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Calculating income tax liability

Liability to Taxation - sections 4-1, 4-10
Section 4-1 - Income tax is payable by each individual and company, and by some other entities - trustees, unincorporated bodies, etc. Section 4-10(1) - You must pay income tax for each year ending on June 30, called the financial year. Section 4-10(2) - Your income tax is worked out by reference to your taxable income for the income year. The income year is the same as the financial year except for: (a) a company, the income year is the previous financial year; (b) if you adopt an accounting period ending on a day other than 30 June, the income year is the accounting period adopted in place of the financial year or previous financial year, as appropriate. Tax Formula section 4-10(3) Taxable income = assessable income - deductions. Income tax = (taxable income X rate) - tax offsets. Offsets - (formerly credits, rebates) for example medical offset, dependant offset, eligible termination payments rebates, imputation offset, foreign tax credits, etc. Subtract offsets from the basic income tax liability = tax owed. If total tax offsets exceed basic income tax liability - no refund, no entitlement to offset the excess against any other liability. Exception if imputation offsets exceed tax liability refund. Definitions S. 995-1 ITAA97 (1) Assessable income - has the meaning given by sections 6-5, 6-10 and 6-15, ITAA97 (2) Deduction - an amount that you can deduct. S. 6-1(1) ITAA97 assessable income consists of ordinary income and statutory income. Section 6-5(1) - Your assessable income includes income according to ordinary concepts which is called ordinary income. Section 6-10(1) - Your assessable income includes some amounts that are not ordinary income - for a list of these items - section 10(5) Section 6-10(2) - Amounts that are not ordinary income but are included in your assessable income by provisions about assessable income are called statutory income.

Ordinary income

Section 6-5(2), { 25(1)(a)} - If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia during the income year. Section 6-5(3), { 25(1)(b)} - If you are not an Australian resident, your assessable income includes: (a) the ordinary income you derived directly or indirectly from all Australian sources during the income year: and (b) other ordinary income that a provision includes in your assessable income for the income year on some other basis other than having an Australian source.

Statutory income
Section 6-10(4), { 25(1)(a)} - If you are an Australian resident, your assessable income includes your statutory income from all sources, whether in or out of Australia. Section 6-10(5), { 25(1)(b)} - If you are not an Australian resident, your assessable income includes: (a) your statutory income from all Australian sources; and (b) other statutory income that a provision includes in your assessable income on some other basis other than having an Australian source.

Exempt income
S. 6-15-2 if an amount is exempt income it is not assessable income S. 6-20(1) - an amount of ordinary income or statutory income is exempt income if it is made exempt from income tax by a provision of this Act. Exempt income reduces a tax loss. Division 11A provides a list of classes of exempt income. These include section 23L(2) ITAA36, non-cash business benefits under section 21(A) ITAA36 not in excess of $300.

Non-assessable non-exempt income

Defined in section 6-23. This section ensures that income in this category does not reduce tax losses in the way that exempt income does. Section 11-55 provides a list of non-exempt non-assessable provisions. These include section 17-5 GST payable on a taxable supply is excluded from both assessable income and exempt income; section 23L(1), ITAA36, fringe benefits are not assessable and not exempt.

A taxpayer may be liable for a levy, for example, a Medicare levy, gun levy, East Timor levy.

Receipts covered by the ITAA

(a) Income according to ordinary concepts and usage
The ITAA uses terms such as: Assessable income Taxable income Exempt income All based on the common law concept of the meaning of income, that is, income according to ordinary concepts

General provisions capturing assessable income Sections 6-5(1-3), 6-10(1-5), {25(1)} Section 6-5(2-3) and section 6-10(4-5) - assessable income of a taxpayer includes where the taxpayer is a (a) Resident ordinary and statutory income derived from all sources in or out of Australia (b) Non resident - ordinary and statutory income derived from all sources in Australia Section 6-5(2-3) and section 6-10(4-5) {25(1)} include various terms that shall be examined in this course. These are: derivation (unit 1) residence (unit 2) source of income (unit 2) income (unit 3) Section 6-5(2-3) {S.25(1)} employs the general common law concept of income, ie income according to ordinary concepts - which is based on principles provided by cases relevant to determining whether gains from certain activities are gains in the nature of income or gains of a capital nature. These include gains from: employment; rendering services; carrying on a business; speculative activity or profit-making schemes; property including rent, interest, dividends, royalties; There is no single test for determining whether a gain is of an income nature or a capital nature but numerous tests depending upon the circumstances. Starting point - what is income? There is no definition of "income" in the ITAA. On the other hand, many provisions in the ITAA make use of the concept of 'income.' Section 6(1) (1936) - distinguished between: (1) Income from personal exertion which means: "income consisting of earnings, salaries, wages, commissions, fees, bonuses, pensions, allowances and gratuities received in the capacity of employee or in relation to services rendered", "income consisting of the proceeds of any business carried on by the taxpayer", 3

"income consisting of any profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale or from the carrying on or carrying out of any profit-making undertaking or scheme" (2) Income from property which means "all income which is not income from personal exertion. Note that the definitions in section 6(1){1936} do not define income but are circular definitions, that is, the word income appears on both sides of the equation: "Income from personal exertion, property" means "income" consisting of ... wages, allowances, gratuities.... While the definitions differentiate between different aspects on an undivided whole, they do not actually define the word "income." It is still necessary to show that a particular gain is of an income nature. It is necessary to look to the cases as to the meaning of the word "income" in respect of any particular gain. But the definitions in section 6(1) {1936} are an aid to strengthen a conclusion independently reached that a particular gain is income.

(b) Non-income gains made assessable income by statutory extension s. 6-10 Certain gains, though not income at common law, are made specifically assessable under the ITAA - section 10-5 .These include: Capital gains Division 100ff. though not of an ordinary income nature and therefore not caught as "income" by section 6-5(2-3) are treated as "assessable income" by section 6-10 Non-cash, non-convertible to cash benefits - section 15-2, ITAA97, includes as assessable income gains, the value to the taxpayer of all allowances, benefits, etc, provided in relation, directly or indirectly to any employment or services whether provided in money or any other form. Unlike the old s. 26, but under s. 23L(1), ITAA36, fringe benefits are non-assessable non-exempt income. Non-cash business benefits received in relation to business relations - section 21A {1936} Non-cash, non- convertible to cash benefits include: rent-free accommodation, low interest loans, free use of employer's vehicle. Section 15-15 includes in assessable income profits made on the disposal of property acquired before 20 September 1985 if the property was purchased for the purpose of profitmaking by resale or from carrying on a profit-making scheme. Section 20-110 where lease charges in respect of a leased motor vehicle are wholly or partly deductible, any profit on the sale of the leased vehicle is assessable to the lessee. 4

(c) Amounts that may be income according to ordinary concepts but which are taxed under specific provisions of the ITAA
For example: Section 26AC {1936} - includes as assessable income - amounts received on retirement or termination of employment in lieu of annual leave; Section 26AD {1936} - includes as assessable income - amounts received on retirement or termination of employment in lieu of long service leave; Section 27A-27J {1936} - includes as assessable income - superannuation and eligible termination payments received on termination of employment.

Examples of receipts not covered by ITAA

(a) gambling winnings - unless associated with the carrying of a business of gambling are generally not regarded as being of an income nature. (b) certain gifts - that are not a product of employment or the rendering of services (c) lottery winnings (d) bequests.

The Distinction between Deductions and Rebates

(a) General deductions - expenses that are deductible according to ordinary concepts, pursuant to section 8-1 {51(1)}. These expenses require the establishment of a sufficient nexus between the expense and the earning of assessable income. (b) Specific deductions are granted on the basis of government policy. Although generally incurred for the purpose of earning of assessable income are non-deductible under section 8-1 {51(1)} due to their capital nature. (c) Specific non-deductions - certain expenses, though deductible under the general principles of section 8-1 {51(1)}, have been made non-deductible for policy reasons, for example, certain entertainment expenses, club fees, fines, accrued leave. (d) Offsets (formerly rebates, credits) - usually based on government policy, reduce tax payable by the amount of the offset. For example, supporting spouse offset medical offset, foreign tax offset, dividend imputation offset. While deductions are deducted from assessable income in order to determine taxable income to which the tax rate is then applied, offsets are deducted after the basis income tax liability has been established. This means that the value of a deduction is determined by the taxpayer's marginal tax rate, say, 47%, while on the other hand an offset provides a full dollar reduction of tax for the taxpayer. For example, 2001 tax rates Assessable income Deduction Taxable income Medical offset $ 60,000 10,000 50,000 2,000 Tax Payable $ 21,100 17,100 15,100 Tax saving $ 4,700 (47%) 2,000 (100%)

Other concepts to consider

Progressive taxation (Australia individuals) compared to proportional taxation (Australia companies, superannuation funds) and regressive taxation (sales tax, goods and service taxes). 5

Role of Income Tax Rulings Income Tax Rulings indicate the Commissioner's policy and interpretation of legislation and cases. Such rulings do not bind taxpayers although they are binding upon the Commissioner. It is possible to obtain a private ruling from the Commissioner that is binding on the Commissioner in relation to a particular arrangement implemented on of after 1 July 1992 where the ruling is favourable to the taxpayer.

Tax formula
Assessable income (s. 6, ITAA97) Less: Deductions (s. 8 ITAA97) Equals Taxable income (s. 4 ITAA97) Taxable income X tax rates Equals gross tax payable Less: rebates (tax offset in 1997 act), credits (tax offset in 1997 act), prepaid tax Add: medicare levy, hecs liability Equals: refund or net tax payable