Tax For Australians For Dummies

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2nd Edition

Tax For Australians FOR

DUMmIES

‰

by Jimmy B. Prince

Wiley Publishing Australia Pty Ltd

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Tax For Australians For Dummies®, 2nd Edition Published by Wiley Publishing Australia Pty Ltd 42 McDougall Street Milton, Qld 4064 www.dummies.com

Copyright © 2011 Wiley Publishing Australia Pty Ltd The moral rights of the author have been asserted. National Library of Australia Cataloguing-in-Publication data: Author:

Prince, Jimmy B.

Title:

Tax For Australians For Dummies / Jimmy B. Prince

Edition:

2nd Australian ed.

ISBN:

978 1 74246 848 8 (pbk.)

Notes:

Includes index.

Subjects:

Taxation — Australia. Income tax — Australia.

Dewey Number: 336.200994 All rights reserved. No part of this book, including interior design, cover design and icons, may be reproduced or transmitted in any form, by any means (electronic, photocopying, recording or otherwise) without the prior written permission of the Publisher. Requests to the Publisher for permission should be addressed to the Contracts & Licensing section of John Wiley & Sons Australia, Ltd, 42 McDougall Street, Milton, Qld 4064, or email [email protected]. Cover image: © Daisy Daisy, 2010, Used under license from Shutterstock.com Typeset by diacriTech, Chennai, India Printed in China by Printplus Limited 10â•‡ 9â•‡ 8â•‡ 7â•‡ 6â•‡ 5â•‡ 4â•‡ 3â•‡ 2â•‡ 1 Limit of Liability/Disclaimer of Warranty: THE PUBLISHER AND THE AUTHOR MAKE NO REPRESENTATIONS OR WARRANTIES WITH RESPECT TO THE ACCURACY OR COMPLETENESS OF THE CONTENTS OF THIS WORK AND SPECIFICALLY DISCLAIM ALL WARRANTIES, INCLUDING WITHOUT LIMITATION, WARRANTIES OF FITNESS FOR A PARTICULAR PURPOSE. NO WARRANTY MAY BE CREATED OR EXTENDED BY SALES OR PROMOTIONAL MATERIALS. THE ADVICE AND STRATEGIES CONTAINED HEREIN MAY NOT BE SUITABLE FOR EVERY SITUATION. THIS WORK IS SOLD WITH THE UNDERSTANDING THAT THE PUBLISHER IS NOT ENGAGED IN RENDERING LEGAL, ACCOUNTING, OR OTHER PROFESSIONAL SERVICES. IF PROFESSIONAL ASSISTANCE IS REQUIRED, THE SERVICES OF A COMPETENT PROFESSIONAL PERSON SHOULD BE SOUGHT. NEITHER THE PUBLISHER NOR THE AUTHOR SHALL BE LIABLE FOR DAMAGES ARISING HEREFROM. THE FACT THAT AN ORGANISATION OR WEBSITE IS REFERRED TO IN THIS WORK AS A CITATION AND/OR A POTENTIAL SOURCE OF FURTHER INFORMATION DOES NOT MEAN THAT THE AUTHOR OR THE PUBLISHER ENDORSES THE INFORMATION THE ORGANISATION OR WEBSITE MAY PROVIDE OR RECOMMENDATIONS IT MAY MAKE. FURTHER, READERS SHOULD BE AWARE THAT INTERNET WEBSITES LISTED IN THIS WORK MAY HAVE CHANGED OR DISAPPEARED BETWEEN WHEN THIS WORK WAS WRITTEN AND WHEN IT IS READ. Trademarks: Wiley, the Wiley logo, For Dummies, the Dummies Man logo, A Reference for the Rest of Us!, The Dummies Way, Making Everything Easier, dummies.com and related trade dress are trademarks or registered trademarks of John Wiley & Sons, Inc. and/or its affiliates in the United States and other countries, and may not be used without written permission. All other trademarks are the property of their respective owners. Wiley Publishing Australia Pty Ltd is not associated with any product or vendor mentioned in this book.

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Dedication This book is dedicated to my wife, Maria Rosa Prince.

About the Author Jimmy Prince is a fellow of CPA Australia and a tax specialist. He is a former lecturer and tutor in income tax law at LaTrobe University and Melbourne Institute of Technology, and teaches a number of investment courses for the CAE in Melbourne. He is the author of several investment books including Building Wealth and Loving It and Shares and Taxation, and has written articles for Your Mortgage magazine and http://thebull.com.au. In 2000, Jimmy was nominated for an Adult Learners Week 2000 outstanding tutor award. In his earlier years, Jimmy worked for the Australian Taxation Office and also consulted to CPA Australia — Technicall.

Author’s Acknowledgments I would like to thank the staff and editors at Wiley Publishing Australia Pty Ltd (especially the great work of my editor, Robi van Nooten) in helping me complete this second edition.

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Publisher’s Acknowledgments We’re proud of this book; please send us your comments through our online registration form located at http://dummies.custhelp.com. Some of the people who helped bring this book to market include the following: Acquisitions, Editorial and Media Development Project Editor: Robi van Nooten, On-Track Editorial Services Acquisitions Editor: Rebecca Crisp Editorial Manager: Hannah Bennett

Production Graphics: Wiley Art Studio Cartoons: Glenn Lumsden Proofreader: Pam Dunne Indexer: Don Jordan, AntipodesÂ€Indexing

The author and publisher would like to thank the following organisation for their permission to reproduce copyright material in this book. •

Tables in Appendix A: Australian Taxation Office 2010 © Commonwealth of Australia, reproduced by permission.

Every effort has been made to trace the ownership of copyright material. Information that will enable the publisher to rectify any error or omission in subsequent editions will be welcome. In such cases, please contact the Permissions Section of John Wiley & Sons Australia, Ltd.

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Contents at a Glance Introduction............................................................. 1 Part I: How You’re Taxed in Australia........................ 7 Chapter 1: Understanding the Australian Tax System...............................................................................................9 Chapter 2: Taxing Australians: The Formula You Had to Have....................................................................................17 Chapter 3: Lodging Your Tax Return: This One Is for the Nation.........................................................................................31 Chapter 4: Receiving a Visit: When the Tax Office Comes Knocking....................................................................................41

Part II: Income from Personal Exertion..................... 49 Chapter 5: Taxing Employees: Working Class Man...............................51 Chapter 6: Living in Your Castle: Main Residence................................65 Chapter 7: Taxing Issues That Affect Your Children.............................73

Part III: Tax Effective Investments........................... 85 Chapter 8: Interesting Stuff: Bank Deposits and Tax............................87 Chapter 9: Owning Part of the Company: Investing in Shares................................................................................91 Chapter 10: Building Your Dreams: Investing in Bricks and Mortar...............................................................................103 Chapter 11: Catching Up on Capital Gains Tax....................................117

Part IV: Running a Business.................................. 135 Chapter 12: Structuring Your Business for Maximum Gain.....................................................................................137 Chapter 13: Starting a Business: On Your Mark! Get Set! Go!...........................................................................................153 Chapter 14: Reducing Your Small Business Tax Bill............................167 Chapter 15: Collecting Tax for the Government: Goods and Services Tax.....................................................................179 Chapter 16: Living on the Fringe: Fringe Benefits Tax........................189 Chapter 17: Getting Wealthy: CGT and Small Business......................197

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Part V: Thinking Long Term................................... 205 Chapter 18: Preparing for Retirement Using Superannuation...........207 Chapter 19: Reaping What You Sow: Receiving a Pension and Government Concessions............................................229 Chapter 20: Death and Taxes: Wills and Business Succession Planning...........................................................................241

Part VI: The Part of Tens....................................... 251 Chapter 21: Ten Ways to Minimise Your Tax while Keeping the Tax Office Happy...........................................................................253 Chapter 22: Ten of the Top Retirement Tax Tips................................261

Part VII: Appendixes............................................. 269 Appendix A: Income Tax Rates and Tables..........................................271 Appendix B: Taxing the Visitors: Non-Residents.................................293

Glossary.............................................................. 299 Index................................................................... 311

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Table of Contents Introduction........................................................ 1 About This Book..........................................................................2 Conventions Used in This Book................................................2 What You’re Not to Read............................................................2 Foolish Assumptions...................................................................3 How This Book is Organised......................................................3 Part I: How You’re Taxed in Australia............................3 Part II: Income from Personal Exertion..........................4 Part III: Tax Effective Investments..................................4 Part IV: Running a Business.............................................4 Part V: Thinking Long Term.............................................4 Part VI: The Part of Tens..................................................4 Part VII: Appendixes.........................................................5 Icons Used in This Book.............................................................5 Where to Go from Here...............................................................6

Part I: How You’re Taxed in Australia................... 7 Chapter 1: Understanding the Australian Tax System. . . . . . . 9 Explaining the Australian Tax System......................................9 Understanding Your Income Tax Rates..................................10 Federal taxes....................................................................10 State taxes........................................................................11 Local taxes.......................................................................11 Taxing Major Income Streams..................................................12 Taxing your treasures: CGT assets...............................12 Bringing home the money: International sources of income...........................................................................13 Taxing a Company.....................................................................14

Chapter 2: Taxing Australians: The Formula You Had to Have. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Doing Your Sums........................................................................17 Declaring What You Earn: Assessable Income......................18 Ordinary income..............................................................19 Statutory income.............................................................20 Keeping What You Receive: Exempt Income.........................20

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Tax For Australians For Dummies, 2nd Edition Reducing Your Tax Bill: General Deductions.........................23 Checking out the first leg: First positive limb.............24 Examining the next leg: Second positive limb............25 Being aware of the negatives: Negative limbs.............25 Figuring out when something is incurred....................28

Chapter 3: Lodging Your Tax Return: This One Is for the Nation. . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Preparing Your Individual Tax Return....................................32 Receiving a PAYG payment summary...........................33 Claiming car expenses....................................................34 Claiming a standard deduction.....................................36 Receiving a Thank-You Note: Notice of Assessment............37

Chapter 4: Receiving a Visit: When the Tax Office Comes Knocking. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Being Honest with Yourself: Self-Assessment........................41 Getting a Reality Check Over: Tax Audit................................43 Preparing for an audit.....................................................44 Points to keep in mind...................................................45 Mending Your Ways: Amendments and Objections..............46

Part II: Income from Personal Exertion............... 49 Chapter 5: Taxing Employees: Working Class Man. . . . . . . . 51 Earning a Living: Salary and Wages........................................51 Determining your employment status..........................52 Reducing the burden: Receiving an allowance...........54 Adding to the nest egg via SG.......................................55 Adding to the nest egg via personal contributions................................................................56 Easing the pain: Getting a termination payment........57 Moving on: Getting a redundancy payment................59 Claiming a Tax Deduction: What’s On the Menu...................60 Proving what you did: Substantiation provisions.....................................................................61 Common types of work-related deduction..................61

Chapter 6: Living in Your Castle: Main Residence. . . . . . . . . 65 Addressing the Issue: This Is Where I Live............................65 Buying Your Main Residence: Taxation Concessions...........66 Keeping What’s Yours: Exempt from Tax...............................69 Sharing What’s Yours: When You Have to Pay Tax...............70

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Table of Contents

Chapter 7: Taxing Issues That Affect Your Children. . . . . . . . 73 Raiding the Piggy Bank: Taxation of Under 18s....................73 Taxing your children’s investment accounts..............74 Taxing the paper round: Employment income............75 Getting a Distribution from a Trust........................................76 Getting Something Back: The Tax Offsets You Had to Have....................................................................80 Family Tax Benefit (Part A)............................................81 Family Tax Benefit (Part B)............................................81 Baby Bonus......................................................................81 Child care rebate.............................................................81 Education tax refund......................................................82

Part III: Tax Effective Investments..................... 85 Chapter 8: Interesting Stuff: Bank Deposits and Tax. . . . . . . 87 Banking the Return: Interest....................................................87 Starting a First Home Saver Account......................................89 Interesting Claims......................................................................90

Chapter 9: Owning Part of the Company: Investing in Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Sharing the Profits: Dividends.................................................91 ‘Frankly’ my dear .â•›.â•›.â•›.......................................................92 Reducing dividend payments: What can I claim?........................................................97 Borrowing to build your wealth: Interest payments........................................................98 Taxing Your Gains and Losses...............................................100

Chapter 10: Building Your Dreams: Investing in Bricks and Mortar. . . . . . . . . . . . . . . . . . . . . . 103 Collecting the Rent..................................................................103 Reducing the Costs: What You Can Claim...........................104 Apportioning Expenditure: The Bits You Can’t Claim........106 Claiming Specific Deductions: What’s on the List..............106 Depreciating your assets..............................................106 Understanding capital works deductions..................109 Repairing what is yours................................................111 Going in reverse: Negative gearing.............................112 Calculating non-deductible expenditure....................113 Paying 10 per cent: Goods and services tax.............115

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Tax For Australians For Dummies, 2nd Edition

Chapter 11: Catching Up on Capital Gains Tax. . . . . . . . . . . 117 Looking at the Rules: CGT Assets.........................................118 Taxing your stamp collection: Collectables..............120 Taxing your underwear: Personal use assets............121 Taxing all your treasures: Your other assets.............121 Calculating a Capital Gain......................................................123 Rolling in dough: Capital proceeds.............................125 Adding up the costs: Cost base..................................126 Going modern: After 21 September 1999...................127 Getting a history lesson: Before 21 September 1999....................................................129 Crying over spilt milk: Capital losses.........................133

Part IV: Running a Business............................ 135 Chapter 12: Structuring Your Business for Maximum Gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 Choosing a Business Entity....................................................137 Becoming a Sole Trader: Going It Alone..............................139 Inhaling the good news................................................140 Exhaling the bad news..................................................140 Forming a Partnership: Sharing the Workload....................141 Key partnership taxation principles you need to know..............................................................142 Sharing the good stuff..................................................143 Taking on board the bad stuff.....................................144 Creating a Company: The More the Merrier........................144 Understanding the good bits.......................................145 Dealing with the bad bits.............................................146 Trusting in Trusts....................................................................148 Examining what’s good about trusts..........................149 Checking out the evils of trusts..................................149

Chapter 13: Starting a Business: On Your Mark! Get Set! Go!. . . . . . . . . . . . . . . . . . . . . . . . . 153 Getting the Show on the Road...............................................153 Obtaining a tax file number.........................................154 Applying for an Australian Business Number...........154 Registering for GST.......................................................154 Getting to Grips with Record Keeping..................................155 Taking on Employees..............................................................157 Examining Tax Concessions for Small Business..................158 Choosing How You Recognise Your Income........................161

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Table of Contents Taking Stock of Things............................................................163 Valuing your trading stock...........................................163 Understanding the nitty gritty of trading stock........164

Chapter 14: Reducing Your Small Business Tax Bill. . . . . . 167 Understanding the Rules: What Can I Claim?......................167 Getting Specific with Problematic Deductions....................170 Dealing with bad debts.................................................170 Paying interest on borrowings....................................171 Borrowing expenses......................................................173 Losing money by theft..................................................173 Getting a legal opinion: Legal costs............................174 Getting tax help: Tax-related expenses......................175 Stamping a lease: Lease document expenses...........176 Discharging the mortgage............................................176 Claiming a superannuation deduction.......................176 Losing money: Business losses...................................177

Chapter 15: Collecting Tax for the Government: Goods and Services Tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . 179 Collecting 10 Per Cent.............................................................180 Taxing your sales: What are taxable sales (supplies)?........................................................181 Examining what are input taxed sales (supplies).....184 Checking out what are GST free sales (supplies).....184 Registering for GST..................................................................186 Paying the GST.........................................................................187

Chapter 16: Living on the Fringe: Fringe Benefits Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 Coming to Terms with FBT....................................................189 Calculating the FBT.................................................................192 Calculating a Car’s FBT...........................................................193 Using the statutory formula method..........................193 Using the operating cost method...............................195 Packaging Your Salary.............................................................195

Chapter 17: Getting Wealthy: CGT and Small Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 Keeping What You Sow: Tasting the Tax Incentive Goodies.........................................................197 Qualifying for CGT relief...............................................198 CGT assets that don’t qualify for CGT relief.............198 Businesses operated through a company or trust.......................................................199

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Tax For Australians For Dummies, 2nd Edition CGT Concessions for Small Business...................................200 Checking out the 15 year exemption..........................200 Getting a helping hand: 50 per cent reduction.........201 Thinking about retiring: Retirement concession......202 Transferring your gains: Rollover concession..........203

Part V: Thinking Long Term............................. 205 Chapter 18: Preparing for Retirement Using Superannuation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207 Complying and Non-Complying Super Funds......................207 Non-complying superannuation funds.......................208 Complying superannuation funds...............................208 Choosing a Goose to Lay the Golden Egg............................208 Shopping around: Retail funds....................................210 Working long hours: Industry funds...........................210 Doing it yourself: Setting up your own fund.............210 Taxing Your Nest Egg..............................................................213 Taxing super funds........................................................213 Claiming a tax deduction.............................................214 Making a Contribution: Understanding the Rules...............216 Examining concessional and non-concessional contributions..............................................................218 Getting older: Under and over 65 years.....................219 Helping out the boss: Employee.................................219 Being in charge: Employer contributions..................220 Working for yourself: Self-employed...........................220 Getting what is due: Government incentives............221 Getting the Money: Conditions of Release...........................222 Maturing nicely: Under 55 years.................................224 Reaching your preservation age.................................225 Between 55 years and 59 years...................................225 Between 60 years and 64 years...................................226 Feeling great: Over 65 years........................................227

Chapter 19: Reaping What You Sow: Receiving a Pension and Government Concessions . . . . . . . . . . . . . 229 Paddling the Superannuation Stream: Types of Super Pension..................................................................................230 Transition to retirement pensions..............................230 Understanding non-account-based pensions............232 Understanding account-based pensions....................234

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xiii

Getting Help: Government Pensions and Allowances........236 Taxing pensions and allowances.................................237 Getting back what you deserve: Tax offsets.............238 Being allowed to keep it: What isn’t taxed................239

Chapter 20: Death and Taxes: Wills and Business Succession Planning. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241 Preparing a Will........................................................................241 Taxing Your Income.................................................................243 Sharing Your Pension..............................................................245 Taxing All Your Treasures......................................................247 Planning Ahead: Business Succession Planning..................249

Part VI: The Part of Tens................................. 251 Chapter 21: Ten Ways to Minimise Your Tax while Keeping the Tax Office Happy. . . . . . . . . . . . . . . . . 253 Keep Good Records.................................................................253 Take Advantage of New Developments................................254 Get a Helping Hand from the Tax Office...............................255 Lose Money the Right Way.....................................................255 Contribute to a Super Fund....................................................257 Claim a Super Tax Deduction.................................................257 Take Advantage of the Low Income Threshold...................257 Package Your Salary................................................................258 Tap In to Negative Gearing.....................................................259 Account for Income and Deductions....................................260

Chapter 22: Ten of the Top Retirement Tax Tips . . . . . . . . . . 261 Plan Ahead................................................................................261 Live Within Your Means..........................................................262 Do a Budget..............................................................................263 Get Proper Advice...................................................................263 Work for the Pension: Transition to Retirement.................264 Earn Some Tax-Free Pocket Money.......................................264 Update Your Pension Entitlement.........................................265 Take Advantage of the Main Residence CGT Provisions.....................................................................265 Downsize: Too Big for Comfort..............................................266 Exploit Your Winning Edge.....................................................267

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Part VII: Appendixes....................................... 269 Appendix A: Income Tax Rates and Tables. . . . . . . . . . . . . . 271 Appendix B: Taxing the Visitors: Non-Residents. . . . . . . . . 293

Glossary......................................................... 299 Index.............................................................. 311

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Introduction

A

ustralian income tax law can be very complex and difficult to understand. You have to thumb through two income tax assessment Acts equivalent in size to four telephone books, thousands of income tax rulings and a library full of legal books to find the right answer. The dominant purpose of the income tax legislation is to raise revenue by levying a tax on taxable income. The tax Acts point out that assessable income minus deductions equals taxable income, and then tells you the rules you need to follow to calculate your assessable income and allowable deductions. The Acts also tell you who must pay income tax and how to work out how much income tax you must pay. Generally, you have a choice of two ways to solve your tax liability problems. You can either pay a registered tax agent or solicitor who specialises in income tax law, or you can try to find out the answer yourself. If you pay someone, you quickly find that the meter starts ticking the moment you walk through the door. Although seeking professional advice is highly recommended and encouraged, you need never underestimate your own abilities. If you use basic research skills that you acquired during your student days plus the skills you use to do your job, you may be pleasantly surprised at how adept you are at taking on responsibility for your own tax journey. So, if you have a winning edgeÂ€— the skills to do basic researchÂ€— why not have a go? If you can’t solve your problem or you lack confidence, at least you tried. And if you do seek professional advice, you’re in a position to have a meaningful conversation (especially if the fee is substantial!). As a student once said to me: ‘I’ll at least be in a position to verify and check the facts out myself and not feel like a fool!’

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About This Book Tax For Australians For Dummies caters for tax beginners and is useful as a quick reference for the more tax-savvy readers. AsÂ€well as helping you come to terms with the basic principles of income tax law, it also appeals to students who plan to study tax law, because it closely follows the content of a standard course syllabus. The book explains in simple terms core taxation concepts that you need to be aware of when dealing with Australian issues. Throughout the book, case studies reinforce core taxation principles. Also, you have the option of checking out technical information such as references to major fact sheets and income tax rulings that tax professionals use and rely on to solve taxation issues. This level of information is useful to readers who are studying income tax law or who wish to understand how the Tax Office comes to certain tax conclusions in its own interpretation of the tax laws.

Conventions Used in This Book To keep things consistent and easy to follow, here are a couple of the conventions this book uses 55 Tax terms appear in italics and are closely preceded or followed by an easy-to-understand definition. 55 When I reference tax office publications or provide websites of interest, I include the address in a special typeface like this: www.ato.gov.au.

What You’re Not to Read Here and there throughout this book, you see sidebars — text boxes that are separate from the regular content and feature a grey background. Sidebars include information that’s related to the content in the chapter but is also independent of it. You don’t have to read them, and your understanding of the chapter’s subject matter isn’t going to suffer if you don’t. While you’re not going to miss critical information if you decide to skip them, many of the worked examples are great to come back to at a more relevant time, that is, when you’re preparing your own tax return and the like.

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3

Introduction Another thing you can safely skip without worrying about it are the occasional paragraphs with a Technical Stuff icon beside them. Big surprise, this is stuff for tech-minded readers and represents information that’s interesting (downright fascinating sometimes!), but not crucial to your general understanding of the subject matter.

Foolish Assumptions I wrote this book with some assumptions in mind. I assume 55 You’re in one or more of the following categories — accountant or adviser on tax, employee, employer, investor, self-employed, retiree, taxation student, worker in the tax industry. 55 You want simple facts on the complex subject of tax in an easy-to-use format. 55 You want to have on hand the many ways to minimise your tax while keeping the Tax Office happy. 55 You’re likely to be aged 18 years and upwards.

How This Book is Organised This book has seven parts, divided as follows:

Part I: How You’re Taxed in Australia Part I shows that Australian income tax law uses a formula to tax income. Australian residents are taxed differently to nonresidents, so it’s important that you’re aware of your residential status for the purposes of income tax legislation. This part also explains what happens if your tax affairs are audited.

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Part II: Income from Personal Exertion If you’re an employee and you derive a salary or wage, your employer is required to deduct income tax from your pay and make a contribution to a superannuation fund on your behalf. At the end of the financial year you need to lodge a tax return for individuals disclosing your taxable income. This part shows that your main residence is exempt from tax and how your children are taxed on income they derive.

Part III: Tax Effective Investments In this part, I discuss the key taxation issues associated with investing and their impact on your investment’s overall performance. You may be liable to pay tax on investment income and capital gains tax on gains. Further, you may qualify for certain tax deductions and some very handy tax offsets.

Part IV: Running a Business If you plan on starting a business, you need to come to terms with the complex tax rules associated with operating a business. In this part of the book, you find what you must do to comply with the tax Acts and the benefits you can gain from running a small business. You also find out about the four ways you can structure your financial affairs. This part also discusses fringe benefits tax and the goods and services tax provisions.

Part V: Thinking Long Term Planning ahead and covering all your bases makes good financial sense. In this part, you find issues associated with preparing for retirement using superannuation and the taxation of pension options. You also find how your income and assets are taxed after you die and how to reduce the tax burden.

Part VI: The Part of Tens In this part of the book, I look at ten different ways to help you reduce your tax bill and ten ways to help you live comfortably in retirement.

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5

Introduction

Part VII: Appendixes This part contains three useful references: 55 Appendix A contains income tax rates and tables. 55 Appendix B discusses taxation issues for non-residents. 55 Appendix C lists leading tax cases and Tax Office publications. This online reference is a handy tool if you want to know whether a specific expense is tax deductible or you’re studying taxÂ€law. You can find this appendix on our website: www.dummies.com/go/taxforaustraliansfd

Icons Used in This Book Some people are more visual than others. That’s where icons come in handy. This book uses several icons and each has a little titbit of information associated with it. Here’s what each icon means. If you’re keen and eager to learn more about tax, this icon points you to handy websites to help you quickly solve tax issues that may come your way. This icon highlights a change in tax rules that the federal government is proposing for the future. Where possible, fixed commencement dates are given. Everyone can use a friendly reminder. The Remember icon is a quick and easy way to identify some of the more important tax points that you may want to make note of throughout the book. Sometimes we get carried away with technical stuff. Some of you are going to find this level of information really interesting; some of you may be bored to tears. Skip it if you wish or use it if you want a more complete understanding of your tax issue. Tips include tax information that can help you save time or cut down on frustration. Text flagged with the Warning icon can keep you out of trouble. Serious legal issues encourage you to watch your tax step.

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6


Where to Go from Here Tax For Australians For Dummies may not be the exciting novel that you read from cover to cover. Rather, you can dip in and out to suit the occasion (tax return time) or when your interest level is piqued (due to a change in personal circumstance or making plans for your retirement). Each chapter is uniquely designed to give you a good overview of a specific tax topic you may be interested in, with case studies to reinforce the learning process. While sitting in a comfortable chair or at your desk with a cup of coffee, within a matter of minutes you can come to terms with specific issues such as assessable income, deductions, superannuation and business structures. The book also provides a quick summary of the capital gains tax, fringe benefits tax and goods and services tax provisions. By the way, if you’re cramming for an exam or you’re not sure about a particular issue, Tax For Australians For Dummies can quickly steer you in the right direction and save you much time and heartache! Note: Check out a number of leading tax cases and Tax Office publications in AppendixÂ€C, which is online at our website: www.dummies.com/go/taxforaustraliansfd. And, if you wish to brush up on a tax term, you can flip to the Glossary for a quick prompt.

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Part I

How You’re Taxed inÂ€Australia Glenn Lumsden

‘We declare you a free man. Now get back to the chain gang, you’re a taxpayer.’

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A

In this part .â•›â†œ.â•›â†œ.

ustralia uses two income tax assessment Acts to levy tax on taxable income. They’re the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997. When you thumb through the 1936 Tax Act you would think it was written in a foreign language. Fortunately, the 1997 Tax Act was written in plain English to help you to better understand your tax obligations. In this part of the book, you find that Australian income tax law is made up of rules and regulations that you need to know and follow. I explain the rules for lodging your annual tax return, how self-assessment works and what happens if your tax affairs are audited.

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Chapter 1

Understanding the Australian Tax System In This Chapter `Èxplaining the tax system ``Progressing through the tax rates and rules ``Determining sources of income ``Paying tax if you’re a company

I

f you find tax a — excuse the pun — taxing subject, then you’re not alone. Most people are confused by and would rather not pay taxes. However, we all know the cliché: Death and taxes are the only sure things in life. So, put another way, you probably need to take some time to understand taxation. This chapter goes over some basic info that you need to understand in order to lodge your tax return in Australia. I explain the basics of the Australian tax system, tell you how to work out sources of income and examine what tax you need to pay if you’re aÂ€company.

Explaining the Australian TaxÂ€System In Australia, two income tax assessment Acts are used to levy tax on taxable income. They’re equivalent in size to four telephone books and contain the various tax Acts that give the federal government the authority to tax you. They’re the Income Tax Assessment Act 1936 and Income Tax Assessment Act 1997. The reason for two Acts is because the 1936 Tax Act is gradually being replaced with the more user-friendly 1997 TaxÂ€Act.

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Part I: How You’re Taxed in Australia

Taxing matters: How it all began In 1915, the Fisher Government introduced an Act to impose a tax on income from personal exertion, income from property and company profits. The major reason given was to help fund Australia’s involvement in the Great War. However, after you let such a genie out of the bottle, stopping a politician from continually dipping a hand in your wallet or purse is a nigh impossibility. The federal government has since introduced

three additional taxes — capital gains tax (CGT, introduced in 1985), fringe benefits tax (FBT, 1986) and the goods and services tax (GST, 2000). When you come to think about it, the federal government has just about covered every conceivable way you can be taxed. The only thing it hasn’t done is tax the air you breathe. But, wait on, hold your breath .â•›â†œ.â•›â†œ. I’m quite sure some diligent bureaucrat in Canberra is currently examining this possibility!

Understanding Your Income TaxÂ€Rates For resident individuals, tax is levied on worldwide income on a progressive basis, referred to as marginal tax rates. Your marginal tax rates can vary between 0Â€perÂ€cent and 45Â€perÂ€cent (marginal tax rates are shown in AppendixÂ€A). This rating system means the more income you earn, the greater the amount of tax you’re liable to pay. Australia has numerous federal, state and territory, and local government taxes that you need to deal with.

Federal taxes The most important federal taxes include the following: 55 Capital gains tax (CGT) is paid on gains you make when you sell assets you own and on the occurrence of certain CGT events. Your main residence is exempt from tax and some other concessions may potentially be available. 55 Customs duty is paid on certain goods you import into Australia (for example, cameras, perfume, alcohol and cigarettes).

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Chapter 1: Understanding the Australian Tax System

11

55 Excise duty is levied on certain goods manufactured in Australia, such as alcohol and tobacco. 55 Fringe benefits tax applies to certain benefits you may receive (for example, your employer provides you with a car for private use). 55 Fuel tax is levied on petrol. 55 Goods and services tax is applied to most purchases and sales. 55 Income tax is paid on income you derive from worldwide sources. 55 The Medicare levy is used to help fund the Australian healthÂ€system. (The rate is 1.5 per cent of your taxable income, and if you don’t have private health insurance, youÂ€may be liable to pay a 1Â€perÂ€cent Medicare levy surcharge ifÂ€your taxable income is above a certain threshold amount.) 55 Withholding tax is paid on certain income derived by a nonâ•‚resident.

State taxes Following are some of the taxes levied by states. 55 Gambling tax is levied on certain gambling transactions (such as licence fees, poker machines). 55 Land tax is paid on some property holdings. 55 Payroll tax is levied on wages and fringe benefits an employer pays their employees. 55 Stamp duty applies to certain transactions, particularly when you buy a property.

Local taxes Property valuation and rate charges fund local government services (such as rubbish collection).

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Part I: How You’re Taxed in Australia The Australian Taxation Office (Tax Office) is the federal government authority responsible for administering Australia’s tax laws. To help you meet your legal requirements, the Tax Office regularly issues free-of-charge fact sheets, income tax rulings, tax determinations and interpretative decisions to explain tax issues that need clarification. You can get copies of these fact sheets and tax rulings from your local tax office or you can visit the Tax Office’s website (www.ato.gov.au).

Taxing Major Income Streams Income is normally derived from three major sources: 55 Income from personal exertion, such as salary and wages, bonuses and commissions you earn as an employee, and any allowances you receive (see ChapterÂ€5) 55 Income from property, such as interest, dividends, rent, annuities and royalty payments (see ChaptersÂ€8–10) 55 Income from carrying on (running) a business, such as profits you earn from your business activities (see ChapterÂ€12)

Taxing your treasures: CGT assets You may be liable to pay capital gains tax (CGT) on profits you make when you sell CGT assets such as shares, real estate and collectables. However, just 50Â€perÂ€cent of the capital gain you make is liable to tax if you own CGT assets for more than 12Â€months. This concept is discussed in more detail in ChapterÂ€11. Under the CGT provisions, your main residence is exempt from tax. The good news is if you’re temporarily absent from Australia, your main residence continues to be exempt for an indefinite period if the property isn’t used to earn assessable income. Alternatively, if you lease the property while you’re away your main residence is exempt from tax for up to sixÂ€years (for more details, see ChapterÂ€6).

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Chapter 1: Understanding the Australian Tax System

Bringing home the money: International sources of income As an Australian resident, you’re required to disclose income you earn from worldwide sources, while a non-resident is required to disclose income that has only an Australian source. Unfortunately, the tax Acts don’t provide a statutory definition of source. Generally, three key tests are used to determine source of income: 55 The place where you perform the services 55 The place where you sign the contract to perform those services 55 The place of the payment Ordinarily, your source of income is where you perform the services. For example, if you earn salary and wages, the source of income is the place where you perform the work, while the source of business profits is where you carry on the business activities. From 1 July 2009, if you’re a resident of Australia deriving foreign employment income such as salary and wages, you need to include the amount you earn overseas in your Australian tax return and pay tax here. If you pay foreign tax while working overseas, you can claim a foreign income tax offset in respect of the foreign tax that you pay. However, this rule harbours an exception. Foreign employment income derived by charity workers, certain government employees (for instance the military and police) and people working on approved projects of national importance is exempt from tax in Australia. This exemption applies on the proviso that you work overseas for more than 90Â€days and you’re liable to pay foreign tax on the income you earn. The bad news is, if you don’t pay tax on income you earn overseas, you have to include it in your Australian tax return and pay tax here. Unfortunately, you can’t win all the time! If you earn foreign income such as dividends, interest and royalties, and withholding tax is deducted from the payment, you can claim a foreign tax credit for the foreign tax you pay. You need documentary evidence to substantiate your claim for a foreign tax credit (for example, notice of assessment and receipt of payment).

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14


Checking your residency status Your residency status determines the amount of tax you’re liable to payÂ€— because different tax rules and taxÂ€ rates apply to residents and non‑Â� residents. A resident of Australia is a person who normally lives in Australia and has a permanent home and job in Australia (commonly known as the residency test). In most cases, deter‑ mining residency is relatively straight‑ forward. But this determination could become a little cloudy if you’re absent from Australia for a long time. Your personal circumstances can change from year to year, so a number of tests may be used to check whether you’re a resident. The main tests are 55 Do you intend to live in Australia? 55 A re you physically present in Australia? 55 H ow long do you stay in Australia each financial year? 55 D o you have a family home in Australia? 55 D o you have business and family ties in Australia?

55 A re your personal assets located in Australia? As a general rule, if you’re out of the country for more than two years and you sever your economic and social ties with Australia (for example, you quit your job and your family goes with you), you’re most likely going to be treated as a non-resident for income tax purposes. After you leave Australia, it doesn’t mean you can’t change your mind and come back in the future. On the other hand, if you migrate to Australia you’re generally considered a local for tax purposes from the date of your arrival, which means you’re taxed as a resident from day one, and you gain all the tax con‑ cessions available to residents. If you become a resident of Australia during the financial year, you can’t claim the full $6,000 tax free threshold. (The tax free threshold is the maximum amount of income you can receive that isn’t taxed — see AppendixÂ€ A.) You need to pro rata the amount. You can claim $500 for each month you’re in Australia including the month you arrive. For example, if you arrive in Australia on 13Â€October, your tax free threshold is $4,500 ($500Â€×Â€9Â€months).

Taxing a Company A company is a separate legal entity. It must apply for a tax file number (see ChapterÂ€5) and lodge a company tax return at the end of the financial year, disclosing the taxable income it earns. A company is liable to pay a 30Â€perÂ€centÂ€flat rate of tax on

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Chapter 1: Understanding the Australian Tax System taxable income it earns (derives). The good news is a company isn’t liable to pay aÂ€1.5Â€perÂ€cent Medicare levy. The federal government proposes to reduce the company tax rate to 29Â€perÂ€cent in 2013–14. A company can also be a resident or non-resident of Australia. Under Australian income tax law, a company is a resident of Australia if it incorporates in Australia. If this scenario isn’t the case, a company can still be a resident for tax purposes if: 55 It runs a business in Australia 55 Its central management and control is in Australia 55 Its voting power is controlled by shareholders who are residents of Australia A company’s central management and control is usually where the company directors ordinarily meet to manage and run the company’s ongoing business operations. In ChapterÂ€12, I guide you through the tax issues relating to a company structure.

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16

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Chapter 2

Taxing Australians: The Formula You Had to Have In This Chapter `Ùnderstanding the tax formula `Ìdentifying assessable income ``Working out exempt income ``Dissecting the general deduction provisions

I

n this chapter, I guide you through the key components that make up the tax formula and explain the statutory regulations you need to follow to comply with its application.

Doing Your Sums Tax is levied on taxable income. At the end of each financial year (which commences on 1 July and ends on 30Â€June), Australian residents are required to disclose the taxable income they derive from all sources in and out of Australia, while non-residents are required to disclose only taxable income they derive from sources in Australia (refer to ChapterÂ€1 and AppendixÂ€B). The Australian tax system uses the following tax formula to calculate your taxable income: Assessable income - allowable deductions = taxable income The system then sets out the rules you need to follow to determine your taxable income. FigureÂ€2-1 sets out an overview of the various elements that make up this tax formula.

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Part I: How You’re Taxed in Australia minus

Assessable income

Deductions

Derived

Ordinary income Income from personal exertion • Salary and wages • Allowances

equals

Incurred

Statutory income

Deductible

Not deductible

Capital gains

First positive limb Actually incurred

Negative limbs • Capital in nature • Private or domestic in nature • Deriving exempt income • Statutory exclusions

Income from property • Interest • Royalties • Dividends • Annuities • Rent

Second positive limb Necessarily incurred running a business

Taxable income Tax payable on taxable income plus Medicare levy (1.5% of taxable income) minus Domestic tax offsets (rebates)

Proceeds from carrying on a business Business profits

Figure 2-1: Charting the tax formula you had to have.

Declaring What You Earn: Assessable Income Assessable income is income that you’re liable to pay Australian income tax on. Assessable income is a combination of two key components: Ordinary income and statutory income (see the next sections). You’re considered by the Tax Office to have derived (earned) assessable income when you receive a payment, or when you can legally demand payment for the services you’ve provided. The following classes of assessable income are considered to have been derived when they’re paid to you: 55 Business profits if you use the cash or receipts basis to recognise your income (for more details see ChapterÂ€13) 55 Dividends 55 Interest 55 Rent 55 Salary and wages

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Chapter 2: Taxing Australians: The Formula You Had to Have

19

You’re liable to pay tax only on assessable income you derived during the year of income. This liability means that payments you haven’t earned aren’t taxed. You’re considered to have derived or earned the amount as soon as you instruct someone as to how the income should be applied on your behalf (for instance, you instruct your employer to pay a bill on your behalf rather than giving the income to you). If you run a business and use the accruals or earnings basis to recognise your income, you’re considered to have derived your business profits when you have a legal right to demand payment (see ChapterÂ€13). Further, if you receive a payment before providing the services, you’re considered to have derived this amount when the services have been completed. The Tax Office provides fact sheets and tax rulings to help you to understand the meaning of assessable income. The main ones (‘Income — what is it?’ and ‘Income from dividends’) are available from the Tax Office website: www.ato.gov.au

Ordinary income Ordinary income can cover a broad category of potential receipts. The Tax Act doesn’t tell you what ordinary income means, so you need to follow the general principles associated with identifying the characteristics of ordinary income. Ordinary income is income that someone commonly understands the term to be. It is generally divided into three broad categories: 55 Income from personal exertion, particularly salary and wages, bonuses and commissions you earn as an employee, and any allowances you receive. Income derived from this source is taxed at your marginal tax rates (refer to ChapterÂ€1). If you’re a resident of Australia, you may qualify for certain domestic tax offsets (rebates). 55 Income from property, such as interest, dividends, rent, annuities and royalty payments. If you’re a resident of Australia, income derived from this source is taxed at your marginal tax rates. Further, if you receive a dividend, you may qualify for a dividend franking credit tax offset (see ChapterÂ€9). If you’re a non-resident, certain payments you receive are liable only to withholding tax (see AppendixÂ€B).

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Part I: How You’re Taxed in Australia 55 Proceeds from carrying on (running) a business, such as the profits you earn from your business activities. Income earned from this source is taxed at your marginal taxÂ€rates. However, if you run a business in a company structure, you pay a 30Â€perÂ€cent flat rate ofÂ€tax. In 2013–14, the federal government is proposing to reduce the company tax rate to 29Â€perÂ€cent. Assessable income, particularly ordinary income, can also arise from an isolated commercial transaction outside the scope of what you normally do for a living; for example, if you’re a fashion designer and decide to build a block of flats. This tax liability is on the proviso that the intention or purpose of entering into the transaction is to make a profit or gain. Any profit or gain you make is treated as assessable income. Conversely, if you make a loss, you can claim a tax deduction. Because this area of the law is complex, you’re best to seek advice from a registered tax agent or solicitor.

Statutory income Statutory income is assessable income liable to tax because it’s specifically listed in the Tax Act. This tax liability may arise, for example, if you make a net capital gain on the sale of a CGT asset or the occurrence of some other CGT event (see ChapterÂ€11), or you receive a franking credit attached to a dividend (see ChapterÂ€9).

Keeping What You Receive: ExemptÂ€Income Not everything that comes your way has to be shared with the Tax Office — phew! Why? Because certain payments you may receive are exempt from tax. For example, you don’t have to pay tax if you receive regular maintenance payments from a former spouse, you’re a full-time student in receipt of a scholarship, or you receive certain government pensions or allowances (see ChapterÂ€19). Other payments that are exempt from income tax include certain: 55 Defence force allowances 55 Family assistance allowances

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Chapter 2: Taxing Australians: The Formula You Had to Have 55 Educational assistance allowances 55 Compensation payments

The good news gets even better because certain organisations are also exempt from tax. They can include registered employer associations, non-profit societies for the encouragement of music and charitable institutions, non-profit sports clubs, public educational institutions and non-profit hospitals. (Because these organisations don’t pay tax on income derived, more money is available to help fund their activities!) A number of payments are exempt from tax, so you need to know which ones are assessable or exempt. As a general rule, exemption depends on why you received the payment. The confusing bit is that a payment can come from many different sources — for example: 55 An income-earning activity such as employment or from running a business 55 An isolated commercial transaction with a view to making a profit or gain 55 Investment activities 55 Gifts from friends and relatives 55 A deceased estate 55 A hobby or pastime 55 A big win at the casino or races 55 Proceeds on the sale of CGT assets It may be difficult to work out which of these payments are assessable or exempt. To make matters even more confusing, if the payment is a capital receipt it can be liable to tax under the CGT provisions (see ChapterÂ€11). Income has the following characteristics: 55 Income is a periodical cash receipt (or benefit that can be converted into cash), recurrent and regular (for example, pension payments) 55 Income usually arises if a sufficient connection exists between an income-earning activity and the payment (such as salary and business profits). If a sufficient connection isn’t present, the receipt is most likely exempt fromÂ€tax.

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Part I: How You’re Taxed in Australia The following payments are examples of receipts that are normally exempt from tax because they fail the sufficient connection test: 55 Money you receive from windfall gains such as lottery, gambling and betting wins. 55 Personal gifts you may receive from friends and relatives. 55 Pocket money you give to your children. 55 Proceeds from a hobby or pastime. However, if you’re getting $5,000 from selling fruit and vegetables, for example, you may be liable to tax because you may be considered to be running a business if you’re doing this on a regular basis. 55 Money you may inherit. 55 Certain compensation payments (such as for losing an eye or limb). If you like horse racing, regularly buy lotto tickets in the hope of hitting the jackpot, or play poker, I’ve got some good news. The proceeds from gambling and betting are normally exempt from tax, unless you can prove you’re running a business of gambling and betting. Whether a sufficient connection exists to make these proceeds assessable is a question of fact. As a general rule, proving this connection to the Tax Office is extremely difficult — because activities involving an element of chance are normally considered to be no more than a hobby or pastime and not a business. Unless you’re connected with the racing industry (for example, you’re a bookmaker, trainer or horse breeder) you’re unlikely to succeed in your attempt to convince the Tax Office. Before you start sending thank-you letters to the Tax Office, the reason it isn’t keen to tax your winnings is because if it treats your activities as a business, any gambling and betting losses you incur become a tax deductible expense. And, because losing generally trumps winning, the Tax Office isn’t eager to subsidise your bad habits! If you want to know more about whether your horse-racing activities are a business or hobby, check out Taxation Ruling ‘TRÂ€2008/2Â€— Horse racing, training and breeding activities’ on the Tax Office website: www.ato.gov.au

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Reducing Your Tax Bill: GeneralÂ€Deductions You must satisfy a number of conditions to claim a general deduction (referred to as the general deduction provisions). You can also claim certain specific deductions. I cover this issue in ChapterÂ€14. The general deduction provisions set out the following rules for claiming a tax deduction. You can deduct from your assessable income any loss or outgoing to the extent: 55 The loss or outgoing is incurred in gaining or producing your assessable income;Â€or 55 The loss or outgoing is necessarily incurred in carrying on (running) a business for the purpose of gaining or producing your assessable income. However, you’re warned that you can’t deduct a loss or outgoing under the general deduction provisions to the extent that it is a loss or outgoing of capital, or of a capital nature; or it is a loss or outgoing of a private or domestic nature; or a provision of this Act prevents you from deducting it. (For more details, see the sections later in this chapter.) When you examine the nuts and bolts that make up the general deduction provisions, twoÂ€positive limbs allow you to claim a taxÂ€deduction (see the next section), and fourÂ€negative limbs prevent you from claiming a tax deduction (see the section ‘Being aware of the negatives: Negative limbs’, later in this chapter). Further, you can claim a deduction only to the extent to which they’re incurred in gainingÂ€or producing your assessable income. This means you’re allowed to separate the parts of expenditure that may be partly allowable for deriving assessable income and partly not allowable because they’re private or domestic in nature. For example, this could arise if you use your car partly for the purposes of deriving assessable income (for example, you use your car for only two days a week to earn income). Under these circumstances, two-sevenths of your car expenses are deductible, while the balance would be private or domestic in nature. The general deduction provisions also point out you can only claim expenditure that has been incurred in gaining or producing assessable income.

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Part I: How You’re Taxed in Australia To comply with the deduction part of the tax formula (refer to FigureÂ€2-1), you need to come to terms with the following key concepts: 55 First positive limb 55 Second positive limb 55 The negative limbs 55 Meaning of incurred

Checking out the first leg: FirstÂ€positive limb The first positive limb sets out the rules for claiming a tax deduction. It applies to individuals who derive personal exertion income such as salary and wages, and income from property, such as interest, dividends and rent. (If you’re not running a business, you must rely only on the first limb to claim a tax deduction.) The first positive limb points out that you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income. To claim a tax deduction under this limb, you need to demonstrate that the loss or outgoing was incurred in the course of gaining or producing your assessable income, and that it must be incidental and relevant to that end. Further, for the expenditure to be deductible, a perceived connection between the expenditure and the gaining or producing of your assessable income must be shown to exist. The perceived connection is determined by examining the character of the expense. To qualify for a tax deduction under the first positive limb: 55 A direct connection must exist between the expenditure and the derivation of your assessable income. 55 The expenditure must be incurred while you’re deriving your assessable income.

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Examining the next leg: SecondÂ€positive limb To claim a tax deduction under the second positive limb, you need to demonstrate you’re running a business. The deduction must necessarily be incurred in running a business for the purpose of gaining or producing your assessable income. We discuss whether you’re actually running a business in ChapterÂ€12. Generally speaking, to qualify for a tax deduction under the second positive limb, the outgoing must be part of theÂ€cost of trading operations. This assessment depends on two key conditions: 55 The outgoing was necessarily incurred in running a business. 55 Running the business was for the purpose of gaining assessable income.

Being aware of the negatives: Negative limbs The general deduction provisions of the Tax Act also tell you what loss or outgoing isn’t a tax deductible expense. They point out you can’t deduct a loss or outgoing under this section if: 55 The loss or outgoing is capital, or of a capital nature (seeÂ€the next section) 55 The loss or outgoing is of a private or domestic nature (forÂ€example, if you can’t show a sufficient connection with earning your assessable income) 55 A provision of the Tax Act prevents you from deducting it. (Certain expenses such as entertainment expenses and fines are specifically not tax deductible.) 55 The loss or outgoing is incurred in relation to gaining or producing exempt income

Checking out what is capital in nature Unfortunately, the area of the law concerning whether a loss or outgoing is capital, or of a capital nature is very complex. Whether the expenditure is capital and not deductible, or tax deductible can depend on a fine level of judgement. Generally,

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Part I: How You’re Taxed in Australia if an expense is designed to bring into existence a lasting or enduring benefit, such as getting a driver’s licence in order to get a job, or is a one-off payment (for example, purchasing your business premises), the expenditure is most likely to be capital in nature and not tax deductible. Other examples that are not tax deductible include 55 Undertaking a course of study that has no relevance to your current occupation (such as a motor mechanic studying accountancy) 55 Costs associated with trying to find a job Ordinarily, two key tests are used to help you determineÂ€whether certain expenditure is capital or income in nature. The tests are 55 The nature or character of the expense 55 The advantage to be sought by incurring the expense For example, if an expense arises out of the day-to-day activities of your business or income-producing activity (such as advertising costs and salaries you pay your staff), the expenditure is likely to be tax deductible. On the other hand, if the expenditure is devoted towards a structural rather than an operational purpose (such as certain legal costs associated with setting up a business), the expenditure is of a capital nature and the expenses aren’t tax deductible. Expenses associated with establishing, replacing, enlarging or improving the business structure, as distinct from working or operating expenses, are capital in nature and not tax deductible. Some capital expenses may be deductible over a period of time, while some may be deductible outright under specific provisions of the tax law. To find even more info, visit the Tax Office website (www.ato.gov.au), and check out its publication ‘Income and deductions for small business (NATÂ€10710)’.

Checking out what is private or domestic in nature The fact that an expense is necessary to derive assessable income isn’t a test for deductibility. For example, you have to wear clothes in order to go to work, but that fact doesn’t necessarily mean you can claim the cost of your clothes as a tax deduction. This interpretation is because the clothes lack a direct or relevant connection with deriving assessable income. So, if a loss or outgoing isn’t incurred in the course of gaining

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Chapter 2: Taxing Australians: The Formula You Had to Have or producing assessable income, or is a prerequisite to earning assessable income, the expenditure is considered to be private or domestic in nature. Following are examples of expenditure that are held by the Tax Office to be private or domestic in nature. 55 Childminding expenses for looking after your children while you work. These expenses have no direct or relevant connection to an employment activity. The expense is simply a prerequisite to earning your assessable income. However, although these types of expenses aren’t tax deductible, you may qualify for a child care rebate (seeÂ€ChapterÂ€7). 55 Expenditure incurred in travelling from home to work. While you’re travelling to work you’re not actually performing any duties associated with deriving your assessable income. No direct or relevant connection exists between the travel and the work you do to qualify for a taxÂ€deduction. 55 Food and drink. Living expenses are ordinarily considered to be private or domestic in nature, because they lack the character of a working or business expense. Searching for relevance between eating king prawns and enjoying a few beers at your favourite restaurant and doing your work is fruitless. It would be great if you could! 55 Hairdressing, cosmetics and other personal grooming. These types of expenses don’t have a direct or relevant connection with an income-earning activity. However, you can take advantage of an exception to this rule if you happen to work under harsh conditions and you’re expected to be well groomed, for example, if you’re a flightÂ€attendant. 55 Purchasing and maintaining conventional clothing. Unless your clothes are part of a recognised work uniform, they lack a direct and relevant connection with an employment activity. These costs are incurred in order for you to be able to commence an employment activity (they’re incurred because you can’t go to work naked!).

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Figuring out when something isÂ€incurred Under Australian income tax law, to claim a tax deduction you need to establish that the expenditure has been incurred. Ordinarily, you’re considered to have incurred an expense when you have a legal obligation to make a payment for certain goods or services you receive. This obligation normally arises at the time you receive an invoice. When you incur an expense, you can claim a tax deduction. One interesting point to keep in mind is that you don’t have to make an actual payment to claim a tax deduction. The only condition is that you’re definitely committed and you have a legal obligation to pay theÂ€bill. In order for a loss or outgoing to be deductible, it must be incurred in gaining or producing your assessable income, or be necessarily incurred in running a business for the purpose of gaining or producing your assessable income. In a major judicial decision (see the online AppendixÂ€C — www.dummies.com/go/taxforaustraliansfd — NewÂ€Zealand Flax Investments Ltd v FCTâ•›â†œ) on the meaning of incurred, it was pointed out ‘incurred does not mean only defrayed, discharged or borne, but rather it includes encountered, run into or fallen upon. But it does not include a loss or expenditure which is no more than impending, threatened or expected’. No proof of payment or actual disbursement need be established. However, what’s clearly necessary is the need for a presently existing liability (that is, a bill exists) and more particularly, that you’re definitely committed to making the payment. The mechanics of figuring out whether an expense has been incurred becomes an issue only at the end of each financial year. This point in time is when you have to decide whether the expense is deductible in the current financial year or in the following financial year. If an expense arises but you’re not sure exactly how much it is going to cost, provided you can make a reasonable estimation of the cost and you’re committed to making a payment, you may be able to claim a tax deduction. This situation normally arises if you run an insurance business where insurance claims are continually arriving and they haven’t been fully processed.

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If you want to know more about the meaning of incurred, see TRÂ€97/7 ‘Meaning of “incurred” — timing of deductions’. You can get a copy from the Tax Office website: www.ato.gov.au Appendix C sets out a number of leading tax cases with respectÂ€to claiming a general deduction. This online resource (www.dummies.com/go/taxforaustraliansfd) is a handy tool if you want to know whether a specific expense is tax deductible or you’re studying taxÂ€law.

Case study: Determining when an expense is incurred William runs a business and has an item of plant and equipment that is due for a general overhaul in threeÂ€ months. The overhaul is going to cost $10,000. William can’t claim a tax deduction at this point in time because: 55 Presently, the proposed expenditure isn’t an existing liability. 55 William isn’t definitely committed to making the payment. 55 The expenditure is no more than impending, threatened or

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expected — no matter how certain William is about which year of income that the loss or expenditure is going to be incurred in the future. However, when William’s plant and equipment is serviced and he receives a bill for $10,000, he’s considered to have incurred the expense. This consequence is the case, even if William hasn’t paid the amount, because now he has a presently existing liability and he’s definitely committed to paying theÂ€bill.

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Chapter 3

Lodging Your Tax Return: This One Is for the Nation In This Chapter ``Preparing and lodging your tax return ``Receiving a notice of assessment

A

t the end of each financial year, whether you like it or not, you have a legal obligation to lodge a tax return for individuals with the Tax Office by 31Â€October (unless you’reÂ€on a tax agent’s lodgement program). This obligation means you have to disclose the taxable income you derived during the previous financial year. Remember, Australia’s financial year commences on 1Â€July and ends on 30Â€June. The headache part of the exercise is the records you have to keep, and grappling with the various tax issues associated with preparing your tax return. (Knowing that you can always see a tax agent if you get into difficulty takes the pressure off when preparing and lodging your return.) If you run a business in a partnership, company or trust structure (see ChapterÂ€12 for more on these business types), you also have to lodge a tax return disclosing the net profit or loss your business earned during the year of income. You also need to disclose your share of any profits (or losses) that were distributed to you. In this chapter, I guide you through the process you need to follow to lodge your annual tax return for individuals.

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Preparing Your Individual TaxÂ€Return You can lodge your tax return in two ways. You (or your tax agent) can fill out the paper tax form included in ‘TaxPack’ and post it to your local Tax Office, or you (or your tax agent) can lodge your tax return online using e-tax. ‘TaxPack’ is a booklet that the Tax Office releases each year to help you to correctly fill out your tax return. This publication is ordinarily available at your local newsagent. E-tax is a free electronic lodgement service provided by the Tax Office that allows you to lodge your tax return online. To take advantage of this online tool, you need to download the Tax Office e-tax software package that permits you to prepare your individual tax return electronically and lodge it over the internet. E-tax returns are usually processed within 14Â€days — great news if you’re expecting to get a tax refund cheque. For more details, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘General information about e-tax’. If you want to lodge online using e-tax, you need to insert the following details shown on your previous notice of assessment: 55 The sequence number 55 Date of issue 55 Your name A notice of assessment is a statement you receive from the Tax Office after you lodge your tax return that summarises the details in your tax return (see the section ‘Receiving a Thank-You Note: Notice of Assessment’, later in this chapter). If you’re a traditionalist at heart and prefer to lodge a paper tax return, you must sign and date the tax return prior to lodging it to confirm the information that you disclose is true and correct. If you don’t lodge your tax return by 31Â€October, you can be liable to pay a late lodgement penalty (an amount that depends on your taxable income and the period of time the tax return is late by). You can avoid this penalty if you see a tax agent. This exemption exists because tax agents are given an extension of time to lodge tax returns on behalf of their clients.

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33

Chapter 3: Lodging Your Tax Return: This One Is for the Nation

To help you to prepare your tax return, the Tax Office issues free of charge a number of publications. The main publications are 55 ‘TaxPack’ 55 ‘TaxPack supplement’ 55 ‘Guide to Capital Gains Tax (NAT 4151)’ 55 ‘Rental Properties (NAT 1729)’ 55 ‘You and Your Shares (NAT 2632)’ If you want a copy of these publications, you can contact the Tax Office directly or you can visit its website (www.ato.gov.au). If you experience difficulty preparing your tax return, you can contact the Tax Office for assistance, or you can go to a tax agent who specialises in preparing income tax returns. If you don’t have to lodge a tax return, you need to notify the Tax Office and complete a non-lodgement advice form. One reason you may not need to lodge a return is if your taxable income is below the senior Australians tax offset taxable income threshold (see ChapterÂ€19).

Receiving a PAYG payment summary At the end of the financial year, if you’re a salary and wage earner your employer gives you a ‘PAYG payment summaryÂ€— individual non-business statement’. This payment summary is a statement that sets out the gross income and allowances you received between 1Â€July and 30Â€June, and the total pay-as-you-go (PAYG) withholding tax that was deducted from your pay (see the sidebar ‘Case study: Receiving a PAYG payment summary’). You need to include all the relevant details from this payment summary in your tax return. If you’re unable to get a copy of this payment summary from your employer, you need to complete a ‘Statutory declaration (NAT 4135)’. You can get a copy from the Tax Office website (www.ato.gov.au). If you want to know more about PAYG payment summaries, visit the Tax Office website and check out the fact sheet ‘How to complete the PAYG payment summaryÂ€— individual non-business form (NAT 0046)’

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Case study: Receiving a PAYG paymentÂ€summary Beverly Power is an employee who works for James Brown Pty Ltd. At the end of the financial year,Â€ Beverly receives a PAYG payment summaryÂ€—

individual non‑business statement from her employer. Beverly needs to include this information in her tax return.

PAYG payment summaryÂ€— individual non-business Payment summary for financial year ending 30 June 20XX Payee details Payee’s tax file number

123 456 789

Payee’s name

Beverly Power

Payee’s address

47 Beverly Street, North Hobart

Period employed

1 July 20XX to 30 June 20XX

Gross payments

$60,000

Total PAYG withholding tax

$12,600

Car allowance

$1,500

Payer details Payer’s name

James Brown Pty Ltd

Payer’s ABN

98765432100

Appendix A contains a comprehensive list of the types of tax offsets you may be eligible to claim. A tax deduction is deducted from your assessable income, while a tax offset reduces the amount of tax you’re liable to pay.

Claiming car expenses Under the car substantiation provisions, you can claim a car expense in four ways and you can choose the method that gives you the greatest deduction. However, you need to satisfy certain conditions such as the number of kilometres you travel and whether you keep a record of all your car expenses.

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Chapter 3: Lodging Your Tax Return: This One Is for the Nation The four methods of claiming a car expense are 55 Cents per kilometre method 55 12Â€perÂ€cent of original value method 55 One-third of actual expenses method 55 Log book method

You should ensure that any claim for work-related travel is based on reasonable estimates. The allowable rate for claims changes from year to year, so check the Tax Office website or see your tax agent to get this year’s rate. The rates for the year ended 30Â€JuneÂ€2010 are set out in TableÂ€3-1.

Table 3-1

Rates per Business Kilometre (2009–10)

Ordinary Car Engine Capacity

Rotary Engine Car Engine Capacity

Cents per Kilometre

1600cc (1.6 litre) or less


63 cents

1601–2600cc (1.601–2.6 litre)

801–1300cc (0.801–1.3 litre)

74 cents

2601cc (2.601 litre) and over

1301cc (1.301 litre) and over

75 cents

Using cents per kilometre method This method is restricted to the first 5,000 business kilometres you travel. You need to know approximately how many business kilometres you travel each year and your car’s engine capacity. This method is very easy to calculate and you don’t need to keep a record of your car expenses. If you travel 4,000 business kilometres and your car’s engine capacity is 1601cc, you can claim $0.74 per kilometre, which amounts to $2,960 (4,000Â€ìÂ€$0.74) (refer to TableÂ€3-1). If you travel more than 5,000 business kilometres you can still use the cents per kilometre method, but you can claim only up to a maximum of 5,000 kilometres.

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Using 12 per cent of original value method To use this method, you need to travel more than 5,000 business kilometres and know the cost price of your car. The amount you can claim is limited to 12 per cent of the cost price. For example, if you paid $40,000 for your car, you can claim $4,800Â€(12Â€perÂ€cent of $40,000).

Using one-third of actual expenses method To use this method, you need to travel more than 5,000 business kilometres and keep an accurate record of all your car expenses. For example, if your car expenses were $12,000, you can claim $4,000 (1⁄3 ì $12,000).

Using the log book method To use this method, you need to maintain a log book of your business and private kilometres and keep an accurate record of all your car expenses.

Claiming a standard deduction From 1 July 2012, if your tax return is fairly straightforward (for instance, your income is predominantly from salary and wages and your tax deductions are minimal), you can lodge a simplified tax return and claim an automatic standard deduction. This method is designed to cover work-related expenses and costs associated with managing your tax affairs. For the 2012–13 financial year, the standard deduction amount is $500. This amount is set to increase to $1,000 in the 2013–14 financial year. This approach means you’re going to be able to claim a bigger amount if your total deductions is below the standard deduction limit, and you’re not going to have to keep receipts to substantiate them! But the good news gets even better because you’re going to pay less tax (and your tax refund is going to increase!), and you could save paying fees to a tax professional to prepare and lodge your tax return. By the way, if your total tax deductions exceed the standard deduction limit, you can still claim them the ol’-fashioned way.

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Receiving a Thank-You Note: Notice of Assessment After you lodge your tax return, the Tax Office calculates the net tax payable based on the information you submit. As a general rule, a paper tax return is processed within six weeks from the date you lodge it. But if you lodge over the internet using e-tax, processing your return takes twoÂ€weeks. Using e-tax may be worth considering if you’re expecting a big tax refund and you’re keen to get your hands on it. After your tax return is processed, the Tax Office issues you with a notice of assessment, a document that summarises the details in your tax return. This document is your official receipt and sets out details such as: 55 The assessment notice sequence number 55 Date of issue 55 Your name and address 55 Your taxable income 55 Tax on taxable income 55 Medicare levy 55 PAYG credits and other entitlements 55 Amount payable or refundable 55 Due date for payment of tax, if applicable You need to keep your notice of assessment for five years and use it if you intend to lodge future tax returns online using e-tax. If you consider the information set out in your notice of assessment is wrong, you can lodge an objection or request the Tax Office to fix the error (ChapterÂ€4 has further information on this matter). If an adjustment is made, the Tax Office issues a notice of amended assessment. If you want to know more about notices of assessment, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘Your notice of assessment’.

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38

Part I: How You’re Taxed in Australia If you don’t have private health insurance, you may be liable to pay a 1Â€perÂ€cent Medicare levy surcharge if your taxable income is above a certain threshold amount (indexed for inflation). For more details, see AppendixÂ€A.

Case study: Preparing your tax return During the financial year Beverly Power receives the following payments, in addition to those shown in the case study ‘Receiving a PAYG payment summary’: 55 $9,000 net profit distribution from a partnership business arrangement 55 $1,000 bank interest from an investment Beverly’s work-related expenses are $575. These expenses consist of $200 union fees, $175 protective clothing and $200 tools of trade, which she can deduct from her assessable income. Her total work-related expenses exceed $300 and Beverly keeps receipts to substantiate her deductions (see ChapterÂ€5). According to Beverly’s records, during the financial year she travels 4,000Â€business kilometres and her car’s engine capacity is 1601cc. However, she doesn’t keep a log book or a record of her car expenses (see ChapterÂ€5). During the financial year, Beverly also incurs $2,500 net medical expenses. Under Australian income tax law, you’re liable to pay tax on your taxable income at your marginal tax rates (see AppendixÂ€ A). Taxable income means the total assessable income you derive each year minus allowable deductions you incur in earning your assessable income. As a general rule, the allowable deductions must have a relevant and necessary connection with how you derive your assessable income to qualify for a tax deduction (refer to ChapterÂ€2). In this case, Beverly’s assessable income is as follows: Salary and wages

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$60,000

Car allowance

$1,500

Interest

$1,000

Net partnership distribution

$9,000

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39

Beverly can deduct the following amounts because they have a relevant and necessary connection with the income she earns. Beverly keeps proper receipts to substantiate her deductions: Union fees

$200

Protective clothing

$175

Tools of trade

$200

Beverly needs to select one of the four statutory methods to substantiate her work-related car expenses (refer to ‘Claiming car expenses’, earlier in this chapter for more details). According to Note 2, she can claim $2,960 under the cents per kilometre method. The amount of PAYG withholding tax deducted from Beverly’s pay (plus tax offsets she can claim) is deducted from the tax payable. Beverly is also liable to pay a Medicare levy (but, because she is privately insured and below the income threshold, she doesn’t have to worry about the 1Â€perÂ€cent surcharge — see AppendixÂ€A). The Medicare levy is 1.5Â€perÂ€cent of her taxable income. If Beverly’s total tax credits (PAYG tax plus tax offsets) exceed the tax payable plus Medicare levy, the Tax Office refunds her the excess (Beverly receives a tax refund). But, if Beverly’s total tax credits are less than the tax payable plus the Medicare levy, she must pay the shortfall to the Tax Office. Beverly’s taxable income and tax payable are calculated as follows. Tax return for individual’s income Salary or wages

Tax withheld

Income

$12,600

$60,000

Car allowance

$1,500

Gross interest

$1,000

Net partnership distribution

$9,000

TOTAL INCOME

$71,500

Less deductions Work-related car expenses (Note 2)

$2,960

Other work-related expenses

$575

TOTAL DEDUCTIONS

$3,535

TAXABLE INCOME

$67,965 (continued)

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40


(continued)

Calculating Beverly’s tax refund or tax debt TAXABLE INCOME

$67,965

TAX PAYABLE (Note 1)

$13,939

Plus Medicare levy (1.5%)

$1,019

$14,958

Less Tax offsets (Note 3)

$100

PAYG credits

$12,600

NET TAX PAYABLE

$12,700 $2,258

Note 1: Calculating tax payable Taxable income $67,965 $6,000

Nil

$31,000@15%

$4,650

$30,965@30%

$9,289

$67,965

$13,939

Note 2: Work-related car expenses Because Beverly receives a $1,500 car allowance and travels 4,000 business kilometres, she can claim work-related car expenses. Beverly has travelled fewer than 5,000 kilometres, so she can’t use the 12Â€ perÂ€ cent of original value method or the one-third of actual expenses method. Further, because Beverly doesn’t keep a log book or a record of her car expenses, she can’t use the log book method. In this case, Beverly can claim $2,960 using the cents per kilometre method. At the time of writing, the 2010–11 rates per business kilometre haven’t been released. This example includes the 2009–10 rates. Please visit the Tax Office website (www.ato.gov.au) for the latest rates. Note 3: Net medical expenses tax offset Because Beverly incurs $2,500 net medical expenses (total medical expenses minus medical claims), she can claim a tax offset amounting to 20Â€ perÂ€ cent in excess of $2,000. In this case, the tax offset is $100 ($500Â€ì 20Â€perÂ€cent).

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Chapter 4

Receiving a Visit: When the Tax Office Comes Knocking In This Chapter `Ùnderstanding self-assessment ``Having your tax affairs audited `Àppealing against a Tax Office decision

T

he Australian taxation system works on a self-assessment basis. This means the onus is on you to declare the correct amount of income you derive each year and claim the correct amount of tax deductions and tax offsets. However, the Tax Office has the authority to check whether you’re complying with the tax laws. Penalties apply if you understate your income or overstate your claim for a tax deduction or tax offset. In this chapter, I explain how self-assessment works and discuss what you should do if your tax affairs are audited. I also explain how you can appeal against a Tax Office decision.

Being Honest with Yourself: Self‑Assessment In 1986, the federal government introduced self-assessment. Under this system, when you lodge a document or submit an income tax return to the Tax Office, the Tax Office basically accepts its contents as being true and correct and, generally speaking, no further action is taken. Apart from correcting any obvious mistakes the matter ends there.

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42

Part I: How You’re Taxed in Australia When you lodge your tax return, you’re issued with a notice of assessment based on the information you supply to the Tax Office (refer to ChapterÂ€3). If you find at a later date that you made a mistake on your tax return (for example, you didn’t include something on your tax return that you should’ve) you can ask for an amended assessment or lodge an objection. Lodging an objection is a ‘formal’ request to correct the error. To help you to comply with the tax laws, the Tax Office regularly issues, free of charge, fact sheets, income tax rulings, tax determinations, Tax Office interpretative decisions and other educational material to explain specific issues that need to be clarified and brought to your attention (as illustrated throughout this book). In return, you’re required to retain proper records and receipts in accordance with the Tax Act to verify and substantiate what you submit. Further, the Tax Office reserves the right to audit your tax affairs to check you’re complying in accordance with the Tax Act. One great thing about self-assessment is you can get free advice from the Tax Office. This is especially the case if you happen to come across a complex or tricky issue you’re not sure of. You can do this by simply applying for a private ruling. The Tax Office examines your request and gives you a written response on how it would interpret the laws in respect of the issue you raise. To apply for a private ruling, download and complete the appropriate private ruling application form from the Tax Office website: www.ato.gov.au The Tax Office has issued the following fact sheets about how self-assessment works and seeking a private ruling if you need some technical help with preparing your tax return: 55 ‘Self-assessment and the taxpayer’ 55 ‘Data matching’ î†Ł ‘Private rulings and advice essentials’ If you want a copy of these publications, you can contact the Tax Office directly by phoning 1300Â€720Â€092 or you can visit its website: www.ato.gov.au If you’re contemplating juggling the books or not declaring all the income you derive, don’t. The various methods the Tax Office uses to check whether you’re complying with the tax laws eventually find you out.

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43

Chapter 4: Receiving a Visit: When the Tax Office Comes Knocking

Taxing times: Before self-assessment This utopian and civilised way of doing business with the Tax Office wasn’t always the case. Prior to 1986, when you lodged your annual income tax return the Tax Office required you to provide a comprehensive summary of how you calculated your taxable income, as well as receipts and other documents to support your claims. It was basically you against the bureaucracy. A tax assessor would scrutinise your tax return with a fine-toothed comb (plus a magnifying

glass) in case something was missed. And if a mistake were found, the tax assessor would jump for joy; your return would be amended accordingly and (if applicable) penalties would apply. Practically no assistance, apart from a few formal instructions written along the lines of the Ten Commandments on how to complete your tax return, was available to the humble taxpayer. Fortunately, those days are now confined to the history books.

Getting a Reality Check Over: TaxÂ€Audit All taxpayers run the risk of an audit, whether you’re a business owner or a wage earner. An audit is simply an official examination of your tax records to determine whether you’re complying with the Tax Act. Notice that you’re going to be audited usually comes via a telephone call or a letter in the mail from the Tax Office. The official who conducts the audit is called an auditor. Most business audits take place at the business (or at your tax agent’s place of business). The Tax Office also conducts desk audits, randomly selecting individuals — especially salary and wage earners — for routine audits and chats about their tax affairs. If your lucky number is pulled out of the barrel, the Tax Office politely asks that you pay them a visit and produce documentary evidence to verify the accuracy of your tax return (who said you’ve never won a prize in a raffle!). If the Tax Office pays your business a visit or invites you to visit, expect questions regarding the contents of your tax return.Â€TheÂ€auditor compares your records to the information you disclose in your tax return. You may be required to produce

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44

Part I: How You’re Taxed in Australia receipts and other supporting evidence to verify and support your claims. If any mistakes are detected, your tax return isÂ€amended. If you breach the Tax Act you incur a financial penalty (or fine), plus an interest charge on the shortfall. The extent of the penalty depends on the seriousness of your offence. If your offence is extremely serious, you can be prosecuted and civil and criminal penalties may apply (that is, you may need to get your pyjamas and spend some time in the slammer). If you want to know more about this matter, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘About penalties and interest charges’.

Preparing for an audit If you’re selected for an audit, follow these steps:

1. Get your records in order before the audit interview.

Review your return so that you can fully explain what you claimed and why, and re-familiarise yourself with what supporting paperwork you’ve got. If some critical paperwork is missing, obtain a duplicate copy.

2. If necessary, consult with your tax agent and/or legal adviser about whether they should be present.

Business owners especially should consider having their tax agent present. Whatever fees you pay (which are tax deductible) to have your tax agent present may be more than offset by the expertise they bring to the conversation and the peace of mind they bring you.

3. Remember to keep your emotions in check and cooperate appropriately.

No-one likes to be audited, but keep your emotions in check and don’t be belligerent. Under Australian income tax law, the Tax Office has a right to full and free access to all buildings, places, books, documents and other papers for the purposes of the Tax Act. This law means you must provide all reasonable facilities and assistance and produce appropriate documents to verify the accuracy of your tax affairs.

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45


Privileged paperwork? Rarely .â•›â†œ.â•›â†œ. Whereas the Tax Office, ordinarily, has the right to inspect any of your paperwork that pertains to the Tax Act, under certain circumstances, youÂ€ may be entitled to claim legal professional privilege for certain documents. In such cases, you don’t

have to give that information to the Tax Office. Such a case may arise if you run a business and you seek legal advice from a lawyer. Before assuming your paperwork qualifies as privileged, discuss the matter with your tax agent or legal adviser.

If you’re still anxious about the process, visit the Tax Office website to get the following fact sheets about what happens ifÂ€you’reÂ€audited: 55 ‘Tax audits — what are they?’ U ‘Taxpayers’ Charter — If you’re subject to review or audit’

Points to keep in mind If you’re an individual, expect the Tax Office to compare the routine interest and dividend information in your tax return with records from the various paying institutions. That kind ofÂ€mistake is the most common one discovered during a desk audit — an incorrect amount claimed on a form. The most common tax mistakes associated with running a small business include 55 Failure to apportion your business and private and domestic expenses (refer to ChapterÂ€2) 55 Failure to disclose capital gains on disposal of CGT assets (see ChapterÂ€11) 55 Failure to lodge your BAS by the due date in respect of GST collected (see ChapterÂ€13) 55 Failure to pay FBT on fringe benefits provided to employees (see ChapterÂ€16) 55 Failure to register for GST if your turnover (sales) exceeds $75,000 (see ChapterÂ€15)

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Part I: How You’re Taxed in Australia 55 Failure to remit PAYG tax collected from your employees’ salary and wages by the due date (see ChapterÂ€13) 55 Failure to remit superannuation guarantee payments to the Tax Office by the due date (see ChapterÂ€13) 55 Incorrectly accounting for assessable income and, more particularly, your cash sales (see ChapterÂ€13) 55 Incorrectly calculating car fringe benefits (see ChapterÂ€16) 55 Incorrectly claiming certain business expenses such as repairs, capital works deductions, bad debts, borrowing expenses and depreciation (see ChaptersÂ€10 andÂ€14) 55 Incorrectly claiming GST credits (see ChapterÂ€15) 55 Incorrectly claiming tax offsets (see AppendixÂ€A) 55 Incorrectly valuing your trading stock (see ChapterÂ€13) U Over claiming your business expenses (see ChapterÂ€14)

Mending Your Ways: Amendments and Objections If your tax return is found to be incorrect, the Tax Office has the power to amend an assessment. Ordinarily, a time limit applies — between twoÂ€and fourÂ€years from the date you receive an assessment notice setting out the date any tax you have to pay becomes due and payable. However, in the event of fraud and evasion, the Tax Office has the power and the authority to amend an assessment at any time. In return, you have the right to seek an amendment or lodge an objection if you’re dissatisfied with an assessment or a Tax Office decision (provided you lodge the objection within the prescribed time limit, normally within 60Â€days of service of the notice of assessment). Further, you have the right to appeal to the Administrative Appeals Tribunal — Small Taxation Claims Tribunal or Tax Appeals Division. You can appeal as high as the High Court of Australia if your objection is in respect of a question ofÂ€law. Under the small-business concessions provisions, eligible entities have two years, rather than four, to amend a notice of assessment. The amendment period commences from the date the Tax Office issues the notice of assessment. The Tax Office

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47


can amend a notice of assessment to either increase or decrease a tax liability only within the same two-year amendment period. However, this time frame isn’t the case in the event of fraud or evasion (which is beyond the scope of this book, so in such a case you’re best to seek advice from a professional adviser). If you want to know more about amendments, objections and appeals, go to the Tax Office website (www.ato.gov.au) and check out the fact sheet ‘Objections, amendments and reviews essentials’.

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48

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Part II

Income from Personal Exertion Glenn Lumsden

‘I’ve reassessed my business goal for this year. I’ll be happy to make enough money to pay the tax on the money I make.’

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A


t the end of the financial year, you must lodge a tax return disclosing the income you earned. Most people lodging tax returns are classified as employees earning a salary or wage (income from personal exertion).

In this part of the book, I examine the tax issues of salary and wage earners. I also cover tax issues associated withÂ€owning your main residence, how your children areÂ€taxed and family tax benefits you can gain.

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Chapter 5

Taxing Employees: Working Class Man In This Chapter `Èarning salary and wages ``Claiming and substantiating your tax deductions

I

n this chapter, I explain that if you’re an employee, your employer must deduct income tax from the amount you earn and make a contribution to a complying superannuation fund on your behalf. I also go over what happens if your employment is terminated and the conditions you need to satisfy to qualify for aÂ€work-related tax deduction.

Earning a Living: Salary and Wages If you’re planning on looking for a job, you need to get a tax file number (TFN) from the Tax Office and quote it to your employer. Your new employer asks you to complete a tax file declaration form within 14Â€days of commencing employment. This declaration form covers payments in respect of services you perform and payments of superannuation benefits. You also need to quote your TFN if you have an account with a financial institution and you derive interest (see ChapterÂ€8). If you need to apply for a TFN, visit the business.gov.au website (www.business.gov.au), go to Business Home and click Registration & Licences.

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52

Part II: Income from Personal Exertion

Case study: Calculating the tax Robert works on a full-time basis as a panel beater for Motor Repairs Pty Ltd. When he’s first employed, he quotes his TFN to his employer. Robert gets paid $1,000 a week. He

checks the Tax Office website and finds the amount of tax payable is $186 a week. But, if he doesn’t quote his TFN, he’s liable to pay $465 in tax ($1,000Â€ìÂ€46.5Â€perÂ€cent).

If you don’t have a TFN, 46.5Â€perÂ€cent tax may be deducted fromÂ€the amount you earn. However, this factor is taken into account when the Tax Office calculates your tax liability and is refunded to you if you pay too much tax. If you’re employed on a full-time or part-time basis, your employer pays you a salary or wage for the work you do. When you receive your pay slip each week, fortnight or month, you find an amount representing the pay-as-you-go (PAYG) withholding tax deducted from your gross salary or wage. TheÂ€amount of tax you pay depends on how much you earn. Under the PAYG withholding tax system, the more you earn the more tax you pay. If you want to calculate the amount of tax you have to pay on the gross income you earn each week, fortnight or month, you can contact the Tax Office directly, or visit its website (www.ato. gov.au). (Click Find a Rate or Calculator ➪ Tax Calculators.)

Determining your employment status At the outset, being aware of your employment status for tax purposes is important. Most people working for a living in Australia are classified as employees who earn a salary or wage (income from personal exertion, which is a tax term commonly used when discussing income from salary and wages). Most people are employees. An employee is a person who receives a salary or wage for work they do under a contract wholly or principally for their labour. An employee can also be a paid company director, sportsperson, artist or performer. As a general rule, you’re considered to be an employee where a master–service relationship exists. Under this arrangement, you

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Chapter 5: Taxing Employees: Working Class Man work under a contract wholly or principally for your labour and you’re under the control and direction of the person (the boss) who’s employing you.

If you’re an employee, your employer ordinarily issues regular pay advice slips setting out the hours you work, the salary and wage you receive, the amount of PAYG withholding tax deducted, and the amount of superannuation guarantee contributions made to your super fund.

Contractor or employee? Your employment status becomes an issue if you run a personal services business — for example, if you’re an independent contractor and you perform certain tasks that are similar in nature to that of an employee. Then, if you operate a personal services business, no PAYG withholding tax is deducted from your payments and you’re not eligible for superannuation guarantee (SG) contributions. Instead, you can claim certain tax deductions that aren’t available to employees, such as contributions to a complying superannuation fund. On the other hand, if you’re an employee, PAYG withholding tax is deducted from your salary or wage and your employer has a statutory obligation to make a superannuation contribution under the super guarantee legislation on your behalf. On certain occasions, establishing whether you’re a contractor or an employee may be tricky because of the fine line between the two

Â� classifications. The following tests are used to determine your employment status: U A contractor normally advertises for jobs. Not so if you’re an employee. U A contractor is required to supply their own tools and equipment. An employee uses their employer’s tools and equipment to perform their duties. U A contractor is responsible for fixing defects. Not necessarily the case if you’re an employee. U A contractor can delegate tasks to other people. An employee, on the other hand, can’t bring in someone else to perform their duties. U A contractor has flexibility about how tasks should be completed. Not necessarily the case if you’re an employee. (continued)

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(continued)

U A contractor is paid to do a specific task. An employee is paid on an ongoing basis (normally fortnightly) and performs a number of ongoing tasks as directed. U A contractor can set their own hours and normally work at different locations. An employee on the other hand works set hours (for example, 9.00Â€am to 5.00Â€pm each day) and normally at a particular work location. U A contractor prepares a tax invoice setting out services rendered on completion of a task. If you’re an employee, you’re normally paid on an ongoing basis. You’re considered to be running a personal services business (PSB) if you

satisfy a results test or an 80Â€perÂ€cent rule test. The first test checks whether more than 75Â€perÂ€cent of the income you derive is from using your own equipment to produce a result and whether you’re required to fix any defects. The second test checks whether more than 80Â€perÂ€cent of your income is derived from at least two unrelated sources. Further, you satisfy this test if you have an unrelated employee (or apprentice) to help you perform at least 20Â€ perÂ€ cent of your work, or you operate from business premises that are separate from your main residence. If this test isn’t satisfied, you need to get a PSB determination from the Tax Office. If you’re not sure of your employment status, you should consult a professional accountant or tax agent.

Reducing the burden: Receiving anÂ€allowance If you’re an employee, your employer may pay you an allowance in addition to the salary or wage you derive. For example, this payment could be a travel allowance or a special allowance unique to your particular industry. Ordinarily, an allowance is paid to compensate you for expenditure you may incur in the course of deriving your assessable income. The amount you receive normally forms part of your assessable income (refer toÂ€ChapterÂ€3). When you get an allowance, you can usually claimÂ€a tax deduction for expenditure you incur in performing your duties. If your employer gives you an allowance, which is then included in your assessable income, you can’t assume you can automatically claim a tax deduction just because you receive that allowance. Keep in mind you can claim a tax deduction

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Chapter 5: Taxing Employees: Working Class Man only if you satisfy certain tests (see the section ‘Claiming a Tax Deduction: What’s On the Menu’ later in this chapter). According to the Tax Office fact sheet ‘Allowances paid to employees’, allowances may include the following types of payments: U Allowances for qualifications; for example, a first-aid certificate U Allowances for tools, clothing or laundry U Award transport payments U Car, travel or transport allowances U Dirt, height, site, risk, meal or entertainment allowances

Adding to the nest egg via SG Under the superannuation guarantee (SG) legislation, in addition to paying you a salary or wage, your employer is legally obligated to make a superannuation contribution on your behalf to a complying superannuation fund. The SG amount is currently 9Â€perÂ€cent of your gross salary or wage. This information is normally included in the salary package agreement you enter into at the time you’re hired. For example, if someone earns $1,000 a week their employer is legally obligated to contribute $90 (9Â€perÂ€cent of $1,000) into their designated super fund. This amount is invested on their behalf. From 1 July 2012, the federal government is proposing to increase the superannuation guarantee rate in stages — to 12Â€perÂ€cent by 2019–20 (see AppendixÂ€A). The purpose of SG legislation is to help you accumulate funds during your working life that you can then access when you finally hang up the pen or shovel and retire. You can normally access your super funds when you reach 60 years of age and retire or satisfy a condition of release, such as physical or mental ill health or permanent incapacity. To add icing to the cake, the SG payments are normally tax free. (For more details about superannuation and retirement issues, see ChapterÂ€18.) If you earn less than $450 in a particular calendar month or you’re under 18Â€years of age and you work on a part-time basis (fewer than 30Â€hours a week), your employer isn’t required to make an SG contribution. If you terminate your current

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Part II: Income from Personal Exertion employment and the total accumulated SG benefit is less than $200, you can access this amount at the time you leave. Your employer’s pay slip normally sets out the amount of the SG contribution that was forwarded to your designated super fund. If this information isn’t supplied, you should check with your super fund to see whether an employer SG contribution was made on your behalf. If your employer fails to make an SG contribution, you should immediately report the matter to the Tax Office.

Adding to the nest egg via personal contributions If less than 10Â€perÂ€cent of your total assessable income (and reportable fringe benefits) comes from an employment source and you make a personal superannuation contribution, the contribution is a concessional contribution (a tax deductible expense). You may decide to make a personal super contribution if you’re not in full-time employment and you’re under 65Â€years of age (for instance, if you’re a retiree engaged in investment activities). Individual superannuation fund members can split concessional contributions made in the previous financial year with their (non-income or low-income earning) spouses or partners. The maximum permitted is 85Â€perÂ€cent of the concessional contributions cap (see AppendixÂ€A) — which means, before-tax contributions receive concessional tax treatment up to this cap. Under new proposed superannuation rules, splitting concessional contributions may be worth considering if you’re over 50Â€years of age, and your super fund balance is close to $500,000 — because, from 1Â€JulyÂ€2012, if you’re over 50Â€years of age, you can no longer make a $50,000 concessional contributionÂ€if you have more than $500,000 in your super fund (see AppendixÂ€A). Consider making additional contributions to your super fund at regular intervals. Earnings derived are taxed at the rate of 15Â€perÂ€cent, and pensions and lump sum withdrawals are tax free when you reach 60Â€years of age and retire.

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Chapter 5: Taxing Employees: Working Class Man

Signing up to the super co-contributionÂ€club If you want to make some free money every year, the following may appeal to you. If your total Â�assessable income is less than $31,920 and you make a $1,000 non-concessional Â�contribution (a contribution you make from your personal savings that doesn’t qualify for a tax deduction) from your personal savings to your super fund, under the superannuation Â�coâ•‚Â�contribution scheme, the federal government makes a $1,000 Â�contribution to your super fund on your behalf (with no strings attached!). This amount reduces as you earn more money and ceases after you earn more than $61,920. However, the one proviso is: You can’tÂ€ get your hands on this money until you satisfy a condition of release such as when you reach your Â�preservation age and retire (see ChapterÂ€ 18 for more conditions of release).

If you qualify for this government freebie, after you lodge your tax return the Tax Office calculates the amount you’re entitled to receive under the superannuation co-Â� contribution scheme. They notify you of the amount that was credited to your super fund account. If you’re a university student, you may be liable to make a payment under the compulsory Higher Education Loan Program (HELP) or Higher Education Contribution Scheme (HECS). If you work part-time and you make a $1,000 non-concessional contribution from your personal savings to your designated super fund, under the co-contribution scheme the federal government is indirectly funding your liability when it makes a $1,000 contribution on your behalf to your super fund! Getting this free money helps ease the pain of having to pay this compulsory payment to the federal government.

Easing the pain: Getting a termination payment If you receive a polite tap on the shoulder from your employer and you’re informed your valuable services are no longer required because your job has been terminated, you may be entitled to receive an employment termination payment (ETP) and/or a redundancy payment to help ease the pain. If you receive an ETP within 12 months of being terminated, the payment is concessionally taxed at a particular rate as set out

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Part II: Income from Personal Exertion inÂ€Table 5-1. The following payments are examples of an ETP you’re likely to receive: U A golden handshake U Unused rostered days off U Compensation for loss of job U Unused sick leave An employment termination payment (ETP) doesn’t include paymentsÂ€you receive in respect of unused annual leave and long-service leave. From 1 July 2007, when you receive an ETP, the amount of tax you’re liable to pay depends on whether you’re under or over your preservation age (the age you must reach before you can retire and access your superannuation fund benefits — see Appendix A) and whether the payment is a tax-free component or taxable component. As a general rule, an ETP is a taxable component. The rate of tax you’re liable to pay is set out inÂ€Table 5-1. An ETP must be taken as a lump sum payment and you can’t roll over (transfer) the amount into a complying superannuation fund.

Table 5-1

Employment Termination Payments

LIFE BENEFIT PAYMENTS Under preservation age Financial year

Lower cap amount

2009–10

$150,000

2010–11

$160,000

Payments up to lower cap amount: Tax rate 31.5% Payments above lower cap amount: Tax rate 46.5% At or above preservation age Payments up to lower cap amount: Tax rate 16.5% Payments above lower cap amount: Tax rate 46.5%

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Moving on: Getting a redundancy payment If your employment is terminated, you could receive a redundancy payment. This is a gratuitous payment in recognition of your past services. The amount you receive normally depends on your length of service. A payment received under these circumstances is concessionally taxed at a particular rate (as set out later in this section) if certain conditions are met. Two categories of redundancy payments may qualify for concessional tax treatment: U Bona fide redundancy payment: A bona fide redundancy payment is a payment you may receive as a result of being made redundant or retrenched. This situation normally arises if an employer makes a decision that your job as an employee is no longer necessary and ceases to exist, which can happen due to a change in work practices or because your employer has decided to do something different. But a bona fide redundancy can’t occur if you’re dismissed on reaching your normal retirement age or because of disciplinary reasons. U Payment under an approved early retirement scheme: You may receive a payment under an approved early retirement scheme if your employer offers incentives to encourage a certain group of people to retire early or resign. The Tax Office must first approve the scheme before the redundancy payment can be concessionally taxed at a particular rate as set out in this section. Under both arrangements, redundancy payments that can qualify for concessional tax treatment include U A gratuity or ‘golden handshake’ U Lump sum payments of unused long-service leave paid on termination of employment, but not under a formal arrangement U Payment in lieu of notice U Severance payment of a number of weeks’ pay for each year of service

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Part II: Income from Personal Exertion The following payments aren’t treated as part of a redundancy payment that qualifies for concessional tax treatment: U Lump sum payments of unused long-service leave paid on termination of employment under a formal arrangement U Salary and wages owed for work you had done U Unused annual leave Redundancy payments are concessionally taxed in the following way. The amount that falls below a statutory limit is exempt from tax. The following formula is used to work out the statutory exempt amount. This statutory limit is adjusted annually. For the year ended 30 June 2011, the limit is U The first $8,126 you receive is tax free — plus, $4,064 for each completed year of service is also tax free. Any part of the payment above the statutory limit is treated as an ETP from an untaxed source. You can’t roll over amounts in excess of the statutory limit into aÂ€complying superannuation fund.

Claiming a Tax Deduction: What’s On the Menu You can claim as a tax deduction any loss or outgoing incurred in gaining or producing assessable income (refer to ChapterÂ€2). If you derive personal exertion income (and property income), you must be able to show a direct connection between the expenditure you incur and what you do for a living before you can claim a deduction. If the expenditure doesn’t meet these criteria, it is regarded as private or domestic in nature and not tax deductible. For example, you can’t claim travel expenses from home to work (your train, bus or tram fares), nor can you claim childminding expenses to look after your children while you’re at work. If your expenditure is likely to be substantial, you can request the Tax Office to vary the rate of tax payable on your salary and wages. For example, this scenario can arise if you borrow money to buy a rental property and claim an interest expense (see ChapterÂ€10).

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To have the Tax Office vary your rate of tax payable, you need to complete a form titled ‘PAYG withholding variation application 2011 (NAT 2036)’. You can get a copy of this form from the Tax Office website (www.ato.gov.au).

Proving what you did: Substantiation provisions Salary and wage earners who incur work-related expenses are required to substantiate (prove or justify) their expenses. To doÂ€this successfully, you must satisfy the following three important conditions: U A direct connection must exist between your work-related expenses and the derivation of your assessable income. U Your expenses must be incurred in the course of gaining or producing your assessable income. U You must keep written evidence to substantiate your claim for a work-related expense (for instance, receipts).

Common types of work-related deduction The types of work-related expenses you need to substantiate to claim a tax deduction include U Business travel expenses U Car expenses U Work expenses If you want to know the Tax Office view about substantiation, reasonable travel and overtime meal allowance expenses, visit the Tax Office website (www.ato.gov.au) and check out ‘Taxation Ruling TR 2004/6’.

Claiming business travel expenses If you’re required to travel in the course of gaining or producing your assessable income (for instance, your employer asks you to travel overseas or interstate), you need to keep a travel record such as a diary to substantiate your deductions. You need

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Part II: Income from Personal Exertion to record the reason why you travelled, the date and time it happened, how long it lasted and the places you visited. Under the substantiation provisions (refer to the section ‘Proving what you did: Substantiation provisions’ earlier in this chapter), you need to supply written evidence to substantiate your claim for work-related expenses that exceed $300. If your total work-related expenses are $300 or less, you need only to satisfy the direct connection test and that the expenses are incurred in the course of gaining or producing your assessable income (provided they’re not capital, private or domestic in nature). The document you receive from the supplier of the goods and services to which the expense relates must include the following: U Amount of the expense (in the currency in which it was incurred) U Date the document is made out U Date the expense was incurred U Name or business name of the supplier U Nature of the goods or services If you receive an allowance from your employer, you don’t have to substantiate your claim for a tax deduction if the Tax Office considers the allowance you receive is a reasonable amount (that is, it isn’t excessive and falls within Tax Office guidelines). However, if you claim a tax deduction greater than the allowance you receive, you need to substantiate the full amount.

Claiming car expenses Under the substantiation provisions, you can use four statutory methods to substantiate your car expenses. The four methods are discussed in detail in ChapterÂ€3.

Claiming work expenses To claim work expenses, they must have a direct connection with your occupation, and can include expenditure such as: U Books, journals and trade magazines U Laundry expenses U Protective clothing

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U Subscription to a trade union or other professional membership U Tools of trade Appendix C sets out a number of leading tax cases in respect of claiming certain employment-related deductions, home office deductions and self-education deductions. This handy online reference (www.dummies.com/go/taxforaustraliansfd) is a useful tool if you want to know whether a specific expense is tax deductible or you’re studying taxÂ€law.

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Chapter 6

Living in Your Castle: Main Residence In This Chapter `Èxamining what constitutes a main residence `Ùnderstanding the tax concessions when purchasing your main

residence

``Looking at your main residence exemption provisions ``Knowing when you have to pay tax on your main residence

T

he great Australian dream is to own your home, especially your main residence. Owning the very roof you’ve got over your head is something most people would like to experience. In this chapter, I explain the tax concessions that are available to home owners in some instances. I look at the rules that you need to comply with to gain these valuable concessions.

Addressing the Issue: This Is WhereÂ€I Live A main residence is a place where you and your family normally reside and use for private or domestic purposes. It can include 5 An apartment, strata unit or flat 5 A caravan, houseboat or other mobile home 5 A house

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Part II: Income from Personal Exertion U A structure built underground U Certain structures normally associated with your home such as your garage or storeroom Your main residence can also include up to two hectares of land that surrounds your house. The Tax Office (www.ato.gov.au) has issued two tax rulings to help you understand what constitutes a main residence: U ‘Taxation Determination TD 92/158’ U ‘Taxation Determination TD 1999/69’

Buying Your Main Residence: Taxation Concessions Unfortunately, housing affordability may be out of the reach of many Australians. This scenario is because a major barrier to getting into property (and more particularly, buying your dream home) is needing to get together a truckload of money to buy a house outright. Depending in which state or territory you reside, the price of a home can vary upwards from around $200,000 to well over a few million dollars. Getting the necessary finance to buy a property can prove a difficult exercise to manage. And even if you’re successful, having a mortgage can adversely affect your lifestyle and standard of living while you endeavour to service the loan repayments. (For all about purchasing a home, check out Getting Started In Property For Dummies, by Karin Derkley — Wiley Publishing Australia PtyÂ€Ltd.) To add tax salt to the cost wound, in addition to paying the purchase price you can be liable to pay a 10Â€perÂ€cent goods and services tax (GST) at the time you buy the home. You’re liable for this additional cost if you buy new residential premises (such as a newly constructed house). But wait, there’s more! You’re also hit with stamp duty that Australian states and territories levy on property transactions. Fortunately, federal and state and territory governments have a number of concessions to help you achieve the dream of owning

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Chapter 6: Living in Your Castle: Main Residence

your own home. Provided you satisfy certain conditions, you can access three taxation concessions: U The first home owners grant U Stamp duty relief U First home saver accounts The first home owners grant is to help first home buyers purchase a property. To qualify for this grant, you (and/or your spouse or partner) must not have previously owned a property. Under this scheme, if you’re a resident of Australia you can receive a one-off payment of $7,000 to help purchase orÂ€build a property you intend to use as your main residence. (If you purchased your first home between 14Â€OctoberÂ€2008 and 30Â€SeptemberÂ€2009, the grant was $21,000 if you bought a newly constructed home and $14,000 if you bought an existing home. The grant was then reduced to $14,000 and $10,500 respectively if you purchased your first home between 1Â€OctoberÂ€2009 and 31Â€DecemberÂ€2009). One condition is you need to reside in the property within 12Â€months of the settlement date. FirstÂ€home owners grants are administered by the various state and territory governments of Australia. The grant is only available for properties valued up to a certain amount, seeÂ€TableÂ€6.1 for more details.

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Table 6–1

First Home Owners Grant — Eligibility

Jurisdiction

Limits on Value of Property

ACT

No limit at time of writing

NSW

$750,000

NT

$750,000

QLD

$750,000

SA


TAS


VIC

$750,000

WA

$750,000 (north of 26th parallel, $1,000,000)

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Part II: Income from Personal Exertion Stamp duty relief is available under certain circumstances in respect of the purchase of your main residence. Stamp duty is a one-off payment levied on a progressive basis, which means the more you pay for your home, the greater the amount of stamp duty you’re liable toÂ€pay. To find out more about the first home owners grant and/or whether you’re eligible for any stamp duty relief, you can check out the website of your local state and territory government revenue office: 5 Australian Capital Territory (www.revenue.act.gov.au) 5 New South Wales (www.osr.nsw.gov.au) 5 Northern Territory (www.nt.gov.au/ntt/revenue) 5 Queensland (www.osr.qld.gov.au) 5 South Australia (www.revenuesa.sa.gov.au) 5 Tasmania (www.treasury.tas.gov.au) 5 Victoria (www.sro.vic.gov.au) 5 Western Australia (www.dtf.wa.gov.au) The first home saver account is to help you save for a deposit to buy or build your first home. Under this scheme, if you make an after tax contribution of up to $5,500 (indexed) into this account each year, the federal government makes a 17Â€perÂ€cent contribution on your behalf. Therefore, if you save $5,500, the federal government puts in $935. You can also make further (non-qualifying) contributions into this account each financial year. However, a limit (cap) of $80,000 (indexed) applies on your overall account balance (after which you can’t make any further personal contributions). Interest credited to this account is taxed at the rate of 15Â€perÂ€cent. Any withdrawals to buy or build your first home are tax free. One important condition is you need to live in the property for at least sixÂ€months within the first 12Â€months of the purchase or construction. For more details on the first home saver account, visit the Tax Office website (www.ato.gov.au) for the fact sheet ‘First home saver accounts — common questions’. A major stumbling block to buying a home is that under Australian income tax law interest on borrowings to finance theÂ€purchase isn’t a tax deductible expense. This sad fact isÂ€because the purpose (or use) of the loan is to buy a

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non-Â�income-Â�producing property. On the other hand, if you buy an income-producing property (for example, a property you intend to lease) the interest is tax deductible. To help ease the pain, the trade-off here is your main residence is exempt from CGT. I suppose you can’t have it both ways, because if the interest is tax deductible you’re liable to pay CGT when you sellÂ€it. For a comprehensive discussion on the CGT issues associatedÂ€with owning a main residence, the Tax Office providesÂ€a publication called ‘Guide to capital gains tax (NATÂ€4151)’. To getÂ€a copy of this guide, go to the Tax Office websiteÂ€(www.ato.gov.au).

Keeping What’s Yours: Exempt from Tax Ahh, now for some good news! Under the CGT provisions, owning a main residence is normally exempt from tax — which means any increase in its value during the period you own the property isn’t going to be taxed. If you examine this issue from a tax planning point of view, buying your home in a location where property prices are continually rising may prove to be prudent. As a general rule, property in good locations tends to double in value every sevenÂ€to tenÂ€years. The strategy then of buying a home may prove an excellent way of building up wealth that isn’t liable to tax. The downside is if your property falls in value, any capital loss you make on disposal can’t be offset against any current or future capital gains because your main residence is exempt fromÂ€tax. Under the CGT provisions, disposal means a change in ownership. A disposal normally arises when you sell an asset such as property. A disposal can also arise if you donate an asset to someone or it gets lost, destroyed or compulsorily acquired. Here’s something that may be of interest. Under the temporary absence rule, if you move out of your main residence and you lease out your property, it is still exempt from tax for up to sixÂ€years while you’re away — for example, if you move interstate or go overseas for an extended period. However, if you decide not to lease out your property, it is exempt from tax during the entire period you’re away (rather than just sixÂ€years if the property was leased).

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Part II: Income from Personal Exertion However, if you buy another property and move into it, you need to make an election as to which one is your main residenceÂ€— because under the CGT provisions you can’t own two main residences. It would be great if you could! From a tax planning point of view, you’re best to keep the property more likely to appreciate in value at a faster rate as your main residence. If you choose the new property as your main residence, under these circumstances, your old home ceases to be exempt from CGT. This choice means that from this point onwards you’re liable to pay CGT on any subsequent increase in value, from the date your old property stops being your main residence to the date you sellÂ€it. Here’s some more good news. If you buy land adjacent to your property and use it as a part of your main residence (for instance, you buy your neighbour’s block of land), the additional land is also exempt from tax. However, this exemption is on the condition the total land surrounding your property doesn’t exceed the two-hectare limit. And, for a further condition, if you sell your main residence at a later date, you have to sell both holdings simultaneously to the new owner. If you don’t do this, the land adjacent to your original property is liable toÂ€CGT.

Sharing What’s Yours: When You Have to Pay Tax A major condition for your main residence to be exempt from tax is that the property must be used solely forÂ€private or domestic purposes; that is, you can’t use it to earn assessable income. The moment you start to use your home to earn assessable income, the residence is no longer fully exempt from CGT and you may have to pay CGT when you sell or otherwise dispose ofÂ€your home. For example, this liability can arise if you use part ofÂ€your home for residential accommodation and you use part for running your business activities (for example, you own a shop and you reside in the back of the premises). Further, if the land that surrounds your home covers more than twoÂ€hectares (for example, you own a ten-hectare property), the amount in excess of the two-hectare limit (eightÂ€hectares) is liable toÂ€CGT on disposal.

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If your main residence is situated on more than twoÂ€hectares, you’re allowed to choose the best twoÂ€hectares for the purposes of qualifying for the CGT exemption. If you subdivide your main residence and sell off part of your property, the part you sell is liable to CGT — because, to gain a full exemption, you need to sell your main residence in its entirety. Under these circumstances, you need to apportion the property’s cost base at the time you do the subdivision, for the purposes of calculating whether you made a capital gain or capital loss on disposal. If you want to know more about the taxation of a main residence, visit the Tax Office website (www.ato.gov.au) and check out ‘Guide to capital gains tax (NATÂ€4151)’Â€(particularly the bit that deals with real estate and main residence).

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Chapter 7

Taxing Issues That Affect Your Children In This Chapter ``Taxing children’s income ``Distributing trust income ``Getting a tax offset and child support payments

A

number of anti-avoidance tax provisions stop you from distributing income to your children. You can also use a number of tax benefits to help reduce the cost of raising children. In this chapter, I examine these anti-avoidance provisions and identify the various tax benefits you can gain from supporting your children.

Raiding the Piggy Bank: Taxation of UnderÂ€18s Be careful if you want to give money to your children, because anti-avoidance provisions apply with respect to income earned by children underÂ€18. The purpose of the provisions is to stop parents putting (or perhaps hiding) large sums of money into their children’s accounts, in order to avoid or reduce the amount of tax payable on the investment income derived. The good news is these rules no longer apply after a child turns 18Â€years of age. (In Australia, a child becomes an adult when reaching 18Â€years ofÂ€age.)

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Part II: Income from Personal Exertion The major concern here is if a child derives investment income, whose money is it? Does it really belong to the child or to a parent? The answer to this question determines who’s liable to pay the tax.

Taxing your children’s investment accounts Children’s savings and investment accounts can be in the name of the child or in a trust account, with the trustee normally being the child’s parent. The latter is generally the preferred option. This section examines the taxation issues associated with each. If an account is held in trust for a child under 16Â€years of age (which is normally the case) and the account earns more than $120 a year, the trustee needs to provide a tax file number (TFN) to a bank, building society or credit union (check out ChapterÂ€5 for how to apply for a TFN). The number can be either the trust’s TFN or the trustee’s personal TFN. If no TFN is quoted, tax is withheld from the payment at the rate of 46.5Â€perÂ€cent. This is because the account is deemed to belong to the trustee (for example, a parent). On the other hand, if a child is under 16Â€years of age and holds an investment account in their own name, they don’t have to provide a TFN to a financial institution if they receive less than $420 investment income each year. However, the $420 threshold doesn’t apply where a child under 16Â€years of age receives dividends from a public company. No threshold applies for income received from these investments. You may find the following information from the Tax Office (www.ato.gov.au) helpful: U Fact sheets: ‘Children’s savings accounts’; ‘Children’s share investments’ U Tax rulings: ‘TD 93/148: Income tax: are monetary gifts received by a child or any interest earned on investing such money treated as “excepted assessable income”?’; ‘ITÂ€2486: Income tax: children’s savings accounts’

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Chapter 7: Taxing Issues That Affect Your Children

Taxing the paper round: EmploymentÂ€income A low income earner (such as a child under 18Â€years in full-time education) who works part-time is unlikely to pay tax on the income they derive. The reason is because low income earners can claim a low income tax offset (see TableÂ€7-1). When you apply the tax offset against the tax payable on income derived, no tax is payable if taxable income is below: U $14,000 in 2008–09 U $15,000 in 2009–10 U $16,000 in 2010–11

Table 7-1

Low Income Tax Offset: Eligibility Applicable to Low Income Resident Individuals 2008–09

2009–10

2010–11

$1,200

$1,350

$1,500

Taxable income threshold

$30,000

$30,000

$30,000

Taxable income upper limit

$60,000

$63,750

$67,500

Maximum tax offset

The tax offset is reduced by fourÂ€cents for every dollar you earn above the taxable income threshold ($30,000), and fully phases out as soon as the taxable income upper limit isÂ€met. From 1 July 2013, if you earn less than $37,000 and a concessional contribution is made to your superannuation fund, the federal government proposes to contribute up to $500 on your behalf to eliminate any tax payable, and to help boost the super nest egg (see ChapterÂ€18 for more details).

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Case study: Child in part-time employment Kim is 16 years of age and works part-time for a fast-food outlet. During 2010–11, she earns $16,000 and pays $1,000 PAYG withholding tax. When she lodges her tax return she’s liable to pay $1,500 tax on the income she makes. Because her taxable income is below $30,000, she can

claim a $1,500Â€ low income tax offset. WhenÂ€the tax offset is deducted from her tax bill, she pays no tax on the $16,000 she derives, which means she receives a $1,000 tax refund in respect of the amount of PAYG withholding taxÂ€ her employer deducted from herÂ€pay.

Tax return for individuals Calculating the taxable income Salary or wages

$16,000

TOTAL INCOME

$16,000

Less: Work-related expenses

Nil

TAXABLE INCOME

$16,000

TAX PAYABLE/TAX REFUND Tax payable on $16,000

$1,500

Less Low income tax offset

$1,500

PAYG withholding tax

$1,000

TAX REFUND

$2,500 $1,000

Getting a Distribution from a Trust One popular way you can invest your money is to set up a trust, particularly a family discretionary trust. Under this arrangement the trustee (the person in control) has discretion about how trust net income (such as interest, dividends, rent and capital gains) should be distributed to the beneficiaries (normally family members).

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One great thing about setting up a trust is your ability to distribute trust income to specific beneficiaries to meet their particular needs. For example, if you have two children attending university, you’re able to distribute $16,000 to each of them that isn’t going to be taxed (see the sidebar ‘Case study: Distributing trust income’ later in this chapter). But it becomes a bit of a minefield if you want to distribute money to children under 18Â€years of age (see discussion in this section). It you intend to set up a family trust, you need to apply for a TFN (refer to ChapterÂ€5) and lodge a trust tax return disclosing the trust net income or (loss) at the end of the financial year. However, the trust isn’t liable to pay tax on the net income it derives. Instead, it becomes part of the assessable income of either the trustee or beneficiaries. As soon as the trustee has calculated the trust net income, the trustee is required to ascertain U Who the beneficiaries are. U Whether any beneficiary is presently entitled to receive a distribution (meaning they have a legal right to demand payment). U Whether any beneficiary is under a legal disability. This normally arises if a beneficiary is under the age ofÂ€18. Expressed simply, if a beneficiary is presently entitled to receive a distribution and has a legal right to demand payment, the distribution is part of the beneficiary’s assessable income and they are liable to pay tax on that distribution. On the other hand, if a beneficiary is presently entitled but under a legal disability, the trustee has to pay the tax. The trustee is also liable to pay the tax if no beneficiaries are presently entitled or if the trustee decides not to make a distribution. If a trustee makes a distribution to a minor beneficiary who is under a legal disability (that is, under 18Â€years of age), the trustee is liable to pay a penal rate of income tax, commonly known as DivisionÂ€6AA tax (see TableÂ€7-2). This part of the Tax Act is an anti-avoidance provision to discourage trustees from distributing unearned income to children under the age of 18. However, a beneficiary under 18Â€years of age can claim a low income tax offset (refer to TableÂ€7-1). When you take the low income tax offset into account you can distribute $2,666 in 2008–09, $3,000 in 2009–10 and $3,333 in 2010–11 before you’re liable to pay tax.

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Part II: Income from Personal Exertion For example, if you distribute $3,333Â€inÂ€2010–11 to a minor beneficiary, the tax payable is $1,500 ($3,333Â€ìÂ€45Â€perÂ€cent). When the $1,500 low income tax offset is deducted from this amount, the tax bill is reduced toÂ€nil.

Table 7-2

Division 6AA — Penal Rate of Income Tax

Taxable Income

Rate of Tax

$0–$416

Nil tax payable

$417–$1,307

66% of excess over $416

Above $1,307

45% on entire amount of taxable income

A resident trustee is liable to pay tax on any trust distributions to non-resident beneficiaries. If the non-resident beneficiary is required to lodge a tax return, the non-resident beneficiary can claim a tax credit in respect of the tax paid.

Understanding what is a trust The Tax Act doesn’t define the meaning of a trust. A trust is a legal obligation, binding a person (referred to as the trustee) who has control over certain business and/or investment assets (referred to as trust property), for the benefit of certain persons (referred to as beneficiaries). Expressed simply, a trust is a combination of four key components: U Beneficiary: The person who stands to benefit from the trust. Companies and other trusts can also be beneficiaries. U Trust deed: A legal document that sets out all the rights and obligations of the trustee.

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U Trust property: May be money, real estate, shares or a business being used to derive income for the benefit of the beneficiaries. U Trustee: Responsible for administering and managing the trust property over which he has control for the benefit of the beneficiaries. A trustee holds legal title to the trust property, but the property isn’t beneficially his. Further, a trustee must act in accordance with the terms of the trust deed. A trustee can be either a person or a company.

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From 1 July 2010, beneficiaries of closely held trusts (such as family discretionary trusts) must supply their TFN to the trustee. If you don’t follow this rule, the trustee must withhold amounts from trust distributions at the top marginal rate (see AppendixÂ€A) plus the Medicare levy (refer to ChapterÂ€1). Beneficiaries who have tax withheld from their distributions can claim a tax offset in their individual tax returns.

Case study: Distributing trust income The trustee of the Phoenix family discretionary trust calculates the trust net income to be $66,000. The trust has two beneficiaries, Maria and Charlie. At the end of the financial year, the trustee distributes $22,000 to Maria (who is a 21-year-old university student), $22,000 to Charlie (who is agedÂ€12 and is in full-time education), and decides to retain and re-invest the balance ($22,000). The $66,000 trust net income is taxed as follows. Because Maria is over 18Â€ years of age, she’s considered to be: U Presently entitled to the trust Â�distribution U Under no legal disability U Personally liable to pay tax on the $22,000 she receives at her marginal tax rates

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Although Charlie is presently entitled to the trust distribution, in this case: U He’s under a legal Â�disability because he’s younger than 18Â€years of age. U The trustee is liable to pay tax on the $22,000 distributed to Charlie. U The trustee is liable to pay a penal rate of income tax under DivisionÂ€ 6AA (currently 45Â€ perÂ€ cent plus 1.5Â€ perÂ€ cent Medicare levy). The $22,000 that isn’t distributed (that is, the portion retained and Â�re-invested) is classified as income to which no beneficiary is presently entitled. Under these circumstances, the trustee is liable to pay tax at the highest marginal rate (plus 1.5Â€ perÂ€ cent Medicare levy) on this amount.

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Part II: Income from Personal Exertion With respect to a distribution to a minor beneficiary, the Tax Act uses the following technical terms. U Prescribed person: A person under 18 years of age and liable to pay a penal rate of income tax under DivisionÂ€6AA (currently 46.5Â€perÂ€cent). For example, because the person is in full-time education. U Excepted person: A person who is under 18Â€years of age but not liable to pay a penal rate of income tax under DivisionÂ€6AA. For example, if a person is in full-time employment or suffers from some disability. U Excepted assessable income: The Division 6AA penal rate of income tax doesn’t apply to employment income or business income that a minor beneficiary may earn — for example, if a minor beneficiary derives a salary for services rendered. Also, the provision doesn’t apply to investment income arising as a result of a deceased estate or from investing their excepted assessable income.

Getting Something Back: The Tax Offsets You Had to Have As every parent can testify, raising children isn’t an easy or inexpensive exercise. The job seems to be getting more and more difficult every year. Besides having to continually feed and clothe children, you have to provide a roof over their head as well as educate them. If you have to go to work, you may have to pay childminding expenses while you’re working to support your family. To add salt to the wound, if you’re raising more than one child the costs start to escalate. If you didn’t already have enough on your plate, as soon as they grow up they want a car, an eighteenth and twenty-first birthday party and a royal wedding. So if you’re crying out for help you’re not the onlyÂ€one. Fortunately, you can tap into a number of tax benefits to help ease the pain.

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Family Tax Benefit (Part A) Family Tax Benefit (Part A) is an annual tax benefit to help you raise your children. To qualify you must have a dependent child under 21, or a dependent student aged 21 to 24 in fulltime education. This payment is subject to you satisfying an incomeÂ€test.

Family Tax Benefit (PartÂ€B) If you’re a single income family or a sole parent you may qualify for an extra payment under Family Tax Benefit (Part B) to help you raise your children. You may also receive an additional payment if your child is younger than fiveÂ€years of age. This payment is subject to you satisfying an income test.

Baby Bonus The Baby Bonus is a non-taxable federal government payment made on the birth of a child. The purpose of this payment is toÂ€help you cover the costs associated with the birth or adoption of a baby. This payment is means tested (that is, available to a couple earning less than $150,000 a year), and is paid in 13Â€equalÂ€fortnightly payments in respect of each child. For more details, see the Family Assistance Office website: www.familyassist.gov.au

Child care rebate This rebate payment is provided by the federal government to help you to cover the costs associated with child care and you can claim it through the Family Assistance Office. The child care rebate is 50Â€perÂ€cent of eligible approved child care expenditure (such as long day care or family day care)Â€and is normally payable on a quarterly basis. See TableÂ€7-3 for the maximum amount you can receive.

Table 7–3

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Child Care Rebate Maximum

Financial Year

Rate

Amount per Child

2009–10

50%

$7,778

2010–11

50%

$7,500

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Part II: Income from Personal Exertion From 1 July 2010, the maximum child care rebate remains at $7,500 and isn’t set to change for the next fourÂ€years. For a comprehensive discussion on what you need to satisfy to qualify for these tax benefits/offsets, go to the Centrelink website (www.centrelink.gov.au) and Family Assistance Office website (www.familyassist.gov.au).

Education tax refund The federal government provides an education tax refund to help Australian working families educate their children. Under this plan, families receiving Family Tax Benefit (PartÂ€A) are able to claim a 50Â€perÂ€cent refund for expenditure suchÂ€as: U Education software U Home computers and associated costs U Home internet connection U Laptop computers U Printers U School textbooks U Stationery U Trade tools for use at school The federal government is proposing to add the cost of approvedÂ€school uniforms to the list of education expenses thatÂ€qualify for the 50Â€perÂ€cent refund in the 2011–12 financialÂ€year. School fees are excluded from the list of education expenditure eligible for the 50Â€perÂ€cent education expense tax offset. The claim is capped to $780 for each child in primary school, and the maximum refundable tax offset is $390 per child each financial year. For children attending secondary school, the claim is capped at $1,558, and the maximum refundable tax offset is set at $779 per child each financial year. You need to lodge a tax return and claim 50Â€perÂ€cent of the education expenditure (mentioned earlier) that you incur each year. The good news gets even better because you can transfer to your spouse any unused tax offset and if you spend more than the maximum you can claim it in the following financialÂ€year.

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Under the federal government child support scheme, if you’re a separated parent you may be liable to make child support payments in respect of your children. These payments are normally deducted from your salary and wages. The amount you pay depends on the taxable income you disclose in your tax return. For more details, you can visit the Child Support Agency website (www.csa.gov.au). On 1 January 2011, the federal government is set to introduce a government-funded, taxable, 18-weeks’ paid parental leave scheme. The payment is at the level of the federal minimum wage rate. Its purpose is to provide financial support for the parents of newborn children. To be eligible you must satisfy aÂ€work test and you can’t earn more than $150,000. The federal government also intends to introduce a 2 weeks’ paid parental leave scheme for fathers.

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11/8/10 3:31 PM

Part III

Tax Effective Investments Glenn Lumsden

‘Mr Harris, it has come to our attention that for the last fiveÂ€years, you’ve been claiming us as a dependant.’

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Y


ou may be interested in many categories of investment, from wine, stamp collecting and works of art, to interest bearing securities, shares and property. An ideal investment is one that grows in value and pays you regular income. Investing in quality blue chip companies or property in good locations are examples of investments that pay regular income and provide capital growth opportunities. You’re best to also check out the tax benefits you may gain from investing, such as interest that is tax deductible. To add icing to the cake, you may qualify for government handouts and some handy tax offsets.

In this part of the book, I investigate traditional investments such as interest bearing securities, shares and property. IÂ€also examine the various taxation issues associated with these investments, particularly taxing capital gains, and tax deductions and tax offsets that you can claim.

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Chapter 8

Interesting Stuff: Bank Deposits and Tax In This Chapter ``Receiving an interest payment ``Getting paid for starting a first home saver account ``Claiming tax deductions — gaining from losses

W

hen you invest in interest bearing securities, you normally deposit your money with financial institutions such as banks, credit unions and building societies. In return for the use of your money, you receive interest on your deposit, which is ordinarily payable at regular intervals. When the loan matures, you get your initial capital back. Because this class of investment can’t increase in value, no capital gains tax issues arise. If you decide to stay with this investment, the purchasing power of your capital decreases if inflation increases and the income you derive decreases if interest rates fall.

In this chapter, I discuss the taxation issues associated with interest bearing securities and your investment options. IÂ€also examine first home saver accounts and tax deductions associated with earning interest.

Banking the Return: Interest When you invest in an interest bearing security such as a term deposit, you earn interest in return for the use of your capital (the money that you invest). Generally, you’re liable to pay tax when the interest is credited to your account. However, from 1Â€JulyÂ€2011, the federal government is set to give you a 50Â€perÂ€cent tax discount on the first $1,000 interest you derive

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Part III: Tax Effective Investments on deposits held with banks, building societies and credit unions, as well as bonds, debentures and annuity products. You need to quote your tax file number (TFN) to the financial institution at the time you open the account. If you don’t, the financial institution may withhold 46.5Â€perÂ€cent tax on the interest you earn. This withholding tax is taken into account when calculating your tax liability and is refunded if you pay too much tax. No capital gains tax (CGT) issues are likely to arise, and no 10Â€perÂ€cent goods and services tax (GST) is levied on input taxed financial transactions (seeÂ€ChapterÂ€15 for all aboutÂ€GST). If you’re under 16Â€years of age, you don’t have to quote your TFN to a financial institution, if you earn less than $420 interest from your account each year (see ChapterÂ€7). Interest isn’t taxed at the time it is paid to you, so under the pay-as-you-go (PAYG) withholding tax system, if you derive a significant amount of interest, you may need to prepare an instalment activity statement disclosing the amount of interest you receive, and pay tax on an ongoing basis (usually quarterly). The Tax Office notifies you if you need to do this. If you take this route, you have to keep accurate records of the interest you receive or is credited to your account, and more particularly, the date you receive the payments. The tax you pay is credited against your end of financial year assessment (or final tax bill). If you want to know about preparing an instalment activity statement, visit the Tax Office website (www.ato.gov.au) and go to ‘PAYG instalments — how to complete your activity statement’. As part of an ongoing compliance program, the Tax Office regularly checks on people by matching interest paid by Australia’s major financial institutions against individual tax returns. You need to disclose the interest you derive in your tax return, and penalties apply if you fail to disclose the correctÂ€amount. The Tax Office pays you interest when you make an early payment of tax or an overpayment of tax. But you need to declare the amount of any such interest you receive on your taxÂ€return as part of your assessable income.

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Chapter 8: Interesting Stuff: Bank Deposits and Tax

Starting a First Home Saver Account The federal government has introduced first home saver accounts to help individuals to save for a deposit to buy or build their first home. Under this scheme, the federal government pays money into your account if you meet certain criteria: U The government contributes a minimum of 17Â€perÂ€cent, if a first home buyer makes an after tax contribution of up to $5,500 (indexed) into such an account opened on or after 1Â€OctoberÂ€2008. So, if you save $5,500, the government contributes $935. U As an individual, you can make further (non-qualifying) contributions into this account each financial year. U Interest credited is taxed at the rate of 15Â€perÂ€cent, which the account holder pays on your behalf. U The government places a limit (cap) of $80,000 (indexed) on the overall account balance (after which no further personal contributions can be made). U You need to quote your TFN at the time you open this account. U Withdrawals from this account to buy or build your first home in which you intend to reside are tax free. U You’re required to live in the property for at least six months within the first 12Â€months of the purchase or completion of construction. U You may still be eligible for the first home owner grant even if you’re eligible for the first home saver account. If you decide you no longer wish to buy or build your first home, you can’t withdraw the money. The balance is transferred to your superannuation fund. You may be liable to penalties if the funds aren’t used to buy or build your first home. For more information on first home saver accounts, see the fact sheet ‘First home saver accounts essentials’ on the Tax Office website (www.ato.gov.au).

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Part III: Tax Effective Investments

Interesting Claims You can deduct from your assessable income any loss or outgoing to the extent the loss or outgoing is incurred in gaining or producing assessable income. So, to qualify for a tax deduction, a direct and relevant connection must exist between the expenditure you incur and earning your assessable income, more particularly the interest you derive. The types of expenditure generally associated with earning interest that you’re likely to incurÂ€are U Interest on borrowings, provided the purpose (or use) of the funds was to gain assessable income and, more particularly, the interest you derive U Account keeping fees that a financial institution may chargeÂ€you U Certain taxes that a state or territory government may charge you You may find helpful the following fact sheets from the TaxÂ€Office: U ‘Interest income’ U ‘D7 Interest deductions’ U ‘Interest and dividend deductions’ U ‘Children’s savings accounts’ U ‘Introduction to pay as you go income tax instalments (NATÂ€4637)’

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Chapter 9

Owning Part of the Company: Investing in Shares In This Chapter `Ùnderstanding shares, dividends and capital gains tax ``Claiming tax deductions

W

hen you invest in the share market, you’re pinning your hopes for income and capital growth on the business operations of publicly listed companies such as CBA, Qantas and Woolworths. In this chapter, I explain the unique taxation issues associated with this category of investment.

Sharing the Profits: Dividends When you buy shares in a company, you become a part ownerÂ€— a shareholder — of the company. This status means you can vote at the annual general meeting and give your two bob’s worth of advice to the company directors. One tangible benefit of being a shareholder is the right to receive a share of the profits, referred to as dividends. Companies ordinarily pay dividends to you twice a year, and dividends are normally liable to tax when they’reÂ€paid. When you buy shares, quote your tax file number (TFN — refer to ChapterÂ€5) to the company. Otherwise, the company is liable to withhold 46.5Â€perÂ€cent tax on your dividend payment (referred to as TFN amounts withheld from dividends). This situation may arise if the company pays you an unfranked dividend (see the next section). Under these circumstances, you can claim a tax credit on the amount the company withholds when you lodge your tax return.

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‘Frankly’ my dear .â•›â†œ.â•›â†œ. Franking is a very important concept that you need to be aware of. When a company pays you a dividend, it must tell you whether the payment is fully franked, partially franked or unfranked. Franking credits are tax offsets that you can apply against the net tax payable on dividends (and other income) you derive. The good news is if your total franking credits exceed the net tax payable, the Tax Office refunds you the difference (see the sidebar ‘Case study: Receiving a fully franked dividend’ for moreÂ€details).

Case study: Receiving a fully frankedÂ€dividend At the end of the financial year, Paz Fisher derives a $20,000 salary from her employment activities and pays $2,000 PAYG withholding tax. She also receives a $4,000 fully franked dividend from XYZ Ltd. The franking credit is $1,714: Fully franked dividend XYZ Ltd Holder identification number: XÂ€000438791 Payment date: 5Â€OctoberÂ€20XX Paz Fisher 14 Roberts Street Robertsville Shareholder dividend statement Fully franked final dividend for year ended 31 December 20XX Class of shares

Dividend rate per share

Number of shares held

Franked amount

Franking credit (30% tax rate)

Ordinary shares

80 cents

5,000

$4,000

$1,714

Dividend amount $4,000

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Chapter 9: Owning Part of the Company: Investing in Shares

93

When Paz lodges her tax return, she needs to include the $4,000 dividend plus the $1,714 franking credit as part of her assessable income. She also incurs $500 interest on borrowings to finance the purchase of her share portfolio. Paz is taxed as follows: Tax return for individuals Income Salary or wages

$20,000

Dividends: Franked amount

$4,000

Franking credit

$1,714

TOTAL INCOME OR LOSS

$25,714

Less Interest deductions

$500 $25,214

TAXABLE INCOME Calculation of tax payable/refund Tax payable on $25,214

$2,882

Plus 1.5% Medicare levy

$378

Tax payable

$3,260

Less PAYG withholding tax

$2,000

Low income tax offset*

$1,500

Franking credits

$1,714

REFUND OF TAX

$5,214 $1,954

* In this case study, Paz is also entitled to a low income tax offset. For further details, see AppendixÂ€A.

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Part III: Tax Effective Investments Your dividend payment could be 55 Fully franked: A fully franked dividend means the company has paid 30Â€perÂ€cent tax on its profits. This benefit, referred to as a franking credit, can be passed on to you (and your dividend yield will increase!). You can get a franked dividend only from a resident Australian company. 55 Partially franked: If the dividend is partially franked, youÂ€receive a franking credit to the extent the dividend isÂ€franked. 55 Unfranked: If you receive an unfranked dividend, the company may not have paid taxes on its profits. You receive no franking credits if the dividend is unfranked. If you receive an unfranked dividend, you pay more tax because no tax offset is available for you to deduct from the net tax payable (as is the case when the dividend is fully franked or partially franked). When you lodge your tax return, you need to include both theÂ€dividend and franking credit as part of your assessable income. This process is called grossing-up. You’re taxed on theÂ€total amount and the franking credit is applied against the tax payable. The federal government is proposing to reduce the company tax rate to 29Â€perÂ€cent in 2013–14, which means the franking credit is set to decrease accordingly. You may find helpful the following fact sheets from the Tax Office: 55 ‘You and your shares (NAT 2632)’ 55 ‘CGT on shares or units’ 55 ‘Investments, shares and options essentials’ When you prepare your tax return, you find the following items in the section of the return form that deals with income: 55 Unfranked amount 55 Franked amount 55 Franking credit

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Chapter 9: Owning Part of the Company: Investing in Shares The following example shows you how to include both the dividend and franking credit as part of your assessable income:

If a company pays you a $1,000 fully franked dividend and tells you the franking credit is $428, you need toÂ€include $1,428 as part of your assessable income ($1,000 + $428) in your tax return (refer to the sidebar ‘Case study: Receiving a fully franked dividend’). You’re liable to pay tax on the grossed-up amount ($1,428). The good news is you can offset (deduct) the franking credit ($428) against the net tax payable. If your total franking credits exceed the net tax payable, the Tax Office refunds you the difference. This offset can significantly benefit investors who pay no tax or a 15Â€perÂ€cent marginal rate of tax, because the refund increases the overall return on your investment (cash dividend received + refund of tax). If your marginal tax rate is 30Â€perÂ€cent, you effectively pay no tax on the dividend, because the franking credit (worth 30Â€perÂ€cent) matches the rate of tax payable on your grossed-up dividend. However, if your marginal tax rate is above 30Â€perÂ€cent, you’re liable to pay tax on the difference between the higher marginal rate (for instance, 37Â€perÂ€cent) and 30Â€perÂ€cent.

The formula used to calculate the franking credit on a dividend payment is: CashÂ€dividend ì

CompanyÂ€taxÂ€rate (0.30)

1Â€–Â€CompanyÂ€taxÂ€rateÂ€(0.70) Using the earlier example, the $428 franking credit was calculated as follows: $1,000 ì 30/70 = $428

If the company pays a 50Â€perÂ€cent partially franked dividend, the franking credit is reduced to the extent it is franked (for example, $428 ì 50% = $214). If the dividend is unfranked, you receive no franking credits. The Tax Office may deny you a franking credit if you buy and sell shares within 45Â€days of acquiring them and you become entitled to receive a franked dividend. However, under the small shareholder exemption provisions, this ruling isn’t applicable if the total franking credits you receive from all your share holdings is $5,000 or less. As the application of these taxation provisions can be complex, you’re best to seek advice from a qualified accountant or tax agent.

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Part III: Tax Effective Investments Under the PAYG withholding tax system, when you receive investment income (such as a dividend payment), you may need to prepare an instalment activity statement disclosing dividends (but not the franking credits) paid or reinvested on your behalf, and pay tax on an ongoing basis (usually quarterly). The Tax Office notifies you if you need to follow this procedure. You’re required to keep all the dividend statements you receive and note the date you receive the payment. The tax you pay is credited against your end of financial year assessment. For details about preparing an instalment activity statement, you can visit the Tax Office website (www.ato.gov.au) and go to ‘PAYG instalments — how to complete your activity statement’. If you participate in a dividend reinvestment plan (where you receive additional shares, instead of a dividend payment), you still need to declare the dividend as part of your assessable income.

Why companies may not pay fully frankedÂ€dividends U A company may not have sufficient tax credits in its franking account to pass on to its shareholders.

same as calculated for accounting purposes — you’re able to make a loss under income tax law and a profit under commercial law. (Note: Tax is payable only onÂ€ profits calculated under taxÂ€law.)

U A company may have prior year losses that they can offset against current year profits, which affects the amount of tax payable on net profits derived.

U A company may derive much of its profits from overseas sources, which may affect the rate of Australian tax payable on the profits that a company derives.

U Net profit calculated under income tax law may not be the

U A company policy may include not fully franking its dividends.

A company may not pay you a fully franked dividend for a number of reasons. The main ones are

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Reducing dividend payments: WhatÂ€can I claim? In ChapterÂ€2, I explain the rules of claiming a tax deduction under the general deduction provisions. With respect to dividend payments, to qualify for a tax deduction, a direct and relevant connection must exist between the expenditure you incur and the dividends you receive. Examples of the types of expenditure that meet this key test include 55 Bookkeeping and postage to manage your share portfolio 55 Costs of subscriptions to share market information services and investment journals, provided they’re for the purpose of deriving dividends 55 Depreciation of share trading software 55 Interest on money you borrow to buy shares in companies that normally declare dividends 55 Internet and data access costs incurred for share trading activities 55 Mobile phone call costs for a share trader to access live market information 55 Newspapers and journals that provide information necessary to manage your share portfolio 55 Travel expenses to consult a stockbroker or attend company annual general meetings The Tax Office has issued the fact sheet ‘Carrying on a business of share trading’ that deals with share trading activities.

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Running a share trading business You can apply a number of tests to check whether you’re running a share trading business: U Do you intend to make a profit? U Are you running your activities in a business-like manner? U How much capital are you planning to invest? U Do you plan to trade on a regular basis (for example, 10Â€ trades a week)? U What volume of trades do you plan to make each year (for instance, 500Â€trades a year)? U Are you keeping proper records (for example, buy and sell contract notes)? Generally speaking, passing these tests isn’t difficult. The stumbling

block to being accepted as running a share trading business is normally theÂ€ volume of trades you make each year. As a general rule, the more trades you make the greater the chance of being accepted as a share trader. A significant advantage of being accepted as a share trader is any trading losses you incur can be offset against other assessable income you derive. On the other hand, if you’re an investor any capital loss you incur can be offset only against a capital gain. The downside is a share trader can’t take advantage of the 50Â€perÂ€cent discount on gains made on shares held for more than 12Â€months. However, this rule is unlikely to be a major concern because a share trader is unlikely to hold shares for more than 12Â€months.

Borrowing to build your wealth: Interest payments One major expense you’re likely to incur is interest on borrowings. Provided the purpose (or use) of the loan is to derive assessable income, especially dividends, you can normally claim the interest as a tax deductible expense. Before you borrow, you need to check the company’s dividend payment history. If you find that a company has never declared a dividend, a looming and strong possibility is that the interest expense may not be tax deductible. This possibility presents because the purpose or use and direct and relevant connection tests are not being satisfied: You’re not going to be earning assessable income, because the company doesn’t pay dividends. This scenario can arise if you buy shares in mining companies

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that don’t declare dividends. To claim a tax deduction, you must reasonably expect to receive a dividend. If you borrow to buy shares, and then find that the companies don’t pay dividends and you’re not sure what to do, you’re best to seek professional advice. However, all is not lost! Under the capital gains tax provisions, the interest you incur (referred to as non-deductible holding costs) can be added to the share’s cost base. However, this provision applies only to investments and, more particularly, shares you bought after 20Â€AugustÂ€1991, and can be taken into account only if you make a capital gain. Unfortunately, the provisions can’t be used to create or increase a capital loss.Â€The sidebar ‘Case study: Non-deductible holding costs — shares’ illustrates theseÂ€points.

Case study: Non-deductible holding costs — shares Eleven months ago Angela borrows $30,000 to buy a parcel of shares in a mining company that hasn’t ever declared a dividend. She pays $30,000 for the shares and sells the parcel of shares today for $40,000. During the time Angela owns the shares, she pays $3,000 interest. The Tax Office advises her that the interest isn’t tax-deductible because her mining shares don’t pay dividends. Under these circumstances, the interest can be added to the cost base. The net capital gain Angela makes on disposal is calculated as follows: Capital proceeds

$40,000

Less Cost base Purchase price Non-deductible holding costs NET CAPITAL GAIN

$30,000 $3,000

$33,000 $7,000

If the sale price is $20,000, Angela can’t take the $3,000 non-deductible holding costs (interest) into account, because she can’t use it to create or increase a capital loss. On the other hand, if the sale price is $32,000, she can take $2,000 of her non-deductible holding costs (interest) into account.

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Part III: Tax Effective Investments If you enter into a capital protection loan agreement to buy shares, the amount of interest you can claim is restricted to the Reserve Bank of Australia’s indicator rate for standard variable housing loans (plus a further 1Â€perÂ€cent). Under a capital protection loan arrangement, you can protect yourself from incurring losses (if your shares fall in value) by paying for a risk premium in your interest charge (so you don’t have to repay the loan if the investment arrangement is unsuccessful).

Taxing Your Gains and Losses When you buy shares from a stockbroker you receive a buy contract note, which sets out the price (plus costs) you pay and the date of purchase. If you sell the shares at a later date, you receive a sell contract note, which sets out the sale price (minus costs) and the date of sale. You use these two documents to quickly calculate whether you make a capital gain or capital loss on sale. The documents also tell you how long you own the shares. You need to know this fact to check out whether you make a discount capital gain or a non-discount capital gain and how much tax you’re liable to pay on the gain. These issues are discussed in greater detail in ChapterÂ€11. Your capital gains can be taxed in two ways: 55 Discount capital gain: Only 50Â€perÂ€cent of the gain is taxed at your marginal tax rate if you hold the shares for more than 12Â€months (see the sidebar ‘Case study: Making a capital gain’). 55 Non-discount capital gain: If you hold the shares for lessÂ€than 12 months, the entire gain is taxed at your marginal tax rate (see the sidebar ‘Case study: Making a capital gain’). If you sell shares and make a capital loss, and you buy them back immediately (referred to as a wash sale), you take a risk that the Tax Office may disallow the capital loss you make. This interpretation may apply because the Tax Office may take the view that you only sold the shares in order to gain a tax benefit that arises when the capital loss is deducted from a capital gain. Here’s an example:

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If you make a $20,000 capital gain on a parcel of shares that you own, and your marginal rate of tax is 30Â€perÂ€cent, you’re liable to pay $6,000 in tax ($20,000 ì 30%). However,

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if you sell another parcel of shares that you own in order to make a $20,000 capital loss (and you buy the shares backÂ€immediately), the Tax Office may take the view (since you still own the shares) that you’re only selling the shares to reduce the $20,000 capital gain you make to nil. When you use this strategy, you still own the shares that created the capital loss and you gain a tax benefit, because you’re no longer liable to pay $6,000 tax on the $20,000 capital gain you made (all a good reason why the Tax Office isn’t going to be impressed!). To overcome this anti-tax avoidance provision, it’s important if you sell the shares and make a capital loss, that you don’t buy the shares back immediately. However, you can still buy the shares back at a later date, for example, if you find one month after you sell the shares that the company’s business prospects have improved. If you’re not sure what to do, you need to seek professional advice.

Case study: Making a capital gain Three years ago Fabien purchases 1,000 CBX Ltd shares. The buy contract note shows he pays $20,100 for them (including $100 brokerage and GST). Fabien sells the shares today. According to the sell contract note, the sale price is $29,000 and he pays $100 brokerage and GST to sell them. The net capital gain Fabien makes on disposal is calculated as follows: Capital proceeds

$29,000

Less Cost base Purchase price

$20,000

Brokerage & GST (buy)

$100

Brokerage & GST (sell)

$100

NET CAPITAL GAIN

$200

$20,200 $8,800

Because Fabien holds the shares for more than 12Â€months, he’s taken to have made a discount capital gain. Just 50Â€per cent of the gain ($4,400) is liable to be taxed at his marginal tax rate.

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Part III: Tax Effective Investments The Tax Office has issued ‘Taxpayer Alert TA 2008/7’ that deals with wash sales arrangements and sets out the Tax Office policy on these types of transactions.

Case study: Making a capital loss Julianne purchases a parcel of shares for $20,000. Her brokerage fees and GST are $100. She sells them for $9,000 (again, her brokerage fees and GST are $100), making a capital loss on disposal. Under these circumstances, the net capital loss she makes on disposal is calculated as follows: Capital proceeds (sale price)

$9,000

Less Reduced cost base Purchase price

$20,000

Brokerage and GST (buy)

$100

Brokerage and GST (sell)

$100

NET CAPITAL LOSS

$20,200 $11,200

Note: If you make a capital loss, the cost base becomes the reduced cost base. Because Julianne makes an $11,200 capital loss, she can offset this loss only against any capital gains she may make. If she makes no capital gains during the financial year, she can carry forward the capital loss for an indefinite period and apply it against future capital gains that she may make. She can offset the capital loss against capital gains she may make on disposal of other categories of assets such as property. The only exception is, Julianne can’t offset a capital loss against a capital gain on a collectable.

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Chapter 10

Building Your Dreams: Investing in Bricks andÂ€Mortar In This Chapter ``Deriving rental income ``Working out what you can claim ``Separating business expenditure from private usage ``Calculating your tax deductions

I

nvesting in real estate can range from buying residential property or land, to commercial property such as office space, shops and factories. If you plan to invest in bricks andÂ€mortar, you buy land and buildings for income and capitalÂ€growth. Significant tax benefits may be gained from investing in real estate. In this chapter, I identify these tax benefits and explain what you need to do to qualify for them.

Collecting the Rent One of the great pleasures of leasing a property is the regular rental payments you receive from your tenant. You’re normally liable to pay tax on rental income in the financial year you receive the payment. If you own an

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Part III: Tax Effective Investments income‑producing property, you may be liable to pay tax on the following types of transaction: U Bond money: If you receive bond money from a tenant, you normally pay tax on it at the time you’re legally able to keep it. (This situation may arise, for example, when a tenant refuses to pay you rent or damages your property.) U Insurance policy payments: You may have to pay tax on payments you get from an insurance policy that compensate you for loss of rent. U Prepaid rent: You normally pay tax on this transaction in the financial year you receive the payment. Rent isn’t taxed at the time you receive the payment, so under the PAYG withholding tax system (refer to ChapterÂ€3), you may need to prepare an instalment activity statement disclosing the gross rent you receive and pay tax on an ongoing basis (usually quarterly). The Tax Office notifies you if you need to do this. This situation means you need to keep an accurate record of the gross rent you receive and the date you receive it. The Tax Office credits the tax you pay against your end of financial year assessment (orÂ€taxÂ€bill). For details about preparing an instalment activity statement, visit the Tax Office website (www.ato.gov.au) and go to ‘PAYG instalments — how to complete your activity statement’. If you lease residential property used predominantly for residential accommodation, you don’t need to apply for an Australian Business Number (ABN) and quote it to your tenant. (An ABN is a number you have to quote when you enter into certain business transactions; otherwise 46.5Â€perÂ€cent tax is withheld from your payments.) If you run a business and you receive a cash incentive from a landlord to enter into a long-term lease or to remain on the premises, the receipt is normally treated as assessable income.

Reducing the Costs: What You CanÂ€Claim A major bugbear with rental investments is dealing with the constant stream of expenses. A bill in the in-tray is always waiting to be paid! For an expense to be deductible, you

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105

must show a relevant and necessary connection between the expenditure you incur and the rental income you earn. If you own a rental property you must charge a commercial rate of rent. Otherwise, your expenses may be disallowed or reduced to an amount the Tax Office considers reasonable. For example, if you charge a relative $10 a week rent and your annual rental expenses are $20,000, you risk a strong possibility that your deductions are going to be denied or substantially reduced because you’re not charging a genuine rent. Further, you can claim rental property deductions only for the period that you rent out the property or, if the property is vacant, it must be genuinely available for rent (for example, the property is with aÂ€real estate agent). Expenditure associated with rental property normally consists of the following types of outlay: U Advertising to find a tenant U Agent’s commission to manage your property and collect the rent on your behalf U Bank fees and charges U Body corporate fees if you own an apartment U Borrowing expenses (see ChapterÂ€14) U Capital works deductions (see the section ‘Understanding capital works deductions’ later in this chapter) U Council rates U Depreciation or decline in value for items such as furniture and fittings (see the section ‘Depreciating your assets’, later in this chapter) U Gardening and lawn mowing U Insurance premiums for building and loss of rent U Interest to finance the purchase of an income-producing property (see the section ‘Going in reverse: Negative gearing’ later in this chapter) U Land taxes U Legal expenses associated with the preparation of a lease U Pest control U Repairs and maintenance (see the section ‘Repairing what is yours’ later in this chapter) U Security costs

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Part III: Tax Effective Investments U Stationery and postage U Tax-related matters (see ChapterÂ€14) U Telephone calls U Travel costs (to inspect your property, collect the rent and perform general maintenance) U Water and sewerage charges

Apportioning Expenditure: The Bits You Can’t Claim If you use only part of your property to derive rental income, you have to apportion the expenditure you incur. This rule applies because the Tax Office considers part of the expenditure to be private or domestic in nature and not tax deductible (see ChapterÂ€2). Working out the percentage of deductible expenses is normally done on a floor or area basis; for example, if your property consists of 12Â€rooms and you use four of the rooms for income-producing purposes by leasing them or running a business from them, one-third of your total outlays are deductible expenses. The balance is considered to be private or domestic in nature and, therefore, not deductible. The Tax Office has issued two booklets titled ‘Rental properties’ and ‘Guide to depreciating assets’ that provide guidelines on taxation of rental properties and expenses you can claim.

Claiming Specific Deductions: What’s on the List To claim certain deductions, you need to follow specific rules — as this section describes.

Depreciating your assets Nothing lasts forever, especially household items that seem to be always breaking down. You can claim depreciation (wear and tear) on certain assets or articles you own and use to derive rental income. (The Tax Office prefers to use the term decline in value rather than depreciation.)

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You can depreciate items such as clothes dryers, curtains and blinds, dishwashers, floor coverings, furniture, refrigerators, stoves, television sets and washing machines. To fulfil the depreciation rules correctly, you need to keep a depreciation schedule, listing all the items you can depreciate plus the date you buy them and the purchase price. When working out how much depreciation you can claim each year, you have the option to use a rate of depreciation based on the item’s estimated effective life, or the Tax Office recommended depreciation rates as set out in its tax rulings. If you buy a depreciable item costing $300 or less you can claim an outright deduction in the financial year you incur the expense. You can make this claim only if you earn non-business income such as rent you receive from a residential property. And now for the bad news! Unfortunately, you can’t depreciate everything you own in a rental property. For example, you can’t depreciate items such as built-in kitchen cupboards, carports, in-ground swimming pools, saunas and spas. Why? Because the Tax Office considers these types of items to form part of the building structure and are, therefore, capital in nature (refer to Chapter 2). However, all is not lost. Although they’re not depreciable, you may be able to claim a tax deduction under a different section of the Tax Act referred to as the capital works provisions (see the section ‘Understanding capital works deductions’ later in this chapter). You have a choice of two methods to work out how much depreciation (or decline in value) you can claim each year: U Using the prime cost method (PCM), you can claim a fixed amount each financial year. U Using the diminishing value method (DVM), you can claim a larger amount in the earlier years and a lesser amount in later years. The method of depreciation that you select depends on the amount of depreciation you want to claim each year and how quickly you want to claimÂ€it. When weighing up which method to use, remember that the rate of depreciation under DVM is always twice the rate under PCM (when working out how much depreciation you can claim, you can use a rate of depreciation based on the item’s estimated effective life, or the Tax Office recommended depreciation rates as set out in its tax rulings). For example, if the rate of depreciation under PCM is 10Â€perÂ€cent, the rate under DVM

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Part III: Tax Effective Investments is automatically 20Â€perÂ€cent. This difference means that if you choose DVM, instead of PCM, you can recoup your initial outlay at a faster rate (see the sidebar ‘Case study: Claiming a depreciation deduction’). When you sell a depreciable item, the Tax Office refers to the process as a balancing adjustment event. If the sale price (or termination value) is less than the adjusted value, the amount not yet written off is a tax deductible expense. For example, if the adjusted value is $10,500 at the time the balancing adjustment event occurs (that is, when you sell the asset), andÂ€you receive $5,000 for the asset, the $5,500 loss you incur isÂ€tax deductible. On the other hand, if the termination value (sale price) is more than the adjusted value, the excess is assessable. For example, if you receive $12,000 when you sell the depreciable item and the adjusted value is $10,500, the $1,500 profit you make is assessable income that you must declare on your tax return and,Â€therefore, is liable toÂ€tax.

Case study: Claiming a depreciation deduction On 1 July 2010, Anton pays $15,000 for a new deluxe oven for his rental property. He chooses to use PCM of depreciation (rate 10Â€perÂ€cent). (If Anton had chosen DVM, the rate would have been 20Â€perÂ€cent (twice 10Â€perÂ€cent).) The amount Anton can claim each year under both methods is shown here:

Deluxe oven Decline in value (2011) Adjusted value Decline in value (2012) Adjusted value Decline in value (2013) Adjusted value

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PCM (10%)

DVM (20%)

$15,000

$15,000

$1,500

$3,000

$13,500

$12,000

$1,500

$2,400

$12,000

$9,600

$1,500

$1,920

$10,500

$7,680

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Another method of depreciation, called low value pools, is where you can pool (accumulate) all items that cost less than $1,000. For example, if you buy fiveÂ€depreciable items that cost $600 each, the accumulated value under the low value pools method is $3,000Â€($600Â€ìÂ€5). Under this method, the DVM is used and the rate of depreciation is 37.5Â€perÂ€cent a year. If you acquire a particular item part way through the financial year, the rate is 18.75Â€perÂ€cent in the financial year you acquire it. If you want to know more about low value pools, see the Tax Office publication ‘Guide to depreciating assets’. You can get a copy from the Tax Office website (www.ato.gov.au).

Understanding capital works deductions Ordinarily, you can’t claim a tax deduction in respect of the purchase of a building. This rule applies because the outlay is considered to be capital in nature and not tax deductible under the general deduction provisions (refer to ChapterÂ€2). However, you may be able to claim a tax deduction under the capital works provisions, which allow you to write off certain construction costs of a building over a period of time. Under these capital works provisions, you can claim a 2.5Â€perÂ€cent deduction over a 40-year period. This rule applies to certain construction costs of new, income-producing property (for example, rental properties, business premises and factories) constructed after 15Â€SeptemberÂ€1987. The annual rate for property constructed between 22Â€AugustÂ€1984 and 15Â€SeptemberÂ€1987 is 4Â€perÂ€cent rather than 2.5Â€perÂ€cent. This special capital works deduction also applies to any capital improvements or extensions you make to an income-producing property — for example, if you improve your property or add an extra room(s). In the Tax Office publication ‘Rental properties’ the Tax Office provides a number of examples of expenditure that qualify for a special deduction and expenditure that don’t qualify. You can get a copy from the Tax Office website (www.ato.gov.au). Whenever you buy or build a rental property (or business premises), you need to know the building’s construction cost for the purposes of working out the amount of capital works deductions that you can claim each year (see the sidebar ‘CaseÂ€study: Capital works deduction and capital gains tax’).

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Part III: Tax Effective Investments OnÂ€the other hand, if you sell an income-producing property that qualifies for a capital works deduction, the annual deduction not yet claimed can be transferred to the new owner. If you sell an investment property (or business premises) you purchased after 13Â€MayÂ€1997, the accumulated amount of capital works deductions you claim each year must be deducted from the property’s cost base (see ChapterÂ€11). You need to follow this procedure in order to work out the correct amount of capital gain or capital loss you make if you sell it. The federal government is effectively giving you a tax deduction with one hand and taking it away from you with the other!

Case study: Capital works deduction andÂ€capital gains tax Seven years ago SamuelÂ€paysÂ€$600,000 for a new residential property that he intends to lease. He is advised the construction cost of the building for the purposes of claiming a 2.5Â€perÂ€cent capital works deduction is $400,000. Samuel sells the property today and receives $1,000,000. During the period

of time Samuel leases the property he claims a $10,000 capital works deduction each year ($400,000 ì 2.5%). Because Samuel sells the property, he needs to reduce the Â�property’s cost base by $70,000 ($10,000 ìÂ€ 7), for the purposes of working out the amount of net capital gain that’s liable to tax.

Capital proceeds

$1,000,000


$600,000

Less Capital works deduction NET CAPITAL GAIN

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$70,000

$530,000 $470,000

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Repairing what is yours When you own a property, over time you’re likely to incur repairs. But certain repairs you make to your property may not qualify as a tax deduction. This rule applies because if you make an improvement rather than a repair, the Tax Office considers the expenditure to be capital in nature and not tax deductible. The difficult part for the rental property owner is figuring out the difference between an improvement and a repair for income tax purposes. Because this area of tax law can be a bit tricky, you need to get your understanding of this difference right. If you plan to repair an item, the important point is that you merely restore the item to its previous condition and you don’t improve or change the function of the item you’re repairing. For example, if you repair a crack that appears in a wall made of timber with some appropriate filler, the expenditure you incur is clearly a repair. However, if you decide to pull the entire wall down and build a better and stronger brick wall in its place, the expenditure is going to be disallowed because you’re considered to have improved and changed the character of the wall (rather than merely repairing a crack in the existing timber wall). Under these circumstances, the expenditure is considered to be capital in nature. However, you may qualify for a deduction under the capital works provisions (refer to the preceding section). The following list sets out the types of repairs you’re likely to incur that may qualify for a tax deduction: U General property maintenance U Painting your property U Repairing the floor U Repairing the roof U Replacing a broken window The Tax Office has issued two important taxation rulings relating to repairs, TR 97/23 ‘Income tax: deduction for repairs’ and TDÂ€98/19 ‘Income tax: capital gains: may initial repair expenditure incurred after the acquisition of a capital gains tax (CGT) asset be included in the relevant cost base of the asset?’.

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Part III: Tax Effective Investments If you undertake repairs to a rental property that has become vacant, the expenditure you incur may qualify as a tax deductible expense. Further, repairing a property after it’s no longer used to derive income may also qualify as a tax deductible expense. You can’t claim a deduction for initial repairs. These type of repairs are repairs you make to a newly acquired incomeproducing property. For example, if you decide to paint the building before you lease it or you decide to repair existing defects, the Tax Office considers these expenses to be capital in nature and to form part of the cost base of the property. This rule applies because these repairs didn’t arise during your period of ownership. Rather, they arose as a consequence of the previous owner’s period of ownership. However, these costs can be deducted under the capital works provisions (refer to the preceding section).

Going in reverse: Negative gearing A substantial outlay normally associated with investing in real estate is interest on borrowings. Provided the purpose (or use) of the loan is to finance the purchase of an income-producing property or derive assessable income (for example, rental income), your interest payments are normally a tax deductible expense. If the interest (plus other deductible expenses you incur) is more than the rent you receive, you can deduct the loss from your other assessable income such as salary and wages, investment income and business profits (see the sidebar ‘CaseÂ€study: Negative gearing a property’). When you follow this path, you reduce the amount of tax you’re liable to pay on your other assessable income. This tax approach to property investment is called negative gearing. If you negative gear, you effectively use the tax system to help you finance the purchase and service the debt — which isn’t allÂ€bad! If your rental expenditure (for example, interest, rates, insuranceÂ€and repairs) on a negatively geared property is likely to be substantial, you can request the Tax Office to vary the rate of taxÂ€payable on your salary and wages. To take this route, you need to complete the form ‘PAYG withholding variation application 2011 (NATÂ€2036)’. Go to the Tax Office website (www.ato.gov.au) to get a copy of this form.

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Case study: Negative gearing a property Lance borrows $300,000 to buy an income-producing property that he intends to lease. At the end of the financial year, he calculates that he paid $25,000 interest on his loan and he received $16,000 rent. His other deductible expenses amount to $5,000. In the same year, Lance also derives a $60,000 salary, and his marginal tax rate plus the Medicare levy is 31.5Â€perÂ€cent. Lance’s taxable income is calculated as follows: Rental income

$16,000

Less Interest on loan Other deductible expenses

$25,000 $5,000

Net loss from rent

$30,000 $14,000

Because Lance has incurred a $14,000 net loss on his rental property, he can deduct this amount from the salary he earned: Salary and wages

$60,000

Less Net loss from rent

$14,000

TAXABLE INCOME

$46,000

As his marginal tax rate plus the Medicare levy is 31.5 per cent, the tax payable on his salary is reduced by $4,410 ($14,000 ì 31.5%).

Calculating non-deductible expenditure You can’t claim expenditure such as interest, rates and land taxes, insurance and repairs in respect of non-incomeproducing property (such as a holiday house that you use for your personal use and enjoyment). However, under the CGT provisions, you can use these costs to reduce a capital gain. If you borrow money and the purpose of the loan isn’t to derive assessable income, you can’t claim a tax deduction for interest and other expenses you incur. This situation may be the case if you buy a block of land, your main residence or a holiday

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Part III: Tax Effective Investments house. Under the CGT provisions, if you acquire a non-incomeproducing property after 20Â€AugustÂ€1991, you can add non-deductible expenditure such as interest, rates and land taxes, insurance and repairs to the property’s cost base. These costs are referred to as non-deductible holding costs and form part of the third element of the cost base. (For more details see ChapterÂ€11.) So, you can take these expenses into account if you make a capital gain on disposal. To ensure you follow this rule correctly, you need to keep proper records of all the expenditure you incur. The bad news is you can’t take these types of expenses into account if you happen to make a capital loss. The sidebar ‘Case study: Non-deductible holding costs — real estate’ explains how this principleÂ€works.

Case study: Non-deductible holding costs — realÂ€estate Ten years ago Roger pays $250,000 for a house that he intends to use for his personal use and enjoyment. During the time he owns the house, he pays $35,000 interest on a loan he takes out to buy the property, and $25,000 for rates and land taxes, insurance and repairs. Because these expenses aren’t tax deductible, he can add them to the cost base. Roger sells the property today for $450,000. The net capital gain Roger makes on disposal is calculated as follows: Capital proceeds on disposal

$450,000


$250,000

Non-deductible holding costs Interest

$35,000

Other expenses

$25,000

NET CAPITAL GAIN

$310,000 $140,000

If the sale price was less than $250,000 Roger couldn’t take the $60,000 nondeductible holding costs into account, as you can’t use them to create or increase a capital loss. On the other hand, if the sale price was $300,000, RogerÂ€could take $50,000 of his non-deductible holding costs into account.

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Paying 10 per cent: Goods and services tax The goods and services tax (GST) provisions commenced in Australia on 1 July 2000. GST is a broad-based tax of 10Â€perÂ€cent on most goods and services that are sold or consumed in Australia. Generally, you’re liable to pay GST if you buy new residential property from a registered entity such as a property developer (or a property that has been substantially renovated). Under the GST provisions, if you lease a residential property used mainly for residential accommodation, the transaction is classified as an input taxed supply. This term means you can’t charge GST on the rent you collect from your tenant. You also can’t claim a GST credit on GST you incur on your rental expenditure (see ChapterÂ€15). The following are liable to GST: U Advertising, repairs, agent commission and insurance U Alterations and renovations you make to your property U New property where the vendor is a registered entity U Property that is being substantially renovated U Rent on commercial property U Rent on short-term accommodation U Sale of commercial rental premises such as a hotel or motel The following aren’t liable to GST: U Rent from residential property used predominantly for residential accommodation U Water, sewerage and drainage If you lease a residential property used predominantly for residential accommodation, you don’t need to get an ABN and quote it to your tenant. Appendix C sets out a number of leading tax cases in respect of income-producing properties. This online reference (www. dummies.com/go/taxforaustraliansfd) is a useful tool if you want to know whether a specific expense is tax deductible or you’re studying taxÂ€law.

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Renovating properties as a business If you enter into a profit-making activity of renovating property and selling it at a later date, the Tax Office may treat your activities as a business. If you are running these activities as a business, you may need to register for GST and charge GST on your sales (see ChapterÂ€ 15). Further, you may be liable to pay tax on the entire profit you make on sale. On the other hand, if you’re not running a business, the Tax Office taxes the profit under the CGT provisions. Under these provisions, only 50Â€ perÂ€ cent of the capital gain is liable to tax if you sell the property after 12Â€months (see ChapterÂ€11). Here are the tests to check whether you’re running a business of renovating properties: U Are you running your activities in a business-like manner?

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U Are you undertaking these activities for the purposes of making a profit? U Are your activities similar to people who run a business of renovating properties? U How much money are you outlaying? U How often do you undertake these activities? U Is the size and scale of your activities significant? Because these issues are very complex, you may wish to seek professional advice from a tax consultant. The Tax Office has issued the fact sheet ‘Are you in the business of renovating properties?’ that deals with this matter.

11/8/10 1:44 PM

Chapter 11

Catching Up on CapitalÂ€Gains Tax In This Chapter `Èxamining three types of CGT assets `Ùnderstanding how to calculate a capital gain

Y

ou’ve just found out that the ‘worthless’ old painting youÂ€inherited from a distant relative is really a RenoirÂ€—Â€and you can’t call Christie’s or Sotheby’s soon enough.Â€As soonÂ€as the auction gavel falls, you’re going to beÂ€setÂ€for life. Right? Well, probably, but unless you want to spend some time in theÂ€tax court, you’re best to make sure the Tax Office gets its share. Why? Because if you sell things like shares, real estate, works of art, or other assets that you acquired after 19Â€SeptemberÂ€1985, you may be liable to pay capital gains tax (CGT), on any capital gains you make on sale (this date is when the CGT provisions started). Just to complicate things, the federal government tweaked the rules again inÂ€1999. But don’t worry: In this chapter, I explain how to calculate a capital gain or capital loss and how capital gains are taxed under the old rules and new rules.

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How capital gains tax began The idea of levying a tax on capital gains first arose in the early 1970s under the Whitlam Labor Government. But the issue was quickly knocked on the head and put back into its box stamped ‘never to be opened again’. During the 1984 federal election cam‑ paign, rumours started to circulate that the incumbent government was planning to impose a tax on capital gains. At that time the rumours were vigorously refuted. However, shortly

after the federal government was re‑elected, legislation to tax capital gains was introduced. When this decision was made, an outcry of foul play resounded around the halls of Parliament House and among com‑ munity groups. The government’s response was pure politics at its best: ‘We didn’t mislead you. We’ve merely changed the policy!’ As they say in the classics, the rest is history.

Looking at the Rules: CGT Assets The CGT provisions are all about taxing gains you make on disposal of CGT assets and the rules to work out how much tax you have to pay. Perhaps the worst part about making a capital gain is giving some of it to the Tax Office. I’m going to stick out my neck here and say of all the taxes you have to deal with, CGT is probably the easiest to understand. Why? Because you need to examine just three conditions to check whether you have to pay tax. When you do this exercise, keep in mind that if any of these conditions aren’t present, generally, you don’t have a CGT issue to worry about. U A CGT asset must exist. U The CGT asset must have been acquired after 19Â€September 1985. To fulfil this requirement you need to keep records to verify the date you acquired the asset. According to thisÂ€condition, if you own assets that were acquired before this date no CGT liability arises. This rule means that if you sell them today you don’t have to pay CGT on any gain youÂ€make.

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Chapter 11: Catching Up on Capital Gains Tax

119

U A CGT event and, more particularly, a disposal of a CGT asset must have occurred. A disposal normally occurs when there’s a change in ownership, such as when you sell the asset. The Tax Act provides a comprehensive list of CGT events that can lead to a disposal of a CGT asset, suchÂ€as: • Beneficiary becoming entitled to a trust asset • Creating contractual or other rights • Granting a lease • Loss or destruction of a CGT asset (for example, your house burns down) • Selling a CGT asset A CGT event normally arises at the time of the making of the contract to sell the asset rather than when you receive the money for the sale. This rule means that if the contract is signed during one financial year (for example, in June) and you receive the money twoÂ€months later in the following financial year (in August), you’re liable to pay tax in the financial year that you signed the contract. A CGT asset is ‘any kind of property; or a legal or equitable right that is not property’. The Tax Act definition is so broad it can range from your most-prized valuables such as real estate, shares and your Ferrari, right down to your undies andÂ€shoelaces. Three categories of CGT assets are liable to tax: U Collectables U Personal use assets U Other assets The good news is that some of these CGT assets are exempt from tax. Figure 11-1 illustrates the various components that make up the CGT provisions and how they interact with each other.

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CGT assets

Collectables

Personal use assets

$500 or less exempt

$10,000 or less exempt

Pre 21 September 1999

Other CGT assets

Taxable CGT assets

Exempt CGT assets • Main residence • Cars

Post 21 September 1999

Discount method

Indexation method

Discount capital gain (Held more than 12 months)

50% of capital gain taxable



Non-discount capital gain (Held less than 12 months) 100% of capital gain taxable

Figure 11-1: Understanding the dynamics of CGT at a glance.

Taxing your stamp collection: Collectables The Tax Act defines collectables as ‘(a) artwork, jewellery, an antique, or a coin or medallion; (b) a rare folio, a manuscript or book; or (c) a postage stamp or first day cover; that is used or kept mainly for your or your associate’s personal use and enjoyment’. A capital gain or loss you make on a collectable is exempt from tax if you originally acquire it for $500 or less. So, if you like collecting postage stamps that cost more than $500 you may be liable to pay tax on any gain you make on their disposal. As a general rule, if you sell individual items that are normally sold as part of a set, the individual items are exempt from tax only if the set was acquired originally for $500 or less (excluding any GST paid on acquisition).

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You can offset a capital loss on disposal of a collectable only against a capital gain you make on disposal of another collectable. Further, you can’t include the third element of the cost base (that is, non-deductible holding costs that don’t qualify for a tax deduction) of a collectable in the collectable’s cost base. (See the section ‘Adding up the costs: Cost base’ later in this chapter.)

Taxing your underwear: Personal useÂ€assets Personal use assets are assets such as household items, furniture, electrical goods, boats and the clothes you wear, thatÂ€you use for your personal use and enjoyment. So, basically, all your personal belongings, ranging from your cooking utensils and every button on your shirt, right down to your bras and underwear, are potentially liable to tax under the CGTÂ€provisions. To avoid the absurdity of having to account for every item you own, the Tax Act conveniently deems items that fall under the definition of personal use assets to have a cost base of $10,000. For example, if you pay $20 for a dress, under the CGT provisions the cost base is $10,000 rather than $20. If you make a capital gain or loss on a personal use asset acquired for $10,000 or less, you’re not liable to tax on it. This approach eliminates the need for you to account for these items and effectively takes them out of the CGT provisions. And, it becomes an issue only if you sell your personal use assets and receive more than $10,000 for each item. In the unlikely event of you actually getting this amount, you’re liable to pay CGT only on any excess over $10,000. So, every time you put your clothes on, you should feel like a multi-millionaire, given that each item is worth $10,000 under the CGT provisions. Who says tax is boring!

Taxing all your treasures: Your otherÂ€assets Assets that don’t fall within the definition of collectables and personal use assets are liable to CGT unless they’re specifically exempt. These assets can include leases, goodwill, rights and options, shares and real estate. You need to keep proper records of these types of CGT assets as they may be liable toÂ€CGT.

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122

Part III: Tax Effective Investments Fortunately, a number of CGT assets are exempt from CGT. The most notable are U Cars and motorcycles U Collectables that cost $500 or less U Compensation or damages for personal injury (such as loss of an eye or limb) U Marriage breakdown settlements. U Personal use assets that cost $10,000 or less U Valour decorations (for example, bravery medal awarded to the original holder) U Winnings from gambling, a game or a competition with prizes U Your main residence One major CGT asset on the exemption list is your main residence (the place where you reside). From a tax planning point of view, you’re best to live in good locations where property values are continually rising, because you pay no tax on any gain you make on disposal. (For more details, refer to ChapterÂ€6.)

Leaving the land down under If you decide you no longer want to live in Australia, a major issue to consider before you leave is how the Tax Office is likely to tax your CGT assets under the CGT provisions. This issue is important to consider because after you pack your bags and go, you’re deemed to have disposed of your CGT asset(s) at their market value. This rule means you can be liable to pay CGT on any subsequent capital gain you make (thanks for the memories!).

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If you find yourself in this predicament, I’ve got some good news: You can delay paying CGT by electing CGT assets you own to be taxable Australian property (see AppendixÂ€B). If you approach labelling your assets in this way, you can delay paying taxÂ€ until they’re eventually sold (at non-resident rates) or, if unsold, until you decide to become an Australian resident again.

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Cars are also on the list of exempt assets. If you happen to own a vintage car or a Ferrari and you make a $1,000,000 capital gain on disposal, you’re not liable to pay tax on the gain. So why is the federal government so generous when it comes to cars, you may ask? The answer is quite clear. As a general rule, cars depreciate in value, which means everyone who owns a car can potentially claim a capital loss! If the odd car is sold at a profit, the Tax Office isn’t going to be overly concerned. Under the CGT small business concessions provisions, certain gains you make on disposal of active assets (such as business premises) that you use in running your business are exempt from tax. IÂ€discuss this issue in detail in ChapterÂ€17. If you own land that you acquired before 20Â€SeptemberÂ€1985, and you construct a dwelling after this date, under the CGT provisions you’re considered to own two separate assets. The land is treated as a pre-CGT asset and exempt from CGT, while the dwelling is a post-CGT asset and liable to CGT on disposal. This rule applies, too, if you make certain capital improvements to a pre-CGT property, and is triggered only if the cost of the improvement in a particular year exceeds a threshold of $126,619 for the 2010–11 financial year. Under these circumstances, the capital improvements you make after 19Â€SeptemberÂ€1985 are treated as post-CGT assets. For a discussion on capital improvements to a dwelling, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘Separate assets for CGT purposes’, particularly the section about improvement thresholds.

Calculating a Capital Gain Under the CGT provisions you’re considered to have made a capital gain if the capital proceeds (sale price) from the disposal of a CGT asset are more than the CGT asset’s cost base (purchase price plus costs you incur). The way you calculate a capital gain depends on whether you acquired the CGT asset before or after 21 September 1999, and whether you held the CGT asset for more or less than 12Â€months (refer to FigureÂ€11-1).

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How to calculate a net capital gain You use five steps to calculate whether a net capital gain is liable to tax. The following example (with values I’ve inserted) explains how to do this calculation. (Step 1) Total capital gains you made during financial year

$50,000

Less (Step 2) Total capital losses you made during financial year

$15,000

Equals Notional capital gain

$35,000

Less (Step 3) Prior year capital losses you may have made Equals

$5,000 $30,000

Less (Step 4) 50% discount (if applicable)

$15,000 $15,000

Less (Step 5) Small business concession (if applicable) NET CAPITAL GAIN

Nil $15,000

To determine the tax implications for a capital gain:

1. Figure out how much you made on the deal.

Think this is just cash? Think again, then check out ‘Rolling in dough: Capital proceeds’ later in this chapter.

2. Calculate the cost base of the CGT asset you sold.

This calculation involves the purchase price and any allowable expenses. (See the section ‘Adding up the costs: Cost base’ later in this chapter.)

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125

Subtracting the cost base (the number from Step 2) from how much you made on the deal (Step 1) gives you something called the notional capital gain. Think of it simply as a subtotal.

3. Subtract any losses on other CGT assets.

You can use the losses on one CGT asset to offset a gain from the disposal of another CGT asset, or a cluster of assets. (The section ‘Crying over spilt milk: Capital losses’, later in this chapter, gives you more detail.)

4. Subtract any discounts you may be due — because, when you purchased the CGT asset makes a difference.

This situation normally arises if you owned a CGT asset for more than 12Â€months.

5. Subtract any small business concessions for which you’re eligible.

See ChapterÂ€17 for more on small business concessions. The sum of this grand exercise is called the net capital gain. The sidebar ‘How to calculate a net capital gain’ shows an example of how this all works. The following sections drill down into some of the specifics about each of the categories.

Rolling in dough: Capital proceeds Capital proceeds is a term associated with the disposal of a CGT asset. Capital proceeds can include money you receive or are entitled to receive from a CGT event and the market value of any property you receive or are entitled to receive from a CGT event. For example, when you sell a CGT asset the capital proceeds canÂ€be U A cash payment (which is normally the case) U A cash payment plus property such as a car or yacht U Property A CGT event is considered to have arisen when you make the contract, not when you receive the capital proceeds.

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Adding up the costs: Cost base The cost base of a CGT asset is made up of a combination of various costs associated with buying, holding and selling a CGT asset. Under the CGT provisions, the cost base of a CGT asset is made up of five key elements: U First element: Money you pay to buy a CGT asset, such as the purchase price. U Second element: Incidental costs associated with acquiring (buying) a CGT asset plus costs associated with the disposal (selling) of a CGT asset. Incidental costs you’re likely to incur when acquiring a CGT asset include stamp duty, brokerage costs, and legal and accounting costs. Incidental costs you’re likely to incur when disposing of a CGT asset include agent commissions, brokerage and advertising costs, and legal and accounting costs. U Third element: Non-deductible holding costs are costs associated with owning a CGT asset such as interest, rates, insurance and repairs that don’t qualify for a tax deduction. For more details see ChapterÂ€10.

The non-deductible holding costs associated with ownership — often called the ‘third element of the cost base’ because they’re listed third in the tax codes — can’t be included in a collectable’s cost base for tax purposes.

U Fourth element: Capital costs may be associated with increasing the value of a CGT asset. For example, this situation may arise if you add an extra room or rooms toÂ€anÂ€existing property. U Fifth element: Capital costs to preserve or defend title or right to a CGT asset may arise. This situation may happen if someone illegally builds a dwelling on land you own and you take legal action to stop this from happening. You need to keep an accurate record to calculate the various elements that make up the cost base. If you don’t retain any records, trying to work out the capital gain or capital loss you may have made on disposal can prove costly. When you sell an income-producing property, any tax deductible expenses that you incur can’t be added to the cost base.

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Going modern: After 21 September 1999 If you’re fortunate enough to make a capital gain on CGT assets you acquired after 21Â€SeptemberÂ€1999, the good news is you pay tax only on 50Â€perÂ€cent of the gain if you owned the asset for more than 12Â€months. This gain is called a discount capital gain. The other 50Â€perÂ€cent is totally exempt. However, the rules are different if you buy and sell a CGT asset within 12Â€months. Under these circumstances, the entire gain — called a non-discount capital gain — is liable to tax. So, if you’re holding an asset that continues to increase in value, you’re best to keep the asset for at least 12Â€months. You can discount a capital gain by 50Â€perÂ€cent only after you deduct from your capital gains any current year losses and prior year losses that you may incur.

Case study: Calculating a net capitalÂ€gain Six years ago, Hans pays $250,000 for a property he intends to lease and use to derive rental income. The incidental costs associated with acquiring the property are $8,000 stamp duty and $500 legal costs. Hans sells the property today for $400,000. The incidental costs associated with selling it are $10,000 agent’s commission and $500 legal costs. ThreeÂ€years prior to selling the property Hans adds an extra room at a cost of $25,000. Hans also incurs the following expenses, which are tax deductible: Interest $15,000

Insurance $6,000

Rates and land taxes $10,000

Repairs $4,000.

Two years ago, Hans makes a $10,000 capital loss on sale of shares that he hasn’t yet claimed. (continued)

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(continued)

The net capital gain Hans makes on disposal is calculated as follows: Capital proceeds (sale price)

$400,000

Less Cost base First element Purchase price

$250,000

Second element Stamp duty

$8,000

Legal costs (buying)

$500

Agent’s commission

$10,000

Legal costs (selling)

$500

Third element Can’t be used (see Note 1)

Nil

Fourth element Extension

25,000

Notional capital gain

$294,000 $106,000

Less Prior year capital losses

$10,000

Less

$96,000

50Â€perÂ€cent discount (see Note 2â•›)

$48,000

NET CAPITAL GAIN

$48,000

Note 1: Because Hans is selling an income-producing property, the tax deductible expenses he incurs can’t be added to the cost base. Note 2: Because Hans holds the property for more than 12Â€months, just 50Â€perÂ€cent of the gain is liable to tax ($48,000). The balance is specifically exempt.

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129

Getting a history lesson: Before 21Â€September 1999 Before 21Â€SeptemberÂ€1999, the rules of calculating a capital gain were different to the way you do this calculation today. If you own assets you purchased before this date, you can choose between two ways to calculate the capital gain: the discount capital gain method and the indexed cost base method. You have the option to select the method that results in you paying the least amount of tax. The discount capital gain method is normally the preferred option.

Case study: Using the discount method On 13 January 1991, Kevin pays $25,000 for 1,000 XYZ Ltd shares, and pays $100 brokerage fees and stamp duty to acquire them. Kevin sells the shares today for $37,300, and pays $200 brokerage fees and GST to sell them. Under the discount capital gain method, Kevin’s net capital gain is calculated as follows: Capital proceeds (sale price)

$37,300

Less Cost base First element Purchase price

$25,000

Second element Brokerage & stamp duty (buy)

$100


$200

NET CAPITAL GAIN

$25,300 $12,000

Because Kevin purchased the shares before 21Â€ SeptemberÂ€ 1999 and makes a capital gain on disposal, just 50Â€ perÂ€ cent of the capital gain (namely $6,000) is liable to tax. The balance is exempt.

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Discount capital gain method The discount capital gain method, normally the preferred option of calculating a capital gain, is identical to the way you calculate a capital gain for a CGT asset purchased after 21Â€SeptemberÂ€1999: Because you held the CGT asset for more than 12Â€months, just 50Â€perÂ€cent of the net capital gain you make on disposal (after you recoup capital losses) is liable toÂ€tax.

Indexed cost base method Before the federal government changed the rules in SeptemberÂ€1999, you were allowed to adjust the cost base of a CGT asset for inflation so that you didn’t have to pay tax on gains that arose simply because of inflation. However, you had to be a mathematical genius to work it out. As the rules were changed on 21Â€SeptemberÂ€1999, the indexed cost base method has limited application, because you can only adjust for inflation between the date you acquired the asset and 30Â€SeptemberÂ€1999Â€— phew what a relief! Under the indexed cost base method, you have to index the various elements that make up the cost base for inflation. However, you can’t index the third element (see the earlier section ‘Adding up the costs: Cost base’) of the cost base, the non-deductible holding costs associated with ownership. To calculate a capital gain under the indexed cost base method you need to use the consumer price index (CPI — the index used to calculate Australia’s annual rate of inflation) to adjust the various elements of the cost base. TableÂ€11-1 lists theÂ€CPI. To use the indexed cost base method, you need to adjust the first, second, fourth and fifth elements of the cost base for the period of time between the date you acquired the asset and 30Â€September 1999 (see the sidebar ‘Case study: Using the indexation method’).

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Table 11-1

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131

Consumer Price Index Figures

Year

31 March

30 June

30 September

31 December

1985

0

0

71.3

72.7

1986

74.4

75.6

77.6

79.8

1987

81.4

82.6

84.0

85.5

1988

87.0

88.5

90.2

92.0

1989

92.9

95.2

97.4

99.2

1990

100.9

102.5

103.3

106.0

1991

105.8

106.0

106.6

107.6

1992

107.6

107.3

107.4

107.9

1993

108.9

109.3

109.8

110.0

1994

110.4

111.2

111.9

112.8

1995

114.7

116.2

117.6

118.5

1996

119.0

119.8

120.1

120.3

1997

120.5

120.2

119.7

120.0

1998

120.3

121.0

121.3

121.9

1999

121.8

122.3

123.4

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Case study: Using the indexation method On 13 January 1991, Kevin pays $25,000 for 1,000 XYZ Ltd shares, and pays $100 brokerage fees and stamp duty to acquire them. Kevin sells the shares today for $37,300, and pays $200 brokerage fees and GST to sell them. Under the indexed cost base method, because Kevin buys the shares before 21Â€ SeptemberÂ€ 1999, he needs to index each element of the cost base for inflation (except the $200 brokerage fees and GST he incurs after 21Â€ SeptemberÂ€ 1999). The following formula is used to make this adjustment: CPI at 30 September 1999

(123.4)

(Note 1)

CPI at date of purchase

(105.8)

(Note 2â†œ)

Note 1: On 30 September 1999, the CPI was 123.4 (refer to TableÂ€11-1). Note 2: Because Kevin purchases his shares and incurs all the costs inÂ€theÂ€CPI quarter ending 31Â€March 1991, the CPI figure is 105.8 (refer to TableÂ€11-1). Capital proceeds

$37,300

Less Indexed cost base First element Purchase price ($25,000 ì 123.4/105.8)

$29,175

Brokerage & stamp duty (buy) ($100 ì 123.4/105.8)

$117


$200

NET CAPITAL GAIN

$29,492 $7,808

Note: When you apply the indexation formula, you must calculate to three decimal points; for example, 123.4/105.8Â€=Â€1.167. If Kevin uses this method, he needs to include $7,808 as part of his assessable income. In this case, Kevin would be better off using the discount method because he’s liable to pay tax on just $6,000 rather than $7,808 under the indexed cost base method (refer to the case study ‘Using the discount method’).

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Crying over spilt milk: Capital losses No-one likes losing money, especially yours truly. Unfortunately, when you own CGT assets like shares, real estate and collectables you run the risk of incurring a loss if they fall inÂ€value. Under the CGT provisions, you can’t deduct a capital loss from assessable income that you derive from other sources such as salary and wages, investment income and business income. You can deduct a capital loss only from a capital gain. If you don’t make a capital gain in the financial year you make a capital loss, under these circumstances you can deduct it from capital gains you make in the future. If you find yourself in this position, make sure you keep an accurate record of all your capital losses. By the way, you can deduct a capital loss that you make on one class of investment (for example, real estate) from a capital gain you make on disposal of another class of investment (such as shares). One exception applies to this rule. You can deduct a capital loss on a collectable only from a capital gain that you make on another collectable. (Refer to the section ‘Taxing your stamp collection: Collectables’ earlier in the chapter for more information.) If you make a capital loss on CGT assets you acquire before 21Â€SeptemberÂ€1999, you can’t adjust the cost base for inflation. When you sell a CGT asset and you make a capital loss, you need to use the reduced cost base rather than the cost base. Apart from a minor technical adjustment, as a general rule the two are identical.

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Case study: Calculating a capital loss Six years ago, Yelena buys a residential property. She pays $350,000 plus $12,000 stamp duty and legal fees to acquire it. Yelena sells the property today and receives $330,000. She pays $10,000 sale costs (such as agent’s commission and legal fees) to sell the property. The capital loss she makes on disposal is calculated as follows: Capital proceeds

$330,000

Less Reduced cost base Purchase price

$350,000

Purchase costs

$12,000

Sale costs

$10,000

CAPITAL LOSS

$372,000 $42,000

Because the capital proceeds on sale ($330,000) is below the reduced cost base ($372,000), Yelena makes a $42,000 capital loss. She can deduct this capital loss from a current or a future capital gain if she has no current capital gains.

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Part IV

Running a Business Glenn Lumsden

‘Ahh .â•›â†œ.â•›â†œ. nothing like doing your BAS to take the gloss off a really good quarter.’

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T

In this part .â†œæ¸€.â•›â†œ.

he greatest of all the feelings you’re likely to experience running your own business is that you’re the boss of an enterprise (‘The buck stops here!’). I’m a great admirer of people who are prepared to back their judgement, bite the bullet and have a go. To see something grow from nothing more than an idea into a large enterprise is something that can never be taken away from you. Although the potential rewards you stand to gain may be great, you also need to weigh up the risks and all the legal obligations and responsibilities that come with running a business. In this part of the book, I consider the tax issues associated with running a business and what you need to do to comply with the Tax Act. Emphasis is on starting and structuring a business, claiming tax deductions and dealing with the goods and services tax, fringe benefits tax and capital gains tax.

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Chapter 12

Structuring Your Business for Maximum Gain In This Chapter ``Structuring your business affairs ``Setting up as a sole trader ``Running a partnership ``Setting up a company ``Forming a trust

Y

ou need to be aware of a number of commercial and taxation issues that are associated with setting up a business in Australia — before you hang out your sign. In this chapter, I cover the major taxation issues that come into play when you set up a business, particularly the administration concerns that you need to attend to in order to comply with Australian income tax law. I guide you through the various steps that are associated with setting up your business and advise where you can get additional help to fulfil all your legal obligations.

Choosing a Business Entity Before you can start up a business, you need to give serious consideration to how you can structure your business affairs.

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138

Part IV: Running a Business You can legally structure your business affairs in one of four ways. You can trade as a 55 Sole trader 55 Company 55 Partnership 55 Trust The business structure you select depends on your personal circumstances and/or preferences. You need to comply with many legal issues when setting up a business. Keep in mind when weighing up your options that you can set up a structure involving a mix of business entities (for example, a partnership of discretionary trusts). However, you need to consider the benefits and costs of developing such a structure. If you make a mistake when setting up and deciding on the structure of your business, trying to correct it can be very costly and time consuming. Make sure you fully understand the consequences of your decisions. The key issues you need to consider when assessing an appropriate business structure are 55 The extent to which you want to maintain legal control in respect of your business and financial affairs 55 The likely risks associated with operating under aÂ€particular business structure 55 The amount of capital you need to contribute to operate aÂ€business 55 The cost associated with setting up and running a business structure 55 The amount of tax you’re liable to pay under the different business structures 55 The amount of tax you’re liable to pay if you make a capital gain under the different business structures 55 Your capacity to maximise tax deductible expenses you incur 55 Your capacity to distribute/split income and losses you derive between family members

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Chapter 12: Structuring Your Business for Maximum Gain

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55 The likely division of wealth from a subsequent marriage breakdown 55 Estate planning considerations 55 Protection of your capital from potential creditors if you’re sued or if your business venture fails The following sections set out the key issues that you need to examine to determine which of the four legal business structures suits you. You need to look at the various benefits that each structure can offer you and the potential limitations of each. Setting up a business is a complex issue and you’re best to seek advice from a qualified accountant, tax agent and/or solicitor before you sign on the dotted line.

Becoming a Sole Trader: Going ItÂ€Alone If you decide to carry on business as a sole trader, you’re in total control of all your assets and business decisions. This level of control can be good and bad. The good bit is you stand to retain all the income you derive and any capital gain you make on the sale of your assets. The bad bit is that you’re on your own, which means that every time you need help you have to open your wallet or purse and pay for it solo. Being a sole trader means you’re personally liable for any debts that your business incurs and your personal assets can be used to cover these debts. You need to know what you’re doing at the outset — that you have the appropriate skills and experience to run a successful business. Otherwise, you’re helping to feed a lot of starving accountants, solicitors and tax agents, who are all eager to get your business and charge you lots of money. As a sole trader you’re required to use your individual TFN and lodge an annual income tax return disclosing the taxable income you derive.

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Part IV: Running a Business

Inhaling the good news You may find that operating as a sole trader has a number of significant and appealing benefits, as follows: 55 The business is easy to establish and operate. 55 Fewer legal restraints exist. 55 You can calculate your income using the cash or receipts basis (refer to ChapterÂ€13). 55 Your financial affairs aren’t available for public scrutiny, as is the case with a company structure (see the section ‘Creating a Company: The More the Merrier’ later in this chapter). 55 You can nominate beneficiaries in your will. Some of the tax issues involved in operating as a sole trader are as follows: 55 You don’t have to register for GST if your GST turnover is $75,000 or less. 55 You can own a main residence that is exempt under the CGT provisions (which isn’t the case in a company or trust structure). 55 You benefit from the 50Â€perÂ€cent discount on disposal of CGT assets owned for more than 12 months. (This discount isn’t available in a company structure.) 55 You benefit under the CGT small business concessions (seeÂ€ChapterÂ€17 for more details on this issue). 55 You can gain immediate access to all the losses that the business may incur to be offset against other income such as investment income. (This offset isn’t the case in a company or trust structure.) 55 You can claim a tax deduction when you make a concessional contribution on your behalf to a complying superannuation fund.

Exhaling the bad news Although the benefits from operating as a sole trader are attractive, you also need to take into account the various limitations and risks that you’re taking.

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Chapter 12: Structuring Your Business for Maximum Gain On a commercial basis, operating as a sole trader may not appeal to you because 55 You risk being sued and if you get into financial difficulty, your creditors could have a legal claim over all your personal assets. 55 Your ability to grow the business is limited to the amount of capital you can raise and your capacity to service the debt.

Some of the scary taxation issues involved in operating as a sole trader are as follows: 55 You can’t split business profits (or losses) and capital gains (or losses) made with family members. 55 You’re personally liable to pay tax on all the income and capital gains derived.

Forming a Partnership: Sharing the Workload Remember the old saying two heads are better than one? No truer words have been spoken when it comes to running a business. One of the great things about running a partnership is your capacity to spread the workload between the business partners. You can have no partnership existing under commercial law but one existing under Australian income tax law. Here’s why: 55 Under commercial law, a partnership is a business with two or more people running that business, each aiming to make a profit. 55 Under Australian income tax law, you need only to be ‘in receipt of ordinary or statutory income jointly’ for a partnership to exist. Further, a profit motive isn’t essential, and no limits exist restricting the number of people who can be partners for income tax purposes. A partnership isn’t treated as a separate legal entity, as is the case with a company, but you need to apply for a partnership TFN (refer to ChapterÂ€5). A partnership isn’t liable to pay tax on any net partnership income it derives. The partnership net

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Part IV: Running a Business income (or loss) must be distributed in accordance with the partnership agreement to the individual partners and each partner is liable to pay tax on the amount distributed. If you derive investment income jointly, such as interest from aÂ€joint bank account, dividends from shares that you own jointlyÂ€or rent from a jointly owned property, you usually don’t have to lodge a partnership return. However, you’re required to disclose your share of the investment income in your individual tax return. Each partner is personally responsible for any (and potentially all) debts that the partnership incurs. If you plan to set up a partnership, you need to consult a solicitor to help you enter into a formal partnership agreement.

Key partnership taxation principles you need to know Keep the following tax principles in mind if you’re thinking of setting up a partnership. 55 If a new partner is introduced or an existing partner retires, the old partnership ceases and a new partnership comes into existence. 55 Because a partnership isn’t a separate legal entity for tax purposes, a partner can’t be an employee of the partnership. The tax implication is that a partnership can’t claim a tax deduction in respect of any superannuation contributions the partnership makes on behalf of the partners. 55 Partners aren’t paid a salary, but are entitled to a distribution of the partnership net income (or loss). 55 Partnership assets are proportionally owned by each partner in accordance with their respective partnership interests. Any capital gains or losses made on the disposal of these assets are proportionally derived by each partner for disclosure in their individual tax returns.

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See the following Tax Office Taxation Rulings for technical help: 55 ‘IT 2316 Income tax: Distribution of partnership profits andÂ€losses’ 55 ‘TR 93/32 Income tax: rental property — division of net income or loss between co-owners’ 55 ‘TR 94/8 Income tax: whether business is carried on in partnership (including ‘husband and wife’ partnerships)’ 55 ‘IT 2540 Income tax: capital gains — application to disposals of partnership assets and partnership interests’

Sharing the good stuff Running a business in partnership has a number of unique features that may appeal to you. The main ones are summarised here. On a commercial basis, operating as a partnership may suit you because 55 A partnership is easy to set up, operate and dissolve. 55 Partnership details and accounts aren’t available for public scrutiny, as is the case with a company. Some of the taxation issues involved in operating as a partnership are 55 A partnership allows you to split income and expenses among family members in proportion to their legal entitlement. (This option isn’t the case for sole tradersÂ€— refer to the section ‘Becoming a Sole Trader: Going It Alone’ earlier in this chapter.) 55 You can distribute net partnership losses to individual partners to be offset against other income they may derive, such as investment income. (This option isn’t the case in a company or trust structure.) 55 A partnership allows you to access capital gains tax exemptions. (This option isn’t the case in a company structure.)

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Taking on board the bad stuff You may find certain features associated with running a business as partners not so appealing, because 55 Individual partners may need to give personal guarantees in respect to partnership loans. 55 Each partner is responsible for the actions and decisions of the other partner(s). Conducting your commercial activities in a business-like manner is most important. Some of the potentially less-than-appealing taxation issues involved in operating as a partnership are 55 A partnership can’t elect how partnership net income or losses should be distributed to partners. For example, you can’t distribute income only to partners who pay no tax or distribute partnership losses to those partners who stand to gain the most from such a distribution. 55 A partnership can’t retain profits within the partnership structure, as is the case with a company. Partnership net profits must be distributed to the partners. 55 A partnership can’t carry forward partnership losses; partnership losses must be distributed to the partners. 55 Superannuation contributions made on behalf of the partners can’t be taken into account when calculating allowable deductions.

Creating a Company: The More theÂ€Merrier A company can be classified as a public company (such as those companies listed on the Australian Securities Exchange) or a private company. If you plan to set up a company, you’re most likely to set up a private company. When a business is set up as a company, shares are issued in this company. These shareholders are the owners of the company. A company is a separate legal entity and, so, needs to have a TFN (see ChapterÂ€13), an Australian Business Number (ABN, see ChapterÂ€13) and a public officer. A company can carry on aÂ€business in its own right, own assets, can sue someone and

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can also be sued. At the end of the financial year a company must lodge a company tax return disclosing the taxable income, and self-assess the amount of tax payable. A company is liable toÂ€pay income tax at a flat rate of 30Â€perÂ€cent on the taxable income it derives. The federal government proposes to reduce the company income tax rate in 2013–14 — from 30Â€perÂ€cent to 29Â€perÂ€cent. And, if you run a small business, the 29Â€perÂ€cent rate is set to commence on 1Â€JulyÂ€2012. The Tax Office has issued the fact sheet ‘Tax aspects of incorporating your business’ to help small businesses decide whether to incorporate and to explain the tax implications of that decision. You can get a copy from the Tax Office website (www.ato.gov.au).

Understanding the good bits A company structure has specific advantages that may appeal to you. The main advantages are 55 A company can benefit from limited liability, which means shareholders’ liability is limited to the value of their shares in the company, even if company losses were to exceed that value. 55 A company has a continuous life. 55 A company can own assets in its own right. 55 A company can be operated by one person. Some of the taxation issues involved in operating as a companyÂ€are 55 A company doesn’t have to distribute net profits it derives to shareholders. Company profits can be retained within the company structure. 55 A company can choose when to make a dividend distribution to shareholders. 55 Shareholders are entitled to receive dividend franking credits in respect to the dividends they receive. (For more details about franking, refer to ChapterÂ€9.)

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Part IV: Running a Business 55 Company losses can be carried forward for an indefinite period and offset against future company profits (subject to meeting certain tests discussed in the next section). 55 Company superannuation contributions made on behalf of company directors and employees to a complying superannuation fund are tax deductible. 55 A company can act as trustee for a self-managed superannuation fund (see ChapterÂ€18). 55 A company isn’t liable to pay a Medicare levy. 55 A company can claim a research and development (R&D) tax concession in respect of eligible expenditure incurred on R&D activities. From 1Â€JulyÂ€2010, a company can claim an R&D tax credit in respect of expenditure incurred. If your business earns less than $20Â€million a year, you can claim aÂ€45Â€perÂ€cent refundable credit.

Dealing with the bad bits You need to take into account a number of disadvantages associated with running a company when assessing whether this business structure is right for you. Here are the main disadvantages to assess when considering a company business structure: 55 A company is an expensive business structure to set up, operate and dissolve. 55 Company directors and/or shareholders may need to give personal guarantees in respect to company loans. 55 A company must comply with complex legal rules and regulations as set out under the Corporations Act and the Income Tax Assessment Act. 55 Company details and accounts must be made available for public inspection. Some of the taxation issues involved in operating as a companyÂ€are 55 A company must register for GST if turnover is greater than $75,000 and it must prepare ongoing business activity statements (BAS). See ChapterÂ€13 for more on preparing aÂ€BAS.

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55 Company profits derived from all sources are taxed as dividends when distributed to the shareholders. 55 A company can’t stream profits to specific shareholders. Dividend distributions are made in proportion to the shares held by the shareholders. 55 A company can’t distribute losses to its shareholders. Company losses are retained within the company structure. This aspect of a company business structure may become a major concern if a company has substantial losses, because shareholders can’t deduct these losses from other assessable income that they derive. 55 Under the capital gains tax provisions, a company can’t own a main residence that is normally exempt from tax. This rule applies even if a shareholder resides in the property. 55 A company can’t gain a 50Â€perÂ€cent discount on capital gains that it may make on disposal of assets owned for more than 12Â€months (which is available to individuals). 55 A company must keep franking accounts for the purpose of distributing franking credits to shareholders (refer to ChapterÂ€9). 55 A private company must satisfy a 50Â€perÂ€cent continuity ownership test to access a carry forward loss. To satisfy the continuity ownership test, more than 50Â€perÂ€cent of the shareholders must be present in the loss year through to the year the loss is recouped. If you fail this test, you get another opportunity to access the loss if you can satisfy an alternate test, called the same business test, which checks whether the new owners are running the same business. If this is the case, you can claim the carry forward loss. 55 Payments and loans (and forgiveness of debts) made by a private company to shareholders (or their associates) are deemed unfranked dividends unless the company enters into a commercial loan agreement before the company’s tax return is lodged. 55 A private company that owns assets such as cars, boats and real estate must charge a commercial rate of rent if they’re made available to their shareholders or associates. Otherwise, the Tax Office treats the benefit as a deemed dividend and, therefore, liable to tax.

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Dealing with complex business issues Many legal and technical issues are associated with running a business in a company structure. These issues are too complex for this book. You need to seek advice from a corporate

lawyer and/or registered tax agent to ensure you’re complying with the rules and regulations as set out in the Corporations Act and Income Tax Assessment Act.

Trusting in Trusts Running a business through a trust structure is similar to operating as a sole trader or partnership, the notable differences being 55 The way you’re taxed on income that the trust derives 55 The trustee’s capacity to distribute trust net income to those beneficiaries who stand to benefit from the trust As the trustee (the person in control), you’re required to apply for a TFN (see ChapterÂ€13) and lodge an annual trust return disclosing the net income of the trust. The trust isn’t liable to pay tax on income derived. Tax is assessed to the trustee or to the beneficiaries if they’re entitled to receive the trust netÂ€income. The most popular types of trusts are family discretionary trusts where the trustee has discretion as to how trust net income is to be distributed to the beneficiaries (who are normally family members). (For more details, refer to ChapterÂ€7.)

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Examining what’s good about trusts You may benefit from the unique advantages associated with running a business through a trust structure. The main ones are 55 A trustee’s assets may potentially be protected from creditors if correctly structured. 55 As the trustee, you can have beneficial use and control of the trust property without actually owning it. Some of the taxation issues involved in operating as a trust are 55 The trustee can stream trust net income between family beneficiaries, which isn’t the case with a sole trader orÂ€company. 55 Distributions that flow through a discretionary trust retain their identity when distributed to beneficiaries. For example, if the trust pays you a capital gain or dividend, this payment is a capital gain or dividend in your hands. This situation isn’t the case in a company structure because a company can only distribute dividends to shareholders.

Checking out the evils of trusts You need to consider the limitations associated with running a business through a trust structure. The main limitations are 55 Net trust distributions paid to minor beneficiaries (under 18Â€years) are liable to pay tax at the top marginal rate plus the Medicare levy (currently 46.5Â€perÂ€cent). 55 The trustee can’t distribute trust losses to beneficiaries as is the case with partnerships (refer to the section ‘Forming a Partnership: Sharing the Workload’ earlier in this chapter). Like companies, trust losses are retained within the trust structure and can be applied only against future trust income. 55 Trusts must follow complex rules set out in the Tax Act in order to claim a trust loss.

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If you want to know more about claiming a trust loss, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘Family trust elections and interposed entity electionsÂ€— trust loss measures questions and answers’.

55 If a trustee doesn’t distribute trust net income, the trustee is liable to pay tax at the top marginal rate plus the Medicare levy (currently 46.5Â€perÂ€cent) on the undistributed amount. (This rule doesn’t apply in a company structure.) 55 A trust can’t own a main residence for CGT exemption purposes, even if the beneficiaries reside in the property. 55 A discretionary trust with a nil net income or a net loss isn’t entitled to a refund of excess dividend franking credits (refer to ChapterÂ€9).

Finding out whether your hobby is a business Any proceeds from a hobbyÂ€orÂ€pastime are normally exempt from tax. However, if your output increases Â�significantly you may, in fact, be running a business. If you contact the Tax Office for some friendly advice, the types of questions they ask are

Although you may be considered to be running a business under commercial law, this may not be the case under tax law. A number of technical tests are used to establish whether you’re running a fair dinkum business.

U Do you have a business plan?

Some of the key tests you need to satisfy areÂ€set out below:

U Do you use specialised knowledge or skills?

U Do your activities have a significant commercial purpose?

U How much capital have you invested in the activity?

U Do you have a genuine intention to carry on a business?

U How much time do you spend on the activity?

U Do you have the intention to make a profit (or is it likely to be Â�profitable)?

U Do you give quotes and supply invoices?

U Do you keep proper records?

U Do you advertise?

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U Are you doing this on a regular basis? U Are your activities similar to what other people do in your industry? U Are your activities planned, organised and carried on in a business-like manner with a view to making a profit? The greater the time you devote to the job and the more money you make, the greater the chance that you’re running

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a business. If you’re not sure, seek advice from a qualified accountant or registered tax agent, because you may quickly find yourself with one big headache if things go wrong. See also the Tax Office fact sheets ‘Am I in business? (NATÂ€2598)’, ‘All the tax information you need to know when running a business’, and ‘Tax Ruling TRÂ€97/11: Income tax: am I carrying on a business of primary Â�production?’

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Chapter 13

Starting a Business: On Your Mark! Get Set! Go! In This Chapter `Ùnderstanding business administration requirements ``Keeping records of your financial transactions `Èmploying staff ``Taking advantage of tax concessions for small business ``Choosing between a cash or accruals basis ``Doing a stocktake

A

fter you set up your business structure, you need to familiarise yourself with all the legal obligations and responsibilities that come with running a business. Keep in mind that pulling out at a later date can prove very costly, especially if you plan to borrow a substantial amount of money and employ people to help run the business. In this chapter, I emphasise the legal requirements associated with running a business and what you need to do to comply.

Getting the Show on the Road As soon as you decide on your business entity, you need to attend to the administration involved in setting it up. In the following sections, I cover the basics. See also Small Business For Dummies, 3rd Australian & New Zealand Edition, byÂ€Veechi Curtis (published by Wiley Publishing) for more detailed information on setting up and running a business.

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Part IV: Running a Business If you want to know more about setting up a business, check out business.gov.au (www.business.gov.au) and AusIndustry (www.ausindustry.gov.au).

Obtaining a tax file number Individuals, partnerships, companies, trusts and superannuation funds that derive assessable income must contact the Tax Office and apply for a tax file number (TFN). This number is required under the Income Tax Assessment Act and must be quoted to the Tax Office when lodging your annual income tax returns.

Applying for an Australian BusinessÂ€Number You need to quote an Australian Business Number (ABN) whenever you conduct a business transaction. If you don’t have an ABN or quote this number on your invoices, an amount of tax equivalent to 46.5Â€perÂ€cent may be withheld from payments made to you. The amount withheld is remitted to the Tax Office. To apply for an ABN, visit Australian Business Register (www.abr.gov.au) and go to Apply for Australian Business NumberÂ€(ABN).

Registering for GST You must register for GST and collect tax if your GST turnover is likely to be $75,000 or more (or $150,000 or more for nonprofit entities). You can still register for GST if you’re below the threshold and you intend to claim back GST credits. Claiming back your GST credits is the amount of GST that you were charged on your own purchases. For more details see ChapterÂ€15. To register for GST, fill out the following forms from the Tax Office website (www.ato.gov.au) under GST for small business: 55 ‘Application for ABN registration for individuals (sole traders) (NATÂ€2938)’ 55 ‘ABN registration for companies, partnerships, trusts and other organisations (NATÂ€2939)’

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Chapter 13: Starting a Business: On Your Mark! Get Set! Go!

Surrounding yourself with the best To seek the help of a qualified accountant and/or tax agent and a business lawyer is the smart way to begin your business journey. Experienced service providers can steer you through the murky waters of

setting up a business. Having the right people around you to advise and help you get started gives you a lot of con‑ fidence. Don’t worry about the cost because the fees they charge are nor‑ mally tax deductible!

Getting to Grips with Record Keeping The Tax Office requires you to keep proper records of your financial transactions, and more particularly your assessable income and allowable deductions. You may find it helpful to do a basic bookkeeping course so that you know how to balance the books and minimise headaches. You may find yourself paying a truckload of money at the end of each month if you use an accountant to do all your recordkeeping paperwork. Take the time to do it yourself — practice makes perfect! The Tax Office publication ‘Record keeping for small business (NATÂ€3029)’ provides information on business records that you need to keep (such as those mentioned in this section) and outlines a basic record-keeping system. If you’re registered for GST, you’re obligated to prepare a business activity statement (BAS) (normally on a quarterly basis) and disclose the amount of GST you collect from your customers, and remit the net GST payable to the Tax Office. To complete this step correctly, you need to keep a record of all your sales and purchases, especially your tax invoices. (For more details see ChapterÂ€15.) You also need to keep records to support the annual tax return that you lodge with the Tax Office. These are the types of records that you need to keep to make the Tax Office folk happy.

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Part IV: Running a Business A record of all your sales (assessable income): 55 Bank deposit books and all bank statements 55 Cash register tapes 55 Credit card statements 55 Sales invoices, particularly your tax invoices A record of all your expenses (allowable deductions): 55 Cheque butts and bank statements 55 Motor vehicle expenses 55 Purchases and expenditure, particularly your tax invoices (see ChapterÂ€15) 55 Records to do with how you calculate any expenditure of private or domestic in nature Other records: 55 Depreciation schedules 55 Details of fringe benefits provided (see ChapterÂ€16) 55 List of all your debtors and creditors 55 Register of your capital gains and capital losses 55 Stocktake, especially the valuation method you used 55 Superannuation records One of the great things about having a cheque account is that you receive regular bank statements that summarise all your business transactions. Your accountant can use your cheque butts when preparing your annual tax return to identify and summarise the expenditure that you incur. For the purposes of the Tax Act, you’re required to keep all business records for fiveÂ€years. Penalties may apply if you fail to comply with this legal requirement.

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Taking on Employees So, business is booming and you intend to employ people in your business on a full-time, part-time or casual basis. You need to comply with the following taxation and superannuation obligations. Under the PAYG withholding tax system, you’re required to withhold the prescribed amount of tax from your employees’ pay and forward the amounts withheld to the Tax Office at regular intervals. A new employee needs to complete a TFN declaration form that must be forwarded to the Tax Office within 14Â€days of commencing employment. This declaration covers payments in respect of work and services performed and payments of superannuation benefits. To calculate the amount of tax you need to withhold fromÂ€your employees’ pay, visit the Tax Office website (www.ato.gov.au) and choose Find a Rate or Calculator ➪ Calculate Tax to Withhold from Pay. If you provide a fringe benefit to an employee (for example, you make a car that you own or lease available for the private use of an employee), you’re liable to pay fringe benefits tax on the taxable value of the benefit provided. (See ChapterÂ€16 for more on this tax.) You must make super contributions on behalf of eligible employees to a complying superannuation fund or retirement savings account. Payments are made on a quarterly basis and penalties apply if you fail to meet your statutory obligations. An employer needs to give new employees a choice of superannuation fund standard choice form to complete within 28Â€days of commencing employment. You can get this form from the Tax Office. If an employee has no particular preference, you can choose a default superannuation fund for them. The super contributions that you make on behalf of eligible employees are tax deductible expenses. You need to set up a super fund (commonly known as a default fund) to make super guarantee contributions on behalf of your employees. You can also contribute on your own behalf. From 1Â€JulyÂ€2008, employer-nominated super funds must offer a minimum level of life insurance cover for members.

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Part IV: Running a Business If you intend to employ an associated person (for example, a relative such as your spouse or child), make sure you pay them a commercially acceptable salary for what they do. The Tax Office has the authority to reduce your claim for a tax deduction (ifÂ€excessive) to an amount that it considers to be reasonable.

Examining Tax Concessions for Small Business Surprise! Your business may be entitled to freebies that the federal government hands out. You usually find them popping up around election time or the last May Budget before the next federal election. If you operate a small business and your annual turnover is less than $2 million, you may be eligible to pick and choose from a number of tax concessions, such as: 55 Accounting for GST on a cash or receipts basis: This concession means you need only to account for GST when you receive a cash payment from your customers. 55 Paying GST by instalments: This concession gives you the option to pay or claim GST on an instalment basis (for example,Â€every three months rather than monthly). 55 Annual apportionment of GST input tax credits: This concession applies when you purchase something partly for business and partly for private use. Under this concession, you can make an annual private apportionment election. This election means you don’t need to estimate the private portion when making a GST claim. You need only to make one single adjustment at the end of the financial year (see ChapterÂ€15). 55 Simplified trading stock rules: The Tax Act stipulates that you can use cost price, market selling value and replacement value to value your trading stock. However, under the simplified trading stock rules, you can use a different way to value your trading stock. Under this rule you don’t need to do a stocktake or make any adjustments if your stock valuations are unlikely to vary by more than $5,000 each year, which means your closing stock valuations are deemed to be the same as your opening stock valuations.

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55 Simpler depreciation rules: The Tax Act stipulates that you can use the prime cost method or diminishing value method to depreciate your plant and equipment (refer to ChapterÂ€10). However, under the simpler depreciation rules, you can choose to use a different way of depreciating your plant and equipment. Under this rule, you can claim an immediate deduction for assets that cost less than $1,000, and you can pool assets that cost more than $1,000 and write them off at the rate of 30Â€perÂ€cent each year (provided they have a life expectancy of less than 25Â€years). (The rate is 5Â€perÂ€cent if the effective life is 25Â€years or more.)

The good news gets even better! The federal government proposes that from 2012–13 you can claim an immediate tax deduction for assets that cost $5,000 or less. For assets (other than buildings) that cost more than $5,000, you can depreciate them at the rate of 30Â€perÂ€cent.

55 Small business CGT concessions: You can consider four concessions: • CGT 15-year asset exemption • CGT 50 per cent active asset reduction • CGT retirement exemption • CGT rollover concession 55 These concessions allow you to reduce or exempt capital gains you may make on disposal of your active business assets. I discuss this issue in more detail in ChapterÂ€17. 55 Immediate deductions for certain prepaid business expenses: This concession allows you an immediate claim of certain prepaid expenses, instead of having to apportion them over the period to which they relate; for example, if you make a prepayment of rent or interest during the financial year that isn’t due until the next financial year. 55 Small business and general business tax break: Eligible small business entities that invested in new eligible assets costing $1,000 or more between 13Â€DecemberÂ€2008 and 31Â€DecemberÂ€2009, can claim an additional 50Â€perÂ€cent tax deduction if they’re first used or installed ready for use by 31Â€DecemberÂ€2010 (see AppendixÂ€A).

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Part IV: Running a Business If you run a business and you don’t qualify for the small business concessions, you can also claim an additional deduction for new eligible assets that cost more than $10,000. Depending on when they’re first used or installed, you can claim an additional 30Â€perÂ€cent or 10Â€perÂ€cent deduction (see AppendixÂ€A). 55 Company tax rate: If you run a small business in a company structure, the federal government proposes (from 1Â€JulyÂ€2012) to reduce the company tax rate from 30Â€perÂ€cent to 29 per cent (see AppendixÂ€A). If you elect to use the concessions available to small business entities, you may be eligible for the entrepreneurs’ tax offset (ETO). This eligibility arises if your net business income (that is, business income minus business expenses) is $50,000 or less a year. If you’re eligible, you can claim a 25 per cent ETO on tax payable on the net business income you derive. The tax offset is reduced if you earn more than $50,000 and ceases when you earn more than $75,000. On 1Â€JulyÂ€2009, a new income test was introduced to ensure income such as salary and wages are considered when working out the amount of the ETO you can claim. If you fail this new income test, the entrepreneur’s tax offset reduces by 20Â€cents for every dollar you earn above a certain threshold; namely, $70,000 a year for individuals and $120,000 a year for families. By the way, the reduction still applies if you earn more than $50,000. For more information on small business tax concessions, see ChaptersÂ€15 andÂ€16. If you’re contemplating using these concessions, discuss the matter with your accountant and/or tax agent before you commence business and before deciding whether to adopt some or all of the concessions. For a comprehensive discussion on all the various tax concessions for small business, check out the Tax Office website (www.ato.gov.au/businesses). See also ChaptersÂ€15 andÂ€16. See the following Tax Office fact sheets to help you to comply with the taxation and superannuation obligations associated with running a small business: 55 ‘Helping small business stay on track’ 55 ‘GST for small business’

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55 ‘Record keeping for small business’ 55 ‘Tax basics for small business’ 55 ‘Income and deductions for small business’ 55 ‘Fringe Benefits Tax — what you need to know’ 55 ‘Business deductions essentials’

Choosing How You Recognise YourÂ€Income I once saw a sign in a shop in outback Australia that read: ‘In God we trust. Everyone else pays cash’. When you operate a business, you need to be assured that your customers are going to pay you for the goods you sell them and/or services you perform. Otherwise, you can quickly find yourself in financial difficulty. You also need to know how you recognise income from your business transactions. When you run a business, you need to decide at what point in time you recognise the profits you make for income tax purposes and, more particularly, how those profits need to be calculated. Under Australian income tax law, you can run your business accounts in one of two ways: 55 Cash or receipts basis: Under the cash or receipts basis, income is recognised only when a payment is actually received. Put simply: no dough, no show. Income is recognised only when the money is received. 55 Accruals or earnings basis: The accruals or earnings basis takes into account money due but not yet paid to you. You have a legal right to demand payment, such as when you invoice a customer for the services you have rendered. This means you need to keep an account of all your debtors and creditors and do a lot of bookkeeping. The way you calculate and recognise income for tax purposes therefore varies in accordance with the accounting basis you use. Both methods aren’t alternatives that you can choose whenever you feel like it, and you can’t vary the basis you select from year to year. The correct basis of accounting for income ultimately depends on its actual appropriateness and whether

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Part IV: Running a Business in the circumstances of the case it is calculated to give a true indication of your income. Generally, the cash or receipts basis is considered the appropriate method to use if you run a small business as a sole trader, or you run a personal services business where you’re responsible for the work you do and employ a few people (for example,Â€you run a small accounting practice). On the other hand, the accruals or earnings basis would be the appropriate method to use if you run a business on a large scale and you employ many people to service your customers. If you’re not sure which method to choose, you can seek professional advice from a tax accountant. Here are some legal principles that you need to know about before you make your decision: 55 Fees paid in advance for work not yet commenced aren’t assessable income in the year of receipt and aren’t derived until they’re earned (for example, until you have a legal right to demand payment for the work you performed) where such advance payments are potentially refundable (see: Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLRÂ€314 online in AppendixÂ€C — www.dummies.com/go/ taxforaustraliansfd). 55 Under the accruals or earnings basis of accounting for income, the Tax Office points out in Taxation Ruling TRÂ€93/11 professional fees are normally derived ‘when a recoverable debt is created such that the taxpayer is not obliged to take any further steps before becoming entitled to payment’. 55 Generally, where there is no entitlement to payment untilÂ€aÂ€project is completed, the value of work in progress isn’t assessable income, until after the completion of a project (per Tax Office Interpretative Decision IDÂ€2002/1002). Appendix C provides a list of the leading tax cases relating to accounting for income. This online resource (www.dummies.com/ go/taxforaustraliansfd) is a handy tool if you want to know more about accounting methods or you’re studyingÂ€taxÂ€law.

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Taking Stock of Things When you’re running a business, you need to hold sufficient trading stock in your warehouse store or garage to sell to your prospective customers. Unfortunately, at the end of the financial year, you need to count all the stock you have on hand and put a value on each item (otherwise known as the dreaded stocktake) to verify the accuracy of your accounting records and to check the closing value of stock on hand for taxation purposes. It’s amazing how everyone seems to be on sick leave whenever you’re about to conduct a stocktake! Section 70–10 of the Income Tax Assessment Act 1997 defines trading stockÂ€as: ‘(a) anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of running a business;Â€and (b) live stock’. These are the things you need to do to complete your stocktake: 55 List all the items of trading stock that you have on hand. 55 Put a value on each item that you have on hand. 55 Record the name of the person who’s doing the stocktake. 55 Record the date the stocktake takes place. 55 Record the method you used to value your trading stockÂ€—Â€either cost price, market selling value or replacement value. 55 Record the name of the person who does the valuation. One of the concessions for small businesses is that if the value of your trading stock hasn’t changed by more than $5,000 over the year, you don’t have to do a stocktake. This concession may be worth considering — it can save you a lot of time and money.

Valuing your trading stock At the end of each financial year, you need to count your trading stock when you calculate your taxable income. You must keep accurate records such as invoices of your purchases. AÂ€stocktake is done to verify the accuracy of your recordkeeping obligations.

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Part IV: Running a Business The Tax Act sets out three methods that you can use to value your trading stock: 55 Cost price: This valuation method is used most in practice. The cost of an item of stock is normally the price you paid to acquire it plus any costs you incur to bring the stock to your place of business. 55 Market selling value: This valuation method is the current market value of stock that you sell to your customers. 55 Replacement value: This method is the cost to replace (buy) an item of stock on the last day of trading at the end of the financial year.

Understanding the nitty gritty of trading stock Each financial year, you can change the way you value your trading stock. However, one important rule that you must follow is that the closing value of your trading stock on hand at the end of the financial year must be the same as the opening value of your trading stock on hand at the beginning of the next financial year. For example, if the closing value on 30Â€June was $25,000, then the opening value on 1Â€July must also be $25,000. If the value of your closing trading stock (for example, $30,000) is greater than the value of your opening trading stock (for instance, $27,000), the excess ($3,000) is included as part of your assessable income. On the other hand, if the opening value of your trading stock is greater than the closing value of your trading stock, the difference is allowed as a tax deduction. The increase or decrease in the value of trading stock must be based on the records you keep. See the following Taxation Rulings for help: 55 ‘IT 2350 Value of trading stock on hand at end of year: cost price: absorption cost’ 55 ‘IT 2670 Meaning of “trading stock on hand”â†œ’ 55 ‘TR 98/7 Whether packaging items (ie, containers, labels, etc) held by a manufacturer, wholesaler or retailer are trading stock’

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See also the online Appendix C (www.dummies.com/go/ taxforaustraliansfd), which lists the leading tax cases

relating to trading stock.

If you find you’ve got trading stock on hand that you consider obsolete (such as due to a change in fashion) or that any other special circumstances apply (for example, you no longer sell it), you can elect to value your trading stock below the cost price, market selling value or replacement value. The Tax Office has released Tax Ruling TRÂ€93/23, which deals with the valuation of trading stock subject to obsolescence or other special circumstances.

Taxing matters for manufacturers If you’re running a manufacturing business, you’re required to use the absorption cost method to value your goods and work in progress. Because this method is a very complex issue, your best option is to consult your accountant or tax agent, because this entire process of valuing your goods can turn into a messy affair if you don’t understand what you’re doing. How messy? Well, according to the Tax Office, the cost price of manufac

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tured trading stock on hand at the end of the year includes not just the mat erial and direct labour costs that went into producing the product, but also an appropriate proportion of produc tion overhead costs. And you have to weigh the same factors when adding up how much your work in progress is worth, too. What? Don’t have that all handy? That’s why you should call in the experts to get things right and keep things tidy.

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Chapter 14

Reducing Your Small Business Tax Bill In This Chapter `Ìdentifying allowable deductions ``Claiming tax deductions

W

hen you run a business, logic dictates that if more money is coming in than is going out you’re ahead. However, if more of the hard-earned stuff is going out than coming in, you could quickly find yourself with one big headache if things don’t improve. Under these circumstances, two options are available to you. You can either seek professional advice or simply shut up shop for good and go fishing. Expenditure that you incur in earning business income may qualify for a tax deduction. In this chapter, I guide you through the legal ways you can claim a tax deduction and the different types of expenditure you can claim — all of which is going to help keep your business in the black.

Understanding the Rules: WhatÂ€Can I Claim? You can use two methods to find out what is a tax deductible expense: Get the Tax Office to compile a comprehensive list of every conceivable item you’re likely to incur, or use a general deduction formula (referred to as the general deduction provisions). If you choose the former option, you need to constantly thumb through a pile of books equivalent in size

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Part IV: Running a Business to your local telephone directory. So, reason concludes the alternative method has more merit. Under the general deduction provisions, you can deduct from your assessable income any loss or outgoing that you incur in gaining or producing assessable income. A direct connection must exist between the expenditure and earning your assessable income, and you must incur the expenditure in the course of deriving your assessable income. I discuss the general deduction provisions in ChapterÂ€2. The following business expenses are examples of the types of loss and outgoing that qualify for a tax deduction: 55 Advertising expenses 55 Bad debts 55 Borrowing expenses 55 Business car expenses 55 Capital works deductions (refer to ChapterÂ€10) 55 Cost of providing fringe benefits to employees 55 Depreciation (decline in value) (refer to ChapterÂ€10) 55 Insurance premiums 55 Interest on borrowings 55 Legal expenses 55 Office stationery 55 Operating a commercial website 55 Rates and land taxes 55 Recruiting employees 55 Rent or lease of your business premises 55 Repairs and maintenance to your business premises (refer to ChapterÂ€10) 55 Salary or wages, bonuses, commissions or allowances paid 55 Superannuation contributions 55 Tax-related expenses 55 Telephone expenses 55 Trading stock

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Chapter 14: Reducing Your Small Business Tax Bill

169

For an expense to be an allowable deduction, you must be able to show a direct or necessary connection between your business activities and the expenditure you incur. Every time you open your wallet or purse to pay a bill, ask yourself why you’re paying this amount. If the payment is part of the cost of running your business operations and is similar in nature to the expenses mentioned earlier, your bill is likely to be an allowable deduction. If no direct link exists (for example, you purchase tickets to the footy or you pay your dentist bill), the bills are most likely private or domestic in nature and, therefore, not tax deductible. If you purchase a car for business use, a car depreciation limit cuts in, in respect of the amount of depreciation you can claim. For the 2010–11 financial year, the car depreciation cost price limit was $57,466. This rule means you can’t claim depreciation for amounts that exceed this limit. For example, if you pay $80,000 for a car, the cost price limit for depreciation purposes is $57,466. If you incur a fine (such as a parking fine), while you’re conducting an income-earning activity, the fine isn’t tax deductible. Keep in mind that you can’t claim a tax deduction if the expenditure is capital in nature. Unfortunately, this is a very difficult part of the law to come to terms with. While a library full of books that have examined this matter in much detail may interest (or bore) you, a general rule to remember is as follows: Expenditure associated with establishing, replacing, enlarging, protecting or improving the business structure is considered to be capital in nature (as distinct from the day-to-day operating expenses of running your business). This rule also applies to expenses associated with selling your business. However, some capital expenses may be deductible over a period of time (for example, capital improvements you make to an income-producing property), while some may be deductible outright under a specific provision (for example, assets costing less than $1,000 can be deducted outright under the simpler depreciation rules). Because this capital concept is a complex issue you’re best to seek professional advice if you’re not sure what toÂ€do.

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They’re called ‘experts’ for a reason .â•›â†œ.â•›â†œ. If you’re a little confused about claiming a tax deduction, you’re not the only one. Unfortunately, tax isn’t a subject you can quickly master overnight. In my professional life I’ve seen plenty of starving accountants tightening their belts, but I’ve never seen a tax agent specialising in tax

law begging for a quid! I always tell my students that if you want to earn around $250 an hour, study tax law! So if you’re not sure what is or isn’t tax deductible, contact a registered tax agent for some friendly help. But don’t give up all hope justÂ€yet!

Getting Specific with Problematic Deductions You can claim certain specific deductions. When you examine these deductions you find that they contain their own unique rules that you need to satisfy before you can claim a tax deduction.

Dealing with bad debts Unfortunately, when you run a business you’re going to come across the odd occasion where customers aren’t going to pay you for the services you provide. Under these circumstances, you can either call in a ‘heavy’ (debt collector) to get the money or you can take legal action. If your chance of getting the money is really grim, you can write off the debt as bad and claim a tax deduction. However, getting to that point isn’t as simple as it may seem at first glance, because you have to satisfy a certain number of technical conditions. Under Australian income tax law, four key tests (conditions) must be present for you to claim a deduction for bad debts: 55 A debt must be in existence. 55 The debt must be bad rather than merely doubtful.

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55 The debt must’ve been included in your assessable income for the income year or for an earlier income year (which means that if you use the cash or receipts basis — refer to ChapterÂ€13 — you can’t claim a bad debt). 55 You must write off that debt as bad in the income year. To claim a deduction for bad debts, you must physically write off the debt as bad (for example, in your accounting records you write a note as to why you consider the debt isÂ€bad). You can claim a tax deduction only for bad debts that are still in existence at the time you write them off. The reason is because a debt can’t be written off as bad after it ceases to exist (for example, because the debt has been settled, compromised, extinguished or assigned). The way you account for bad debts depends on whether you elected to use the cash or receipts basis or accruals or earnings basis to recognise your revenue. For more details on this issue see ChapterÂ€13.

Paying interest on borrowings A major business expense you’re likely to incur is interest on borrowings — you need money to make money. Borrowing money is normally required to fund the acquisition of incomeproducing assets and your ongoing business operations. Interest payable on business borrowings is a tax deductible expense. However, you have to obey certain rules before you can claim a tax deduction.

Examining the purpose (or use) of the loan Interest payable on borrowings is a tax deductible expense, if theÂ€purpose (or use) of the loan is to earn assessable income (for example, business profits) or to acquire an incomeproducing asset (such as your business premises, trading stock, and plant and equipment). To qualify for a tax deduction, a direct connection must exist between the expenditure and earning your assessable income. On the other hand, if the purpose (or use) of the loan is to buy an asset that doesn’t generate revenue (for example, you purchase your main residence), the interest isn’t tax deductible. Further, if just part of the loan is for the purpose of deriving

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Part IV: Running a Business assessable income, under these circumstances you’re entitled to just a part deduction. For example, if you purchase a computer for your business and you use it only 50 per cent of the time for business purposes, you can claim only 50 per cent of the interest you incur as a tax deduction. If you use an asset partly for business purposes and partly for private use, you need to keep a record of how the use was calculated. A point to keep in mind if you intend to borrow money is that the security or collateral you offer to secure a business loan has no relevance to whether you can claim a tax deduction. For example, whether or not you offer as security a non-incomeproducing property such as your main residence to obtain a business loan is irrelevant.

Interesting deductions: When interest is and isn’t deductible Interest is tax deductible in the following circumstances: 55 A sole trader running a business is entitled to a deduction for interest incurred on moneys borrowed to pay income tax (ATO IDÂ€2006/269). 55 Interest payable on loans used to finance the purchase of shares that pay dividends is a tax deductible expense. Interest isn’t tax deductible in the following circumstances: 55 Partners aren’t entitled to a deduction for interest on borrowings to pay personal income tax (Taxation Determination TDÂ€2000/24). 55 Interest incurred on money borrowed to make superannuation contributions aren’t allowable deductions. 55 Interest incurred on a loan taken out after the cessation of a business isn’t tax deductible (ATO IDÂ€2002/1092). 55 Interest incurred by an individual taxpayer on a loan taken out in order to pay a tax debt isn’t tax deductible (ATOÂ€ID 2002/607). Visit the Tax Office website for more information on its Interpretative Decisions and Taxation Determinations: ` www.ato.gov.au

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Borrowing expenses When you borrow money from a financial institution, you may incur borrowing expenses such as loan establishment fees, mortgage insurance and legal fees. If the purpose (or use) of the loan is to earn assessable income, the costs associated with borrowing are tax deductible. In most cases you need to spread the expenditure you incur over the period of the loan. If your borrowing costs are $100 or less, you can claim the amount outright. Borrowing costs that exceed $100 need to be spread over the period of the loan or over fiveÂ€years if the period is more than 5Â€years. The following formula is used to apportion your annual tax deductions for a borrowing expense: Borrowing costs ì

PeriodÂ€inÂ€year TotalÂ€periodÂ€of loanÂ€(maximumÂ€5Â€years)

If you take out a loan part way through the financial year, you’re entitled to just a partial deduction in the first year.

Losing money by theft When you run a business, you may have money stolen from you in various ways. However, you may be able to qualify for some tax relief to help offset your loss. To qualify for a tax deduction under the Tax Act, a loss caused by theft, stealing, embezzlement, larceny, defalcation (misappropriation by a trustee) or misappropriation by your employee or agent is deductible only if the money was previously included in your assessable income for the income year or for an earlier income year. For example, if your auditor finds that one of your employees steals business takings that are included as part of your assessable income in a previous financial year, the loss is a tax deductible expense. If you can’t claim a tax deduction under the provision that allows you to claim a deduction for loss by theft, you can have another go under the general deduction provisions (refer to the section ‘Understanding the Rules: What Can I Claim?’ earlier in this chapter). You need to demonstrate there is a direct or necessary connection between your business activities and the loss you incur. You may need to talk this matter over with a tax agent because this issue can be a rather tricky one to deal with.

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Case study: Claiming a borrowing expense On 1 September 2010, Masato, who is a sole trader running a retail business, incurs $5,000 borrowing costs in respect of a loan he takes out to finance the purchase of his business premises. The period of the loan is 10Â€ years. Because the purpose (or use) of the loan is to buy an incomeproducing asset, Masato can spread the $5,000 borrowing costs over the

shortest of either the period of the loan (10Â€ years) or 5Â€ years. Because the loan he takes out exceeds 5Â€years, Masato needs to apportion the $5,000 borrowing expenses over a fiveyear period (1,826 days), which is the shortest of either the period of the loan (10Â€ years) or 5Â€ years, as illustrated here:

Year 2011

$830 (303 days ó 1,826 days ì $5,000)

2012

$1,000

2013

$1,000

2014

$1,000

2015

$1,000

2016

$170 (being the balance of deduction)

Getting a legal opinion: Legal costs When you run a business, you may need to consult a lawyer about various legal issues associated with running your business. This need for referral can arise when dealing with complex tax law matters and having to comply with all the red tape that goes with running a business. Legal expenses associated with running your business are tax deductible, provided they’re not capital, private or domestic in nature. You can also claim deductible specific types of legal expenses, suchÂ€as: 55 Tax-related expenses 55 Lease document expenses

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55 Borrowing expenses (refer to the section ‘Borrowing expenses’, earlier in the chapter) 55 Expenses of discharging a mortgage Unfortunately, a major dilemma is whether your legal costs are revenue in nature and deductible, or whether they’re capital, private or domestic in nature and not deductible. The answer depends on why you had to seek legal advice. If the nature or character of the legal expenses is part of your day-to-day activities associated with running your business, they’re most likely tax deductible. On the other hand, if they relate to the business structure (such as protecting the business entity), they’re capital in nature and, therefore, not tax deductible. At the time you seek legal advice, checking with the person giving you advice whether the bill you receive is tax deductible always pays.

Getting tax help: Tax-related expenses Unfortunately, trying to understand and comply with Australian income tax law can be mind-boggling. The good news is if you seek the services of a recognised tax adviser (registered tax agent or a legal practitioner) to help you manage your tax affairs, the expenditure you incur is normally tax deductible. When you seek the advice of professionals, they generally tell you whether you can claim a tax deduction for the advice they give you. The types of tax-related expenses you can claimÂ€are 55 Costs incurred to prepare your individual tax return 55 Dealing with a tax audit (refer to ChapterÂ€4) 55 General tax advice for the purposes of complying with the Tax Act 55 Helping you to complete your business activity statement 55 Lodging an objection and appealing against an assessment notice (refer to ChapterÂ€4)

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Stamping a lease: Lease document expenses You can claim a tax deduction for expenditure you incur for preparing, registering or stamping a property lease, or an assignment or surrender of a property lease, provided you use the property for earning assessable income.

Discharging the mortgage You can deduct expenditure you incur to discharge a mortgage that you give as security for the repayment of money you borrow, provided the money you borrow is used to derive assessable income. For example, if you use your property as collateral to secure a business loan that you no longer need andÂ€you incur a fee to discharge the mortgage, you can deduct the expenditure.

Claiming a superannuation deduction If less than 10 per cent of your total assessable income (and reportable fringe benefits) comes from employment as an employee and you make a personal contribution (or concessional contribution) to a complying superannuation fund, the amount you contribute is a tax deductible expense. This rule can come into play if you’re self-employed, substantially self-employed or under 65Â€years of age and not in full-time employment. However, there’s a limit on how much you can claim each year. The maximum concessional contributionÂ€you can claim depends on whether you’re under or over 50Â€years ofÂ€age. For the year ended 30Â€JuneÂ€2010–11 the maximum is $25,000 (indexed) if you’re under 50Â€years of age and $50,000 ifÂ€you’re over 50Â€years of age between 1Â€JulyÂ€2007 andÂ€30Â€JuneÂ€2012. From 1 July 2012, the federal government proposes that if you’re over 50Â€years of age you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund. (For more details, see ChapterÂ€18.)

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Losing money: Business losses When you run a business you run the risk of incurring business losses. This scenario can arise while you build up your business or if you run it on a small scale. Ordinarily, you can offset business losses against other assessable income you earn, such as employment income, interest, dividends or rent. If you don’t have any other income, you can carry forward your business losses for an indefinite period and offset them against your future income. Special rules apply for claiming business losses incurred by a sole trader or partnership. Under the non-commercial losses provisions, you may be denied from offsetting your business losses against other assessable income you earn. This rule is an anti-avoidance provision to stop people who don’t operate a commercial business (for example, running a hobby type business) from accessing those losses. In order to claim a business tax loss, you need to pass at least one of the following four technical tests: 55 Assessable income test: Under this test, you need to be earning at least $20,000 assessable income. 55 Other assets test: Under this test, you need to have other assets (other than motor vehicles) in excess of $100,000. 55 Profits test: Under this test, your activity must have resulted in taxable income in at least three out of the last five years (including the current financial year). 55 Real property test: Under this test, you need to have property (such as land and buildings) worth at least $500,000. The good news is you can carry forward and utilise these losses when you finally satisfy one of these tests. If you find yourself in this position, you’re best to seek advice from a qualified accountant or tax agent. From 1 July 2009, an income test was introduced to restrict highincome earners from claiming a tax deduction. If your adjusted taxable income is more than $250,000, and you incur losses from non-commercial business activities, you can’t offset those losses from your salary and wages and other income you derive. These

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Part IV: Running a Business losses are quarantined and you can only deduct them from the business activities you’re running. The good news is the existing rules still apply if your adjusted taxable income is less than $250,000. The Tax Office has discretion to allow you to claim a business loss under certain circumstances. For example, such a situation may arise if special circumstances beyond your control affect your business activities (for example, due to weather conditions) or because you may need to wait for a period of time before your business is likely to become a commercially viable operation. You may find the following Tax Office publications helpful: 55 ‘Non-commercial losses: Overview (NAT 3379) fact sheet’ 55 ‘Taxation Ruling TR 2001/14: Non-commercial business losses’ 55 ‘Non-commercial losses — changes to restrict loss deductions for high-income individuals’ Appendix C sets out a number of leading tax cases in respect of claiming certain business-related expenses. This useful online tool (www.dummies.com/go/taxforaustraliansfd) is a handy reference if you want to know whether a specific expense is tax deductible or you’re studying taxÂ€law.

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Chapter 15

Collecting Tax for the Government: Goods and Services Tax In This Chapter ``Recognising taxable and input taxed sales ``Working out if you have to register for GST ``Preparing a BAS

A

goods and services tax (GST) was introduced in Australia on 1Â€JulyÂ€2000. This broad-based tax of 10Â€perÂ€cent is added on to the cost of most goods and services that are sold or consumed in Australia. The A New Tax System (Goods and Services Tax) ActÂ€1999 (GST Act) requires entities, particularly business entities that are registered for GST, to collect 10Â€perÂ€cent tax from their customers and remit the amount to the Tax Office on either a monthly, quarterly or annual basis. In this chapter, we discuss the three different types of GST sales (or supplies) and how GST is collected only on taxable sales. Further, if you register for GST (ChapterÂ€13), you can claim a GST credit in respect of any GST you’re charged on your own acquisitions that are made in the course of making supplies (other than input taxed supplies).

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How GST was introduced The first real attempt to introduce a GST in Australia was raised in the mid‑ 1980s, when the then Labor Treasurer, Paul Keating, put it up for discussion. The next genuine attempt happened during the 1993 federal election when John Hewson, the Liberal leader of the federal opposition, decided to make it an election issue. However, he failed to win the election and the matter quickly died. But you can’t put

a good politician down. When John Howard became Prime Minister in 1996, the GST issue was again put back onto the political agenda. The matter became a major election issue during the 1998 federal election cam‑ paign. When the Howard Government was re‑elected it was only a matter of time before GST was introduced and, as they say in the classics, the rest is history.

Collecting 10 Per Cent Under the GST provisions you’re likely to enter into three typesÂ€of GST sales (or supplies) (see FigureÂ€15-1): 55 Taxable sales (or supplies) 55 Input taxed sales (or supplies) 55 GST free sales (or supplies)

GST registered entity

Remit to ATO

Taxable sales

Input taxed sales

GST free sales

Collect 10% GST

No 10% GST collected

No 10% GST collected

Can claim GST credits

Cannot claim GST credits

Can claim GST credits

Figure 15-1: Understanding the three types of GST sales.

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Chapter 15: Goods and Services Tax

181

Every time you conduct a financial transaction, you need to know whether the transaction is a taxable sale, an input taxed sale or a GST free sale. Ordinarily, the issue is relatively straightforward. If in doubt, your best action is to immediately contact the Tax Office or seek professional advice because you’re personally liable to collect the tax. This is a tax imposed on the end consumer and, so, GST registered entities can claim a GST credit in respect to GST they’re charged on their own acquisitions (other than in respect of input taxed supplies).

Taxing your sales: What are taxable sales (supplies)? Taxable sales (supplies) are transactions of most goods and services sold within Australia by registered entities. They canÂ€include 55 Sale of goods such as your trading stock 55 Sale of specific services such as repairs and tax advice 55 Buying and leasing property If you’re not registered for GST, no GST is charged on your supply of goods and services. However, you need to apply for an Australian Business Number (ABN) (refer to ChapterÂ€13) and quote this number when you enter into a supply of goods and services. Otherwise, your customers are required to withhold tax on the payments they make toÂ€you. The GST Act points out four conditions that must be present for an entity to make a taxable supply and collect GST on behalf of the federal government: 55 You make a supply for consideration. 55 The supply is made in the course or furtherance of an enterprise that you carry on. 55 The supply is connected with Australia. 55 The entity is registered or required to be registered. This condition applies if your GST turnover (or sales) is or is likely to be $75,000 or more a year (or $150,000 a year if you operate a non-profit organisation).

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Part IV: Running a Business If you’re a registered entity (which is most likely to be the case ifÂ€you run a business), you become a mini tax collector in respect of the taxable sales you make to your customers. As if you don’t already have enough on your plate, under this system the Tax Office makes you do all the work. This arrangement is because when you make a taxable sale you’re obligated to collect GST (being one-eleventh of your invoice price) and forward the amount to the Tax Office. For example, if you charge a customer $880 (including GST) you need to collect $80, which is one-eleventh ofÂ€$880. You need to issue a tax invoice for taxable sales of more than $82.50 (including GST) if a customer requests one within 28Â€days of the sale. If you issue a tax invoice to your customers, the information you need to disclose depends on whether the amount is more or less than $1,000. For amounts less than $1,000, you must disclose 55 The words ‘tax invoice’ on your invoice 55 Your ABN (that is, the supplier’s ABN) 55 Your name (that is, the supplier’s name) 55 Date of issue 55 A description of the goods and/or services supplied 55 The total price (including GST) 55 A statement that the price includes GST (alternatively, the GST can be shown separately) For amounts over $1,000, in addition to the above details, you also need to disclose the purchaser’s name, their ABN or address and the quantity supplied (see FigureÂ€15-2). You’re not required to have a tax invoice to claim a GST credit for purchases of $82.50 or less (including GST). You don’t have to issue a valid tax invoice to a customer where the sale you make is $82.50 or less (including GST). Further, you don’t have to withhold tax from a supplier who doesn’t provide you with an ABN if the sale is $75 or less (excluding anyÂ€GST).

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R. G. Furniture Pty Ltd 23 Rupert Street Footscray ABN 95 123 456 789 Tax invoice 23 March 2011 Customer Andrew Jones 147 Lumber Street Northcote Qty

Description

1

Table

4

Chairs

Unit price

Total

$1,500

$1,500

$200

$800

Total price (excluding GST) GST Total price (including GST)

$2,300 $230 $2,530

Figure 15-2: Providing the correct details on your tax invoice.

If you want to know more about GST, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘GST overview’. If you purchase goods that you use partly for business and partly for private purposes (for example, a car or computer), you can claim a GST credit only in respect of the business portion. Under the small business concessions provisions, you can make an annual private apportionment election. This rule means you don’t need to estimate the private portion each time you prepare your business activity statement (BAS). Rather, you can elect to make one single adjustment at the end of the financial year (refer to ChapterÂ€13).

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Examining what are input taxed salesÂ€(supplies) An input taxed sale relates to financial services and, more particularly, to money transactions (for instance, lending or borrowing money and share trading transactions) and to residential property for use as residential accommodation (suchÂ€as a residential rental property). No GST is charged on input taxed sales and you can’t claim a GST credit in respect ofÂ€your acquisitions to make that sale (supply). You may find helpful the Tax Office fact sheet ‘Input taxed supplies — residential rent’.

Checking out what are GST free salesÂ€(supplies) GST free sales (or supplies) means no GST is charged on these transactions and you can claim a GST credit on GST you pay to make a GST free sale. The following transactions are examples of GST free sales: 55 Cars for use by disabled people 55 Certain childcare (for example, family day care provided by an approved childcare service) 55 Certain education courses (for example, preschool, primary and secondary courses) 55 Certain exports (such as Australian goods sold to overseas customers) 55 Certain food for human consumption (for example, fruit and vegetables, bread, dairy products, meat and fish, tea and coffee) 55 Certain medical, health and care services that qualify for a Medicare benefit (such as doctors’ fees, hospital fees, dental fees and home nursing) 55 Certain religious services and charitable activities (such asÂ€religious services — worship, baptisms, religious retreats and funerals — and non-commercial charitable activities — raffles and bingo)

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55 Farmland 55 International mail 55 International transport and related matters 55 Precious metals 55 Services provided by travel agents in arranging overseas travel and overseas supplies such as accommodation and sight-seeing tours 55 Supplies through inward duty free shops 55 The sale of a business as a going concern 55 The supply of accommodation and meals to residents of retirement villages by certain operators 55 Water and sewerage services One important GST free transaction mentioned in the preceding list is the sale of a business as a going concern. This transaction can be likened to selling your truck with the engine still running.Â€At the point of sale you jump out of the driver’s seat and a new owner takes over. Generally speaking, for the transaction to be exempt from GST, four conditions must be present, namely: 55 The business must still be functionally operating until the date of sale (all things necessary for the continued operation of the enterprise are made available to the purchaser). 55 The purchaser must be registered or required to be registered forÂ€GST. 55 The sale (supply) must be for consideration (for example, you receive a sum of money). 55 Both the seller and purchaser must agree in writing that the sale (supply) is of a going concern. You’re best to seek professional advice from a qualified accountant or tax agent to ensure you’re complying with these technical issues.

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Part IV: Running a Business You may find the following fact sheets and publications from the Tax Office website (www.ato.gov.au) helpful: 55 ‘GST credits for business (NAT 3019)’ 55 ‘GST essentials’ 55 ‘GST for small business (NAT 3014)’ 55 ‘GST overview’ 55 ‘How to set out tax invoices and invoices (NAT 11675)’ 55 ‘Sale of a business as a going concern — checklist’ 55 ‘Valid tax invoices and GST credits’

Registering for GST Under the GST provisions, you’re required to register for GST if your annual GST turnover is likely to be $75,000 or more (orÂ€$150,000 or more for non-profit entities). However, if your annual turnover is below the GST turnover thresholds mentioned, you have the option to make an election to register for GST. You also need to apply for an ABN and quote this number when you enter into a business transaction (refer to ChapterÂ€13). To apply for an ABN, visit the Australian Business Register website (www.abr.gov.au) and go to Apply for an Australian Business NumberÂ€(ABN). If you have the option to register for GST, before you make your decision you need to weigh up all the pros and cons. For example, a major benefit if you register is you can claim a GST credit in respect of any GST you’re charged on your own acquisitions. To claim a GST credit correctly, you need to hold a tax invoice to substantiate your claim for a GST credit. The downside is the red tape and all the headaches that go with the paperwork you need to fill out to comply with the GST legislation.

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If you need to register for GST, you can do it online at www.business.gov.au, or you can fill out the following formsÂ€that you can obtain from the Tax Office website (www.ato.gov.au) (go to GST for Small Business): 55 ‘ABN registration for companies, partnerships, trusts and other organisations (NAT 2939)’ 55 ‘ABN registration for individuals (sole traders) (NATÂ€2938)’ If you cease running a business and/or you’re no longer required to register for GST, you can cancel your registration within 21Â€days of ceasing to trade. You need to contact the Tax Office and complete the form ‘Application to cancel registration (NATÂ€2955)’.

Paying the GST If you’re registered for GST you’re obligated to prepare a BAS (normally on a quarterly basis). You need to disclose in this document the amount of GST you collect from your customers minus any GST credits you’re entitled to claim back, and remit the amount to the Tax Office. To fulfil this requirement correctly, you need to keep a record of all your sales and purchases, especially all your tax invoices, in order to prepare your BAS andÂ€to substantiate your claim for a GST credit. If you need help to prepare your BAS, you can get it from qualified bookkeepers who are authorised to prepare GST, BAS and PAYG statements. You can find them on the internet. GST is levied only on taxable sales you make. No GST applies toÂ€transactions that are classified as input taxed sales and GST free sales.

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Chapter 16

Living on the Fringe: FringeÂ€Benefits Tax In This Chapter `Ùnderstanding what is FBT ``Doing the FBT maths ``Working out a car’s FBT ``Packaging your salary and FBT

P

rior to the introduction of the fringe benefits tax (FBT) provisions, you were able to structure your pay packet in such a way that significantly reduced the burden of tax. It was also possible for you to receive non-cash benefits in lieu of a cash salary or wage, or perhaps transfer those benefits to family members. Legislation was introduced inÂ€1986 to put everyone back on an even playing field (subject to certain limited exceptions). In this chapter I explain what FBT is and how to calculateÂ€it.

Coming to Terms with FBT The Fringe Benefits Tax Assessment Act 1986 (FBT Act) was introduced to overcome the inability to tax certain benefits paid to employees (or their associates such as a spouse, child or relative) in lieu of receiving a salary or wage. The employer rather than the employee is liable to pay FBT on certain benefits provided to employees (for example, provision of a work car, paying private expenses such as school fees or membership to your favourite football club). The FBT year begins on 1Â€April and ends on 31Â€March. The employer must lodge an annual FBT return with the Tax Office by 21Â€May. Ordinarily, an employer canÂ€claim as a tax deduction the cost of providing fringe benefits

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Part IV: Running a Business and the amount of FBT paid. An FBT issue normally arises when an employee receives a salary package (see the sidebar ‘CaseÂ€study: Tula’s salary package’ later in this chapter). Ordinarily, three conditions must be present for an FBT liability to arise, namely: 55 An employer–employee (or associate) relationship must be present. This condition means the benefit must be paid as a consequence of an employment arrangement. If a payment is made outside an employment arrangement, then an FBT issue is unlikely to arise (unless the employee was a past employee or is likely to be a future employee). 55 The employer must give the employee (or associate) a fringe benefit. Under the FBT provisions, the term benefit is broadly defined and includes any rights, privileges, or services. For example, you provide a fringe benefit whenÂ€you: • Allow one of your employees to use a work car for private purposes. (For example, your employee can take the car home each night and use it to do the shopping.) • Give an employee a cheap loan for private use (such as to help finance the purchase of their main residence). • Reimburse an expense incurred by an employee, such as school fees. • Provide entertainment by way of food, drink or recreation (subject to certain conditions and exemptions). 55 The fringe benefit isn’t an exempt benefit. The FBT Act specifically exempts certain benefits (work-related items) you may give to your employees (or associates). The following are examples of the types of benefits that are exempt: • Most minor benefits that are infrequent and valued at less than $300 where it would be unreasonable to treat the benefit as a fringe benefit (for example, the annual Christmas party). • Notebook, laptop (mainly for business use) or similar portable computer (one per employee per FBT year). Exemption is available only if the portable computer is used primarily for work-related purposes.

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Chapter 16: Living on the Fringe: FringeÂ€Benefits Tax • Mobile phone or car phone provided the phone is primarily used in employment. • Protective clothing. • Personal digital assistants (PDAs). • Tools of trade such as briefcases and calculators. • Work-related, preventative health care. • Certain relocation expenses. • The first $1,000 worth of in-house benefits in respect of the goods and services that you sell to your customers (for example, you sell televisions to the general public and you give a free television to your employee, or you sell one to them at a substantial discount).

You can see from this definition and examples that FBT is so broad that a fringe benefit issue probably arises whenever you give an employee a benefit. If you’re not sure, you’re best to seek professional advice. Fringe benefits tax isn’t payable in the following circumstances: 55 No car parking fringe benefit arises if you provide car parking for your employees, unless you’re located within 1Â€kilometre of a commercial car park that charges more than $7.46 for all-day parking (FBT year 31Â€MarchÂ€2011). However, car parking benefits provided by eligible small business employers to their employees are normally exempt from FBT (refer to ChapterÂ€13). 55 No FBT is payable on salary and wages your employer paysÂ€you. 55 No FBT is payable on contributions your employer makes to a complying superannuation fund on your behalf. In addition to your current employees, the FBT provisions continue to apply to any benefits you provide to your former employees. It also applies to future employees you intend to employ. For example, you may offer an incentive to someone to work for you in the future, such as paying their school fees if they agree to work for you on completion of their studies. Under the FBT provisions, a principle known as the otherwise deductible rule applies to tax deductible expenses. Under this rule, if an employer pays a tax deductible expense on behalf of an employee (such as a subscription to a trade union),

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Part IV: Running a Business the taxable value of the fringe benefit is reduced to nil. This interpretation applies because if the employee rather than the employer paid the expense, it would have been a tax deductible expense to the employee. In other words, the employer claims the tax deductible expense rather than the employee. If you provide fringe benefits to your employees and your FBT liability is greater than $3,000, you’re required to pay FBT in quarterly instalments. If this situation applies to you, you need to register for FBT. On the other hand, if the amount is less thanÂ€$3,000, you can pay the tax when you lodge your annual FBT return.

Calculating the FBT If you give an employee a fringe benefit, you need to follow three steps to calculate the amount of FBT you’re liable toÂ€pay, namely:

1. Calculate the taxable value. The taxable value depends on the type of benefit you provide to your employee (see the sidebar ‘Case study: Calculating fringe benefits tax on Elise’s cheap loan’) and you need to keep accurate records to calculate and verify its value.

2. Gross up (increase) the taxable value of the fringe benefit. How you gross up the taxable value depends on whether you’re registered for GST: • If you’re registered for GST and entitled to claim a GST credit, you multiply the taxable value by 2.0647 (referred to as typeÂ€1). • If you’re not registered for GST and you’re not entitled to claim a GST credit, you multiply the taxable value by 1.8692 (referred to as typeÂ€2).

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3. Calculate the FBT payable. Multiply the grossed-up taxable value by 46.5Â€perÂ€cent for the FBT financial year ending 31Â€MarchÂ€2011. For later FBT financial years, you can check the Tax Office website (www.ato.gov.au).

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193

Chapter 16: Living on the Fringe: FringeÂ€Benefits Tax

Case study: Calculating fringe benefits tax on Elise’s cheap loan Elise’s employer gives her a $20,000 cheap loan to buy a car for her per‑ sonal use. The rate of interest her employer charges her is 5 per cent. According to the FBT provisions, her employer must charge her a statutory rate of interest to avoid being liable to pay FBT. The statutory rate for the 2010–11 FBT year is 6.65Â€perÂ€cent. Her employer isn’t registered forÂ€GST.

As the interest charged (5 per cent) is below the statutory interest rate (6.65Â€ perÂ€ cent), Elise has received a loan fringe benefit to buy a car for her personal use. Her employer is liable to pay FBT on the difference between the statutory rate of interest (6.65Â€ perÂ€ cent) and the amount of interest charged (5Â€ perÂ€ cent) (that is, $20,000 loanÂ€ìÂ€1.65%Â€=Â€$330).

Calculate the taxable value. $20,000 ì (6.65% - 5%) = $330. Calculate the grossed-up taxable value. As the loan isn’t a taxable supply, her employer multiplies the taxable value byÂ€1.8692 (typeÂ€2): $330 ì 1.8692 = $616. Calculate FBT payable. $616 ì 46.5% = $286 Elise’s employer is liable to pay $286 FBT and can claim a $616 tax deduction ($330 cost of providing fringe benefits plus $286 FBT paid).

Calculating a Car’s FBT You can calculate a car fringe benefit in two ways — the statutory formula method and operating cost method. You can use either method.

Using the statutory formula method Under the statutory formula method, you use the following formula to calculate the car’s taxable value. (ABC)/D - E

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Part IV: Running a Business Where: A = Base value of the car (cost price) B = Statutory fraction (see the following information ‘Statutory fraction’) C = Number of days during the year the car benefit was provided by the employer D = Number of days in the tax year E = Your contribution towards the car’s running costs

Statutory fraction The statutory fraction varies in accordance with the number of kilometres travelled during the year.

Kilometres

Statutory Fraction

Fewer than 15,000

0.26

15,000 to 24,999

0.20

25,000 to 40,000

0.11

More than 40,000

0.07

Calculating a car’s FBT using the statutory formula method Using the following information, you can calculate the taxable value (see the sidebar ‘Case study: Tula’s salary package’): A = $40,000 B = 0.2 C = 365 days D = 365 days E = nil Taxable value: ($40,000 ì 0.2 ì 365)/365 - 0 = $8,000 Calculate grossed-up taxable value: $8,000 ì 2.0647 = $16,517 The FBT payable is $16,517 ì 46.5% = $7,680

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Chapter 16: Living on the Fringe: FringeÂ€Benefits Tax

195

Using the operating cost method Under the operating cost method, you use the following formula to calculate the car’s taxable value. C ì (100% - BP) - R Where: C = Operating cost for holding period BP = Percentage of business use R = Your contribution towards the car’s upkeep If the car is owned by the person providing the fringe benefit, the operating costs include fuel, repairs and maintenance, and registration or insurance charges attributable to the period, plus depreciation (statutory rate is 25Â€perÂ€cent) and imputed interest (a rate of interest even if you didn’t pay any based on the statutory interest rate). In this case, the following information is used to calculate the taxable value. (See the sidebar ‘Case study: Tula’s salary package’.) C = $14,000 BP = 50% R = nil Taxable value: $14,000 ì 50% = $7,000 Calculate grossed-up taxable value: $7,000 ì 2.0647 = $14,452 The FBT payable using the operating cost method is $14,452 ì 46.5% = $6,720

Packaging Your Salary Under a salary packaging arrangement, your employer may offer you a range of options about how you want to be paid. For example, you can elect to be paid in cash, part cash and

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Part IV: Running a Business part benefits, or benefits only. The option you select ultimately determines how you’re taxed. As far as the Tax Office is concerned, as long as the correct amount of tax is paid in respect of your pay packet, everyone is happy — because, if you elect to receive the cash only option, you pay the tax at your marginal rates. On the other hand, if you receive the benefits instead of cash, then your employer pays tax on the fringe benefits you receive.

Case study: Tula’s salary package Tula Jones works as a marketing executive for a large manufacturing company. She is offered the choice of receiving a $100,000 cash salary or $50,000 cash salary plus the following benefits:

U Tula is liable to pay tax on $50,000 at her marginal rates plus a 1.5Â€ perÂ€ cent Medicare levy. Her employer can claim a tax deduction in respect of the $50,000 salary it pays her.

U $150,000 personal loan to buy her home at an interest rate of 5Â€perÂ€cent.

Tula’s employer is liable to pay FBT on the benefits she receives, as follows:

U $1,000 diamond subscription to the Collingwood Football Club. U Tula’s employer to pay her workrelated expenses to the value ofÂ€$750. U A car for her personal use. The car’s cost price is $40,000. During the FBT financial year Tula travels 24,000 kilometres, of which 12,000 kilometres are for business use. Her total running costs are $14,000 and she makes no personal contributions to the car’s running costs. Her employer is registered for GST. If Tula elects to take a $100,000 salary, her entire income is taxed at her marginal rates. However, after discussing the matter with her tax agent, Tula elects to take the salary package. The salary package is taxed as follows:

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U FBT payable on the $150,000 personal loan and the $1,000 subscription to the Collingwood Football Club is calculated in accordance with the three steps mentioned in the section ‘Calculating the FBT’, earlier in this chapter. U With respect to Tula’s $750 workrelated expenses, under the otherwise deductible rule the taxable value of the fringe benefit provided is reduced to nil, because the employer claims these expenses rather than Tula. U In this case, Tula is best to use the operating cost method to calculate the car fringe benefit. Tula’s employer can claim a tax deduction for all the fringe benefits provided to her, as well as the amount of tax payable.

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Chapter 17

Getting Wealthy: CGT and Small Business In This Chapter `Ùnderstanding CGT concessions for small business ``Being rewarded for running a business: CGT exemptions

T

o encourage you to set up and run a small business and employ someone, the federal government has introduced a number of tax incentives. One of the tax incentives relates to capital gains you may make on disposal of business assets. (You may be liable to pay capital gains tax (CGT) on gains you make when you sell or otherwise dispose of CGT assets such as shares, real estate and collectables you acquired on or after 20Â€SeptemberÂ€1985.) The tax incentives are extremely beneficial if you’re contemplating retiring soon and you’re sitting on business assets that have increased in value. In this chapter, I examine these small business concessions and explain what you need to do to qualify for them.

Keeping What You Sow: Tasting the Tax Incentive Goodies Under the CGT concessions for small business, you may qualify for CGT relief when you dispose of certain CGT assets. These concessions are available to 55 Individuals who run a business as a sole trader 55 A partner in a partnership 55 A company 55 A trust

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Qualifying for CGT relief Everyone who runs a business can potentially qualify for CGT concessions. However, before you can taste the goodies, you need to satisfy a number of conditions. Under these provisions, if you run a small business and you make a capital gain on disposal, the gain can be potentially reduced or eliminated if you satisfy one of the following basic conditions: 55 The $6 million net value of business assets test (the value of your net business assets can’t exceed $6Â€million) 55 If the net value of your business assets exceeds $6Â€million, an aggregate turnover of less than $2Â€million test (your business takings must be less than $2Â€million each financialÂ€year) As a general rule, you’re unlikely to have any difficulty passing one of the two basic conditions mentioned in the preceding list, especially the $6Â€million question. If you’re on the borderline, you’re best to seek professional advice, because you need to satisfy complex technical rules. For a comprehensive discussion on these conditions, refer to the Tax Office publication ‘Am I eligible for the small business entity concessions?’ (www.ato.gov.au). In addition to the preceding two conditions, the CGT assets that you own must be active assets. Active assets are assets you own and use (or hold ready for use) in running your business. Active assets can include 55 Your business premises 55 Your plant and equipment 55 Intangible assets such as goodwill or trademarks

CGT assets that don’t qualify for CGTÂ€relief CGT assets that don’t qualify for CGT relief are those that are used to derive passive income such as a rental property your business may own. Again, if you’re not sure about which

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199

assets do or don’t qualify, you need to seek professional advice because you need to satisfy precise rules. The CGT small business concessions don’t apply to capital gains on disposal of depreciable assets that your business owns.

Businesses operated through a company or trust If you operate your business through a company or trust and the CGT asset is a share or interest in a trust, you need to pass the 20Â€perÂ€cent significant individual test to gain the small business concessions. This test examines whether an individual has at least a 20Â€perÂ€cent small business participation percentage (ownership and control percentage) in respect of: 55 The voting power an individual is entitled to exercise in running the business 55 Entitlement to receive any income distributions the business makes 55 Entitlement to receive any capital distributions the business may make This rule means that a maximum of five significant individuals can benefit under this test, provided each individual holds a 20Â€perÂ€cent stake in the company or trust. This rule becomes an important issue to consider if you’re planning to set up a business structure (refer to ChapterÂ€12), especially if more than five individuals own stakes in the company or trust, or you have only a small stake in the business. If you’re the spouse of an individual who satisfies the 20Â€perÂ€cent significant individual test and you hold a small stake in the company (for example, 5Â€perÂ€cent), you also qualify for the CGT small business concessions. This rule means that up to eight individuals can qualify, namely, fourÂ€significant individuals and their respective spouses. For a comprehensive discussion on this test, see the Tax Office (www.ato.gov.au) fact sheet ‘Significant individual test’.

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CGT Concessions for Small Business If you satisfy the basic conditions tests for CGT relief, four CGT concessions are available to you under the CGT concession for small business: 55 CGT 15 year exemption 55 CGT 50 per cent active asset reduction 55 CGT retirement exemption 55 CGT rollover concession You can qualify for more than one small business concession. For example, you can take advantage of the CGT 50Â€perÂ€cent active asset reduction concession and, then, use the $500,000 lifetime retirement exemption concession and/or the CGT rollover concession. If you intend to seek relief under the CGT small business concessions, you need to take into account current year losses, prior year losses and any 50Â€perÂ€cent CGT discount you may be entitled to claim on CGT assets held for more than 12Â€months.

Checking out the 15Â€year exemption The CGT 15 year exemption concession rewards those individuals who have been running a business for a minimum of 15Â€years. Under this concession any capital gain you make on disposal of an active (business) asset is exempt from tax. To qualify for CGT relief you need to satisfy the following conditions: 55 You must have continually owned your active (business) asset for at least 15Â€years. 55 It must have been an active (business) asset for at least a half of the relevant 15-year period (that is, 7.5Â€years). 55 You must be over 55Â€years of age and retired, or permanently incapacitated. If you satisfy these conditions, you don’t have to consider the other three CGT concessions for small business discussed in the following sections because your capital gain is going to be fully

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exempt. Further, if you make any capital losses, you don’t have to deduct them from the capital gains you made. If you put the CGT proceeds from a sale into a complying superannuation fund, you can treat the amount as nonconcessional contributions that aren’t taxed in the super fund. The proceeds help fund your retirement strategies (for more details see ChapterÂ€18). To fulfil this rule correctly, you need to make a CGT cap election. You have to make this election because eligible small business owners can claim a lifetime $1,155,000 (indexed) CGT cap amount (perÂ€2010–11 rates) as well as the non-concessional amounts they can normally make (see ChaptersÂ€13 andÂ€18).

Getting a helping hand: 50Â€perÂ€centÂ€reduction Under this CGT concession, you can get a 50Â€perÂ€cent reduction on the capital gain you make. Ordinarily, if you own a CGT asset for more than 12Â€months, you also qualify for a 50Â€perÂ€cent discount (for more details refer to ChapterÂ€11). This concession means that if you own the CGT asset for more than 12Â€months you stand to gain a 75Â€perÂ€cent discount. For example, if the gain is $100, the first 50Â€perÂ€cent discount reduces the gain to $50, while the second 50Â€perÂ€cent discount reduces the gain to $25 (which is an overall decrease of 75Â€perÂ€cent). However, if you don’t want to pay tax on the balance of the capital gain you make, you can use the other methods (the CGT small business rollover concession and/or the CGT retirement concession) to gain additional relief. To use this 50Â€perÂ€cent active asset method, follow these four steps (these four steps are illustrated in the sidebar ‘Case study: Using the CGT 50Â€perÂ€cent reduction concession’).

1. Calculate the capital gain you make on disposal of your active (business) asset.

2. Deduct any current year capital losses and prior year losses from the capital gain you make (if applicable).

3. Claim the 50Â€perÂ€cent CGT discount, if you hold the CGT asset for more than 12Â€months.

4. Apply the small business CGT 50Â€perÂ€cent active reduction concession.

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Case study: Using the CGT 50Â€perÂ€cent reduction concession Anita has been in business for 10Â€years. During the financial year, she makes a $25,000 capital gain on sale of an active (business) asset she has owned for the past 5Â€years. She also makes a $5,000 capital loss. The amount of the capital gain liable to tax using the CGT 50Â€ perÂ€ cent active asset reduction concession is calculated as follows: Capital gain on active asset Less capital loss

$25,000 $5,000 $20,000

Less 50% CGT discount

$10,000

Less 50% small business reduction

$5,000

$10,000

NET CAPITAL GAIN

$5,000

Anita can either pay tax on the $5,000 net capital gain she made, or apply for further relief under the CGT small business rollover concession and/or CGT retirement concession.

If you run your business through a company structure (refer to ChapterÂ€12), a company isn’t entitled to a 50Â€perÂ€cent discount on sale of CGT assets that are held for more than 12Â€months.

Thinking about retiring: Retirement concession Under the CGT retirement concession, you can claim a $500,000 lifetime retirement exemption on the proceeds of the sale of your active (business) assets. You can get immediate CGT relief if you’re over 55Â€years of age and use this concession. Unfortunately, if you’re under 55Â€years of age, you need to roll over (transfer) the proceeds into a complying superannuation fund, a complying approved deposit fund or retirement saving account.

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Transferring your gains: RolloverÂ€concession The rollover concession allows you to reinvest the proceeds from a capital gain in a replacement asset or make improvements to existing assets. As a general rule, you need to apply the capital gain against assets you buy within oneÂ€year before the sale or against assets you intend to buy within the next twoÂ€years. You may find helpful the following publications from the Tax Office (www.ato.gov.au): 55 ‘Guide to capital gains tax concessions for small business (NATÂ€8384)’ 55 ‘Advanced guide to capital gains tax concessions for small business (NATÂ€3359)’ 55 ‘Significant individual testÂ€— fact sheet’ 55 ‘Am I eligible for the small business entity concessions?’ 55 ‘Tips for claiming CGT concessions for small business’

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Part V

Thinking Long Term Glenn Lumsden

‘I did eventually inherit the Earth, but the tax department took most of it back and I was too meek to argue about it.’

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A


n old saying goes along the lines of ‘no-one knows what’s around the corner’. To ease any possible pain, you’re prudent to think long-term and plan ahead for any unforeseen contingencies. This part of the book looks at issues associated with contributing to a superannuation fund, preparing for retirement and pension options. It also examines how your beneficiaries are taxed when you’re no longer around, as well as business succession planning.

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Chapter 18

Preparing for Retirement Using Superannuation In This Chapter `Èxamining different types of super funds ``Selecting your super fund ``Claiming tax deductions ``Qualifying for government incentives for contributions `Ùnderstanding the conditions of release

S

uperannuation is a scheme to help you fund your retirement. If you’re an employee, your employer has a statutory obligation to make a superannuation contribution on your behalf to a complying super fund. If you’re self-employed, your contributions to a complying super fund are tax deductible. This money is invested on your behalf and can’t be accessed until you satisfy a condition of release such as when you retire. In this chapter, I guide you through the different types of super fund and the benefits you stand to gain when you retire. (For more about superannuation, check out Superannuation For Dummies, 2nd Edition, by Trish Power, published by Wiley Publishing.)

Complying and Non-Complying Super Funds You can contribute money to two types of superannuation funds: Non-complying and complying.

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Part V: Thinking Long Term

Non-complying superannuation funds Non-complying superannuation funds haven’t made an election to be regulated under the Superannuation Industry (Supervision) Act 1993 (SIS Act), or have failed to meet certain standards prescribed by the federal government. These funds don’t qualify for any federal government concessions and are liable to pay tax at the rate of 45Â€perÂ€cent (rather than 15Â€perÂ€cent as is the case with complying funds).

Complying superannuation funds Complying superannuation funds have made an election to be regulated under the SIS Act. Superannuation funds must agree to be regulated to qualify for certain federal government concessions. All the major Australian superannuation funds are regulated funds. Being a complying superannuation fund becomes an issue only if you decide to set up your own super fund. In this Chapter,Â€I confine my discussions to complying superannuation funds. The basic points to note about complying super funds are 55 Complying superannuation funds pay tax at the rate of 15Â€perÂ€cent. The amount of tax payable can be reduced if a super fund receives dividend franking credits (refer toÂ€ChapterÂ€9). 55 Pensions payable to individuals aged 55 to 59 qualify for a 15Â€perÂ€cent tax offset (credit or rebate). 55 Pensions and lump sums paid to members after age 60 are tax free. 55 Income and capital gains to fund pension options are exempt from tax.

Choosing a Goose to Lay the Golden Egg On 1 July 2005, the federal government introduced choice of superannuation fund legislation. Its purpose is to give you the option to select your own superannuation fund or retirement savings account to help fund your retirement. Under this initiative, you can elect to which fund your employer is to make

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Chapter 18: Preparing for Retirement Using Superannuation

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your future compulsory superannuation contributions. If you have no particular preference, your employer chooses a default superannuation fund for you. If you want to know more about the choice legislation, check out Superannuation: Choosing a Fund For Dummies, by Trish Power, published by Wiley Publishing or go to the Tax Office website (www.ato.gov.au) and read ‘Choosing a super fund — How to complete your Standard choice form (NATÂ€13080)’. You can contribute money to four types of superannuation fund: 55 Industry funds: Set up for specific industries. 55 Public sector funds: Set up specifically for government employees. Normally, you have to be a government employee to make a contribution to these funds. 55 Retail funds: Set up by Australia’s leading financial institutions, such as banks and insurance companies. 55 Self-managed superannuation funds: Set up by individuals who prefer to manage and operate their own superannuation fund. You can generally make a contribution to any of these funds (except government funds because for this type of fund you need to be a government employee). You’re also at liberty to roll over (transfer) your account balance between superannuation funds if you’re dissatisfied with their performance. The issues you need to consider when choosing a particular fund to grow your nest eggÂ€include 55 The fees and commissions you’re charged. This issue is a very important point to consider because fees and commissions can adversely affect the overall growth of your nest egg. You need to find out what fees and commissions you pay, why you have to pay them and how they’re calculated. 55 Insurance options, particularly death and disability insurance (from 1Â€JulyÂ€2008, employer-nominated funds must offer life insurance death cover to members). Knowing to what extent you’re covered in the event of death or disability is just plain common sense.

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Part V: Thinking Long Term 55 Investment options that you’re relying on to grow your capital and fund your retirement. It’s important that you’re aware of the investment risks you’re taking and the fact that investments can decrease in value. 55 The services and special features that superannuation funds can offer their members (the more the merrier). You can find out information about super fund fees, insurance and investment options, and services and features from the super fund’s Product Disclosure Statement (a document that summarises all the important information you need to know about joining a fund).

Shopping around: Retail funds Retail funds are operated by all the major Australian banks and insurance companies. They’re open to the general public and are suitable for people who prefer someone to manage a superannuation fund on their behalf. The fees they charge are normally based on a percentage of the amount you have in yourÂ€account. The Association of Superannuation Funds of Australia (ASFA) website (www.superannuation.asn.au) provides a comprehensive list of retail funds to which you can contribute money to fund your retirement.

Working long hours: Industry funds Industry funds are generally not-for-profit superannuation funds set up by specific industries for their employees. These funds are open to the general public and the fees they charge are generally lower than those operated by retail funds. Check out the Industry SuperFunds website (www. industrysuper.com) to find out more about industry superannuation funds.

Doing it yourself: Setting up your own fund Self-managed superannuation funds (SMSF) are funds you personally set up and run yourself. Under this arrangement, you

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select the investment strategy to fund your retirement and you can pay yourself a pension when you retire. A significant benefit is you’re in total control of your superannuation fund. Although running your superannuation fund may sound like a great idea, you must comply with a number of restrictive rules.

Checking out the rules If you want to set up your SMSF, you must agree to be regulated (usually by the Tax Office) in order to qualify for certain tax concessions. Professionals who hold an Australian Financial Service Licence (for instance financial planners and certain accountants) can help you set up a SMSF. You must make an election to be regulated within 60Â€days of establishing your SMSF. If you make an election within the prescribed time, you need to comply with the following majorÂ€rules: 55 You can’t have more than four members in your fund. 55 The sole purpose of setting up your own super fund must be to provide benefits to members upon their retirement, or provide benefits to dependants in the event of your death. This rule means you can’t use the fund to help fund your current lifestyle. Further, you could breach the ‘sole purpose’ test (or some other regulation) if you conduct certain business activities. For more details read the Tax Office publication ‘Carrying on a business in a self-managed superannuation fund’. 55 You can’t mix your personal assets with your superannuation fund assets. 55 You must keep proper records. 55 You must set up an investment strategy outlining how you intend to invest your money to help fund your retirement. 55 Your super fund can’t lend money to you. 55 You can’t lend money to your super fund. 55 All your financial transactions must be done at ‘arm’s length’ (that is, on a strictly commercial basis). 55 As a general rule your super fund can’t borrow money (see Tip following).

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Part V: Thinking Long Term 55 You can’t access your funds until you satisfy a condition of release such as when you retire (for more conditions of release, see the section ‘Getting the Money: Conditions of Release’ later in this chapter). 55 You must appoint an independent auditor to verify you’re complying with all the rules. A SMSF can accept listed securities (such as shares listed on the Australian Securities Exchange) from its members. These contributions are treated as if you were making cash contributions and they’re taxed in the same way as cash contributions. Note: If you’re running a business, you can transfer your business real property (that is, your business premises) to your super fund and lease it back at a commercial rate of rent. A SMSF can borrow to buy certain approved investment assets such as property. But strict rules apply. For more details, check out the Tax Office publication ‘Limited recourse borrowing arrangements by self-managed super funds — questions and answers’. If you fail to comply with these strict rules, the Tax Office treats your fund as a non-complying superannuation fund, which means you become liable to pay tax at the rate of 45Â€perÂ€cent. Check out DIY Super For Dummies, by Trish Power (Wiley Publishing), for all you need to know about SMSFs — a specialist microcosm of the entire sector of superannuation.

Getting help from the Tax Office with SMSFs If you want to know more about setting up and running a SMSF, visit the Tax Office website (www.ato.gov.au) and read the following publications: 55 ‘A look at self-managed super funds’ 55 ‘Thinking about self-managed super (NAT 72579)’ 55 ‘Running a self-managed super fund (NAT 11032)’ 55 ‘Self managed superannuation fund — key messages for trustees (NAT 71128)’ 55 ‘Legal responsibilities for self-managed superannuation funds’ 55 ‘Setting up a self-managed super fund (NATÂ€71923)’

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Taxing Your Nest Egg At the end of the financial year, superannuation funds (including SMSFs), are required to lodge an annual superannuation fund tax return by 31Â€October that discloses taxable income, unless otherwise included on a tax agent’s lodgement program. For more details, read the Tax Office publication ‘Completing the self managed super fund annual return’ online at www.ato.gov.au When you lodge your annual superannuation fund tax return, you must pay a $150 supervisory levy. And, your fund must be audited by an appropriately qualified accountant, before you can lodge the return.

Taxing super funds A superannuation fund is liable to pay tax on receipts from threeÂ€major sources: 55 Income derived from the superannuation fund’s investment activities 55 Capital gains when the superannuation fund disposes of its investment assets 55 Concessional contributions (before-tax contributions, see the section ‘Examining concessional and non-concessional contributions’ later in this chapter) from members who can claim a tax deduction (such as employers and the self-employed) If an employer makes a concessional contribution to a complying superannuation fund on behalf of an employee, the contribution is a tax deductible expense. Under these circumstances, the contributions are treated as assessable income and the super fund is liable to pay tax at the rate of 15Â€perÂ€cent. This rule also applies when a self-employed or substantially self-employed person makes a concessional contribution to a complying superannuation fund. To offset the 15Â€perÂ€cent tax payable on concessional contributions to a complying superannuation fund, the federal government proposes (from 1 July 2013) to contribute up to $500 on your behalf (if you earn less than $37,000 a year).

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Part V: Thinking Long Term The maximum concessional contribution that qualifies for a tax deduction is $25,000 a year (indexed) if you’re under 50Â€years of age, or $50,000 a year (non-indexed) if you’re over 50Â€years of age between 1Â€JulyÂ€2007 and 30Â€JuneÂ€2012 and you’re under 75Â€years of age. From 1 July 2012, the federal government proposes that if you’re over 50Â€years of age you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund. A self-employed person is someone who receives no superannuation support from an employer. You’re considered to be substantially self-employed if less than 10Â€perÂ€cent of your assessable income is derived from a superannuation-supported source (for example, from salary and wages). If an employee is over 75Â€years of age, an employer can still make superannuation contributions that are required under certain industrial awards. For a concessional contribution to qualify as a tax deductible expense, the person making the contribution must inform the trustee of their super fund that they intend to claim a taxÂ€deduction. If you want to claim a tax deduction for a superannuation contribution, you must lodge a notice of intent to claim a tax deduction for super contributions or vary a previous notice (check out the Tax Office publication: ‘Deduction for personal super contributions — NATÂ€71121’). You must show how much is claimed as a tax deduction and confirm that it wasn’t covered by an earlier notice.

Claiming a tax deduction In ChapterÂ€2, I point out that you can claim a tax deduction in respect of expenses you incur in deriving your assessable income. For an expense to be deductible under the general deduction provisions, you must be able to show a relevant and necessary connection between the expenditure you incur and earning your assessable income.

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Case study: Calculating the taxable income During the financial year, Apex com‑ plying superannuation fund receives a $40,000 concessional contribution from a self‑employed member. The member informs the trustee of the super fund that they intend to claim a tax deduction for the contribution made. Under these circumstances, the $40,000 contribution is treated as assessable income. The fund derives $42,000 dividends that are fully franked

from its investment activities and the franking credits were $18,000. (For more details about franking credits, refer to ChapterÂ€ 9.) It also makes a $21,000 capital gain on sale of shares held for more than 12Â€ months. The fund’s deductible expenses are $4,000. Apex complying superannuation fund’s taxable income is calculated as follows:

Superannuation fund return Income Concessional contributions Dividends

â•⁄ $40,000 Franked amount

â•⁄ $42,000

Franking credits

â•⁄ $18,000

Net capital gain (see Note 1)

â•⁄ $14,000

TOTAL INCOME OR LOSS

$114,000

Less deductible expenses

â•⁄â•⁄ $4,000

TAXABLE INCOME

$110,000

Calculation of tax payable/refund TAX PAYABLE (15% of $110,000)

â•⁄ $16,500

Less Dividend franking credits

â•⁄ $18,000

REFUND OF TAX

â•⁄â•⁄ $1,500

Note 1: Because the shares are held for more than 12 months, just two‑ thirds of the gain is liable to tax ($14,000).

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Part V: Thinking Long Term The following expenses are examples of the types of deductions your super fund can claim: 55 Accountancy fees 55 Actuarial costs 55 Administration and compliance costs, including trustee fees 55 Audit fees 55 Death and disability premiums 55 Insurance 55 Investment advice 55 Legal costs 55 Tax agent fees The cost of amending a superannuation trust deed is also tax deductible. On the other hand, the payment of benefits to members isn’t tax deductible. For a comprehensive discussion on superannuation deductionsÂ€the Tax Office has released taxation ruling ‘TR 93/17 Income tax: income tax deductions available to superannuationÂ€funds’. Interest on borrowings to pay for personal superannuation contributions aren’t tax deductible.

Making a Contribution: Understanding the Rules The taxation issues associated with making a contribution to a complying superannuation fund depend on whether: 55 The contribution is a concessional or non-concessional contribution. Only concessional contributions are tax deductible (see next section).

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55 You’re under or over the age of 65Â€years. The amount you can put into a super fund each year depends on your age at the time you make the contribution. After you turn 65 you have to satisfy an employment test to make a contribution (see the section ‘Getting older: Under and over 65Â€years’, later in this chapter). 55 You’re an employee, employer, self-employed or substantially self-employed. Only an employer, selfemployed or substantially self-employed person can claimÂ€aÂ€tax deduction for a contribution to a super fund (see the sections ‘Helping out the boss: Employee’ andÂ€‘Working for yourself: Self-employed’, later in this chapter). Further, you may qualify for government concessions if you make a non-concessional contribution (a contribution that doesn’t qualify for a tax deduction, see next section). In Figure 18-1, I illustrate the rules associated with making a contribution to a complying superannuation fund.

Superannuation contributions

Concessional contributions

Under 50 years

Non-concessional contributions

Over 50 years (July 2007–June 2012) and under 75 years

Maximum $25,000 pa

Maximum $50,000 pa

Liable to 15% tax

Liable to 15% tax

$450,000 over 3 years

Excessive contributions liable to additional 31.5% tax

Under 65 years

65–74 years

Over 75 years

Maximum $150,000 pa

Maximum $150,000 pa

Nil

No employment test applies

Employment test applies

Excessive contributions liable to additional 46.5% tax

Figure 18-1: Making a superannuation contribution.

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Examining concessional and non-concessional contributions You can make two types of contribution to a superannuation fund: 55 Concessional contribution: A concessional contribution is a contribution that qualifies as a tax deduction and can be made only if you’re an employer or self-employed (or substantially self-employed). 55 Non-concessional contribution: A non-concessional contribution is a contribution that doesn’t qualify for a taxÂ€deduction.

Concessional contributions Concessional contributions become assessable income in the superannuation fund and are taxed at the rate of 15Â€perÂ€cent. Concessional contributions in excess of $25,000 (indexed) per employee per annum (or $50,000 non-indexed if you turn 50 between 1 July 2007 and 30Â€JuneÂ€2012 and you’re under 75Â€years of age) are taxed at the additional rate of 31.5Â€perÂ€cent (refer to FigureÂ€18-1). From 1 July 2013, if you earn less than $37,000, the federal government proposes to contribute up to $500 on your behalf to eliminate any tax payable. And, from 1Â€JulyÂ€2012, if you’re over 50Â€years of age, you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund. Individual superannuation fund members can split concessional contributions made in the previous financial year with their (non-income or low-income-earning) spouses or partners. The maximum permitted is 85Â€perÂ€cent of the concessional contributions cap (see Tax Office publication ‘Contributions splitting (NATÂ€15237)’ for more details). Note: Under new proposed superannuation rules, this approach may be worth considering if you’re over 50Â€years of age, and your super fund balance is close to $500,000 (see AppendixÂ€A).

Non-concessional contributions Non-concessional contributions are treated as a capital contribution in a superannuation fund and aren’t liable to tax. For the rules that govern you when you’re under or over 65Â€years, see the next section.

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Getting older: Under and over 65Â€years If you’re under the age of 65Â€years, no restrictions prevent you from making a non-concessional contribution to a complying superannuation fund. If you’re between 65Â€and 74Â€years, you need to satisfy an employment test to make a superannuation contribution. Under this test, you have to work a minimum 40Â€hours over 30Â€consecutive days during the financial year. However, as soon as you turn 75Â€years of age you can’t make a non-concessional contribution to a complying superannuationÂ€fund. You can contribute a maximum of $150,000 a year (indexed) non-concessional contributions. Alternatively, you can make a $450,000 (indexed) non-concessional contribution over a threeyear period, provided you’re under the age of 65Â€years at the time you make the payment. Excessive contributions are taxed at the rate of 46.5Â€perÂ€cent (refer to FigureÂ€18-1).

Helping out the boss: Employee If you’re an employee, your employer has a statutory obligation to make a concessional contribution on your behalf to a complying superannuation fund. This amount (called superannuation guarantee contribution) is currently 9Â€per cent of the gross salary you derive. As an employee, you can also make additional contributions under a salary sacrifice arrangement, where extra superannuation contributions are deducted from your gross pay. However, you can’t claim a tax deduction for the amount you contribute. Both the employer and employee portion is limited to $25,000 a year (indexed) if you’re under 50Â€years of age, or $50,000 a year non-indexed if you’re over 50 between 1Â€JulyÂ€2007 and 30Â€JuneÂ€2012 and under 75Â€years of age (refer to FigureÂ€18-1). From 1 July 2012, the federal government proposes to increase the superannuation guarantee contribution in stages, to 12Â€perÂ€cent by 2019–20 (see AppendixÂ€A). And, from 1 July 2012, if you’re over 50Â€years of age, you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund.

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Being in charge: Employer contributions An employer can make concessional contributions on behalf of an employee under the age of 75Â€years. Contributions up to $25,000 a year (indexed) per employee under 50Â€years or $50,000 a year (non-indexed) if you’re over 50 between 1Â€JulyÂ€2007 and 30Â€JuneÂ€2012 and under 75Â€years of age are tax deductible. However, these contributions are taxed in the superannuation fund at the rate of 15Â€perÂ€cent. Contributions that exceed these limits are taxed at the additional rate of 31.5Â€perÂ€cent (refer to FigureÂ€18-1). From 1 July 2012, if you’re over 50Â€years of age, you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund.

Working for yourself: Self-employed A concessional contribution made by a self-employedÂ€or substantially self-employed person (someone where less than 10Â€perÂ€cent of total assessable income comes from employment as an employee) to a complying superannuation fund is a tax deductible expense. The maximum concessional contribution that qualifies for a tax deduction is $25,000 a year (indexed) if you’re under 50Â€years of age, or $50,000 a year non-indexed if you’re over 50Â€years of age between 1Â€JulyÂ€2007 and 30Â€JuneÂ€2012 and under 75Â€years of age (refer to FigureÂ€18-1). From 1 July 2012, if you’re over 50Â€years of age, you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund. Although making a concessional contribution to a complying superannuation fund is a tax deductible expense, you need to be aware of a major limitation if you’re self-employed (or substantially self-employed): These contributions are only deductible to the extent that you have a taxable income. This rule applies because concessional contributions can’t create or increase a tax loss. For example, if your taxable income is $20,000 and you make a $25,000 concessional contribution, you can claim only $20,000, because the excess ($5,000) creates a taxÂ€loss.

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If less than 10Â€perÂ€cent of your total assessable income (and reportable fringe benefits) comes from employment as an employee and you make a personal contribution to a complying superannuation fund, the amount you contribute is also a tax deductible expense. This situation can arise if you’re selfemployed, substantially self-employed or under 65Â€years and not in full-time employment (for example, you’re a retiree engaged in investment activities).

Getting what is due: Government incentives The federal government provides two tax incentives to encourage low-income earners to make a contribution to a complying superannuation fund: 55 Co-contribution scheme: If your total assessable income is less than $31,920 and you make a non-concessional contribution of $1,000 to your superannuation fund, under the co-contribution scheme (refer to ChapterÂ€5 for more information about this scheme) the federal government makes a $1,000 contribution on your behalf (see AppendixÂ€A). Taking up this federal government offer is a good way of getting free money for putting $1,000 into your super fund. However, this amount reduces as you earn more money and ceases as soon as you earn more than $61,920 a year. This benefit applies to employees and individuals who are self-employed (or substantially self-employed). 55 Spouse contribution: If your spouse’s assessable income is $10,800 or less in a financial year, you may be able to qualify for a $540 tax offset. To qualify for the maximum, you need to make a $3,000 spouse contribution to a complying superannuation fund or retirement savings account operated by an approved financial institution. The tax offset is progressively reduced if your spouse earns more than $10,800 a year, and fully phases out if your spouse earns more than $13,800 a year.

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If you want to know more about spouse contributions, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘Superannuation spouse contribution tax offset’.

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Part V: Thinking Long Term From 1 July 2013, if you earn less than $37,000 a year and a concessional contribution is made to your superannuation fund, the federal government proposes to contribute up to $500 on your behalf. This amount is to offset the 15Â€perÂ€cent tax payable on concessional contributions to a complying superannuation fund; and your fund balance increases accordingly.

Getting the Money: Conditions ofÂ€Release Over a number ofÂ€years, the nest egg in your super fund is likely to grow substantially. To access your accumulated benefits you have to satisfy a condition of release. The main conditions are 55 Benefits not exceeding $200 55 Compassionate grounds 55 Death of member (see ChapterÂ€20) 55 Permanent incapacity 55 Physical or mental ill health 55 Retirement 55 Severe financial hardship 55 Temporary incapacity 55 Temporary residents (departing Australia) 55 Terminal medical condition The most common condition of release is your retirement. In Figure 18-2, I illustrate how you’re taxed when you receive a lump sum payment from your super fund. When you examine Figure 18-2, you see that the amount of tax you’re liable to pay depends on your age at the time you withdraw your benefits and whether the payment is a tax free component and/or taxable component.

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When you receive a payment from a superannuation fund, the payment can consist of three components: 55 Tax free component: Payments that are tax free and excluded from taxable income. They include nonconcessional contributions and certain other contributions such as CGT exempt components and pre-1983 accumulated amounts. 55 Taxable component — taxed element: Post-July 1983 accumulated benefits in a super fund that was liable to tax. These payments are liable to tax when distributed, but are tax free when you turn 60Â€years of age. 55 Taxable component — untaxed element: Post-July 1983 accumulated benefits in a super fund that haven’t been taxed. These payments normally come from certain federal and state government super schemes that don’t pay tax, and proceeds of a life insurance policy, and are liable to tax when distributed.

Financial year Low rate cap amount (LRCA) 2009–10 $150,000 2010–11 $160,000

Superannuation lump sum payments

Taxable component (taxed element)

Under preservation age

Preservation age to 59 years

Untaxed plan cap amount (UPCA) $1,100,000 $1,155,000

Taxable component (untaxed element)

Aged 60 and above


Aged 60 and above

Preservation age to 59 years

Entire amount

Amount up to LRCA

Amount above LRCA

Entire amount

Amount up to UPCA

Amount above UPCA

Amount up to LRCA

Amount between LRCA and UPCA

Amount above UPCA

Amount up to UPCA

Amount above UPCA

Tax rate 21.5%

Tax rate nil

Tax rate 16.5%

Tax rate nil

Tax rate 31.5%

Tax rate 46.5%

Tax rate 16.5%

Tax rate 31.5%

Tax rate 46.5%

Tax rate 16.5%

Tax rate 46.5%

Tax rate includes 1.5% Medicare levy.

Figure 18-2: Receiving a superannuation lump sum payment.

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Accessing your superannuation benefits The section of your annual superannuation benefit statement that deals with access to your benefit lists the following details:

55 You can access restricted nonpreserved benefits when you retire or leave your current employment.

55 You can access preserved benefits when you satisfy a condition of release — such as when you reach your preservation age and retire.

55 Unrestricted non-preservedÂ€ benefits are benefits that you voluntarily keep within the superannuation system after you meet a condition of release. You can access these benefits at any time.

Maturing nicely: Under 55Â€years Ordinarily, if you’re under 55Â€years of age, you can’t access your preserved benefits (the amount that must remain in your super fund) until you reach your preservation age (between 55 and 60Â€years; see TableÂ€18-2 and the next section). In the meantime, your benefits are invested on your behalf until you satisfy a condition of release (refer to the preceding section). If you receive a superannuation lump sum payment from a taxable component — taxed element (an amount that was previously liable to tax), the entire payment is taxed at the rate of 21.5Â€perÂ€cent (including the Medicare levy — refer to ChapterÂ€1). (Payments from this source come from complying superannuation funds that payÂ€tax.) On the other hand, if you receive a superannuation lump sum payment from a taxable component — untaxed element (an amount that wasn’t previously liable to tax), payments up to an untaxed plan cap amount (UPCA) (indexed) are taxed at the rate of 31.5Â€perÂ€cent (including the Medicare levy), while payments in excess of the UPCA (indexed) are taxed at the rate of 46.5Â€perÂ€cent (including the Medicare levy) (refer to TableÂ€18-1 and FigureÂ€18-2). Note: Taxable component — untaxed element payments are normally made from certain governmentoperated superannuation funds that don’t pay tax or a life insuranceÂ€policy.

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Table 18-1

225

Taxable Component — Untaxed Element

Financial Year

Untaxed Plan Cap Amount

2009–10

$1,100,000

2010–11

$1,155,000

For laterÂ€years, see the Tax Office website (www.ato.gov.au).

Reaching your preservation age Before you can retire and access your funds, you need to have reached your preservation age — an age that depends on the date you were born (see TableÂ€18-2).

Table 18-2 Date of Birth

Preservation Age Preservation Age

Before 1 July 1960

55Â€years

1 July 1960 – 30 June 1961

56Â€years

1 July 1961 – 30 June 1962

57Â€years

1 July 1962 – 30 June 1963

58Â€years

1 July 1963 – 30 June 1964

59Â€years

After 30 June 1964

60Â€years

Between 55Â€years and 59Â€years If you’re between your preservation age and 59Â€years and want to access your preserved benefits, you need to satisfy the trustee of your superannuation fund that you have no intention to be gainfully employed for more than 10Â€hours a week. However, you can avoid doing this if you elect to take a transition to retirement pension. Under this option, you can receive a pension while still working (see ChapterÂ€19).

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Part V: Thinking Long Term If you receive a superannuation pension from a taxable component — taxed element, your pension is taxed at your marginal tax rates plus a Medicare levy, but you qualify for a 15Â€perÂ€cent tax offset (see ChapterÂ€19). If you receive a superannuation lump sum payment from a taxable component — taxed element, payments up to the low rate cap amount (LRCA) are tax free, while amounts above the LRCA are taxed at the rate of 16.5Â€perÂ€cent (including the Medicare levy) (see TableÂ€18-3 and FigureÂ€18-2). If you receive a superannuation pension from a taxable component — untaxed element, the pension is taxed at your marginal tax rates plus the Medicare levy (see ChapterÂ€19). If you receive a superannuation lump sum payment from a taxable component — untaxed element, you’re taxed as follows: 55 Amounts up to the LRCA are taxed at the rate of 16.5Â€perÂ€cent (including the Medicare levy). 55 Amounts between the LRCA up to the UPCA are taxed at the rate of 31.5Â€perÂ€cent (including the Medicare levy) (see TablesÂ€18-1 andÂ€18-3 and FigureÂ€18-2). 55 Amounts above the UPCA are taxed at the rate of 46.5Â€perÂ€cent (including the Medicare levy).

Table 18-3 Financial Year

Taxable Component — Untaxed Element Low Rate Cap Amount

2009–10

$150,000

2010–11

$160,000

For laterÂ€years, see the Tax Office website (www.ato.gov.au).

Between 60Â€years and 64Â€years After you turn 60Â€years of age, you need only to terminate your current employment arrangement and satisfy the trustee you’re no longer contributing to your superannuation fund to access your super benefits.

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Chapter 18: Preparing for Retirement Using Superannuation All superannuation pensions and superannuation lump sum payments from a taxable component — taxed element are tax free after you turn 60Â€years of age (see ChapterÂ€19).

If you receive a superannuation pension from a taxable component — untaxed element, you’re liable to pay tax at your marginal tax rates (plus Medicare levy), but you qualify for a 10Â€perÂ€cent tax offset (see ChapterÂ€19). If you receive a superannuation lump sum payment from a taxable component — untaxed element, payments up to the UPCA are taxed at the rate of 16.5Â€perÂ€cent (including the Medicare levy), while payments above the UPCA are taxed at the rate of 46.5Â€perÂ€cent (including the Medicare levy) (refer to TableÂ€18-1 and FigureÂ€18-2).

Feeling great: Over 65Â€years After you reach 65Â€years of age, you can open the champagne bottle and start celebrating. You no longer need to retire to access your superannuation benefits. You can choose when to withdraw your benefits and still remain gainfully employed. Superannuation fund benefits are made up of a combination of tax free components and taxable components. Note: When you turn 60Â€years of age all payments from taxable componentsÂ€— taxed elements are tax free. However, you need to withdraw a combination of any tax free components and taxable components in proportion (ratio) to the total amount held in your superannuation fund. This rule applies so that in the event of your death your beneficiaries are liable to pay tax on any taxable component held in your superannuation fund (see ChapterÂ€20). If you receive a superannuation pension from a taxable component — untaxed element, you’re liable to pay tax at your marginal tax rates (plus Medicare levy) but you qualify for a 10Â€perÂ€cent tax offset (see ChapterÂ€19). If you receive a superannuation lump sum payment from a taxable component — untaxed element, payments up to the UPCA are taxed at the rate of 16.5Â€perÂ€cent (including the Medicare levy), while payments above the UPCA are taxed at the rate of 46.5Â€perÂ€cent (including the Medicare levy) (refer to TableÂ€18-1 and FigureÂ€18-1).

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Chapter 19

Reaping What You Sow: Receiving a Pension and Government Concessions In This Chapter ``Receiving a superannuation pension ``Taxing government pensions and allowances

T

he good old days of popping down to Centrelink and lining up to receive the old age pension when you retire are long gone. Unfortunately, no-one gets a free lunch anymore. The federal government has introduced an income and asset test to restrict your capacity to receive the old age pension. To add salt to the wound, the government has announced its intention to progressively increase the old age pension age (currently 65Â€years) to 67Â€years byÂ€2023. Ouch! The government provides a number of tax incentives to encourage you to put money into a complying superannuation fund and fund your own retirement. In this chapter, I discuss the three pension options that are normally offered to self-funded retirees. Each option has particular features that may appeal to you. I also examine the various types of government pension and allowance that you can receive if you satisfy certain conditions. These payments can be either taxable or exempt from tax.

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Paddling the Superannuation Stream: Types of Super Pension A self-funded retiree can purchase three types of superannuation pension (known as superannuation income streams) with their accumulated benefits: U Transition to retirement pensions (see the next section) U Non-account-based (life) pensions (see the section ‘Understanding non-account-based pensions’ later in this chapter) U Account-based (allocated) pensions (see the section ‘Understanding account-based pensions’ later in this chapter) Keep in mind when you get a superannuation pension that your payment can consist of three components: U Tax free component (refer to ChapterÂ€18) U Taxable component — taxed element (refer to ChapterÂ€18) U Taxable component — untaxed element (refer to ChapterÂ€18) The tax issues that you need to consider depend on your age at the time you receive the pension (see FigureÂ€19-1).

Transition to retirement pensions To encourage you to keep on working rather than taking the early retirement option, the federal government has set up the transition to retirement pension option. A transition to retirement pension allows you to receive a superannuation pension (also known as a superannuation income stream) while you’re still gainfully employed — the classic Clayton’s substitute scenario: ‘The retirement you have when you’re not contemplating retirement!’

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Chapter 19: Receiving a Pension and Government Concessions Superannuation pension (superannuation income stream)

Taxable component (taxed element)

Taxable component (untaxed element)

Under 55 years

55–59 years

Over 60 years

Under 60 years

Over 60 years

Pension taxed at marginal rates plus Medicare levy


Pension tax free



Claim 15% tax offset

Claim 10% tax offset

FigureÂ€19-1: Using the tax connection between your age and your pension.

To qualify for the transition to retirement concession, you need to be at least 55Â€years of age and you must elect to receive a non-commutable pension. While you’re in receipt of this pension, you can’t withdraw any lump sum payments from your superannuation fund until you reach 65Â€years of age or retire. Under this arrangement, your pension must fall between 4Â€perÂ€cent and 10Â€perÂ€cent of the balance in your superannuation fund account. The taxable component — taxed element part of the pension qualifies for a 15Â€perÂ€cent tax offset and, after you turn 60Â€years of age, the pension becomes tax free (refer to FigureÂ€19-1). In the meantime, any income or capital gain that your super fund derives during the pension phase to fund your pension payments isn’t liable to tax. You also have the option to salary sacrifice employment income that you derive back into the super fund to access when you retire. (Note: All withdrawals after ageÂ€60Â€are tax free.) These contributions are taxed at the rate of 15Â€perÂ€cent because they’re classified as concessional contributions (refer to ChapterÂ€18). Because you’re over 55Â€years of age, you qualify for a $500 mature age tax offset for the employment income you derive (see FigureÂ€19-2).

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Part V: Thinking Long Term The tax offset starts to phase out when your net working income exceeds $53,000 and fully phases out when such income exceeds $63,000. (For more details, see the Tax Office publication ‘Mature age worker tax offset — overview’.)

Working for the pension: Transition to retirement 55 years of age

Start transition to retirement pension. Maximum limited to 10% of super fund balance

Pension qualifies for 15% tax offset

Continue in employment

Qualify for $500 mature age offset

Pension tax free after 60 years of age

Make salary sacrifice contributions

Withdrawals tax free after 60 years of age

FigureÂ€19-2: Going with a transition to retirement pension.

Understanding non-account-based pensions If you’re a traditionalist at heart and you like some sense of certainty in your life, choosing the option of taking a non-accountbased pension may be for you. This type of superannuation pension is normally a lifetime pension, which means you’re assured of receiving the pension for the rest of your life. In the event of your death, your pension can continue to be paid as a death benefit income stream to a dependent reversionary beneficiary (for instance your spouse) (see ChapterÂ€20).

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Chapter 19: Receiving a Pension and Government Concessions

Case study: Transition to retirement pension Jonathon is 55Â€ years of age and has $360,000 in his superannuation fund account. He decides to receive a transition to retirement pension. The amount he can take out must fall between $14,400 a year (4Â€ perÂ€ cent of $360,000) and $36,000 a year (10Â€perÂ€cent of $360,000). He elects to receive $36,000, which is the maximum amount he can withdraw. The pension is liable to tax at his marginal tax rates (plus the Medicare levy) and he quali fies for a $5,400 tax offset (15Â€perÂ€cent of $36,000).

TheÂ€good news is that when Jonathon turns 60Â€ years of age the pension is tax free. Any income or capital gain that the superannuation fund derives during the pension phase to fund the pension is exempt from tax. In the meantime, Jonathon decides to salary sacrifice some of his employ ment income into his superannuation fund, which he can access when he retires. Because Jonathon is over 55Â€ years of age, he also qualifies for the full amount of the $500Â€mature age tax offset.

With this option, you need to exchange a lump sum payment for a non-account-based pension. The pension payment you receive each year can increase only to counter the impact of inflation. If you’re betweenÂ€55Â€and 59Â€years of age, the pension qualifies for a 15Â€perÂ€cent tax offset, and, when you turn 60Â€years of age, the pension is tax free (refer to FigureÂ€19-1). Any income or capital gain that your super fund derives during the pension phase to fund your pension payments is exempt from tax. The bad news is you normally can’t withdraw any funds or commute (change) the pension to a lump sum payment. Another disadvantage of this type of super pension is you also can’t vary your pension payments from year to year except to make an adjustment forÂ€inflation. If you happen to be a government employee and you receive a super pension paid from a taxable component — untaxed element, the pension is taxed at your marginal tax rates (plus the Medicare levy) — see AppendixÂ€A. Unfortunately, if you’re betweenÂ€55Â€and 59Â€years of age, you don’t qualify for a 15Â€perÂ€cent tax offset because certain government super funds don’t pay tax. However, when you turn 60Â€years of age, you qualify for a 10Â€perÂ€cent tax offset (refer to FigureÂ€19-1).

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Case study: Non-account-based pension (life pension) Joanne is 55Â€ years of age and has $600,000 in her superannuation fund account. She decides to receive a life pension in lieu of the $600,000 balance as a lump sum, because she likes the idea of receiving aÂ€ guaran teed pension. She’s entitled to receive a $36,000 pension for life and the pension is adjusted annually to counter the impact of inflation. The taxable componentÂ€ —Â€ taxed element

of the pension ($36,000) — is liable to tax at her marginal tax rates (plus the Medicare levy) and she qualifies for a $5,400 tax offset (15Â€ perÂ€ cent of $36,000). When Joanne turns 60Â€years of age the pension is tax free. Any income or capital gain that the super annuation fund derives during the pension phase to fund the pension is exempt from tax.

Understanding account-based pensions Account-based pensions are also known as allocated pensions. Under this option, you need to exchange a lump sum payment for a pension (superannuation income stream). You have the option to vary your pension payments from year to year, and no set term is specified. You must receive the pension at least annually and continue to receive it until all your funds are diminished. Therefore, you’re best to invest your money wisely. Further, no maximum withdrawals are imposed. However, you must receive a prescribed minimum, which can vary according to your age — from between 4Â€perÂ€cent and 14Â€perÂ€cent each year (see TableÂ€19-1).

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For example, if you’re between 55Â€and 64Â€years of age,Â€you must withdraw 4Â€perÂ€cent of your account balance and 14Â€perÂ€cent if you’re over 95Â€years of age.

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Table 19-1 Age

235

Minimum Superannuation Pension Payments Min. Pension Withdrawals from Account

2010–11 Min.

Under 65

4%

2.0%

65–74

5%

2.5%

75–79

6%

3.0%

80–84

7%

3.5%

85–89

9%

4.5%

90–94

11%

5.5%

95 and over

14%

7.0%

Note: For the 2010 and 2011 financialÂ€years, the federal government has reduced the minimum withdrawal requirements by 50Â€perÂ€cent for each age group.

The pension is recalculated at the beginning of each financial year and the amount you receive depends on the balance in your account. A major benefit is you can commute (change) the pension back into a lump sum payment. If you’re between 55 and 59Â€years of age the taxable component — taxed element of the pension qualifies for a 15Â€perÂ€cent tax offset and after you turn 60Â€years of age, the pension is tax free (see FigureÂ€19-1). Any income or capital gain that the superannuation fund derives during the pension phase to fund the pension is exempt from tax. In the event of your death, your pension can continue to be paid as a death benefit income stream to a dependent reversionary beneficiary (for instance your spouse) (refer to ChapterÂ€20). For the 2010 and 2011 financialÂ€years, the federal government has reduced the minimum withdrawal requirements by 50Â€perÂ€cent for each age group.

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Case study: Account-based pension (allocated pension) Asbel is 55Â€ years of age and has $600,000 in his superannuation fund account. He decides to receive an allocated pension because he likes the flexibility of the various options he can use. The minimum Asbel can receive is $24,000 a year (4Â€ perÂ€ cent of $600,000). This financial year he elects to receive a $36,000 pension, butÂ€ he has the option to receive more or less next year. The taxable

Â� component (taxed element) of the pensionÂ€($36,000) is liable to tax at his marginal tax rates (plus the Medicare levy) and he qualifies for a $5,400 tax offset (15Â€ perÂ€ cent of $36,000). However, as soon as Asbel turns 60Â€years of age the pension is tax free. Any income or capital gain that the superannuation fund derives during the pension phase to fund the pension is exempt from tax.

Getting Help: Government Pensions and Allowances You may be eligible to receive many Australian government pensions, allowances and other payments. These payments can be either taxable or exempt from tax. If you receive any government assistance payments, at the end of the financial year you may receive a PAYG payment summaryÂ€— individual non-business statement that sets out the total of your payments assessable for tax (refer to ChapterÂ€3). If you want to know whether you qualify for government pensions, allowances and payments and whether they’re taxable or exempt from tax, you can check out the following websites: U Centrelink (www.centrelink.gov.au) — go to Individuals ➪ Factors ➪ Paying tax on a payment from Centrelink. U Australian Government (www.australia.gov.au) — go to Individuals ➪ Tax return for individuals instructions. U Australian Taxation Office (www.ato.gov.au) — read the fact sheet ‘Australian government pensions and allowances’.

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U Family Assistance Office (www.familyassist.gov.au)Â€ —Â€read the fact sheet ‘The What, Why and How of FamilyÂ€Assistance’.

Taxing pensions and allowances As a general rule, federal government payments are confined to those people who are financially disadvantaged as well as targeted individuals who may be eligible to receive a specific allowance. One notable payment is the age pension, which is payable to eligible individuals who satisfy an income test and asset test. This pension is liable to tax. The following Australian government pensions, allowances and other payments are taxable, that is, when you lodge your tax return, you need to include these payments as part of your assessable income: U Age pension U Austudy payments U Bereavement allowance U Certain carer payments U Certain Defence Force payments U Certain disability pensions U Farm family restart U Mature age allowance U Newstart allowances U Sickness allowance U Various service pensions U Widow allowance U Widow pension U Youth allowance

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Getting back what you deserve: TaxÂ€offsets Although the pensions, allowances and other payments mentioned in the previous section are taxable, when you take into account the various tax offsets that you may qualify for, the amount of tax payable may reduce to nil. This scenario can arise if you’re a low-income earner and you qualify for a low income tax offset (where your income is below the taxable income threshold of $30,000 a year), or you receive an age pension and qualify for the senior Australians tax offset (which depends on your taxable income and whether you’re single or part of a couple) (see the next section).

Case study: Low income tax offset Christine is eligible to receive a $16,000 government allowance, which is liable to tax. This allowance is her sole source of income. The amount of tax she is liable to pay on this amount is $1,500. According to the

Table, because her taxable income is below the taxable income threshold, Christine qualifies for a low income tax offset. When she takes into account the tax offset, she pays no tax on the amount she receives.

Low Income Tax Offset Eligibility Applicable to Low Income Resident Individuals Year

2009–10

2010–11

$1,350

$1,500


$30,000

$30,000


$63,750

$67,500

Max tax offset

For every dollar you earn above the taxable income threshold ($30,000), the tax offset reduces by four cents.

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Case study: Senior Australians tax offset John and Betty are eligible to receive an age pension and qualify for the senior Australians tax offset. They also derive investment income. During the 2010–11 financial year, their Â�combined

taxable income is $32,000. According to the Table, because their combined taxable income is below the taxable income threshold, they pay no tax on the amount they derived.

Senior Australians Tax Offset Single Financial year

Taxable Income Threshold

2009–10

$29,867

2010–11

$30,685

Couple (entitlement for each member of a couple) Financial year


2009–10

$25,680

2010–11

$26,680

The tax offset reduces by 12.5 cents for every dollar aboveÂ€ the respective thresholds. If you don’t fully use the tax offset, you can transfer the excess to your respective spouse.

Being allowed to keep it: What isn’tÂ€taxed Many Australian government pensions, allowances and other payments are specifically exempt from tax. One notable payment is a carer allowance for people who provide daily care and attention at home for an adult or child with a severe disability or medical condition. The major payments that are exempt from tax are U Australian government disaster recovery payments U Baby bonus payable by Centrelink U Carer allowance U Certain child support and spouse maintenance payments

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Part V: Thinking Long Term U Certain Defence Force payments U Certain payments under ABSTUDY U Certain scholarship payments and bursaries U Childcare benefit U Disaster relief payment U Double orphan pension U Employment entry payments U Rent assistance U Super co-contributions If you want to know what Australian government pensions, allowances and other payments are exempt from tax, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘Amounts that you do not pay tax on’.

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Chapter 20

Death and Taxes: WillsÂ€andÂ€Business Succession Planning In This Chapter ``Distributing your assets when you die ``Taxing death benefit distributions ``Taxing your pension after you die ``Taxing assets distributed to beneficiaries ``Looking at business succession planning

A

n old saying states that you can’t escape two things: Death and taxes. Although you can’t predict with certainty your death, you can at least reduce the impact of taxation when you die. In this chapter, I explain how death benefits are taxed when they’re paid to your dependants and non-dependants and howÂ€the capital gains tax (CGT) provisions apply to certain assets that you plan to distribute to your beneficiaries after you die. IÂ€also chat about the prudence of having a business succession plan in place.

Preparing a Will A will is a legal document that sets out your instructions for the distribution of your assets and personal belongings when you die. When you set up a will you need to choose an executor to administer the will in accordance with your instructions. Because your personal circumstances can quickly change

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Part V: Thinking Long Term (forÂ€example, marriage, divorce, birth of a child, death of a family member, retirement), you’re prudent to amend and update this document at regular intervals. Preparing a will is an important exercise if you want your assets distributed to specific beneficiaries. Having a will is also essential if you receive a superannuation pension and, on your death, you want payments (death benefits) to go to a specific dependant (such as your spouse) or to a number of your dependants. How your beneficiaries are taxed depends on a number of factors, which IÂ€discuss in this chapter. If you want your death benefits to be paid to a specific dependant or to your estate, you need to sign a binding death benefit nomination form. If you do this the trustees of your super fund must comply with your request. Otherwise, you introduce a risk that the fund may not pay the death benefit to the person(s) you nominate or may not even comply with your wishes. This form needs to be renewed every three years for it to remain valid. You can get a copy of a binding death benefit nomination form from your superannuation fund. How your estate is taxed depends on whether your beneficiaries are dependants or non-dependants, because dependants are taxed differently to non-dependants in respect of death benefit distributions. For the purposes of receiving a death benefit distribution (such as your pension), the following beneficiaries are dependants: 55 Spouse, de facto spouse, former spouse or former de facto spouse 55 Child (including stepchild, adopted child and ex-nuptial child) less than 18 years of age 55 Person financially dependent on the deceased at date of death (for example, a child younger than 25Â€years of age) 55 Person in an interdependency relationship (such as two people who have a close personal relationship, live together, provide financial support for one another and attend to each other’s personal and domestic needs) Although Australia doesn’t have death taxes or an inheritance tax, CGT may have an adverse impact on the distribution of the assets you intend to give to certain beneficiaries. This

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Chapter 20: Wills and Business Succession Planning

243

consequence is because some assets are exempt from CGT (for instance, your main residence and car), while the tax treatment of your other assets depends on whether you acquired them on or after 20Â€SeptemberÂ€1985. CGT was first introduced in Australia on this date. (See the section ‘Taxing All Your Treasures’ later in this chapter.) Estate planning is complex, so you’re best to seek professional advice when preparing your will, especially regarding the steps you need to put into place to minimise the impact of taxation when you die.

Taxing Your Income In the event of your death, the executor of your estate takes control of your financial affairs. The executor is responsible for the administration of your estate until all your assets have been distributed in accordance with your will. One important duty your executor needs to attend to is your tax affairs. The executor needs to lodge a tax return that discloses the income you derive up to the date of your death and a trust return for any income you receive after your death (such as income from your investments). The trust net income is liable to tax — to either the beneficiaries who are presently entitled to receive a distribution (meaning they have a legal right to demand payment) or to the executor. If you’re still working when you die, your beneficiaries, especially your dependants and non-dependants, may be entitled to receive a death benefit employment termination payment (ETP). Death benefit ETPs include 55 A golden handshake 55 Payment in lieu of notice 55 Unused rostered days off 55 Unused sick leave A death benefit ETP doesn’t include payments for unused annual leave and long service leave. Nor does it include the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

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Part V: Thinking Long Term The following beneficiaries are dependants for the purposes of receiving a death benefit distribution: 55 Spouse, de facto spouse, former spouse 55 Child younger than 18 years of age 55 Person financially dependent on the deceased (at date ofÂ€death) 55 Person in an interdependency relationship (such as two people who have a close personal relationship, live together, provide financial support for one another and attend to each other’s personal and domestic needs) How death benefit ETPs are taxed depends on whether the payment is a tax free component or a taxable component (refer to ChapterÂ€18), and whether the payment is above or below the lower cap amount threshold. TableÂ€20-1 sets out the rules for taxing a death benefit ETP.

Table 20-1

Tax Rates for Death Benefit ETPs

Financial Year

Lower Cap Amount

2009–10

$150,000

2010–11

$160,000

Dependants (any age) Tax free component Nil tax payable Taxable component Tax free — up to lower cap amount Tax rate 46.5% — above lower cap amount Non-dependants (any age) Tax free component Nil tax payable Taxable component Tax rate 31.5% — up to lower cap amount Tax rate 46.5% — above lower cap amount Note: Tax rates include 1.5% Medicare levy.

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If you want to know more about taxation of deceased estates, visit the Tax Office website (www.ato.gov.au) and read the fact sheet ‘Managing the tax affairs of someone who has died’.

Sharing Your Pension If you’re receiving a superannuation pension when you die, your pension can continue to be paid as a death benefit income stream to a dependent reversionary beneficiary (a person who can continue to receive your pension after you die until all the money runs out). If your beneficiary is a financially dependent child, your pension can continue to be paid until the child reaches 25Â€years of age. Your super pension then becomes a taxfree superannuation lump sum death benefit payment. However, if your dependent child is permanently disabled, the payment can continue to be paid as a death benefit income stream to thatÂ€person. The amount of tax payable depends on your age when you die, the age of your dependant(s) and whether the payment is fromÂ€a tax free component, taxable component — taxed element, or taxable component — untaxed element (see FigureÂ€20-1).

Death benefit income stream (pension)

Deceased aged 60 and over

Deceased aged under 60

Dependant (any age)

Tax free component

Tax free component

Taxable component — taxed element

Taxable component — untaxed element

Tax free

Taxed at marginal tax rates

Tax free

Less 10% tax offset

Taxable component — taxed element

Taxable component — untaxed element

Tax free Dependant under 60

Dependant 60 and over

Dependant under 60

Dependant 60 and over


Tax free



Less 15% tax offset

Less 10% tax offset

Figure 20-1: Paying tax on a death benefit income stream. (Note: A 1.5% Medicare levy may also apply.)

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Part V: Thinking Long Term When you receive a payment from a superannuation fund, the payment can consist of three components: 55 Tax free component (refer to ChapterÂ€18) 55 Taxable component — taxed element (refer to ChapterÂ€18) 55 Taxable component — untaxed element (refer to ChapterÂ€18) From 1 July 2007, a superannuation death benefit income stream (pension) can’t be paid to a non-dependant. Alternatively, the balance in your superannuation account can be paid out as superannuation death benefit lump sum payments. Under these circumstances, the tax treatment depends on whether your beneficiary is a dependant or non-dependant and whether the payment is a tax free component or taxable component. TableÂ€20-2 sets out the rules of taxing a superannuation death benefit lump sum payment consequently distributed to a dependant and/or non-dependant on your death.

Table 20-2

Super Lump Sum Death Benefits

TAX RATES Dependants (any age) Tax free component Tax free Taxable component — taxed and untaxed elements Tax free Non-dependants (any age) Tax free component Tax free Taxable component — taxed element Tax rate 16.5% on entire amount Taxable component — untaxed element Tax rate 31.5% on entire amount Note: Tax rates include 1.5% Medicare levy.

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Taxing All Your Treasures During your lifetime, you may accumulate many assets. These precious items can include real estate, particularly your main residence, a share portfolio and other assets that you keep for your personal use and enjoyment (such as collectables and personal use assets). Unfortunately, when you die you can’t take them with you. Over the centuries, though, many people from different cultures have tried — without success. Fortunately, Australia doesn’t have death taxes or an inheritance tax to worry about. Further, under the CGT provisions, death doesn’t constitute a disposal of your assets. Thus, when your CGT assets are distributed to your beneficiaries, no tax liability arises. Before your beneficiaries open the Champagne bottle, though, and start celebrating, the catch is that they become liable to pay CGT when they sell the assets. This rule applies because when you inherit assets you’re deemed to acquire them on the date of death of the deceased. The tricky part comes next. If you (as the deceased) acquired the assets before 20Â€SeptemberÂ€1985, your beneficiaries are deemed to acquire them on the date of your death at their market value. This interpretation means that any increase in their value up to this point in time is ignored by the Tax Office for tax liability. However, your beneficiaries are liable to pay tax on any subsequent increase in value above the market value (this amount is the cost base for CGT purposes). To work out the market value of the assets, you may need to get a professional valuation (such as a sworn valuation). On the other hand, if you (as the deceased) acquired the assets on or after 20Â€SeptemberÂ€1985, your beneficiaries are deemed to have acquired them on the date of your death at the value you acquired them. This rule means that for the purposes of working out whether your beneficiaries make a capital gain or capital loss, the deceased’s cost base is used. To add salt to the wound, your beneficiaries are personally liable to pay tax on any increase in the value of the assets during the time you (as the deceased) owned the assets, plus any further increase in value during the time your beneficiaries own them.

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Part V: Thinking Long Term From a tax planning point of view, you need to be aware of how the CGT provisions apply to assets you intend to distribute to your beneficiaries. The amount of tax payable on disposal of assets you inherit depends on 55 The date the deceased originally acquired the assets and whether they were acquired before, on or after 20Â€SeptemberÂ€1985 55 Whether they’re exempt from tax (for example, main residence and cars) How the CGT provisions apply can become a vexing issue to ponder when distributing assets to your beneficiaries that 55 Are specifically exempt from tax 55 Were acquired before 20 September 1985 55 Were acquired on or after 20 September 1985 The application of the CGT provisions is tricky because different tax rules apply when your beneficiaries sell them. Perhaps the most aggrieved beneficiaries are those who inherit nonexempt assets that were acquired on or after 20 September 1985, because they stand to pay the most amount of tax on a subsequent disposal (especially if the asset increases substantially in value). In ChapterÂ€6, I point out under the CGT provisions that owning a main residence is normally exempt from tax. In the event of your death, the good news is the main residence exemption concession can be transferred to your beneficiaries. If you inherit a deceased person’s main residence the following rules apply: 55 If you sell the property within twoÂ€years of the person’s death, no CGT applies. This is the case even if you decide to lease the property during this period of time. 55 If the property becomes your main residence, the property continues to be exempt from CGT. If you want to know more about inheriting a main residence, visit the Tax Office website (www.ato.gov.au) and read ‘Guide to capital gains tax (NAT 4151)’.

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Case study: Inheriting an asset Chen inherits a parcel of shares from a deceased relative. The deceased bought the shares eightÂ€ years ago and paid $100,000 for them. Chen is deemed to have acquired the shares he inherits on the date of the death of his relative. The deemed cost base is $100,000 because the shares were purchased on or after 20Â€ SeptemberÂ€ 1985. As at the date of his relative’s death, Chen is informed that the market value of the shares is $400,000. If Chen sells the shares, he’s personally liable to pay tax on the accrued increase in their value from the date the deceased acquired the shares to the date Chen sells them. At this point in time, Chen indirectly inherits a potential $300,000 CGT liabilityÂ€—Â€ouch! Chen sells the shares one year later for $450,000. He is personally liable to pay tax on $350,000, being the increase in value from the date the

deceased acquired them to when Chen sells them. To help ease the pain, because the shares were owned for more than 12Â€ months (by the deceased and Chen), Chen is liable to pay tax on only one-half of the gain (that is, $175,000). For more details, refer to ChapterÂ€11. On the other hand, if the deceased relative had bought the shares before 20Â€ SeptemberÂ€ 1985, the cost base would’ve been $400,000, being the market value as at the date of death. Under these circumstances, Chen is liable to pay CGT only on any subsequent increase in value above $400,000. When Chen sells the shares oneÂ€ year later for $450,000, he’s personally liable to pay tax on the $50,000 gain he makes on sale. Because the shares were owned for more than 12Â€ months, Chen is liable to pay tax on only one-half of the gain (that is, $25,000).

Planning Ahead: Business Succession Planning When you run a small business, you need to plan ahead. A good business succession plan involves choosing an appropriate business structure to run your business (refer to ChapterÂ€12), reducing the impact of CGT if you sell the business, and utilising the CGT small business concessions, particularly the 15-year asset exemption provisions (refer to ChapterÂ€17). As business succession planning can be a complex issue, you’re best to seek advice from a qualified tax accountant or solicitor.

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Part V: Thinking Long Term If you want to know more about developing a business succession plan, visit the Business Victoria website (www.business.vic.gov.au) and check out ‘Developing a successionÂ€plan’.

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Part VI

The Part of Tens Glenn Lumsden

‘Here’s an itemised bill for my services, including the five minutes of friendly chit-chat, your cup of coffee and me explaining all this to you right now .â•›â†œ.â•›â†œ.’

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he first thing people want from me at a social gathering when they find out I’m a tax consultant is a free tax tip to help them reduce their tax bill. It seems everybody has a tax problem that needs to be attended to immediately. Unfortunately, there’s no such thing as a free lunch and, so, ifÂ€you want good tax advice you simply have to pay for it. In this part of the book, I examine the various ways to minimise your tax bill, satisfy the Tax Office and live comfortably in retirement.

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Chapter 21

Ten Ways to Minimise Your Tax while Keeping the TaxÂ€Office Happy In This Chapter ``Taking advantage of the tax system ``Claiming tax deductions ``Taking advantage of superannuation

I

n a federal government inquiry into the media in 1991, Kerry Packer, who was at that time the richest man in Australia, made the following attention-grabbing headline statement: ‘If anyone in this country doesn’t minimise their tax, they want their head read’ (enough said!). To avoid getting your head read, in this chapter I discuss ten ways to help you minimise your tax bill while keeping the Tax Office happy.

Keep Good Records Keeping proper records is the first step necessary to minimise your tax bill. Set up a good recording system to keep track of all your assets, income and expenses. If the Tax Office audits your tax return, the onus of proof that your tax affairs are in order rests with you (refer to ChapterÂ€4). Ordinarily, you need to keep your records for fiveÂ€years. A tax agent can help you set up a

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Part VI: The Part of Tens good recording system to meet your statutory obligations. The key records you need to keep include 55 A record of all the assessable income you derive and expenditure you incur each year (ChapterÂ€2). 55 Receipts to substantiate work-related expenses that exceed $300 (ChapterÂ€5). 55 A record of all expenditure that may be included in eligible tax offsets such as the medical expenses rebate and low income superannuation spouse rebate. 55 A register of all your capital gains tax (CGT) assets, particularly the date of purchase and cost base (ChapterÂ€11). 55 If you own property, the contract of purchase that sets out the property’s cost base. 55 A record of improvements you make to your property, because you can add these expenses to the cost base. 55 If you own non-income-producing assets (such as a holiday house) that you acquired after 20Â€AugustÂ€1991, a record of all your interest payments, rates, insurance and repairs, because you can add these types of expenses to the asset’s costÂ€base (ChapterÂ€10). 55 If you own shares, all your buy and sell contract notes for the purposes of calculating whether you made a capital gain or capital loss (ChapterÂ€9). 55 A record of capital losses that you can offset against current and future capital gains. The effect of this rule may mean you keep records of your capital loss until the year in which the loss is applied against a capital gain, which may be for more than fiveÂ€years.

Take Advantage of New Developments Federal governments constantly introduce new tax initiatives to stimulate economic activity and savings to influence your behaviour. These announcements are normally made when a federal budget is brought down or during the lead-up to a federal election. Therefore, you need to be aware of these changes and what you need to do to comply. The changes are normally

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associated with running a business, superannuation and family benefits. For example, the federal government has introduced 55 Small business tax concessions to simplify the running of a business (ChapterÂ€13) 55 Small business CGT concessions to reduce or totally eliminate the impact of CGT on your business assets (ChapterÂ€17) 55 Tax incentives to encourage you to fund your retirement (ChapterÂ€18) 55 Incentives to help you buy your first home (ChapterÂ€6) 55 Tax incentives to educate your children (ChapterÂ€7) Failure to take advantage of these initiatives can cost you dearly in the long term. A good tax accountant can review your current personal and/or business position, thereby, helping you to tap into any worthwhile federal government benefits.

Get a Helping Hand from the TaxÂ€Office The Tax Office website contains a wealth of information you can access free of charge. This library of tax information is useful because the Tax Office regularly issues fact sheets, income tax rulings, tax determinations and ATO interpretative decisions to explain specific tax issues that need to be clarified. With a little practice, you can quickly find information that you can use to your advantage. This website can prove to be a valuable resource if you’re running a business or you need some specific details. Further, if you apply for a private ruling, the Tax Office examines your request and gives you a written response about how it would interpret the laws in respect to the issue you raise (free of charge!).

Lose Money the Right Way While you’re building up your wealth, sadly, the strong possibility exists that some of your investment holdings can turn sour. Note: You’re not going to win all the time. (If you do

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Part VI: The Part of Tens manage to never lose money, I’ll be first in line to buy your best-selling book.) If your investments decrease in value, you can do two things. You can cry over spilt milk and hold your investments in the hope they come good again, or you can become proactive and turn your bad news into good news. Here’s how: 55 If your investments fall in value, you can’t claim a capital loss until they’re sold. On the other hand, if you sell them, the loss you crystallise can be immediately offset against any current capital gains you may have made. 55 If you make no capital gains during the financial year, the loss can be carried forward for an indefinite period and offset against any future capital gains you may make. A key rule to capitalise on, if you make a capital loss on one category of investment (such as shares), is you can offset the loss against a capital gain on another category of investment (for example, real estate). One exception to the rule relates to collectables such as artwork and antiques. You can only offset a capital loss you make on a collectable against a capital gain on another collectable. When you apply a capital loss against a capital gain you save having to pay tax on the gain. Therefore, you’re best to keep in mind that a loss has value. The extent of that value depends on your current marginal tax rates.

When a loss is lost forever When I indicated that a loss has value during one of my lectures, a student became rather agitated. A few years ago he incurred a substantial capital loss and, in his knee‑jerk disgust,

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decided to destroy all the evidence. When, during the lecture, he realised a loss has tax value, I wished him all the best in his attempt to piece together the evidence.

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Contribute to a Super Fund The federal government has introduced a number of incentives to encourage employees to make a contribution to a complying super fund. Earnings derived by a super fund are taxed at the rate of 15Â€perÂ€cent, and pensions and lump sum withdrawals are tax free after you reach 60Â€years of age and retire. Refer to ChapterÂ€18 for more information about superannuation contributions. From 1 July 2013, if you earn less than $37,000 and you make a concessional contribution to your superannuation fund, the federal government proposes to contribute up to $500 on your behalf to eliminate any tax payable, and help boost the nestÂ€egg.

Claim a Super Tax Deduction If you’re self-employed (or substantially self-employed), any concessional contribution you make to a complying superannuation fund on your behalf is a tax deductible expense. If you’re under 50Â€years of age, you can claim up to $25,000 a year (indexed) and up to $50,000 a year (non-indexed), if you’re over 50Â€years of age between 1 JulyÂ€2007 and 30 JuneÂ€2012 and under 75Â€years of age. This rule allows you to increase your nest egg and decrease your taxable income. From 1 July 2012, the federal government proposes that if you’re over 50Â€years of age, you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund.

Take Advantage of the Low IncomeÂ€Threshold Under current tax legislation, an individual can earn up to $16,000 before being liable to pay tax (per 2010–11 tax rates). If you have a spouse who isn’t working or who derives a minimal amount of income, you may take advantage of his or her low income threshold. For example, if you have money to invest, you can consider investing those funds in your spouse’s name. Under these circumstances, your spouse isn’t liable to pay tax on the investment income derived if the amount is below the

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Part VI: The Part of Tens low income thresholds. If the investment is in shares that pay fully-franked dividends, in addition to receiving a dividend, your spouse also receives a refund of the excess franking credits. To add icing to the tax relief cake, the rate of return on your spouse’s investment increases. Further, if your spouse’s assessable income is $10,800 or less you may qualifyÂ€for a $540Â€tax offset if you make a $3,000 contribution on your spouse’s behalf.

Package Your Salary One option you can consider to minimise your tax bill is salary sacrificing part of your salary and wages for additional superannuation contributions paid to your complying superannuation fund. This approach may be worth considering if you’re a high income earner and nearing your retirement age. If you follow this route you gain two significant benefits: 55 You reduce the amount of tax payable on the salary you derive. 55 You increase the retirement nest egg that you can access when you retire. If you salary sacrifice your salary or wage to below $37,000, you pay no tax on the first $6,000 and no more than 15Â€perÂ€cent tax on the next $31,000 you derive (per 2010–11 tax rates). Further, you may also qualify for a low income tax offset and a $500 mature age tax offset if you’re over 55Â€years of age. You pay just 15Â€perÂ€cent tax on the amount of your salary you contribute to super as opposed to paying your marginal tax rates if the salary were paid to you. From 1 July 2013, if you earn less than $37,000, the federal government proposes to contribute up to $500 on your behalf. This contribution is to offset the 15Â€perÂ€cent tax payable on concessional contributions to a complying superannuation fundÂ€— and your nest egg also increases. If your marginal tax rate is between 30Â€perÂ€cent and 45Â€perÂ€cent, you’re ahead. If you’re under 50Â€years of age, you can salary sacrifice up to $25,000 a year (indexed) of your salary or wage into your super fund or up to $50,000 a year (nonindexed) if you’re over 50Â€years of age between 1Â€JulyÂ€2007 and 30Â€JuneÂ€2012.

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From 1 July 2012, the federal government proposes that if you’re over 50Â€years of age, you can still make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund.

Tap In to Negative Gearing The Australian tax system can offer you significant tax incentives to help you to increase your wealth. One such benefit is commonly known as negative gearing. Using this technique can help you to acquire assets such as investment property and shares that have the capacity to increase in value and pay you regular income. If you borrow money to buy an investment asset, the interest you incur is tax deductible. Further, if your total expenditure (being predominantly interest) exceeds your investment income, you can offset the loss against other assessable income you derive, such as your salary and wages, other investment income and business profits. If you take this route, you reduce the amount of tax payable on your other assessable income. In the meantime, if the investment asset increases substantially in value, you’re ahead. If you decide to use this strategy, you’re effectively using the tax system to help you to finance the purchase and service the debt. For this strategy to work, five key components must be present: 55 Assessable income: You need to be deriving another source of income in order to claim a tax deduction. Negative gearing greatly benefits individuals who pay a high marginal rate of tax. From 1Â€JulyÂ€2010, no tax is payable if your taxable income is below $16,000. 55 Cash flow: You must be capable of servicing the loan repayments. You can use the income you derive to pay your loan. 55 Interest rates: Interest payments can be fixed or variable and tax deductible if the purpose of the loan is to buy assets that generate income.

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Part VI: The Part of Tens 55 Investment growth: The investment must increase in value; otherwise you’re financing the purchase of an asset of decreasing value. Note: You gain no tax advantages by holding an unrealised capital loss. 55 Income from asset: You can claim a tax deduction only if the asset generates income.

Account for Income and Deductions The tax Acts require you to bring to account on a yearly basis your revenue and expenditure for the purposes of calculating your taxable income. To satisfy this rule correctly, you’re required to make timing adjustments in respect of recognising certain revenue and expenditure. When you make end of financial year adjustments you’re able to delay recognising revenue and bringing forward tax deductions. A tax accountant can show you how to take tax advantage of this rule to your benefit.

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Chapter 22

Ten of the Top RetirementÂ€TaxÂ€Tâ†œips In This Chapter ``Planning for your retirement ``Living off your pension `Ùsing the main residence exemption provisions

T

he first difference that hits you when you retire is your regular salary or wage payments cease the moment you step outside the boss’s premises. From that moment onwards, you’re on your own. Therefore, knowing you can fund the next phase of your life is very important. In this chapter, I explain ten ways to help you to live comfortably in retirement.

Plan Ahead As every farmer is likely to tell you, before you can reap the harvest you must first sow the seeds, water the plants and wait for the crops to mature. This realistic approach is also the case if you plan to support yourself in retirement. Ordinarily, you can follow two options. You can simply do nothing and pray to the superannuation gods to help you fund your retirement or you can try to make it happen. Under current legislation, your employer has a statutory obligation to contribute 9Â€perÂ€cent of your weekly salary or wage into super. This contribution (super guarantee — refer to ChapterÂ€13) amounts to around $5,400 a year if you’re currently earning $60,000 a year. And, of course, the contribution is

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Part VI: The Part of Tens even less if your salary or wage is below that amount. If you rely on this option you may find yourself begging for a quid inÂ€retirement. Incidentally, the federal government proposes to increase the rate of super guarantee, in stages, to 12Â€perÂ€cent by 2019–20 (see AppendixÂ€A). Your alternative option is to simply become proactive and build up your wealth both inside and outside the superannuation system. With respect to the superannuation option, you can consider salary sacrificing (ChaptersÂ€18 andÂ€21). Under this arrangement, you can put more money into super by forgoing part of your salary. In return, you stand to gain a tax benefit. For example, if your marginal tax rate is 30Â€perÂ€cent and you put an additional $10,000 into super, you stand to save $1,500 in tax each year. This saving happens because your super fund is liable to pay tax at the rate of 15Â€perÂ€cent on the $10,000 you contribute, instead of you paying 30Â€perÂ€cent tax if you decided to keep the money. You can also consider making a non-concessional contribution (ChapterÂ€18) to help boost the nestÂ€egg. You can endeavour to accumulate wealth outside the superannuation system by investing in assets such as shares and real estate. These types of investment have the capacity to increase in value and pay regular income. If you borrow money to buy these assets, the interest you incur is ordinarily a tax deductible expense.

Live Within Your Means A major issue you need to resolve — if you’re contemplating retirement in the foreseeable future — is whether you have accumulated enough capital. Generally, the amount of capital you need depends on the pension amount that you require to live on comfortably in retirement. As a general rule, 60Â€perÂ€cent of your final salary is considered a reasonable amount to liveÂ€on. The capital you need to amass to achieve this percentage is between 13Â€and 17Â€times your desired pension. For example, if you consider you need $50,000 as a yearly pension, you need to have up to $850,000 in your superannuation fund account. When you convert your superannuation fund account from the accumulation phase to the pension phase, the income and any

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capital gains your super fund derives to fund your pension is exempt from tax.

Do a Budget If you’re retired or plan to retire, one very important thing you really need to do is prepare (and keep up to date) a simple budget of all your cash inflows and outflows. Doing a budget allows you to control your spending habits and you can plan ahead with some degree of confidence. Note: As long as your cash inflows exceed your cash outflows, you’re in front. On the other hand, if you find your cash outflows exceed your inflows you may quickly find yourself queuing up for a handout. As a general rule, wherever possible, you’re best to continually reinvest surplus funds to supplement your future cash inflow needs. During the next phase of your life, the majority of your cash inflows consist of a pension and investment income. These payments tend to be regular and are unlikely to vary to any great extent. On the other hand, your cash outflows are predominantly basic living costs and ongoing household expenditure such as rates, insurances, gas, electricity and telephone bills. With respect to your cash outflows, they’re unlikely to decrease and are, in fact, more likely to increase. Your cash inflows, therefore, need to increase each year to cover all your cash outflows, especially unbudgeted extraordinary costs that tend to regularly pop up. Many pension schemes make provision to increase your pension payments each year, and if you’re over 60Â€years of age and retired, you can withdraw tax-free, lump sum payments. Having a healthy superannuation fund balance is a nice feeling if you want to live comfortably in retirement!

Get Proper Advice If you’re retired or plan to retire, seek professional advice from a financial planner. This qualified person can review your current financial position and steer you in the right direction. A financial planner can also advise you on whether you qualify for any Centrelink benefits to supplement your pension and what you need to do to get them. Furthermore, a planner is authorised to give you financial advice in respect of investing your money.

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Part VI: The Part of Tens Keep up to date, too — read the daily newspapers, particularly the part that offers readers financial advice. They can give you some good ideas that may apply to your particular circumstances, and keep you informed on the latest developments relating to pensions and taxation matters. Also check out Superannuation For Dummies, 2nd Edition, by Trish Power, and Sorting Out Your Finances For Dummies, by BarbaraÂ€Drury (both published by Wiley Publishing) and the superannuation pageÂ€of the Australian Government website (australia.gov.au).

Work for the Pension: Transition to Retirement To encourage you to remain in the workforce rather than take the early retirement option, the federal government has introduced the transition to retirement pension. Under this arrangement, you can elect to receive a superannuation pension and still remain gainfully employed. To take advantage of this concession, you need to be at least 55Â€years of age and you must elect to receive a non-commutable pension until you reach 65Â€years of age. This means while you’re in receipt of this pension, you can’t withdraw any lump sum payments from your superannuation fund until you reach 65Â€years of age or retire. Your maximum pension can’t exceed more than 10Â€perÂ€cent of the balance in your superannuation fund, while the minimum pension can’t be less than 4Â€perÂ€cent of your balance. The good news here is that if you’re over 60Â€years of age the entire pension is tax free. On the other hand, if you’re aged between 55Â€and 59Â€years, you qualify for a 15Â€perÂ€cent tax offset. In the meantime, the entire earnings generated to fund your pension are tax free. ChapterÂ€19 provides more information about the transition to retirement pension.

Earn Some Tax-Free Pocket Money One great thing about getting a superannuation pension comes in after you reach 60Â€years of age — the pension you receive from a complying superannuation fund is tax free. But wait — the news gets even better! The superannuation pension is also

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Chapter 22: Ten of the Top RetirementÂ€TaxÂ€Tips excluded from your assessable income. This rule means that if this super pension is your sole source of income, as far as the Tax Office is concerned your taxable income is nil. You can use this tax provision to your advantage if you need to work on aÂ€part-time basis or sell some investment assets and take a capital gain.

When you take into account the $6,000 tax free threshold, the low income tax offset, the $500 mature age tax offset and the senior Australians tax offset, you can earn up to $37,000 before you’re likely to pay any significant amount of tax. To add icing to the cake, if you make a contribution to your superannuation fund, you qualify for a contribution under the federal government co-contribution scheme! (Refer to ChapterÂ€18 for more on the benefits of turningÂ€60.)

Update Your Pension Entitlement If you’re in receipt of a superannuation pension, being prudent about regularly reviewing and updating your legal documents that indicate who you want to receive your pension in the event of your death makes good sense. Why? Because your personal circumstances can quickly change (for example, your spouse could die or you could get divorced), and beneficiaries who were originally eligible to receive your pension may now be ineligible (for instance, children who are no longer dependants). If you want your pension to be paid to a specific beneficiary, you need to sign a binding death benefit nomination form. If you take this route, the trustee must pay your pension to the person or persons you nominate. To ensure the nomination is valid, though, you need to renew the form every threeÂ€years. (Refer to ChapterÂ€20 for all about tax implications for your beneficiaries.)

Take Advantage of the Main Residence CGT Provisions If you reside in a property that was acquired before 20Â€SeptemberÂ€1985, the property is excluded from the CGT provisions (refer to ChapterÂ€11). The fact the property happens to be your residence is irrelevant because you acquired it before the CGT provisions were introduced. Note: The CGT provisions apply only to CGT assets you acquire on or after this date. You

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Part VI: The Part of Tens can use this rule to your advantage if you’re contemplating buying another property. For example, if you buy property in a location where you may like to live in retirement (such as at a seaside resort), the property is exempt from tax if it becomes your main residence. In the meantime, you can lease your pre-CGT property. If your personal circumstances change (or you decide you no longer want to live by the sea), you have the option to move back into your pre-CGT property. Under the temporarily absent rule, you can lease your new main residence for up to sixÂ€years without affecting its exemption status. Alternatively, the property remains exempt from tax for an indefinite period if you decide not to lease it.

Downsize: Too Big for Comfort Under the CGT provisions (refer to ChapterÂ€11), if you acquire your main residence on or after 20 SeptemberÂ€1985, the property is exempt from CGT. If you’re fortunate enough to own a property that increases substantially in value, you can be effectively sitting on a potential goldmine that isn’t liable to tax. If you’re a self-funded retiree and you think you may not have enough income to fund your retirement, one option you can consider is that of selling the property. With the net proceeds, you can buy a cheaper house or apartment and reinvest the balance. If you choose this route, you achieve three things: 55 The capital gain you make on disposal is exempt from tax. 55 You still own a main residence, which continues to be exempt from tax. 55 You can purchase a quality share portfolio that pays franked dividends to help supplement your income, or you can put the money into a complying superannuation fund and buy a pension. If you’re over 60Â€years of age, the pension is tax free. The news gets even better because any income or capital gain your super fund derives during the pension phase to fund your pension payments isn’t liable to tax. However, if you’re between 65Â€and 74Â€years of age, you need to satisfy an employment test before you can make a contribution to a superannuation fund. Unfortunately, after you turn 75Â€years of age, your window of opportunity closes, because youÂ€can no longer make a contribution to a superannuationÂ€fund.

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Exploit Your Winning Edge The long-serving scout’s motto — ‘Be prepared’ — has an important place in your retirement strategy. During your years in retirement, you need to be constantly on the lookout for good buying opportunities that can pop up from time to time. This advice is especially the case if the income you derive isn’t likely to be taxed. In general, you’re best to continually build wealth to help fund your retirement and counter the impact of inflation. Otherwise, you may find yourself behind as you get older. For example, using your home as collateral to secure a line of credit is a facility you can use to your advantage. This need may arise whenever a slump in the share market occurs. So, if you have this type of facility at your disposal, you’re able to access cash at short notice and you then have the option to buy shares at a cheaper price, which then have the capacity to increase in value and supplement your income.

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Part VII

Appendixes Glenn Lumsden

‘Officially, you don’t exist but, as far as the Tax Office is concerned, you’re non-residents and you owe us a mozza.’

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I


n this part of the book, you find the various tax rates and tables that are used in Australian tax law and a summary of the key tax offsets that you may be entitled to claim. You also find info about how non-residents are taxed on income derived in Australia. If you need to do some tax research, you can download a list of tax cases and tax publications from AppendixÂ€C, which is on our website: www.dummies.com/go/ taxforaustraliansfd

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Appendix A

Income Tax Rates and Tables Australian Tax Rates Individual — Resident (2008–09) Taxable Income

Marginal Tax Rates

$0–$6,000

0%

$6,001–$34,000

15%

$34,001–$80,000

30%

$80,001–$180,000

40%

Over $180,000

45%

Individual — Resident (2009–10) Taxable Income $0–$6,000

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Marginal Tax Rates 0%

$6,001–$35,000

15%

$35,001–$80,000

30%

$80,001–$180,000

38%

Over $180,000

45%

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Part VII: Appendixes

Individual — Resident (2010–11) Taxable Income

Marginal Tax Rates

$0–$6,000

0%

$6,001–$37,000

15%

$37,001–$80,000

30%

$80,001–$180,000

37%

Over $180,000

45%

Individual — Non-Resident (2008–09) Taxable Income

Marginal Tax Rates

$0–$34,000

29%

$34,001–$80,000

30%

$80,001–$180,000

40%

Over $180,000

45%


Marginal Tax Rates

$0–$35,000

29%

$35,001–$80,000

30%

$80,001–$180,000

38%

Over $180,000

45%


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Marginal Tax Rates

$0–$37,000

29%

$37,001–$80,000

30%

$80,001–$180,000

37%

Over $180,000

45%

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Appendix A: Income Tax Rates and Tables

273

Company tax rate Financial Years

Rate

2009–10

30%

2010–11

30%

The federal government proposes to reduce the company tax rate to 29Â€perÂ€cent in 2013–14. If you run a small business, from 1Â€JulyÂ€2012, the proposed company tax rate reduces to 29Â€perÂ€cent.

Medicare levy low income threshold Financial Year

Low Income Threshold (Individuals)

(Families)

2008–09

$17,794

$30,025

2009–10

$18,488

$31,196

Additional amount for each dependent child increased from $2,757 to $2,865 in 2009–10.

Medicare levy surcharge Financial Year

Individuals

Family/Couples

2008–09

$70,000

$140,000

2009–10

$73,000

$146,000

Family/couples threshold increases by $1,500 for each dependent child after the first child.

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274


Capital gains tax Consumer Price Index Year

31 March

30 June

30 September

31 December

1985

0

0

71.3

72.7

1986

74.4

75.6

77.6

79.8

1987

81.4

82.6

84.0

85.5

1988

87.0

88.5

90.2

92.0

1989

92.9

95.2

97.4

99.2

1990

100.9

102.5

103.3

106.0

1991

105.8

106.0

106.6

107.6

1992

107.6

107.3

107.4

107.9

1993

108.9

109.3

109.8

110.0

1994

110.4

111.2

111.9

112.8

1995

114.7

116.2

117.6

118.5

1996

119.0

119.8

120.1

120.3

1997

120.5

120.2

119.7

120.0

1998

120.3

121.0

121.3

121.9

1999

121.8

122.3

123.4

Source: Australian Bureau of Statistics

Capital gains tax: Improvement threshold Financial Year

bapp01.indd 274

Threshold (pre-CGT Asset)

2009–10

$124,258

2010–11

$126,619

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275

Car depreciation limit Financial Year

Depreciation Limit

2009–10

$57,180

2010–11

$57,466

Car substantiation Rates per Business Kilometre (2009–10) Ordinary Car Engine Capacity

Rotary Engine Car Engine Capacity

Cents per Kilometre



63 cents

1601–2600cc (1.601–2.6 litre)

801–1300cc (0.801–1.3 litre)

74 cents

2601cc (2.601 litre) andÂ€over

1301cc (1.301 litre) andÂ€over

75 cents

Death benefit payments Lump Sum Superannuation Death Benefit Payments TaxÂ€Rates Tax Free Component

Taxable Component

Dependant

Nil

Nil

Non-dependant

Nil

16.5%

Dependant (untaxed element): Whole amount tax-free. Non-dependant (untaxed element): Whole amount taxed at 31.5Â€per cent.

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276


Death Benefit Employment Termination Payments TaxÂ€Rates Financial Year

Lower Cap Amount (LCA)

2009–10

$150,000

2010–11

$160,000

Dependant (taxable component): Tax-free up to LCA. Above LCA: Tax rate 46.5%. Non-dependant (taxable component): Tax rate 31.5% up to LCA. Above LCA: Tax rate 46.5%.

Employment termination payments Life Benefit Payments Financial Year

Lower Cap Amount (LCA)

2009–10

$150,000

2010–11

$160,000


Preservation age and above

Up to LCA: Tax rate 31.5%

Up to LCA: Tax rate 16.5%

Above LCA: Tax rate 46.5%

Above LCA: Tax rate 46.5%

First home owner grant Limits on Value of Properties

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Jurisdiction

Limit

ACT


NSW

$750,000

NT

$750,000

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277

Limits on Value of Propertiesâ•… (continued) Jurisdiction

Limit

Qld

$750,000

SA


Tas.


Vic.

$750,000

WA

$750,000 (north of 26th parallel, $1,000,000)

First home saver accounts Account Balance Cap Threshold Financial Year

Account Balance Cap

2009–10

$75,000

2010–11

$80,000

Maximum Annual Contributions Thresholds Financial Year

Maximum Contribution

Maximum Government Contribution

2009–10

$5,000

$850

2010–11

$5,500

$935

Fringe benefit tax rate

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FBT Year Ending

Rate

31 March 2010

46.5%

31 March 2011

46.5%

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278


FBT: Car parking threshold FBT Year Ending

Rate

31 March 2010

$7.25

31 March 2011

$7.46

Fringe benefits tax: Gross-up rates FBT Year Ending

Type 1

Type 2

31 March 2010

2.0647

1.8692

31 March 2011

2.0647

1.8692

FBT: Statutory benchmark interestÂ€rate FBT Year Ending

Rate

31 March 2010

5.85%

31 March 2011

6.65%

FBT: Statutory formula method (car) statutory fraction Kilometres

bapp01.indd 278

Statutory Fraction

Less than 15,000

26%

15,000–24,999

20%

25,000–40,000

11%

More than 40,000

â•⁄ 7%

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279

Higher Education Loan Program (HELP) Repayment Threshold Rates Financial Year

HELP Repayment Income Threshold

Rate

2009–10

Below $43,151

Nil

2010–11

Below $44,912

Nil

Compulsory repayment rate of between 4Â€and 8Â€perÂ€cent applies after you earn more than the threshold amount (for more details, see the Tax Office website: www.ato.gov.au).

Investment allowance Small business tax breaks Financial Year

Deduction

2009–10

50% cost of eligible asset

2010–11

50% cost of eligible assets

General business tax breaks: For eligible assets that cost more than $10,000, the following tax breaks apply: 55 If you commit to investing in new eligible assets between 13Â€December 2008 and 30 June 2009, you can claim a 30Â€perÂ€cent tax deduction if you first use or install the asset by 30Â€June 2010. 55 If you commit to investing in new eligible assets between 13Â€December 2008 and 30Â€June 2009, you can claim an additional 10Â€perÂ€cent tax deduction if you first use or install the asset between 1Â€JulyÂ€2010 and 31Â€DecemberÂ€2010. 55 If you commit to investing in new eligible assets between 1Â€July 2009 and 31Â€December 2009, you can claim an additional 10Â€perÂ€cent tax deduction if you first use or install the asset by 31 DecemberÂ€2010.

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280


Minor beneficiaries special rates ofÂ€tax Taxable Income

Rate of Tax

$0–$416

Nil tax payable

$417–$1,307

66% of excess over $416

Above $1,307

45% on entire amount of taxableÂ€income

Paid parental leave scheme From 1 January 2011, eligible parents of newborn babies canÂ€receive a federal government funded 18Â€weeks of paid parental leave. The payment is at the national minimum wage rate. To be eligible, you must satisfy a work test and you can’t earn more than $150,000. (The federal government intends to introduce 2Â€weeks of paid parental leave for fathers asÂ€well.)

Redundancy payments/approved early retirement schemes Tax Free Thresholds Financial Year

bapp01.indd 280

Base Limit

For Each Completed Year of Service

2009–10

$7,732

$3,867

2010–11

$8,126

$4,064

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281

Superannuation Under 50 years of age Concessional Contributions (Cap) Financial Year

Maximum Cap

2009–10

$25,000

2010–11

$25,000

Over 50 years of age You can claim up to $50,000 a year (non-indexed) until 2011–12. The cap then reverts to under the maximum cap rate for those younger than 50Â€years of age. From 1 July 2012, the federal government proposes that if you’re over 50 years of age you can make a $50,000 concessional contribution if you have less than $500,000 in your superannuation fund.

Non-Concessional Contributions (Cap) Financial Year

Maximum Cap

2009–10

$150,000

2010–11

$150,000

Non-Concessional Contributions Capital Gains Tax (CGT) Cap Amount Financial Year

bapp01.indd 281

Maximum CGT Cap

2009–10

$1,100,000

2010–11

$1,155,000

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282


Maximum super guarantee contribution base Financial Year

Amount

2009–10

$40,170 per quarter

2010–11

$42,220 per quarter

Minimum superannuation pensionÂ€payments Age

Pre-30 June 2009

1 July 2009 to 30 June 2011

Under 65

4%

2.0%

65–74

5%

2.5%

75–79

6%

3.0%

80–84

7%

3.5%

85–89

9%

4.5%

90–94

11%

6.5%

95 and over

14%

7.0%

For financial years ended 30 JuneÂ€2009 toÂ€2011 inclusive, the federal government has reduced the minimum withdrawal requirements by 50Â€perÂ€cent for each age group.

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283

Preservation age Date of Birth

Preservation Age

Before 1 July 1960

55 years

1 July 1960 – 30 June 1961

56 years

1 July 1961 – 30 June 1962

57 years

1 July 1962 – 30 June 1963

58 years

1 July 1963 – 30 June 1964

59 years

From 1 July 1964

60 years

Superannuation co-contribution threshold rates Financial Year

Low Income (Thresholds)

High Income (Thresholds)

2009–10

$31,920

$61,920

2010–11

$31,920

$61,920

If your total assessable income is less than $31,920 and you make a $1,000 non-concessional contribution to your super fund,Â€the federal government makes a $1,000 contribution on your behalf. The co-contribution amount reduces at the rate of 3.333 cents for every dollar you earn above $31,920 and ceases after you earn more than $61,920.

Superannuation contributions rebate From 1 July 2013, if you earn less than $37,000, the federal government proposes to contribute up to $500 on your behalf. This contribution is to eliminate the 15Â€perÂ€cent tax payable on concessional contributions to a complying superannuation fund, and your superannuation fund balance also increases.

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284


Superannuation contributions splitting Individual superannuation fund members can split concessional contributions made in the previous financial year with their (non-income or low-income-earning) spouses or partners. The maximum permitted is 85 per cent of the concessional contributions cap (see Tax Office publication ‘Contributions splitting (NAT 15237)’ for more details).

Superannuation guarantee paymentsÂ€rate The current superannuation guarantee (SG) rate is 9Â€perÂ€cent of employee earnings. The federal government proposes for this current SG rate to apply until 2011–12. From 1 July 2012, the rate is set to increase in stages as follows:

Financial Year

SG Rate

2013–14

â•⁄ 9.25%

2014–15

â•⁄ 9.50%

2015–16

10.00%

2016–17

10.50%

2017–18

11.00%

2018–19

11.50%

2019–20

12.00%

Currently, the SG age limit is 70 years of age. From 1Â€JulyÂ€2013, the federal government proposes to increase this age limit to 75Â€years ofÂ€age.

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285

Superannuation lump sum payments Untaxed Element Low Rate Cap Amount Financial Year

Cap Amount

2009–10

$150,000

2010–11

$160,000

Untaxed Plan Cap Amount Financial Year

Cap Amount

2009–10

$1,100,000

2010–11

$1,155,000

Tax Offsets (Rebates) You can use tax offsets to reduce your tax payable. You can’t use tax offsets to reduce your Medicare levy liability. Ordinarily, you can’t have unused tax offsets refunded back to you. The three exceptions are 55 Baby Bonus tax offset 55 Franking credit tax offset 55 Private health insurance rebate You can transfer to your spouse some unused tax offsets such as senior Australians tax offsets. The major tax offsets you’re likely to use are listed in the next sections.

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286


Baby Bonus The Baby Bonus payment is a non-taxable federal government payment made on the birth of a child. Its purpose is to help you cover the costs associated with the birth or adoption of a baby. This payment is means tested and is paid in 13, equal, fortnightly payments in respect of each child. For more information, see the Family Assistance Office website (www.familyassist.gov.au).

Child care rebate The child care rebate is to help you cover the costs associated with child care and you can claim it through the Family Assistance Office (www.familyassist.gov.au). The child care rebate is 50Â€perÂ€cent of eligible approved child care expenditure (such as long day care or family day care) and is normally payable on a quarterly basis. The maximum you can receive is as follows:

Financial Year

Rate

Amount

2009–10

50%

$7,778

2010–11

50%

$7,500

From 1 July 2010, the maximum child care rebate is set to remain at $7,500 and isn’t likely to change for the next fourÂ€years.

Dependant rebate (tax offset) The spouse (without a dependent child or student) maximum tax offset for 2009–10 is $2,243. (For the 2008–09 financial year, the amount was $2,159.) To qualify for this tax offset, you must maintain (support) your spouse, and your spouse’s adjusted taxable income must be less than $282. The rebate reduces by $1 for every $4 in excess of $282 and ceases as soon as your spouse’s adjusted taxable income exceeds $9,254. Further, your spouse must be a resident and neither you nor your spouse is entitled to family tax benefit PartÂ€B — see the section ‘Family tax benefit (PartÂ€B)’ later in thisÂ€Appendix.

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287

Other dependant rebates (tax offsets) may include 55 Child-housekeeper 55 Housekeeper 55 Invalid relative 55 Parent/parent-in-law From 1 July 2009, your adjusted taxable income is used to check whether you can claim a dependant tax offset. You’re ineligible if you and your spouse’s combined adjusted taxable income exceeds $150,000.

Education tax refund Under this plan, families receiving family tax benefit (PartÂ€A)Â€— see the section ‘Family tax benefit (Part A)’ later in this Appendix — are able to claim a 50 per cent refund for certain education expenses. The claim is capped at $780 for each child in primary school, and the maximum refundable tax offset is $390 per child each financial year. For children attending secondary school, the claim is capped at $1,558 and the maximum refundable tax offset is set at $779 per child each financial year. You need to lodge a tax return and claim 50Â€perÂ€cent of the education expenditure you incur each year. You can transfer to your spouse any unused tax offset. If you spend more than the maximum, you can claim the additional expenses in the following financial year.

Entrepreneurs’ tax offset If you elect to use the concessions available to small business entities, you may be eligible for the entrepreneurs’ tax offset (ETO). This opportunity arises if your net business income (that is, business income minus business expenses) is $50,000 or less a year. If you’re eligible, you can claim a 25Â€perÂ€cent ETO on tax payable on the net business income you derive. The tax offset reduces if you earn more than $50,000 and ceases as soon as you earn more than $75,000. An income test applies to reduce the entrepreneurs’ tax offset if your income exceeds a certain threshold, namely, $70,000 a year for individuals and $120,000 a year for families (see the Tax Office website for more details: www.ato.gov.au).

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288


Family Tax Benefit (Part A) This tax offset is an annual tax benefit to help you raise your children. To qualify, you must have a dependent child younger thanÂ€21Â€years, or a dependent student aged 21 toÂ€24 in full-time education. This payment is subject to you satisfying an income test — see the Centrelink website (www.centrelink.gov.au) for more details.

Family Tax Benefit (Part B) If you’re a single income family or a sole parent you may qualify for an extra payment under family tax benefit (PartÂ€B) to help you raise your children. You can also receive an additional payment if your dependent child is younger than 16Â€years of age. This payment is subject to you satisfying an income test (see the Centrelink website for more details: www.centrelink.gov.au).

Franking credit tax offset You can claim a franking credit tax offset if you receive a dividend that’s franked. Unused franking credits can be refunded to you.

Low income tax offset Eligibility for the low income tax offset is applicable to low income resident individuals.

Year

2009–10

2010–11

$1,350

$1,500


$30,000

$30,000


$63,750

$67,500

Maximum tax offset

The low income tax offset reduces by 4Â€cents for every dollar you earn above the taxable income threshold ($30,000).

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289

Mature age tax offset Residents over 55 years of age receiving net income from working are eligible to receive the mature age tax offset. Net income from working is the total assessable income you receive as a reward for your personal effort or skills (for example, from salary, wages and allowances) minus any related deductions. The maximum tax offset is $500 if your net income from working is between $10,000 and $53,000. The mature age tax offset reduces by 5Â€cents in the dollar if your net income from working is below $10,000 or above $53,000 and fully phases out if such income exceeds $63,000.

Medical expenses tax offset If you incur net medical expenses that exceed a medical expenses tax offset threshold, you can claim 20Â€perÂ€cent of the excess as a tax offset.

Financial Year

Threshold

Tax offset

2009–10

$1,500

20% of excess over $1,500

2010–11

$2,000

20% of excess over $2,000

From 1 July 2011, the medical expenses threshold is set to be adjusted annually.

Private health insurance rebate (taxÂ€offset) If you’re a member of a private health insurance fund, 30Â€perÂ€cent of the cost you incur is either a claimable rebate or you can use it to reduce the cost of your health insurance premium. The rebate increases to 35 per cent if you’re between 65 and 69 years of age and 40 per cent if you’re 70Â€years or over.

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290


Senior Australians tax offsets Residents who are eligible to receive a Commonwealth age pension or a Department of Veteran Affairs’ payment are eligible for the senior Australians tax offset.

Financial Year


Single 2009–10

$29,867

2010–11

$30,685

Couple (Each) 2009–10

$25,680

2010–11

$26,680

The senior Australians tax offset reduces by 12.5Â€cents for every dollar above the respective thresholds. If a member hasn’t fully used the tax offset, the excess is transferable to the member’s spouse.

Superannuation pension tax offset If you’re between 55 and 59 years of age and you receive a pension from a complying superannuation fund, you may qualify for a tax offset. The amount of the tax offset is equal to 15Â€perÂ€cent of the taxable component of the pension payment you receive. If you’re over 60 years of age and you receive a superannuation pension from an untaxed source (for example, from certain Commonwealth and state government superannuation schemes), you can claim a 10Â€perÂ€cent tax offset on the untaxed component of the pension.

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291

Superannuation spouse contribution tax offset If your spouse’s assessable income is $10,800 or less in a financial year, you may qualify for a $540 tax offset. To qualify for the maximum tax offset, you need to make a $3,000 spouse contribution to a complying superannuation fund or retirement savings account operated by an approved financial institution. The tax offset reduces if your spouse earns more than $10,800 and ceases if your spouse earns more than $13,800.

Zone tax offset If you live or work in a remote part of Australia or you’re in the defence forces serving overseas, you may be eligible for a zone tax offset. The zone tax offset applies to two classifications known as zone A and zone B. For details regarding eligibility and selected areas within these zones, visit the Tax Office website (www.ato.gov.au) and check out the fact sheets ‘Australian Zone List’ and ‘Regional tax essentials’.

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292

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Appendix B

Taxing the Visitors: Non-Residents

N

on-residents of Australia are liable to pay tax only at non-resident rates on income that has an Australian source, such as salary and wages, business profits and rental income (refer to AppendixÂ€A and, more particularly, FigureÂ€B-1). However, a non-resident isn’t liable to pay a 1.5Â€perÂ€cent Medicare levy. Plus, a non-resident can’t claim domestic tax offsets (rebates) and the $6,000 tax free threshold.

Income sourced in Australia

Taxed in Australia

• Salary and wages • Business profits • Rental income

Withholding tax

Capital gains

• Dividends • Interest • Royalties

Not taxable

Taxable

Shares listed on Australian Securities Exchange

Taxable Australian property (real estate, business assets)

Managed investment trust income (fund payment)

Figure B-1: Income sourced in Australia by non‑residents.

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294

Part VII: Appendixes You can be treated as a tax resident as soon as you’re in Australia for more than 183Â€days. However, this isn’t the case if you can satisfy the Tax Office that your permanent place of abode is outside of Australia and you have no intention to live here. If you’re an overseas student and you enrol at an Australian institution in a course that takes more than six months to complete, you’re usually considered a resident of Australia for tax purposes while you’re here. If you work in Australia while on holidays, you need to lodge a tax return disclosing the salary or wages you’re paid. If you leave Australia before the end of the financial year, you need to fill out the form ‘Taxpayer leaving AustraliaÂ€— request for early assessment (NAT 3407)’. You can get a copy from the Tax Office website (www.ato.gov.au). Before you commence working in Australia, you need to apply forÂ€a tax file number and quote this to your employer. Otherwise, you’re automatically taxed at the highest marginal tax rate (45Â€perÂ€cent). If as a temporary resident and a foreign non-resident, you purchase a property while in Australia, you must sell the property when you depart Australia. Stiff penalties apply if you fail to comply. If you’re a temporary resident of Australia holding an eligible temporary resident visa and you permanently leave Australia, you may be entitled to claim back any superannuation contributions made on your behalf (see ChapterÂ€5). For more details visit the Tax Office website (www.ato.gov.au) and read the form ‘Applying for a departing Australia superannuation payment (NAT 7204)’. Non-residents are liable to pay tax on capital gains tax (CGT) assets that are ‘taxable Australian property’ and are physically located in Australia. For example, this requirement may arise if you own property in Australia or assets in a business that operates through an Australian branch. You’re normally not liable to pay tax on any capital gain you make when you sell shares listed on the Australian Securities Exchange because they’re not classified as ‘taxable Australian property’ (refer to FigureÂ€B-1).

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Appendix B: Taxing the Visitors: Non-Resisdents

295

If you’re a temporary resident and you cease to be an Australian resident, you aren’t considered to have disposed of your CGT assets. If you want to know more about Australian income of foreign residents, visit the Tax Office website (www.ato.gov.au) to access the following fact sheets: 55 ‘Australian income of foreign residentsÂ€— overview’ 55 ‘Doing business in AustraliaÂ€— overview’ 55 ‘Investing in AustraliaÂ€— overview’ 55 ‘Non-residentsÂ€— lodging an Australian income tax return’ 55 ‘Working in AustraliaÂ€— overview’ If you’re a non-resident and earn Australian sourced interest, dividends or royalties, you don’t need to lodge an Australian tax return, nor include these payments as part of your assessable income. This rule applies even if you do have to lodge a tax return (for example, you earn salary and wages in Australia) because you’re liable to pay withholding tax only on the amount you receive (refer to FigureÂ€B-1). The rate of tax payable depends on whether an international tax treaty exists between Australia and the foreign country where you reside. If no tax treaty exists, 10Â€perÂ€cent tax is ordinarily withheld from interest payments, and 30Â€perÂ€cent tax is usually withheld from unfranked dividends and royalty payments. No withholding tax applies if you receive aÂ€fully-franked dividend. When a resident Australian company pays a dividend to a non-resident, the company must state whether the dividend is franked, partially franked or unfranked. Franked means Australian income tax is paid on its Australian profits and this benefit can be passed on to you (for more details, refer to ChapterÂ€9). On the other hand, if the dividends are partially franked, some withholding tax may be withheld from your payment and, if the dividends are unfranked, you’re liable to pay the full amount of withholdingÂ€tax.

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296


Case study: Taxing a non-resident ofÂ€Australia Franco, who is a non-resident of Australia, earns a $20,000 salary while working in Australia and pays $5,800 PAYG withholding tax. His work-related expenses are $200. He also receives $500 interest on an Australian investment account. The financial institution withholds 10Â€ perÂ€ cent withholding tax on this payment because he quotes his tax file number and overseas address to it. While Franco is in Australia he makes a $3,000 capital gain on shares listed on the Australian Securities Exchange. He also receives a $28,000 salary in the country where he normally resides. Because Franco is a non-resident, he’s liable to pay tax only on income sourced in Australia. Franco is taxed in the following way: 55 The $20,000 salary he earns in Australia is liable to tax at nonresident rates.

55 He can claim a $200 tax deduction for his work-related expenses. 55 TenÂ€ perÂ€ cent withholding tax is deducted from the $500 interest, so Franco doesn’t have to pay any further tax on this amount, nor include it in his Australian tax return. 55 The $3,000 capital gain he makes on his share transaction isn’t taxed because it isn’t classified as ‘taxable Australian property’. 55 The $28,000 salary Franco earns in the country where he normally resides isn’t liable to Australian taxÂ€because the source is outside of Australia. Franco is a non-resident, so he can’t claim the $6,000 tax free threshold available to Australian residents. He isn’t liable to pay the 1.5Â€ perÂ€ cent Medicare levy. Franco’s taxable income (assessable income less deductions) and tax payable are calculated as follows.

Tax return for individuals Calculating the taxable income Salary or wages

$20,000

TOTAL INCOME

$20,000

Less: Work-related expenses TAXABLE INCOME

bapp02.indd 296

$200 $19,800

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297

Appendix B: Taxing the Visitors: Non-Resisdents

TAX PAYABLE/TAX REFUND Tax payable on $19,800 (Note 1)

$5,742

Less Tax withheld on salary Tax Refund

$5,800 $58

Franco’s total tax credits ($5,800) exceed the tax payable ($5,742), so the Tax Office refunds the excess ($58). Note 1: Calculating tax payable $19,800 @ 29% =

$5,742

TAX PAYABLE

$5,742

If you want to know whether Australia has a tax treaty with a foreign country, visit the Tax Office website (www.ato.gov.au) and check out the fact sheet ‘Countries that have a tax treaty with Australia’. If you earn Australian-sourced interest, you need to advise the paying institution your overseas address. Otherwise, 46.5Â€perÂ€cent tax is withheld from your payment, instead of 10Â€perÂ€cent. If a non-resident invests in an Australian managed investment trust (MIT), such as those listed on the Australian Securities Exchange, the trust is required to withhold tax from certain fund payment distributions it makes to a non-resident investor (such as rent and capital gains on ‘taxable Australian property’). However, MIT withholding tax doesn’t apply to interest, dividend and royalty payments because these distributions continue to be taxed under the existing withholding tax provisions (refer to FigureÂ€B-1).

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298

Part VII: Appendixes From 1 July 2008, the withholding tax rate reduces over a threeyear period from a non-final withholding tax rate of 30Â€perÂ€cent (which was the case in 2007–08) to a final withholding tax rate of 7.5Â€perÂ€cent. The new transitional withholding tax rates are set out below: 55 A final withholding tax rate of 15Â€perÂ€cent applies in the 2009–10 financial year. 55 A final withholding tax rate of 7.5Â€perÂ€cent applies in the 2010–11 and subsequent financial years. The term non-final withholding tax means a non-resident investor who receives an MIT distribution is required to lodge a tax return. This investor can claim a tax deduction and refundable credit for the amount of tax withheld. The term final withholding tax means a non-resident investor in receipt of an MIT distribution is liable to pay only a final withholding tax. The investor isn’t required to lodge a tax return and can’t claim a tax deduction for expenses incurred in deriving an MIT distribution. If a non-resident investor resides in a country that doesn’t have an effective exchange of information on tax matters agreement with Australia, a distribution from an MIT is liable to a final withholding tax rate of 30Â€perÂ€cent. For more information, see the Tax Office website (www.ato.gov.au) and read ‘Tax havens and tax administration (NAT 10567)’.

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Glossary absorption cost method: An accounting method that takes into account all manufacturing costs (that is, both fixed and variable) when valuing trading stock. account-based pension: AÂ€superannuation pension where you can vary the payments each year and which continues to pay until your funds are diminished. You must receive a prescribed minimum each year, which can vary from between 4 perÂ€cent and 14Â€perÂ€cent of your account balance. accruals or earnings basis: Method of accounting for income that takes into account money due but not yet paid to you. This generally arises when you have a legal right to demand payment, such as when you invoice a client for the services you have rendered. adjusted taxable income: Your taxable income plus other amounts such as reportable fringe benefits, tax-free pensions or benefits, foreign income, reportable super contributions, losses from negative gearing financial investments minus child support payments. age pension: A federal government payment payable to eligible individuals who satisfy an income test and asset test. allowable deduction: An expense you can deduct from your assessable income.

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allowance: A payment you receive from your employer — in addition to the salary or wage you receive. Usually, the payment is to compensate you for any expenditure you incur in the course of deriving your assessable income and normally forms a part of your assessable income. approved auditor: A qualified accountant who’s authorised to auditÂ€superannuation funds. approved early retirement scheme: A payment you receive from your employer under a scheme that offers incentives to encourage a certain group of people to retire early or resign. The Tax Office must approve the scheme before the payment can be concessionally taxed. assessable income: Ordinary incomeÂ€and statutory income that’s liable to tax. asset test: The minimum value ofÂ€assets you can own and still receive the age pension. The age pension reduces as the value of yourÂ€assets increases and ceases as soon as they reach a certain value. Australian Business Number (ABN): The number you quote whenever youÂ€conduct a business transaction. If you don’t quote thisÂ€number, 46.5Â€per cent tax may be withheld from payments made to you.

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Australian Taxation Office (Tax Office): The federal government authority responsible for administering Australia’s tax laws. bad debt: A bad debt arises when a customer is unlikely to pay you money for the goods and services you have rendered. balancing adjustment event: A term the Tax Office uses to describe the process of selling a depreciable item. beneficiary: A person entitled to receive a distribution from a trust. benefit: Any rights, privileges or services under the fringe benefits tax provisions. bona fide redundancy payment: A payment you receive from your employer when your job is made redundant. This payment is concessionally taxed. borrowing expenses: Costs you incur when you borrow money. Borrowing costs that exceed $100 need to be spread over the period of the loan or over 5 years if the period of the loan is more than 5Â€years. brokerage fee: A charge you incur from a stockbroker when you buy or sell shares that form part of the costÂ€base. business activity statement (BAS): A statement under the pay-as-you-go system that’s prepared at the end of each reporting period disclosing certain income liable to tax and any GST collected. business real property: A business premises such as a shop, office or

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factory that you use to derive your assessable income. buy contract note: An invoice you receive from a stockbroker at the time you purchase shares. It summarises the details of the transaction and is used to calculate a capital gain or capital loss for taxation purposes. capital gain: A gain you make when you sell a CGT asset for a price greater than its cost base. A capital gain is liable to tax. capital gains tax (CGT): A tax on gains you make on disposal of CGT assets such as shares, real estate and collectables you acquire on or after 20 September 1985. capital in nature: Expenses that aren’t tax deductible because they don’t have a direct or relevant connection with deriving assessable income. capital loss: A loss you make when you sell a CGT asset for a price below its reduced cost price. A capital loss can be applied only against a capital gain. capital proceeds: The sale price from the disposal of a capital gains tax asset. capital works deduction: A specific tax deduction you can claim for the construction costs of an income-producing property, or any improvements or extensions you make to an income-producing property. carry forward loss: A tax loss you can deduct from income you derive in future financial years.

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Glossary cash or receipts basis: A method of accounting for income that recognises income only when a payment is actually received. CGT asset: An asset that’s liable to be taxed under the CGT provisions. CGT event: Normally arises when there’s a change in ownership of a CGT asset, such as when you sell it. It can also arise if a CGT asset is lost, destroyed or given away. child care offset: A federal government initiative to help cover the costs associated with child care expenses incurred by working families. collectables: Assets such as antiques, paintings, rare books, stamps, coins and jewellery. Collectables that cost more than $500 are liable to tax under the CGT provisions. commercial loan agreement: A formal loan agreement that sets out the terms of a loan and charges a commercial (or market) rate of interest. company (companies): A separate legal entity that can run a business in its own name. complying superannuation fund: A fund that made an election to beÂ€regulated under the Superannuation Industry (Supervision)Â€Act. A complying superannuation fund is taxed at the rate of 15 per cent and can pay pensions to its members. concessional contributions: Superannuation contributions you make to a complying superannuation

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fund and that qualify for a tax deduction. concessional contributions cap: Before-tax contributions receive concessional tax treatment up to thisÂ€cap. condition of release: A condition you must meet before you can access your benefits in a superannuation fund, such as when you retire. consumer price index: An index used to measure the rate of inflation in Australia. cost base: Under the CGT provisions, the price (and costs) you pay for CGT assets like shares, real estate and collectables. It may also include sale costs and other associated costs youÂ€incur. crystallise: To sell CGT assets in order to make a capital gain or capital loss for taxation purposes. customs duty: A federal government tax on certain goods (such as camera, perfume, alcohol and cigarettes) imported to Australia. decline in value: A term the Tax Office uses instead of depreciation. defalcation: Misappropriation by a trustee. dependent reversionary beneficiary: A person who can continue to receive your pension after you die until all the money runs out. depreciation: Writing off the value of assets you use to derive your assessable income. Under tax law, this amount is referred to as a decline in value.

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derived: Income you have obtained that’s liable to be taxed. You’re considered to have derived income when you receive a payment or can legally demand a payment for services rendered, or when it’s applied or dealt with in any way on your behalf or as you direct. desk audit: A tax audit where the Tax Office asks you to visit them and produce documentary evidence to verify the accuracy of your tax return. diminishing value method (DVM): An accounting method whereby you can work out depreciation that you can claim each year — a larger amount in earlier years and a lesser amount in later years. discount capital gain: A capital gain that arises when you dispose of CGT assets that you acquired after 21 September 1999 and owned for at least 12 months. Just one-half of the capital gain you make is liable to tax at your marginal tax rates (plus the Medicare levy). discount capital gain method: The preferred option of calculating a capital gain. discretionary trust: A type of trust that gives the trustee discretion about how the trust net income should be distributed to the beneficiaries. disposal: Under the CGT provisions, a disposal normally arises when there’s a change in ownership of a CGT asset, such as when you sell it. It can also arise if a CGT asset is lost, destroyed or given away.

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distribution: Income you receive from a company or trust. dividend: A distribution of profits by a company to its shareholders, referred to as income from property. dividend franking credit: A tax credit you receive from a dividend that’s franked. The size of the credit depends on the company tax rate (currently 30Â€perÂ€cent). employment termination payments (ETP): Certain payments you receive from your employer when you terminate your employment. These payments are liable to a special rate of tax. entrepreneurs’ tax offset (ETO): A tax offset available to an eligible small business entity that has derived $50,000 or less net business income. The tax offset is 25 per cent of tax payable on the net business income derived. The tax offset is reduced if you earn more than $50,000 and ceases if you earn more than $75,000. From 1 July 2009, a new income test applies to restrict access to theÂ€ETO. e-tax: A free electronic lodgement service provided by the Tax Office to allow you to lodge your tax returnÂ€online. excepted assessable income: Income derived by a minor beneficiary of a trust (such as employment or business income) that isn’t liable to a special tax, commonly known as Division 6AAÂ€tax. excepted person: A person under 18 years of age not liable to pay a special tax under Division 6AA of the Income Tax Assessment ActÂ€1936.

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Glossary excise duty: A federal government levy on certain goods (such as alcohol) manufactured in Australia. exempt income: Certain payments or receipts exempt from tax. fact sheet: Information issued by the Tax Office that deals with a specific tax issue. final withholding tax: A non-resident investor in receipt of an Australian managed investment trust (MIT) distribution is liable to pay only a final withholding tax. The investor isn’t required to lodge a tax return and can’t claim a tax deduction in respect of expenses incurred in deriving an MIT distribution. financial year: Australia’s financial year, commencing 1 July and ending 30 June. first home owner grant: A federal government initiative to help first home buyers buy or build their first home. Under this scheme, first home owners normally receive a one-off payment of $7,000 to purchase or build a property they intend to use as their main residence. first home saver accounts: A federal government initiative to help first home buyers save for a deposit to buy or build their first home. foreign employment income: Employment income such as salary and wages that a resident of Australia derives while working outside of Australia. foreign income tax offset (credit): Foreign tax paid on income derived

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from overseas sources that can be offset against Australian tax payable on taxable income derived from worldwide sources. franked dividend: A dividend that carries a franking credit (or tax offset). The credit is applied against the tax payable. If no credit is received the dividend is unfranked. It’s also possible to receive a partially franked dividend. This means only a certain percentage of the dividend carries a credit. franking credits: Tax offsets that youÂ€can apply against the net tax payable on dividends and other income you derive. fringe benefits tax: A tax levied on employers for certain benefits provided to their employees or their associates, such as a spouse, child or relative. fully franked dividend: Means the company has paid 30 per cent tax on its profits. This benefit can be passed on to you. general deduction provisions: A section of the Tax Act that sets out a general formula for claiming a tax deductible expense. golden handshake: A generous payment you receive from your employer to reward past services when you retire or terminate your employment contract. goods and services tax (GST): A 10Â€per cent tax on goods and services on purchases and sales. Commonly referred to as GST.

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grossing up (grossed up): Including both the dividend you receive and the franking credit as part of your assessable income. You’re taxed on the total amount and the franking credit is applied against the tax payable. GST credit: A refund of the 10 per cent goods and services tax you incur on your costs or inputs. higher education loan program (HELP): A loan you receive from the federal government to help you cover the cost of higher education. income: Money you derive and which is liable to tax. income from personal exertion: Employment income such as salary and wages, bonuses, commissions and allowances that you earn as an employee. income from property: Income such as interest, dividends, rent, annuities and royalty payments. income tax: A federal tax you pay on income you derive. income test: The minimum income you can earn and still receive the age pension. The age pension reduces as you earn more income and ceases when you earn more than a certain amount. incurred: The point in time when you can legally claim a tax deduction. This point in time normally arises when you’re definitely committed and have a legal obligation to make a payment for certain goods and services you have received.

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indexed: An annual adjustment to an amount of income you receive or tax offset and/or tax deduction you canÂ€claim. indexed cost base: The purchase price of a CGT asset you acquired prior to 30 September 1999, plus certain costs you incur that have been adjusted for inflation. initial repairs: Repairs you make to a newly acquired property. These repairs are not tax deductible expenses. input tax supply: A GST term relating to financial services and residential property for use as residential accommodation. No GST is charged on input tax supplies, and you can’t claim a GST credit in respect of your acquisitions to make that supply. instalment activity statement: A statement under the pay-as-you-go system you prepare at the end of each reporting period disclosing certain income that’s liable to tax. interest: A payment you receive in return for the use of your capital. This payment is referred to as income from property. It is also the amount of money you pay when you borrow money. investment strategy: A document that sets out how you intend to invest and monitor funds you have in a self-managed superannuation fund to fund your retirement. land tax: A state and territory government tax paid on some property holdings.

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Glossary log book: Under the car substantiation provisions, a document to record the actual number of business kilometres you travel over a period of 12Â€weeks. This record is used to calculate a reasonable estimate of the number of business kilometres you’re likely to travel during the financial year. low-value pools: A method of depreciation, whereby you can pool (accumulate) all items that cost less than $1,000. main residence: The place where you normally reside. It can also include up to 2 hectares of land that surround your home. Your main residence is normally exempt from tax under the capital gains tax provisions. managed investment trust: A pooled investment scheme that invests in a diverse range of financial products such as interest bearing securities, property and shares. marginal tax rate(s): The rate of tax payable on the last taxable income dollar you earn. means test: A statutory test you need to satisfy to qualify for a certain tax offset, government payment or pension. Medicare levy: A medical levy based on a percentage of your taxable income (currently 1.5 per cent) to help fund the Australian health system. negative gearing: A term associated with borrowing money to buy income-producing assets such as

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shares and real estate. Negative gearing arises when your deductible expenses, particularly interest, exceed the income you derive. net capital gain: The amount of the capital gain you make on disposal of a CGT asset that’s liable to tax. net income: The amount of income left over when you deduct your allowable deductions from your assessable income. net loss: A loss that arises when your allowable deductions exceed your assessable income. non-account-based pension: Normally, a lifetime pension, which means you’re guaranteed a pension for the rest of your life. The pension payment can increase only to counter the impact of inflation. In the event of your death, the pension can continue to be paid as a death benefit income stream to a dependent reversionary beneficiary (for instance your spouse). non-deductible holding costs: Under the CGT provisions, these costs are expensesÂ€such as interest, rates and land taxes, repairs and insurance you incur on non-income-producing assets that you acquired after 20 August 1991. These expenses form part of the third element of the cost base of a CGT asset and can be used to reduce a capital gain. non-commercial losses: An antiavoidance provision that prevents you from claiming business losses unless you can satisfy a number of statutory tests as set out in the TaxÂ€Act.

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non-commutable pension: A pension that can’t be readily converted back into a lump sum cash payment (for instance non-account-based (life) pensions). non-complying superannuation fund: A fund that has not made an election to be regulated under the Superannuation Industry (Supervision) Act 1993, or has failed to meet certain standards prescribed by the federal government. non-concessional contributions: Superannuation contributions you make to a complying superannuation fund that does not qualify for a tax deduction. non-discount capital gain: A capital gain on disposal of a CGT asset you acquired after 21Â€September 1999 and that was owned for less than 12 months. The entire capital gain is liable to tax at your marginal tax rates plus the Medicare levy. non-final withholding tax: A nonresident investor in receipt of an Australian managed investment trust (MIT) distribution is required to lodge a tax return and can claim a tax deduction and refundable credit for the amount of tax withheld. non-resident of Australia: A person who doesn’t normally reside in Australia and has no intention to live here. Non-residents are liable to pay tax only on income sourced in Australia.

after you lodge your tax return summarising the details in your tax return. notional capital gain: A temporary or unofficial gain that presently exists until the actual amount of the capital gain that’s liable to tax is determined. objection: A formal challenge against a Tax Office assessment or decision. operating cost: Running costs of owning a car that includes costs such as fuel, repairs and maintenance. operating cost method: A method to calculate the taxable value of a car fringe benefit under the fringe benefits tax provisions. ordinary income: Income that an average person would commonly understand is taxable (such as salary and wages). Ordinary income can be income from personal exertion, property and profits from running a business. partially franked: You receive a franking credit to the extent the dividend is franked. pay-as-you-go (PAYG) payment summary: A statement you receive from your employer (normally at the end of the financial year) that sets out the gross income you derived during the financial year and the income tax deducted.

notice of amended assessment: An adjustment notice issued by the Tax Office to fix an error.

pay-as-you-go (PAYG) withholding tax: Employers have an obligation to withhold a certain amount of tax from an employee’s pay and remit the amount to the Tax Office.

notice of assessment: The statement you receive from the Tax Office

payroll tax: A state or territory government tax levied on wages and

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Glossary fringe benefits that an employer pays its employees. penal rate of tax: An anti-avoidance tax rate under Division 6AA of the Income Tax Assessment Act 1936 to discourage a trustee from distributing unearned income to children under 18 years of age. It also applies if a trustee doesn’t distribute trust income to beneficiaries. personal exertion income: Income such as salary and wages, bonuses, commissions and allowances that an employee earns as a consequence of using their personal labour and skill. personal services business: Running your own business and deriving income from many unrelated clients, using your own tools and equipment and fixing any faulty work you do to achieve a specific result. prescribed person: A person under 18 years of age who’s liable to pay a special rate of tax under Division 6AA of the Income Tax Assessment ActÂ€1936. presently entitled: The right of a beneficiary of a trust to demand an immediate distribution of the trust’s net income. preservation age: The age you must reach before you can retire and access your superannuation fund benefits. Depending on when you were born, this point in time can vary from between 55 and 60Â€years of age. preserved benefits: Benefits you can access when you satisfy a condition of release such as when you reach your preservation age and retire.

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prime cost method (PCM): An accounting method whereby you can work out a fixed amount of depreciation that you can claim eachÂ€year. private or domestic in nature: Expenses that aren’t tax deductible as they don’t have a direct or relevant connection with deriving assessable income. private ruling: Written advice you receive from the Tax Office about how it would interpret the tax laws in respect to a specific issue you raise. Product Disclosure Statement: A document that summarises all the important information you need to know about joining a fund. property valuation/rate charges: Local government taxes levied to fund local services (such as rubbish collection). rent: Money you receive from a tenant for the use of your property. Under tax law, this money is referred to as income from property. resident of Australia: A person who normally resides in Australia (it can also include a company or trust). Residents are taxed on their worldwide income. restricted non-preserved benefits: Benefits you can access when you retire or leave your current employment. reversionary beneficiary: A person (such as your spouse) who can continue to receive your pension from a superannuation fund after youÂ€die.

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salary sacrifice: Payment made by an employee to make extra superannuation contributions to a super fund instead of receiving the amount as cash salary. self-assessment: The Australian tax system works on a self-assessment basis. This approach means the onus is on you to declare to the Tax Office the correct amount of income you derive each year and claim the correct amount of tax deductions and tax offsets. self-employed: A person who derives assessable income from operating their own business (such as a sole trader or partner in a partnership), rather than from being employed by someone and deriving a salary orÂ€wage. self-funded retiree: A person who is using their own money to fund their retirement. self-managed superannuation funds: A superannuation fund set up by individuals (to fund their retirement) who would prefer to manage and operate the fund themselves. sell contract note: An invoice you receive from a stockbroker at the time you sell your shares. It summarises the details of the transaction and can be used to calculate a capital gain or capital lossÂ€for taxation purposes. shares: A term associated with the ownership of a company. Owning shares entitles you to receive a share of the profits, referred to as dividends.

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sole purpose: A test to check that the dominant reason for setting up a selfmanaged superannuation fund is to fund retirement strategies. source of income: The place where you usually derive your income. For example, if you earn salary and wages, your source of income is where the work is performed, and if you run a business this is where the business activities are carriedÂ€on. spouse contribution: A superannuation contribution you make to a complying superannuation fund or retirement savings account on behalf of your spouse. stamp duty: A state or territory government tax that applies to certain transactions, particularly property. stamp duty relief: A reduction in the payment of stamp duty imposed by state or territory governments on certain transactions. statutory formula method: A method to calculate the taxable value of a car fringe benefit under the fringe benefit tax provisions. statutory income: Income that’s liable to tax because a specific provision in the tax Act requires you to include it as part of your assessable income; for example, a capital gain you make on disposal ofÂ€a CGT asset. substantially self-employed: A person who derives assessable income from operating their own business (for example, sole trader or partner in a partnership). Less than

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Glossary 10 per cent of their total assessable income comes from employment as an employee. superannuation fund: A fund set up to finance retirement strategies. Money can’t normally be accessed until you satisfy a condition of release, such as when you retire. superannuation guarantee (SG) contribution: A contribution to a complying superannuation fund that an employer is legally obligated to make on behalf of an employee. The amount is currently 9Â€perÂ€cent of what an employee earns. taxable Australian property: Assets owned by non-residents of Australia that are located in Australia (such as property and business assets) and which are liable to capital gains tax when they’re disposed of. taxable component — taxed element: Post-July 1983 accumulated benefits in a superannuation fund that was liable to tax. These payments are liable to tax when distributed, but are tax free when youÂ€turn 60 years of age. taxable component — untaxed element: Post-July 1983 accumulated benefits in a superannuation fund that haven’t been taxed. These payments normally come from certain federal and state government superannuation schemes that don’t pay tax, and proceeds of a life insurance policy. These payments areÂ€liable to tax when distributed. taxable income: The amount of income that’s liable to tax. Taxable income equals assessable income minus deductions.

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tax file number (TFN): A number you get from the Tax Office that you need to quote to certain organisations and when you lodge your annual tax return. tax free component: Payments that are tax free and excluded from taxable income. They include non-concessional contributions and certain other contributions, suchÂ€asÂ€CGT-exempt components andÂ€pre-1983 accumulated amounts. tax free threshold: The maximum amount of income you can receive that isn’t taxed. tax offset: A tax credit or rebate you can use to reduce the amount of tax payable. tax refund: Money you get back from the Tax Office if your total tax credits (tax previously paid plus tax offsets) exceed the amount of tax you’re liable to pay. tax return for individuals: A form you lodge with the Tax Office by 31Â€October, disclosing the amount of taxable income (assessable income minus deductions) you earned that’s liable to tax, plus any tax you’ve paid and tax offsets you can claim. tax ruling: A public ruling issued by the Tax Office to explain and clarify how the Taxation Commissioner interprets tax legislation in respect ofÂ€a specific issue. temporary resident: A person who resides and works in Australia on an eligible temporary resident visa. termination value: The sale price of a depreciable item.

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transition to retirement pension: AÂ€pension you can receive from a super fund while you’re still working on either a full-time or part-time basis. The pension must fall between 4 per cent and 10Â€per cent of the balance in your superannuation fund account. You qualify for a 15 per cent tax offset if you are between 55 and 59 years ofÂ€age. trust: A legal obligation binding a person (referred to as the trustee) who has control over certain business and/or investment assets (referred to as trust property), for theÂ€benefit of certain persons (referred to as beneficiaries). trustee: A person responsible for administering and managing the trust property over which he or she has control for the benefit of the beneficiaries. under a legal disability: Indicates that a beneficiary of a trust isn’t in a legal position to deal with a trust distribution, such as a minor, bankrupt or insane person.

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unfranked dividend: A dividend that carries no franking credits that you can claim. unrestricted non-preserved benefits: Superannuation benefits you can access at any time. wash sale: Selling shares to make a capital loss and gain a tax benefit, then buying them back immediately. will: A legal document that sets out your final instructions for the distribution of your assets and personal belongings in the event of your death. withholding tax: Tax that was withheld from a payment of income such as interest, dividends and royalties made to a non-resident of Australia. zone tax offset: A tax offset you can claim if you live or work in a remote part of Australia or you’re in the defence forces serving overseas.

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Index 15 year exemption CGT concession, 200–201 20 per cent significant individual test, 199 50 per cent reduction CGT concession, 201–202

•A• absorption cost valuation method, 165 account-based (allocated) pensions, 234–236 accruals or earnings basis for business income, 161–162 active assets, 198 age and superannuation benefits, 224–227 age and superannuation contributions, 217,Â€219–220 allowable tax deductible expenses, 167–169 allowances paid to employees, 54–55 amendments to assessments, 46–47 approved early retirement schemes, payments under, 59–60 assessable income, 18–19 assessments, amendments and objectionsÂ€to, 46–47 assets CGT-exempt, 69–70, 121–123 CGT-liable, 118–121 cost base, 126 depreciation of, 106–109 disposal, 69, 247–248 negative gearing, 112–113, 259–260 taxing upon death, 247–248 Association of Superannuation Funds of Australia (ASFA) website, 210 audits. See tax audits Australian business number (ABN), applying for, 154 Australian Business Register website, 154 Australian Government pensions and allowances tax offsets, 238–239 tax-exempt, 239–240 taxable, 237

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Australian Tax Office (ATO) information from, 255 website, 12 Australian tax rates, 271–280

•B• Baby Bonus, 81, 286 bad debts, 170–171 balancing adjustment events (depreciatingÂ€asset), 108 beneficiaries of trusts, tax payable by, 77–80 beneficiaries of wills need for updating, 265 and taxation, 222 binding death benefit nomination form, 242 bona fide redundancy payments, 59 bond money, tax on, 104 borrowing expenses in business claiming, 174 interest, 98–100 tax deductibility of, 171–173 budgeting, in retirement, 263 business. See also small business claiming travel expenses, 61–62 employees, 157–158 recognising income from, 20, 161–162 record keeping, 155–156 status of hobbies, 150 succession planning, 249–250 tax deductibility of losses, 177–178 trading stock valuation, 163–165 business activity statement (BAS), 155, 183 business structures choosing, 137–139 company, 144–147 partnership, 141–144 sole trader, 139–141 trust, 148–149, 151 business website (government), 172 businesses CGT concessions, 197–199 setting up, 153–155 buy contract notes, 100

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•C• capital expenditure, 25–26 capital gains calculation capital gains and losses, 101, 102 capital proceeds, 125 cost base of assets, 126 discount capital gain (post-1999), 127 discount method (pre-1999), 129–130 indexation method (pre-1999), 130–132 net capital gain, 123–125 net capital gain (post-1999), 127–128 non-discount capital gain (post-1999), 127 capital gains tax (CGT). See also capital gains calculation 15 year exemption concession, 200–201 20 per cent significant individual test, 199 50 per cent reduction concession, 201–202 after capital works deductions, 110 assets of deceased estate, 248 assets liable for, 118–120 collectables, 120–121 and CPI over time, 274 exempt assets, 69–70 house downsizing, 266 improvement threshold, 274 interest on borrowings, 98–100 on leaving Australia, 122 main residence provisions, 69–71, 265–266 non-residents, 294–295 personal use assets, 121 qualifying for concessions, 197–199 retirement concession, 202 rollover concession, 203 shares, 100–102 small business concessions, 158–160, 199–203 capital losses on CGT assets, 133–134 on investments, 255–256 rules for, 121, 133–134 capital proceeds, 125 capital protection loan agreements, 100 capital works deductions for incomeproducing properties, 109–110 car expenses depreciation limit, 275 fringe benefits tax, 193–195, 278 methods of claiming, 34–36 parking threshold for FBT, 278 rates per business km, 35

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statutory fraction for business km, 278 substantiation rates, 275 case studies account-based (allocated) pension, 236 capital gains, 101 capital loss calculation, 134 capital losses, 102 capital works deduction and CGT, 110 CGT 50 per cent reduction concession, 202 child in part-time employment, 76 claiming a borrowing expense, 174 depreciation deduction, 108 discount method of capital gain calculation, 129 franked dividends, 92–93 fringe benefit tax, 193 incurring an expense, 29 indexation method of capital gain calculation, 132 inheriting an asset, 249 low income tax offset, 238 negative gearing, 113 net capital gain calculation, 127–128 non-account-based pension, 234 non-deductible holding costs real estate, 114 shares, 99 PAYG payment summaries, 34 preparation of tax returns, 35–38 salary packaging, 196 senior Australians tax offset, 239 super fund taxable income calculation, 215 tax return preparation, 40 taxing a non-resident, 296–297 TFN and tax, 52 transition to retirement pension, 233 trust income distribution, 79 cash or receipts basis for business income, 162–163 Centrelink website, 82 cents per km method (car expenses), 35 CGT assets. See assets CGT. See capital gains tax child care tax rebate, 81–82, 286 Child Support Agency website, 83 children Division 6AA tax, 77–80 employment income, 75 investment accounts, 74 tax offsets, 80–83 taxation of, 73–74 trust distributions, 76–79 co-contributions to super funds, 57, 221

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Index collectables, CGT on, 120–121 companies business structure, 144–147 CGT concessions, 199 company tax, 14–15, 160, 273 concessional contributions to super funds employer on behalf of employee, 219–220 personal, 56 rules, 216–218 self-employed people, 220–221 as tax deduction, 220–221 tax on redundancy payments, 59–60 condition of release of super contributions, 55, 222–227 consumer price index (CPI) figures, 131, 274 contractor status, 53–54 cost base of CGT assets, 123, 126 cost price valuation method, 164 customs duty, 10

•D• death tax on bequeathed assets, 247–249 tax on income, 243–245 will preparation, 241–243 death benefits income streams, 245–246 nomination form, 242 paid to dependant, 244 tax on employment termination payments, 244, 276 tax on lump sum payments, 246, 275 deductions. See tax deductible expenses default superannuation funds, 157 dependant beneficiaries, 245 dependant rebate (tax offset), 255 dependant reversionary beneficiaries, 245–246 dependant tax rebate, 286–287 depreciation of assets calculation methods, 107, 108 for rental income, 106–109 for small businesses, 149 diminishing value method (DVM) for asset depreciation, 107 discharge of mortgage, 176 discount capital gain method for assets, 129–130 on shares, 100 disposal of assets, 69, 247–248 dividend payments franking, 92–96 from shares, 91

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reducing, 97 to non-residents, 295–297 dividends, instalment activity statements,Â€96 Division 6AA tax, 77–80 domestic expenditure, 26–27

•E• e-tax, 32 early retirement scheme payments, 59–60,Â€280 education tax refund, 82–83, 287 employee status, 52–53 employees of businesses, 157–158 employers, super guarantee contribution, 219–221 employment income, of children, 75–76 employment status, contractor versus employee, 52–54 employment termination payments (ETPs) amounts, 58 as death benefit, 243–244 tax rates, 276 types, 57–58 entrepreneurs’ tax offset (ETO), 160, 287 excepted assessable income, 80 excepted persons and trust distributions, 80 excise duty, 11 executors of estates, duties of, 243 exempt income, 20–22 expenses. See also tax deductible expenses capital, 25–26 incurring, 28–29 private or domestic, 26–27 work related, 61–63

•F• Family Assistance Office website, 82 family discretionary trusts, 76–80 Family Tax Benefit (Parts A and B), 81, 288 federal taxes, 10–11 final withholding tax, 297–298 financial planning advice, for retirement, 263–264 first home owners grant, 67, 276–277 first home saver account cap threshold and maximum annual contributions, 277 definition, 68 starting, 89

11/9/10 12:30 PM

314


first positive limb, 24 foreign income and credits, 13 franking, of dividend payments, 92–96 franking credit tax offset, 95, 288 Fringe Benefits Tax Assessment Act 1986 (FBT Act), 189–190 fringe benefits tax (FBT) calculation, 192–193 car parking threshold, 278 cars, 193–195 conditions for liability, 190–192 definition, 11 gross-up rates, 278 otherwise deductible rule, 191–192 rate, 277 in salary packaging, 195–196 statutory benchmark interest rate, 278 statutory fraction for car km, 278 fully franked dividend payments, 92–94, 96

•G• general deduction provisions business expenses, 167–169 definition, 23–24 first positive limb, 24 negative limbs, 25–27 second positive limb, 25 going concern, sale of business as, 185 goods and services tax (GST) GST free sales or supplies, 184–186 input taxed sales or supplies, 184 introduction in Australia, 180 on residential property, 115 paying, 187 registering for, 154, 186–187 for small business, 158–159 taxable sales or supplies, 181–183 types of sales or supplies, 180–181 grossing-up for FBT, 192 for franking, 94 tax rate, 278 GST free sales (supplies), 184–186

•H• Higher Education Contribution Scheme (HECS), 57 Higher Education Loan Program (HELP), repayment rates, 279 hobby, as a business, 150

bindex.indd 314

•I• improvement threshold for CGT, 274 improvements to property, 100 income assessable, 18–19 business, 20, 161–162 international sources, 13–14 local sources, 12 ordinary, 19–20 personal exertion, 19, 52 property, 19 rental properties, 103–116 statutory, 20 tax-exempt, 20–22 income tax, penal rate, 78 Income Tax Assessment Act 1936, 9 Income Tax Assessment Act 1997, 9, 163 income tax returns car expenses, 34–36 case study, 38–40 non-residents, 294 notice of assessment, 37–38 PAYG payment summary, 33–34 preparation, 32–33, 38–40 standard deductions, 36 timing of income and deductions, 260 incurred expenditure, 28–29 indexation method of capital gain calculation, 130–132 individual tax rates, 271–272 Industry SuperFunds website, 210 inheritance of assets, tax payable, 227, 228–229 initial repairs to rental property, 112 input taxed sales or supplies definition, 184 residential rent, 115 instalment activity statements, 96 insurance payments for loss of rent, taxÂ€on,Â€104 interest on borrowing for shares, 98–100 on borrowing for business, 171–172 receipt by non-residents, 295, 297 as tax deduction, 90 interest bearing securities, 87–88 interest earning expenditure, claiming, 90 investment accounts, children’s, 74 investments decrease in value, 255–256 in share market, 91–102

11/9/10 12:30 PM

Index

•L• land tax, 11 lease document expenses, tax deductibility, 176 legal costs, tax deductibility, 174–175 limbs, for tax deductions, 23–27 local taxes, 11 log books (car expenses), 36 low income earners tax incentives for super contributions, 221–222 tax offset, 75, 238, 288 tax threshold, 257–258 low rate cap amount of super benefit, 226 low value pools method of depreciation, 109 lump sum death benefits from super, 223, 246

•M• main residence CGT exemption, 69–70 CGT payable, 70–71 definition, 65–66 downsizing, 266 first home owners grant, 67 first home saver accounts, 68 interest on borrowings, 68–69 pre-1985 CGT provisions, 265–266 stamp duty relief, 68 tax concessions on purchase, 66–69 manufacturing, absorption cost method of valuation, 165 marginal tax rates, 10 market selling value valuation method, 164 mature age tax offset, 289 medical expense tax offset, 289 Medicare levy, 11, 273 minor beneficiaries, tax rates, 280 mortgage discharge, tax deductibility of, 176 motor cars. See car expenses

•N• negative gearing of assets, 112–113, 259–260 negative limbs, 25–27 net capital gain calculation, 123–125, 127–128 non-account-based (life) pensions, 232–234

bindex.indd 315

315

non-capital costs. See non-deductible holding costs non-commutable pensions, 231 non-complying super funds, 208 non-concessional contributions to superÂ€funds by age, 218–219 rules, 216–217 non-deductible expenditure on property, 113–114 non-deductible holding costs interest on shares, 99 real estate, 114 non-dependant beneficiaries, 242 non-discount capital gains, on shares, 100 non-final withholding tax, 297–298 non-income producing property, capital gains on, 113–114 non-residents receipt of interest, dividends and royalties, 295, 297 tax case study, 296–297 tax status, 294–295, 297 taxable Australian income sources, 293 withholding tax, 298 notice of assessment, 32–33, 37–38

•O• objections to assessments, 46–47 operating cost method for car FBT, 195 ordinary income, 19–20

•P• paid parental leave scheme, 280 partially franked dividend payments, 94 partnership business structure, 141–144 pay-as-you-go (PAYG) instalment activity statements, 96 payment summaries, 33–34 withholding tax system, 157 payroll tax, 11 pensions. See retirement pensions personal exertion, income from, 19, 52 personal service business (PSB), tests for, 53–54 personal use assets, CGT on, 121 prepaid business expenses, and small business, 159 prepaid rent, tax on, 104 prescribed persons, and trust distributions, 80

11/9/10 12:30 PM

316


preservation age definition, 225 and ETP amount, 58 reaching, 283 preserved superannuation benefits, access to, 224–227 prime cost method (PCM) for asset depreciation, 107 private companies, 144 private expenditure, 26–27 private health insurance tax offset, 289 property capital works deductions, 109–110 income from, 19 non-income-producing, 113–114 renovation as business, 1016 valuation charges, 11 public companies, 144 public sector super funds, 209

•R• rate charges, 11 real estate investment, 103–116 rate charges, 11 record keeping, 155–156, 253–254 redundancy payments, 59–60, 280 renovating properties as business, 116 rental income apportioning expenditure, 106 capital works deductions, 109–110 depreciation of assets, 106–109 expenditures in gaining, 105–106 and GST, 115 negative gearing, 112–113 non-deductible expenses, 106 repair costs, 111–112 taxing, 103–104 repair of property costs, as tax deduction, 111–112 replacement value method of valuation, 164 residency status, 14 restricted non-preserved super benefits, access to, 224 retail super funds, 210 retirement CGT concession, 202 living within means, 262–263 planning, 261–262 tax tips for, 261–267 retirement pensions account-based (allocated), 234–236

bindex.indd 316

as death benefit, 245–246 eligibility for, 224–227 non-account-based (life), 232–234 tax offset, 238–239, 290 tax-exempt, 239–240 taxable, 237 taxes on, 230 transition to retirement, 230–232 and work income, 265 rollover CGT concession, 203 royalties, receipt by non-residents, 264–266

•S• salary packaging, 195–196, 258–259 salary sacrifice super contributions, 219 sales (supplies), types for GST, 181–183 second positive limb, 25 self-assessment, 41–42 self-employed persons, super contributions by, 220–221 self-managed superannuation funds (SMSFs), 210–212 sell contract notes, 100 senior Australians tax offset, 239, 290 share dividends deductions, 97 franking credits, 92–96 tax on, 81, 91 share trading businesses, 98 shares interest on borrowing for, 98–100 wash sales, 100–101 SMSFs. See self-managed superannuation funds small business. See also business bad debts, 170–171 borrowing expenses, 173 business losses, 17–178 CGT concessions, 200–203 common tax mistakes, 45–46 interest on borrowings, 171–172 lease documentation expenses, 176 legal costs, 174–175 loss by theft, 173 mortgage discharge, 176 succession planning, 249–250 super deductions, 176 tax breaks, 279 tax concessions, 158–161 tax deductible expenses, 167–169 tax-related expenses, 175–178 sole trader business structure, 139–141 splitting, of super contributions, 218

11/9/10 12:30 PM

Index spouse contributions to super fund, 221–222 stamp duty, 11 stamp duty relief, for main residence purchase, 68 standard deductions, claiming, 36 state taxes, 11 statutory benchmark for FBT, interest rate, 278 statutory formula method for car FBT, 193–194, 278 statutory income, 20 stocktakes, 163–165 substantiation of work-related expenses, 61 succession planning, 249–250 superannuation benefits 55 to 59 years, 225–226 60 to 64 years, 226–227 accessing, 224 conditions of release, 55, 222–227 lump sum death benefits, 246 lump sum payments, 223, 285 minimum pension payments, 282 over 65 years, 227 payment components, 223 preservation age, 58, 225 tax rates, 237–240 tax-free component, 223 taxable component, 223, 224–227 under 55 years, 224–225 superannuation contributions on behalf of employees, 157, 219–220 co-contribution scheme, 57, 221, 283 concessional and non-concessional caps, 281 maximum base level, 282 personal, 56 rebate, 283 restrictions and options, 216–222 self-employed persons, 220–221 splitting, 284 tax deductibility, 176 tax offset for spouse, 221–222, 291 to complying fund, 208–212, 257 superannuation funds advantages of contributing, 257 annual tax return, 213–216 claiming tax deductions, 214–216 complying funds, 208 complying and non-complying, 208 industry, 210 public sector, 209 retail, 210 setting up a SMSF, 210–212

bindex.indd 317

317

tax incentives for low income earners, 204–205 tax payable by, 213–214 superannuation guarantee, payment rate, 284 superannuation guarantee contribution, 55–56, 219, 281 superannuation income streams. See retirement pensions Superannuation Industry (Supervision) ActÂ€1993 (SIS Act), 208 superannuation pensions. See retirement pensions superannuation spouse contribution tax offset, 259

•T• tax calculation, 52 and children, 73–83 on death benefit income, 245 government-initiated changes, 254–255 on lump sum super payments, 224–227 on pensions and allowances, 237 on super fund receipts, 223 tax audits amendments and objections, 46–47 common mistakes, 45–46 general, 43–44 preparing for, 44–45 tax benefits. See tax offsets and rebates tax breaks for small business, 279 tax concessions on main residence, 66–69 for small business, 158–161 tax deductible expenses. See also expenses allowances, 54–55 bad debts, 170–171 borrowing expenses, 173 business losses, 177–178 claiming, 60–61 from property rental, 106–113 general, 23–29 interest on borrowings, 171–172 lease document expenses, 176 legal costs, 174–175 loss by theft, 173 mortgage discharge costs, 176 substantiation, 61 super contributions, 176, 257 super funds, 214–216, 220–221 tax-related expenses, 175 work related, 61–63

11/9/10 12:30 PM

318


tax file number (TFN) applying for, 51, 154 for children under 16, 74 tax invoices for taxable sales, 182–183 tax on lump sum super payments 55 to 59 years, 225–226 60 to 64 years, 226–227 over 65 years, 227 under 55, 224–225 tax offsets and rebates Australian government pensions and allowances, 238–239 Baby Bonus, 81, 286 child care, 81–82, 286 dependants, 286–287 education tax refund, 82–83, 287 entrepreneurs, 160, 287 families, 81, 288 franking credits, 288 low income earners, 238, 288 mature age, 289 medical expenses, 289 private health insurance, 289 senior Australians, 290 super pension, 290 super spouse contribution, 291 zone, 291 Tax Pack (Instructions for Taxpayers), 32 tax rates CGT with CPI over time, 274 company, 273 death benefit ETPs, 244, 275 Division 6AA, 77–80 employment termination payments, 276 fringe benefit, 277–278 individual resident and non-resident, 271–272 lump sum super payments, 223, 285 marginal, 10, 271–272 Medicare levy, 273 minor beneficiaries, 280 penal, 78 redundancy payments, 280 super lump sum death benefits, 246 withholding, 298 tax rebates. See tax offsets and rebates tax returns. See income tax returns tax rules, changes to, 254–255 tax-exempt income, 20–22, 239–240 tax-exempt payments, 219–220 tax-related expenses, tax deductibility of, 175–176 taxable income formula, 17–18, 21–22 super fund calculation, 215

bindex.indd 318

taxable sales (supplies) for GST, 181–183 temporary absence rule for CGT on main residence, 12 term deposits, interest on, 87–88 termination payments, 57–58 theft losses, tax deductibility of, 173 trading stock valuation methods, 163–165 transition to retirement pensions, 230–232, 233, 264 trust income distribution beneficiaries, 69 case study, 71 to minor beneficiaries, 70–71 trustees, liability for tax, 77–79 trusts beneficiaries, 77 as business structure, 148–149, 151 CGT concessions, 199 definition, 78 distribution of income from, 76–80 Division 6AA tax, 77–80

•U• unfranked dividend payments, 94 unrestricted non-preserved super benefits, access to, 224 untaxed plan cap amount (UPCA) of super benefit, 224–225, 227

•V• valuing trading stock, 163–165

•W• wash sales of shares, capital loss from, 100–101 wills, 241–243, 265 withholding taxes, 261, 298 work income, and retirement pension, 264–265 work-related expenses, 61–63

•Y• young people, taxation of, 73–76

•Z• zone tax offset, 291

11/9/10 12:30 PM

Notes

bindex.indd 319

11/9/10 12:30 PM

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