Week 5 Flashcards
Tax planning
Legitimate organisation of an investor’s affairs to minimise tax while complying with tax laws.
Tax avoidance
Planning which is ultimately designed to avoid taxes payable under the law.
Tax evasion
Unlawfully escaping liability for, or payment of, tax by deliberately and dishonestly evading tax.
The Australian Taxation System
Income tax has been levied by the Australian Government since 1942.
Sources of taxation law:
Income Tax Assessment Act 1936 and 1997 (ITAA97)
Case law
Australian Taxation Office rulings and determinations
Forms of taxation Income Tax Capital Gains Tax (CGT) Fringe Benefits Tax (FBT) Goods and Services Tax (GST)
Income Tax
Pay as you go (PAYG)
All existing payment and reporting systems for individuals and companies, was replaced with the “pay as you go” (PAYG) system from 1 July 2000.
All forms of income tax paid by businesses are generally paid in quarterly instalments at the time of remitting GST payments.
PAYE tax instalments deducted from employees salary & wages are aligned with these quarterly instalments.
Reporting of tax obligations provided to Taxation office through Business Activity Statement (BAS)
Income Tax calculations
Taxpayers pay income tax for each financial year, normally ending 30 June.
Income tax = (Taxable income x Rate) + Levy – Tax offsets
Taxable income involves consideration of both income and deductions.
Taxable income = Assessable income – Allowable Deductions
Net tax payable calculation
Assessable income
less Allowable Deductions
= Taxable income
x tax rate applicable
= Gross tax payable
less non-refundable tax offsets (i.e. LITO, LMITO)
Less refundable tax offsets (i.e. private health insurance rebate, franking credit)
Plus Medicare Levy/ Medicare Levy Surcharge (calculated on taxable income)
Less PAYG credits (i.e. total tax already paid during the year)
= Net Tax payable
Assessable income for taxation purposes
Assessable income consists of ordinary income and statutory income derived during the income year.
Need to ascertain not only whether income has been derived but also where it comes from.
Income is not defined in the Income Tax Assessment Act (S.6-5(1) of ITAA).
Courts have interpreted income to mean “income according to ordinary concepts”.
Sources of ordinary income
Income from personal exertion
earnings from providing personal services
e.g. under employment (wages, LSL, directors fees) or other contract.
there must be a nexus between the provision of the services and the receipt of the benefit
excludes hobbies, gambling and gifts not related to the personal service.
Income from business activities
Includes normal proceeds from carrying on a business activity
What is deemed to be a business needs to be determined in the light of the case - otherwise deemed a hobby.
Characteristics of a business: eg.
frequency;
size of activity;
profit potential;
whether the activity is systematic
Allowable deductions
General
The ITAA classifies deductions as either of a general or specific nature:
General - (S. 8-1 of ITAA)
is any loss or outgoing to the extent that it is incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for income producing activities.
must be a nexus between the outgoing and assessable income.
does not include outgoings that are of a capital, private or domestic nature or incurred in producing exempt income.
Specific deductions
Some deductions that would not be allowable under the general provisions are nonetheless deductible under specific provisions of the Act.
Most common provisions relate to expenditure incurred on capital items:
repairs and maintenance (s. 25-10)
depreciation (ss. 40-43)
certain donations (s. 30)
Substantiation
Where work expenses exceed $300 in total, an employee must be able to satisfy substantiation rules:
written evidence of expenditure required to be kept for 5 years
Audit
Tax Return facilitation
Property Investment Deductions
Entities Subject To Income Tax
Basic entities relevant for taxation planning are
Individuals Partnerships Trusts Superannuation funds Companies
Individuals
Tax Planning Issues
Advantages
Salary packaging
Split of property income
Main residence exempt from CGT
Possible halving of CG(note Labour party proposal to reduce it to 25%)
Tax-free threshold and graduated tax scale
Domestic losses carried forward
Individuals
Tax Planning Issues
Disadvantages
Not possible to split salary or wage income
Minors subject to penalty tax on certain types of income
Marginal rates climb to 45%
Medicare levy at certain income levels
Medicare Levy Surcharge may apply as well
Partnerships
A partnership exists between persons carrying on business jointly.
Tax Planning Issues
Capacity to split income
Capacity to direct property and therefore income to partner with lowest income
Losses are distributed to partners to offset against other income
Relative simple to administer
Trusts
Tax Planning Issues
Advantages
A capacity to direct income to the beneficiaries with the lowest tax rates
Possible halving of capital gain (be aware of Labour Party proposal to change this)
Trusts
Tax Planning Issues
Disadvantages
No main residence exemption
Losses are trapped inside the trust and can be offset only against future trust income
Costs of administration
Superannuation Funds
Tax Planning Issues
Advantages
15% tax rate on earnings
Possible reduction of capital gain by one-third
Superannuation Funds
Tax Planning Issues
Disadvantages
No main residence exemption
Borrowing not allowed
Costs of administration
Companies
Tax Planning Issues
Advantages
Tax rate at 27.5% (< 50 mil turnover) or 30% (greater than 50< mil turnover)
Normally, losses can be carried forward (subject to meeting one of two tests)
Companies
Tax Planning Issues
Disadvantages
No main residence exemption
Losses are kept within the company
No concession on the calculation of capital gains tax
Costs of administration
Taxing of minors - Div 6AA
A person under 18 years at the end of the year of income is taxed on unearned (unexcepted) income at penalty rates:
$417 - $1,307: 66% of excess over $416
>$1,307: of total amount is taxed at highest MTR (45%)
Unearned income includes interest, dividends and rent obtained from sources other than from employment, reasonable business activity or from deceased Estate / inheritance.
Taxing of minors - Considerations
Minors can no longer claim a Low Income Tax Offset (LITO) of $445 for unearned income
Investment options include : Life Insurance/ Friendly society bonds Will Trusts Distributions – Taxed as adults ATO’s View Who has earned the income?
Medicare Levy
A levy is payable by an individual who is a resident during a year of income.
levy based on taxable income
rate is 2.0%
levy not payable for taxpayers with low taxable income (single $ 21,980; rates apply for families and pensioners)
surcharge of up to an additional 1.5 % of taxable income is payable where taxpayer does not have private patient hospital insurance- Now Income Tested
individual adjusted taxable income > $90,000
family adjusted taxable income > $180,000 ( no children)
increased by $1,500 for each dependent child after first
Tax offsets and rebates
Differentiate between a tax deduction and a tax offset
Tax offsets predominantly apply to individuals
Is there a limit on how much of a tax offset can be claimed?
Generally, tax offsets cannot result in a tax refund being provided.
Exceptions:
private health insurance, franking credits
Taxation of investment income
Property income
1-rental income fully assessable
2-rental expenses tax deductible
including interest on borrowed money if it is reasonable to expect rents will be derived
BE AWARE OF PROPOSED CHANGES TO NEGATIVE GEARING RULES BY LABOUR PARTY
3-capital gains subject to capital gains tax
Taxation of investment income
Interest/income (cash/Bonds)
1-generally assessable
2-joint accounts assumed to be earned equally
not assessable where used to offset against mortgage account under an “interest offset” arrangement
interest on child’s savings account
Taxation of investment income
Share investments
1-dividends fully assessable where paid out of company profits.
2-dividends may be subject to franking credits.
3-profits / losses made on sale subject to capital gains tax.
Dividend imputation
System introduced in 1987 to overcome problem of double taxation
BE AWARE OF PROPOSED CHANGES TO SYSTEM PROPOSED BY LABOUR PARTY
operation of system:
company pays tax on profits
shareholder includes after tax dividend as assessable income
tax paid by the company on the profits [imputation credit (IC)] also included in shareholders assessable income -calculated as:
I C= Dividend received x company tax rate
1 – company tax rate
shareholder pays tax on total based on their MTR
shareholder entitled to a franking credit equal to the imputation credit.
dividends paid by company can be fully franked, partially franked or unfranked.
under Business Reform changes, excess imputation credits have been refunded since
1 July 2000.
Taxation and Managed Investments
Managed investments are structures (typically unit trusts) that stand between the investor and the 4 basic forms of investment: Cash Fixed-interest securities Shares Property
Holders of units in trusts are taxed as beneficiaries on trust earnings which are apportioned to their unit holding
CGT implications:
capital gains of the trust
capital gain on sale of units in the trust
capital gains on switching from one unit trust to another
Agricultural-based managed investments have provided up to 100% deductibility of initial investment
Attractive tax-based incentive for investment
ATO seeking to remove tax-based incentives for non-forestry agricultural based managed investments
Bona Fide Redundancy Payments
Employment position is made redundant ITAA s 27E
Similar to Approved Early Retirement
Initiated by Employer not employee
Payments cannot be rolled over to superannuation
Special tax rules apply:
Tax Free amount- First $ 10,399 + $ 5,200 for each completed year of service.
Amount above tax free portion treated as a Life Benefit ETP and is subject to ETP tax rates based on clients age and cap levels.
Taxation Treatment of lump sum payment drawn from a superannuation fund
From 1 July 2007- Superannuation funds were required to reclassify the components according to the two components: tax free and taxable.
The taxation implications of lump sum withdrawals as cash from 1 July 2007 depends:
The person’s age – whether the person is under or over 55, between 55 and 59 or aged 60 or over.
The tax free and taxable components of the superannuation fund.
In Summary- Tax Strategies
Create Tax effective investment vehicles Increase Deductions Expenses Invest in Tax effective products Reduce Personal Deductions Ensure underlying product is sound Keep up with Tax legislation Keep Good Records Use Superannuation as a long term investment vehicle
