the trust losses can be absorbed. Solution The pattern of distributions test applies to non-fixed trusts and applies independently to both income and capital. Broadly ITAA36 Sch 2F s 269-60 requires that the same group of individuals must have received (directly or indirectly) distributions of more than 50% of both income and capital of the trust in a year prior to the loss year, the income year the loss is recouped and any intervening years over a seven-year period (see also ITAA36 Sch 2F s 269-65(1)). The test only applies if a non-fixed trust has distributed income or capital in the year in which the prior year tax loss is to be claimed (or within two months of the year end) and a distribution of income or capital was made in one of the previous six years. The ITAA36 s 269-60 test requires that the trust must have distributed more than 50% of any distributions of income or capital either directly or indirectly to the same individuals for their own benefit in each year during the test period. As the test is separately applied to income and capital distributions, capital distributions need not be made to the same individuals who received income distributions when applying

the greater than 50% criteria. Consequently, where the income and capital beneficiaries differ as in this case, the test needs to be satisfied twice. To comply with ITAA36 s 269-70 requires beneficiaries who receive different percentages of income and capital distributions in different years, to take into account the smallest percentage of such distributions. Consequently, in applying the pattern of distribution test to the Davidson Trust it is necessary to compare income distributions made in the 2015 and 2020 tax years since during the test period these are the only years in which distributions were made. The lowest percentage of income distributions in these two years will be the percentage of distributions taken into account: Beneficiary

2014/15 tax year

2019/20 tax year

Lowest percentage

Peter

30%

20%

20%

Geraldine

45%

25%

25%

Lenny

25%

55%

25%

Total income

100%

100%

70%

Phillip

40%

30%

30%

Colin

40%

60%

40%

Claire

20%

10%

10%

Total capital

100%

100%

80%

Based on the above table, the trust passes the pattern of distributions test as 70% of the same persons received income distributions over the test period (ie 70% > 50%). The trading loss of $350,000 for the year ended 30 June 2016 can be carried forward to be offset against trust income of 2019/20 tax year or future years. Likewise, the test is also passed for the capital distributions over the test period (ie 80% > 50%) and the capital loss of $200,000 for the year ended 30 June 2016 can be carried forward to be offset against trust capital for the 2019/20 tax year or future years. AMTG: ¶6-262, ¶6-264

¶9-140 Worked example: Revocable trusts Issue Megan Frawley created a trust for the benefit of her unmarried daughter Isabel aged 15 years. Under the terms of the trust settlement the trustee was authorised to use their discretion in deciding the amount to be used for Isabel’s maintenance during the year. The trust deed provided that the amount of net trust income not applied for Isabel Frawley’s maintenance was to be accumulated and paid to her at the trustee’s discretion but not before Isabel attained 21 years of age. Under the trust Megan also had the power to revoke the trust so that she could acquire a beneficial interest in a share of the income or property of the trust. The net trust income for the 2019/20 tax year was $36,000 and the trustee applied $3,000 to pay for Isabel’s education expenses and $6,500 to pay for maintenance expenses. A further $8,000 was paid into a bank account in Isabel’s name. No other income was received by Isabel during the 2019/20 tax year. Megan’s other income for the year ended 30 June 2020 was $50,000 and her spouse Adam received a salary of $30,000. Megan, received amounts from the trust by way of cash allowances throughout the tax year. Assuming the Commissioner exercises his discretion under ITAA36 s 102, how is the net income of the trust assessed? Then calculate the tax payable by Megan, Isabel and the trustee in this situation. Solution As Megan has created the trust herself and the beneficiary is a minor it allows the Commissioner the discretion to apply ITAA36 s 102(1)(b) in lieu of other provisions of ITAA36 Div 6 (s 102(3)). Under s 102(2) the Commissioner may assess the trustee on the basis that the amount of tax payable is the

amount that would have been paid had the creator (Megan) derived the income. Tax payable by the trustee $ Tax payable by Megan on $86,000 ($50,000 + $36,000)

$ 19,497

Medicare levy $86,000 × 2%

1,720 21,217

Less tax payable on $50,000

7,797

Medicare levy

1,000

Additional tax payable by the trustee on $36,000 under s 102

8,797 12,420

Tax payable by Megan $ Tax payable by Megan on $50,000

7,797

Medicare levy $50,000 × 2%

1,000 8,797

Less low income tax offset $445 − ($50,000 − $37,000 × 0.015) NET TAX PAYABLE

250

        8,547

Tax payable by Isabel Nil (s 102(3)). As s 102(1)(b) is limited to children under 18 years and this is a inter vivos trust and none of the income qualifies as excepted trust income, the Commissioner may choose to apply ITAA36 Div 6AA or s 99A penalty rates, as more tax would be payable in this case as opposed to applying s 102. It should be noted that s 102 applies as Megan Frawley was the creator (settlor) of the trust. This situation can be easily avoided by ensuring that the settlor or creator of the trust is unable to revoke or alter the trust to personally acquire a beneficial interest in the trust income or property. Instead a “nominal” settlor (a person unrelated to the family or any objects of the trust) could create the trust by providing a nominal sum, to the trustee to constitute the original trust property. This was the case in Truesdale v FC of T 70 ATC 4056, where the nominal settlor had paid the initial gift of $20 from his own funds and was not reimbursed by the real settlor. Also, after creation of the trust, funds could be transferred from Megan without the risk of the Commissioner invoking s 102. See Hobbs & Anor v FC of T (1957) 98 CLR 151, where s 102 did not apply. AMTG: ¶6-240

¶9-160 Worked example: Family trust elections Issue Andrew Wilson and Leah Barnes are a divorced couple who are discretionary beneficiaries under the “Wilson Family Trust” and also own one share each in Pasco Pty Ltd. In March 2020, the trustee of the Wilson Family Trust made a family trust election in the approved form specifying Andrew Wilson as the test individual whose family group is to be taken into account in relation to the election. Advise Andrew and Leah as to whether their divorce means that Leah will be excluded from Andrew’s family group. Also advise Andrew as to whether Pasco Pty Ltd can be included within Andrew’s family

group. Solution (1) Is Leah a member of Andrew’s family or family group? As the test individual, Andrew’s family group includes his family, specified former family members, the trust covered by the family trust election, entities (including companies) covered by an interposed entity election and entities owned by Andrew’s family (ITAA36 Sch 2F s 272-90). Therefore, Leah, as Andrew’s former spouse, is not a member of Andrew’s family. Andrew’s family includes himself, his spouse, his parents, his spouse’s parents, grandparents, siblings, nephews and nieces (ITAA36 Sch 2F s 272-95). The term spouse also includes a de facto spouse, but not a former spouse (ITAA36 s 6(1)). Although Leah is not a member of Andrew’s family, she will still qualify as a member of Andrew’s family group because she is his ex-wife (s 272-90(2A)). Therefore, distributions to former spouses are exempt from family trust distribution tax (imposed at the rate of 47%). (2) Is the company, Pasco Pty Ltd, a member of Andrew’s family group? The company, Pasco Pty Ltd, owned by Andrew and Leah will, in relation to a conferral or distribution, be a member of Andrew’s family group provided that the company has made an interposed entity election to that effect and the election is in force at the time of a conferral or distribution (s 272-90(4)). Although a company can, in relation to a conferral or distribution, be a member of an individual’s family group without an interposed entity election, this will only be the case where the test individual, or his family or the trustees of one or more family trusts, have fixed entitlements to all the income and capital of the company. In this case, Leah has an entitlement to a share of the income and capital of Pasco Pty Ltd. Consequently, as Leah is not a member of Andrew’s family, Pasco cannot be a member of Andrew’s family group unless an interposed entity election is made (s 272-90(5)). The interposed entity election should indicate that Pasco should be included in the family group of Andrew specified in the family trust election (ITAA36 Sch 2F s 272-85). A family trust election must specify that the trust is a family trust at all times after the beginning of a specified income year (s 272-80). The election must be in the approved form. Elections can be made at any time for earlier years provided that at all times from the beginning of the specified income year until 30 June in the income year preceding the income year in which the election was made: • the entity passes the family control test, and • any conferral of present entitlement or any actual distribution of income or capital of the trust made by the trustee during that period has been made to individuals specified in the election or to members of that individual’s family group (s 272-80(4A); 272-85(4A)). The election must also specify an individual as the individual whose “family group” is the subject of the election. The election should also include other information required by the Commissioner such as the name and address of the trust and the beneficiaries (s 272-80(3)). If a family trust election is revoked, the interposed entity election is automatically revoked (s 272-85(5B)). An interposed entity election cannot be made in respect of more than one family trust unless the individual specified in each family trust election is the same. AMTG: ¶6-266

¶9-180 Worked example: Family group; family trust election; interposed entity election Issue The Axle discretionary trust wishes to make a family trust election for 2019/20 income year. The “test individual” chosen is Alicia Owens. Alicia has the following family members and related entities which are

potential beneficiaries of the trust: • Her husband: Tony • Her sons: Michael and Richard • Her sister: Robin • Robin’s daughter: Angela • Her father and mother: John and Eve • Her cousin: Rachel • Her former husband: Gary • Her brother-in-law (Tony’s brother): Jack • Ace Pty Ltd: A company which is 50% owned by Alicia and 50% by Rachel (Alicia’s cousin). 1. Which family members and entities would be excluded from the family group created once Alicia is the individual specified in the family trust election? 2. For those excluded entities/persons how can distributions be made to them by the trust without attracting family trust distribution tax? 3. What are the advantages of making a family trust election? 4. Alicia wishes to make her husband, Tony the test individual from the 2020/21 income year. Can this be achieved if a distribution was made to Alicia’s father, John in respect of the 2019/20 income year? Solution (1) Family members and entities excluded from the group The test individual Alicia’s family group includes her family, specified former family members, entities covered by an interposed entity election and entities owned by Alicia’s family (ITAA36 Sch 2F s 272-90). Therefore, Alicia’s cousin Rachel is excluded as cousins do not fall within the definition of “family group” in s 272-90. Ace Pty Ltd is also excluded as it is not wholly owned by members of the family group. (2) Interposed entity election To avoid family trust distribution tax on distributions made to Ace Pty Ltd, an interposed entity election would be required. An interposed entity election only applies to elections made by companies, trusts or partnerships and not to natural persons (ITAA36 Sch 2F s 272-85(1)). Therefore, Ace Pty Ltd can make an interposed entity election. However, an election is not available for Rachel, and therefore any distributions to her will be subject to family trust distribution tax. (3) Advantages of family trust elections A family trust election can restrict the entities and individuals to which a trustee can make a distribution in a tax-effective manner. Therefore, the decision to make a family trust election must be considered carefully. An election may be considered in the following circumstances where: • the trust receives franked dividends • the trust has losses • the shares of a company are owned by a discretionary trust • the trust may want to access the small business restructuring roll-over, and

• the trust may want to access distributions from another family trust. The advantages of a family trust election include the following: • The ability to satisfy the 45/90 day “at risk” holding rule in order to access franking credits. • Easier use of carry forward revenue losses. A “family trust” is only required to satisfy the income injection test before it can deduct carried forward losses. • An opportunity for a company or fixed trust with losses to pass the continuity of ownership test or the 50% stake test by treating a family trust with a family trust election as a “person”. • It may be desirable or advantageous to distribute from one discretionary trust to another. However, if the discretionary trust has a family trust election in place, it can only distribute to another trust that also has a family trust election in place with the same test individual. • Small business restructure roll-over ITAA97 Subdiv 328-G. Certain businesses can transfer active assets from one entity to one or more other entities without crystallising an income tax liability. A key requirement to access the small business roll-over is that the restructuring does not change the ultimate economic ownership of the asset. This is difficult to satisfy in the case of a discretionary trust. However, where a family trust election is made because the family group are the ultimate owners, this becomes an easier test to satisfy. • A trust covered by a family trust election or an interposed entity election is exempted from the trustee beneficiary reporting rules (ITAA36 Div 6D). These reporting rules require the trustee of a closely held trust to advise the Commissioner of details about each beneficiary that is presently entitled to a share of the trust’s net income or tax-preferred amount. (4) Varying a test individual A trust can vary a test individual on a once-only basis, provided that: • the new specified individual is a member of the original individual’s family at the time the election is first made, and • there are no conferrals of present entitlement to income or capital made (by the trust or an interposed entity) outside the new specified individual’s family group during the period in which the election has been in force (s 272-80(5A) and (5B)). Given a distribution was made to John, Alicia’s father, in the 2019/20 income year when Alicia was the test individual, any variation of the test individual would still require John to be included in the family group. If Tony was appointed the test individual, then John, Alicia’s father, would be part of the new family group. This is because the family of the individual specified in the FTE consists of the test individual and any parent, grandparent, brother or sister of either the specified individual or the specified individual’s spouse. As John is Alicia’s parent, the variation would be permitted. AMTG: ¶6-266

¶9-200 Worked example: Net trust income; trust law distribution Issue The QRS trading trust has the following details for the 2019/20 income tax year: Trust Income: $ Trading profits

2,000,000

Franked dividends

1,400,000

Capital gain

  900,000

Trust income

4,300,000

Net (taxable) income: $ Trading profits

2,000,000

Franked dividends

1,400,000

Franking credits

600,000

Capital gain (after application of CGT discount)

  450,000

ITAA36 s 95 TAXABLE INCOME

4,450,000

The trustee resolves that the trust income be distributed as follows: • Income beneficiaries – Q 50% – R 50% • Capital beneficiary – S 100%. The trustee distribution resolution deals with trust law income and may only be in favour of the income beneficiaries Q and R. Applying the proportionate approach what is the outcome of the distribution? Solution In the case of FC of T v Bamford & Ors; Bamford & Anor v FC of T 2010 ATC ¶20-170, the High Court held that the proportionate approach applied regardless of how the trustee’s resolution to distribute income is made. That is, whether by reference to dollar amounts, or to fractions or proportions of trust income. The High Court indicated that the natural meaning to give to the word “share” was “proportion” rather than “part” or “portion”. The Commissioner’s Decision Impact Statement in relation to Bamford’s case and Practice Statement PS LA 2010/1 describe the approach taken by the ATO if deliberate attempts are made to exploit the provisions of ITAA36 Div 6 by the re-characterisation of an amount for trust purposes. This is where there is a manipulation of income and capital amounts in order to reduce tax. In this case the proportionate approach will assess the income beneficiaries on the net trust income of $4,450,000 which includes the net capital gain after the discount, notwithstanding that they are not entitled to any capital distribution. Applying the proportionate approach the outcome is: Beneficiary

Taxable income

Cash entitlement per the trust deed

$

$

Q

2,225,000*

1,700,000

R

2,225,000*

1,700,000

S

 0

 900,000

*50% of the $4,450,000 Despite the distribution of cash from the trust to all the beneficiaries, only beneficiaries Q and R pay the tax. This outcome could be avoided if the streaming rules that apply from the 2011/12 tax year can be utilised or if the choice of the trustee to be assessed on account of the beneficiary pursuant to ITAA97 s 115-230 is adopted. As the trustee becomes specifically entitled to all of the capital gain the beneficiary is relieved from taxation. AMTG: ¶6-077, ¶6-080, ¶6-085, ¶6-130, ¶6-200

¶9-220 Worked example: Present entitlement of tax exempt entities Issue During the 2019/20 tax year the Vatican Trust generated $400,000 of business income and $140,000 of franked distributions with $60,000 of franking credits attached to the distributions. Trust expenses came to $100,000 and consequently the taxable income of the trust was $500,000. The trust deed does not define “income” but there is a discretionary clause in the deed that allows the trustee to treat receipts as income or capital. During the income tax year the trustee exercised this discretion to treat $285,000 of the business income as capital and the remaining $15,000 as income and consequently the income of the trust estate was $155,000 (comprising the $140,000 franked distributions and $15,000 business income). The beneficiaries of the Vatican Trust are Peter, Paul and Church Pty Ltd. The trust allocates all of the franked distributions ($140,000) to Peter and appoints all of the remaining income of the trust estate ($15,000) to Church Pty Ltd. The Trust notifies Church Pty Ltd of its entitlement by 30 August 2020 and appoints all capital ($285,000) in respect of that year to Paul. Discuss how the income of the trust estate would be taxed and determine the tax liability of the trustee and beneficiaries. Solution ITAA36 s 101 indicates that “where a trustee has a discretion to pay or apply income of a trust estate to or for the benefit of specified beneficiaries, a beneficiary in whose favour the trustee exercises the trustee’s discretion shall be deemed to be presently entitled to the amount paid to the beneficiary or applied for the beneficiary’s benefit by the trustee in the exercise of that discretion”. Based on this premise in establishing present entitlement we need to consider whether the trustee’s resolution is sufficient. In this regard a beneficiary is presently entitled to income when the income is legally available for distribution and he/she is entitled to immediate payment of the income, or if under a legal disability, he/she would succeed in an action to recover the income but for the legal disability. In this case, if the trustee’s resolution creates a “present entitlement” by providing the beneficiaries with a right to immediate payment (or would but for their legal disability), the beneficiaries would be taxed on the income which the trustee resolved to distribute to them as indicated in FC of T v Whiting (1943) 68 CLR 199, Montgomerie v Commissioner of Inland Revenue (NZ) (1965) 14 ATD 102 and Taylor & Anor v FC of T 70 ATC 4026. This was not the case in Pearson v FC of T 2006 ATC 4352, where the trustee of a discretionary trust was not entitled to the net income of the unit trust as there was no provision in the trust deed to make the trustee presently entitled nor did the unit holders have any legal right to demand payment of undistributed net income. As the beneficiaries are “specifically entitled” to the franked distribution, they will receive an amount equal to the “net financial benefit” referable to the franked distribution in the trust (ITAA97 Subdiv 207-B). The date of payment of the income is not a relevant consideration of present entitlement in this case. As Church Pty Ltd is an exempt entity there are two rules that may deny present entitlement to the income of a trust estate resulting in the trustee being liable under ITAA36 s 99A. The first rule is that the tax exempt entity must be notified in writing of its present entitlement by the trustee within two months of the end of the financial year (ITAA36 s 100AA). The second rule only applies where the first rule does not

apply. The second rule ensures that a tax exempt entity does not have a disproportionate share of the net income of the trust attributed to it (ITAA36 s 100AB). This involves a comparison of the beneficiary’s adjusted “Division 6 percentage” of the trust income with the exempt entity beneficiary’s “benchmark percentage”. An exempt entity will not be treated as presently entitled where the entity’s adjusted Division 6 percentage exceeds the benchmark percentage. To calculate the adjusted net income of a trust, the net (tax) income of the trust must be reduced for any capital gains or franked distributions or increased for any CGT discounts or small business concessions claimed and reduced by any amounts that do not represent “net accretions of the value of the trust estate” (s 100AB). In the case of Church Pty Ltd, the adjusted Division 6 percentage is 100% ($155,000 − $140,000/$15,000 × 100) as it is presently entitled to all of the income of the trust estate after disregarding the $140,000 of franked distributions to which Peter is specifically entitled. It is noted that notification was within two months of the end of the financial year (30 August 2019) however, Church’s Pty Ltd benchmark percentage is only 5% ($15,000 / $300,000). The franked distributions to which Peter is specifically entitled and the attached franking credits (as they do not represent net accretions of value to the trust fund) are excluded from the adjusted net income for the purpose of calculating the benchmark percentage. Consequently, Church’s Pty Ltd adjusted Division 6 percentage exceeds the benchmark percentage by 95% (100% − 5%). Therefore, the trustee of the Vatican trust will be assessed and liable to pay tax on $285,000 (95% × $300,000) under s 99A. Church Pty Ltd’s share of the Vatican trust taxable income will be confined to their entitlement of $15,000. As Paul has no income entitlement he is not subject to tax. AMTG: ¶6-105, ¶6-274

¶9-240 Worked example: Beneficiary; present entitlement; use of disclaimers Issue Mary Richards is an Australian resident taxpayer who was in a 10-year relationship with Jeremy Steele. Mary is aged 40. During the relationship, Mary was financially dependent on Jeremy. When the relationship commenced Jeremy set up a discretionary trust with himself as the trustee, and both Mary and himself as beneficiaries. A trust bank account was established and Mary was given a debit card to access funds in this account which she did on a regular basis. She was not aware of the existence of the trust arrangement and believed she was receiving money from Jeremy as a gift. Jeremy was solely responsible for all tax compliance obligations for himself, the trust and Mary. When the relationship ended in January 2020, Mary was no longer able to withdraw money from the trust account. Jeremy continued to lodge tax returns for the trust and himself, but no longer took care of Mary’s tax affairs. Mary has not lodged a tax return since the 2018/19 income year, and has received a default assessment for that year. The determination was based on data matching the disclosures from the trust’s income tax return lodged by Jeremy in May 2020. Mary claims to have no idea about the distribution from the trust. She believed that she received the money as a gift from Jeremy. She also has a signed disclaimer stating that she rejected the gift amount. Advise Mary if she is assessable on the monies that were distributed to her by accessing the trust account with the debit card. Solution For Mary to be assessed on the trust funds, she must be a beneficiary of the trust estate, who is not under any legal disability, and is presently entitled to a share of the income of the trust estate (ITAA36 s 97). The assessable income of a beneficiary includes so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident. In this case Mary was an eligible beneficiary of the trust based on the trust deed and not under any legal disability. A beneficiary cannot disclaim a discretionary distribution if they have received the benefit of the

distribution. Furthermore, a beneficiary may be presently entitled notwithstanding they are not aware of their entitlement to the trust income, or even if the beneficiary is not aware of the existence of the trust (Vegners v FC of T 89 ATC 5274; see also Taxation Ruling IT 2651). The decision in Alderton v FC of T 2015 ATC ¶10-407 states that a beneficiary is presently entitled to a share of the net income of the trust on the basis that the trust tax return shows that the share of the net income had been distributed to the beneficiary, regardless of whether the beneficiary was unaware of the trust’s affairs and was not involved in its financial dealings. Although Mary had no involvement or knowledge of the trust’s financial affairs, this lack of knowledge did not affect her present entitlement to the income of the trust. A beneficiary’s entitlement to income under a trust is operative from the moment it arises (ITAA36 s 97). On this basis, Mary is assessable on the share of the trust income as she withdrew it from the trust bank account. Operation of disclaimer signed by Mary For a disclaimer to be effective, it must constitute an absolute rejection of the gift, prior to acceptance of the funds and it must occur within a reasonable time of the beneficiary becoming aware of the interest (FC of T v Ramsden 2005 ATC 4136). Mary was not able to reject the gift because, having accepted the benefit of it by withdrawing the funds from the trust bank account she could no longer disclaim the funds. She had the use and benefit of the distribution from the time of the withdrawal of the funds. The disclaimer of her interest in the income is considered invalid. For further guidance on what will constitute a valid disclaimer of trust, see FC of T v Ramsden 2005 ATC 4136; Lewski v FC of T 2017 ATC ¶20-630. The ATO has provided some guidance on when a disclaimer is effective (Interpretative Decision ATO ID 2010/85). The disclaimer can operate retrospectively, however it must be made within a reasonable time that the beneficiary becomes aware of the gift and it must be disclaimed in its entirety. AMTG: ¶6-100, ¶6-105

¶9-260 Worked example: Circulation issues; dividends and distributions; reimbursements agreements; tax avoidance Issue Bill Rodham is the trustee of the Rodham Family Trust (RFT). The beneficiaries of the RFT are his children and grandchildren. Bill, as trustee, owns 100% of the shares in Chelsea Pty Ltd (Chelsea). The purpose of Chelsea is to receive distributions as required from RFT on which the 30% company tax rate is paid. The company undertakes no other business activities. Chelsea’s sole-director is Bill and the company is also a beneficiary of the RFT. This structure was set-up in 1990, and since then funds have circulated between RFT and Chelsea. During the income years spanning 2018/19 and 2019/20 the following events occurred: • 30 June 2019 — Bill as trustee for the RFT resolved to make Chelsea presently entitled to all trust income of RFT for the 2018/19 income year • November 2019 — Bill distributed the income from the RFT to Chelsea • January 2020 — Chelsea lodged the company income tax return for the 2016/17 income year, and included share of the trust’s net income in its assessable income for 2016/17 and paid tax at the corporate rate • March 2020 — Chelsea paid a fully franked dividend to Bill as trustee for the RFT. As Chelsea has no other income, this amount was the RFT income from 2018/19. RFT could utilise the franking credits attached to the dividend that represented that tax that Chelsea paid. The franking credits could offset any tax liabilities for the beneficiaries of the RFT • June 2020 — The dividend received from Chelsea forms part of the trust income for the 2019/20 income year. Bill as trustee for the RFT resolved to make Chelsea presently entitled to all trust income of the RFT.

How do the provisions of ITAA36 Div 6 apply to this arrangement? Solution On the facts there is a recirculation of the same monies, even though this occurs over successive income years. There appears to be a scheme in place with the purpose of avoiding tax. The scheme is representative of a reimbursement agreement and would be captured under the ITAA36 s 100A antiavoidance provision. Reimbursement agreement A reimbursement results in the distribution benefitting the trustee and not the beneficiary who is presently entitled to the net income from the trust. The reimbursement provides for the payment of income from the trustee to the company with the implied understanding, through repetition and common control, that the company would pay a fully franked dividend of a corresponding amount to the trustee. In this case, the distribution benefits Bill and not Chelsea. The reimbursement agreement provides for the payment of income from Bill to Chelsea based on Bill having ultimate control as both the director of Chelsea and the trustee of the RFT. This agreement reduces the overall tax liability compared with Bill accumulating the income in the RFT. However, s 100A does not apply where an agreement has been entered into in the course of an ordinary family or commercial dealing, as these arrangements are not considered to have the character of a reimbursement. Establishing whether an ordinary family or commercial dealing exists requires a consideration of all of the relevant facts and steps comprising the reimbursement agreement. In this case, the agreement would not be considered to be in the course of an ordinary family dealing because all of the entities involved are members of the same “family group”. Bill is managing the RFT on behalf of family beneficiaries, however, there is no other family involvement in the operation of the RFT. Further, the agreement does not appear to be an ordinary commercial dealing as the circulation of funds served no commercial purpose. On this basis, s 100A would apply to this circulation of funds arrangement. The amount distributed to Chelsea would therefore be taxed in the hands of Bill (as trustee of the RFT) at the top marginal tax rate for either 2018/19 or 2019/20 (ITAA36 s 99A) depending on which income year the amount is referable. Since s 100A is an anti-avoidance provision, the Commissioner has an unlimited period within which to make an assessment (ITAA36 s 170(10)). AMTG: ¶6-080, ¶6-085, ¶6-270

¶9-280 Worked example: School fees; reimbursement agreements Issue Innovation Education Trust (IET) was created by the Turner family to fund the private school fees of the Turner children. The beneficiaries of the IET are the Turner family members and any education institutions that any of the beneficiaries attend. One of the child beneficiaries of the IET is currently attending the Goldstein Private School for Girls (Goldstein). The trustee of the IET entered into a formal arrangement with Goldstein to distribute school fees and other education costs to the school. Goldstein is income tax exempt under ITAA97 s 50-5 (item 1.4). What tax consequences can arise from this arrangement? Solution Broadly, a beneficiary who is presently entitled to a share of the income of a trust and is not under a legal disability is assessable on (ITAA36 s 97(1)): • that share of the net income for tax purposes that is attributable to a period when the beneficiary was a resident, whatever the source of the income, and • that share of the net income for tax purposes that is attributable to a period when the beneficiary was

not a resident and that is also attributable to sources in Australia. Where a beneficiary of a trust estate (not under a legal disability) is presently entitled to trust income and the present entitlement is linked directly or indirectly to a reimbursement agreement, ITAA36 s 100A as an anti-avoidance provision applies to disregard the present entitlement and the trust distributions are assessed to the trustee under ITAA36 s 99A. A reimbursement agreement generally involves making someone presently entitled to trust income in circumstances where both: • someone other than the presently entitled beneficiary actually benefits from that income, and • at least one party enters into the agreement for purposes that include receiving a tax benefit. “Benefit” includes the payment or loan of money, the transfer of property, the provision of services or other benefits; or the release, abandonment, failure to demand payment, or postponed payment, of a debt. “Agreement” is defined widely to include arrangements and understandings that can be informal, express or implied. An agreement can comprise a series of steps or transactions (s 100A(13)). In this case, Goldstein has become presently entitled to trust income, permissible by the trust deed, as payment of school fees for another beneficiary of the IET. As Goldstein is an income tax exempt entity, the reimbursement agreement results in the elimination of the tax liability on the distribution as the school would not pay tax on this amount. Whereas, if the amount was distributed to the beneficiary so that they could pay the school fees, then a tax liability would arise in the hands of the beneficiary. Given that the distribution by the trustee of trust income to Goldstein would be considered a reimbursement agreement, then s 100A would apply to the transaction and the trustee would be taxed on the distributed income under ITAA36 s 99. Since, the purpose of s 100A is to prevent tax avoidance, the Commissioner has an unlimited period within which to make an assessment (ITAA36 s 170(10)). Note that ATO Interpretative Decision ID 2005/145 (Income Tax: Assessable income: tax exempt beneficiary and reimbursement agreement) sets out the ATO’s position on this type of arrangement. AMTG: ¶6-080, ¶6-085, ¶6-270

¶9-300 Worked example: COVID-19 stimulus; cash flow boost and JobKeeper Issue Dennis Jones and his sister, Rebecca Jones, own and run an interior design consultancy, Amazing Spaces, through their family trust, the Jones Family Trust. Dennis and Rebecca are the trustees of the trust and are beneficiaries of the trust, together with Dennis’s two children and Rebecca’s three children. Dennis and Rebecca work full-time within the business but are not employees. They remunerate themselves by way of an annual trust distribution paid according to the level of profitability during the year, with payments typically made in the second half of June of each financial year. There are no other employees in the business. Amazing Spaces has been impacted by the economic downturn caused by COVID-19 and Dennis and Rebecca wish to understand which government stimulus measures they may be eligible for. In particular, they have been advised by a friend that they may be eligible for cash flow boosts from the ATO if they register for PAYG withholding, backdated to 1 March 2020, and begin to pay themselves a monthly wage instead of taking a trust distribution in June. They believe that the turnover of Amazing Spaces for the April to June 2020 quarter is likely to be 25% lower than the equivalent quarter in 2019. However, a major contract is due for completion in May 2020 and they believe that by deferring issuing an invoice for the final payment from May 2020 to July 2020, the fall in turnover would be closer to 35%.

Amazing Spaces qualifies as a small business entity for tax purposes. Advise Dennis and Rebecca. Solution Cash flow boost The Boosting Cash Flow for Employers (Coronavirus Economic Response Package) Act 2020 ensures that eligible small- and medium-sized business and not-for-profit organisations that employ staff will receive between $20,000 and $100,000 in cash flow boost amounts by lodging their activity statements up to the month or quarter of September 2020. The cash flow boosts are delivered as credits in the activity statement system to entities that make a payment that is subject to withholding obligations under Subdiv 12-B, 12-C or 12-D of Sch 1 to the Taxation Administration Act 1953 (broadly, a payment of wages or salary or similar remuneration), whether or not any amount is actually withheld, in relation to each monthly or quarterly period from March to June 2020. An additional cash flow boost is applied when activity statements for each monthly or quarterly period from June to September 2020 are lodged. These credits are equal to the total boosts credited for March to June 2020. Under s 5(1)(g) and 6(1)(g), an entity is not entitled to the cash flow boost payments where it has engaged in a scheme for the sole or dominant purpose of seeking to make the entity entitled to the cash flow boost or increase the entitlement of the entity to the cash flow boost. Entities that do not make payments subject to PAYG(W) are specifically excluded from the scheme. This includes partnerships where partners are remunerated by way of drawings, trusts that pay trust distributions and companies that pay dividends to shareholders. In this context, the ATO notes (on its website), that schemes could include artificially restructuring or arranging your business to meet the eligibility criteria. Any sudden changes to the characterisation of payments made by an entity may prompt the ATO to investigate whether the payments are in fact wages. The arrangements that concern the ATO include artificially restructuring businesses to gain access to the cash flow boost, artificially changing the character of payments to salary and wage to maximise the cash flow boost and making false statements or fraudulent attempts to create an entitlement. If the ATO finds that an entity has entered into or carried out a scheme with the aim of becoming entitled to the cash flow boost, or increasing the amounts of the cash flow boost, the entity will be required to repay the entire amount back to the Commissioner. Significant penalties and interest charges can also apply to overpayments of the cash flow boost arising from schemes. Sanctions under criminal law may also apply to fraudulent claims. In this case, Amazing Spaces has no history of making wage payments since it has no employees. The only two people who work in the business (Dennis and Rebecca) are remunerated by way of annual trust distributions. The proposal to backdate PAYG(W) registration and switch to paying a monthly salary is motivated primarily by a desire to secure eligibility to the cash flow boosts that would not otherwise be available to the business. Dennis and Rebecca are advised that Amazing Spaces is not eligible for the cash flow boosts. The proposal to backdate PAYG(W) registration and convert trust distributions is a scheme. In the event that the ATO makes cash flow boost payments, Amazing Spaces would be liable to repay the cash flow boosts and may be subject to penalties and interest. In particular, the backdating of PAYG(W) registration may constitute fraud and may be subject to criminal sanction. JobKeeper Under the Coronavirus Economic Response Package (Payments and Benefits) Rules 2020, a business owner who is actively engaged in operating a business may be entitled to the JobKeeper payment (s 11 and 12 of the Rules). This applies to a sole trader, a partner in a partnership, an adult beneficiary of a trust or a shareholder in or director of a company. An entity is not entitled to a payment for more than one individual and that individual must be actively engaged in the business and must not be an employee of

the business. To qualify, the business entity must satisfy the decline in turnover test, must have an ABN on 12 March 2020 (or a later time allowed by the ATO) and must either have included a business receipt in assessable income for the 2018/19 income year or have made a taxable supply during the period from 1 July 2018 to 11 March 2020 (inclusive). The decline in turnover test is satisfied if the projected GST turnover for the turnover test period falls short of current GST turnover for the relevant comparison period, by the specified percentage (30%, in relation to businesses with an aggregated turnover of $1b or less). Amazing Spaces is potentially eligible for JobKeeper payments of $1,500 per fortnight in relation to one eligible business participant. As both Dennis and Rebecca work full-time in the business, either (but not both) could be nominated as eligible business participants. In order to qualify, Amazing Spaces would need to satisfy the turnover test. The basic test would require a comparison of turnover for the turnover test period (April to June 2020) with the turnover of the comparative period (April to June 2019). Based on the information provided, the decline in turnover is only 25%, meaning that the business does not qualify for JobKeeper in relation to this period. It has been suggested that the business should defer issuing an invoice until the next quarter in order to meet the decline in turnover test. According to s 19 of the Coronavirus Economic Response Package (Payments and Benefits) Act 2020, if one or more entities enter into or carry out a scheme for the sole or dominant purpose of obtaining a JobKeeper payment, or an increased amount of a JobKeeper payment, the Commissioner may determine that the entity was never entitled to the JobKeeper payment. The Commissioner can recover any overpayments and has the power to impose significant penalties and interest. This specific integrity provision is aimed at contrived and artificial arrangements that technically satisfy the eligibility requirements, but have been implemented for the sole or dominant purpose of accessing a JobKeeper payment. PCG 2020/4 discusses when the Commissioner will seek to apply the integrity rules. The PCG spells out several scenarios that the Commissioner deems possible arrangements that could influence the JobKeeper outcome for entities involved — such as artificially deferring the making of supplies, or bringing supply forward — solely to gain JobKeeper entitlement. Deferring the issue of invoices would be one such arrangement. Dennis and Rebecca are advised that Amazing Spaces is not, based on information currently provided, eligible for JobKeeper. They are advised not to defer issuing invoices in order to artificially manipulate turnover. As JobKeeper runs in its original form through until 27 September 2020 (and in a modified form subject to amended rules through to 28 March 2021), they are advised that Amazing Spaces may become legitimately eligible for JobKeeper in a future quarter. They should also be advised that it is possible to measure the turnover test on a monthly basis so if the business is able to establish the required 30% decline in turnover in a particular month (eg April 2020 compared to April 2019), the business may be eligible for JobKeeper, even though the quarterly fall is insufficient. AMTG: ¶10-040

COMPANIES AND DISTRIBUTIONS Base rate entity; base rate entity passive income and impact on company tax rate and franking rate

¶10-000

Preparation of franking account

¶10-010

Franking account and franking deficit tax

¶10-020

Calculating franking credits for small companies

¶10-040

R&D tax offset; impact on franking account

¶10-060

Maximum franking credits and franking account

¶10-080

Receipt of franked dividends; effect on shareholders

¶10-100

Distribution in a liquidation

¶10-120

Application for permission to depart from benchmark rule

¶10-140

Consequences of breaching benchmark rule

¶10-160

Dividend imputation and effect on shareholders

¶10-180

Dividend access shares

¶10-200

Division 7A; deemed dividends

¶10-220

Division 7A; distributable surplus; internally generated goodwill

¶10-240

Shares; debt equity

¶10-260

Carry-forward losses: continuity of ownership and same business test

¶10-280

Calculation of tax liability of resident private company

¶10-300

Tax losses and excess franking offsets

¶10-320

COVID-19 stimulus; cash flow boost and JobKeeper

¶10-340

¶10-000 Worked example: Base rate entity; base rate entity passive income and impact on company tax rate and franking rate Issue Traken Pty Ltd undertakes a business of manufacturing furniture from its premises in Brisbane. Over the years, the company has invested surplus profits from its trading business into the acquisition of several substantial commercial rental properties. During the year ended 30 June 2019, the company disposed of one commercial property, making a net capital gain of $23m. During the year ended 30 June 2019, the company’s turnover from its furniture manufacturing business was $7m. The company earned rental income from its portfolio of properties amounting to $5m, earned interest on surplus cash invested at the bank of $1m and received franked dividends of $1m (including franking credits) in respect of shares held in several ASX listed companies, in all of which Traken Pty Ltd had a voting interest of less than 10%. During the year ended 30 June 2020, the company’s turnover from its furniture manufacturing business was $9m. The company earned rental income from its portfolio of properties amounting to $7m, earned interest on surplus cash invested at the bank of $2m and received franked dividends of $1m (including franking credits) in respect of shares held in several ASX listed companies, in all of which Traken Pty Ltd had a voting interest of less than 10%.

Traken Pty Ltd wishes to pay a dividend to shareholders on 30 June 2020. What rate of company tax will Traken Pty Ltd pay in the year ended 30 June 2020 and at what rate must it frank the dividend to be paid on 30 June 2020? Solution For the 2018/19 and 2019/20 income years, the general company tax rate is 30%, but if the company is a base rate entity the rate is 27.5% (Income Tax Rates Act 1986 s 23). A company will be a base rate entity for an income year if: • it meets an aggregated turnover test which is less than $50m, and • no more than 80% of its assessable income for the income year is “base rate entity passive income (BREPI)”. Under s 23AB of the Income Tax Rates Act 1986 the following types of income are BREPI: • a company dividend — other than a non-portfolio dividend (which is a dividend paid to a company where that company has a voting interest of 10% or more in the company paying the dividend) • a franking credit attached to a dividend other than a non-portfolio dividend • a non-share dividend • interest income, royalties and rent • a gain on qualifying securities • a net capital gain, and • assessable partnership and trust distributions to the extent that they are referable (either directly or indirectly through one or more interposed partnerships or trust estates) to an amount that is BREPI under any of the above bullet points. The ATO has issued a draft Law Companion Ruling LCR 2018/D7 which explains the meaning of these terms. For the purposes of working out the franking rate to apply to the payment of a franked dividend paid in the 2019/20 income year, it is necessary to apply the corporate tax rate (CTR) for imputation purposes, defined in s 995-1(1) to mean the entity’s corporate tax rate for the income year, worked out on the assumption that: • its aggregated turnover for the current income year (2019/20) is equal to its aggregated turnover for the previous income year (2018/19) • its BREPI for the current income year is equal to its BREPI for the previous income year, and • its assessable income for the current income year is equal to its assessable income for the previous income year. In practice, this means that a company’s maximum franking rate for a franked distribution paid in 2019/20 is 27.5% if: • its aggregated turnover for 2018/19 was less than $50m (the aggregated turnover threshold for 2019/20), and • its BREPI for 2018/19 was not more than 80% of its assessable income for 2018/19. Company tax rate for 2019/20 Traken will apply a company tax rate of 27.5% to its profits for the year ended 30 June 2020.

This is because the company is a base rate entity for the year since both tests are passed: • The company’s aggregate turnover for the year is less than $50m (aggregate turnover for the year is $19m, being the sum of the various sources of income for that year), and • The company’s BREPI is $10m for the year, giving a BREPI percentage of 52.6 Franking rate for dividend paid in 2019/20 Traken will apply a corporate tax rate for imputation purposes of 30% in respect of the dividend that it wishes to pay on 30 June 2020. The company satisfies the turnover test, since its aggregate turnover for 2018/19 is $37m, which is less than the 2019/20 turnover threshold of $50m. However, the company fails the BREPI test. The company’s BREPI is $30m for the year, giving a BREPI percentage of 81 ($30m divided by $37m). The net capital gain, the rental income, the bank interest and the gross dividend are all BREPI. AMTG: ¶3-055, ¶4-405, ¶4-640

¶10-010 Worked example: Preparation of franking account Issue Border Pty Ltd (Border) is an Australian resident private company with a corporate tax rate for imputation purposes of 27.5% for the 2019/20 income year.1 On 1 July 2019, its franking account balance was a $45,000 surplus. During the 2019/20 year, the following transactions took place. • 28 July 2019 — payment of June 2019 PAYG instalment: $35,000 • 28 October 2019 — payment of September 2019 PAYG instalment: $35,000 • 28 October 2019 — payment of GST: $60,0002 • 1 November 2019 — receipt of a fully franked dividend from a company with a corporate tax rate for imputation purposes for the 2019/20 year of 30%: $27,000 • 12 December 2019 — receipt of an unfranked dividend: $30,000 • 28 January 2020 — payment of December 2019 PAYG instalment: $35,000 • 1 February 2020 — receipt of a dividend partly-franked to 70% from a company with a corporate tax rate for imputation purposes for the 2019/20 year of 30%: $120,000 • 1 April 2020 — receipt of income tax refund cheque: $12,500 • 28 April 2020 — payment of March 2020 PAYG instalment: $35,000 • 30 April 2020 — payment of FBT: $62,0002 • 1 June 2020 — payment of a fully franked dividend: $70,000 Prepare Border’s franking account for the 2019/20 tax year based on the information provided above. Solution Border’s franking account for the 2019/20 tax year is set out below: Border Pty Ltd Franking account for the tax year ended 30 June 2020 Debit

Credit

Balance

$

$

$

1.7.19

Opening balance

—

—

45,000

28.7.19

Payment of June 2019 PAYG instalment3

—

35,000

80,000

28.10.19

Payment of September 2019 PAYG instalment3

—

35,000

115,000

1.11.19

Receipt of a fully franked dividend of $27,000 from a company with a corporate tax rate for imputation purposes of 30%. The franking credit attached is $27,000 × (30% ÷ 70%) × 100% = $11,5714

—

11,571

126,571

28.1.20

Payment of December 2019 PAYG instalment3

—

35,000

161,571

1.2.20

Receipt of a dividend of $120,000 franked to 70% from a company with a corporate tax rate for imputation purposes of 30%. The franking credit attached is $120,000 × (30% ÷ 70%) × 70% = $36,0004

—

36,000

197,571

1.4.20

Receipt of income tax refund cheque for $12,5005

12,500

—

185,071

28.4.20

Payment of March 2020 PAYG instalment3

—

35,000

220,071

1.6.20

Payment of a fully franked dividend of $70,000. The franking credit attached to the dividend is $70,000 × (27.5% ÷ 72.5%) × 100% = $26,552. Franking debit = $26,5526

26,552

—

193,519

30.6.20

Closing balance7

—

—

193,519

Notes: (1) If Border was a base rate entity for the 2019/20 year (because no more than 80% of its assessable income was Base Rate Entity passive income and it had an aggregated turnover of, for example, $30m for the year, which is less than the 2019/20 $50m threshold), its company income tax rate for the 2019/20 year would be 27.5%. This would not directly affect its franking account. It is worth noting that a base rate entity with a 27.5% company income tax rate can have a corporate tax rate for imputation purposes of 30% for the 2019/20 year. This could arise if the company’s aggregated turnover for the previous income year (2018/19) was, for example, $51m (greater than the $50m threshold for the 2019/20 year) or the company’s Base Rate Entity passive income percentage was greater than 80%: refer to the ITAA97 s 995-1(1) definition of “corporate tax rate for imputation purposes”. However, this does not apply to Border as the question says that its corporate tax rate for imputation purposes for the 2019/20 year is 27.5%. (2) The payment of GST on 28 October 2019 and FBT on 30 April 2020 does not affect Border’s franking account. (3) A franking credit arises if a company pays a PAYG instalment. The amount of the franking credit is usually the amount of the instalment paid by the company (ITAA97 s 205-15(1), item 1 in the table). (4) A franking credit arises if a company receives a franked distribution from another resident company. The amount of the franking credit is the franking credit on the distribution (ITAA97 s 205-15(1), item 3 in the table). (5) A franking debit arises if a company receives a refund of income tax. Assuming Border satisfies the residency requirements and is a franking entity during all of 2019/20, the amount of the franking debit is the amount of the refund (ITAA97 s 205-30(1), item 2 in the table). (6) A franking debit arises if a company franks a distribution. The amount of the franking debit is the amount of the franking credit on the distribution (ITAA97 s 205-30(1), item 1 in the table). (7) The closing balance of the franking account as at 30 June 2020 (ie $193,519) is carried forward and represents the opening franking account balance on 1 July 2020.

AMTG: ¶3-055, ¶4-640, ¶4-700, ¶4-710, ¶4-720, ¶4-770

¶10-020 Worked example: Franking account and franking deficit tax Issue Otage Pty Ltd (Otage) is an Australian resident private company with a corporate tax rate for imputation purposes of 27.5%. It provides the following information relating to its franking account for the 2019/20 tax year: • 1.7.19 — opening balance: $55,000 • 28.7.19 — payment of June 2019 PAYG instalment: $42,000 • 1.10.19 — receipt of a partly-franked dividend to 40% from an Australian public company with a corporate tax rate for imputation purposes of 30%: $80,000 • 28.10.19 — payment of September 2019 PAYG instalment: $42,000 • 1.12.19 — distribution to shareholders of $90,000 with a 100% franking percentage • 28.2.20 — payment of December 2019 PAYG instalment: $42,000 • 28.4.20 — payment of March 2020 PAYG instalment: $42,000 • 2.5.20 — refund of income tax from previous year: $330,000 in respect of the 2018/19 income year. Prepare Otage’s franking account for the 2019/20 tax year and explain any consequences arising from the balance at 30 June 2020. Solution Otage’s franking account for the 2019/20 tax year is set out below: Otage Pty Ltd Franking account for the tax year ended 30 June 2020 Debit

Credit

Balance

$

$

$

1.7.19

Opening balance

—

—

55,000

28.7.19

Payment of June 2019 PAYG instalment: $42,0001

—

42,000

97,000

1.10.19

Receipt of an $80,000 dividend franked to 40% from a company with a corporate tax rate for imputation purposes of 30%. $80,000 × (30% ÷ 70%) × 40% = $13,714 credit2

—

13,714

110,714

28.10.19

Payment of September 2019 PAYG instalment: $42,0001

—

42,000

152,714

1.12.19

Distribution of $90,000 with a 100% franking percentage. $90,000 × (27.5% ÷ 72.5%) = $34,138 debit3

34,138

—

118,576

28.2.20

Payment of December 2019 PAYG instalment: $42,0001

—

42,000

160,576

28.4.20

Payment of March 2020 PAYG instalment: $42,0001

—

42,000

202,576

2.5.20

Refund of income tax in respect of the 2018/19 income year: $330,0004

30.6.20

Closing balance

330,000

—

(127,424)

—

—

(127,424)

Notes: (1) A franking credit arises when a PAYG instalment is paid. The amount of the franking credit is the amount paid (ITAA97 s 205-15(1), item 1 in the table). (2) A franking credit arises if a company receives a franked distribution from a franking entity. The amount of the franking credit is the amount of franking credits attached to the distribution (ITAA97 s 205-15(1), item 3 in the table). (3) A franking debit arises if a company pays a franked distribution. The amount of the franking debit is the amount of franking debits attached to the distribution (ITAA97 s 205-30(1), item 1 in the table). (4) A franking debit arises if a company receives a refund of income tax. The amount of the franking debit is the amount of the refund (ITAA97 s 205-30(1), item 2 in the table). Liability to franking deficit tax Otage’s franking account has a deficit of $127,424 at 30 June 2020 and Otage is required to pay franking deficit tax (ITAA97 s 205-45(2)). Liability to pay franking deficit tax is imposed by the New Business Tax System (Franking Deficit Tax) Act 2002 which states that the amount of the liability is the amount of the deficit (s 5). Otage is liable to pay franking deficit tax of $127,424. Tax offset for the franking deficit tax A company is generally entitled to a tax offset against its future income tax liabilities equal to the amount of franking deficit tax it pays (ITAA97 s 205-70). Where a company’s franking deficit tax liability is more than 10% of the total franking credits arising in the company’s franking account for the year, the company’s tax offset entitlement may be reduced by 30%. The 30% reduction only applies to the extent that the company’s franking deficit tax liability relates to franking debits that arose in provisions specified in s 205-70(8). The specified provisions relate to various situations in which franking debits may arise including franking a distribution and receiving a refund of income tax — the two situations in which franking debits arose for Otage. Otage’s franking deficit tax liability ($127,424) is more than 10% of the total franking credits (10% × $181,714) arising in the company’s franking account for the year, so Otage’s tax offset is $89,197 (ie $127,424 − ($127,424 × 30%)). AMTG: ¶4-640, ¶4-700, ¶4-710, ¶4-720, ¶4-780

¶10-040 Worked example: Calculating franking credits for small companies Issue MNO Pty Ltd (MNO) is a private company that is currently a base rate entity. Pauline Powell is MNO’s sole shareholder and is a part-time employee of the company. Her husband Ben is a full-time employee. They both receive arm’s length salaries from MNO. Pauline and Ben are the company’s only directors. MNO’s tax profile for 2017/18 to 2019/20 is: 2017/18

2018/19

2019/20

$38,000

$43,000

$50,000

Company income tax rate 30%

27.5%

27.5%

Income tax paid

$12,900

$13,750

Taxable income

$11,400

MNO’s aggregated turnover for the 2019/20 and 2020/21 income years is less than $50m. This figure

includes all relevant turnovers of connected entities and affiliates. Accounting profits were the same as taxable income for each of the relevant income years and no dividends were paid in any of those years. The company’s Base Rate Entity passive income is expected to continue to be no more than 80% of its assessable income in 2020/21 and 2021/22. MNO’s 2019/20 tax return was lodged on 15 September 2020. The final tax liability was paid on lodgment of the return. In May 2021, Pauline and Ben, in their capacities as MNO’s directors, decide to pay a fully franked dividend of $100,000 to Pauline. The $100,000 dividend will be funded from the profits earned in each of the last three income years. Before declaring the dividend, the directors need to decide whether to pay the dividend in June 2021 or July 2021. Pauline plans to retire in early July 2021 and she will not derive any employment income in the 2021/22 year. Although she will still have ongoing investment income, her effective income tax rate is expected to decrease significantly. Before any dividend is paid to her, assume Pauline’s marginal rate in the 2020/21 year is 45%, but that it is 32.5% in the 2021/22 year (ignoring Medicare levy and surcharge issues). (1) At what rate should the imputation credit attached to the dividend be calculated? (2) What tax consequences arise for Pauline if she is paid the dividend in June 2021? How would these consequences differ if she is paid the dividend in July 2021? Assume that MNO’s franking account balance exceeds $42,858 when the dividend is paid (ie the balance required to frank the entire dividend at 30%). Solution (1) As a base rate entity, MNO is entitled to the lower corporate tax rate of 27.5% for the 2019/20 tax year. A company with a Base Rate Entity passive income percentage of no more than 80% with an aggregated turnover of under $50m has a 27.5% company income tax rate for the 2019/20 income year. The imputation rules have been amended to deal with inconsistencies caused by the progressive reduction of the company tax rate, depending on the company’s turnover. Companies are required to calculate their maximum franking percentage using the new “corporate tax rate for imputation purposes”. This term is found in the amended ITAA97 s 202-55 and is defined in ITAA97 s 995-1 to generally mean the company’s tax rate for the current income year, assuming that its aggregated turnover is the same as its turnover for the previous income year. This applies because a company will not know its aggregated turnover for the year in which it pays the dividend until after the year ends. If the dividend is paid in June 2021, MNO has a corporate tax rate for imputation purposes for the 2020/21 year of 27.5%. This is because its aggregated turnover for the previous year (2019/20) is less than the relevant turnover threshold for the 2020/21 year ($50m) when the dividend is paid. On paying the fully franked dividend of $100,000 in June 2021, MNO can attach a maximum of $37,931 franking credits (ie $100,000 × (27.5%/72.5%)), representing 27.5% of the underlying pretax company profits. This is irrespective of the fact that the actual tax paid on those profits may have been calculated at rates of 30% (if sourced from 2017/18 profits), or 27.5% (if sourced from 2018/19 or 2019/20 profits). If the dividend is paid in July 2021, MNO also has a corporate tax rate for imputation purposes for the 2021/22 year of 27.5%. This is because its aggregated turnover for the previous year (2020/21) is less than the relevant turnover threshold for the 2021/21 year ($50m) when the dividend is paid. This means that MNO can also attach a maximum of $37,931 in franking credits to the dividend. (2) If Pauline is paid the dividend in June 2021, she will be assessed on it in the 2020/21 income year. Her marginal tax rate of 45% for that year would result in her paying “top-up tax” on the dividend, as the franking credit offset only represents 27.5% of the assessable amount. It would be preferable to defer paying the dividend to Pauline until July 2021. She has a lower marginal rate in 2021/22, resulting in a lower effective tax rate. Therefore, she is likely to pay less “top-up tax” on the $100,000

franked dividend — or she may even receive a refund of excess franking credits, depending on her circumstances. AMTG: ¶3-055, ¶4-405, ¶4-640, ¶4-820

¶10-060 Worked example: R&D tax offset; impact on franking account Issue Jojo Pty Ltd (Jojo) lodges its 2018/19 income tax return in February 2020. It is entitled to an R&D tax offset of $50,000. Its final income tax liability (not taking into account the R&D tax offset) is $30,000. Jojo receives an income tax refund of $20,000 in March 2020. This $20,000 represents the amount by which the R&D tax offset exceeds the final tax liability. Before receiving the refund, Jojo’s franking account balance has a $30,000 surplus, and it has accumulated after-tax profits of $70,000 that Jojo wants to pay as dividends before year end. Jojo’s corporate tax rate for the 2018/19 year, and its corporate tax rate for imputation purposes for the 2019/20 year, is 30%. (1) Should Jojo debit its franking account by $20,000 in March 2020 to reflect the tax refund? (2) What is the effect of the R&D tax offset on the company’s plans to pay dividends? (3) What are the franking account implications if Jojo’s tax refund was $23,000, of which $20,000 was attributable to an R&D tax offset, and $3,000 was attributable to other refundable tax offset amounts? Solution (1) Jojo should not debit its franking account by the $20,000 refund when received in March 2020. ITAA97 s 205-30(2) specifically provides that a tax refund should not be debited to the franking account, to the extent that it relates to an R&D tax offset. Instead, the debit should be deferred. Jojo should therefore record the $20,000 as a deferred debit. When Jojo subsequently pays PAYG instalments or income tax liabilities (which normally give rise to franking account credits), the first $20,000 of those payments will be credited against the deferred debit (ITAA97 s 205-15(4)). After the $20,000 deferred debit has been fully offset by PAYG instalments or payments of income tax, Jojo may recommence crediting the franking account for such amounts. If, for example, Jojo pays a PAYG instalment of $15,000 each quarter, the payment for the March 2020 quarter would be fully offset against the deferred debit and there would be no credit to the franking account. When Jojo pays the June 2020 quarter instalment, the first $5,000 would be offset against the deferred debit. The remaining $10,000 would be credited to the franking account. (2) The requirement to defer a debit that is referable to an R&D tax offset is so that the offset does not give rise to franking deficit tax. If the debit deferral rule did not exist, when Jojo receives its $20,000 tax refund that is referable to the R&D tax offset, its franking account balance would decrease to $10,000. If Jojo declared a fully franked dividend of $70,000 before year end so that the franking credits attached were $30,000, then the franking account falls into a $20,000 deficit (assuming, for illustration purposes, that no other franking account entries happened for the remainder of the year). If that deficit was not rectified by 30 June 2020 (eg by receiving franked dividends with sufficient franking credits attached), then Jojo would be subject to a franking deficit tax liability. This outcome would arise even if Jojo paid company income tax (at 30%) on the $70,000 accumulated profits that it distributes. Because s 205-30(2) requires a deferral of the $20,000 franking account debit, the franking account balance would remain as a $30,000 surplus on receiving the tax refund. Jojo would be able to pay a fully franked dividend of $70,000 before year end, without triggering a franking deficit tax liability because that dividend is paid. Subsequently, the deferred debit would be offset against future

franking credits for PAYG instalments or income tax as and when they arise — without the franking account ever going into deficit because of the R&D tax offset. (3) If Jojo received a tax offset refund of $23,000, comprised of a $20,000 R&D tax offset and $3,000 in other refundable tax offset amounts, it would not be able to defer the entire refund amount. On receiving the refund, Jojo would have to immediately debit its franking account by the $3,000 attributable to the other refundable tax offset amounts, and defer the $20,000 R&D tax offset. AMTG: ¶4-640, ¶4-710, ¶4-720, ¶4-780

¶10-080 Worked example: Maximum franking credits and franking account Issue Coola Pty Ltd (Coola) is an Australian resident private company with a corporate tax rate for imputation purposes of 27.5% for the 2019/20 income year. The following information is relevant to Coola’s franking account for the 2019/20 year: • Coola had a nil balance in its franking account on 1 July 2019 • franking credit entries totaling $620,000 were added to the account during the year, and • franking debit entries totaling $490,000 were made to the account during the year. On 30 June 2020, Coola wants to pay a dividend of $200,000 to its shareholders. Explain: 1. the maximum franking credit that may be attached to the dividend, and 2. the consequences for Coola if it pays a dividend of $200,000, with franking credits of $93,000 attached, assuming it complies with the benchmark rule. Solution 1. The effect of ITAA97 s 202-60(2) is that the maximum franking credit on a distribution is calculated as:

Amount of                   1                  frankable ×  “Corporate tax gross-up rate” of the distribution-making company, for the income year the distribution is ma distribution A company’s “corporate tax gross-up rate” for an income year is defined in ITAA97 s 995-1(1) as: (100% − Corporate tax rate for imputation purposes for the income year) Corporate tax rate for imputation purposes for the income year Coola’s corporate tax rate for imputation purposes for the 2019/20 year is 27.5% (given in the facts), which means that it is a Base Rate Entity. It has an aggregated turnover for the previous year (2018/19) below $50m and Base Rate Entity passive income of no more than 80% of its assessable income in the previous year: ITAA97 s 995-1(1) definition of “corporate tax rate for imputation purposes”; and the Income Tax Rates Act 1986 s 23 (as it applied for the 2019/20 year). This means that Coola’s corporate tax gross-up rate for the 2019/20 year is 72.5%/27.5% (or 2.636 rounded). When applied to the maximum franking credit formula above, the maximum amount of franking credits that Coola can attach to a $200,000 dividend paid on 30 June 2020 is $75,862 [ie $200,000 × (27.5%/72.5%)]. If Coola Pty Ltd franks the dividend with $75,862 in franking credits attached, a franking debit of $75,862 would be recorded in the franking account on 30 June 2020 (ITAA97 s 205-30(1), item 1). Coola had franking account credit entries of $620,000 during the 2019/20 income year. Its franking debit entries for the year totaled $565,862 ($490,000, plus $75,862 for the 30 June 2020 dividend). When

combined with a nil opening balance for the year, the closing balance in Coola’s franking account for the 2019/20 year is a $54,138 surplus. This will be the opening balance in Coola’s franking account on 1 July 2020. 2. If Coola Pty Ltd pays a dividend of $200,000 on 30 June 2020 which is stated in the distribution statement to have a franking credit of $93,000, that is an amount that exceeds the maximum franking amount, the franking credit is taken to be the amount of the maximum franking amount (ITAA97 s 20265). The shareholders will receive franking credits of $75,862 and there will be a franking debit of $75,862 in the franking account. Coola cannot avoid having unused franking credits in 2019/20 by passing on franking credits in excess of the maximum amount. Regardless of the amount of franking credits stated on the distribution statement, the franking credit is taken to never exceed the maximum amount. Unused franking credits at year end become the opening balance for the next income year. AMTG: ¶4-640, ¶4-720

¶10-100 Worked example: Receipt of franked dividends; effect on shareholders Issue Midas Pty Ltd (Midas), a resident Australian company, has a corporate tax rate for imputation purposes for the 2019/20 income year of 30%. It declared a distribution of $160,000 from its after-tax profits on 10 June 2020. The distribution was paid to shareholders on 10 June 2020 and had a franking percentage of 100%. Distributions from Midas were paid to the following shareholders: • $50,000 to Paul Aly, the managing director of Midas, who is a resident individual living in Sydney, Australia • $10,000 to Justin Aly, the son of the managing director, who has been studying in London for three years and is a foreign resident • $15,000 to Opal Pty Ltd (Opal), an Australian resident public company with a 30% company income tax rate, and • $85,000 to the Aly Superannuation Fund, which is a complying superannuation fund. Each of the shareholders satisfies the 45-day holding period rule. Explain how each of the four shareholders of Midas would be taxed on the distribution received in 2019/20. Solution The four shareholders who receive the fully franked distributions from Midas on 10 June 2020 would be taxed in the following way. $50,000 to Paul Aly, a resident individual The $50,000 distribution received by Paul Aly is included in his assessable income (ITAA36 s 44(1)). The distribution is grossed up for the $21,429 franking credit on the distribution (ie $50,000 × 30 / 70 = $21,429) and the franking credit is included in assessable income (ITAA97 s 207-20(1)). Paul Aly is taxed on his taxable income at 2019/20 individual resident tax rates and is entitled to a tax offset for the $21,429 franking credit (ITAA97 s 207-20(2)). He is entitled to a refund if the amount of the franking credit exceeds his tax liability (ITAA97 s 67-25(1)). $10,000 to Justin Aly, a non-resident individual Because Justin Aly is a non-resident individual and does not satisfy the residency requirements in ITAA97 s 207-75, the franking credit on the fully franked distribution is not included in his assessable income and he is not entitled to a tax offset (ITAA97 s 207-65(1)). Also, because the distribution is fully franked, there is no withholding tax payable by Midas (ITAA36 s

128B(3)(ga)). If the distribution had not been fully franked, withholding tax would have been payable to the extent that it was unfranked (s 128B(1)). Although the distribution is not subject to withholding tax, it is excluded from Justin Aly’s assessable income in the same way as it would have been if it had been subject to withholding tax (ITAA36 s 128D). $15,000 to Opal, an Australian resident public company Because Opal satisfies the residency requirements in ITAA97 s 207-75, its assessable income includes both the $15,000 distribution (ITAA36 s 44(1)) and the franking credit on the distribution (ITAA97 s 20720(1)). The amount of the franking credit is $6,429 (ie $15,000 × 30 / 70). Opal will be taxed on its taxable income at its 30% company income tax rate (Income Tax Rates Act 1986 s 23). Opal is entitled to a tax offset for the $6,429 franking credit (s 207-20(2)). The general rule that taxpayers are entitled to a refund if their tax offsets for franked distributions exceed their tax liability (ITAA97 s 67-25) does not apply to corporate shareholders. Instead, excess franking tax offsets are converted to a deemed tax loss for the year (ITAA97 s 36-55). That would be the case for Opal if it has excess franking credits for 2019/20. The franking credit of $6,429 on the distribution gives rise to a $6,429 franking credit in Opal’s franking account for 2019/20 (ITAA97 s 205-15(1), item 3), and these franking credits may be passed on to Opal’s shareholders when it makes a franked distribution. $85,000 to the Aly Superannuation Fund, a complying superannuation fund A superannuation fund cannot be a complying superannuation fund unless it is a resident fund (Superannuation Industry (Supervision) Act 1993 s 42). The fact that the Aly Superannuation Fund is a complying superannuation fund shows that it satisfies the residency requirements in ITAA97 s 207-75, and its assessable income includes both the $85,000 distribution (ITAA36 s 44(1)) and the franking credit on the distribution (ITAA97 s 207-20(1)). The amount of the franking credit is $36,429 (ie $85,000 × 30 / 70). Being a complying superannuation fund, the Aly Superannuation Fund is taxed at 15% on its taxable income (from arm’s length sources). The fund is entitled to a tax offset for the $36,429 franking credit (s 207-20(2)) and to a refund of any excess franking tax offset (s 67-25). AMTG: ¶4-640, ¶4-800, ¶4-820, ¶4-840

¶10-120 Worked example: Distribution in a liquidation Issue Vanquish Pty Ltd is a resident private company that goes into liquidation in the 2019/20 income year. In the course of the winding up, the liquidator sells two assets held as long-term investments. Relevant details about those assets are: Asset

Acquired

1

1.11.84

2

1.11.2003

Cost base

Proceeds from sale

$

$ 60,000

65,000

115,000

133,000

Explain how the proceeds from the sale of the two assets will be taxed when they are distributed to the four shareholders of the company. Solution Amounts distributed to shareholders by a liquidator in the course of winding up a company are assessable as deemed dividends to the extent that they represent “income” in the hands of the company being liquidated (ITAA36 s 47(1)). The exception is income that has been properly applied to replace a

loss of paid-up share capital. The meaning of “income” for the purposes of s 47(1) is extended by s 47(1A) which provides that, as well as amounts of an income nature, income includes: • any amount that has been included in assessable income of the company, other than capital gains, and • any net capital gain that would arise under the CGT provisions if each capital gain were calculated without regard to indexation and if capital losses were ignored. For Asset 1, the distribution of the proceeds from the sale does not result in any amount being deemed a dividend because: • the proceeds from its sale would be a capital receipt (not income according to ordinary concepts) • it is a pre-CGT asset (having been acquired on 1 November 1984) and there are no CGT consequences from its sale, and • it would otherwise not be included in assessable income as statutory income. For Asset 2, the distribution of the $18,000 profit from the sale ($133,000 − $115,000) is deemed to be income derived by the company and is potentially a deemed dividend paid to the shareholders under s 47. The deemed dividends are assessable in the hands of the shareholders (ITAA36 s 44) as though they had been paid by the company out of profits while the company was still operating. The deemed dividend received by the shareholders is a frankable distribution (ITAA97 s 202-40) and should be franked consistently with the benchmark rule (ITAA97 s 203-5) to avoid any related penalty. AMTG: ¶4-300, ¶4-620, ¶4-660

¶10-140 Worked example: Application for permission to depart from benchmark rule Issue Flora Pty Ltd (Flora) is an Australian resident private company that carries on a florist business in the Sydney CBD. In July 2019, Flora paid dividends to its shareholders franked to 60% and this established its benchmark franking percentage as 60% for the 2019/20 franking period. Flora proposed to make another distribution in December 2019 franked to 60% (consistent with the benchmark rule). Flora declared a distribution of $400,000 in December 2019 from profits from the florist business. It expected to be able to attach 60% franking credits to the distribution from franking credits that would arise in its franking account from a PAYG instalment it would pay in February 2020. Unfortunately for Flora, business was not as profitable as expected and consequently the PAYG instalment was lower. This was because unanticipated construction works carried out by the state government blocked access to the shopfront and caused the business to be disrupted over some months. The lower PAYG instalment meant fewer franking credits in its franking account and it was unable to attach franking credits at the 60% benchmark percentage as required by ITAA97 s 203-15 (without its franking account going into deficit). Advise Flora on any action that can be taken to avoid a penalty if it departs from its benchmark percentage of 60%. Solution Under the benchmark rule, Flora must not make a frankable distribution with a franking percentage that differs from Flora’s benchmark percentage for the franking period (s 203-25). As set out in s 203-50, if a company underfranks a distribution, because the franking percentage for the distribution is lower than the company’s benchmark franking percentage for the franking period, a franking debit arises in the company’s franking account. The amount of the franking debit is calculated by the formula in s 203-50(2)(b).

The Commissioner could permit Flora to frank a distribution at a franking percentage that is lower than the benchmark franking percentage if the Commissioner considers there are “extraordinary circumstances” that justify the exercise of the Commissioner’s power (s 203-55(1), (2)). Before this can happen, Flora must apply in writing giving all information that supports its application. The Commissioner must then decide if there are extraordinary circumstances that justify making a determination, having regard to the matters set out in s 203-55(3). The Commissioner would need to consider: • Flora’s reasons for departing from the benchmark rule and the extent of the departure • if the circumstances that gave rise to Flora’s application are within its control and, if so, whether Flora had previously sought an exercise of the Commissioner’s powers • whether a shareholder of Flora would be disadvantaged from the departure, such as by receiving fewer franking credits • whether a shareholder of Flora would receive greater imputation benefits than another shareholder because one of them receives a distribution that is franked at a percentage that differs from the benchmark franking percentage, and • any other matters considered to be relevant. The circumstances that led to Flora’s departure from the benchmark rule are likely to be considered extraordinary. The lower profits, leading to a lower PAYG instalment and fewer franking credits in Flora’s franking account, were caused by the government’s actions. They were unanticipated by Flora and were outside its control. A determination by the Commissioner to permit a departure from the benchmark rule would deem a distribution that is franked in accordance with the determination to comply with the benchmark rule (s 20355(5)). It would not change Flora’s benchmark franking percentage for the franking period. Therefore, any further distribution that is not covered by the determination, but is made within the franking period, must be franked at the benchmark franking percentage. Change in the franking rate Care should be taken when establishing the benchmark franking percentage in an environment of decreasing corporate tax rates. This is because the level of franking credits that may be attached to a distribution is influenced by the paying company’s “corporate tax rate for imputation purposes” (as defined in ITAA97 s 995-1(1)) for the payment year (s 202-60, and related definitions). This may not always align with the company’s income tax rate for the payment year. If a company’s aggregated turnover for the previous year is less than the aggregated turnover threshold for the current year that the distribution is paid ($50m for 2019/20) and the company had Base Rate Entity passive income of no more than 80% of its assessable income in the previous year, then its corporate tax rate for imputation purposes is 27.5% for the payment year; if either criteria is not met, it is 30%. An exception applies for the first year a paying company exists when a 27.5% rate is also used for imputation purposes. A recipient company’s imputation tax rate does not affect the level of franking credits attached to distributions it receives. AMTG: ¶4-405, ¶4-640, ¶4-660

¶10-160 Worked example: Consequences of breaching benchmark rule Issue Muddy Waters Ltd (Muddy Waters) is an Australian resident private company, with a corporate tax rate for imputation purposes for the 2019/20 income year of 30%. It pays a dividend on 1 July 2019 that is franked to 60%. On 1 September 2019, the company pays a dividend of $10,000 that is franked to 40%. On 1 March 2020, the company pays a dividend of $30,000 franked to 70%. Explain the consequences for Muddy Waters Ltd from making these various distributions.

Solution Under the benchmark rule in ITAA97 s 203-5, a company must frank all frankable distributions within a particular franking period at the franking percentage set as the benchmark percentage for that period. The purpose of the rule is to ensure that one shareholder is not preferred over another when the company franks distributions (ITAA97 s 203-15). The benchmark rule does not apply to companies where the share ownership makes it difficult to stream benefits to one shareholder over another (eg a listed public company with a single class of membership interests at all times during the franking period) (ITAA97 s 203-20). The benchmark rule means that the franking percentage for the first distribution in a franking period must be continued throughout the period (ITAA97 s 203-30). The franking period for a private company is the 12 months of the income year (ITAA97 s 203-45). The franking percentage (ITAA97 s 203-35) for a frankable distribution is calculated as: Franking credit allocated to the distribution × 100  Maximum franking credit for the distribution  A company that breaches the benchmark rule by franking a distribution at a percentage that either exceeds or is less than the benchmark percentage is liable to a penalty based on the difference between the benchmark franking percentage and the actual franking percentage for the distribution (ITAA97 s 20350). This is known as its franking percentage differential. The Commissioner may permit a departure from the benchmark franking percentage in some circumstances (ITAA97 s 203-55(1)). The consequences for a company are as follows: (a) over-franking tax is payable if the franking percentage for a distribution exceeds the benchmark franking percentage, and (b) a franking debit arises in the company’s franking account if the franking percentage is less than the benchmark franking percentage. The amount of the over-franking tax or franking debit is calculated according to the formula in s 203-50(2) as follows: Amount of the frankable distribution

×

Franking percentage differential  Applicable gross-up rate 

The “applicable gross-up rate” is the distribution-paying company’s “corporate tax gross-up rate” for the income year the distribution is made. This expression is defined in ITAA97 s 995-1(1) as: (100% − Corporate tax rate for imputation purposes for the income year) Corporate tax rate for imputation purposes for the income year For the 2018/19 and later income years the corporate tax rate for imputation purposes, of an entity for an income year, is the entity’s corporate tax rate for the income year, worked out on the assumption that the entity’s aggregated turnover, base rate entity passive income and assessable income for the income year is equal to its aggregated turnover, base rate entity passive income and assessable income for the previous income year (ITAA97 s 995-1). The corporate tax rate for the 2018/19 to 2019/20 income years is 27.5% for a company that is a base rate entity and 30% for all other companies (ITAA97 s 995-1). An exception applies for the first year a paying company exists when a 27.5% rate is also used for imputation purposes. A recipient company’s imputation tax rate does not affect the level of franking credits attached to distributions it receives. This means that the “applicable gross-up rate” of Muddy Waters for the 2019/20 year is (70%/30%) because its corporate tax rate for imputation purposes is 30%. When Muddy Waters paid the dividend on 1 July 2019 that is franked to 60%, the benchmark percentage for the company’s 12-month franking period became 60%. The consequences for Muddy Waters when the two other distributions are made during the franking

period are as follows: (a) The $10,000 dividend paid on 1 September 2019 and franked to 40% results in a franking debit in the company’s franking account. The amount of the debit is: $857 [$10,000 × (20%/(70%/30%)] (b) The $30,000 dividend paid on 1 March 2020 and franked to 70% results in liability to over-franking tax calculated as: $1,286 [($30,000 × (10%/(70%/30%)] AMTG: ¶4-640, ¶4-660, ¶4-665, ¶4-670

¶10-180 Worked example: Dividend imputation and effect on shareholders Issue During the 2019/20 income year, Punin Pty Ltd (Punin), a resident Australian private company, pays an $11,200 distribution, with $4,800 franking credits attached, to each of its three shareholders. The shareholders are: • Benin Pty Ltd (Benin PL), a resident private company that receives no other income for the 2019/20 income year. Benin PL’s company income tax rate is 27.5% for the 2019/20 year • Benin Super, a self-managed superannuation fund that is a complying superannuation fund with other assessable income of $110,000 for the 2019/20 income year, and • PB Securities Pty Ltd (PBS), a non-resident company that has derived investment income in Hong Kong but has no other Australian-sourced income. Punin has a corporate tax rate for imputation purposes of 30% for the 2019/20 income year. Explain to the three shareholders the tax treatment of receiving these distributions for the 2019/20 income year. Solution The tax treatment for Benin PL, Benin Super and PBS receiving these amounts for the 2019/20 income year is as follows. Benin PL, a resident private company $ Franked distribution (ITAA36 s 44(1))

11,200

Franking credit (ITAA97 s 207-20(1))

4,800

Assessable income Less: allowable deductions TAXABLE INCOME Tax on taxable income: $16,000 @ 27.5%

16,000   0 16,000 4,400

Less: franking tax offset (s 207-20(2))

(4,800)

NET TAX PAYABLE

  0

The $4,800 tax offset for the franked distribution received by Benin PL exceeds the company’s $4,400 tax liability. The general rule that taxpayers are entitled to a refund if their tax offsets for franked distributions exceed their tax liability (ITAA97 s 67-25) does not apply to corporate shareholders. Instead, excess franking offsets are converted to a deemed tax loss for the year (ITAA97 s 36-55).

The $400 excess franking credits are converted to a deemed tax loss for Benin PL, using the calculation mechanism in ITAA97 s 36-55(2). Benin Super, a complying superannuation fund $ Franked distribution (ITAA36 s 44(1))

11,200

Franking credit (ITAA97 s 207-20(1))

4,800

Other income

110,000

Assessable income

126,000

Less: allowable deductions TAXABLE INCOME

0 126,000

Tax on taxable income: $126,000 @ 15% (the complying superannuation fund rate)

18,900

Less: franking tax offset (s 207-20(2))

(4,800)

NET TAX PAYABLE

14,100

PBS, a non-resident company Being a foreign resident, PBS has no tax liability in Australia for its foreign-source income (ITAA97 s 65(3)). Because the $11,200 distribution is fully franked, there is no withholding tax payable by Punin Pty Ltd when it makes the distribution to PBS (ITAA36 s 128B(3)(ga)). If the distribution had not been fully franked, withholding tax would have been payable to the extent that it was unfranked (ITAA36 s 128B(1)). Not only is the distribution not subject to withholding tax, it is also excluded from PBS’s assessable income (ITAA36 s 128D). AMTG: ¶4-640, ¶4-800, ¶4-820, ¶4-840

¶10-200 Worked example: Dividend access shares Issue Hilltop Pty Ltd (Hilltop) has two classes of issued shares: “A” and “B” class. The “A” class shares are held by both Robert Harrison and David Billson directly and also indirectly on behalf of their respective superannuation funds. The “B” class shares are held directly and indirectly through superannuation funds and family trusts as follows: “B” class shares Robert Harrison 100,000 David Billson

100,000

Greta Jones

5,000

There is greater than 40% control (direct and indirect) of Hilltop by David Billson and Robert Harrison. In the 2019/20 income year, dividends were paid to “B” class shareholders at $1 per share. Hilltop has accumulated profits that can be distributed as fully franked dividends. Hilltop wishes to issue redeemable preference shares (RPSs) at a discounted $1 issue price to the Harrison and Billson superannuation funds, and then pay a dividend to the RPS shareholders. 1. What are the tax implications for the superannuation fund in relation to receiving dividends from the

RPSs? 2. Are there any CGT consequences for the shareholders of Hilltop from the issuing of the RPSs? 3. Are there any tax avoidance implications arising from issuing RPSs in Hilltop? Solution The issuing of an RPS that can take advantage of frankable distributions is considered a dividend access share (DAS) (Taxpayer Alert TA 2012/4). A typical DAS arrangement exists where a private company that is “pregnant” with profits issues a new class of shares for nominal consideration. These new shares are offered to existing ordinary shareholders and their associates such as superannuation funds. The shares usually carry no voting rights, but the possibility to receive a dividend at the discretion of the voting shareholders. Any dividends that may flow to the DAS shareholders could result in less tax liability compared with dividends paid to the original shareholders. There are a number of specific tax issues that raise concerns in relation to a DAS. (1) Non-arm’s length income of superannuation funds In relation to superannuation funds, most assessable income is taxed at the concessional rate of 15%. However, for income where dealings are not at arm’s length, the income is assessed at the top marginal rate. A common source of non-arm’s length income derived by a superannuation fund is dividends received from private companies, unless the amount could be consistent with an arm’s length dealing. As both individuals are directors of Hilltop and they and/or their associates are beneficiaries of their respective superannuation funds, then the closely held nature of these entities would determine that any dividends received from Hilltop to either superannuation funds would not be considered arm’s length income. (2) Value shifting Broadly a value shift can occur where something is done which results in the value of one asset increasing and the value of another asset decreasing in a company that is controlled (greater than 40%) by a shareholder and their associates (ITAA97 Div 725). By proposing to issue RPSs at a discount, the market value of the existing A and B class shares decreases, and conversely the market value of the new RPSs issued increases. This may trigger a capital gain for the existing A and B class shareholders if the total market value of the decrease in the value of the A and B class shares is at least $150,000. A possible counter position would be that the mere issue of the DAS does not cause a shift in the market value away from the existing shares, as there are no substantive rights associated with the new RPS issue, and accordingly, the RPS issue price at nominal value would be equivalent to the market value. However, the ATO in Taxation Determination TD 2014/1 considers that the DAS should be valued on the basis of prospective entitlement to the dividends and accordingly some market value adjustment between the existing and new shares will arise. (3) Anti-avoidance The issue by Hilltop of an RPS at a $1 issue price and a payment of a dividend thereon is subject to the anti-avoidance provisions in ITAA36 Pt IVA. The ATO has stated in TA 2012/4 and TD 2014/1 that a DAS could be considered a scheme to gain a tax benefit and accordingly, be subject to the general tax anti-avoidance provisions. A tax benefit in the case of a DAS would include an amount not included in assessable income or the use of franking credits to reduce the amount of tax payable. Part IVA applies if the scheme of the DAS was entered into for the sole or dominant purpose of gaining a tax benefit. Generally, Pt IVA will not apply if it can be successfully argued that the sole or dominant

purpose was for commercial, economic or business reasons and supported by documentary evidence. In this case, a tax benefit would arise from distributing fully franked dividends (with attached franking credits) to superannuation funds if the amounts were nominally taxed at 15%. The fully franked dividend has been previously taxed at 30% in the hands of Hilltop, and the remaining franking credits can reduce tax payable from other assessable income in the superannuation fund. The benefits of the RPSs could also be neutralised if there is a “dividend stripping scheme” to which ITAA36 s 177E applies or a “franking credit scheme” under ITAA36 s 177EA. If either of these antiavoidance provisions apply, the recipient of the dividend cannot gross-up its assessable income to include the relevant franking credit, and any tax offset to which it would otherwise have been entitled as a result of the distribution is denied (ITAA97 s 207-145). Dividend stripping may arise where a company has undistributed profits and the predominant purpose of the arrangement is to avoid additional tax on the distribution of dividends (s 177E). In this situation, where new RPSs are issued at a discount, a dividend stripping arrangement arises whereby the economic benefit of the company’s accumulated profits is transferred from the A and B class shareholders to the RPS shareholders. The RPS shareholders, being the superannuation funds, could be argued to be concessionally taxed compared with the original shareholders, and accordingly the dividend stripping provisions are likely to be triggered. Part IVA can also be attracted where a scheme involving a disposition of shares is entered into with a purpose of enabling the taxpayer to obtain a franking credit benefit (s 177EA). The ATO has warned that s 177EA may apply to a scheme in which a private company with accumulated profits channels franked dividends to a self-managed superannuation fund (Taxpayer Alert TA 2015/1). AMTG: ¶12-810, ¶13-170, ¶30-120, ¶30-130, ¶30-180, ¶30-190, ¶30-195

¶10-220 Worked example: Division 7A; deemed dividends; distributable surplus Issue ABC Pty Ltd (ABC) is wholly owned in equal proportions by Bill and Jill Smith. On 1 January 2020, ABC loaned $100,000 to Jill to assist her with the purchase of an investment property. The only documentation evidencing the loan was a director’s minute and the relevant entry in the company’s books of account. At 30 June 2020 ABC’s balance sheet was: $ Issued capital

10,000

Accumulated profits

20,000 30,000

Represented by: $ Bank account

10,000

Land and building at cost*

190,000

Loan to Jill

100,000 300,000

Less loans and creditors

270,000 30,000

*Market value $240,000 The loan to Jill of $100,000 remains outstanding at 30 June 2021.

Advise Bill and Jill Smith on the tax consequences of the loan to Jill. Solution ITAA36 Div 7A is a specific anti-avoidance measure designed to prevent private companies from making tax-free distributions of profits to shareholders or to their associates in the form of payments, loans or debts that are forgiven. If Div 7A applies, amounts paid, lent or forgiven after 3 December 1997 by a private company to a shareholder or their associates are treated as dividends, unless they come within specified exclusions. Will the loan result in a deemed dividend? ITAA36 s 109D provides that loans by a private company to a shareholder or an associate of a shareholder will result in a deemed dividend unless: • the loan is repaid before the company’s “lodgment day” (s 109D(6)), or • the loan is the subject of a written agreement which complies with the requirements of s 109N by the lodgment day. At 30 June 2021 the loan remains unpaid and no loan agreement has been executed, therefore a deemed dividend will arise. When will a dividend be deemed to be paid? Section 109D(1) provides that where a private company makes a loan to a shareholder, the company will be taken to pay a dividend at the end of the year of income in which the loan is made. Therefore, Jill would be deemed to receive a dividend on 30 June 2020. What is the amount of the deemed dividend? The deemed dividend cannot exceed the “distributable surplus” of ABC at the end of the year of income (ITAA36 s 109Y). The distributable surplus of the company at 30 June 2020 would be $70,000, calculated as follows: $ Net assets

80,000*

Less paid up share capital

10,000

Distributable surplus

70,000

*Note: Assets must be reflected at market value and therefore the net assets are: $ Per accounting records

30,000

Add increase land and buildings to market value

50,000

Net asset value

80,000

While the loan to Jill was $100,000, the deemed dividend is limited to the amount of the distributable surplus, that is $70,000. The remaining $30,000 is non assessable income as it is like a return of shareholder funds. AMTG: ¶4-200, ¶4-210, ¶4-230, ¶4-249

¶10-240 Worked example: Division 7A; benefits for directors and shareholders Issue PrivateCo Pty Ltd (PrivateCo) is a private company for income tax purposes. On 31 January 2020, in the 2019/20 tax year, PrivateCo paid $5,000 to a travel agent for an overseas holiday for Simon Weston and

his family. At the same time, it also made an interest-free, at-call loan of $20,000 to Angelina Greenwald. Simon and Angelina are directors and shareholders of PrivateCo. What are the tax consequences of these transactions for Simon and Angelina? Solution The first question to determine is the capacity in which the payment made to Simon was made. Where a shareholder or an associate of a shareholder in a private company is also an employee of that same company, the FBT provisions, instead of ITAA36 Div 7A, may apply to the payments and other benefits received by the shareholder or associate. Payments to directors are subject to PAYG withholding (TAA s 12-40) and therefore directors are treated as employees for the purposes of FBT (FBTAA s 136(1) and 137). A payment will not be treated as a dividend under Div 7A where it is made by a private company to a shareholder or an associate of a shareholder, if the payment is made to the individual in their capacity as an employee or an associate of an employee (s 109ZB(3)). However, this does not apply to loans as Div 7A takes precedence (s 109ZB(1)). Division 7A Assuming that the payment was made to Simon in his capacity as a shareholder (and not in his capacity as an employee), then Div 7A will apply. Under Div 7A, where a private company makes a payment to, lends money to or forgives the debts of shareholders or their associates, it may result in the payment, loan, etc, being treated as an assessable dividend in the hands of the recipient, unless a specific exclusion applies. In most cases, the deemed dividends are unfrankable. The payment made to the travel agent on Simon’s behalf is taken to be a payment to him and it will be deemed to be an assessable dividend in his hands at the end of the 2019/20 tax year (s 109C). PrivateCo and Simon could avoid this outcome if, before the date on which PrivateCo must lodge its 2019/20 tax return, they treat the payment as a loan to Simon (s 109C(3A)) and either he repays it before that date or they take steps to put the loan on a commercial basis, with a written loan agreement and an appropriate term and interest rate (s 109N). The interest-free, at-call loan of $20,000 to Angelina will be a deemed Div 7A dividend at the end of the 2019/20 tax year (s 109D). This is regardless of the capacity in which Angelina received the loan (s 109ZB(1)). The amount of the deemed dividend is the amount of the loan that has not been repaid before PrivateCo’s lodgment date for its 2019/20 tax return. PrivateCo and Angelina could avoid that outcome if Angelina repaid the loan in full before PrivateCo’s 2019/20 tax return lodgment date. They would also avoid Div 7A if, before that lodgment date, the loan is put on a commercial basis in accordance with s 109N (see above). If the loans are put onto a commercial basis in accordance with s 109N then, in each tax year after 2019/20 (starting with 2020/21), Simon and Angelina must make a minimum repayment of their loan to avoid the further application of Div 7A (s 109E). If either do not make a payment, or the payment is less than the minimum required, the shortfall is a deemed dividend in that particular year. The amount that is deemed to be a dividend under Div 7A is limited by the total amount that the company is able to distribute in the income year, called the “distributable surplus” (s 109Y). If the deemed Div 7A dividend (or dividends) in a year is more than the distributable surplus, the amount of the deemed dividend is limited to the distributable surplus. The Commissioner has an overriding power to negate the effects of Div 7A in some cases of hardship (s 109Q) or if the taxpayer can prove that Div 7A applied as a result of an honest mistake or inadvertent error or omission (s 109RB). Fringe benefits tax If the payment was made to Simon in his capacity as a director, then the FBT provisions will apply (ie FBT takes precedence in this situation: s 109ZB(3)). Under the FBT provisions, employers are liable to pay tax on the taxable value of certain benefits that have been provided to their employees, or to associates of those employees, in respect of their employment.

The payment to the travel agent on behalf of Simon will constitute a fringe benefit. This could be a residual fringe benefit (FBTAA s 45), a property fringe benefit (FBTAA s 40), an expense fringe payment (FBTAA s 20), or depending on the income tax status of PrivateCo, a tax-exempt body entertainment fringe benefit (FBTAA s 38). The classification of the benefit depends on what was actually provided. In most cases, the taxable value will be the value of the benefit provided, that is, $5,000. This will be reduced if Simon makes an employee contribution to PrivateCo. The taxable value of the benefit will be reduced by the amount of the contribution. Tax is then payable on the net taxable value by grossing up the value by the gross factor applying to non-GST creditable benefits (that is, 1.8868 for the FBT year ended 31 March 2020) and then applying the applicable FBT rate (47% for the FBT year ended 31 March 2020). The interest free loan to Angelina cannot give rise to a fringe benefit as she is a shareholder in a private company and Div 7A takes precedence for loans (s 109ZB(1) and (paragraph (r) of the definition of “fringe benefit” in FBTAA s 136(1)). Any FBT paid by PrivateCo is tax deductible. AMTG: ¶4-200, ¶4-205, ¶4-620, ¶35-270, ¶35-330, ¶35-490, ¶35-570, ¶35-617

¶10-260 Worked example: Shares; debt equity Issue The share capital of Acme Pty Ltd (Acme) comprises two classes of instruments: • 100,000 ordinary shares ($100,000), and • 100,000 redeemable preference shares (RPSs) ($100,000). The RPSs have the following terms: • a fixed redemption date of five years from issue date • a right to a cumulative dividend of 6% per annum (ie if a dividend is not paid in respect of one year, the amount accrues and carries over to the following year) • no voting rights, and • the amount payable on redemption is $100,000 plus any unpaid annual dividend entitlement. How should the ordinary shares and the RPSs be treated for tax purposes by Acme under the debt equity provisions? Solution The debt and equity rules (ITAA97 Div 974) classify certain financing arrangements as debt or equity for tax purposes and for determining whether a return paid by a company on a financing interest that it has issued is frankable. The debt and equity rules are intended to operate on the basis of the economic substance of the arrangement rather than merely its legal form. To classify whether an arrangement is equity, debt or neither, the rules are systematically applied. The provisions state to first determine whether the arrangement is equity, and regardless of the result, then apply the methodology for a debt. If the arrangement satisfies both, then a tie breaker rule is applied to treat the arrangement as debt (s 974-70(1)(b)). If the arrangement satisfies neither, then any amount for which a tax deduction is claimed must satisfy ITAA97 s 8-1. Equity test A scheme giving rise to an equity interest satisfies the equity test (s 974-75(1)) if: (1) it gives rise to an interest in the company as a member or shareholder of the company

(2) it is a financing arrangement that gives rise to an interest carrying a right to a return from the company, and the right or return is contingent on the economic performance of the company, a connected entity or part of their activities (3) it is a financing arrangement that gives rise to an interest carrying a right to a return from the company and the right or return is at the discretion of the company or a connected entity (eg Interpretative Decision ATO ID 2003/752), or (4) it is a financing arrangement that gives rise to an interest issued by the company that either: (a) gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or a connected entity of the company; or (b) is or may be convertible into such an interest. A company cannot claim a tax deduction for a dividend paid on an equity interest, and cannot deduct a non-share distribution or a return that has accrued on a non-share equity interest (ITAA97 s 26-26). The dividend franking provisions apply generally to a non-share equity interest and an equity holder in the same way that they apply to a share and a shareholder. The holder of an equity interest in a company is known as an “equity holder”. Debt test A scheme giving rise to a debt interest in an entity satisfies the “debt test” in relation to the entity (s 97415) if: (1) it is a financing arrangement for the entity, or the entity is a company and the scheme gives rise to an interest as a member or shareholder of the company, and (2) the entity or a connected entity receives or will receive some financial benefit under the scheme, and (3) the entity has, or both the entity and a connected entity have, an effectively non-contingent obligation (ENCO) under the scheme to provide financial benefit(s) to one or more entities after the time when the first of the financial benefits in (2) above is received, and (4) it is substantially more likely than not that the value provided under (3) above will be at least equal to the value received under (2) above. A share that is not an equity interest (eg is or is part of a debt interest) is a “non-equity share” and a distribution relating to such a share is unfrankable. A return paid on a debt interest will be deductible where it meets the general deduction criteria of ITAA97 s 8-1. Acme’s ordinary shares Given that, in applying the equity or debt tests, debt overrides equity where the arrangement complies with both criteria, it is practical to consider the debt test first, because if the arrangement is debt, it cannot be equity. Applying the debt test to Acme’s ordinary shares reveals that these shares are not a debt interest. Although there is a scheme that is a financing arrangement, under which Acme will receive a financial benefit ($100,000 subscription funds), Acme does not have an ENCO to provide a financial benefit as dividends will be paid at their discretion and there is no redemption date of the shares. Also, it is not substantially more likely that the financial benefit to be provided will be at least equal to the benefit received, or to be received. The shares are however an equity interest as there is an interest in the company as a member or shareholder of the company. As an equity interest, dividends paid on the ordinary shares are frankable and not deductible to Acme. Acme’s RPSs The RPSs are a debt interest because they satisfy the debt test. A scheme exists which is a financing

arrangement under which Acme receives a financial benefit ($100,000 subscription funds). Acme has an ENCO to provide a financial benefit, because the 6% per annum cumulative dividend and the $100,000 payable upon redemption are both obligatory and non-contingent upon the happening of any event. It is also substantially more likely than not that the financial benefit to be provided will be at least equal to the benefit received or to be received — the financial benefit received is $100,000 and the financial benefit to be provided is at least $100,000 (being the nominal value of the shares). Since the RPSs satisfy the debt test, the equity test does not require consideration. This is because under the tie breaker rule, an instrument that passes both the debt and the equity tests is deemed to be debt (s 974-70(1)(b)). As a debt interest, dividends paid on the RPSs are not frankable and any distributions are deductible to Acme. AMTG: ¶16-740, ¶23-100, ¶23-105, ¶23-115

¶10-280 Worked example: Carry-forward losses: continuity of ownership and business continuity test Issue From the time it was incorporated in 2003, Byclo Pty Ltd ran a business of assembling, repairing and selling bicycles that were manufactured in Australia. Byclo had four equal shareholders who each held 100 of the 400 issued shares in the company. The business was successful until 2018/19 when there was a downturn in sales and the shareholders started to squabble about the direction of the company. As a result there was a tax loss of $55,000 for 2018/19. On 1 July 2019, three of the shareholders (A, B and C) sold their shares to the fourth shareholder (D) who had insisted that the company should be run according to his plans. Once D had control of the company, he and his staff continued to assemble, repair and sell bicycles but a more significant portion of its bicycles were imported fully assembled, resulting in Byclo changing its location as it no longer required as large a factory space. The company’s business also expanded into the sale of fully assembled scooters. Byclo Pty Ltd derived a profit in the 2019/20 income year and wants to carry forward the tax loss from 2018/19 as a deduction against its 2019/20 assessable income. Advise Byclo. Solution For a company to carry losses forward from a previous year and to deduct them against income of the current year, the company must satisfy either: (i) the continuity of ownership test in ITAA97 s 165-12, or (ii) the business continuity test in ITAA97 s 165-13 (ITAA97 s 165-210). The continuity of ownership test requires that shares carrying more than 50% of all voting, dividend and capital rights are beneficially owned by the same persons at all times during the ownership test period. The ownership test period is the period from the start of the loss year to the end of the income year in which the tax loss is to be deducted (ITAA97 s 165-12(1)). For Byclo to satisfy the continuity of ownership test and to be able to carry the $55,000 tax loss incurred in 2018/19 forward to 2019/20, it would have to be shown that there is a person (or group of persons) who beneficially owned shares carrying more than 50% of the relevant rights at all times throughout the period from 1 July 2018 to 30 June 2020. The ownership of the shares was as follows: Shareholder

Shares held in 2018/19 Shares held in 2019/20

A

100

0

B

100

0

C

100

0

D

100

400

The continuity of ownership test is not satisfied because the same owners do not have over 50% (ie over 200) of the same shares from the beginning of the loss year (2018/19) to the end of the income year (2019/20). There are two legs to the business continuity test (BCT). The test is satisfied if a company carries on either the “same business” or a “similar business” in the income year as it carried on immediately before the “test time” which, for Byclo, would be the start of the loss year. The similar business test is applicable only for losses that arose, or a debt that was incurred, in income years on or after 1 July 2015. The test is, in general terms, more flexible than the same business test, which has existed for many years, but does not replace it. Accordingly, both tests need to be considered when determining if the BCT is passed. The Commissioner’s views on the meaning of “same” in the same business test are set out in Taxation Ruling TR 1999/9. According to the ruling, “same” means more than similar but does not necessarily mean identical. A company may be able to expand or contract its activities without ceasing to carry on the same business. But a company may fail the test if it changes its essential character or if there is a sudden or dramatic change in the business because of a significant acquisition or loss of activities. A company does not satisfy the same business test if it derives assessable income during the income year from: (i) a new business, that is a business of a kind that it did not carry on before the test time, or (ii) a new transaction, that is a transaction of a kind that it had not entered into in the course of its business operations before the test time (s 165-210(2)). Various factors are relevant to determine whether the same business test is satisfied. A single important factor can be determinative but a combination of factors, weighted appropriately can determine whether the test is satisfied. Relevant factors to Byclo include a change in the product the business sells and changes in its processes, such as ceasing certain aspects of its previous activities, and a change in location to cater for its different requirements. The business in 2018/19 was to assemble, repair and sell bicycles that were manufactured in Australia. For 2019/20, the business expanded significantly to include the sale of fully assembled imported bicycles. Also of significance, the business in 2019/20 included the sale of scooters. Byclo may be able to satisfy the test by showing it has simply expanded its activities. On the other hand, it has derived assessable income in 2019/20f from a transaction of a kind that it did not previously enter into. Based on the factors above, Byclo may be at risk of failing the same business test. Having considered the same business test, consideration also needs to be given to the similar business test, which is the recently introduced second-leg of the BCT. The test requires that throughout the relevant test period, a company carry on a business that is similar to the business it carried on before the relevant test time. Unlike the same business test, the similar business test is generally not failed simply by the company engaging in new business activities or transactions. In working out whether the current business is similar to the former business, regard must be had to the following four factors, which are not exhaustive: • the extent to which the assets (including goodwill) used in the current business to generate assessable income were also used in the company’s former business to generate assessable income • the extent to which the activities and operations from which the current business generates assessable income were also the activities and operations from which the former business generated assessable income • the identity of the current business and the identity of the former business, and • the extent to which any changes to the former business resulted from the development or commercialisation of assets, products, processes, services, or marketing or organisational methods,

of the former business. Per LCR 2019/1, it will be more difficult to satisfy the similar business test if substantial new business activities and transactions do not evolve from, and complement, the business carried on before the test time. In contrast, where a company develops a new product or function from the business activities already carried on, and this development opens up a new business opportunity or allows the company to fill an existing gap in the market, the business as a whole is likely to satisfy the similar business test. In the case of Byclo, the existing business of assembling, repairing and selling bicycles continued. The diversification into selling fully assembled imported bicycles and scooters is an evolution of the business already carried on that opened up new business opportunities in the bicycle market. Accordingly, the similar business test is likely to be passed and the overall BCT is therefore also likely to be passed. As Byclo passes the BCT, the tax loss from 2018/19 can be carried forward to 2019/20. AMTG: ¶3-105, ¶3-120, ¶3-125

¶10-300 Worked example: Calculation of tax liability of resident private company Issue Serendipity Pty Ltd (Serendipity) is an Australian resident, private company, with an income tax rate of 27.5% for the 2019/20 income year. Its income and expenses for that year were: Income:

$

Operating revenue

$

3,600,000

Distribution franked to 60% from a resident public company with a 2019/20 corporate tax rate for imputation purposes of 30%

270,000

Unfranked distribution from resident public company

90,000 3,960,000

Less expenses: Operating expenses

(750,000)

Fines paid for environmental breaches

35,000

Interest paid on loan for purchasing equipment

 65,000

NET INCOME

  850,000 3,110,000

Calculate Serendipity’s taxable income and income tax payable for the 2019/20 income year. Explain assumptions and give brief explanations as appropriate. Solution Serendipity’s taxable income and income tax payable for the 2019/20 income year is calculated as follows. Serendipity Pty Ltd Statement of taxable income for the tax year ended 30 June 2020 $ Operating revenue Distribution from resident public company Franking credit on distribution franked to 60%1 2 Unfranked distribution from resident public company1 Less: Allowable deductions

$

3,600,000 270,000 69,429  90,000 4,029,429

Operating expenses

750,000

Interest paid on loan for purchasing equipment TAXABLE INCOME Gross tax payable: $3,214,429 @ 27.5% Less: franking tax offset (ITAA97 s 207-20(2))4 NET TAX PAYABLE

65,000

(815,000) 3,214,429

883,968 (rounded)   (69,429)  814,539

Assumptions and explanations 1. Both the franked and unfranked distribution are included in Serendipity’s assessable income (ITAA36 s 44). 2. The franked distribution is grossed up for the franking credit ($270,000 × 30 / 70 × 60% = $69,429) and the franking credit is included in assessable income (ITAA97 s 207-20(1)). 3. The $35,000 fines paid for environmental breaches are not deductible (ITAA97 s 26-5). 4. Serendipity is entitled to a franking tax offset for the franking credit on the distribution (ITAA97 s 20720(2)). AMTG: ¶3-055, ¶4-100, ¶4-640, ¶4-800

¶10-320 Worked example: Tax losses and excess franking offsets Issue Q Co is an investment, manufacturing and trading company that has operated for the past 50 years. The company’s philosophy is to “follow the profits” and its business decisions are based on the likelihood of generating profit, no matter the specifics of the industry. The company has an annual aggregated turnover in excess of $50m. In the 2018/19 income year Q Co incurred tax losses of $280,000 (revenue). In the 2019/20 income year, the company’s taxable income was $350,000 (gross tax payable of $105,000). In preparing Q Co’s 2019/20 income tax return, the company’s accountant is seeking to deduct the $280,000 of carry forward losses against all of the taxable income. In the 2019/20 income year, Q Co also received franked dividends with $135,000 franking credits attached. The share capital of Q Co comprised 100 ordinary shares on issue. Each share carried equal rights to vote, dividends and capital distributions. The shareholdings as at 30 June 2019 were: • Abby — 40 shares • Bill — 30 shares • Carly — 15 shares • The Domino Family Trust — 15 shares. The Domino Family Trust made a family trust election in the 2004/5 income year. On 14 November 2019, Abby sold 25 shares to Carly. On 9 February 2020, Abby sold her remaining 15 shares and Carly sold all of her 40 shares to the Domino Family Trust. On 5 May 2020, Bill sold 20 shares to Eric. There were no more shareholding changes to 30 June 2020.

Advise Q Co as to whether tax losses incurred in the 2018/19 income year can be carried forward and offset against the taxable income from the 2019/20 income year. If the losses cannot be carried forward, and assuming Q Co could apply $105,000 of the franking credits to reduce its income tax payable to nil, how would the remaining $30,000 of franking offsets be treated? Solution For companies, tax losses and capital losses incurred in earlier income years, and yet to be deducted against taxable income, are subject to tests that must be satisfied in order to deduct the losses (or other tax attributes). These tests apply to ensure losses are only deductible in the hands of either: • the same owners who incurred the losses (continuity of ownership (COT) test), or • failing that, by a company carrying on a similar, or the same, business as that which originally incurred the losses (business continuity test (BCT)) broadly, at the time the ownership of the loss making company changed. Date of COT breach Based on the shareholder transactions undertaken throughout the 2019/20 income year, the COT was first breached on 9 February 2020. The sale of shares from Abby to Carly on 14 November 2019 did not cause a COT breach because the same persons collectively held more than 50% of the rights to vote, dividends and capital distributions both before and after the sale (ITAA97 s 165-12). The sale of the shares on 9 February 2020 resulted in Bill maintaining a 30% shareholding, however, the Domino Family Trust increased its shareholding to 70%. Before this date, Bill and the trust did not collectively hold more than 50% of the rights to vote, dividends and capital distributions. Therefore, the COT was breached on 9 February 2020. The trustee of the trust is deemed to be a beneficial owner of the shares to which it has legal title because the trust has made a family trust election and is thereby a family trust (ITAA97 s 165-207). BCT and test time For the tax losses to be utilised, the BCT must be satisfied. Q Co’s business during the 2019/20 income year is to be compared to its business immediately before the relevant “test time”. The test time in this case is 9 February 2020, that is the date of the COT breach (ITAA97 s 165-13(2)). The business continuity test has two elements; the test may be satisfied by a company either: • carrying on the same business in circumstances that would satisfy the same business test that has applied for many years, or • carrying on a similar business to that formerly carried on in circumstances that would satisfy the new similar business test that applies in relation to a tax loss, taxable income or a net capital loss for an income year starting on or after 1 July 2015. The three tests comprising the same business test are: 1. The same business test — the company must carry on the same business that it carried on immediately before the SBT test time 2. The new business test — the company must not derive assessable income from carrying on a business of a kind that it did not carry on before the SBT test time, and 3. The new transaction test — the company must not derive assessable income, in the course of its business operations, from a transaction of a kind that it had not entered into before the SBT test time. The three tests are not alternative tests. They must all be passed in order for the same business test to be satisfied (ITAA97 s 165-210(1), (2) and (3)).

To satisfy the similar business test, a company must throughout the relevant continuity test period carry on a business that is “similar to” the business carried on immediately before the relevant test time (s 165211 ITAA97). The legislation provides for four matters that must be taken into account (along with any other considerations that are relevant in the particular situation) in ascertaining whether a company’s current business is similar to its former business. In broad terms, these four matters are: • the extent to which the same assets are used to generate income • the extent to which assessable income is generated from the same activities and operations • the identity of the current business and the identity of the former business, and • the extent to which changes to the former business result from development or commercialisation of assets, products, etc (s 165-211(2) ITAA97). To work out if Q Co passes the BCT, it is necessary to analyse its activities before and after the test time — 9 February 2020. Q Co is involved in diverse activities and its business philosophy is to “follow the profits”, no matter the specifics of the industry. If that means, for example, that Q Co stopped carrying on a business after the test time, or after the test time it started a new business of a kind it did not carry on before the test time or it derived income from a kind of transaction that it had not entered into in the course of its business operations before the test time, it may fail the same business test. It may however satisfy the similar business test, based on an analysis of all of the commercial operations and activities of the former business compared with all commercial operations and activities of the current business. If both tests are failed, the carried forward tax losses would not be available for use in the 2019/20 income years or beyond. If the same business test was failed but the similar business test was passed, the carried-forward tax losses would be available for use in the 2019/20 income year or beyond. Excess franking offsets Companies are not entitled to a refund of excess franking offsets (ITAA97 s 67-25). Instead, the excess franking offsets are converted into an equivalent amount of tax loss available to be carried forward (ITAA97 Subdiv 36-C). The tax loss is calculated by dividing the excess franking offset by the corporate tax rate (30%): Tax loss: $30,000 / 0.30 = $100,000. AMTG: ¶3-075, ¶3-105, ¶3-120, ¶3-125, ¶4-405, ¶16-895

¶10-340 Worked example: COVID-19 stimulus; cash flow boost and JobKeeper Issue Icarus Retail Pty Ltd operates four fashion outlets across Brisbane and South East Queensland. At 1 March 2020, the company employed 20 staff across its four outlets and head office in Brisbane. Twelve of those staff were full time, four were part-time, two had been employed on a casual basis since December 2019 and a further two were employed on a casual basis in December 2018 and had worked regular shifts in stores ever since. Of the part-time staff, two are holders of working holiday (417) visas and are residents of the United Kingdom. None of the staff were also employed elsewhere. As a result of COVID-19 and the associated restrictions placed on the community by federal and state governments, Icarus has been badly impacted. Company turnover for the April to June 2020 quarter is forecast (in April 2020) to be $2m. Company turnover for the same period in 2019 was also $2m but at that point the company owned just two stores. The other two stores were purchased from a competitor on 17 July 2019. Company turnover in the July 2019 to September 2019 quarter was $3m and in the October 2019 to December 2019 quarter was $4m. In April 2020, the Managing Director of Icarus, Sarah Sutton, requests your advice on whether the company will be eligible for the cash flow boost and JobKeeper support measures, recently announced by the government. In addition to general guidance on eligibility, Sarah wishes for advice on the following:

• The company wishes to stand down 14 of its staff, including all temporary and casual staff. It does not wish to pay JobKeeper to the stood down staff. Is this possible? • What are the company’s super guarantee obligations in relation to JobKeeper payments? • Currently, only two of the company’s 20 staff earn more than $1,500 per fortnight. Does the company need to make the full JobKeeper payment to staff currently earning less than $1,500 per fortnight? During the March 2020 quarter, the company withheld $30,500 in PAYG withholding in relation to staff wages. It is not clear at the time that Sarah seeks advice what amount of PAYG withholding will be accounted for in the June 2020 quarter. The company is up to date with all its tax return and BAS lodgment obligations, with the 2018/19 income tax return lodged on 31 January 2020. In July 2020, Sarah requests your further advice on the impact of the recent relaxation of restrictions on the support available. Sarah notes that three full-time staff resigned on 1 July 2020 and that a general rebound in retail sales has led to turnover projections for the quarter July to September 2020 being increased to $3m. Solution Cash flow boost The cash flow boost consists of tax-free payments of up to $100,000 for small or medium business entities that employ people, with a minimum payment of $20,000. Rules regarding the cash flow boost are set out in the Boosting Cash Flow for Employers (Coronavirus Economic Response Package) Act 2020. The payments are made in two stages. The first payment is available from 28 April 2020. The second cash flow boost payment for employers is made from 28 July 2020. To be eligible for the first cash flow boost, the following criteria must be met: • The business must be a small or medium business entity or not-for-profit. This means the business must have an aggregated annual turnover of less than $50m. Aggregate turnover includes turnover of connected or affiliated entities (excluding transactions between entities), including overseas entities. • The business must have held an ABN on 12 March 2020. • The business must have made payments to employees subject to withholding (even if the amount withheld is zero), under Subdiv 12-B, 12-C and 12-D TAA 1953 such as: – salary and wages – director fees – eligible retirement or termination payments – compensation payments – voluntary withholding from payments to contractors • The business must have lodged, before 12 March 2020, at least one of: – a 2018/19 income tax return showing business income – an activity statement or GST return for any tax period that started after 1 July 2018 and ended before 12 March 2020 showing taxable, GST-free or input-taxed sales. Eligible businesses receive a credit equal to 100% of the amount of PAYG withheld. Monthly lodgers will receive a credit for March 2020 which is 300% of their withholding for that month. The minimum credit is $10,000 across March to June 2020, even if total withholding is less than $10,000

(or even if it is zero). Total cash flow boosts for March to June 2020 cannot exceed $50,000. Where the minimum credit of $10,000 is paid, no further cash flow boosts will be credited until PAYG withholding exceeds $10,000 over the eligibility periods. The payments are automatically calculated by the ATO and are delivered as a credit to the entity upon lodgment of their activity statements. Where this places the entity in a refund position, the ATO will deliver the refund within 14 days. Eligible businesses do not have to apply for the cash flow boosts. The payments are non-assessable non-exempt income (ITAA97 s 59-90). The timetable for receipt of cash flow boost payments differs depending on whether the eligible business lodges BAS on a quarterly or monthly basis as follows. Quarterly lodgers are eligible to receive the credit for: • quarter 3 (January, February and March 2020). Lodgment due date is 28 April 2020, and • quarter 4 (April, May and June 2020). Lodgment due date is 28 July 2020. Monthly lodgers are eligible to receive the credit for: • March 2020 (with additional credit for January and February 2020). Lodgment due date is 21 April 2020. • April 2020. Lodgment due date is 21 May 2020. • May 2020. Lodgment due date is 22 June 2020. • June 2020. Lodgment due date is 21 July 2020. To qualify for the second cash flow boost payment, the entity must simply continue to be active over the next six months. It is not necessary to retest any of the eligibility criteria that apply to the first cash flow boost. The amount of cash boost an employer receives in the second payment period does not relate to the tax withheld in that period. Instead, eligible entities receive an additional payment equal to the total of the first cash flow boost payment received. Monthly lodgers will get a payment equal to a quarter of their first cash flow boost payment following the lodgment of their June, July, August and September BASs. Quarterly lodgers will get a payment equal to half of their total first cash flow boost payment following the lodgment of their June and September BASs (up to a total of $50,000). As an active business that employs staff, Icarus will be entitled to the cashflow boost. The amount of the cashflow boost will be calculated and paid to Icarus automatically by the ATO upon lodgment of the relevant BAS. The company is not required to take any action to receive the amounts. The first cash flow boost should be credited within 14 days of submission of the March quarter BAS (due date 28 April 2020). The amount of the cash flow boost should be equal to the PAYG withheld in that quarter, being $30,500. The cash flow boost will be applied to reduce liabilities arising from the same activity statement, such as GST, with any excess refunded to Icarus as a cash amount. A further cash flow boost will be applied to the June 2020 BAS based on PAYG withholding paid in that quarter. As Icarus does not know the amount to be withheld (which will depend on the number of staff to be retained and the amounts paid to them), the exact amount of this credit cannot be quantified but it cannot exceed $19,500 (the maximum cash flow boost for the period to June 2020 is $50,000). Further cash flow boost payments will flow in the second half of the year. The amount that will be paid is equal to the amount that was paid in relation to the first cash flow boosts. Half of that amount will be paid following the lodgment of the June 2020 BAS and the other half following the lodgment of the September 2020 BAS. This means that two amounts will be credited in relation to the June 2020 BAS — the last part of the first cash flow boost and the first part of the second cash flow boost. Once again, Icarus needs to do nothing to receive the second cash flow boost. In particular, the improved turnover of the business from July 2020 onwards will not affect eligibility. JobKeeper JobKeeper is a wage subsidy scheme to provide payments of $1,500 per fortnight to eligible employees

of qualifying businesses. Details are set out in the Coronavirus Economic Response Package (Payments and Benefits) Rules 2020. Payments are made via the ATO to businesses that have experienced financial impacts during the period of the scheme, mostly but not exclusively caused by COVID-19. These businesses can access the subsidy from the Australian Government to continue paying their employees. Affected employers can claim a taxable fortnightly payment of $1,500 per eligible employee between 30 March 2020 and 27 September 2020, a period of 26 weeks, which must then be passed on to employees. From 28 September 2020, the JobKeeper Payment will be extended for businesses and not-for-profits that have been most significantly impacted, the payment rates will be stepped-down and two tiers of payment will be introduced. From 28 September 2020, businesses and not-for-profits seeking to claim JobKeeper Payment will be required to re-assess their eligibility for the JobKeeper extension with reference to their actual turnover. Payments are made to the employer monthly in arrears by the ATO. These must then be paid on to eligible employees with PAYG tax deducted in the normal way. Employers are eligible for JobKeeper if: • their business has a turnover of less than $1b and their turnover will be reduced by more than 30% relative to a comparable period a year ago (of at least a month), or • their business has a turnover of $1b or more and their turnover will be reduced by more than 50% relative to a comparable period a year ago (of at least a month), and • the business is not subject to the Major Bank Levy. For businesses that are not able to demonstrate that their turnover is down 30% compared to a comparable period a year ago, alternative tests exist to establish that they have been significantly impacted. It does not matter whether it is COVID-19 or some other factor (or a combination of factors) that has caused the drop in turnover, provided the turnover has fallen by the required percentage and the other eligibility criteria are met. Qualifying businesses must register on the ATO website or via their tax agent and assess that they have or will experience the required turnover decline. They must also provide information to the ATO on their eligible employees, including the number of eligible employees engaged as at 1 March 2020 and those currently employed by the business (including those stood down or rehired). Employees of a qualifying employer are eligible for JobKeeper if they: • are currently employed by an eligible employer (including if they have been stood down or rehired) • were employed by the employer at 1 March 2020 • are full-time, part-time or a long-term casual (a casual employed on a regular basis for longer than 12 months as at 1 March 2020). Casuals employed for less than 12 months are excluded • were aged 18 years or older at 1 March 2020 (16 and 17 year olds can also qualify for fortnights before 11 May 2020, and continue to qualify after that if they are independent or not undertaking fulltime study); • are an Australian citizen, the holder of a permanent visa, a Protected Special Category Visa Holder, a non-protected Special Category Visa Holder who has been residing continually in Australia for 10 years or more, or a Special Category (Subclass 444) Visa Holder. New Zealand citizens qualify but other temporary visa holders are excluded • were not in receipt of the following payments during the JobKeeper fortnight: – government parental leave or dad and partner pay under the Paid Parental Leave Act 2010, and – a payment in accordance with Australian worker compensation law for an individual's total incapacity for work

• are not in receipt of a JobKeeper payment from another employer. As of 3 August 2020, the key date for assessing employee eligibility becomes 1 July 2020, rather than 1 March 2020. Once an employer decides to participate in the JobKeeper scheme and their eligible employees have agreed to be nominated by the employer, the employer must ensure that all of these eligible employees are covered by their participation in the scheme. This includes all eligible employees who are undertaking work for the employer or have been stood down. The employer cannot select which eligible employees will participate in the scheme. To qualify for the JobKeeper payment, a business needs to show a 30% drop in turnover (50% if turnover is over $1b or 15% if a charity). The starting point in demonstrating this is the basic test: • if reporting monthly, compare turnover in March or April 2020 or a later month before October 2020 to turnover in March or April or the equivalent month in 2019 • if reporting quarterly, compare the June quarter of 2020 to the June quarter in 2019, or a later quarter before October 2020 with the equivalent quarter in 2019. If that comparison shows a 30% drop, the business meets the turnover test and no further testing needs to be done. If a business does not pass the basic test, it can look to apply an alternative test. The grounds for applying an alternative test are that the comparison period is not an appropriate reference point. Therefore, something needs to have happened in the prior 12 months that renders the comparison period unfair. The details of the alternative tests are in the Coronavirus Economic Response Package (Payments and Benefits) Alternative Decline in Turnover Test Rules 2020 (F2020L00461). Before an alternative test can be applied, the ATO must be satisfied that there is no appropriate comparison period for the entity in 2019. The rules set out the following circumstances in which an alternative test can be relevant: • entities that newly commenced business such that there is no relevant comparison period in 2019 • entities that acquired or sold part of their business, which affected their turnover • where there was a restructure of the business, which affected the turnover • where a business experienced rapid growth in turnover such that its projected turnover is not comparable to the 2019 period • the business was affected by drought or other natural disasters • a business has an irregular turnover that is not cyclical, for example the building and construction sector, and • a sole trader or partner in a small partnership (less than five partners) did not work due to illness, injury or leave in the comparable period, which affected the turnover. These alternative tests are only applicable if the basic test is failed. The Commissioner has determined that these are the only classes of business that the alternative test applies to. Therefore, for an alternative test to apply a business needs to come under one of these classes. In relation to Icarus, the company cannot satisfy the basic test since turnover for the April to June 2020 quarter, having opted to report turnover quarterly, has not fallen by the requisite 30%; in fact, it has not fallen at all. However, the reason for this is that the company acquired two additional stores during the year, doubling the number of retail outlets in its portfolio. Accordingly, the company can look to apply the alternative turnover test that applies where an entity has acquired or sold part of their business. This alternative test applies where an entity has undergone large changes to the structure of their business during the comparison period. As a result of these changes, using the normal comparison period turnover

would not be appropriate to determine an accurate measure of the business’s decline in turnover. The alternative test for businesses in this situation is to compare the entity’s projected GST turnover for the applicable test period with the current GST turnover for the month (or quarter) immediately following when the last disposal, acquisition or restructure took place. In this case, the acquisitions took place in July 2019. Company turnover for the quarter following the acquisitions (October to December 2019) was $4m. Comparing that to the expected turnover for the April to June 2020 quarter ($2m), it can be seen that turnover has fallen by 50%, well in excess of the requisite 30%. As Icarus meets all the other eligibility requirements, it is able to enrol for JobKeeper for eligible employees. On the basis that JobKeeper is a “one-in, all-in” scheme, all employees must be included, with the exception of those that do not qualify. Icarus is able to stand down employees for whom there is no work but it must continue to pay them JobKeeper. The only way Icarus can avoid paying JobKeeper for eligible employees is to terminate their employment altogether. The company has 16 eligible employees and 4 non-eligible employees. The non-eligible employees are the two casuals who were first employed in December 2019 (who do not meet the criteria of being engaged as casuals for longer than 12 months at 1 March 2020) and two part-time staff who are on working holiday-maker visas, who do not satisfy the residency criteria. The 16 eligible employees must be included in JobKeeper (unless their employment is terminated) and must be paid $1,500 per fortnight before tax, starting with the first JobKeeper fortnight for which a claim has been made. As the ATO makes JobKeeper payments monthly in arrears, Icarus may have to fund the first one or two JobKeeper payments from its own cash reserves until the first amount is received from the ATO. PAYG is withheld from payments made to employees in the normal way. As JobKeeper is specifically paid at a flat rate of $1,500 per fortnight, this amount must be paid to employees. It is not open to Icarus to pay lesser amounts, for instance to staff that do not currently earn $1,500 per fortnight. Icarus must continue to pay SG on behalf of staff on their normal wages. To the extent that their normal wages are less than $1,500 per fortnight, Icarus is not obliged to pay SG on “top-up” amounts paid to employees to make wages up to $1,500 (though it may choose to do so). Businesses only need to assess their eligibility for JobKeeper once — at the point of application. Provided the turnover criteria is met at that point, the business is eligible for JobKeeper. If, as with Icarus, turnover later recovers, this has no impact on eligibility and JobKeeper payments continue until the end of the first version of the scheme on 27 September 2020. Although monthly reporting of turnover to the ATO is required, this is for the purposes of statistical collection; it is not a retest of turnover. From 28 September 2020, businesses and not-for-profits seeking to claim JobKeeper Payment will be required to re-assess their eligibility for the JobKeeper extension with reference to their actual turnover in the September quarter 2020. Businesses and not-for-profits will need to demonstrate that they have met the relevant decline in turnover test in this quarter to be eligible for JobKeeper from 28 September 2020 to 3 January 2021. Businesses and not-for-profits will need to further reassess their eligibility in January 2021 for the period from 4 January to 28 March 2021. Businesses and not-for-profits will need to demonstrate that they have met the relevant decline in turnover test in the December quarter 2020 to remain eligible for the March quarter 2021. Also as part of monthly reporting, employers are required to reconfirm the number of eligible employees. Where an employee leaves employment, JobKeeper payments should stop from the first full JobKeeper fortnight the employee becomes ineligible. The three staff who resigned on 1 July 2020 will therefore cease to receive JobKeeper from the first JobKeeper fortnight after their departure. Note that JobKeeper is also available to “eligible business participants” such as sole traders, partners in a partnership and active beneficiaries of a trust. See example ¶9-300 — COVID-19 stimulus; cash flow boost and JobKeeper. AMTG: ¶10-040

ADMINISTRATION AND ASSESSMENT Foreign resident CGT withholding regime

¶11-000

PAYG withholding; Commissioner’s discretion

¶11-020

Period of review; amended assessment

¶11-040

Promoter of a tax exploitation scheme

¶11-060

Reporting; withholding and payment obligations relating to employee share schemes

¶11-080

Tax liability on income earned by deceased taxpayer while alive

¶11-100

Access to accountant’s working papers

¶11-120

Lodgment of returns

¶11-140

Notice by Commissioner to produce documents

¶11-160

Disputing an ATO decision

¶11-180

PAYG withholding obligations

¶11-200

Commissioner’s power to amend an assessment

¶11-220

Taxpayer’s challenge to an assessment

¶11-240

Validity of an assessment

¶11-260

Director’s penalties

¶11-280

Taxpayer’s right to information

¶11-300

Administrative penalties under the uniform penalty regime

¶11-320

Departure prohibition order

¶11-340

¶11-000 Worked example: Foreign resident CGT withholding regime Issue Ping and Chi Xu are sisters. Ping is a tax resident in Australia and Chi is a tax resident in China. Ping works full time as a pharmacist and invests in the property market. She does this through two companies — Residential Pty Ltd and Commercial Pty Ltd. These companies are part of a tax consolidated group with Ping Pty Ltd as the head company. In February 2012 Ping and Chi purchased an investment property together in residential Balwyn. Ping through Residential Pty Ltd and Chi directly in her name. Both parties are on title. In February 2020 Ping and Chi decided to sell the property. On the advice of their real estate agent, the property is expected to sell for more than $750,000 before the end of the 2019/20 income year. Chi has always met her Australian income tax obligations and declared her Australian taxable income in relation to this property over the ownership period of the investment property. Advise Ping and Chi on the documentation required to comply with and manage the impact of the foreign resident CGT withholding (FRCGTW) regime with respect to the sale of the property. Solution The acquisition of taxable Australian real property under a contract entered into on or after 1 July 2017 with a market value greater than $750,000 requires the purchaser to withhold 12.5% of the purchase price as a non-final tax where the property is acquired from a foreign resident vendor (or a vendor whom the

purchaser has reason to believe is a foreign resident) (TAA Sch 1 Subdiv 14-D). The amount withheld must be remitted to the ATO by the purchaser on or before settlement. To ensure that 12.5% of the purchase price is not withheld, Australian residents selling property for $750,000 or more must obtain a clearance certificate from the ATO confirming that they are not a foreign resident. This certificate is valid for 12 months and must be given to the purchaser on or before settlement. Foreign resident vendors who believe that a withholding rate of 12.5% is inappropriate may apply to the ATO for variation of that rate using the “Variation application for foreign residents and other parties form”. The variation may reduce the withholding rate down to nil. The foreign resident vendor would then have to provide the purchaser with this variation notice issued by the ATO on or before settlement to ensure that the reduced rate of withholding applies. A variation notice is also valid for 12 months. Ping and Chi’s sale of the Balwyn property In this case there are multiple vendors, that is Ping, an Australian tax resident and Chi, a foreign tax resident. Even though the foreign ownership proportion of the property is less than a market value of $750,000, the market value of the whole property is the determining factor for the application of FRCGTW regime (Legislative Instrument F2016L01123). Ping can avoid 12.5% of the purchase price being withheld from her half of the sale amount by providing the purchaser with a clearance certificate on or before settlement. Since Ping’s properties are in a tax consolidated group, she can apply for one certificate on behalf of the head company of the group with all the subsidiary companies, Residential Pty Ltd and Commercial Pty Ltd listed on it. Ping can then use this clearance certificate for all disposals during the 12-month period that the certificate is valid. Chi has the option of applying to the ATO for a variation notice that she must give to the purchaser on or before settlement to avoid the purchaser withholding up to 12.5% of half of the purchase price. In applying for the variation notice, Chi would need to estimate her taxable income attributed to Australia for the 2019/20 income year, and propose the appropriate amount that should be withheld from the sale of the property. This would require a provisional tax calculation that would include her taxable income from Australian sources being rent from the property, capital gain from the sale of the property and any prior year tax attributes such as losses that could be utilised. If Chi has determined that her estimated tax liability for 2019/20 income year would be greater than the 12.5% withholding, then she would not apply for the variation and allow the 12.5% to be deducted from her share of the purchase price. Chi should note that from 8 May 2012 non-residents are no longer eligible for the 50% CGT discount for holding CGT asset for more than 12 months. However, Chi would be permitted to apportion this discount from the date of acquisition of the Balwyn property until 8 May 2012. As this is not a final withholding tax, Chi must lodge an Australian tax return to self-assess her Australian tax obligation for the 2019/20 income year. Any amount withheld would be available to Chi to offset her tax liability. AMTG: ¶12-725, ¶26-269

¶11-020 Worked example: PAYG withholding; Commissioner’s discretion Issue In 2020, ABC Pty Ltd was the subject of an ATO PAYG audit. As a result of the audit, the ATO estimated PAYG withholding amounts of $115,000 were payable pursuant to TAA Sch 1 Div 268. These were debited to the integrated account of ABC for the quarters for which no Business Activity Statements (BAS) had been lodged. Following the audit, ABC lodged all outstanding BASs and as a result the PAYG withholding liability on these BASs came to $115,000. ABC has PAYG withholding debits of $230,000 on the integrated account (plus fines and the general interest charge). Advise ABC on whether the ATO is obliged to credit the $115,000 that ABC paid as a result of the ATO

audit against the PAYG liability that arose when ABC lodged its outstanding BASs. Solution ABC’s liability to pay an ATO estimate made under Div 268 is separate and distinct from the liability to which the estimate relates, being the liability to remit the actual amounts withheld (s 268-20). The liability to remit the amounts actually withheld is imposed upon ABC in accordance with TAA Sch 1 s 16-70. The fact that the Commissioner has issued a PAYG estimate prior to the actual liability being determined does not change the actual PAYG liability. Although the estimated PAYG liability is separate and distinct from the actual PAYG liability, ABC is entitled to have the Commissioner’s estimate reduced by the actual unpaid amount where it gives the Commissioner a statutory declaration specifying the actual amount of the unpaid liability (s 268-40). The statutory declaration must comply with s 268-40 and must be made within seven days from when the Commissioner sends his notice of estimate (s 268-40(1)). If the Commissioner refuses to exercise discretion to reduce the estimate and has taken proceedings to recover the estimated liability, ABC can file an affidavit with a court pursuant to s 268-40(1) asking the court to confirm that the unpaid amount of the underlying liability is less than the estimate. The court can then enter a judgment in favour of the Commissioner for this lesser amount (s 268-40(2)). The effect is that where ABC pays an amount toward discharging one of the liabilities, the parallel liability is itself discharged to the extent of the payment. If ABC pays an amount to discharge the estimate and that exceeds the unpaid amount of the underlying liability, the Commissioner must refund the excess or apply the excess against any other tax liability of ABC which arises under an Act administered by the ATO (s 268-60(1)). AMTG: ¶25-560

¶11-040 Worked example: Period of review; amended assessment Issue Cupcake Pty Ltd (Cupcake) is a small business entity. On 15 May 2018, it lodged its 2016/17 income tax return. The Commissioner is deemed to have given a notice of assessment to the company on that date. As a small business entity, the company has a period of amendment of two years after the date of the notice of assessment under Item 2 of the table in ITAA36 s 170(1). In January 2020, Cupcake found out that it had incorrectly omitted a net capital gain from its 2016/17 tax return. It lodged a request to amend the return. On 12 February 2020, the Commissioner issued an amended notice of assessment to account for the revised net capital gain. The amendment increased the company’s tax liability for 2016/17. It is now September 2020 and Cupcake has just discovered that the net capital gain had been overstated. Cupcake also found that it had omitted to claim a foreign exchange loss that it was entitled to in 2016/17. Is Cupcake entitled to request an amendment for its 2016/17 assessment to reduce the net capital gain and include the foreign exchange loss? Solution In September 2020, Cupcake can request an amendment in relation to the net capital gain but not in relation to the foreign exchange loss. When an assessment is amended, the amendment period is refreshed only in relation to the particular that was amended in certain circumstances. ITAA36 s 170(3) sets out the three specific situations in which the amendment period may be refreshed. Situation one This occurs where: • the amendment of the particular reduced the taxpayer’s tax liability for the income year, and

• the Commissioner had accepted a statement made by the taxpayer in making the amendment. The amendment period is refreshed from the date of the first amended assessment where the further amendment of the same particular would increase the taxpayer’s tax liability for the income year. Situation two This occurs where the amendment of the particular increased the taxpayer’s tax liability for the income year. The amendment period is refreshed from the date of the first amended assessment where the further amendment of the same particular would decrease the taxpayer’s tax liability for the income year. Situation three This occurs where the amendment of the particular reduced the taxpayer’s tax liability for the income year, other than in a situation covered by situation one. The amendment period is refreshed from the date of the first amended assessment where the further amendment of the same particular would decrease the taxpayer’s tax liability for the income year. Application to Cupcake Cupcake’s 2016/17 return can be amended again in relation to the net capital gain by 12 February 2022. This is because the original amendment increased Cupcake’s tax liability for 2016/17 and the further amendment would decrease the tax liability. However, it is now outside the time limit to amend the return to deduct the foreign exchange loss. The deduction could only have been claimed within the original two-year amendment period, that is by May 2020. AMTG: ¶25-300, ¶25-310

¶11-060 Worked example: Promoter of a tax exploitation scheme Issue Eric Munchen arranged for the incorporation of two companies — Troilos Pty Ltd and Radic Capital Pty Ltd — and was the sole director of both companies. The purpose of the arrangement was to use the two companies to implement an idea that he believed would have beneficial tax consequences for the participants. His idea was to purchase and import drugs from Mexico for the treatment of malaria, and then donate the drugs to charities with operations in countries where malaria was endemic. An arrangement was entered into between Munchen, Troilos and Radic, under which Troilos and Radic: • incurred a liability to pay, at a grossly inflated price, for the drugs for use in the foreign markets • were required to pay upfront only 7.5% of the purchase price, with the 92.5% balance deferred for 50 years at very low interest, and • claimed an immediate deduction for the full amount. The three entities were paid as follows for their participation: (a) Munchen received a salary for marketing and encouraging the arrangement, (b) Troilos received a marketing fee representing a percentage of sales of drugs, and (c) Radic received a membership fee paid by Munchen and Troilos. Explain whether the promoter penalty provisions in TAA Sch 1 Div 290 could be used to deter participation in arrangements such as this. Solution Under the promoter penalty provisions in Sch 1 Div 290, a penalty may be imposed on an entity if it engages in conduct that results in it or another entity being a “promoter” of a “tax exploitation scheme”. An entity is a promoter of a tax exploitation scheme if:

• the entity markets, encourages the growth of, or encourages interest in a tax exploitation scheme, and • the entity, or an associate of the entity, receives (directly or indirectly) consideration in respect of marketing or encouraging the scheme, and • it is reasonable to conclude that the promoter has had a substantial role in respect of that marketing or encouragement (s 290-60). An entity includes, for these purposes, an individual, a company, a partnership, an unincorporated association, a trust or a superannuation fund. A scheme is a tax exploitation scheme if, when it is promoted: • it is reasonable to conclude that an entity that entered into or carried out the scheme has a sole or dominant purpose of getting a reduced tax-related liability from the scheme, and • it is not reasonably arguable that the benefit is available under the tax laws (s 290-65). The Commissioner may seek a civil penalty in relation to a contravention of Div 290 (s 290-50) or an injunction restraining an entity from promoting a tax exploitation scheme (s 290-125). Application of the promoter penalty provisions The arrangement between Munchen, Troilos and Radic is very similar to the scheme entered into by three entities in FC of T v Arnold & Ors 2015 ATC ¶20-486 where the Federal Court held that: (a) the scheme was a tax exploitation scheme which each of the entities entered into for the dominant purpose of reducing their income tax liability, and the fact that they may also have had the purpose of making a commercial profit or facilitating donations to charities was not inconsistent with this conclusion, and (b) each of the entities was a promoter of the scheme, as indicated by the facts that they each had a substantial role in marketing and encouraging participation in the scheme and were paid for their role in doing so. The court noted in Arnold that the promoter penalty provisions do not require the Commissioner to prove that the entity knew that the scheme, the promotion of which resulted from the entity’s conduct, had the characteristics of a tax exploitation scheme. This means that an entity that promotes a scheme may contravene s 290-50 even if not aware that another entity has the dominant purpose of obtaining a scheme benefit that is not available by law. On the basis of the decision in Arnold, and taking account the similarity of the schemes, it is likely that Munchen, Troilos and Radic would each be found to be a promoter of a tax exploitation scheme. If they were penalised in the same way as the entities in Arnold, Munchen would be ordered to pay a civil penalty of $1m, Troilos $400,000 and Radic $100,000. AMTG: ¶29-000, ¶30-300

¶11-080 Worked example: Reporting; withholding and payment obligations relating to employee share schemes Issue Trollope Pty Ltd manufactures machine parts and is considering setting up an employee share scheme (ESS) for its employees. Trollope proposes that, under the scheme, employees would be offered shares, or rights to shares, in the company at a price which is a discount to the market value. Trollope has not operated an employee share scheme previously, and is concerned about the potential administrative burden associated with the reporting, payment and withholding obligations that may arise. Explain to Trollope Pty Ltd the requirements that would need to be satisfied. Solution

If Trollope Pty Ltd decides to operate an employee share scheme, it will have reporting, payment and withholding obligations from the first year it operates the scheme. Reporting to the ATO Trollope would be required to provide an ESS annual report to the ATO by 14 August after the end of the relevant financial year. The ESS annual report must include, but is not limited to, the following information for each participating employee and for each ESS that the employee is participating in: • general information such as a plan identifier, the date the ESS interests were acquired, the date a taxing point happened to an ESS interest, and TFN amounts withheld • if Trollope is an eligible start-up company and the start-up concession is available — the number of ESS interests acquired and their market value, the acquisition price of ESS interests that are shares and the exercise price of ESS interests that are rights • if the discount on ESS interests acquired under Trollope’s scheme were taxed upfront — the number of ESS interests eligible for a $1,000 reduction and the number not eligible, and the discount on the ESS interests eligible for reduction or not eligible for reduction, and • if tax is deferred under the scheme — the number of ESS interests for which a deferred taxing point arose during the financial year and the discount on those interests. If Trollope became aware of any material change to or omission from any information given to the ATO, this would have to be reported to the ATO within 30 days. Reporting to employees Trollope would be required to provide an ESS statement to an employee by 14 July after the end of the financial year if the employee (or associates of the employee, eg a spouse) has acquired ESS interests at a discount during the financial year and: (a) the discount is taxed upfront, or (b) the ESS were acquired under a tax-deferred ESS and a taxing point happened during the financial year. The ESS statement must include, but is not limited to, the following information which the employee needs to report in an income tax return: • the discount for ESS interests acquired under taxed-upfront schemes • the discount for ESS interests acquired under a tax-deferred scheme if a taxing point happened during the financial year, and • the total TFN amount withheld from discounts during the financial year. If Trollope is an eligible start-up company and an employee is eligible for the start-up concession, Trollope must give the employee information about the number of ESS interests acquired, their market value and acquisition date, the acquisition price of ESS interests that are shares and the exercise price of ESS interests that are rights. The employee would need this information to determine the cost base of their CGT assets and calculate any capital gain or capital loss when they dispose of their ESS interests. The information that must be given to the ATO, or to an employee, for a financial year is prescribed by TAA Sch 1 s 392-5 and 392-10. Withholding and payment obligations If an amount is included in an employee’s assessable income for a financial year as a result of Trollope providing ESS interests to the employee, for example a discount is taxed upfront in the year the ESS interest is acquired, and the employee has not quoted a tax file number to Trollope, Trollope must pay TFN withholding tax to the ATO (TAA Sch 1 s 14-155).

For 2019/20, the TFN withholding tax rate is 47% of the assessable amount, and is due and payable by 21 days after the end of the financial year in which the relevant amount was included in the employee’s assessable income. If Trollope fails to pay the tax by the due date, general interest charge would be payable on the unpaid amount (TAA Sch 1 s 16-80). TFN withholding tax is imposed by the Income Tax (TFN Withholding Tax (ESS)) Act 2009. The amount of TFN withholding tax paid by Trollope in relation to an employee may be recovered by Trollope from the employee, and the amount may be set off against a debt due by Trollope to the employee (TAA Sch 1 s 14-165). AMTG: ¶10-091, ¶10-096

¶11-100 Worked example: Tax liability on income earned by deceased taxpayer while alive Issue In June 2017, Alec Leamas was notified of assessments of income tax for the years ending 30 June 2012 to 30 June 2016. Alec died in September 2017 and a notice of assessment for $983,500 was issued to the “Executor for Alec Leamas” dated 3 August 2019 for the year ended 30 June 2017. There was no “executor” at the time. No person had applied for a grant of probate under the terms of a will made by Alec Leamas or for letters of administration, and the estate of Alec Leamas was unadministered at all relevant times. The sister of Alec Leamas, as a person with an interest in the estate, argued to the Commissioner that there could be no liability for tax on income earned by her brother during his lifetime but which was not assessed until after his death. In any event, even if a tax debt existed, as the estate was unadministered, there was no person who could be responsible for payment of the debt. Explain whether the Commissioner can recover the tax debt. Solution As a general rule, it is the duty of those charged with the administration of a deceased estate to get in the assets of the deceased and pay out the debts, including tax-related debts owing to the Commissioner. The failure to appoint a person to administer an estate can delay the recovery of debts by creditors, although creditors may apply for probate or letters of administration where executors fail to do so themselves, for example under the Probate and Administration Act 1898 (NSW) s 75. In the case of the Commissioner, there are special provisions to aid in the recovery of unpaid tax from unadministered deceased estates. Commissioner’s power to recover from an unadministered estate TAA Sch 1 s 260-145 applies where neither probate of a person’s will nor letters of administration of a person’s estate have been granted within six months after the person’s death. The processes under s 260-145 are as follows. 1. The Commissioner may determine the total amount of “outstanding tax-related liabilities” that the person had at the time of death. A “tax-related liability” is defined in TAA Sch 1 s 255-1 as a pecuniary liability to the Commonwealth arising directly under a taxation law, including a liability the amount of which is not yet due and payable. “Taxation law” means “an Act of which the Commissioner has the general administration” (ITAA97 s 9951(1)), which would include the ITAA36, the ITAA97 and the TAA. An “outstanding tax-related liability” of an entity at a particular time, as defined in s 995-1(1), means a taxrelated liability of the entity: (a) that has arisen at or before that time (whether or not it is due and payable at that time), and (b) an amount of which has not been paid before that time. According to the Full Federal Court in Binetter v FC of T; FC of T v Bai 2016 ATC ¶20-593, an outstanding tax-related liability includes tax on income earned by a deceased person but not assessed

during their lifetime. This is the case even though the debt for the liability is not recoverable until the assessment that sets out the specific amount owing and its due date for payment has been issued to the estate of the deceased taxpayer. 2. The Commissioner must publish notice of the determination twice in a daily newspaper circulating in the state or territory where the person resided at the time of death. 3. A notice of the determination is conclusive evidence of the outstanding tax-related liabilities, unless the determination is later amended. 4. A person who is dissatisfied with the Commissioner’s determination of the outstanding tax liability may object in the manner set out in TAA Pt IVC if they claim an interest in the estate or are granted probate of the deceased person’s will or letters of administration of the estate. Recovery from the Alec Leamas estate As long as the steps set out in s 260-145 are followed, the Commissioner may authorise a person to recover: (a) the total amount of the outstanding tax-related liabilities of Alec Leamas as determined in s 260-145, and (b) any reasonable costs incurred by the authorised person in recovering that amount by seizing and disposing of any of his property (TAA Sch 1 s 260-150). AMTG: ¶25-530, ¶44-170

¶11-120 Worked example: Access to accountant’s working papers Issue On 1 February 2020, an authorised taxation officer visited the offices of Babbages Accountants. The taxation officer sought access to the firm’s working papers relating to advice prepared for Future Success, a vocational college. Some of the working papers to which the taxation officer sought access related to the preparation of Future Success’s income tax return for the 2017/18 income year. Other papers related to advice given by Babbages on Future Success merging with another vocational college and the structural and financial benefits expected to flow from the merger. Advise Babbages on whether it can prevent access to the working papers. If Babbages does not comply with the taxation officer’s request for access, will it be liable to penalties? Solution In seeking access to the accounting firm’s working papers, the taxation officer is relying on TAA Sch 1 s 353-15(1), which gives very wide powers of access. Taxation officer’s access powers Section 353-15(1) provides that, for the purposes of the taxation law, an authorised taxation officer: • may at all reasonable times enter and remain on any land, premises or place • is entitled to full and free access at all reasonable times to any documents, goods or other property • may inspect, examine, make copies of, or take extracts from, any documents, and • may inspect, examine, count, measure, weigh, gauge, test or analyse any goods or other property and, to that end, take samples. Section 353-15(2) provides that an authorised officer is not entitled to enter and remain on any land, premises or place if, after having been requested by the occupier to produce proof of their authority, the officer fails to do so.

An occupier who fails to provide all reasonable facilities and assistance to an authorised taxation officer for the effective exercise of s 353-15(1) powers is guilty of a criminal offence of strict liability. This carries a maximum fine of 30 penalty units (a penalty unit is $210: s 4AA Crimes Act 1914). Before 1 July 2015, the power of an authorised taxation officer to access, examine and copy materials was provided by ITAA36 s 263. Section 353-15 is worded similarly to s 263 and is generally intended to state the same law, so cases and rulings relevant to s 263 apply also for s 353-15. Can Babbages prevent access to the working papers? The wide access powers given in s 353-15 mean that it is very difficult for an occupier to prevent an authorised taxation officer having access to documents held by the occupier. The access power may, however, be restricted by the doctrine of legal professional privilege (FC of T & Ors v Citibank Ltd 89 ATC 4268) which protects communications made between a lawyer and client for the dominant purpose of giving or receiving legal advice. The doctrine also applies to communications between a client, the client’s lawyer and third parties for the dominant purpose of use in existing or anticipated litigation (Esso Australia Resources Ltd v FC of T 2000 ATC 4042). Legal professional privilege does not currently apply to communications between an accountant and client but may be extended to tax advice documents prepared by accountants. The Commissioner’s current policy in seeking access to documents held by independent external accountants and their clients is set out in the ATO’s “Accessing Professional Accounting Advisors’ Papers” guidelines, which have been incorporated into its Access and Information and Gathering Manual. When dealing with accountants, the Commissioner’s approach is that taxation officers: (1) will seek access without restriction to all documents that record a transaction or arrangement entered into by taxpayers, for example contracts and accounting records such as working papers (source documents), and (2) will only seek access to restricted source documents and non-source documents in exceptional circumstances, for example where fraud or illegal activity is suspected. Restricted source documents include papers prepared solely for the purpose of advising on tax-related matters prior to or at the time of the conception, implementation and completion of a transaction. Nonsource documents include papers provided after a transaction has been completed which do not materially contribute to a tax strategy, and working papers in a current audit or prepared for a due diligence report. Advice for Babbages In relation to the working papers to which the taxation officer sought access, the ATO guidelines suggest as follows. 1. The working papers relating to the preparation of Future Success’s income tax return would be source documents to which the taxation officer could exercise the right of access without restriction. In Taxation Determination TD 93/222, for example, the Commissioner states that documents prepared before the completion of a tax return and showing an analysis of shareholdings to establish continuity of ownership were source documents. As stated in the determination, tax working papers are source documents because “they are used in assembling and compiling information preparatory to the completion of tax returns”. 2. The papers related to advice on Future Success merging with another vocational college and the structural and financial benefits expected to flow from the merger would likely come under the restricted source document category, and access would only be allowed if it could be shown that there are exceptional circumstances. AMTG: ¶25-220, ¶25-230

¶11-140 Worked example: Lodgment of returns

Issue Advice is required on whether the following persons and entities must lodge an income tax return for 2018/19: 1. a resident individual whose taxable income is more than $18,200 2. a resident individual aged 23 years whose taxable income is $16,000 and who has had amounts of PAYG withheld from their salary and wages during the year 3. an unmarried individual aged 17 years at 30 June 2019 who has $400 income from dividends and no other income 4. a non-resident individual who carried on business in Australia during 2018/19 5. a resident individual who has taxable income of $12,000 for 2018/19 with no amounts withheld by their employer but whose payment summary shows a reportable fringe benefits amount 6. a person who has an individual interest in a primary production partnership that has a net partnership loss for the year, and 7. the executor of the estate of a deceased individual who died in October 2018 and whose taxable income for the year is $23,500. Solution Toward the end of each financial year, the Commissioner issues a legislative instrument calling for the lodging of annual income tax returns. A person or entity that is required to lodge a return and fails to do so by the due date may be liable to prosecution or to the payment of penalties. The legislative instrument issued by the Commissioner calling for the lodgment of returns appears in the Federal Register of Legislative Instruments and also on the ATO website (see Legislative Instrument F2019L00675). In relation to the persons and entities listed above, the legislative instrument shows: 1. A resident individual must lodge an income tax return if their taxable income exceeds $18,200 (the tax free threshold for 2018/19). 2. A resident individual must lodge an income tax return if they have had amounts of PAYG withheld from their salary or wage income during 2018/19. 3. An unmarried individual aged 17 years on the last day of the year is a “prescribed person” for the purposes of ITAA36 Div 6AA and must lodge an income tax return only if their unearned income (ie other than certain excepted income) for the year exceeds $416. 4. A non-resident individual who carries on business in Australia is required to lodge an income tax return because the Australian-source income derived from the business would be assessable income of the non-resident and tax is payable from the first dollar. 5. A resident individual who has taxable income below the $18,200 tax free threshold would not normally be required to lodge an income tax return if no PAYG amounts have been withheld by their employer unless their payment summary shows a reportable fringe benefits amount — if the individual’s employer has provided fringe benefits with a taxable value of at least $2,000 to the individual, the gross-up taxable value must be reported on the payment summary and an income tax return lodged. 6. Although not a taxable entity, a partnership must always lodge a partnership return showing that the partnership has a net partnership loss or net partnership income for the year. Further, a person who has an individual interest in a primary production partnership that has a net partnership loss for the year must lodge an individual income tax return.

7. An individual income tax return must generally be lodged for a deceased taxpayer for the period from the beginning of the income year in which the death occurred to the date of death. However, a return does not have to be lodged if the taxpayer would not have been required to lodge a return, for example because their income is below the tax free threshold or because no PAYG amounts have been withheld. A trust return must generally be lodged for the deceased estate for the period from the date of death to the end of the income year. AMTG: ¶2-000, ¶2-010, ¶2-030, ¶2-060, ¶2-070, ¶2-080

¶11-160 Worked example: Notice by Commissioner to produce documents Issue Robo Ltd is an Australian company that imports fully assembled industrial robots and robot components for repairs. It trades primarily with an industrial robot manufacturer in India. The ATO commenced a tax audit of Robo Ltd in 2017 and in September 2019 gave notice to Robo Ltd to provide details of the products it had imported from India since 2015, the wholesale price charged for the products in India and the transport costs associated with the importation. Looking for ways to avoid releasing the information, Robo Ltd responded that all the information was confidential and that it did not have access to much of the information requested because it was kept in India. Robo Ltd seeks advice on whether it must comply with the request for information, and if it chooses not to comply, whether it would be liable to penalties. Solution The Commissioner has wide powers to obtain information from a taxpayer or any other person. Commissioner’s power to ask for information to be furnished TAA Sch 1 s 353-10 provides that the Commissioner may, for the purpose of the administration or operation of a taxation law, require a person, by notice in writing, to: • provide such information as the Commissioner may require • attend and give evidence before the Commissioner or any authorised officer concerning that person’s, or any other person’s, income or assessment, and • produce all documents in that person’s custody or control relating to that income or assessment. Before 1 July 2015, the Commissioner’s power to obtain information, documents and evidence was provided by ITAA36 s 264. Section 353-10 is worded similarly to s 264 and is generally intended to state the same law, so cases and rulings relevant to s 264 apply in the same way to s 353-10. The Commissioner is authorised to make wide-ranging inquiries that need not relate to a particular taxpayer or to a particular topic, provided they relate to the performance of the Commissioner’s functions. The power enables a roving inquiry or a fishing expedition into the income or assessment of taxpayers. The Commissioner may exercise the powers for the purpose of conducting an audit of a taxpayer’s affairs, including where the taxpayer is selected for audit at random, provided the audit relates to the ascertainment of the taxpayer’s taxable income or tax liability (Industrial Equity Ltd & Anor v DFC of T 90 ATC 5008). As long as the s 353-10 power is exercised in good faith and for the purpose of enabling the Commissioner to perform his functions under a taxation law, the power is limited only by any express limitations in the wording of the section. This makes it very difficult for a taxpayer to successfully resist furnishing requested information by arguing that the burden is harsh because it requires considerable time or resources to comply or that advance warning should have been given. A taxpayer may be able to show they have not been given sufficient time to comply (Perron Investments Pty Ltd & Ors v DFC of T 89 ATC 5038), in which case the ATO may extend the time for compliance.

A taxpayer cannot justify non-compliance with a s 353-10 notice on the grounds of a contractual duty of confidentiality or by relying on the privilege against self-incrimination. Failure to comply with a s 353-10 notice may be a breach of TAA s 8C or 8D and may carry criminal penalties. The Commissioner may also issue an “offshore information notice” under ITAA36 s 264A requiring a taxpayer to produce information or documents that are located outside Australia and that relate to the assessment of the taxpayer. If the taxpayer does not provide the information requested, the information is not admissible in later proceedings disputing the taxpayer’s assessment. Advice for Robo Ltd To the extent that they relate to the determination of Robo Ltd’s assessable income and tax liability, the Commissioner would have power under s 353-10 to request that the information and documents be furnished. Robo Ltd may be liable to criminal penalties if it fails to comply with the Commissioner’s notice. Robo Ltd may be able to claim legal professional privilege to resist production of the documents, but only if they are communications created for the dominant purpose of obtaining legal advice or in preparation of litigation (Esso Australia Resources v FC of T 2000 ATC 4042). If the Commissioner issues an offshore information notice for production of information or documents located overseas and Robo Ltd does not comply with the notice, Robo Ltd would be prevented from using the information in a later attempt to challenge an assessment or amended assessment issued by the Commissioner. AMTG: ¶21-220, ¶25-240, ¶29-700

¶11-180 Worked example: Disputing an ATO decision Issue On 16 December 2019, Ellie Maine received a notice of assessment in respect of her income tax return for the year ended 30 June 2019. She believes the assessment is unfair because the ATO disallowed some deduction claims despite her being able to substantiate her expenditure. Ellie is a bank employee and the deduction claims relate to: • expenses for a briefcase and computer software • the cost of a flu injection to protect her from contracting the flu from customers • taxi travel to get to work on time on four mornings she woke up late, and • expenditure on comfortable shoes because her work duties require her to stand for long periods during the day. Ellie Maine believes she is entitled to a deduction for these expenses and wants advice on what steps she would need to take to dispute the ATO assessment. Solution There are various actions that may be taken by a taxpayer who is dissatisfied with an assessment. 1. The taxpayer may lodge an objection in the approved form (TAA Sch 1 s 388-50) against the assessment (TAA s 14ZU). This would need to be done within two years of service of the notice of assessment or decision for most individuals and small business taxpayers, or within four years of service of the notice of assessment or decision for taxpayers with more complex tax affairs (TAA s 14ZW). If out of time, the taxpayer can apply for an extension of time to lodge an objection. 2. Once notice of the Commissioner’s decision on the objection (TAA s 14ZY) is served on the taxpayer, the taxpayer must, if dissatisfied with the Commissioner’s decision on the objection, decide what to do next. The taxpayer may accept the Commissioner’s decision, or may seek further review by the Administrative Appeals Tribunal (an administrative review) or appeal to the Federal Court (a

judicial review) (TAA s 14ZZ). Application to the AAT or appeal to the Federal Court must generally be lodged within 60 days of service of the notice of the Commissioner’s objection decision (TAA s 14ZZN). 3. Whether the taxpayer chooses the AAT or the Federal Court, the taxpayer is limited to the grounds stated in their objection (TAA s 14ZZK(a) and 14ZZO(a)), unless the AAT or the court allows otherwise. 4. Whether the taxpayer chooses the AAT or the Federal Court, the taxpayer bears the burden of proving not only that the amount of the assessment is incorrect but what the actual taxable income should be (FC of T v Dalco 90 ATC 4088) (TAA s 14ZZK(b) and 14ZZO(b)). 5. A taxpayer who is dissatisfied with a decision of the AAT can, if they intend to continue pursuing their rights, appeal to a single judge of the Federal Court (AAT Act s 44), but only on a question of law. The appeal must generally be lodged within 28 days. 6. A taxpayer who is dissatisfied with a decision of a single judge of the Federal Court may appeal to the Full Federal Court, and the appeal must generally be lodged within 21 days. 7. An appeal against the decision of the Full Federal Court may be taken to the High Court, but only if the High Court grants special leave to appeal. AMTG: ¶28-010, ¶28-080, ¶28-130

¶11-200 Worked example: PAYG withholding obligations Issue A cleaning business run by Philip and Isobel Rawal through their private company Rawal Cleaning Pty Ltd made various payments to employees, contractors and other persons during 2019/20. The payments were: 1. Salary and wages paid to employees. 2. Overtime payments to employees. 3. Remuneration to Mr and Mrs Rawal as directors of Rawal Cleaning. 4. A termination payment to an employee whose contract was terminated early. 5. A payment to the spouse of a deceased employee for accrued wages up to the date of death. 6. A payment to an electrical contractor who supplied his ABN on the invoice. 7. A payment to a gardening contractor who did not supply his ABN on the invoice. Mr and Mrs Rawal seek advice as they are unsure whether they have carried out their PAYG obligations in relation to the payments and whether penalties may be imposed if they have failed to do what is required. Solution Under PAYG withholding, amounts are withheld from certain payments (“withholding payments”). Usually, the person who makes the payment is required to withhold an amount from the payment and then to pay the withheld amount to the Commissioner. Payments subject to PAYG withholding are summarised in the table in TAA Sch 1 Pt 2-5 s 10-5(1). The most common withholding payments, payments for work and services, are described in TAA Sch 1 Subdiv 12-B (s 12-35 to 12-60). Other withholding payments described in TAA Div 12 include:

• payments for retirement or because of termination of employment (s 12-80 to 12-90) • benefit and compensation payments (s 12-110 to 12-120) • payments for a supply where a TFN or ABN has not been quoted (s 12-140 to 12-190), and • dividend, interest and royalty payments (s 12-210 to 12-285). In relation to the various payments made by Mr and Mrs Rawal in 2019/20: 1. Salary and wages paid to employees are withholding payments from which amounts must be withheld, generally according to the Commissioner’s withholding schedules (s 12-35), with amounts withheld at a higher rate if an employee does not give a TFN declaration to the employer. 2. Overtime payments are “payments to employees” and are covered by s 12-35 in the same way as salary and wages. 3. Remuneration to Mr and Mrs Rawal as directors of Rawal Cleaning comes within s 12-40 which requires an incorporated company (Rawal Cleaning Pty Ltd) that pays remuneration to an individual as a director to withhold an amount from the payment. 4. A payment to an employee whose contract is terminated early is an employment termination payment if it is made in consequence of the termination of the employee’s employment, and an amount must be withheld by the employer before the payment is made (s 12-85). 5. A payment to the spouse of a deceased employee for accrued wages up to the date of death is not a payment to an employee within s 12-35 (even though it relates to services performed by an employee) and withholding is not required. 6. A payment to an electrical contractor who supplied their ABN on the invoice does not require the payer to withhold an amount. Section 12-190 states that where a payer pays an entity for a supply that the entity makes in the course of an enterprise, withholding is not required if an ABN has been correctly quoted. 7. In the absence of other information, it appears that an amount should have been withheld from a payment to a gardening contractor who did not supply his ABN. The amount that must be withheld by the payer of a withholding payment is, in most cases, set out in the Commissioner’s withholding schedules or in the regulations. The fact that the recipient of the payment has not made a TFN declaration may affect the amount that should be withheld (TAA Sch 1 Div 15). As Mr and Mrs Rawal have made withholding payments in 2019/20, they may be liable to penalties (TAA Sch 1 Div 16) if they: • fail to withhold the required amount from a payment • fail to pay the withheld amount to the Commissioner by the due date and in the required manner • fail to be registered as a withholder • fail to notify the Commissioner of the amounts they withhold • fail to give an annual report to the Commissioner • fail to give an annual payment summary to recipients when required to do so, or • fail to keep records. AMTG: ¶26-120, ¶26-130, ¶26-150, ¶26-180, ¶26-220, ¶26-450, ¶26-500, ¶26-550, ¶26-600, ¶26-620, ¶26-640, ¶26-730, ¶26-750, ¶29-300

¶11-220 Worked example: Commissioner’s power to amend an assessment Issue Dr Amy Tan commenced her medical practice in March 1983 and operated it as a sole practitioner for several years. In 2011/12 she set up a unit trust and sold the medical practice to the unit trust. The unit trust was made up of 120 units, which were allocated equally to Dr Amy Tan, her spouse Oliver Wang and their adult daughter Betty Wang. In her personal tax return for 2011/12, Dr Tan returned as “trust income” one-third of the net income of the unit trust. The medical practice had been acquired by Dr Tan in 1983 and was therefore a pre-CGT asset, and it owned no trading stock or depreciating assets when its ownership passed to the unit trust. In consequence, no amount was returned in Dr Tan’s tax return in relation to the sale. The ATO issued an assessment to Dr Tan for the 2011/12 income year based on the information supplied by Dr Tan. In 2019/20, the ATO became interested in the sale of the medical practice to the unit trust, and decided to treat the transaction as a tax avoidance scheme to split Dr Tan’s personal income with her spouse and her daughter. The ATO issued an amended assessment increasing the tax payable by Dr Tan for 2011/12. Dr Tan seeks advice on whether the amended assessment was validly issued. Solution The Commissioner has a general power to amend an assessment, as set out in ITAA36 s 170, but the exercise of the power is restricted by time limitations, which are as follows. 1. The standard period in which the Commissioner can amend an assessment for most individuals and small business entities, that is taxpayers with simple tax affairs, is two years from the day on which the Commissioner gives notice of the assessment. 2. For taxpayers with complex tax affairs, a four-year amendment period applies. 3. If, in the Commissioner’s opinion, there has been an “avoidance of tax” due to “fraud” or “evasion”, the Commissioner has an unlimited time to amend an assessment. Avoidance of tax occurs where less tax is paid than ought to have been paid, without any fault on the part of the taxpayer (Mynott v FC of T 2011 ATC ¶10-195). Fraud generally means the absence of a genuine belief in the truth of a statement or representation, or a reckless carelessness as to its truth or falsity (Mynott). Evasion is less than fraud but more than avoidance or mere withholding of information (Dixon J in Denver Chemical Manufacturing Co v C of T (NSW) (1949) 79 CLR 296). There must be a blameworthy act or omission on the taxpayer’s part, for example the taxpayer deliberately fails to give information which causes the Commissioner to conclude that the taxpayer’s taxable income is lower than it actually is. Advice to Dr Tan Because the Commissioner amended the assessment eight years after the original assessment was issued, it can only be valid if the Commissioner has formed the opinion that there has been an avoidance of tax due to fraud or evasion (ITAA36 s 170). If the amended assessment is challenged by Dr Tan, she would have to show on the balance of probabilities that there was no fraud or evasion. AMTG: ¶25-300, ¶25-310, ¶25-330, ¶28-100, ¶31-020

¶11-240 Worked example: Taxpayer’s challenge to an assessment Issue Following an audit, Computer Solutions Ltd received an amended assessment on 3 March 2020 for the

year ended 30 June 2018. That assessment amended an earlier assessment dated 2 February 2019 by disallowing deductions for expenditure on entertaining clients and on software for use in the business. Computer Solutions lodged an objection to the amended assessment on 15 April 2020 but was dissatisfied with the Commissioner’s decision on the objection which it received on 1 June 2020. The amount of tax involved in the dispute with the Commissioner is $4,500 and Computer Solutions is committed to obtaining the deductions to ensure certainty for the treatment of its future similar expenditure. Computer Solutions is aware that, if it wants to challenge the Commissioner’s objection decision, it must first decide whether to take the administrative path by applying to the Administrative Appeals Tribunal (AAT) or the judicial path by appealing to the Federal Court. Computer Solutions seeks advice on what considerations should be taken into account in making the decision. Solution A taxpayer who is dissatisfied with a “reviewable objection decision” (which, as defined in TAA s 14ZQ, includes most objection decisions) may choose either to: • refer the matter to the AAT for review, or • appeal directly to the Federal Court (in which case, a single judge would hear the matter). An application to the AAT or an appeal to the Federal Court must generally be lodged within 60 days of service of the notice of the Commissioner’s objection decision (TAA s 14ZZN). The following factors need to be considered in making the decision. 1. AAT hearings are seen as better for simple legal issues, issues of fact and issues requiring review of the Commissioner’s discretion, whereas Federal Court hearings are seen as better for complex legal issues. 2. If there is a small amount at issue, it may be preferable to appeal to the AAT to avoid the higher costs associated with an appeal to the Federal Court. 3. The taxpayer may request a private AAT hearing, whereas court hearings are normally heard in public. 4. Reported AAT decisions are edited to preserve anonymity, whereas public court hearings carry the risk of the taxpayer being identified. 5. The AAT can exercise the Commissioner’s powers and discretions, whereas the court has limited power to override the Commissioner’s discretions (Kajewski & Ors v FC of T 2003 ATC 4375). 6. The AAT has only limited power to order the parties to pay their opponent’s costs (AAT Act s 69A and 69B), but the court has the power to make such an order. 7. Representation by a lawyer or accountant is not required before the AAT and the taxpayer may appear personally, whereas formal legal representation is generally required before the court, with a resultant increase in costs. 8. A taxpayer is directed to use as little formality and technicality as possible before the AAT, whereas formal rules of procedure and evidence apply before the court. 9. The taxpayer may only appeal to the Federal Court from a decision of the AAT on a question of law, and the Federal Court may affirm the AAT decision, set it aside or refer the issue back to the AAT. An appeal from a Federal Court decision to the Full Federal Court can be pursued only if a question of law is involved.

Whether the taxpayer chooses the AAT path or the Federal Court path, the taxpayer needs to be mindful of the following. 1. The grounds of the taxpayer’s argument are limited to the grounds stated in the objection, unless the AAT or Federal Court allows otherwise (TAA s 14ZZK(a) and 14ZZO(a)). The AAT and Federal Court have a broad discretion to permit the grounds of objection to be amended, and could permit significant changes, such as to add a completely new issue not stated in the original objection. But the taxpayer does not have an automatic right to an order to amend the grounds. 2. The taxpayer bears the burden of proving not only that the amount of the assessment is incorrect but what the actual taxable income should be (TAA s 14ZZK(b) and 14ZZO(b)). The taxpayer must prove on the balance of probabilities that the assessment is excessive in the sense of exceeding the amount of the taxpayer’s true liability, and what the correct assessment should be (FC of T v Dalco 90 ATC 4088). The ATO does not bear any onus to positively prove its case (McCormack v FC of T 79 ATC 4111). AMTG: ¶28-080, ¶28-085, ¶28-090, ¶28-100, ¶28-110, ¶28-120, ¶28-130, ¶28-160, ¶28-170, ¶28-180

¶11-260 Worked example: Validity of an assessment Issue Brighton Pty Ltd entered into a complex set of arrangements involving the transfer of assets in subsidiaries which resulted in various capital gains. Brighton lodged a tax return showing a taxable income of $46m. In 2018, the Commissioner issued Brighton Pty Ltd with an amended assessment increasing its taxable income by $23m as a result of share disposals. In 2019, the Commissioner issued a second amended assessment that increased Brighton’s taxable income by a further $51m. This amended assessment was issued on the basis that the general anti-avoidance provisions in ITAA36 Pt IVA applied, and included the $23m capital gain. The second amended assessment effectively double counted the $23m which had already been added to Brighton’s taxable income as a result of the first amended assessment. The ATO would rely on the “compensating adjustment” power in s 177F(3) of Pt IVA to refund the $23m if it turned out that the amount should not have been included in the second amended assessment. Brighton wishes to challenge the second amended assessment on the ground that the Commissioner deliberately overstated Brighton’s taxable income by including $23m in its taxable income twice, and had purported to make an assessment that was known to be incorrect and, therefore, invalid. Explain whether Brighton is likely to be successful in its challenge to the amended assessment. Solution Brighton Pty Ltd is in a similar situation to the taxpayer in FC of T v Futuris Corporation Ltd 2008 ATC ¶20-039. The taxpayer in Futuris Corporation also received two amended assessments, with the second increasing the taxpayer’s taxable income by $83m, which included $19m that had already been added to the taxpayer’s taxable income by the first amended assessment. The taxpayer instituted proceedings in the Federal Court under the Judiciary Act 1903 s 39B. Section 39B allows people affected by decision-making by an officer of the Commonwealth to have the decision reviewed. The aim is to have the decision set aside on the ground that there has been an error of law (a jurisdictional error) in the decision-making process that makes the decision invalid. The Commissioner argued that Futuris Corporation could not challenge the amended assessment in s 39B proceedings but only under proceedings under TAA Pt IVC. The High Court rejected the taxpayer’s argument that it could rely on s 39B to have the second amended assessment set aside. The taxpayer’s argument failed because, where the Commissioner makes an assessment that is final and definitive in form, and not tentative, provisional or affected by conscious maladministration, ITAA36 s 175 applies to protect the assessment and s 39B cannot apply. Section 175 states that the validity of an assessment is not affected by non-compliance with any of the

provisions of the income tax laws, although failure to exercise the assessment power in good faith is not protected. According to the High Court in Futuris Corporation, deliberate double counting of assessable income subject to later compensating adjustments does not constitute lack of good faith. Section 175 does not protect the Commissioner if no assessment has been made. This may be the case if the taxpayer could show that a formally proper assessment is tentative or provisional, or affected by conscious maladministration. There would then be no “assessment” to protect, and remedies under, for example, s 39B may be available for the taxpayer to remedy a jurisdictional error. The message from the Futuris Corporation decision is that the taxpayer’s ability to choose how assessments could be challenged was very limited and the likelihood of success very low. Once other avenues of challenge were closed off and Futuris Corporation was forced into the Pt IVC appeal procedure, the potency of s 175 as a weapon in the hands of the Commissioner was a severe obstacle for the taxpayer. Brighton’s challenge to the assessments would likely face these same obstacles and its challenge may have the same lack of success. AMTG: ¶25-100, ¶28-180

¶11-280 Worked example: Director’s penalties Issue When George Saunders became the director of a company in 2016 he satisfied himself that the company had no outstanding tax liabilities. There were two other directors, and George regarded them as being in charge of the management of the company. In 2018, George became concerned about the management of the company. He discovered that it had not been remitting PAYG deductions to the Commissioner as required under TAA Sch 1 Div 16. George informed the ATO of the company’s liability and attempted to raise and pay the amount himself, but was only able to discharge a small part of the debt. In 2019, he tried unsuccessfully to persuade the other directors to put the company into liquidation. In December 2019, George received a notice from the ATO stating that, 21 days after receipt of the notice, he would be liable to pay a penalty equal to the amount of the unremitted PAYG deductions. The penalty would be remitted if, by the end of 21 days, the liability had been discharged, an administrator of the company had been appointed or the company had begun to be wound up. George attempted again, unsuccessfully, to persuade the other directors to agree to put the company into liquidation. In February 2020, the Commissioner issued a director penalty notice to George requiring him to pay the amount of the company’s unpaid liability. George Saunders wants to know if he has any defences against the imposition of the director penalty. Solution Special regimes in TAA Sch 1 Div 268 and 269 enable the Commissioner to recover from the directors of companies unpaid amounts under the PAYG withholding system. Division 268 applies where the Commissioner makes a reasonable estimate of a person’s PAYG liability or the amount of unpaid superannuation guarantee charge for a quarter. Division 269 applies where a company has failed to remit amounts in respect of PAYG withheld, an alienated personal services payment received, a non-cash benefit provided, an estimate under Div 268 or superannuation guarantee charge for the quarter. Under Div 269, there is a duty on a director of a company to ensure the company: • meets its obligations to remit amounts • goes into voluntary administration, or • begins to be wound up (s 269-15). If the company fails to undertake one of these options by the due date for the remittance of the deductions or amounts withheld, the directors of the company are each personally liable to pay to the Commissioner, by way of penalty, an amount equal to the unpaid amount of the company’s liability (s

269-20). Before instituting proceedings to recover, by way of penalty, the unpaid amount of the company’s liability, the Commissioner must give 21 days’ notice (s 269-25). The person to whom a notice is sent does not have to be a current director. It is sufficient if the person is in office for at least some of the period before the due date when the company became liable to make the payment (Canty v DFC of T 2005 ATC 4470). A director has three possible defences against proceedings to recover the penalty: • they were not involved in the management of the company for a good reason such as illness and it was reasonable for them not to be involved • they took all reasonable steps to ensure the directors complied, or there were no reasonable steps they could have taken, and • in relation to unpaid superannuation guarantee charge, the company treated the superannuation guarantee charge legislation as applying to a matter in a way that was “reasonably arguable” and the company took reasonable care in applying the legislation (s 269-35). In practice, it can be very difficult to satisfy these defences. The facts encountered by George are similar to the situation of the director in DFC of T v Saunig 2002 ATC 5135 where a director who had concerns about the management of a company was unable to rely on the defence that he had taken all reasonable steps to ensure compliance. The New South Wales Court of Appeal said the test of what is “reasonable” is objective. It is not decided only by reference to what a director knew or did not know, but also by reference to what ought to have been known. It was no defence therefore for the director that he did not know amounts had not been remitted or that he had obligations under the legislation. The court acknowledged that the director had tried to convince the other directors, but noted that, as a single director, he could have caused the company to begin to be wound up and should have obtained professional advice at an earlier stage. On the basis of the Saunig case, George’s chances of successfully raising a defence to being personally liable for the company’s debts seem very slim. AMTG: ¶25-560

¶11-300 Worked example: Taxpayer’s right to information Issue Sayed Pont, an engineer, received a notice of assessment for the 2018/19 income year on 11 December 2019. In assessing Sayed, the ATO disallowed various deduction claims and imposed penalty tax for failing to take reasonable care. Sayed wants to challenge the assessment but believes that the lack of information makes it very difficult to show that the assessment is excessive or has been invalidly made. He asks whether he has the right to obtain a copy from the ATO of the relevant documents, and his rights of discovery as to the method by which the ATO arrived at his taxable income. Solution The income tax legislation does not specifically require the Commissioner to provide information to a taxpayer. Sayed’s best chance of obtaining a copy of the information in the possession of the ATO is to use the Freedom of Information Act 1982 (FOI Act). Under the FOI Act, every person has a legally enforceable right to access a “non-exempt document” held by a Commonwealth agency such as the ATO. A request for information, which is free, must be in writing and preferably made on the “Request under the Freedom of Information Act 1982” form available on the ATO website. The FOI Act has been used by taxpayers in a number of cases to gain access to ATO documents, for

example: • in Murtagh v FC of T 84 ATC 4516, a taxpayer successfully applied for access to ATO internal working documents • in McKinnon v FC of T 2002 ATC 2043, an applicant was granted access to a final report by a consultant to the ATO on proposals to simplify the personal income tax system, and • in Walker & Ors v FC of T 95 ATC 2001, taxpayers were granted access to file notes disclosing the views of ATO officers on the application of the anti-avoidance provisions. The ATO can deny access to documents on various grounds, including: • where disclosure of documents could reasonably be expected to prejudice the conduct of an investigation into tax evasion or prejudice the proper administration of the law (FOI Act s 37) • where disclosure of documents or the information contained in them is prohibited under the secrecy provisions (FOI Act s 38) • where the documents are protected by legal professional privilege (FOI Act s 42) • where the documents contain material obtained in confidence (FOI Act s 45), and • where the documents disclose trade secrets or commercially valuable information (FOI Act s 47). If the ATO refuses to provide information, the applicant can seek review of the decision either by the ATO itself or by the Australian Information Commissioner, with a further right of review by the AAT. The FOI Act makes a significant amount of information potentially available to taxpayers and can be of considerable benefit, particularly if it is used in conjunction with other legislation. For example, information obtained under the FOI Act about a decision could support an application for review of that decision under the Administrative Decisions (Judicial Review) Act 1977 or other legislation. AMTG: ¶28-060

¶11-320 Worked example: Administrative penalties under the uniform penalty regime Issue Dorothy Stevens owns and operates a hairdressing salon. Her clients can pay up to $150 for her services. Some of her clients are accountants and tax agents from whom she seeks advice about her tax affairs. In addition to paying for their hair treatments, a number of clients also “tip” Dorothy for her skill and personal attention. During the 2019/20 year Dorothy declared a taxable income of $95,000 in her income tax return. However, Dorothy failed to include “tips” received during the year, amounting to $6,500. Further, Dorothy failed to include a balancing adjustment from the disposal of hairdressing equipment, where the termination value exceeded the adjustable value by $3,800. Following a tax audit the Commissioner issued Dorothy with a notice of an amended assessment which increased Dorothy’s taxable income by $10,300. The Commissioner also imposed an administrative penalty of 25% under the administrative penalty regime as well as a general interest charge (GIC). Although Dorothy accepts the amended assessment she would like to appeal against the imposition of the administrative penalty and the GIC. Advise Dorothy Stevens on the basis for calculation of penalties and defences under the uniform penalty regime and the GIC. Solution The uniform penalty regime in TAA Sch 1, Pt 4-25 imposes administrative penalties across a range of breaches of the taxation law, such as, failure to lodge documents or making false or misleading

statements in respect of income tax law. The penalties are based on “penalty units”. For 2019/20, the dollar value of one penalty unit was $210. In general, there is a “base penalty” amount, which may be increased or decreased or remitted depending on aggravating or mitigating factors. There are a number of defences available to taxpayers for arguing for a reduction or remission of administrative penalties. A common reason for the imposition of an administrative penalty is a “taxation shortfall”, where tax paid was less than properly payable, as shown on the amended assessment (s 284-80). The GIC is imposed where, for example, there is an underpayment of tax following an amended assessment or a failure to pay tax by the due date. It is intended to discourage taxpayers from not paying tax due or not paying on time. The GIC is calculated under TAA s 8AAC, on a compounding daily basis, by adding 7% to the basic interest rate (being the monthly average yield on 90-day bank accepted bills). Division 284 tax shortfall penalties TAA Div 284 sets out the circumstances in which administrative penalties apply for making false or misleading statements and taking a position that is not reasonably arguable. It also sets out the amount of those penalties. A taxpayer will be liable for an administrative penalty if they make a statement about a tax-related matter that is false or misleading in a material particular to the Commissioner (s 284-75). A statement may be false or misleading either because of things contained in it or omitted from it, such as, omitting income that is assessable or claiming a deduction where expenditure has not been incurred. Where the statement leads to a “tax shortfall” (Practice Statement PS LA 2012/5) the “base penalty” is a set percentage of the shortfall, ranging from 75% down to 25% of the shortfall amount (s 284-90). There are defences available to the taxpayer where no administrative penalty will be imposed: • the taxpayer has taken reasonable care, and • the taxpayer’s position is reasonably arguable. Taxpayer has taken reasonable care (s 284-75(5)) Where the shortfall amount is caused by the failure of the taxpayer to take reasonable care to comply with the taxation laws, the taxpayer is liable to a penalty of 25%. Reasonable care requires the taxpayer to take the same care in fulfilling their tax obligations as could be expected of a reasonable person in their shoes and will depend on the facts and circumstances of each case. Miscellaneous Taxation Ruling MT 2008/1 provides some guidance. Reasonable care takes into account: • the taxpayer’s personal circumstances • whether the taxpayer carries on a business • whether the taxpayer has made reasonable inquires or sought professional advice, and • whether the taxpayer has obtained a private ruling. Taxpayer’s position is reasonably arguable A separate defence is to argue that the taxpayer has taken a “reasonably arguable position”. If this is not accepted the penalty is 25% of the shortfall amount, if the shortfall amount exceeds the “reasonably arguable threshold” of $10,000 or 1% of the income tax payable (s 284-90, item 4). The test for reasonably arguable is whether, having regard to relevant authorities, it would be concluded that the taxpayer’s argument is about as likely to be correct as incorrect, or more likely to be correct than incorrect (s 284-15(1)). The Commissioner’s views are expressed in Miscellaneous Taxation Ruling MT 2008/2. The relevant authorities to be taken into account in determining whether the taxpayer’s position is reasonably arguable include taxation laws, decisions of courts or tribunals, extrinsic materials and public rulings (Sch 1 s 284-15(3); see Walstern Pty Ltd v FC of T 2003 ATC 5076).

Calculating the base penalty The base penalty amount is worked out using the table in s 284-90(1). Where the shortfall amount is the result of: • intentional disregard of a taxation law — 75% • recklessness — 50% • failure to take reasonable care — 25%. Aggravating factors applying to increase the base penalty The base penalty amount is increased by 20% (eg from 50% to 60% of the shortfall amount) where (s 284-220): • the taxpayer takes steps to prevent or hinder the Commissioner from finding out about the false or misleading nature of a statement or shortfall amount • the taxpayer became aware of the false or misleading nature of the statement or shortfall but failed to tell the Commissioner, or • the base penalty amount is payable for lack of reasonable care, recklessness, intentional disregard of the law or the taxpayer does not have a reasonably arguable case and the taxpayer was liable for a penalty for any of those reasons previously. Factors leading to a remission of the penalty A base penalty amount is reduced to the extent that the false or misleading nature of a statement or shortfall is attributable to (s 284-224(1)): • advice received from the Commissioner • a statement in an ATO publication, or • general administrative practice of the Commissioner. The base penalty amount may also be reduced for voluntary disclosure by the taxpayer (s 284-225; Miscellaneous Taxation Ruling MT 2012/3). Relief for inadvertent errors The ATO may provide penalty relief during their audits for inadvertent errors in tax returns and activity statements that are due to failure to take reasonable care or taking a position on income tax that is not reasonably arguable. Penalty relief applies to eligible individuals and entities with a turnover of less than $10m, including small businesses, SMSFs, strata title bodies, not-for-profit organisations and cooperatives. Wealthy individuals and their businesses are excluded. Relief is also not available if in the past three years the taxpayer: • has had penalty relief applied • has been penalised for reckless or intentional disregard of the law • has evaded tax or committed fraud • has been involved in the control or management of another entity which has evaded tax, or • has incurred debts without the intention of being able to pay, such as phoenix activity. Penalty relief is available once every three years at most. The ATO will provide it automatically if it applies. Penalty relief was introduced from 1 July 2018 but can be applied after that date to earlier years. Advice to Dorothy Stevens

By failing to include her tips of $6,500 and the $3,800 balancing adjustment in her assessable income in her income tax return Dorothy has made a statement that is false or misleading in a material respect, resulting in a tax shortfall. By not paying the correct amount of tax on time, Dorothy leaves herself open to the imposition of the GIC and administrative penalty. The Commissioner has not found that Dorothy intentionally or recklessly made the false or misleading statement. The Commissioner has imposed a 25% base penalty on the grounds that Dorothy did not take reasonable care in the preparation and submission of her income tax return. In practice, the Commissioner would be likely to provide penalty relief to Dorothy. This is on the basis that the error was inadvertent and due to Dorothy’s failure to take reasonable care or that she took a position that was not reasonably arguable. If Dorothy has previously had penalty relief applied in the past three years (perhaps in relation to an audit for an earlier year that was settled after 1 July 2018), penalty relief would not be available for this period and penalties would apply. In that event, Dorothy is not able to use the “reasonably arguable position” defence as her penalty does not exceed her “reasonably arguable threshold” of $10,000 for the income year. There are no aggravating or remission factors which apply to increase, reduce or remit the base penalty. Dorothy is advised that she can lodge an objection against the Commissioner’s amended assessment (ITAA36 s 175A) and establish that she has taken reasonable care in the preparation and submission of her income tax return. If she is able to establish this, the base penalty amount should be remitted. The objection must demonstrate that the assessment is incorrect and what the correct assessment should be. Dorothy can argue that she did take reasonable care in that she sought taxation advice from her clients who are qualified accountants and tax agents. Further, Dorothy can argue that the tips were not in relation to the hairdressing services she provided, for which she was well remunerated, but were mere gifts inspired by goodwill and personal gratitude (Scott v FC of T (1966) 117 CLR 514). On the other hand, the failure to include the balancing adjustment in her income tax return does reflect a failure to make appropriate inquiries or seek appropriate professional advice. Dorothy could argue that the shortfall penalty should be reduced in that one of the two statements was reasonably arguable and did not reflect a failure to take reasonable care. AMTG: ¶28-010, ¶28-040, ¶29-000, ¶29-140, ¶29-160, ¶29-190

¶11-340 Worked example: Departure prohibition order Issue Tony Benton has an outstanding income tax liability of over $70,000. His income and assets indicate that he has the financial ability to pay the liability, however he has disputed the amount with the ATO and refused to pay the debt. The Commissioner issued a departure prohibition order (DPO) to prevent Tony from leaving Australia until he pays the tax liability or makes satisfactory arrangements for payment. Three months after the DPO was issued Tony’s elderly widowed mother who lives in the UK was diagnosed with a potentially terminal illness. Treatment is expected to last for at least a few months and the likelihood of a full recovery is uncertain. Tony wishes to care for his mother during her medical treatment. Advise Tony if the DPO can be revoked allowing him to leave Australia and travel to the UK to care for his mother? Solution Revocation of departure prohibition order The Commissioner is empowered to revoke a DPO under either TAA s 14T(1) or s 14T(2). Under s 14T(1), the Commissioner is required to revoke a DPO where either:

(a) the taxpayer’s tax liabilities have been wholly discharged and the Commissioner is satisfied that any impending tax liabilities arising out of a completed transaction can also be wholly discharged or would be completely irrecoverable, or (b) the Commissioner is satisfied that the tax liabilities are completely irrecoverable. Under s 14T(2), a DPO may be revoked at the Commissioner’s discretion for any reason not covered by s 14T(1). It is unlikely that the Commissioner will grant Tony a revocation of his DPO under s 14T(1). Tony’s tax liabilities have not been discharged and the Commissioner is unlikely to be satisfied that his tax liabilities are completely irrecoverable because the debt is still in dispute and Tony has the financial ability to pay it in full. It is also unlikely that the Commissioner will exercise his s 14T(2) discretion to revoke the DPO on compassionate or humanitarian grounds, that is the grounds relating to Tony’s sick mother. Practice Statement PS LA 2011/18 sets out the Commissioner’s policy for applying s 14T(2). Even though s 14T(2) provides the Commissioner with the discretion to revoke a DPO for any reason, the Commissioner is “not bound to consider any humanitarian circumstances” in deciding whether to exercise the discretion. PS LA 2011/8 cites an example of a taxpayer who has an ill spouse overseas as a situation in which the Commissioner will not revoke a DPO under s 14T(2) on “humanitarian grounds”. According to PS LA 2011/8, the Commissioner holds this view because humanitarian circumstances are addressed by TAA s 14U, which allows the Commissioner to issue the taxpayer with a departure authorisation certificate (see below) to allow a taxpayer to temporarily depart Australia for humanitarian reasons. Departure authorisation certificate Section 14U(1) enables a taxpayer, in respect of whom a DPO is in force, to apply to the Commissioner for a departure authorisation certificate (DAC) which, if granted, would permit the taxpayer to leave Australia temporarily, even though the DPO remains in force. The Commissioner must issue a DAC where either: (a) the Commissioner is satisfied that if the taxpayer is granted a DAC, it is likely that the taxpayer will return to Australia within an appropriate period, any liabilities will be discharged or irrecoverable, and it is not necessary or desirable for the taxpayer to give security under s 14U(2) for their return, or (b) where the Commissioner is not satisfied in relation to the matters in (a), then either: (i) the taxpayer gives security for their return to Australia in accordance with s 14U(2), or (ii) if the taxpayer is unable to give security, the Commissioner is satisfied that either: – a DAC should be issued on humanitarian grounds, or – that a refusal to issue a DAC would be detrimental to the interests of Australia. Based on the facts it is unlikely that the Commissioner will grant Tony a DAC under s 14U(1)(a). However, Tony may be able to obtain a DAC under s 14U(1)(b) if he either provides security to the Commissioner’s satisfaction, or satisfies the Commissioner that his mother’s illness constitutes relevant humanitarian grounds on which a DAC should be issued. If Tony decides to provide security for his return to Australia he must do so by a specified date or arrange for someone else to provide the security on his behalf. The security may be given by bond, deposit or any other means (s 14U(2)). The value of the security requested by the Commissioner may not be equal to the value of the tax liabilities. According to PS LA 2011/8, the following factors may be relevant in determining the amount of the security: • the risk that the taxpayer may not return to Australia as required under the DAC and the impact this would have on the prospects of the tax liabilities being wholly discharged • whether the asset being offered as security is owned by a person or entity other than the taxpayer

• the impact on the taxpayer (as distinct from the person or entity providing the security) should the security be forfeited due to their failure to return to Australia • the size of the security compared to the amount of tax liabilities outstanding • the size of the security compared to the value of assets controlled by the taxpayer • the willingness of the taxpayer to fully disclose financial and other information to enable the Commissioner to properly consider their application for a DAC. Only if Tony is unable to provide the required security would it be appropriate for him to apply to the Commissioner for a DAC on humanitarian grounds. In the context of s 14U, “unable” means something that the particular taxpayer could not do in the existing circumstances, and it is not enough that the taxpayer is merely either unwilling to do so, or unable to obtain the Commissioner’s agreement (Lui v FC of T (No 2) 2009 ATC ¶20-127). This means that Tony can only rely on humanitarian grounds to obtain a DAC if he truly cannot pay the security for financial, legal or other reasons; he cannot simply refuse to provide the security. AMTG: ¶25-550

GOODS AND SERVICES TAX AND OTHER INDIRECT TAXES Registration requirements

¶12-000

Taxable supply

¶12-020

Partly taxable supplies

¶12-040

GST registration and taxable supply

¶12-060

Change of supply; adjustment of input tax credits

¶12-100

GST adjustments; creditable purpose

¶12-120

Lease agreement; inducement payment; GST consequences

¶12-140

Second-hand goods

¶12-160

Digital currency transactions

¶12-170

Withholding obligations for new residential properties

¶12-175

GST; importer; exporter

¶12-180

GST payable; margin scheme

¶12-200¶12-220

Accounting for GST

¶12-240

Calculating the net GST amount for a tax period

¶12-260

Calculating the net GST amount for a tax period

¶12-280

Fuel tax credits

¶12-300

¶12-000 Worked example: Registration requirements Issue In July 2019, Aus Co commenced carrying on a business of selling customised protective covers for a new communication device, the e-Fone. Aus Co purchases the e-Fone covers from an Australian manufacturer and directly sells the covers to end consumers both in Australia and overseas. At the time the business commenced, it was anticipated that the first year’s gross turnover would be $62,000 from local sales and $15,000 from exports. In June 2020, the actual gross turnover for the first year of operations was $68,000 from local sales and $17,000 from exports. The amounts of GST that Aus Co paid to the manufacturer in the 2019/20 income year were $5,000 in relation to covers set aside for local sale and $1,000 in relation to covers set aside for export. Of these purchases, 20% of each category remained unsold at year end. The manufacturer’s practice is to send a tax invoice to Aus Co immediately the purchase order is approved. Note that all sales figures are GST-exclusive, and Aus Co uses the accruals basis of accounting for all of its accounting and tax obligations. Advise Ausco on the following issues: 1. Which of the local sales and the export sales are to be taken into account in determining turnover for registration purposes? 2. In which month would Aus Co be required to register for GST? 3. In what circumstances would the overseas sales be GST-free?

4. What are the total input tax credits in respect of the e-Fone cover purchases which Aus Co is entitled to claim for the 2019/20 income year? Solution (1) Sales included in registration turnover calculations Determining whether registration for GST is mandatory for an entity depends on whether the entity’s GST turnover meets or exceeds the registration turnover threshold (GST Act s 23-5). GST turnover (either the current GST turnover or the projected GST turnover) includes the value of all supplies made in the relevant period but specifically excludes the value of certain types of supplies (GST Act s 188-15 and 188-20). Neither the local sales nor the export sales fall within the excluded categories. Therefore, all of the sales are included in the registration turnover calculations. Note that the export sales are likely to be GST-free (GST Act s 38-185) but GST-free supplies are not excluded from the registration turnover calculation. (2) Mandatory registration Aus Co was required to register for GST in July 2019 when its GST turnover met the registration turnover threshold of $75,000. The registration turnover threshold requires consideration of both the current GST turnover (the turnover for the current month and preceding 11 months (s 188-15)) and the projected GST turnover (the expected turnover for the current month and next 11 months (s 188-20)). As none of the sales are input taxed supplies, they are all included in the turnover calculation. At July 2019, the projected GST turnover was $77,000 ($62,000 + $15,000) which exceeds the threshold of $75,000 (GST Act s 23-15). (3) GST-free exports The exported e-Fones would be GST-free under item 1 of the table in s 38-185(1) if Aus Co exports them within 60 days of the earlier of receiving any consideration from the customer or giving the customer an invoice. Note that the ATO accepts that the supplier has exported the goods once it has handed over possession of the goods to an international transport provider or delivered the goods to a ship or aircraft operator for the purposes of export (GST Ruling GSTR 2002/6). (4) Input tax credits Aus Co is entitled to claim $6,000 of input tax credits in respect of its stock purchases for the 2018/19 income year. All of its purchases are creditable acquisitions (GST Act s 11-5). Aus Co was required to be registered in July 2019 and the supplies of the stock from the manufacturer would have been taxable supplies in the hands of the manufacturer. Even though Aus Co makes some GST-free supplies, an entitlement to input tax credit does not require that the goods be used in making taxable supplies only. Aus Co accounts for GST on an accruals basis and therefore it is irrelevant that some stock is still unsold at year end. AMTG: ¶34-100, ¶34-110, ¶34-165

¶12-020 Worked example: Taxable supply Issue Bossy Pty Ltd (Bossy), is a Sydney-based company that is registered for GST. Janet North, a senior manager in the company is provided with a car that she uses for both private and business purposes. Bossy owns the car and pays FBT in respect of the private use. Janet is about to retire after working 15 years with Bossy. To show their appreciation for Janet’s long period of service the directors of Bossy intend to let her keep the car as a gift. Is the supply of the car to Janet a taxable supply for GST purposes? Solution

GST is charged or levied on the making of every “taxable supply” and “taxable importation” (GST Act s 71). For an entity, in this case Bossy, to make a taxable supply five cumulative conditions must usually be met. Bossy makes a “taxable supply” and therefore must charge GST if (GST Act s 9-5): (a) it makes a taxable supply for consideration (b) the supply is made in the course or furtherance of an enterprise that it carries on (c) the supply is connected with the indirect tax zone (d) Bossy is either registered or required to be registered, and (e) the supply is not GST-free or input taxed. Supply for consideration Consideration is defined in GST Act s 195-1 to mean “any consideration, within the meaning given by GST Act s 9-15, in connection with the supply”. The s 9-15 definition refers to “any payment, or any act or forbearance, in connection with” the supply. Consideration may therefore be in non-monetary form. The Explanatory Memorandum to the A New Tax System (Fringe Benefits) Bill 2000 states that “services provided by an employee would constitute ‘consideration’ within the broad definition of that term in section 9-15”. Even though that Explanatory Memorandum discusses amendments to the GST Act in relation to the supply of fringe benefits, parliament’s interpretation that consideration would include services provided by an employee to their employer would apply equally to supplies that are not fringe benefits. The s 9-15 definition of consideration does not differentiate between supplies of fringe benefits and other supplies. There is a direct connection between Janet’s employment services to Bossy, and Bossy’s supply of the car. Accordingly, the s 9-5 requirement that the supply of the car is made for consideration, where the consideration is Janet’s services to Bossy, is satisfied. Supply is made in the course or furtherance of an enterprise Bossy is carrying on an enterprise. It makes the supply of the car to Janet in the course of its enterprise as it is done in acknowledgement of services rendered by an employee in the enterprise. Therefore the enterprise condition in s 9-5 is satisfied. Indirect tax zone GST Act s 9-25 sets out the situations in which a supply is “connected with the indirect tax zone”. Under s 9-25(1), a supply of goods is connected with the indirect tax zone if the goods are delivered, or made available, in the indirect tax zone to the recipient of the supply (ie Janet). The indirect tax zone means Australia, with some exclusions that do not apply in this case (s 195-1). Bossy is located in Sydney and the motor car is provided to Janet there. Accordingly, the indirect tax zone requirement in s 9-5 is satisfied. Registration As stated in the facts, Bossy is registered for GST. This condition is satisfied. Exclusions No part of the supply of the car is a GST-free supply (under GST Act Div 38) or an input taxed supply (under GST Act Div 40). Therefore, no part of the supply is excluded from being a taxable supply. The supply of the car to Janet is a taxable supply as all of the conditions in s 9-5 have been met. Therefore, Bossy will be required to remit GST in relation to the transfer of the car. AMTG: ¶34-105

¶12-040 Worked example: Partly taxable supplies

Issue Amchem Pty Ltd operates a chain of chemists throughout Australia. The company has discovered that it can increase business by taking phone orders and delivering the orders to its customers. One particular order contained the following items: Item

Value

GST

Price

$

$

$

Mens aftershave (taxable) Medicines (GST-free)

200 50

20.00 220.00 0

50.00

Electric shavers (taxable)

400

40.00 440.00

Tablets (GST-free)

300

0 300.00

Delivery (taxable)

20

2.00

22.00

Packaging (composite cost)

30

3.00

33.00

What are the GST implications? Solution In determining how to apportion a supply that is taxable and non-taxable, reference can be made to GST Ruling GSTR 2001/8 with regards to reasonable methods to apply. Generally, the ruling indicates that any reasonable method of apportionment will be acceptable provided it is supportable and appropriate records are kept. A direct method is preferred but if it is not practical an indirect approach can be used. A direct method apportions a mixed supply on the basis of relevant variables such as price, time to perform a service or an area of property. The ruling indicates an indirect method may include the cost and profit margin of separate items being used to estimate the portion of items contained in a package. Apportionment could also be based on cost and the usual mark-up of the products when they are sold separately depending on how each separate product is sold. With regards to the order by Amchem, the delivery of the order is clearly a separate service and should be treated as a separate taxable supply. The packaging should be spread over all the items as it is composite to the whole order. A reasonable method of allocating GST-free ($350) and taxable items ($660) to the packaging would be to do so on the basis of price of each item, excluding delivery as this is a separate service. GST on the packaging: Packaging value × 10% × (taxable item price / total price) = $30 × 10% × ($660 / $1,010) = $1.96 AMTG: ¶34-105

¶12-060 Worked example: GST registration and taxable supply Issue Bob Slack is a builder who constructs new homes and also assists his customers with their home renovations. Bob is not currently registered for GST purposes. Bob’s income from his building activities was $65,000 in the 2018/19 tax year, and he expects to earn a similar amount during the 2019/20 tax year. In June 2019, he finished building an investment property south of Brisbane which he began to rent out as a residence in July 2019. The rental income he earned from this enterprise was $2,000 per month. In June 2020, Bob was

approached by a real estate agent asking whether he was interested in selling the investment property. The real estate agent had a client who was willing to pay up to $550,000 for the property. Bob is interested in selling the property, but is concerned about whether he will have to account for GST on the sale. Advise Bob whether he will be liable for GST on the sale of his investment property and indicate whether your advice would be different if Bob was registered for GST. Solution Bob would be liable for GST on the sale of his property if the supply was a taxable supply. To be a taxable supply under GST Act s 9-5, Bob must either be registered or required to be registered for GST. Since Bob is not currently registered, does he have a requirement to register? Bob would be required to register if his annual turnover meets the registration turnover threshold. According to GST Act s 23-15 (and GST Regulations reg 23-15.01), the registration turnover threshold is $75,000 per annum (or $150,000 per annum for non-profit bodies). In determining whether his turnover meets the threshold, we need to consider both his current annual turnover and his projected annual turnover. The calculation of Bob’s turnover is generally governed by GST Act Div 188. Specifically, turnover from supplies that are input taxed (s 188-15(1)(a) and s 188-20(1)(a)) is not included, nor is turnover from the sale of capital assets (s 188-25). Accordingly, the rental income and any proceeds from the sale of the investment property are not required to be included in the calculation of Bob’s turnover. Based on the information provided, Bob’s current and projected turnover would be $65,000. Since this is below the turnover threshold Bob is not required to register for GST and the sale of his property will not be subject to GST. If we instead assume that Bob is registered for GST then the first step is to establish if there has been taxable supply. A supply is a taxable supply under GST Act s 9-5 if: (a) The supply is for consideration — in this case, it would be. (b) The supply is made in the course or furtherance of an enterprise carried on by Bob. Bob is carrying on an enterprise of renting the property (even though this is an input taxed supply), so a sale of the property would be a supply made in the course or furtherance of that enterprise (GST Act s 9-20(1)). (c) The supply is connected with the indirect tax zone — since the property is located in Australia, the supply is connected with the indirect tax zone which is Australia. (d) Bob is registered or required to be registered for GST — in this case, Bob is registered. (e) The supply is not GST-free — GST Act Div 38 does not apply to the sale of real estate, so the supply is not GST-free. (f) The supply is not input taxed — since this property has not previously been sold as a residence, it is new residential premises as defined in GST Act s 40-75. The supply of new residential premises is not an input taxed supply (GST Act s 40-65(2)(b)). Since all the criteria of s 9-5 are met, the sale of the property is a taxable supply, and Bob would be required to account for 1/11th of the proceeds as GST, ie $550,000 × 1/11 = $50,000. AMTG: ¶34-100, ¶34-105

¶12-100 Worked example: Change of supply; adjustment of input tax credits Issue Leia Caldwell is a property developer who is registered for GST. In the 2018/19 income year she constructed 10 townhouses on a large suburban block. Leia intended to sell the 10 townhouses as new

residential premises with each sale considered a taxable supply for GST purposes. The 10 townhouses were placed on the market while they were being constructed. During the 2018/19 income year, Leia made creditable acquisitions totaling $3.3m and claimed $300,000 of input tax credits for materials used in the construction of the townhouses. In the 2019/20 income year, Leia only sold seven of the townhouses for the prices she was seeking. In that year she decided to keep the remaining three townhouses and lease them to tenants in the long term as she benefited from the regular cash flow for future property developments. Advise Leia as to whether she is still entitled to all of the $300,000 in input tax credits that she claimed, and the administrative mechanism for any adjustments to the input tax credits. Assume that Leia remits her Business Activity Statement (BAS) on a quarterly basis. Solution An input tax credit is a credit on an entity’s business inputs. The input tax credit available to an entity is the amount of tax paid (or payable) by it to acquire the inputs that it will use to generate its taxable and GST-free supplies. However, no GST is payable on a supply that is input taxed, and the entity cannot claim input tax credits for the GST payable on the inputs that relate to that supply (GST Act s 9-5, 11-15). The lease of private residential premises is input taxed if the premises are to be used predominately for residential purposes (GST Act s 40-35), and accordingly, no GST is payable on the supply and no input tax credit can be claimed on inputs to make the supply. Leia’s original intention was to only make taxable supplies by selling the 10 townhouses as new residential premises entitling her to the full input tax credit claimed. However, based on the change of intention, that is from selling the remaining three townhouses as taxable supplies to renting them, she is now making input taxed supplies on these three residential premises. This change of supply requires Leia to correct the amount of input tax credit she had originally claimed and remit, via her BAS, the proportion of the input tax credit to which she is now no longer entitled. Adjustments to previously declared input tax credits are required where input tax credits claimed are incorrect. This includes changes to intended use as is the case in this situation (GST Act Div 129). Adjustments can be either increasing adjustments or decreasing. An increasing adjustment increases the net amount of GST for a tax period by reducing the input tax credit on acquisitions (GST Act s 19-50, 1975, 19-80). The amount of the increasing adjustment that Leia must remit is calculated as follows: Increasing adjustment = full input tax credit (intended use − actual application) = $300,000 (100% − 70%) = $90,000 (GST Act s 129-70) The timing of the adjustment to the BAS is set out in GST Act s 129-20 and explained by the Commissioner in GST Ruling GSTR 2009/4. Given that the creditable acquisition amount to which the input tax credits pertain is greater than $500,000, the increasing adjustment is made over 10 adjustment periods commencing for the BAS relating to the period ended 30 June 2020. AMTG: ¶34-110, ¶34-145, ¶34-170, ¶34-230

¶12-120 Worked example: GST adjustments; creditable purpose Issue Fiona Wilkes runs a delivery business and is registered for GST. Fiona purchased a Ford Falcon for $33,000 (GST inclusive) on 15 October 2014 to use in her delivery business. Fiona had planned to use the vehicle 90% for business and 10% privately. However, on 21 April 2016 Fiona calculates that she has used the vehicle 80% for business and 20% privately. During the year ended 30 June 2017 the vehicle was used 95% for business and only 5% privately. Unfortunately, on 1 September 2017 the vehicle was damaged in an accident and was not used for three

months while the car was off the road and the damages were repaired. For the period to 30 June 2018 the vehicle had been used 90% for business and 10% privately. Then for the period to 30 June 2019 Fiona discovers that her vehicle usage was 92% business and 8% private while for the year ended 30 June 2020 the vehicle’s usage indicated 88% business and 12% private. What is the impact of the change in use of the vehicle on the net amount of GST? Solution The period of time after acquisition in which an adjustment is required depends on the GST-inclusive value of the acquisition and whether or not it relates to business finance. In this case the adjustment does not relate to business finance and the adjustment periods for an item between $5,001 and $499,999 is five adjustment periods. In this case the vehicle was acquired for $33,000 (GST Act s 129-20(3)). The first adjustment period is the tax period that starts at least 12 months after the end of the tax period in which the acquisition was made and ends on the following 30 June (s 129-20). The delay in the first period is designed to allow adequate time to assess the use of the item. To work out if an adjustment arises for an acquisition or importation, you compare the “actual application of the thing” with the “intended or former application of the thing”. The intended or former application of a thing is either: • the planned application for a creditable purpose as at the time the thing was acquired or imported (ie the intended use), or • if there has been a previous adjustment under GST Act Div 129 for the thing — the actual application of the thing in respect of the previous adjustment period (ie the former use). Fiona Wilkes has made a creditable acquisition of a motor vehicle but the private use is not a creditable purpose and therefore the input tax credit must be apportioned (GST Act s 11-30). At the time of purchase the percentage of business use was estimated at 90% and therefore the input tax credit would be $2,700 ($3,000 × 90%). In the case of adjustment events the adjustments are attributed to the tax period in which the entity becomes aware of it. Five adjustment periods are required and for the first adjustment period ending 30 June 2016, business use was only 80% instead of the expected 90% resulting in an increasing adjustment of $300 ($3,000 × 10%) (GST Act s 19-50). This increasing adjustment is made to take account of the reduced input tax credit entitlement due to the increased private use. See GST Ruling GSTR 2000/24. In the second adjustment period ending 30 June 2017, business use was 95% resulting in a decreasing adjustment of $150 ($3,000 × 5%) (GST Act s 19-55). This decreasing adjustment is made to take account of the increased input tax credit entitlement due to the increased business use. For the third adjustment period ending 30 June 2018, business use was 90% resulting in no adjustments. It is also noted that in calculating the actual use of the vehicle, Fiona can ignore the three-month repair period. Therefore, provided her actual usage pattern does not change for the remainder of the adjustment period, the actual application of the vehicle for creditable purposes remains at 90%. For the fourth adjustment period ending 30 June 2019, business use was 92% resulting in a decreasing adjustment of $60 ($3,000 × 2%) (s 19-55). Finally in the fifth adjustment period ending 30 June 2020, business use was only 88% instead of the expected 90% resulting in an increasing adjustment of $60 ($3,000 × 2%) (s 19-50). The overall result after the five adjustment periods is an increasing adjustment of $150. An entity must also hold an adjustment note (GST Act s 29-75) at the time it lodges its tax return for the tax period in which the adjustment is claimed (GST Act s 29-20). The adjustment note must be issued by the supplier within 28 days after either receiving a request from the recipient or becoming aware of the adjustment provided that a tax invoice was issued in relation to the original supply (s 29-75). AMTG: ¶34-145

¶12-140 Worked example: Lease agreement; inducement payment; GST

consequences Issue Tim West and Associates is a partnership of solicitors that is registered for GST and is planning to move to new rented office premises. In the current economic climate there is a surplus supply of office space so the firm was able to negotiate with the landlord to pay the partnership an inducement fee of $30,000 to enter the new lease agreement. The partnership will use these funds to refurnish the new premises. What are the GST consequences, if any, for either party as a result of entering the lease agreement and the inclusion of the inducement payment? Solution Entering into the lease agreement creates the supply of a service (access to the premises) by the landlord to the solicitors’ partnership. The “consideration” is the rental payments which are subject to GST in the hands of the landlord. As this is a commercial and not a residential rental agreement it is not input taxed. Presumably, both the landlord and the tenant solicitor’s firm are registered for the GST. In relation to the inducement payment, it is also necessary to consider if there is a supply and consideration. Under GST Act s 9-5 the solicitors’ partnership (the tenant) has made a supply by agreeing to enter the lease contract and the consideration received is the inducement payment. As a result the lessee partnership is liable to remit GST to the ATO at the rate of $30,000 / 11 = $2,727.27 (see GST Ruling GSTR 2003/16). On the other hand, where a lessee pays a lease premium in order to secure a lease that will be a supply by the lessor who will be liable to account for the GST on the premium. It should be noted that lessors and lessees may pay to get out of a lease. If the payment is made by the lessor, the lessee must account for the GST. If the payment is made by the lessee, the lessor must account for the GST. AMTG: ¶34-105, ¶34-230

¶12-160 Worked example: Second-hand goods Issue Melissa Downing is registered for GST and operates a second-hand furniture store. Melissa acquires most of her stock from other second-hand furniture stores while some are purchased directly from members of the public and through deceased estates. All of her sales are to non-registered customers. During the accounting period of October 2019 to December 2019 Melissa’s purchases included: Item

Dining table (deceased estate)

Cost

GST included in the price

Sold (including GST)

$

$

$

2,000

—

4,400

Filing cabinet

880

80

1,350

Computer desk incorporating new shelves

750

68.18

920

Lamp stand (deceased estate)

150

—

120

Chest of drawers (deceased estate)

280

—

460

What are the GST implications for Melissa for the quarter ended December 2019? Solution Special rules apply to the purchase of second-hand goods by second-hand dealers as these goods are usually acquired from non-registered persons. Second hand goods are defined as goods that have been

previously owned but do not include goods to the extent that they consist of valuable metal, animals or plants (see GST Determination GSTD 2013/2). GST Act Div 66 allows an input tax credit on the purchase of second-hand goods despite there being no GST in the purchase price in certain circumstances. Section 66-5 indicates that the acquisition of second-hand goods can be a creditable acquisition provided that the second-hand goods are for resale or exchange and not: • for manufacture • a GST-free supply • goods that are divided for re-supply • imported goods • hired, or • used to make a non-taxable supply. The dining table was purchased without GST included, however the purchase price is greater than $300. As the sale price is greater than the purchase price the input tax credit under s 66-10 will be 1/11 of the purchase price (1/11 × $2,000 = $181.82). GST liability on the sale is $400. The filing cabinet was purchased with GST included and the purchase price is greater than $300. As the sale price is greater than the purchase price the input tax credit under s 66-10 will be 1/11 of the purchase price (1/11 × $880 = $80.00) and treated as a normal creditable acquisition. The GST liability will be $122.72. The ATO accepts that new goods incorporated into second-hand goods lose their identity and become part of the second-hand item (see GST Determination GSTD 2000/2). Therefore, the computer desk and shelves were purchased with GST included and a purchase price which is greater than $300. As the sale price is higher than the purchase price the input tax credit under s 66-10 will be 1/11 of the purchase price (1/11 × $750 = $68.18) and treated as a normal creditable acquisition. The GST liability will be $83.64. The lamp stand was purchased without GST included in the price and for less than $300. As the sale price is less than the purchase price the input tax credit under s 66-10 will be 1/11 of the sale price (1/11 × $120 = $10.90). GST liability on the sale is also $10.90. The chest of drawers was purchased without GST included in the price and for less than $300. As the sales price is greater than the purchase price the input tax credit under s 66-10 will be 1/11 of the purchase price (1/11 × $280 = $25.45). GST liability on the sale is $41.82. Total GST input tax credits for the quarter ended December 2019 = $366.35. Total GST liability for the quarter ended December 2019 = $659.08. Net amount owing for the quarter ended December 2019 = $292.73. AMTG: ¶34-260

¶12-170 Worked example: Digital currency transactions Issue Robert owns a digital marketing agency and is registered for GST. He has just signed a contract to provide marketing services to Galaxy4 (a social media start-up) for a GST-inclusive price of $77,000. Galaxy4 is registered for GST. Galaxy4 wishes to pay for Robert’s services using digital currency. Robert has an agreement with BoosterPay, an intermediary, for BoosterPay to purchase digital currency from him, which Paul receives from Galaxy4 as payment for the sale of his marketing services. Under the

agreement, BoosterPay acquires the digital currency from Robert and then provides payment to Robert in Australian currency. Under the arrangement, Robert pays commission to BoosterPay equal to 1% of the amount paid by Galaxy4. BoosterPay agrees to deposit Australian currency (immediately or within one day) into Robert’s nominated bank account. There is no agreement between Galaxy4 and BoosterPay. What are the GST implications for Robert and Galaxy4 in relation to these transactions? Solution For supplies or payments made on or after 1 July 2017, the GST treatment of digital currency such as bitcoin is aligned with that of money. Per s 195-1 “digital currency” refers to digital units of value that: • are designed to be “fungible”, or fully interchangeable for the purpose of their use as consideration for a supply • are generally available to members of the public, without any substantial restriction on their use as consideration • are not denominated in any country’s currency • do not have a value that depends on the value of anything else (such as gold), and • do not give an entitlement to receive or to direct the supply of a particular thing, unless that entitlement is merely incidental. Prior to 1 July 2017, sales and purchases of digital currency (such as bitcoin) were subject to GST. This means that if you were registered for GST, you had to pay GST and were entitled to GST credits on any transactions in relation to digital currency. The practical effect of the pre 1 July 2017 rules is that businesses that used digital currency as a medium of payment or receipt within their business would have two GST transactions; one in relation to the actual supply of goods or services from their business and one in relation to the sale or purchase of digital currency associated with the payment or receipt. Since 1 July 2017, sales of digital currency are input taxed sales (financial supplies), which means that: • GST is not paid on the sales of digital currency made • GST credits generally can’t be claimed for the GST included in the price paid for anything purchased to make those sales. However, it may be possible to claim GST credits on purchases used to make digital currency sales in the following situations: • if the financial acquisitions threshold isn’t exceeded, in which case there is a full entitlement to GST credits for purchases relating to digital currency sales • if the financial acquisitions threshold is exceeded, it may be possible to claim reduced GST credits if specific types of purchases are made. Sections 189-5 and 189-10 of the GST Act set out when an entity will exceed the financial acquisitions threshold. The financial acquisitions threshold is exceeded if, based on purchases made over a 12-month period, you make or are likely to make, financial acquisitions where the input tax credits related to making those acquisitions would exceed the lesser of either: • $150,000, or • 10% of the total amount of input tax credits to which you would be entitled. When Robert accepts digital currency as payment, there are no GST consequences for Robert in relation to that payment. However, normal GST consequences arise in relation to the provision of services that Robert has made

for which the digital currency was payment. When Robert lodges his activity statement, he includes $7,000 GST for the taxable sale of marketing services to Galaxy4. When Galaxy4 lodges its activity statement, it claims a GST credit of $7,000 for the acquisition of Robert’s marketing services. The fact that the payment was in digital currency does not impact the GST outcome of the transaction. The sale of digital currency by Robert to the intermediary (through the transfer of digital currency received from Galaxy4) is an input taxed sale on which no GST is payable. BoosterPay would not generally be entitled to GST credits for its purchase of digital currency from Robert. As the commission charged by BoosterPay is in relation to an input taxed financial supply, ordinarily no GST credit would be available to Robert. However, depending on Robert’s circumstances, he may be entitled to a full GST credit if he does not exceed the financial acquisitions threshold, or a reduced GST credit. AMTG: ¶34-105, ¶34-190

¶12-175 Worked example: Withholding obligations for new residential properties Issue On 15 December 2019, Alan enters into a contract to purchase a new apartment from Well-Built Homes for $860,000. Settlement occurs on 28 May 2020. What are Alan’s GST withholding obligations in relation to the purchase in each of the following scenarios: • The margin scheme does not apply to the sale? • Alan and Well-Built Homes agree that the margin scheme should be applied to the sale? Solution Purchasers of newly constructed residential premises or new subdivisions of potential residential land have an obligation to withhold an amount on account of GST and remit it directly to the Commissioner (Administration Act, Sch 1, s 14-250). In general, the withholding obligation applies to any supplies for which any of the consideration (other than a deposit) is first provided on or after 1 July 2018. The obligation arises where there is a supply by way of sale or long-term lease of: • new residential premises other than those created through a substantial renovation of a building • subdivisions of potential residential land that is included in a property subdivision plan and does not contain any building that is in use for a commercial purpose. This would include house and land packages in areas zoned for residential premises (s 195-1; Administration Act, Sch 1, s 14-250). The obligation to withhold falls on the purchaser. In the case of joint purchasers, each is liable for the payment, and either may discharge it. Tenants in common are each liable for a share of the payment, proportionate to their interest in the property. Before making the supply (normally at settlement), the vendor must provide the purchaser with a written notice, stating whether the purchaser must remit the GST and if so, specifying how much, and when, plus other details such as the vendor’s ABN (Administration Act, Sch 1, s 14-255). This notice is normally included in the contract of sale. The amount required to be remitted to the ATO is based on the GST-inclusive price for the supply, which can normally be found in the contract. If the sale is subject to the margin scheme, 7% of the price needs to be remitted, with any subsequent adjustment needed to cover the actual margin scheme liability being made through the developer’s BAS. Otherwise, 1/11th of the price should be remitted. Where the supply is made between associates for less than the GST-inclusive market value, market value is substituted for

the price paid and the purchaser must remit 10% of that market value on the day on which the supply is made. The amount must generally be paid to the ATO on or before the day that any consideration for the supply, other than the deposit, is first provided. Typically, this will occur on settlement of the sale. The full amount must be paid even where the purchase price is paid in instalments. The purchaser can also provide the vendor with a bank cheque for the relevant amount made out to the Commissioner. In this case, the purchaser is protected from any penalties if the supplier does not pass this on to the Commissioner. Where the purchaser has fulfilled the requirement to withhold, the amount remitted reduces the price the purchaser is liable to pay to the supplier, and when the supplier lodges its BAS it will get a corresponding credit from the Commissioner for the amount paid (Administration Act, Sch 1, s 18-60). Margin scheme does not apply to the sale The contract of sale drawn up in relation to the transaction must include the required notice providing relevant details to enable Alan to withhold and remit the correct amount to the ATO at settlement. WellBuilt Homes advises Rick that he will be required to make a payment of $78,181 (1/11th of the contract price of $860,000) on or before the day of settlement. At the date of settlement, 28 May 2020, Alan’s conveyancer makes a payment to the ATO of $78,181 (the GST component of the purchase) and notifies the ATO of a payment of the withheld amount. The balance of the purchase price, $781,819, is paid to Well-Built Homes on settlement, which receives a credit for $78,181 in their BAS for the June 2020 quarter and accordingly does not have to pay this amount across to the ATO in relation to the sale. Note that because adjustments are not factored into the calculation, the actual GST payable by Well-Built Homes may be slightly higher or lower than the amount withheld by the purchaser. Margin scheme does apply to the sale In the contract of sale, the notice required to be provided by Well-Built Homes to Alan will instead advise that the GST amount Alan will be required to pay to the ATO is 7% of the contract price of $860,000. The resulting sum of $60,200 is paid to the ATO by Alan’s conveyancer at the date of settlement. AMTG: ¶26-330, ¶34-230

¶12-180 Worked example: GST; importer; exporter Issue Lanes Electrical Goods Pty Ltd (Lanes) is an Australian company that both imports and exports high quality white goods for the Australian public. During the 2019/20 tax year Lanes imported goods to the value of $180,000, excluding freight and insurance charges of $17,000 and customs duty of $12,000. The executive staff of the company used $30,000 worth of the imported goods for private purposes. Lanes also exported goods to the value of $100,000 during the 2019/20 tax year which were invoiced on 1 November and paid on 30 November 2019, but the actual export took place on 23 December 2019. Some of the goods Lanes have exported have also been re-imported back into Australia in their original state. During the 2019/20 tax year Lanes also took the opportunity to access some computer services from an overseas third party in order to upgrade its ordering and purchasing systems. This service cost Lanes a further $50,000. Of the services provided, 10% were used privately by some staff members of Lanes. What are the GST implications for Lanes? Solution Imports/creditable purpose GST is payable on imported goods that have entered Australia for home consumption and have cleared Australian customs control. GST is payable by the importer rather than the overseas supplier (GST Act s 13-5).

The GST is calculated as 10% of the value of the importation. The value incorporates the customs, insurance, freight value. The customs value is based on the free on board (FOB) value plus the additional costs of transporting the goods to their place of consignment in the indirect tax zone (Australia), including insurance and any customs duty or wine tax (GST Act s 13-20(2)). Calculation of the GST in this case is therefore 10% of ($180,000 + $17,000 + $12,000 = $209,000) = $20,900. The GST is payable in the same way and at the same time as customs duty would be payable (GST Act s 33-15(1)). In practice, a special deferred GST scheme will enable approved importers to defer the GST until the first business activity statement (BAS) is submitted after the goods are entered for home consumption subject to certain conditions. The deferral usually results in the GST being cancelled out as a corresponding input tax credit will be claimed in the same BAS return. This improves the cash flow of Lanes as they are not required to pay GST “upfront” (see GST Ruling GSTR 2003/15 generally). To be able to claim the GST credit, the taxable importation must be for a “creditable purpose” (see GST Ruling GSTR 2008/1). As the executive staff used $30,000 of the imported goods for private purposes, the extent of input tax credit is reduced in the formula in GST Act s 11-30(3) (ie it becomes partly creditable), and is calculated as: Full input tax credit × Extent of creditable purpose × Extent of consideration = $20,900 × 83% (150,000 / 180,000) × 100% = $17,347 Exports The supply of exports is GST-free if the supplier exports them from the indirect tax zone (Australia) before, or within 60 days after receiving any of the consideration for them. Where the goods have been invoiced before any payment is made, they must be exported before or within 60 days after the invoice is given (GST Act s 38-185(1)). Consequently, the export by Lanes is GST-free, as it is within 60 days (it is 53 days from 1 November 2019 to 23 December 2019). It is highly desirable that Lanes maintain records of shipping documents, airway bills, bills of lading, and other customs documentation to substantiate the timing requirements for exports to remain GST-free. When a supplier re-imports goods back into the indirect tax zone a supply is generally not GST-free. However, in Lanes’ case, as the goods have been exported and then returned to the indirect tax zone without having been subjected to any treatment, repair or alteration, they will still qualify as a non-taxable importation (GST Act s 42-10(1)). Offshore supplies of services A reverse charge rule may apply where an overseas provider supplies something other than goods or real property (GST Act Div 84). If the service is not provided through an Australian enterprise of the provider as is the case here, it would not be connected with Australia and the GST will not apply. To overcome this situation, GST will apply provided the following conditions are satisfied: • the supply is not connected with Australia • the recipient is registered or required to be registered • the supply is provided in return for consideration • the recipient acquires the thing supplied at least partly for the purposes of an enterprise that it is carrying on in Australia, and • the recipient does not acquire the thing supplied wholly for a creditable purpose. In this case the services provided to Lanes will be subject to GST and will be payable by Lanes under s 84-10 as a “reverse charge” as the overseas provider is not subject to the Australian GST system. GST =

10% of $50,000 price of supply = $5,000 (s 84-12). However, as some services were also provided privately to staff members the input tax credit would be adjusted accordingly. The input tax credit is then 10% more or (11/10) 110% of the credit that would have been allowed under the normal rules had it been a taxable supply s (84-13). Full input tax credit × Extent of creditable purpose × Extent of consideration = $5,000 × 110% (55,000 / 50,000) × 100% = $5,500 Also the Commissioner accepts that the recipient does not need to hold a tax invoice in order to claim the input tax credit in this case (GST Ruling GSTR 2000/17). AMTG: ¶34-105, ¶34-165, ¶34-250

¶12-200 Worked example: GST payable; margin scheme Issue Joanne Black, a property developer who, on 1 July 2000 registered for GST, bought land in January 2000 for construction of a house and sale. In January 2020, she sold the house and land for $640,000. At 30 June 2000, the house had been partly constructed and the costs incurred were: $ Land at cost

300,000

Local government application fees

4,000

Legal fees

2,000

Design fees

2,000

Labour

1,500

Materials

17,000

Subcontractors

23,000

Total

349,500

Assuming the total cost of completion was $500,000, what is the GST payable under the margin scheme? Solution The percentage completion as at 1 July 2000 is calculated at $349,500/500,000, or 70%. Therefore, the value of the house and land as at 1 July 2000 is 70% of $640,000 (GST inclusive sale price), or $448,000. The GST payable under the margin scheme is calculated as follows: Margin = GST inclusive sale price − value at 1 July 2000. = $640,000 − $448,000 = $192,000 GST payable = 1/11 of $192,000 = $17,454 Where the margin scheme (GST Act Div 75) has been applied to a property acquired by the taxpayer, s 75-20 denies an input tax credit on the acquisition even though the normal requirements of GST Act s 115 have been met. The input tax credit is denied as the margin only applies the GST to the value added

and not the full value of the supply. In general the supplier and recipient must agree in writing that the margin scheme is to apply. Under s 755(1A) the agreement must be made on or before making the supply, or within such further period as the Commissioner allows. Where a further period in which to make the agreement is denied, this becomes a reviewable GST decision (see TAA Sch 1 Subdiv 110-F). AMTG: ¶34-230

¶12-220 Worked example: GST payable; margin scheme Issue In March 1995, Hans Leiberman acquired a block of land. Due to the introduction of the GST regime, he registered and obtained a market valuation as at 1 July 2000. The property was valued at $250,000 at that time. In February 2019, Hans decided to develop the property and build three new townhouses. He spent $1.1m on the preliminary work for the development. In November 2019, Hans was experiencing financial problems and decided to sell the property. At this time building of the townhouses had not yet commenced. In January 2020, Luke Tran purchased the property. Hans provided everything necessary to continue the development such as plans, contracts and supplies. In doing so, he was permitted to sell the property to Luke as a going concern. The consideration was $1.5m, and based on the going concern status, the sale was GST-free and no GST was levied on the sale. Both Hans and Luke are registered for GST. Luke spent an additional $330,000 completing the development and in February 2020, he sold the three townhouses for $900,000 each to purchasers not registered for GST. What are Luke’s GST liabilities in relation to the development of the townhouses? Would he have been better off using the margin scheme rather than purchasing the property as a going concern? Solution The sale of a new residential premises is a taxable supply (GST Act s 40-65). GST may be payable on the supply where the vendor is registered for GST such as builders and developers. However, a partially built building is not a residential premises until it becomes fit for human habitation (GST Ruling GSTR 2012/5). Hans and Luke had three options in relation to the GST liability on the sale. Hans could have sold the property to Luke as: (i) a taxable supply under standard GST conditions, (ii) as a going concern, or (iii) under the margin scheme. Where a purchase of land is part of the acquisition of a going concern, the acquisition is GST-free. The supply of a going concern is GST-free if: • the supply is for consideration • the recipient is registered or required to be registered • the supplier and the recipient have agreed in writing that the supply is of a going concern • the supplier supplies the recipient with all of the things that are necessary for the continued operation of the enterprise, and • the supplier carries on the enterprise until the date of sale (GST Act s 38-325). The margin scheme can apply to calculate the GST on the taxable supply of real property (GST Act Div 75). The margin scheme was introduced so as not to disadvantage transactions where the vendor purchased the property prior to the introduction of the GST regime. The supplies of real property that may be eligible for the margin scheme are:

• the sale of a freehold interest in land • the sale of a stratum unit, and • the grant or sale of a long-term lease (50 years or more) (GST Act s 75-5(1)). Under the margin scheme, the GST payable is calculated on the “margin” for the supply, rather than on the consideration. Generally, the margin is the excess of the consideration for the supply over the acquisition consideration or, if the interest, unit or lease was acquired by the vendor before 1 July 2000, its value at that date (GST Act s 75-10). Development purchased as a going concern Luke purchased the development from Hans as a going concern and did not pay any GST on acquisition of the property. At this point in time, the development was not fit for human habitation and therefore not considered a new residential premise. On the eventual sale by Luke of the new residential townhouses that are taxable supplies, Luke is required to levy GST on the sale. To determine the amount of GST, Luke is required to look through the transaction to the point in time where the property came into the GST net. The GST payable is then based on the uplift in value from 1 July 2000 even though Hans owned the property (GST Act s 75-11(5)). The GST is calculated as follows: Proceeds (3 × $900,000)

$2.7m

Valuation as at 1 July 2000 ($250,000) Uplift in value

$2.45m

GST

$222,727

Luke is required to charge $74,242 in GST for each of the purchase prices and remit this amount to the ATO. Under this arrangement, Luke can claim the $30,000 of input tax credits for any creditable acquisitions made in the conduct of the development. Luke’s net GST liability is therefore $192,727 (ie $222,727 less $30,000). Margin scheme Hans and Luke could have mutually agreed in writing to apply the margin scheme. Land that is part of a developer’s enterprise is a taxable supply (Miscellaneous Taxation Ruling MT 2006/1) and would be eligible for the margin scheme. The GST liability on the margin from the initial sale would be calculated as: Proceeds

$1.5m

Valuation as at 1 July 2000 ($250,000) Margin

$1.25m

GST

$113,636

This is the amount of GST under the margin scheme that Hans is required to charge Luke. The margin scheme could then be applied on the subsequent sale of the townhouses as new residential premises. The GST on the sale of the three new townhouses would be calculated as follows: Proceeds

$2.7m

Purchase price ($1.5m) Margin

$1.2m

GST

$109,091

Luke is required to charge $36,363 in GST for each of the purchase prices and remit this amount to the ATO. Where the margin scheme is chosen, there is a denial of input tax credits to the recipient of the supply (GST Act s 75-20). Accordingly, Luke cannot claim back the initial $113,636 on purchase if the margin scheme is applied. However, he is permitted to claim back the $30,000 in input tax credits with respect of the $330,000 development costs (s 11-5). The GST that the ATO receives from the sale of the townhouses is $222,727 regardless of whether the margin scheme or going concerns option is adopted. However, with the margin scheme option Luke has GST leakage of $143,636 since he cannot claim back any input tax credits. There is usually little benefit in using the margin scheme where the purchaser is a registered GST payer entitled to a full input tax credit. However, where the purchaser is not a registered GST payer (eg a private individual) or a person making input taxed supplies, there may be benefits in using the margin scheme so as to reduce the amount of GST on the purchase. In this case, the best option for Luke to limit his non-recoverable GST exposure is to apply the going concern option. AMTG: ¶34-230, ¶34-240

¶12-240 Worked example: Accounting for GST Issue ABC Ltd makes clothing fasteners such as zippers and buttons for clothing manufacturers. ABC is registered, uses the cash basis of accounting for GST, and has a turnover of $1m. “Pre-loved Clothing” company makes mass produced clothes for several retailers. Pre-loved Clothing is registered, uses the cash basis of accounting for GST and has a turnover of $1.8m. During the 2018/19 tax year the following transactions took place: • On 8 October 2018, in tax period 2, ABC delivered fasteners worth $8,800 to Pre-loved Clothing. On 11 December 2018, in tax period 2, ABC issued an invoice for $8,800 to Pre-loved Clothing. On 3 March 2019, in tax period 3, ABC received a payment of $8,800 from Pre-loved Clothing. • On 13 September 2018, in tax period 1, ABC made sales of $22,000 to other customers. • On 4 June 2019, in tax period 4, ABC made sales of $13,200 to other customers. • On 5 May 2019, in tax period 4, Pre-loved Clothing made payments of $5,500 to other customers. After operating on a cash basis for 12 months, ABC and Pre-loved Clothing both decided to change their attribution basis to accruals accounting. During the 2019/20 tax year the following transactions took place: • On 18 November 2019, in tax period 2, ABC delivered fasteners worth $11,000 to Pre-loved Clothing. On 14 February 2020, in tax period 3, ABC issued an invoice for $11,000 to Pre-loved Clothing. On 10 April 2020, in tax period 4, ABC received a payment of $11,000 from Pre-loved Clothing. • On 9 August 2019, in tax period 1, ABC made sales of $22,000 to other customers. • On 14 June 2020, in tax period 4, ABC made sales of $26,400 to other customers. • On 25 June 2020, in tax period 4, Pre-loved Clothing made payments of $3,300 to other customers. What are the GST implications for ABC and Pre-loved Clothing assuming GST returns are lodged quarterly and tax invoices are issued at the time of sales and purchases unless otherwise stated?

Solution Using the cash basis of accounting for ABC for 2018/19 Tax period 1 July–Sept 2018 Tax period 2

GST payable $2,000, input tax credit nil, net $2,000 owing to the ATO Nil

Oct–Dec 2018 Tax period 3

GST payable $800, input tax credit $0, $800 owing to the ATO

Jan–Mar 2019 Tax period 4

GST payable $1,200, input tax credit nil, $1,200 owing to the ATO

April–June 2019 Using the cash basis of accounting for Pre-loved Clothing for 2018/19 Tax period 1

Nil

July–Sept 2018 Tax period 2

Nil

Oct–Dec 2018 Tax period 3 Jan–Mar 2019 Tax period 4 April–June 2019

GST payable $0, input tax credit $800, $800 refundable from the ATO GST payable $0, input tax credit $500, $500 refundable from the ATO

Using the accruals basis of accounting for ABC for 2019/20 Tax period 1 Jul–Sep 2019 Tax period 2

GST payable $2,000, input tax credit nil, net $2,000 owing to the ATO Nil

Oct–Dec 2019 Tax period 3 Jan–Mar 2020 Tax period 4 April–June 2020

GST payable $1,000, input tax credit nil, net $1,000 owing to the ATO GST payable $2,400, input tax credit nil, net $2,400 owing to the ATO

Using the accruals basis of accounting for Pre-loved Clothing for 2019/20 Tax period 1

Nil

Jul–Sep 2019 Tax period 2

Nil

Oct–Dec 2019 Tax period 3 Jan–Mar 2020 Tax period 4

GST payable $0, input tax credit $1,000, net $1,000 refundable from the ATO GST payable $0, input tax credit $300, net $300 refundable from the

April–June 2020

ATO

Adoption of an accounting basis for the GST should be the one which produces a more favourable cash flow. As both ABC and Pre-loved Clothing Pty Ltd are small business entities (ie carrying on a business and satisfying the $10m aggregated turnover test for 2019/20 income year and prior years), they are entitled to account for GST on a cash basis. If the companies exceed this threshold, they would be required to account on an accruals basis unless permission has been granted to remain on a cash basis (GST Act Subdiv 29-B generally). It is noted that both ABC and Pre-loved Clothing were able to change their attribution basis (ie from cash basis to accruals) as a minimum period of 12 months had elapsed from the start of using a particular basis. It is also noted that small business entities and entities which do not carry on a business but that have a GST turnover of $2m or less will have the option to undertake annual apportionment of input tax credits for acquisitions used partly for non-business purposes. Importantly, ABC and Pre-loved Clothing will not be entitled to attribute an input tax credit to a tax period unless they have a tax invoice for the acquisition when they lodge their BAS for that period (GST Act s 29-10(3); see also Chalmers & Anor v FC of T 2008 ATC ¶10-021). AMTG: ¶34-130

¶12-260 Worked example: Calculating the net GST amount for a tax period Issue Reece Owens owns and operates a gift shop near Sydney Harbour which provides Australian souvenirs and local ornaments to both tourists and locals. The business also provides a photography service for people wishing to have a record of their visit to the harbour. The shop employs four general staff members and one photographer and is registered for GST. The shop operates from rented premises. For the tax period ending 30 June 2020 Reece reported the following transactions: Receipts (inclusive of GST where appropriate): $ Sale of merchandise

33,000

Sale of photos

11,000

Sale of old display table

2,500

Expenses (inclusive of GST where appropriate): Rent

6,000

Promotional advertising displayed at local tourist office

1,200

Repairs to photography equipment Building maintenance (no ABN supplied) Wages (including PAYG withholding)

450 1,100 88,000

Supplies of merchandise (tax invoice not received)

7,000

Purchase of new shop furniture

4,500

Repayments of business loan (interest $2,500, capital $500)

3,000

Determine the net GST amount for the tax period ending 30 June 2020, assuming all supplies are taxable (where appropriate), and that a valid tax invoice has been provided unless stated otherwise. Solution Receipts (inclusive of GST where appropriate) Taxable supplies under GST Act s 9-5

incl GST

GST

$

$

Sale of merchandise

33,000

 3,000

Sale of photos

11,000

 1,000

2,500

 227.27

Sale of old display table Total GST liability

4,227.27

Expenses (inclusive of GST where appropriate) incl GST

GST

$

$

Rent

6,000

545.45

Promotional sign

1,200

109.09

450

40.90

1,100

—

88,000

—

Merchandise supplies (tax invoice not received)*

7,000

—

New furniture for the shop

4,500

409.09

Repayments of business loan***

3,000

—

Repairs to photography equipment Building maintenance (no ABN supplied)* Wages, including PAYG withholding**

Total input tax credit entitlement

1,104.53 $   

GST liability

4,227.27

Less input tax credit

1,104.53

NET AMOUNT

3,122.74

Notes: * Not a creditable purpose (GST Act s 11-5 no valid tax invoice GST Act s 29-70(1)(b)) ** Excluded from the definition of enterprise (GST Act s 9-20(2)) *** Financial supply — input taxed (GST Act Div 40) AMTG: ¶34-010, ¶34-105, ¶34-110, ¶34-150

¶12-280 Worked example: Calculating the net GST amount for a tax period Issue Kate Adams is registered for GST, and accounts for GST quarterly on an accruals basis. During the quarter ending 30 June 2020 Kate’s records show the following transactions: Details

Amount $

Paid PAYG instalment

160,000

Paid PAYG withholding

216,000

Paid wages

356,000

Purchased BHP Billiton shares

660,000

Sold real estate costing $200,000 using the margin scheme

350,000

Paid Brokers’ fees relating to the purchase of BHP Billiton shares

6,600

Sold Anglo American Ltd shares

88,000

Paid brokers’ fees relating to the sale of Anglo American shares

880

Legal fees for drawing up the lease agreement for Kate’s office

10,000

Debt collection fees

25,000

Interest received on money lent to Kate’s brother-in-law

5,000

Interest paid on funds borrowed for Kate’s business

8,800

Purchased a commercial building in Burke Street, using the margin scheme. GST of $120,000 was included in the price

850,000

Traded in BMW motor car which had cost $120,000

88,000

Purchased a new Mercedes Benz motor car for the Managing Director

120,000

Paid fringe benefits tax

15,000

Note: All amounts include GST where applicable. Calculate Kate’s net GST amount for the quarter ending 30 June 2020. Solution Taxpayer Kate Adams Details

Amount

GST

Input tax credit

$

$

$

Paid PAYG instalment

160,0001

Paid PAYG withholding

216,0001

Paid wages

356,0002

Sold real estate costing $200,000 using the margin scheme

350,0003

Purchased BHP Billiton shares

660,0004

Sold Anglo American Ltd shares

13,636

88,0004

Brokers’ fees relating to the sale and purchase of shares

7,480

680

Legal fees for drawing up the lease agreement for Kate’s office

10,000

 909

Debt collection fees

25,000

  2,273

Interest received on money lent to Kate’s brother-in-law

5,0004

Interest paid on funds borrowed for Kate’s business

8,8004

Purchased a commercial building in Burke Street, using the margin scheme. GST of $120,000 was included in the price

850,0005

Traded in BMW motor car which had cost $120,000 Purchased a new Mercedes Benz motor car for the Managing Director Paid fringe benefits tax NET AMOUNT PAYABLE

88,0006

 8,000

120,0007

  5,235

15,0001 12,539

21,636

9,097

Notes: 1. Australian taxes, fees and charges are generally exempt from GST under GST Act Div 81, s 81-5(1). Discharging a liability to make a payment is not the provision of consideration to the extent that the payment is Australian tax. 2. Wages do not attract GST. This is because employees are not carrying on an enterprise in relation to their employment, so they cannot be registered for GST (see GST Act s 9-5 and 9-20(2)). 3. Where the margin scheme is used, GST is calculated on the margin for the supply rather than the consideration, ie 1/11 × ($350,000 − $200,000) = $13,636. 4. Shares and loans are financial supplies, and therefore input taxed. As such, there is no GST on sale and no input tax credit on purchase. 5. Under GST Act s 75-20, acquisitions where the margin scheme was used do not give rise to input tax credits. 6. Even though this vehicle was sold for more than the car limit of $57,581, GST is payable on the full amount of the consideration. 7. Vehicles purchased for more than the car limit do not qualify for full input tax credits. The input tax credit is limited to 1/11th of the car limit (GST Act s 69-10) (ie 1/11 × $57,581 = $5,235). AMTG: ¶34-010, ¶34-150

¶12-300 Worked example: Fuel tax credits Issue Charteris Haulage is a haulage and logistics company that transports goods around Australia by road, using a network of heavy goods vehicles. The company claims fuel tax credits in relation to the use of their heavy vehicles to transport goods. It has come to the attention of management that they may have been systematically under-claiming fuel tax credits for several years, at least as far back as the financial year ended 30 June 2013, due to incorrectly deducting road user charges associated with toll roads from the fuel tax credits claimed. The company’s Board believes that the road user charge is about compensating public authorities for the need to maintain public road surfaces and that toll roads are not public roads, being privately maintained by the toll operators. The Board of the company seeks advice as to whether their understanding that toll roads are not public roads for the purposes of the Fuel Tax Act is correct and whether they are able to amend fuel tax credit claims as far back as the financial year 2013. Solution Fuel tax credits provide a credit for the fuel tax (such as excise or customs duty) that is included in the price of fuel. Part 3-1 of the Fuel Tax Act (FTA) 2006 provides for fuel tax credits to ensure that, generally, fuel tax is effectively only applied to: • fuel used in private vehicles and for certain other private purposes, and • fuel used on-road in light vehicles for business purposes. To do this, a fuel tax credit is provided to reduce or remove the incidence of fuel tax applied to:

• fuel used in carrying on an enterprise (other than fuel used on-road in light vehicles) • fuel used for domestic heating and domestic electricity generation • fuel packaged for use other than in an internal combustion engine, and • fuel supplied into certain kinds of tanks. Section 41-20 of the FTA provides that a fuel tax credit is not available to the extent that fuel is acquired for use in a vehicle with a gross vehicle mass of four and a half tonnes or less travelling on a public road. This means that fuel tax credits are generally available in relation to fuel acquired for use in heavy vehicles such as those used by Charteris. Section 43-10 sets out how the amount of a fuel tax credit is to be calculated and also provides for circumstances in which that credit is to be reduced. Specifically, s 43-10(3) provides that to the extent that you acquire, manufacture or import taxable fuel to use, in a vehicle, for travelling on a public road, the amount of your fuel tax credit for the fuel is reduced by the amount of the road user charge for the fuel. “Vehicle travelling on a public road” is not defined in the FTA. The ATO considers that it is not restricted to registered vehicles and should be construed broadly to include any vehicle that can be authorised to travel on a public road by the relevant road traffic authority. The issue of what constitutes a public road was considered in Linfox Australia Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia [2019] FCAFC 131. The Court held that a public road is a road generally accessible as of right to the public and includes privately operated toll roads. Linfox had objected to an assessment made by the Commissioner in relation to its claim of fuel tax credits for fuel used in heavy vehicles operated by it on toll roads. Linfox had originally reduced the fuel tax credit it had claimed by the road user charge applicable at the time but now argued that the reduction was in error and that the road user charge should not apply as toll roads (such as the M2 motorway in Sydney and the Sydney Harbour Tunnel) are not public roads. As noted above, the Federal Court disagreed. However, there was also an issue as to whether Linfox was entitled to retrospectively alter its fuel tax claims because the additional credits had not been claimed in Linfox’s BAS within the relevant four-year period imposed by s 47-5 of the FTA. This section imposes a time limit on claiming fuel tax credits to the extent that those credits had not been taken into account in an assessment of a net fuel amount during the four years after the day on which the taxpayer’s tax return for the relevant tax period or fuel tax return period was due. The Commissioner accordingly claimed that Linfox’s entitlement to fuel tax credits had now ceased. The Federal Court rejected the Commissioner’s arguments on this issue and found that s 47-5 of the FTA did not operate to bar Linfox from claiming fuel tax credits (even though in practice there were no additional credits to be claimed because the issue around the definition of public roads was lost by the taxpayer). This was on the basis that the amount had been “taken into account” as it formed part of the calculation process in producing the net amount recorded in Linfox’s BAS. Note that similar wording to s 47-5(1) is also used in s 93-5 of the A New Tax System (Goods and Services Tax) Act 1999. Therefore, this decision will also be of relevance in a situation where a taxpayer seeks to claim an additional GST input tax credit out of the four-year time limit period. Applying the principles from the Linfox case to Charteris Haulage, it can be seen that the company is, in principle, able to amend fuel tax credits beyond the normal four-year window as the original assessment “took into account” the fuel tax credits, albeit that there was a dispute about the method of calculating those credits. However, no actual amendment can be made because the Board’s view that toll roads are not public roads is incorrect, meaning that no additional fuel tax credits can actually be claimed. AMTG: ¶40-200, ¶40-210

Case Table References are to Paragraph numbers. FC of T, DFC of T or other taxation authorities are listed alphabetically according to the name of the taxpayer. Administrative Appeals Tribunal and Taxation Board of Review cases are listed on page 563.

A Paragraph Alderton v FC of T 2015 ATC ¶10-407

¶9-240

All States Frozen Foods Pty Ltd v FC of T 90 ATC 4175

¶5-000; ¶5-020; ¶5080; ¶5-120; ¶5200

Allied Mills Industries Pty Ltd v FC of T (1989) 20 FCR 288

¶1-100

Allsop v FC of T (1965) 113 CLR 341

¶1-100

Anstis; FC of T v 2010 ATC ¶20-221

¶4-220

Applegate; FC of T v 79 ATC 4307

¶1-240; ¶1-260

Arnold & Ors; FC of T v 2015 ATC ¶20-486

¶11-060

Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314

¶1-320; ¶1-360

Athineos v FC of T 2006 ATC 2334

¶4-380

Australasian Jam Co Pty Ltd v FC of T (1953) 88 CLR 23

¶5-120

Australian National Hotels Ltd v FC of T 88 ATC 4627

¶4-200

B Paragraph BHP Billiton Finance Ltd; FC of T v 2010 ATC ¶20-169

¶4-080

Bamford & Anor v FC of T 2010 ATC ¶20-170

¶9-200

Barina Corporation Ltd v DFC of T 85 ATC 4186

¶5-000; ¶5-060

Binetter v FC of T; FC of T v Bai 2016 ATC ¶20-593

¶11-100

Bivona Pty Ltd; FC of T v 90 ATC 4168

¶4-080

Bohemians Club v Acting FC of T (1918) 24 CLR 334

¶1-140

British Insulated & Helsby Cables v Atherton [1926] AC 205

¶4-400; ¶6-000

Broken Hill Proprietary Company Ltd (The); FC of T v 69 ATC 4028

¶4-360

Brown; FC of T v 99 ATC 4600

¶4-180; ¶4-200; ¶4400

Burton v FC of T 2019 ATC ¶20-709; [2019] FCAFC 141

¶2-360

C

Paragraph CSR Ltd; FC of T v 2000 ATC 4710

¶1-100

Californian Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904) 5 TC 159 ¶1-180 Californian Oil Products (in liq) v FC of T (1934) 52 CLR 28

¶1-100

Canty v DFC of T 2005 ATC 4470

¶11-280

Casimaty v FC of T 97 ATC 5135

¶1-180

Chalmers & Anor v FC of T 2008 ATC ¶10-021

¶12-240

Citibank Ltd; FC of T & Ors v 89 ATC 4268

¶11-120

Collings; FC of T v 76 ATC 4254

¶4-240

Colonial Mutual Life Assurance Society Ltd v FC of T (1946) 73 CLR 604

¶1-140

Consolidated Fertilizers Ltd; FC of T v 91 ATC 4677

¶4-120

Cooke and Sherden; FC of T v 80 ATC 4140

¶1-200

Cooling; FC of T v 90 ATC 4472

¶1-220; ¶2-140

Corporate Initiatives Pty Ltd & Ors v FC of T 2005 ATC 4392

¶9-100

Cyclone Scaffolding Pty Ltd v FC of T 87 ATC 4021

¶5-000

D Paragraph Dalco; FC of T v 90 ATC 4088

¶11-180; ¶11-240

Denver Chemical Manufacturing Co v C of T (NSW) (1949) 79 CLR 296

¶11-220

Dibb v FC of T (2004) 55 ATR 786

¶1-420

Dunn; FC of T v 89 ATC 4141

¶1-340

Duro Travel Goods Pty Ltd; FC of T v (1953) 10 ATD 176; (1953) 87 CLR 524 ¶4-120

E Paragraph Economedes v FC of T 2004 ATC 2353

¶4-200

Eichmann; FC of T v 2019 ATC ¶20-728; [2019] FCA 2155

¶2-303

Ell & Anor v FC of T 2006 ATC 4098

¶4-380

Ellison v Sandini Pty Ltd; FC of T v Sandini Pty Ltd 2018 ATC ¶20-651

¶2-110

Elmslie & Ors v FC of T 93 ATC 4964

¶2-120

Esso Australia Resources Ltd v FC of T 2000 ATC 4042

¶11-120; ¶11-160

Evans v FC of T 89 ATC 4540

¶1-040

Everett; FC of T v 80 ATC 4076

¶8-180

Executor, Trustee & Agency Co of South Australia Ltd; C of T (SA) v (1938) 63 CLR 108

¶1-340; ¶1-360

F Paragraph Finn; FC of T v (1961) 106 CLR 60

¶4-220

Firstenberg; FC of T v 76 ATC 4141

¶1-340

Fortunatow v FC of T 2018 ATC ¶10-486; [2018] AATA 4621 ¶1-290 French; FC of T v (1957) 98 CLR 398

¶1-260

Futuris Corporation Ltd; FC of T v 2008 ATC ¶20-039

¶11-260

G Paragraph GE Crane Sales Pty Ltd v FC of T 71 ATC 4268

¶4-080

Galland; FC of T v 86 ATC 4885

¶8-180

Glenboig Union Fireclay Co Ltd v IR Commrs (1922) 12 TC 427 ¶4-120 Gray & Anor v FC of T 89 ATC 4640

¶2-140

H Paragraph Hancox v FC of T 2013 ATC ¶20-401

¶3-160

Harding v FC of T 2018 ATC ¶20-660; [2018] FCA 837

¶1-250

Harding v FC of T 2019 ATC ¶20-685; [2019] FCAFC 29

¶1-240; ¶1-250

Harris v FC of T 2002 ATC 4659

¶4-280

Hart & Anor; FC of T v 2004 ATC 4599

¶4-200

Heavy Minerals Pty Ltd v FC of T (1966) 115 CLR 512

¶1-100

Henderson v FC of T 70 ATC 4016

¶1-340

Highfield; FC of T v 82 ATC 4463

¶4-220

Hobbs & Anor v FC of T (1957) 98 CLR 151

¶9-140

I Paragraph Industrial Equity Ltd & Anor v DFC of T 90 ATC 5008

¶11-160

Investment & Merchant Finance Corporation Ltd v FC of T 71 ATC 4140 ¶5-000

J Paragraph JD Roberts, FC of T v; FC of T v Smith 92 ATC 4380

¶8-000

J Rowe & Son Pty Ltd v FC of T 71 ATC 4001

¶1-360

J Rowe & Son Pty Ltd v FC of T 71 ATC 4157

¶1-360

James Flood Pty Ltd; FC of T v (1953) 88 CLR 492

¶1-360

Jenkins; FC of T v 82 ATC 4098

¶1-240

John Holland Group Pty Ltd & Anor v FC of T 2015 ATC ¶20-510

¶3-190

Jones; FC of T v 2002 ATC 4135

¶4-180; ¶4-200; ¶4400

K Paragraph Kajewski & Ors v FC of T 2003 ATC 4375

¶11-240

Kelly v FC of T 85 ATC 4283

¶1-200

Krakos Investments Pty Ltd; FC of T v 96 ATC 4063 ¶2-140 Kurts Development Ltd; FC of T v 98 ATC 4877

¶5-060

L Paragraph Law Shipping Co Ltd v IR Commrs (1924) 12 TC 621

¶4-040; ¶4-060

Lees & Leech Pty Ltd v FC of T 97 ATC 4407

¶1-220; ¶4-400

Levene v IR Commrs [1928] AC 217

¶1-240

Lewski v FC of T 2017 ATC ¶20-630

¶9-240

Linfox Australia Pty Ltd v C of T of the Commonwealth of Australia [2019] FCAFC 131

¶12-300

Lister Blackstone Pty Ltd v FC of T 76 ATC 4285

¶4-400

Lui v FC of T (No 2) 2009 ATC ¶20-127

¶11-340

Lunney v FC of T; Hayley v FC of T (1958) 100 CLR 478

¶7-400

Lysaght; IR Commrs v [1928] AC 234

¶1-240

M Paragraph MI Roberts; FC of T v 92 ATC 4787

¶4-220

McCorkell v FC of T 98 ATC 2199

¶1-180

McCormack v FC of T 79 ATC 4111

¶11-240

McDonald v FC of T 98 ATC 4306

¶2-120

McKinnon v FC of T 2002 ATC 2043

¶11-300

McLaurin v FC of T (1961) 104 CLR 381

¶1-100

Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542

¶4-120

Meeks; C of T (NSW) v (1915) 19 CLR 568

¶1-100

Mitchum; FC of T v (1965) 113 CLR 401

¶1-260

Monier Colourtile Pty Ltd v FC of T 84 ATC 4846

¶6-260

Montgomerie v Commr of IR (NZ) (1965) 14 ATD 102

¶9-220

Montgomery; FC of T v 99 ATC 4749

¶1-220

Munro; FC of T v (1926) 38 CLR 153

¶4-200

Murry; FC of T v 98 ATC 4585

¶1-100

Murtagh v FC of T 84 ATC 4516

¶11-300

Myer Emporium Ltd (The); FC of T v 87 ATC 4363

¶1-180; ¶2-240

Mynott v FC of T 2011 ATC ¶10-195

¶11-220

N Paragraph Nathan v FC of T (1918) 25 CLR 183

¶1-260

National Australia Bank v FC of T 93 ATC 4914

¶3-360

New Zealand Flax Investments Ltd v FC of T (1938) 61 CLR 179 ¶1-360

P Paragraph Parfew Nominees Pty Ltd v FC of T 86 ATC 4673

¶5-120

Payne; FC of T v 2001 ATC 4027

¶4-240

Pearson v FC of T 2006 ATC 4352

¶9-220

Perron Investments Pty Ltd & Ors v DFC of T 89 ATC 5038

¶11-160

Peter Greensill Family Co Pty Ltd (as trustee) v FC of T 2020 ATC ¶20-742; [2020] ¶9-090 FCA 559 Phillip Morris Ltd v FC of T 79 ATC 4352

¶5-120

Phillips v FC of T 77 ATC 4169

¶4-400

Phillips; FC of T v 78 ATC 4361

¶4-400

Phippen & Anor v FC of T 2005 ATC 2336

¶4-380

Pitcher; FC of T v 2005 ATC 4813

¶4-240

Point v FC of T 70 ATC 4021

¶4-080

R Paragraph Ramsden; FC of T v 2005 ATC 4136

¶9-240

Raymor Contractors Pty Ltd v FC of T 91 ATC 4259

¶4-280

Ready Mixed Concrete (Vic) Pty Ltd v FC of T 69 ATC 4038

¶6-260

Reynolds v Commr of State Taxation (WA) 86 ATC 4528

¶8-180

Robert Coldstream Partnership v FC of T (1943) 68 CLR 391 ¶8-120 Rotherwood Pty Ltd v FC of T 96 ATC 4203

¶1-220

S Paragraph St Hubert’s Island Pty Ltd; FC of T v 78 ATC 4104

¶5-000

Sandini Pty Ltd; FC of T v; Ellison v Sandini Pty Ltd 2018 ATC ¶20-651

¶2-110

Sara Lee Household & Body Care (Aust) Pty Ltd; FC of T v 2000 ATC 4378

¶2-120

Saunig; DFC of T v 2002 ATC 5135

¶11-280

Scott v FC of T (1966) 117 CLR 514

¶11-320

Scott v FC of T 2002 ATC 2077

¶8-200

Scottish Australian Mining Co Ltd v FC of T (1950) 81 CLR 188

¶1-180

Sherritt Gordon Mines Ltd; FC of T v 77 ATC 4365

¶1-000

Snowden & Willson Pty Ltd; FC of T v (1958) 11 ATD 463; 99 CLR 431

¶4-120

Social Credit Savings & Loans Society Ltd (The) v FC of T 71 ATC 4232

¶1-140

Stanton v FC of T (1955) 92 CLR 630

¶1-000

Statham & Anor v FC of T 89 ATC 4070

¶1-180

Steele v DFC of T 99 ATC 4242

¶4-200; ¶4-400

Studdert; FC of T v 91 ATC 5006

¶4-220

Sun Newspapers Ltd v FC of T (1938) 61 CLR 337

¶4-120; ¶4-320; ¶4340; ¶4-360; ¶4400; ¶6-000

Suttons Motors (Chullora) Wholesale Pty Ltd; FC of T v 85 ATC 4398

¶5-020

T Paragraph Taylor & Anor v FC of T 70 ATC 4026

¶9-220

Thomas & Ors; FC of T v 2018 ATC ¶20-663

¶9-070

Tingari Village North Pty Ltd v FC of T 2010 ATC ¶10-131

¶2-300

Total Holdings (Australia) Pty Ltd; FC of T v 79 ATC 4279

¶4-200

Travelodge Papua New Guinea Ltd v Chief Collector of Taxes 85 ATC 4432 ¶4-200 Truesdale v FC of T 70 ATC 4056

¶9-140

Tully Co-operative Sugar Milling Assoc Ltd; FC of T v 83 ATC 4495

¶6-260

U Paragraph Uber BV v FC of T 2017 ATC ¶20-608

¶7-440

United Aircraft Corporation; FC of T v (1943) 68 CLR 525 ¶1-000 Ure v FC of T 81 ATC 4100

¶4-200

V Paragraph Van den Berghs Ltd v Clark [1935] AC 431

¶1-100

Vegners v FC of T 89 ATC 5274

¶9-240

Vogt; FC of T v 75 ATC 4073

¶4-220; ¶4-240

W Paragraph W Thomas & Co Pty Ltd v FC of T (1965) 115 CLR 58

¶4-060

Walker & Ors v FC of T 95 ATC 2001

¶11-300

Walstern Pty Ltd v FC of T 2003 ATC 5076

¶11-320

Wangaratta Woollen Mills Ltd v FC of T 69 ATC 4095

¶6-160

“Waratahs (The)” Rugby Union Football Club v FC of T 79 ATC 4337 ¶1-140 Western Suburbs Cinemas Ltd; FC of T v (1952) 86 CLR 102

¶4-060

Whitfords Beach Pty Ltd; FC of T v 82 ATC 4031

¶1-180

Whiting; FC of T v (1943) 68 CLR 199

¶9-040; ¶9-220

Wiener; FC of T v 78 ATC 4006

¶4-240

Wilkinson; FC of T v 83 ATC 4295

¶4-220

Y Paragraph Yarmouth v France [1887] 19 QBD 647

¶6-160

Administrative Appeals Tribunal and Taxation Board of Review Cases ATC Paragraph 70 ATC 46, Case B11

¶4-200

70 ATC 153, Case B32

¶1-080

84 ATC 106, Case R2

¶4-240

85 ATC 225, Case S19

¶1-240

87 ATC 229, Case U29

¶4-220; ¶4-240

88 ATC 335, Case V39

¶4-240

88 ATC 1005, Case V156

¶2-120

91 ATC 268, Case Y24

¶1-100

95 ATC 175, Case 12/95

¶4-200

95 ATC 284, Case 29/95

¶4-200

97 ATC 385, Case 37/97

¶4-120

Finding Lists References are to Paragraph numbers In this list the two main Assessment Acts (1936 and 1997) are listed first, followed by other tax-specific legislation, then other legislation. References to Taxation Rulings, Taxation Determinations, Practice Statements and Interpretative Decisions appear at the end of these Finding Lists.

COMMONWEALTH TAXATION LEGISLATION Income Tax Assessment Act 1936 Section

Paragraph

6(1)

¶1-000; ¶1-240; ¶1-250; ¶1-260; ¶9-160

6C

¶1-000

21

¶1-200; ¶1-220

21A

¶1-200; ¶1-220

21A(2)

¶1-220

21A(3)

¶1-200

21A(4)

¶1-200; ¶1-220

21A(5)

¶4-300

23AG

¶7-300; ¶7-320

23AG(1)

¶7-320

23AG(1AA)

¶7-300; ¶7-320

23AG(2)

¶7-320

23AG(3)

¶7-300

23AG(6)

¶7-320

23AG(6A)

¶7-320

23L

¶1-300; ¶3-180; ¶7-020

23L(2)

¶1-200

44

¶7-060; ¶10-120; ¶10-300

44(1)

¶2-240; ¶7-000; ¶10-100; ¶10-180

47

¶10-120

47(1)

¶10-120

47(1A)

¶10-120

51AGA

¶4-000

51AK(1)

¶4-300

51AK(4)

¶4-300

79A

¶7-020

82A

¶4-220; ¶7-000

Pt III Div 3 Subdiv H

¶4-300

82KZL

¶4-300

82KZMA

¶4-300

82KZMD

¶4-300

90

¶8-000; ¶8-020; ¶8-040; ¶8-080; ¶8-200

92

¶4-400; ¶8-060; ¶8-100; ¶8-260

92(1)

¶8-200

92(2)

¶8-200

94

¶8-120

Pt III Div 6

¶9-140; ¶9-200; ¶9-260

95

¶9-020; ¶9-060; ¶9-200

95(1)

¶9-040

95A(1)

¶9-040

95A(2)

¶9-080

96

¶9-040

97

¶2-320; ¶9-040; ¶9-060; ¶9-240

97(1)

¶9-280

98

¶9-020; ¶9-060; ¶9-090

98(1)

¶9-040

98(3)

¶9-090

98A

¶9-020

99

¶9-040; ¶9-080; ¶9-280

99A

¶9-040; ¶9-060; ¶9-080; ¶9-140; ¶9-220; ¶9-260; ¶9-280

100(1)

¶9-060

100(2)

¶9-060; ¶7-400

100AA

¶9-220

100AB

¶9-220

100A

¶9-260; ¶9-280

100A(13)

¶9-280

101

¶9-220

101A

¶9-040

102

¶8-180; ¶9-140

102(1)(b)

¶9-140

102(2)

¶9-140

102(3)

¶9-140

Pt III Div 6AA

¶9-020; ¶9-060; ¶9-140; ¶11-140

102AC(2)

¶9-020

102AE

¶9-060

102AE(2)(c)

¶7-400

102AG

¶9-060

Pt III Div 6D

¶9-180

Pt III Div 6E

¶9-000

103A

¶3-280

Pt III Div 7A

¶3-280; ¶10-220; ¶10-240

109C

¶10-240

109C(3A)

¶10-240

109CA

¶3-280

109CA(2)

¶3-280

109D

¶3-100; ¶3-280; ¶10-220; ¶10-240

109D(1)

¶3-280; ¶10-220

109D(1AA)

¶3-280

109D(6)

¶10-220

109E

¶10-240

109N

¶3-280; ¶10-220; ¶10-240

109Q

¶10-240

109RB

¶10-240

109Y

¶3-280; ¶10-220; ¶10-240

109ZB

¶3-280

109ZB(1)

¶3-280; ¶10-240

109ZB(3)

¶3-280; ¶10-240

128B(1)

¶10-100; ¶10-180

128B(3)(ga)

¶9-020; ¶10-100; ¶10-180

128D

¶1-260; ¶9-020; ¶10-100; ¶10-180

159H

¶7-040; ¶7-060; ¶9-080

159N

¶7-060

159N(4)

¶9-060

159P

¶7-020

159P(4)

¶7-020

170

¶7-340; ¶11-220

170(1)

¶11-040

170(3)

¶11-040

170(10)

¶9-260; ¶9-280

175

¶11-260

175A

¶11-320

Pt IVA

¶1-290; ¶4-200; ¶10-200; ¶11-260

177E

¶10-200

177EA

¶10-200

177F(3)

¶11-260

251S(1)(c)

¶9-060; ¶9-080

251U

¶7-460

262A(4AJA)

¶2-020

264A

¶11-160

Sch 2

¶3-120

Sch 2F 269-60

¶9-120

Sch 2F 269-65(1)

¶9-120

Sch 2F 269-70

¶9-120

Sch 2F Div 270

¶9-100

Sch 2F 270-10(1)

¶9-100

Sch 2F 270-10(1)(c)

¶9-100

Sch 2F 270-15

¶9-100

Sch 2F 270-20

¶9-100

Sch 2F 270-25

¶9-100

Sch 2F 270-100

¶9-100

Sch 2F 272-80

¶9-160

Sch 2F 272-80(3)

¶9-160

Sch 2F 272-80(4A)

¶9-160

Sch 2F 272-80(5A)

¶9-180

Sch 2F 272-80(5B)

¶9-180

Sch 2F 272-85

¶9-160

Sch 2F 272-85(1)

¶9-180

Sch 2F 272-85(4A)

¶9-160

Sch 2F 272-85(5B)

¶9-160

Sch 2F 272-90

¶9-160; ¶9-180

Sch 2F 272-90(2A)

¶9-160

Sch 2F 272-90(4)

¶9-160

Sch 2F 272-90(5)

¶9-160

Sch 2F 272-95

¶9-160

Income Tax Assessment Act 1997 Section

Paragraph

3-1

¶1-180; ¶4-340

3-3

¶1-180; ¶4-340

4-10(3)

¶7-000

4-15

¶5-080; ¶5-120; ¶5-160

4-15(1)

¶7-000

6-1(1)

¶1-180

6-5

¶1-000; ¶1-020; ¶1-040; ¶1-060; ¶1-100; ¶1-120; ¶1-140; ¶1200; ¶1-250; ¶1-300; ¶1-320; ¶1-340; ¶1-360; ¶3-240; ¶5080; ¶5-120; ¶5-160; ¶5-220; ¶5-240; ¶7-020; ¶7-060; ¶7360; ¶7-440; ¶8-000

6-5(1)

¶1-100; ¶1-180; ¶1-220; ¶1-340; ¶2-140

6-5(2)

¶1-260

6-5(3)

¶1-260; ¶10-180

6-5(4)

¶1-340; ¶1-360

6-10

¶1-250

6-23

¶1-260; ¶1-300

6-25

¶1-180

8-1

¶1-020; ¶1-080; ¶1-140; ¶3-190; ¶3-220; ¶4-020; ¶4-080; ¶4100; ¶4-120; ¶4-160; ¶4-180; ¶4-200; ¶4-220; ¶4-240; ¶4260; ¶4-280; ¶4-300; ¶4-320; ¶4-340; ¶4-360; ¶5-020; ¶5040; ¶5-080; ¶5-120; ¶5-140; ¶5-160; ¶5-220; ¶5-240; ¶6000; ¶6-180; ¶7-020; ¶7-240; ¶7-360; ¶7-400; ¶7-440; ¶8000; ¶8-040; ¶10-260

8-1(1)

¶1-360; ¶2-140; ¶4-060; ¶4-080; ¶4-120; ¶4-200; ¶4-220; ¶4380; ¶4-400; ¶6-020; ¶6-060; ¶8-000

8-1(2)

¶4-120; ¶4-200; ¶4-400

8-1(2)(a)

¶4-060; ¶4-160; ¶4-340; ¶6-020; ¶6-060

8-1(2)(b)

¶4-200; ¶4-300

8-1(2)(d)

¶4-380

8-5

¶4-380

8-10

¶4-400

15-2

¶1-300; ¶3-240; ¶7-060

15-2(3)(d)

¶1-300

15-15

¶2-240

15-15(1)

¶1-220

15-20

¶1-000

15-30

¶1-060

15-50

¶8-220

15-70

¶1-300; ¶7-020

Subdiv 20-A

¶4-080

20-20

¶1-100

20-25

¶1-100

Div 25

¶4-400

25-5

¶7-080

25-10

¶4-040; ¶4-060; ¶4-220; ¶4-360

25-10(3)

¶4-360

25-15

¶4-100

25-20

¶4-120

25-25

¶4-120; ¶4-160

25-35

¶4-080; ¶8-140

25-50

¶4-140

25-95

¶8-220

25-100

¶4-220; ¶4-240

Div 26

¶4-380; ¶4-400

26-5

¶1-080; ¶4-120; ¶7-440; ¶10-300

26-19

¶4-220

26-20

¶3-240; ¶4-220; ¶7-420

26-25(1)

¶4-400

26-26

¶10-260

26-30

¶4-240

26-30(1)

¶4-240

26-30(2)

¶4-240

26-31

¶4-030

26-35(1)

¶8-160

26-45

¶4-380

26-45(1)

¶4-380

26-45(3)

¶4-380

26-47

¶4-380

26-47(2)

¶4-380

26-47(3)

¶4-380

26-47(3)(b)

¶4-380

26-47(4)

¶4-380

26-50

¶4-140; ¶4-380

26-50(1)

¶4-380

26-50(2)

¶4-380

26-50(3)(b)(i)

¶4-380

26-50(3)(b)(ii)

¶4-380

26-50(8)

¶4-380

26-55

¶4-140

26-55(2)

¶7-120

26-80

¶4-200

26-102

¶4-050

26-102(1)

¶4-050

26-102(2)

¶4-050

26-102(8)

¶4-050

26-102(9)

¶4-050

Div 28

¶4-020

28-13

¶4-020

28-20(3)

¶4-020

28-25

¶4-020; ¶7-020

28-25(1)

¶4-020

28-25(2)

¶4-020; ¶4-100

28-25(3)

¶4-020; ¶4-100

28-29(1)

¶4-020

28-29(3)

¶4-020

28-35

¶4-020

28-90(1)

¶4-020

28-90(3)

¶4-020

28-90(5)

¶7-440

28-100(2)

¶4-020

28-100(3)

¶4-020

Subdiv 28-G

¶4-020

Subdiv 28-H

¶4-020

Div 30

¶4-140

30-15

¶7-020

30-45

¶7-000

Div 31

¶4-140

32-5

¶4-240; ¶7-020

32-10(1)

¶3-080

Div 35

¶1-040; ¶4-380; ¶7-100

35-10(5)

¶1-040

35-30

¶7-100

35-35

¶7-100

35-40

¶7-100

35-45

¶7-100

36-1

¶4-140

36-10

¶4-140; ¶9-100

36-15

¶4-380

36-15(3)

¶4-140

36-15(4)

¶4-140

36-15(5)

¶4-140

Subdiv 36-C

¶10-320

36-55

¶10-100; ¶10-180

36-55(2)

¶10-180

Div 40

¶2-060; ¶2-200; ¶4-060; ¶4-220; ¶4-340; ¶4-380; ¶4-400; ¶6120; ¶6-140; ¶6-160; ¶6-180; ¶6-250; ¶7-100; ¶8-060

40-1

¶6-020

40-15

¶6-040

40-25

¶6-040; ¶6-060; ¶6-080; ¶6-280

40-25(1)

¶6-020; ¶6-100

40-25(2)

¶6-020; ¶6-060; ¶6-100

40-25(7)

¶6-020

40-27

¶6-300

40-27(2)(a)

¶6-300

40-27(2)(b)

¶6-300

40-27(2)(c)

¶6-300

40-27(2)(d)

¶6-300

40-30

¶6-000; ¶6-020; ¶6-040; ¶6-080; ¶6-100; ¶6-140; ¶6-160

40-30(1)

¶6-160

40-30(1)(a)

¶6-160

40-30(1)(b)

¶6-160

40-30(1)(c)

¶6-140

40-30(2)

¶6-160

40-40

¶8-220

40-65

¶6-060; ¶12-220

40-65(1)

¶6-080

40-70(2)

¶6-160

40-72

¶5-140; ¶6-000; ¶6-020; ¶6-060; ¶6-080; ¶6-100

40-75

¶6-000; ¶6-020; ¶6-100; ¶6-140; ¶6-160

40-75(5)

¶6-140

40-75(6)

¶6-140

40-80(2)

¶4-110

40-82

¶6-250

40-82(1)

¶6-080; ¶6-250

40-85

¶6-060; ¶6-080; ¶6-100

40-95

¶6-020; ¶6-160

40-95(7)

¶6-140; ¶6-160

40-105

¶6-060; ¶6-080; ¶6-100; ¶6-160

40-175

¶6-180

40-180

¶6-000; ¶6-020; ¶6-060; ¶6-180

40-190

¶6-000; ¶6-020; ¶6-180

40-230

¶6-060

40-230(1)

¶6-250

40-285

¶5-140; ¶6-100; ¶6-120

40-285(1)

¶6-060; ¶6-080; ¶6-100; ¶8-140

40-285(1)(b)

¶6-120

40-285(2)

¶6-060; ¶6-080; ¶6-100

40-285(2)(b)

¶6-120

40-290

¶6-060; ¶6-100; ¶6-120

40-295

¶6-060

40-295(2)

¶8-220

40-300

¶6-060; ¶6-080

40-305

¶6-080; ¶6-100

40-325

¶5-140; ¶6-060; ¶6-250

40-340(3)

¶8-220

40-340(4)

¶8-220

40-365

¶6-080

40-420–40-445

¶6-260

40-420

¶6-200

40-425

¶6-200

40-425(2)

¶6-200

40-425(5)

¶6-200

40-430

¶6-200

40-435

¶6-080; ¶6-200

40-440

¶6-200

40-445

¶6-200

40-450

¶6-000

40-450(1)

¶6-160

40-450(3)

¶6-160

40-455

¶6-000; ¶6-160

40-515–40-575

¶6-280; ¶7-100

40-755

¶4-360

40-755(2)(a)(ii)

¶4-360

40-755(3)

¶4-360

40-755(4)

¶4-360

Subdiv 40-I

¶4-360

40-880

¶4-120; ¶4-320; ¶4-340

40-880(5)(f)

¶4-320

40-880(5)(g) 4-03040-880(5)(h)

¶4-030

40-880(6)

¶4-320

Div 43

¶2-020; ¶2-060; ¶2-200; ¶4-060; ¶4-340; ¶4-360; ¶6-040; ¶6160; ¶6-250; ¶8-200

43-10

¶4-360; ¶6-040

43-25

¶6-040

43-30

¶6-040

43-40

¶4-360

43-70

¶4-360

43-90

¶6-040

43-140

¶6-040

43-150

¶6-040

43-210

¶6-040

43-215

¶6-040

43-235

¶6-040

43-255(a)

¶4-360

43-255(b)

¶4-360

43-285

¶6-040

50-5

¶9-280

51-5

¶4-140

59-90

¶10-340

61-10

¶7-020; ¶7-060

61-100

¶7-020; ¶7-040; ¶7-060

Subdiv 61-G

¶7-040

61-100

¶7-020; ¶7-040; ¶7-060

61-205

¶7-040

67-25

¶10-100; ¶10-180; ¶10-320

67-25(1)

¶10-100

Div 70

¶5-100; ¶5-220; ¶8-060

70-10

¶5-000; ¶5-200

70-10(1)

¶5-100

70-15

¶5-080; ¶5-120; ¶5-240

70-15(1)

¶5-020; ¶5-040

70-15(2)

¶5-020; ¶5-040

70-20

¶5-080

70-25

¶5-080

70-30

¶5-060; ¶5-140

70-35(2)

¶5-080; ¶5-200; ¶5-240

70-35(3)

¶4-400; ¶5-080; ¶5-120; ¶5-160; ¶5-180

70-40

¶5-080; ¶5-120; ¶5-180

70-40(1)

¶5-240

70-45

¶5-040; ¶5-060; ¶5-080; ¶5-100; ¶5-120; ¶5-180; ¶5-200; ¶5240; ¶5-260

70-50

¶5-080; ¶5-120; ¶5-200; ¶5-260

70-55(1)(b)

¶5-160

Subdiv 70-D

¶8-220

70-80–70-100

¶8-220

70-90

¶5-200; ¶8-140

70-90(1)

¶5-180

70-90(2)

¶5-180

70-95

¶5-180

70-100

¶5-280; ¶8-140

70-100(1)

¶5-280

70-100(3)

¶5-280

70-100(4)–(9)

¶8-140

70-100(4)

¶5-280; ¶8-220

70-100(5)

¶5-280

70-100(6)

¶5-280

70-110

¶5-100; ¶5-140; ¶5-160

Div 82

¶1-420

82-10(4)

¶1-420

82-10(6)(c)

¶7-220

82-130

¶1-420

82-135

¶1-420

82-140

¶1-420

82-150(2)

¶7-220

Div 83

¶1-420

Subdiv 83-A

¶1-420

83-10(2)

¶1-420

83-80

¶1-340

Subdiv 83-C

¶1-420

83-170

¶1-420

83-175(1)

¶1-420

83-175(2)

¶1-420

Div 83A

¶1-380

83A-5

¶1-380

83A-10

¶1-380; ¶1-400; ¶3-000

83A-10(1)

¶1-380

83A-10(2)

¶1-380

Subdiv 83A-B

¶3-000

83A-25

¶1-400

83A-25(1)

¶1-380

83A-33

¶1-400

83A-35

¶1-380; ¶1-400

83A-45

¶1-380

Subdiv 83A-C

¶1-380; ¶3-000

83A-110(1)

¶1-380

83A-115

¶1-380

83A-120

¶1-380

Ch 2 Pt 2-42 Div 84–87

¶1-280; ¶7-200

84-5

¶1-280; ¶7-200

Div 85

¶1-280

85-20

¶1-280

85-25

¶1-280

86-1

¶7-200

86-15(1)

¶1-280; ¶7-200

86-15(2)

¶1-280

86-15(4)

¶7-200

86-20

¶7-200

86-20(1)

¶7-200

86-30

¶1-280; ¶7-200

Subdiv 86-B

¶7-200

86-60

¶1-280; ¶7-200

86-65

¶7-200

87-15

¶1-290

87-18

¶1-280

87-20

¶1-280

87-20(1)

¶1-290

87-20(1)(b)

¶1-290

87-20(2)

¶1-290

87-25

¶1-280

87-30

¶1-280

87-60

¶1-280

87-60(3A)

¶1-280

87-60(3B)

¶1-280

87-60(5)

¶1-280

87-60(6)

¶1-280

87-65(3)

¶1-280

100-25

¶2-040

100-40

¶2-040

100-45

¶2-040

100-50

¶2-040

Div 102

¶2-040

102-5

¶2-360; ¶7-280

102-5(1)

¶2-240

102-20

¶6-100

103-25(3)

¶7-280

Div 104

¶2-240

104-5

¶2-240

104-10

¶2-080; ¶2-160; ¶2-200; ¶7-280

104-10(1)

¶2-120; ¶2-140; ¶2-310

104-10(2)

¶2-110; ¶2-120

104-10(3)

¶2-120; ¶2-140; ¶2-200

104-20

¶2-200

104-25

¶1-100; ¶2-140

104-25(3)

¶2-180

104-35

¶2-140; ¶2-180

104-35(1)

¶1-100

104-40

¶2-260

104-40(5)

¶2-260

104-70

¶2-320

104-70(3)

¶2-320

104-71

¶2-320

104-71(4)

¶2-320

Subdiv 104-F

¶2-140

104-110(1)

¶2-140

104-110(3)

¶2-140

104-120

¶2-140

104-125

¶2-140

104-185

¶2-280

104-197

¶2-280

104-198

¶2-280

104-235

¶6-100; ¶6-120

104-235(1)(b)

¶6-300

104-240

¶6-100; ¶6-120

105-25(3)

¶2-180

106-5

¶2-220; ¶8-040; ¶8-060; ¶8-080; ¶8-180

108-5

¶2-180; ¶2-240; ¶6-140

108-5(1)

¶2-140

108-5(2)

¶8-060; ¶8-180

108-5(2)(c)

¶8-080

108-7

¶2-080

108-10(1)

¶2-100

108-10(2)

¶2-100

108-17

¶2-100

108-20

¶1-260

108-20(1)

¶2-100; ¶2-310

108-20(2)

¶2-100

108-55

¶2-200

109-5(1)

¶2-120

109-5(2)

¶2-120

110-25

¶2-200

110-25(2)

¶2-000; ¶2-180; ¶2-310; ¶4-320

110-25(3)

¶2-000; ¶2-180

110-25(4)

¶2-000; ¶4-050

110-25(5)

¶2-000; ¶2-200

110-25(5A)

¶4-320

110-25(6)

¶2-000; ¶4-120

110-35

¶7-000

110-38(4A)

¶4-030

110-45(1A)

¶2-020

110-45(2)

¶2-020

110-50(1A)

¶2-020

110-50(2)

¶2-020

110-55

¶6-100

110-55(9J)

¶4-030

112-25(1)

¶2-200

112-25(2)

¶2-200

112-25(3)

¶2-200

112-30

¶2-180

112-30(2)

¶2-200

112-30(3)

¶2-200

112-30(4)

¶2-200

Div 114

¶2-040; ¶2-180

114-1

¶2-240

Div 115

¶2-040; ¶2-060; ¶2-180; ¶7-280

Subdiv 115-A

¶2-060

115-5–115-50

¶1-380; ¶2-200

115-5

¶2-320

115-10

¶2-040; ¶6-100

115-25

¶1-380; ¶2-240; ¶2-360

115-25(3)

¶2-140; ¶2-260

115-100

¶2-000; ¶2-180; ¶2-280

115-105

¶2-070; ¶7-280

Subdiv 115-C

¶2-320; ¶9-000; ¶9-090

115-215

¶2-320

115-215(3)(c)

¶2-320

115-215(4)(a)

¶2-320

115-215(4)(b)

¶2-320

115-220

¶9-090

115-230

¶9-200

116-20(1)

¶2-000; ¶2-310

116-25

¶2-200

116-30(2)(b)

¶8-180

118-5

¶5-140

118-10(3)

¶2-310

118-20

¶8-060

118-20(1)

¶2-310

118-24

¶5-140; ¶6-080; ¶6-100

118-24(1)

¶6-100

118-24(2)

¶6-100

118-25

¶5-140

Subdiv 118-B

¶2-060; ¶2-080

118-100

¶2-000; ¶2-060

118-110

¶2-060; ¶2-070; ¶2-080; ¶2-180

118-110(3)

¶2-070

118-110(4)

¶2-070

118-110(5)

¶2-070

118-145

¶2-060; ¶2-070; ¶2-080

118-145(2)

¶2-060

118-192

¶2-060

118-195

¶2-070; ¶2-080; ¶2-100

118-195(1)(c)

¶2-070

118-195(1A)(b)

¶2-070

118-197

¶2-080

Subdiv 126-A

¶2-110

126-5

¶2-110

126-5(2)

¶2-110

126-5(5)

¶2-110

126-15

¶2-110

126-20

¶2-110

126-25

¶2-110

Div 128

¶2-080

128-10

¶2-080; ¶2-100

128-15(4)

¶2-100

128-50

¶2-080

128-50(2)

¶2-080

Subdiv 130-A

¶2-240

130-15

¶2-240

130-20(2)

¶2-240

130-20(3)

¶2-240

130-75

¶1-380

134-1

¶2-260

Div 152

¶2-180; ¶2-220; ¶2-320; ¶7-280

152-1

¶2-180

Subdiv 152-A

¶2-280; ¶7-280

152-5

¶2-220; ¶2-280; ¶8-140

152-10

¶2-180; ¶2-300; ¶7-280

152-10(1)

¶2-303

152-10(1AA)

¶2-180; ¶2-280

152-10(2)

¶2-305

152-10(2)(a)

¶2-305

152-10(2)(b)

¶2-305

152-10(2)(c)

¶2-305

152-15

¶2-180; ¶2-280

152-20

¶2-280; ¶8-060

152-35

¶2-303; ¶2-280; ¶2-300

152-35(1)

¶2-300

152-35(2)

¶2-300

152-40

¶2-303; ¶2-280; ¶8-140

152-40(1)

¶2-300

152-40(4)(a)

¶8-140

152-40(4)(e)

¶2-300

Subdiv 152-B

¶2-180; ¶2-220; ¶2-280

152-105

¶2-180; ¶2-280; ¶7-280

Subdiv 152-C

¶2-180; ¶2-220; ¶2-280; ¶2-320

152-205

¶2-180; ¶2-280

152-210

¶2-180; ¶2-280; ¶7-280

152-215

¶2-280

152-220

¶2-280; ¶7-280

Subdiv 152-D

¶2-180; ¶2-220; ¶2-280; ¶7-280

152-305

¶2-280

152-305(1)

¶7-280

152-305(1)(b)

¶7-280

152-310

¶7-280

152-315

¶7-280

152-315(2)

¶7-280

152-315(4)

¶7-280

152-320

¶2-280; ¶7-280

Subdiv 152-E

¶2-180; ¶2-220; ¶2-280

152-410

¶7-280

152-415

¶2-280

165-12

¶10-280; ¶10-320

165-12(1)

¶10-280

165-13

¶10-280

165-13(2)

¶10-320

Subdiv 165-C

¶4-080

165-207

¶10-320

165-210

¶10-280

165-210(1)

¶10-320

165-210(2)

¶10-280; ¶10-320

165-210(3)

¶10-320

165-211

¶10-320

165-211(2)

¶10-320

202-40

¶10-120

202-55

¶10-040

202-60

¶10-140

202-60(2)

¶10-080

202-65

¶10-080

203-5

¶10-120; ¶10-160

203-15

¶10-140; ¶10-160

203-20

¶10-160

203-25

¶10-140

203-30

¶10-160

203-35

¶10-160

203-45

¶10-160

203-50

¶10-140; ¶10-160

203-50(2)

¶10-160

203-50(2)(b)

¶10-140

203-55(1)

¶10-140; ¶10-160

203-55(2)

¶10-140

203-55(3)

¶10-140

203-55(5)

¶10-140

205-15(1)

¶10-010; ¶10-020; ¶10-100

205-15(4)

¶10-060

205-30(1)

¶10-010; ¶10-020; ¶10-080

205-30(2)

¶10-060

205-45(2)

¶10-020

205-70

¶10-020

205-70(8)

¶10-020

Div 207

¶9-070

207-20

¶7-060; ¶7-400

207-20(1)

¶10-100; ¶10-180; ¶10-300

207-20(2)

¶10-100; ¶10-180; ¶10-300

Subdiv 207-B

¶9-000; ¶9-220

207-35

¶9-080

207-35(1)

¶9-020

207-50(1)(b)

¶9-020

207-65(1)

¶10-100

207-75

¶10-100

207-95

¶9-020

207-145

¶10-200

Subdiv 290-B

¶4-200; ¶4-280

290-60

¶4-280; ¶4-380; ¶4-400

Subdiv 290-C

¶4-280; ¶7-120

290-150

¶4-140; ¶4-280; ¶7-120

290-150(3)

¶7-120

290-155–290-170

¶4-280

290-165

¶7-120

290-165(1)

¶4-280

290-168

¶4-280

290-169

¶4-280

290-170(1)

¶4-280; ¶7-120

290-175

¶7-120

290-230

¶7-120

290-235

¶7-120

291-15(a)

¶1-160

291-15(b)

¶1-160

291-20

¶1-160; ¶7-275

291-20(3)

¶7-275

291-20(6)

¶7-275

291-20(7)

¶7-275

Div 292

¶7-280

292-80

¶7-280

292-85(1)

¶7-280

292-85(2)

¶7-278; ¶7-280

292-85(3)

¶7-280

292-85(4)

¶7-280

292-85(5)

¶7-278

292-100(1)

¶7-280

292-100(2)

¶7-280

292-100(7)

¶7-280

292-100(9)

¶7-280

292-102

¶7-265

292-102(1)(i)

¶7-265

292-102(2)

¶7-265

292-102(3)

¶7-265

Div 295

¶7-240

302-60

¶7-260

302-140

¶7-260

302-145

¶7-260

302-195

¶7-260

302-200

¶7-260

303-15

¶1-160

307-120

¶7-260

307-230

¶7-278

Div 313

¶7-270

Div 328

¶6-180; ¶6-250

328-110

¶4-300; ¶6-200; ¶6-220; ¶6-240

328-125

¶2-305

328-125(6)

¶2-305

Subdiv 328-D

¶6-220; ¶6-240; ¶6-260

328-125

¶2-305

328-125(6)

¶2-305

328-175(1)

¶6-240

328-175(10)

¶6-240

328-180

¶6-240

328-180(1)

¶6-220

328-180(1)(b)

¶6-240

328-180(2)(a)

¶6-240

328-180(3)(a)

¶6-240

328-180(4)

¶6-220

328-185

¶6-200

328-190

¶6-220

328-190(1)

¶6-220

328-190(2)

¶6-220

328-190(3)

¶6-220

328-200

¶6-220

328-210

¶6-220; ¶6-240

328-210(1)

¶6-220; ¶6-240

328-210(2)

¶6-220

328-215(2)

¶6-220

328-215(3)

¶6-220

328-250(1)

¶6-240

328-250(4)

¶6-240

328-253(4)

¶6-240

328-360

¶7-080

328-360(1)

¶7-080

328-365

¶7-080

328-365(1)(a)(i)

¶7-080

328-365(1)(b)

¶7-080

328-370

¶7-080

328-375

¶7-080

328-430

¶2-315

328-435

¶2-315

328-455

¶2-315

328-455(2)(a)

¶2-315

328-460

¶2-315

Subdiv 328-G

¶2-315; ¶9-180

328-430

¶2-315

328-435

¶2-315

328-455

¶2-315

328-455(2)(a)

¶2-315

328-460

¶2-315

355-100

¶6-200

Div 405

¶7-180

405-1

¶7-180

405-5

¶7-180

405-15

¶7-180

405-20

¶7-180

405-45

¶7-180

405-50

¶7-180

Div 725

¶10-200

Div 727

¶2-340

727-455

¶2-340

768-910(1)

¶7-360

768-910(3)

¶7-360

768-915(1)

¶7-360

768-980

¶7-360

Div 770

¶2-360

770-10

¶2-360; ¶9-020

770-10(1)

¶7-340

770-75

¶7-340

770-190(1)

¶7-340

770-190(2)

¶7-340

Div 855

¶9-090

855-10

¶9-090

855-15

¶7-360; ¶9-090

855-20

¶2-070

855-25

¶7-360

Div 900

¶4-240; ¶4-260

900-35

¶4-100

900-40

¶4-100

900-50

¶4-260

Subdiv 900-C

¶4-020

Subdiv 900-D

¶4-240

Subdiv 900-E

¶4-240

900-125

¶4-100

Subdiv 900-F

¶4-240

960-285

¶2-280

Div 974

¶10-260

974-15

¶10-260

974-70(1)(b)

¶10-260

974-75(1)

¶10-260

995-1

¶7-100; ¶8-260; ¶10-040; ¶10-160

995-1(1)

¶4-380; ¶5-000; ¶6-140; ¶6-250; ¶10-000; ¶10-010; ¶10-080; ¶10-140; ¶10-160; ¶11-100

995-1(1) (car)

¶6-250

995-1(1) (car limit)

¶6-250

995-1(1) (financial year)

¶6-250

995-1(1) (hold)

¶6-250

Income Tax Assessment Regulations 1997 Regulation Paragraph 70-55.01

¶5-160

Income Tax Assessment (1936 Act) Regulation 2015 Regulation Paragraph 8

¶4-000

A New Tax System (Goods and Services Tax) Act 1999 Section

Paragraph

7-1

¶12-020

9-5

¶12-020; ¶12-060; ¶12-100; ¶12-140; ¶12-280

9-15

¶12-020

9-20(1)

¶12-060

9-20(2)

¶12-260; ¶12-280

9-25

¶12-020

9-25(1)

¶12-020

11-5

¶12-000; ¶12-200; ¶12-220; ¶12-260

11-15

¶12-100

11-30

¶12-120

11-30(3)

¶12-180

13-5

¶12-180

13-15(1)

¶12-180

13-20(2)

¶12-180

19-50

¶12-100; ¶12-120

19-55

¶12-120

19-75

¶12-100

19-80

¶12-100

23-5

¶1-020; ¶12-000

23-15

¶12-000; ¶12-060

29-10(3)

¶12-240

29-20

¶12-120

Subdiv 29-B

¶12-240

29-70(1)(b)

¶12-260

29-75

¶12-120

Div 38

¶12-020; ¶12-060

38-185

¶12-000

38-185(1)

¶12-000; ¶12-180

38-325

¶12-220

Div 40

¶12-020; ¶12-260

40-35

¶1-020; ¶12-100

40-65

¶12-220

40-65(2)(b)

¶12-060

40-75

¶12-060

42-10(1)

¶12-180

Div 51

¶7-040

Div 66

¶12-160

66-5

¶12-160

66-10

¶12-160

69-10

¶12-280

Div 75

¶12-200; ¶12-220

75-5(1)

¶12-220

75-5(1A)

¶12-200

75-10

¶12-220

75-11(5)

¶12-220

75-20

¶12-200; ¶12-220; ¶12-280

Div 81

¶12-280

81-5(1)

¶12-280

Div 84

¶12-180

84-10

¶12-180

84-12

¶12-180

84-13

¶12-180

93-5

¶12-300

Div 129

¶12-100; ¶12-120

129-20

¶12-100; ¶12-120

129-20(3)

¶12-120

129-70

¶12-100

144-5

¶7-440

144-5(1)

¶7-440

Div 188

¶12-060

188-15

¶12-000

188-15(1)(a)

¶12-060

188-20

¶12-000

188-20(1)(a)

¶12-060

188-25

¶12-060

189-5

¶12-170

189-10

¶12-170

195-1

¶7-440; ¶12-020; ¶12-170; ¶12-175

A New Tax System (Goods and Services Tax) Regulations 1999 Regulation Paragraph 23-15.01

¶12-060

Fringe Benefits Tax Assessment Act 1986 Section

Paragraph

5B

¶3-300

5B(1E)

¶3-300

5B(1L)

¶3-300

5E(3)

¶3-320

8(2)

¶3-050

9

¶3-280

9(1)

¶3-020

9(2)(c)

¶3-020

9A

¶3-220

10

¶3-040; ¶3-280

10(2)

¶3-020

10A

¶3-040

16

¶3-100

17

¶3-100

18

¶3-100

19

¶3-100

Div 5

¶3-080

20

¶1-300; ¶3-000; ¶3-060; ¶3-080; ¶7-020; ¶10240

22

¶1-300

23

¶3-200; ¶3-240

24

¶3-060; ¶3-200; ¶3-240

25

¶3-120; ¶3-140; ¶3-200

26

¶3-120; ¶3-200

30

¶1-300; ¶3-160

30(1)

¶3-180

31

¶3-160; ¶3-180

31A

¶3-180

31C

¶3-120; ¶3-160

31D

¶3-160

31E

¶3-180

31F

¶3-160; ¶3-180

31F(1)(a)

¶3-120

31G

¶3-160

35

¶3-200

37

¶3-200

37AC

¶3-200

37AD(a)

¶3-220

37AD(b)

¶3-220

37BA

¶3-220

37CA

¶3-220

37CD

¶3-220

38

¶10-240

Div 10A

¶3-320

39A

¶1-300

40

¶3-200; ¶3-260; ¶10-240

42

¶3-260

42(1)(b)

¶3-260

44

¶3-200; ¶3-260

45

¶3-200; ¶3-240; ¶10-240

47(5)

¶3-120

47(6)

¶3-050

47(6A)

¶3-200

50

¶3-240

51

¶3-240

52

¶3-200

52(1)

¶3-190

Div 13

¶3-240

57A

¶3-300

58P

¶3-060; ¶3-080; ¶3-240; ¶3-260

58X

¶3-060; ¶3-260

58X(2)(d)

¶3-000

58Y

¶3-060; ¶3-240

58Z

¶3-080

58ZC

¶3-140; ¶3-200

58ZD

¶3-200

59

¶3-200

62

¶3-260

123

¶3-040

135M–135Q

¶3-320

136

¶3-120; ¶3-240; ¶3-280

136(1)

¶1-380; ¶3-000; ¶3-040; ¶3-080; ¶3-140; ¶10240

137

¶10-240

148

¶3-080

148(2)

¶3-140

149

¶3-140

Income Tax Rates Act 1986 Section

Paragraph

23

¶10-000; ¶10-080; ¶10100

23AB

¶10-000

Sch 10 Pt I(2)

¶9-080

Income Tax (Transitional Provisions) Act 1997 Section Paragraph 40-120

¶6-250

40-130

¶6-250

New Business Tax System (Franking Deficit Tax) Act 2002 Section Paragraph 5

¶10-020

Superannuation (Excess Concessional Contributions Charge) Act 2013 Section Paragraph 4

¶1-160

Superannuation Guarantee (Administration) Act 1992 Section Paragraph 19

¶7-170

Superannuation Industry (Supervision) Act 1993 Section Paragraph 42

¶10-100

Superannuation Industry (Supervision) Regulations 1994 Section

Paragraph

6.19B

¶7-279

6.19b(1B) ¶7-279 6.19b(1C) ¶7-279 Taxation Administration Act 1953 Section

Paragraph

8AAC

¶11-320

8C

¶11-160

8D

¶11-160

14T(1)

¶11-340

14T(2)

¶11-340

14U

¶11-340

14U(1)

¶11-340

14U(1)(a)

¶11-340

14U(1)(b)

¶11-340

14U(2)

¶11-340

Pt IVC

¶11-100; ¶11-260

14ZQ

¶11-240

14ZU

¶11-180

14ZW

¶11-180

14ZY

¶11-180

14ZZ

¶11-180

14ZZK(a)

¶11-180; ¶11-240

14ZZK(b)

¶11-240

14ZZN

¶11-180; ¶11-240

14ZZO(a)

¶11-180; ¶11-240

14ZZO(b)

¶11-180; ¶11-240

Sch 1 Pt 2-5

¶11-200

Sch 1 10-5(1)

¶11-200

Sch 1 Div 12

¶4-400; ¶11-200

Sch 1 Subdiv 12-B

¶9-300; ¶10-340; ¶11-200

Sch 1 12-35–12-60

¶11-200

Sch 1 Subdiv 12-C

¶9-300; ¶10-340

Sch 1 12-40

¶10-240

Sch 1 12-80–12-90

¶11-200

Sch 1 12-85

¶11-200

Sch 1 Subdiv 12-D

¶9-300; ¶10-340

Sch 1 12-110–12-120 ¶11-200 Sch 1 12-140–12-190 ¶11-200 Sch 1 12-210–12-285 ¶11-200 Sch 1 14-155

¶11-080

Sch 1 14-165

¶11-080

Sch 1 14-250

¶12-175

Sch 1 14-255

¶12-175

Sch 1 Subdiv 14-D

¶11-000

Sch 1

¶14-250; ¶12-175

Sch 1

¶14-255; ¶12-175

Sch 1 Div 15

¶11-200

Sch 1 Div 16

¶11-200; ¶11-280

Sch 1 16-70

¶11-020

Sch 1 16-80

¶11-080

Sch 1 18-60

¶12-175

Sch 1 Pt 2-10

¶7-040

Sch 1 45-140(1)

¶7-040

Sch 1 45-145

¶7-040

Sch 1 45-325(1)

¶7-040

Sch 1 95-10

¶1-160

Sch 1 96-5

¶1-160

Sch 1 96-20

¶1-160

Sch 1 96-50

¶1-160

Sch 1 Subdiv 110-F

¶12-200

Sch 1 Div 131

¶7-270

Sch 1 Div 138

¶7-270

Sch 1 255-1

¶11-100

Sch 1 260-145

¶11-100

Sch 1 260-150

¶11-100

Sch 1 Div 268

¶11-020; ¶11-280

Sch 1 268-20

¶11-020

Sch 1 268-40

¶11-020

Sch 1 268-40(1)

¶11-020

Sch 1 268-40(2)

¶11-020

Sch 1 268-60(1)

¶11-020

Sch 1 Div 269

¶11-280

Sch 1 269-15

¶11-280

Sch 1 269-20

¶11-280

Sch 1 269-25

¶11-280

Sch 1 269-35

¶11-280

Sch 1 Div 284

¶11-320

Sch 1 284-15(1)

¶11-320

Sch 1 284-15(3)

¶11-320

Sch 1 284-70(a)

¶4-120

Sch 1 284-75

¶11-320

Sch 1 284-75(5)

¶11-320

Sch 1 284-80

¶11-320

Sch 1 284-90

¶11-320

Sch 1 284-90(1)

¶4-120; ¶11-320

Sch 1 284-220

¶11-320

Sch 1 284-224(1)

¶11-320

Sch 1 284-225

¶11-320

Sch 1 Pt 4-25

¶11-320

Sch 1 Div 290

¶11-060

Sch 1 290-50

¶11-060

Sch 1 290-60

¶11-060

Sch 1 290-65

¶11-060

Sch 1 290-125

¶11-060

Sch 1 353-10

¶11-160

Sch 1 353-15

¶11-120

Sch 1 353-15(1)

¶11-120

Sch 1 353-15(2)

¶11-120

Sch 1 388-50

¶11-180

Sch 1 392-5

¶11-080

Sch 1 392-10

¶11-080

Other Legislation Administrative Appeals Tribunal Act 1975 (Cth) Section Paragraph 69A

¶11-240

69B

¶11-240

Administrative Decisions (Judicial Review) Act 1977 (Cth) Section

Paragraph

Generally ¶11-300 Anti-Discrimination Act 1998 (Cth) Section Paragraph 44

¶11-180

Boosting Cash Flow for Employers (Coronavirus Economic Response Package) Act 2020 Section

Paragraph

5(1)(g)

¶9-300

6(1)(g)

¶9-300

Generally ¶10-340 Coronavirus Economic Response Omnibus Act 2020 Section

Paragraph

Generally ¶7-279 Coronavirus Economic Response Package (Payments and Benefits) Act 2020 Section Paragraph 19

¶9-300

Coronavirus Economic Response Package (Payments and Benefits) Alternative Decline in Turnover Test Rules 2020 Section

Paragraph

Generally ¶10-340 Coronavirus Economic Response Package (Payments and Benefits) Rules 2020 Rule

Paragraph

11

¶9-300

12

¶9-300

Generally ¶10-340

Crimes Act 1914 (Cth) Section Paragraph 4AA

¶11-120

Family Law Act 1975 Section

Paragraph

Generally ¶2-110 First Home Super Saver Tax Act 2017 Section

Paragraph

Generally ¶7-270 Freedom of Information Act 1982 (Cth) Section Paragraph 37

¶11-300

38

¶11-300

42

¶11-300

45

¶11-300

47

¶11-300

Fuel Tax Act 2006 Section Paragraph Pt 3-1

¶12-300

41-20

¶12-300

43-10

¶12-300

43-10(3) ¶12-300 47-5

¶12-300

47-5(1)

¶12-300

Higher Education Support Act 2003 (Cth) Section

Paragraph

Generally ¶7-420 Judiciary Act 1903 (Cth) Section Paragraph 39B

¶11-260

Medicare Levy Act 1986 (Cth) Section Paragraph 3(5)

¶7-460

8B

¶7-460

Migration Act 1958 Section Paragraph 32

¶7-279

Owners Corporations Act 2006 (Vic) Section

Paragraph

Generally ¶1-120 Paid Parental Leave Act 2010 Section

Paragraph

Generally ¶10-340 Private Health Insurance Act 2007 (Cth) Section

Paragraph

Div 66

¶7-460

Div 69

¶7-460

Div 72

¶7-460

Div 75

¶7-460

Div 78

¶7-460

Div 81

¶7-460

115-1

¶7-460

121-1

¶7-460

121-1(1)(a) ¶7-460 121-5

¶7-460

Private Health Insurance (Prudential Supervision) Act 2015 (Cth) Section

Paragraph

Pt 2 Div 3 ¶7-460 Probate and Administration Act 1898 (NSW) Section Paragraph 75

¶11-100

Student Loans (Overseas Debtors Repayment Levy) Act 2015 (Cth) Section

Paragraph

Generally ¶7-420 Subdivision Act 1988 (Vic) Section

Paragraph

Generally ¶1-120 Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016

Section

Paragraph

Generally ¶7-278 Treasury Laws Amendment (2019 Tax Integrity and Other Measures No 1) Act 2019 Section

Paragraph

Generally ¶7-170 Law Companion Rulings Order

Paragraph

LCR 2016/3

¶2-315

LCR 2018/5

¶7-270

LCR 2018/D7 ¶10-000 LCR 2018/7

¶4-030

LCR 2019/1

¶10-280

Self Managed Superannuation Funds Rulings Order

Paragraph

SMSFR 2009/1 ¶4-030 Taxation Rulings Order

Paragraph

GSTR 2000/17 ¶12-180 GSTR 2000/24 ¶12-120 GSTR 2001/8

¶12-040

GSTR 2002/6

¶12-000

GSTR 2003/13 ¶8-140; ¶8-240 GSTR 2003/15 ¶12-180 GSTR 2003/16 ¶12-140

GSTR 2008/1

¶12-180

GSTR 2009/4

¶12-100

GSTR 2012/5

¶12-220

IT 180

¶4-040

IT 225

¶7-100

IT 2472

¶5-020

IT 2501

¶8-180

IT 2503

¶1-290

IT 2608

¶8-180

IT 2622

¶9-040

IT 2631

¶1-220

IT 2648

¶1-360

IT 2651

¶9-240

IT 2670

¶5-020; ¶5-080

IT 2672

¶7-240

MT 2019

¶3-280

MT 2021

¶3-120

MT 2022

¶3-260

MT 2027

¶4-240

MT 2029

¶3-200

MT 2006/1

¶12-220

MT 2008/1

¶11-320

MT 2008/2

¶11-320

MT 2012/3

¶11-320

TR 92/3

¶1-180

TR 92/15

¶1-300; ¶3-240

TR 92/18

¶4-080

TR 93/17

¶7-240

TR 93/23

¶5-100; ¶5-260

TR 93/30

¶4-220

TR 93/32

¶8-260

TR 94/11

¶6-260

TR 94/22

¶7-440

TR 94/25

¶4-300

TR 94/27

¶3-120

TR 95/6

¶5-000

TR 95/8

¶4-240

TR 95/25

¶8-260

TR 95/33

¶4-200

TR 95/34

¶4-100

TR 95/35

¶1-100

TR 97/11

¶1-040; ¶1-180; ¶4-380

TR 97/12

¶4-100

TR 97/23

¶4-040; ¶4-060; ¶4-360

TR 97/24

¶4-100

TR 98/1

¶1-340; ¶1-360

TR 98/5

¶4-100

TR 98/7

¶5-000

TR 98/8

¶5-000

TR 98/9

¶3-240; ¶4-220

TR 98/17

¶1-240

TR 1999/6

¶3-240

TR 1999/9

¶10-280

TR 2000/2

¶4-200

TR 2001/7

¶1-280; ¶7-200

TR 2001/8

¶1-280; ¶1-290

TR 2003/4

¶4-380

TR 2003/4A

¶4-380

TR 2003/6

¶7-200

TR 2003/10

¶7-200

TR 2003/13

¶1-420

TR 2004/4

¶4-180; ¶4-200; ¶4-400

TR 2004/6

¶4-260

TR 2004/16

¶6-160

TR 2005/1

¶1-040

TR 2005/6

¶1-220

TR 2005/7

¶8-000; ¶8-040; ¶8-200

TR 2006/2

¶4-400

TR 2007/9

¶6-160

TR 2007/12

¶3-060

TR 2009/2

¶1-420

TR 2009/5

¶5-220

TR 2010/1

¶4-280

TR 2011/6

¶4-320

TR 2012/D1

¶9-000

TR 2014/1

¶1-320

TR 2015/3

¶1-120; ¶1-140

TR 2016/3

¶6-180

TR 2017/D6

¶3-140; ¶3-180; ¶4-230; ¶4-240

TR 2018/4

¶7-100

TR 2019/D7

¶3-190; ¶4-230; ¶4-240

Taxation Determinations Determination Paragraph GSTD 2000/2

¶12-160

GSTD 2013/2

¶12-160

TD 92/124

¶5-000

TD 92/162

¶3-220

TD 93/90

¶3-240

TD 93/108

¶7-440

TD 93/159

¶6-260

TD 93/222

¶11-120

TD 93/230

¶3-160

TD 94/89

¶2-160

TD 95/18

¶3-100

TD 95/48

¶5-040

TD 97/3

¶2-200

TD 98/15

¶7-300

TD 1999/47

¶2-110

TD 1999/79

¶2-200

TD 2006/22

¶1-060

TD 2006/71

¶2-320

TD 2006/78

¶2-300

TD 2008/27

¶4-200

TD 2012/1

¶4-200

TD 2012/8

¶7-320

TD 2012/18

¶7-279

TD 2014/1

¶10-200

TD 2014/26

¶2-310

TD 2015/19

¶8-100

TD 2016/8

¶6-060

TD 2016/13

¶4-260

TD 2018/6

¶6-060

TD 2019/D6

¶9-090

TD 2019/6

¶3-100

TD 2019/7

¶3-160; ¶3-180

TD 2019/11

¶4-260

TD 2020/1

¶5-100

Law Companion Rulings Statement

Paragraph

LCR 2018/D7 ¶10-000 LCR 2018/5

¶7-270

LCR 2019/1

¶10-280

ATO Practice Statements and Interpretative Decisions Statements Decision

Paragraph

PS LA 2001/6

¶4-110

PS LA 2004/3 (GA) ¶5-100 PS LA 2006/1 (GA) ¶2-020 PS LA 2010/1

¶9-200

PS LA 2011/8

¶11-340

PS LA 2011/18

¶11-340

PS LA 2012/5

¶11-320

Interpretative Decisions TA

Paragraph

ID 2001/221 ¶4-120 ID 2002/633 ¶2-200 ID 2003/752 ¶10-260 ID 2004/858 ¶6-140 ID 2005/145 ¶9-280 ID 2008/133 ¶3-260 ID 2009/25

¶5-000

ID 2009/42

¶4-340

ID 2010/85

¶9-240

Taxpayer Alerts

Paragraph TA 2012/4 ¶10-200 TA 2015/1 ¶10-200

ATO Guidelines Guidance Notes Paragraph GN 2018/1 ¶7-270 Practical Compliance Guidelines Paragraph PCG 2016/10 ¶3-040 PCG 2018/3

¶3-050

PCG 2020/3

¶4-110

PCG 2020/4

¶9-300

Index References are to Paragraph numbers.

A AAbsence rule

¶2-060; ¶2-070

Accelerated depreciation rates

¶6-280

Backing Business Investment (BBI)

¶6-250

Access accountant's working papers

¶11-120

Accounting for GST

¶12-240

Accruals basis

¶1-360

Active asset test

¶2-303

Adjusted taxable income — see Income; Net income Administration and assessment accountant’s working papers, access

¶11-120

amended assessments — Commissioner's power

¶11-220

— period of review

¶11-040

deceased taxpayer — tax liability

¶11-100

departure prohibition order

¶11-340

disputes

¶11-180

employee share schemes — reports

¶11-080

— withholding and payment obligations

¶11-080

foreign resident CGT withholding regime

¶11-000

lodgment of returns

¶11-140

notice by Commissioner to produce documents

¶11-160

PAYG withholding obligations

¶11-200

— Commissioner's discretion

¶11-020

penalties — administrative

¶11-320

— directors

¶11-280

promoter of tax exploitation scheme

¶11-060

taxpayers — challenges

¶11-240

— information rights

¶11-300

validity of assessment

¶11-260

Administrative penalties

¶11-320

Agreement definition

¶9-280

Airbnb

¶1-020

Alienation of income personal services income

¶1-280

Allowable deductions bad debts

¶4-080

business-related capital expenditure — preservation of value of goodwill capital expenditure

¶4-320 ¶4-320; ¶4-340

capital works — demolition and environmental protection activities

¶4-360

car expenses

¶4-020

— parking

¶4-000

club fees — boating, leisure facilities and activities

¶4-380

costs of borrowing for business purposes

¶4-160

home office expenses

¶4-220

interest expenses

¶4-180

interest on loans

¶4-200

investment rental property — costs of repairs

¶4-040

legal expenses

¶4-120

partnership and service trust

¶4-400

prepaid expenditures and non-deductible non-cash business benefits

¶4-300

repairs and improvements

¶4-060

self-education expenses

¶4-220

superannuation contributions

¶4-280

tax losses of earlier years

¶4-140

travel expenses

¶4-240

— residential rental property

¶4-030

vacant land

¶4-050

work-related expenses

¶4-100

— substantiation exception

¶4-260

work-related travel

¶4-230

working from home expenses — due to COVID-19

¶4-110

Allowances and reimbursements

¶1-300

Amended assessments Commissioner's power

¶11-220

period of review

¶11-040

Assessable income accruals basis

¶1-360

agreement for right to use proprietary software and related services

¶1-320

airbnb

¶1-020

alienation of personal services income

¶1-280

allowances

¶1-300

cash basis

¶1-340

compensation — breach of business agreement

¶1-100

derivation

¶1-320

disaster and relief payments

¶1-060

employee share scheme

¶1-380

— offered by start-up company

¶1-400

illegal activities

¶1-080

income/capital — mere realisation or carrying on business

¶1-180

lease incentive payments

¶1-220

mutuality principle

¶1-120

— taxable income on apportionment of expenses

¶1-140

non-cash business benefits

¶1-200

personal services income (PSI) — personal services business

¶1-290

— unrelated clients test

¶1-290

professional artist business

¶1-040

redundancy payments

¶1-420

reimbursement

¶1-300

rental marketplace

¶1-020

residence

¶1-240

— permanent place of abode, meaning of

¶1-250

resident/non-resident

¶1-240

— source of income

¶1-260

royalties

¶1-000

sharing economy

¶1-020

social media income

¶1-040

strata title body corporate

¶1-120

superannuation contributions

¶1-160

termination of employment

¶1-420

Australian Business Number (ABN) admission of new partner

¶8-240

Australian income tax liability

¶2-360

Australian resident/non-resident

¶1-240

Australian tax residents

¶1-250

Avoidance of tax

¶9-260; ¶11-220

B Backing Business Investment (BBI)

¶6-250

Bad debts

¶4-080

Balancing adjustments decline in value

¶6-060

depreciation

¶6-100

instant asset write-off

¶6-080

Base rate entity

¶10-000

Base Rate Entity Passive Income (BREPI)

¶10-000

impact on company tax rate

¶10-000

impact on franking rate

¶10-000

Benchmark rule consequences of breach

¶10-160

permitted departure

¶10-140

Beneficiaries trusts — income

¶9-000

— present entitlement

¶9-240

— use of disclaimers

¶9-240

Bitcoin

¶2-310

Bonus shares

¶2-240

Business continuity test Business or hobby

¶10-280; ¶10-320 ¶1-040

Business-related capital expenditure preservation of value of goodwill

¶4-320

C Capital expenditure Capital gains and losses

¶4-320; ¶4-340 ¶6-100

Capital gains tax absence rule

¶2-060

active asset test — use in a business

¶2-303

consequences of share and bonus shares transactions

¶2-240

cost base — CGT losses and indexation

¶2-040

— elements

¶2-000

— reduced

¶2-020

— rental property

¶2-020

death — CGT assets including personal assets

¶2-100

— dwelling held as joint tenants

¶2-080

— main residence exemption

¶2-080

demolition, subdivision of lands and construction of units

¶2-200

digital currencies — personal use exemption

¶2-310

disposal of residence and business with restrictive covenant

¶2-180

first used to produce income rule

¶2-060

foreign income — CGT discount and foreign tax offset

¶2-360

foreign residents

¶2-070

granting a lease and lease variation

¶2-140

implications on establishment and dissolution of partnership

¶2-220

indirect value shifting

¶2-340

main residence exemption

¶2-060; ¶2-080

— foreign residents

¶2-070

relationship breakdown rollover relief

¶2-110

sale of property — settlement in following income year

¶2-160

share options

¶2-260

small business CGT concessions

¶2-280

small business restructure rollover

¶2-315

— meaning of active and excluded assets

¶2-300

— on the sale of shares or units

¶2-305

timing of CGT events

¶2-120

unit trust — interaction between ITAA97 Subdiv 115-C and CGT event E4

¶2-320

Capital works deduction

¶6-040

demolition and environmental protection activities

¶4-360

Car expenses

¶4-020

parking

¶4-000

Car fringe benefit

¶3-020; ¶3-300; ¶3-320

exempt car benefits and exempt residual benefits

¶3-050

fleet vehicles

¶3-040

minor private uses

¶3-050

operating cost method

¶3-040

Cash basis

¶1-340

Cash flow boosts Cents per kilometre method CGT asset

¶9-300; ¶10-340 ¶4-020

costs of owning

¶4-050

definition

¶6-140

partnership

¶8-060

CGT discount

¶2-360

CGT marriage breakdown roll-over

¶2-110

CGT small business retirement exemption

¶7-280

Club fees boating, leisure facilities and activities

¶4-380

Companies base rate entity

¶10-000; ¶10-040

carry-forward losses — continuity of ownership and same business test

¶10-280

company tax rate

¶10-000

COVID-19 stimulus — cash flow boost and JobKeeper

¶10-340

distribution — see Distributions dividends — see Dividends excess franking offsets

¶10-320

franking account — benchmark rule, consequences of breach

¶10-160

— benchmark rule, permitted departure

¶10-140

— franking credits

¶10-040

— franking deficit tax

¶10-020

— franking rate

¶10-000

— impact

¶10-060

— maximum franking credits

¶10-080

— preparation

¶10-010

— R&D tax offset

¶10-060

resident private company — calculation of tax liability

¶10-300

shares — debt equity

¶10-260

tax losses

¶10-320

Compensation breach of business agreement

¶1-100

Composite assets

¶6-260

Consideration definition Consignment stock Continuity of ownership test

¶12-020 ¶5-020 ¶10-280

Corporate tax gross-up rate definition

¶10-080

Corporate tax rate (CTR) for imputation purposes definition

¶10-000; ¶10-040

Costs of borrowing

¶4-050

business purposes

¶4-160

Course of education definition

¶4-220

COVID-19 Backing Business Investment (BBI)

¶6-250

cash flow boost and JobKeeper

¶9-300; ¶10-340

early access to superannuation

¶7-279

economic downturn

¶9-300

small business entity assets

¶6-240

working from home — claims

¶4-110

— expenses

¶4-110

— shortcut rate

¶4-110

Cryptocurrency

¶2-310

D De facto relationships CGT roll-over

¶2-110

Death capital gains tax — CGT assets including personal assets

¶2-100

— dwelling held as joint tenants

¶2-080

— main residence exemption

¶2-080

Death benefits dependant definition

¶7-260

Debt test

¶10-260

Deceased taxpayer net income of minors tax liability

¶9-040 ¶11-100

Deductions Allowable — see deductions Deemed dividends

¶10-220

Definitions agreement applicable gross-up rate benefit

¶9-280 ¶10-160 ¶3-080; ¶3-140

car expense

¶4-020

CGT asset

¶6-140

consideration

¶12-020

corporate tax gross-up rate

¶10-080

corporate tax rate for imputation purposes

¶10-040

course of education

¶4-220

death benefits dependant

¶7-260

dependants

¶7-020

depreciating asset

¶6-140

ESS (employee share scheme)

¶1-380

ESS interest

¶1-380

fraud

¶11-220

hospital treatment

¶7-460

in-house software

¶6-140

income

¶10-120

ineligible medical expenses

¶7-020

leisure facility

¶4-380

live stock

¶5-000

medical expenses

¶7-020

net small business income

¶7-080

outstanding tax-related liability

¶11-100

permanent place of abode

¶1-250

prescribed course of education

¶4-220

prescribed person

¶7-460

primary production business

¶7-100

reside

¶1-250

reviewable objection decision

¶11-240

royalty

¶1-000

same

¶10-280

second hand goods

¶12-160

self-education expenses tax-related liability taxable income taxation law taxi travel trading stock unable Demonstration stock

¶4-220 ¶11-100 ¶1-140 ¶11-100 ¶7-440 ¶5-000; ¶5-100 ¶11-340 ¶5-040

Departure authorisation certificate (DAC)

¶11-340

Departure prohibition order (DPO)

¶11-340

Dependant invalid carer tax offset (DICTO)

¶7-020; ¶7-060

Dependants definition

¶7-020

Depreciating assets apportioning deduction for decline in value

¶6-020

definition

¶6-140

disposal

¶6-080

pooling low cost and low value

¶6-200

Depreciation accelerated depreciation rates

¶6-250; ¶6-280

balancing adjustments

¶6-080; ¶6-100

capital gains

¶6-100

capital works deduction

¶6-040

commercial website development expenditure

¶6-180

composite assets

¶6-260

decline in value

¶6-000

— balancing adjustment on disposal

¶6-060

— deductions

¶6-000; ¶6-060

— depreciating asset

¶6-020

— purchase of intangible business assets

¶6-140

depreciating assets

¶6-160

— pooling low cost and low value

¶6-200

disposal — business and non-business assets

¶6-100

— depreciable asset used for private purposes

¶6-120

expensive cars

¶6-250

general small business pool

¶6-220

instant asset write-off

¶6-250

intangible assets

¶6-160

plant

¶6-160

primary producers

¶6-280

second-hand depreciating assets in residential premises

¶6-300

small business entity assets

¶6-220; ¶6-240

temporary changes to immediate deduction

¶6-240

Derivation

¶1-320

Digital currency defined personal use exemption transactions Disaster and relief payments Disputes

¶2-310; ¶12-170 ¶12-170 ¶2-310 ¶12-170 ¶1-060 ¶11-180

Distributions Div 7A — distributable surplus

¶10-240

— internally generated good will

¶10-240

dividends

¶9-260

franked dividends — effect on shareholders

¶10-100

franking credits — benchmark rule, consequences of breach

¶10-160

— benchmark rule, permitted departure

¶10-140

— maximum franking credits

¶10-080

liquidation

¶10-120

net trust income

¶9-020

— trust law

¶9-200

Dividend access share (DAS)

¶10-200

Dividends access shares distributions

¶10-200 ¶9-260

Div 7A — deemed dividends

¶10-220

franking credits

¶10-040

imputation — effects on shareholders

¶10-180

receipt of franked dividends — effect on shareholders

¶10-100

Downsizer contributions

¶7-265

E Elections family trust

¶9-160; ¶9-180

interposed entity

¶9-180

Eligible assets

¶6-250

Employee share scheme (ESS)

¶1-380

offered by start-up company

¶1-400

reports

¶11-080

Employer JobKeeper payments

¶10-340

ordinary time earnings (OTE) base

¶7-170

salary sacrifice arrangement

¶7-170

Employment termination

¶1-420

Entertainment minor benefits exemption

¶3-080

travel and education benefits

¶3-240

ESS interest definition

¶1-380

Evasion Excluded foreign residents

¶11-220 ¶2-070

Exempt benefits fringe benefits tax

¶3-060

minor private use of cars

¶3-050

Exempt foreign income

¶7-320

Exemption CGT small business retirement

¶7-280

exempt foreign income

¶7-320

minor benefits exemption — entertainment

¶3-080

F Family trust elections Farming benefits First Home Super Saver (FHSS) scheme

¶9-160; ¶9-180 ¶3-200 ¶4-280; ¶7-270

First home super saver determination (FHSS Determination)

¶7-270

Fleet vehicles

¶3-040

Foreign health insurance policy

¶7-460

Foreign income

¶7-300

CGT discount and foreign tax offset

¶2-360

exempt foreign income

¶7-320

tax offset

¶7-340

Foreign income tax offset (FITO) Foreign resident CGT withholding regime

¶2-360; ¶7-340 ¶11-000

Foreign residents main residence exemption

¶2-070

trust gains of

¶9-090

Foreign salary and wages income

¶7-300

Foreign tax offset

¶2-360

Franked dividends

receipt

¶10-100

Franking account franking credits for small companies

¶10-040

franking deficit tax

¶10-020

franking rates

¶10-000

impact

¶10-060

maximum franking credits

¶10-080

preparation

¶10-010

streaming franking credits

¶9-070

Fraud

¶11-220

Freedom of information

¶11-300

Fringe benefits tax benefits provided to employees, former employees and customers

¶3-000

car

¶3-020

— exempt car benefits and exempt residual benefits

¶3-050

— fleet vehicles

¶3-040

— minor private uses

¶3-050

— operating cost method

¶3-040

entertainment — minor benefits exemption

¶3-080

— travel and education benefits

¶3-240

exempt benefits

¶3-060

exempt FBT employer

¶3-300

farming benefits

¶3-200

housing

¶3-120

— provision of onsite accommodation

¶3-140

in-house property

¶3-260

living-away-from-home allowances

¶3-160

— fly-in/fly-out

¶3-180

loan fringe benefit

¶3-100

meal entertainment

¶3-220

payment summary

¶3-320

private company providing loans and assets for personal use

¶3-280

reportable fringe benefits amount

¶3-320

salary sacrificed meal entertainment benefits

¶3-300

travel expenses — fly-in, fly-out workers Fuel tax credits

¶3-190 ¶12-300

G Genuine redundancy payments

¶1-420

Goods and services tax — see GST Goodwill internally generated

¶10-240

GST accounting

¶12-240

adjustments — creditable purpose

¶12-120

— input tax credits

¶12-100

change of supply

¶12-100

consequences

¶12-140

digital currency transactions

¶12-170

exporter

¶12-180

fuel tax credits

¶12-300

importer

¶12-180

indirect tax zone

¶12-020

inducement payment

¶12-140

lease agreement

¶12-140

margin scheme

¶12-200; ¶12-220

net calculation

¶12-260; ¶12-280

partly taxable supplies

¶12-040

registration — requirements

¶12-000

— taxable supply

¶12-060

second-hand goods

¶12-160

taxable supply

¶12-020

withholding obligations for new residential properties

¶12-175

H HELP

recovery of debts

¶7-420

Hobby

¶1-040

Home office expenses

¶4-220

Hospital treatment definition

¶7-460

Housing fringe benefits

¶3-120

provision of onsite accommodation

¶3-140

I Illegal activities

¶1-080

Imputation dividends — effects on shareholders In-house property fringe benefits

¶10-180 ¶3-260

In-house software definition

¶6-140

Income — see also Adjusted taxable income; Assessable income; Net income; Taxable income definition derived income

¶10-120 ¶1-340; ¶1360

partnership

¶8-260

Income averaging scheme

¶7-180

foreign income tax

¶7-340

foreign salary and wages income

¶7-300

Income/capital mere realisation or carrying on business

¶1-180

source for resident or non-resident

¶1-260

Income injection test trust losses

¶9-100

Income/capital mere realisation or carrying on business

¶1-180

source for resident or non-resident

¶1-260

Indexation cost base Indirect tax zone

¶2-040 ¶12-020

Indirect value shifting

¶2-340

Inducement payment

¶12-140

Ineligible medical expenses definition

¶7-020

Input tax credits adjustment

¶12-100

Instant asset write-off accelerated depreciation

¶6-250

balancing adjustments

¶6-080

depreciating assets

¶6-080

expensive cars

¶6-250

Intangible assets

¶6-160

Interest expenses

¶4-180

loans

¶4-200

partnership

¶8-260

Interposed entity election

¶9-180

Investment rental property costs of repairs

¶4-040

J JobKeeper payments

¶9-300

eligible business participants

¶10-340

one-in, all-in scheme

¶10-340

L Lease agreement

¶12-140

Lease incentive payments

¶1-220

Legal expenses

¶4-120

Leisure facility definition

¶4-380

Liquidation distribution

¶10-120

Live stock definition

¶5-000

valuation

¶5-160

Living-away-from-home allowances (LAFHA)

¶3-160

fly-in/fly-out

¶3-180

Loan fringe benefit

¶3-100

Lodgment of returns Log book method Low and middle income tax offset (LMITO) Low income super tax offset (LISTO) Low income tax offset

¶11-140 ¶4-020 ¶7-000; ¶7-020; ¶7-060 ¶7-120 ¶7-080; ¶7-300; ¶7-380; ¶7-400

M Main residence exemption

¶2-060

death

¶2-080

foreign residents

¶2-070

Managed investment funds

¶4-050

Marcus Discretionary Trust (MDT)

¶2-315

Margin scheme

¶12-175; ¶12-200; ¶12-220

Meal entertainment fringe benefits

¶3-220

salary packaging arrangement

¶3-300

Medical expenses definition

¶7-020

Medicare levy surcharge

¶7-460

Medium-sized businesses

¶6-250

Minors

¶7-400

net income

¶9-040

Mutuality principle

¶1-120

taxable income on apportionment of expenses

¶1-140

N Net income — see also Income; Partnerships; Taxable income; Trusts distributions

¶9-020; ¶9-200

partnership

¶8-000

tax payable

¶9-060

Net small business income definition

¶7-080

Non-arm's length trading stock

¶5-080

Non-cash business benefits

¶1-200

Non-deductible non-cash business benefits

¶4-300

Non-source documents

¶11-120

Notice to produce documents

¶11-160

O Offsets dependant invalid carer tax offset low income tax offset

¶7-020; ¶7-060 ¶7-080; ¶7-300; ¶7-380; ¶7-400

private health insurance tax offset

¶7-040

small business income tax offset

¶7-080

Offshore information notice

¶11-160

Operating cost method car fringe benefits

¶3-040

Other indirect taxes accounting

¶12-240

adjustments — creditable purpose

¶12-120

— input tax credits

¶12-100

change of supply

¶12-100

consequences

¶12-140

digital currency transactions

¶12-170

exporter

¶12-180

fuel tax credits

¶12-300

importer

¶12-180

indirect tax zone

¶12-020

inducement payment

¶12-140

lease agreement

¶12-140

margin scheme

¶12-200; ¶12-220

net calculation

¶12-260; ¶12-280

partly taxable supplies

¶12-040

registration — requirements

¶12-000

— taxable supply

¶12-060

second-hand goods

¶12-160

taxable supply

¶12-020

withholding obligations for new residential properties

¶12-175

Otherwise deductible rule

¶3-190

Outstanding tax-related liability definition

¶11-100

P Partnerships ABN/TFN requirements — admission of new partner

¶8-240

assignment of partnership interests

¶8-180

capital gain

¶8-040

CGT

¶8-080

— admitting a new partner

¶8-080

— assets

¶8-060

change in partnership

¶8-260

deductions

¶4-400

disposal of partner's interest

¶8-140

distribution to partners

¶8-020

income

¶8-260

interest

¶8-260

net partnership income — calculation

¶8-000 ¶8-020; ¶8-040

residence — profit and loss sharing

¶8-200

retiring partners and distributions

¶8-100

tax returns

¶8-260

trading stock — work in progress

¶8-220

uncontrolled partnership income and penalty tax

¶8-120

variation of partnership interests

¶8-160

Pattern of distribution test trust losses

¶9-120

Payable tax

¶7-020

PAYG instalments and tax offsets

¶7-040

PAYG(W) registration

¶9-300

payment summary

¶3-320

withholding obligations

¶11-200

— Commissioner's discretion

¶11-020

Penalties administrative

¶11-320

directors

¶11-280

penalty tax

¶8-120

Permanent place of abode, meaning of

¶1-250

Personal services business (PSB)

¶1-290

Personal services income (PSI)

¶7-200

personal services business

¶1-290

unrelated clients test

¶1-290

Plant depreciating asset

¶6-160

Prepaid expenditures

¶4-300

Prescribed course of education definition

¶4-220

Prescribed person definition

¶7-460

Primary producers

¶6-280

non-commercial losses

¶7-100

Primary production business definition

¶7-100

Private health insurance tax offset

¶7-040

Private trusts

¶4-050

Professional artist business

¶1-040

Profit and loss sharing

¶8-200

Promoter tax exploitation scheme Public unit trusts

¶11-060 ¶4-050

R Recreational club expenses

¶4-380

Registration GST — requirements

¶12-000

— taxable supply

¶12-060

Reimbursement

¶1-300

agreements

¶9-260

— school fees

¶9-280

Relationship breakdown rollover relief

¶2-110

Rental marketplace

¶1-020

Repairs and improvements

¶4-060

Reportable fringe benefits amount

¶3-320

Research and development (R&D)

¶10-060

Residence permanent place of abode, meaning of Resident/non-resident

¶1-250 ¶1-240; ¶7-000

source of income Restricted source documents

¶1-260 ¶11-120

Returns lodgment of returns partnerships

¶11-140 ¶8-260

Reviewable objection decision definition

¶11-240

Revocable trusts

¶9-140

Ride-sourcing service

¶7-440

Rollover relief, CGT Royalties

¶2-110; ¶2-315 ¶1-000

S Salary packaging arrangement company car

¶7-160

meal entertainment and entertainment leasing facility benefits

¶3-300

tax effectiveness

¶7-140

Salary sacrifice and super guarantee charge

¶7-170

Same business test

¶10-280

Second hand goods definition

¶12-160

depreciating assets in residential premises

¶6-300

Self-education expenses

¶4-220

definition

¶4-220

Self-managed superannuation fund (SMSF)

¶4-050

Service trust deductions

¶4-400

Shares bonus

¶2-240

options

¶2-260

Sharing economy

¶1-020; ¶7-440

Single Touch Payroll (STP)

¶7-170

Small business CGT concessions

¶2-280; ¶2-315

restructure rollover 2-315 retirement exemption

¶7-280

tax offset

¶7-080

Small business entities (SBE) assets Social media income

¶2-315; ¶6-220; ¶6-240 ¶1-040

Statutory tests 183-day test

¶1-250

superannuation test

¶1-250

Strata title body corporate mutuality principle

¶1-120

Streaming franking credits

¶9-070

Super guarantee charge

¶7-170

Superannuation contributions

¶4-280

bring-forward of non-concessional contributions

¶7-278

carry-forward concessional contributions

¶7-275

excess concessional contributions

¶1-160

small business CGT concessions

¶2-315

small business restructure rollover

¶2-315

total superannuation balance

¶7-278

Superannuation death benefits

¶7-260

Superannuation funds Superannuation guarantee (SG) payments

¶4-050; ¶7-240 ¶7-170

T Tax avoidance

¶9-260; ¶11-220

Tax concessions personal superannuation contributions Tax exploitation scheme Tax File Number (TFN)

¶7-120 ¶11-060

admission of new partner

¶8-240

Tax losses

¶4-140

companies

¶10-320

Tax offsets

¶7-060

dependant invalid carer tax offset low income tax offset private health insurance tax offset R&D tax offsets

¶7-020; ¶7-060 ¶7-080; ¶7-300; ¶7-380; ¶7-400 ¶7-040 ¶10-060

small business income tax offset

¶7-080

trust distributions

¶7-080

Tax payable

¶7-020

Tax returns lodgment of returns partnerships Taxable income definition Taxable supplies, GST GST

¶11-140 ¶8-260 ¶7-020; ¶7-060 ¶1-140 ¶12-020; ¶12-040 ¶12-060

Taxation law definition

¶11-100

Taxation of individuals CGT small business retirement exemption

¶7-280

carry-forward concessional superannuation contributions

¶7-275

COVID-19 crisis

¶7-279

downsizer contributions

¶7-265

exempt foreign income

¶7-320

First Home Super Saver Scheme

¶7-270

foreign health insurance policy

¶7-460

foreign income tax offset

¶7-340

foreign salary and wages income

¶7-300

income averaging scheme

¶7-180

medicare levy surcharge

¶7-460

minors

¶7-400

non-concessional superannuation contributions

¶7-278

PAYG — instalments and tax offsets

¶7-040

personal services income

¶7-200

primary producers — non-commercial losses

¶7-100

recovery of HELP debts

¶7-420

resident

¶7-000

ride-sourcing service

¶7-440

salary packaging — company car

¶7-160

— tax effectiveness

¶7-140

salary sacrifice and super guarantee charge

¶7-170

sharing economy

¶7-440

superannuation death benefits

¶7-260

superannuation funds

¶7-240

tax concessions — personal superannuation contributions

¶7-120

tax offsets

¶7-060

— trust distributions

¶7-080

tax payable

¶7-020

taxable income

¶7-020; ¶7-060

temporary residents

¶7-360

termination payments

¶7-220

total superannuation balance

¶7-278

Uber drivers

¶7-440

working holiday makers

¶7-380

Taxi travel definition

¶7-440

Taxpayers challenges

¶11-240

information rights

¶11-300

Temporary residents

¶7-360

Termination employment

¶1-420

payments

¶7-220

Total superannuation balance

¶7-278

Trade incentives

¶5-220

Trading stock

¶5-000

choice of stock

¶5-120

consignment stock

¶5-020

demonstration stock

¶5-040

disposal not in the ordinary course of business

¶5-180

live stock valuation and private use

¶5-160

non-arm's length dealing and stock “on hand”

¶5-080

obsolescence

¶5-120

partial change in ownership of stock

¶5-280

personal consumption — stock written-off due to obsolescence

¶5-100

reasonable valuation

¶5-260

special circumstances

¶5-260

stock in-transit, disposal outside ordinary business, closing balance

¶5-200

trade incentives offered by sellers and buyers

¶5-220

transfer of property

¶5-140

valuation method for similar items

¶5-060

valuation of closing stock to minimise taxable income

¶5-240

work in progress

¶8-220

Travel and education benefits

¶3-240

Travel expenses

¶4-240

deductions — residential rental property

¶4-030

fringe benefits tax — fly-in, fly-out workers

¶3-190

— home to work travel

¶4-230

— work-related travel

¶4-230

Trusts beneficiaries — present entitlement

¶9-240

— use of disclaimers

¶9-240

circulation issues

¶9-260

COVID-19 stimulus

— cash flow boost and JobKeeper

¶9-300

deceased estates — income

¶9-080

— net income for minors

¶9-040

— tax payable

¶9-080

dividends and distributions

¶9-260

elections — family group — family trust — interposed entity

¶9-180 ¶9-160; ¶9-180 ¶9-180

foreign residents — trust gains of

¶9-090

income and trust income of beneficiaries

¶9-000

losses — income injection test

¶9-100

— pattern of distribution test

¶9-120

net trust income — distributions

¶9-020

— tax payable

¶9-060

— trust law distribution

¶9-200

reimbursements agreements

¶9-260

revocable trusts

¶9-140

school fees — reimbursement agreements

¶9-280

streaming franking credits

¶9-070

tax avoidance

¶9-260

tax exempt entities

¶9-220

U Uber drivers

¶7-440

Uncontrolled partnership income

¶8-120

Uniform penalty regime Unit trust

V

¶11-320 ¶2-320

Vacant land deductions

¶4-050

Validity of assessment

¶11-260

Valuation trading stock

¶5-060

— choice of stock

¶5-120

— closing stock to minimise taxable income

¶5-240

— reasonable valuation

¶5-260

W Websites commercial website development expenditure

¶6-180

Withholding tax

¶11-080

new residential properties

¶12-175

Work in progress

¶8-220

Work-related expenses

¶4-100

substantiation exception

¶4-260

Working from home expenses due to COVID-19

¶4-110

Working holiday makers

¶7-380