Mathematical Solutions - Part A

Mathematical Solutions – Part A
Contents
Mathematical Solutions – Part A...........................................................................................................1
Assessable Income...............................................................................................................................1
Category A: Solutions 1 to 33................................................................................................................1
[¶30-001] Solution 1..............................................................................................................................1
Derivation..............................................................................................................................................1
[¶30-002] Solution 2..............................................................................................................................1
Compensation; damages........................................................................................................................1
Workers compensation...........................................................................................................................1
Reimbursement of medical expenses.....................................................................................................1
Damages for personal injury..................................................................................................................2
[¶30-003] Solution 3..............................................................................................................................2
Derivation; doubtful debts.....................................................................................................................2
[¶30-004] Solution 4..............................................................................................................................2
Derivation..............................................................................................................................................3
[¶30-005] Solution 5..............................................................................................................................3
Compensation........................................................................................................................................3
[¶30-006] Solution 6..............................................................................................................................4
Superannuation Benefits........................................................................................................................4
[¶30-007] Solution 7..............................................................................................................................5
Employee termination payments and superannuation benefits..............................................................5
Taxation of the approved early retirement scheme payment..................................................................6
[¶30-008] Solution 8..............................................................................................................................7
Exempt income......................................................................................................................................7
[¶30-009] Solution 9..............................................................................................................................8
Source; exempt income.........................................................................................................................8
[¶30-010] Solution 10............................................................................................................................9
Employee share schemes.......................................................................................................................9
[¶30-011] Solution 11..........................................................................................................................10
Business or hobby................................................................................................................................10
[¶30-012] Solution 12..........................................................................................................................11
Compensation; unliquidated damages..................................................................................................11
[¶30-013] Solution 13..........................................................................................................................12
Work expenses; car allowance; reimbursement...................................................................................12
[¶30-014] Solution 14..........................................................................................................................13
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Remuneration; allowances...................................................................................................................13
[¶30-015] Solution 15..........................................................................................................................13
Annuities.............................................................................................................................................13
[¶30-016] Solution 16..........................................................................................................................14
Residence; source of income...............................................................................................................14
[¶30-017] Solution 17..........................................................................................................................16
Residence; source of income...............................................................................................................16
[¶30-018] Solution 18..........................................................................................................................16
Derivation of income...........................................................................................................................16
[¶30-019] Solution 19..........................................................................................................................18
Retirement income...............................................................................................................................18
[¶30-020] Solution 20..........................................................................................................................18
Scholarship..........................................................................................................................................18
[¶30-021] Solution 21..........................................................................................................................18
Lease incentives and benefits..............................................................................................................18
[¶30-022] Solution 22..........................................................................................................................19
Employment benefits...........................................................................................................................19
[¶30-023] Solution 23..........................................................................................................................19
Various receipts relating to employment..............................................................................................19
[¶30-024] Solution 24..........................................................................................................................20
Accident compensation........................................................................................................................20
[¶30-025] Solution 25..........................................................................................................................20
Termination of employment.................................................................................................................20
(a) Superannuation Payment................................................................................................................21
(b) Employment Termination Payment (ETP).....................................................................................22
[¶30-026] Solution 26..........................................................................................................................22
Mutuality.............................................................................................................................................22
[¶30-027] Solution 27..........................................................................................................................23
Royalties..............................................................................................................................................23
[¶30-028] Solution 28..........................................................................................................................24
Alienation of personal services income...............................................................................................24
[¶30-029] Solution 29..........................................................................................................................25
Bonus; restraint of trade......................................................................................................................25
[¶30-030] Solution 30..........................................................................................................................26
Miscellaneous......................................................................................................................................26
[¶30-031] Solution 31..........................................................................................................................27
Non-resident manufacturer; imported goods........................................................................................27
2
[¶30-032] Solution 32..........................................................................................................................27
Assessable income: various kinds of receipts......................................................................................27
[¶30-033] Solution 33..........................................................................................................................29
Assessable income: miscellaneous examples....................................................................................29
Category B: Solutions 34 to 42............................................................................................................30
[¶30-034] Solution 34..........................................................................................................................30
Capital gain; business..........................................................................................................................30
[¶30-035] Solution 35..........................................................................................................................31
Compensation; unliquidated damages.................................................................................................31
[¶30-036] Solution 36..........................................................................................................................33
Compensation; restrictive covenant.....................................................................................................33
[¶30-037] Solution 37..........................................................................................................................33
Derivation; allowable deduction..........................................................................................................33
[¶30-038] Solution 38..........................................................................................................................34
Residence; exempt income..................................................................................................................34
[¶30-039] Solution 39..........................................................................................................................35
Exempt income; FBT; s 21A...............................................................................................................35
[¶30-040] Solution 40..........................................................................................................................36
Business income; derivation................................................................................................................36
[¶30-041] Solution 41..........................................................................................................................37
Superannuation payments and employee termination payments..........................................................37
(1) Superannuation payments..............................................................................................................37
(2) Early retirement scheme.................................................................................................................38
(3) Long service leave.........................................................................................................................38
(4) Other benefits.................................................................................................................................39
[¶30-042] Solution 42..........................................................................................................................39
Employee share acquisition.................................................................................................................39
Capital Gains.......................................................................................................................................42
Category A: Solutions 43 to 58............................................................................................................42
[¶30-043] Solution 43..........................................................................................................................42
Indexed cost base; netting gains and losses.........................................................................................42
[¶30-044] Solution 44..........................................................................................................................43
Calculation of tax payable...................................................................................................................44
[¶30-045] Solution 45..........................................................................................................................44
Apportionment.....................................................................................................................................44
[¶30-046] Solution 46..........................................................................................................................45
CGT events..........................................................................................................................................45
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[¶30-047] Solution 47..........................................................................................................................46
Sale of a small business.......................................................................................................................46
[¶30-048] Solution 48..........................................................................................................................47
CGT events..........................................................................................................................................47
[¶30-049] Solution 49..........................................................................................................................47
Disposal of residence and business......................................................................................................48
[¶30-050] Solution 50..........................................................................................................................49
Cost base; capital gains tax (CGT)......................................................................................................49
[¶30-051] Solution 51..........................................................................................................................50
Cost base; acquisition..........................................................................................................................50
[¶30-052] Solution 52..........................................................................................................................51
Share options.......................................................................................................................................51
[¶30-053] Solution 53..........................................................................................................................52
Main residence....................................................................................................................................52
[¶30-054] Solution 54..........................................................................................................................52
Partial main residence exemption........................................................................................................52
[¶30-055] Solution 55..........................................................................................................................53
Separate CGT assets............................................................................................................................53
[¶30-056] Solution 56..........................................................................................................................54
Restrictive covenant............................................................................................................................54
[¶30-057] Solution 57..........................................................................................................................54
Trademarks..........................................................................................................................................54
[¶30-058] Solution 58..........................................................................................................................54
Options; necessary connection with Australia.....................................................................................55
[¶30-059] Solution 59..........................................................................................................................55
Capital proceeds; business; compensation...........................................................................................55
[¶30-060] Solution 60..........................................................................................................................56
Business income; capital gains tax (CGT)...........................................................................................56
[¶30-061] Solution 61..........................................................................................................................59
Shares..................................................................................................................................................59
[¶30-062] Solution 62..........................................................................................................................61
Partnership—sale of assets..................................................................................................................61
(a) Indexation method..........................................................................................................................62
(b) CGT Discount method calculation:................................................................................................63
[¶30-063] Solution 63..........................................................................................................................63
Collectables; shares.............................................................................................................................63
4
Disposal of collectable assets..............................................................................................................64
[¶30-064] Solution 64..........................................................................................................................66
Shares—bonus issue............................................................................................................................66
[¶30-065] Solution 65..........................................................................................................................67
Partnership—admission, retirement.....................................................................................................68
[¶30-066] Solution 66..........................................................................................................................70
Partnership...........................................................................................................................................70
[¶30-067] Solution 67..........................................................................................................................71
Main residence; non-residence............................................................................................................71
[¶30-068] Solution 68..........................................................................................................................72
Residence; composite use....................................................................................................................72
[¶30-069] Solution 69..........................................................................................................................73
Leases..................................................................................................................................................73
Category C: Solution 70......................................................................................................................74
[¶30-070] Solution 70..........................................................................................................................74
Death; roll-over relief; valuation.........................................................................................................74
Fringe Benefits....................................................................................................................................81
Category A: Solutions 71 to 77............................................................................................................81
[¶30-071] Solution 71..........................................................................................................................81
Car fringe benefit.................................................................................................................................82
[¶30-072] Solution 72..........................................................................................................................83
Expense payment benefit; entertainment allowance............................................................................83
[¶30-073] Solution 73..........................................................................................................................83
Loan fringe benefit; ‘otherwise deductible’ rule..................................................................................83
[¶30-074] Solution 74..........................................................................................................................84
Residual fringe benefit.........................................................................................................................84
[¶30-075] Solution 75..........................................................................................................................84
Living away from home allowance benefit; travel for overseas employees.........................................84
(1) Living away from home allowance (LAFHA)...............................................................................84
(2) LAFHA as a fringe benefit.............................................................................................................86
[¶30-076] Solution 76..........................................................................................................................86
In-house property fringe benefit..........................................................................................................86
[¶30-077] Solution 77..........................................................................................................................86
Residual benefits.................................................................................................................................86
[¶30-078] Solution 78..........................................................................................................................87
Employee test......................................................................................................................................87
5
(1) Cosmetic product consultants.........................................................................................................89
(2) Part-time interviewers engaged by a research company.................................................................89
(3) Couriers engaged by a courier company........................................................................................89
[¶30-079] Solution 79..........................................................................................................................90
Employee benefits, expense payment benefits, ‘otherwise deductible’ rule, LAFHA and property
benefits................................................................................................................................................90
Rental costs.........................................................................................................................................92
Food costs............................................................................................................................................92
[¶30-080] Solution 80..........................................................................................................................94
Employee benefits; miscellaneous.......................................................................................................94
Airfare and overnight accommodation................................................................................................94
Mary’s salary.......................................................................................................................................94
Relocation allowance...........................................................................................................................96
Temporary accommodation.................................................................................................................96
Financial Review newspaper...............................................................................................................96
[¶30-081] Solution 81..........................................................................................................................96
Employee benefits; miscellaneous.......................................................................................................96
Return airfare to India..........................................................................................................................96
Gold watch..........................................................................................................................................97
Trip to Cairns.......................................................................................................................................97
Emergency assistance..........................................................................................................................97
Frequent flyer points............................................................................................................................97
[¶30-082] Solution 82..........................................................................................................................97
Non-cash business benefits..................................................................................................................97
(1) 15% discount on normal price........................................................................................................98
(2) 10% discount and a safety guard....................................................................................................98
(3) Travel voucher...............................................................................................................................98
(4) Omega watch.................................................................................................................................98
[¶30-083] Solution 83..........................................................................................................................98
Car benefit; superannuation; property benefit......................................................................................99
Motor vehicle......................................................................................................................................99
The statutory formula method (s 9(1)).................................................................................................99
Actual operating cost method (s 10(2))................................................................................................99
Entertainment allowance...................................................................................................................100
Superannuation..................................................................................................................................100
Overdraft facility...............................................................................................................................101
‘In-house’ benefit provided................................................................................................................101
[¶30-084] Solution 84........................................................................................................................102
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Car benefit; expense payment benefit; residual benefit......................................................................102
[¶30-085] Solution 85........................................................................................................................103
Property benefit; car benefit..............................................................................................................103
Factory worker—Ms A......................................................................................................................103
Accountant—Mr B............................................................................................................................103
Director/shareholder—Ms C..............................................................................................................104
[¶30-086] Solution 86........................................................................................................................104
Deductions; FBT liability..................................................................................................................104
Deductions available to Didget..........................................................................................................104
FBT liability of Didget......................................................................................................................105
Deductions.........................................................................................................................................108
Category A: Solutions 87 to 113........................................................................................................108
[¶30-087] Solution 87........................................................................................................................108
Borrowing expenses..........................................................................................................................108
[¶30-088] Solution 88........................................................................................................................108
Capital works.....................................................................................................................................108
[¶30-089] Solution 89........................................................................................................................108
Bad or doubtful debts........................................................................................................................109
[¶30-090] Solution 90........................................................................................................................109
Repairs; maintenance; capital works..................................................................................................109
[¶30-091] Solution 91........................................................................................................................110
General Deductions; legal expenses; lease expenses..........................................................................110
[¶30-092] Solution 92........................................................................................................................110
Non-deductible non-cash business benefits.......................................................................................110
[¶30-093] Solution 93........................................................................................................................111
Tax expenses......................................................................................................................................111
[¶30-094] Solution 94........................................................................................................................111
Misappropriation................................................................................................................................111
[¶30-095] Solution 95........................................................................................................................111
Research and development expenditure.............................................................................................111
[¶30-096] Solution 96........................................................................................................................113
Capital works.....................................................................................................................................113
[¶30-097] Solution 97........................................................................................................................113
Past years’ losses................................................................................................................................113
[¶30-098] Solution 98........................................................................................................................114
Entertainment and other expenditure.................................................................................................114
(1) Entertainment and other expenses................................................................................................114
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(2) Staff motivation expenses.............................................................................................................115
(3) Gymnasium expenditure...............................................................................................................115
(4) Meals in executive dining room...................................................................................................115
[¶30-099] Solution 99........................................................................................................................116
Foreign exchange losses; decline in value; loan costs........................................................................116
(1) Foreign exchange losses and decline in value..............................................................................116
(2) Loan costs....................................................................................................................................116
[¶30-100] Solution 100......................................................................................................................117
Car expenses......................................................................................................................................117
[¶30-101] Solution 101......................................................................................................................117
Overseas travel..................................................................................................................................117
[¶30-102] Solution 102......................................................................................................................118
Bad debts...........................................................................................................................................118
[¶30-103] Solution 103......................................................................................................................118
Fines; tax avoidance...........................................................................................................................118
[¶30-104] Solution 104......................................................................................................................118
Business deductions, Interest deductibility, borrowing costs.............................................................118
Issue 1 Business deductions on s 8-1 (2)............................................................................................119
Issue 2 Interest s 8-1..........................................................................................................................119
Issue 3 Borrowing costs s 25-25........................................................................................................119
Issue 4 Legal expenses s 8-1..............................................................................................................119
Issue 5 Workshop expenses s 8-1.......................................................................................................120
Issue 6 Repairs s 25-10......................................................................................................................120
[¶30-105] Solution 105......................................................................................................................120
Research and development expenditure.............................................................................................120
[¶30-106] Solution 106......................................................................................................................120
Commercial debt forgiveness............................................................................................................120
Is there a commercial debt?...............................................................................................................121
What is the net forgiven amount?......................................................................................................121
Is the duplication of deductions eliminated?......................................................................................121
[¶30-107] Solution 107......................................................................................................................122
Primary production, horticultural plants............................................................................................122
[¶30-108] Solution 108......................................................................................................................122
Legal expenses...................................................................................................................................122
[¶30-109] Solution 109......................................................................................................................123
Legal expenses...................................................................................................................................123
[¶30-110] Solution 110......................................................................................................................124
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Superannuation contributions and associated interest and borrowing costs.......................................124
[¶30-111] Solution 111......................................................................................................................124
Repairs...............................................................................................................................................124
[¶30-112] Solution 112......................................................................................................................126
Industry levy......................................................................................................................................126
[¶30-113] Solution 113......................................................................................................................126
Prepaid expenditure of a tax shelter arrangement..............................................................................126
Category B: Solutions 114 to 128......................................................................................................127
[¶30-114] Solution 114......................................................................................................................127
Deductions for income-producing rental property.............................................................................127
Interest expense of $28,000 on the loan.............................................................................................127
Borrowing expenses of $10,000........................................................................................................127
Roof replacement expense of $22,000...............................................................................................127
Bedroom painting expense of $1,200................................................................................................128
Replacement cost of $4,000 for the laundry floor..............................................................................128
Purchase of gas water heater of $5,200..............................................................................................128
[¶30-115] Solution 115......................................................................................................................128
Environmental impact assessments....................................................................................................128
[¶30-116] Solution 116......................................................................................................................129
Miscellaneous deductions..................................................................................................................129
[¶30-117] Solution 117......................................................................................................................130
Miscellaneous deductions..................................................................................................................130
[¶30-118] Solution 118......................................................................................................................131
Various deductions.............................................................................................................................131
[¶30-119] Solution 119......................................................................................................................131
Overseas travel..................................................................................................................................131
(1) Deductibility of expenditure on overseas travel...........................................................................131
(2) Documentary evidence required...................................................................................................133
[¶30-120] Solution 120......................................................................................................................133
Legal costs.........................................................................................................................................133
[¶30-121] Solution 121......................................................................................................................134
Thin capitalisation; outward investing entities (non-banks)...............................................................134
Introductory steps..............................................................................................................................134
Final steps..........................................................................................................................................134
[¶30-122] Solution 122......................................................................................................................135
Borrowing costs.................................................................................................................................135
Deductibility of expenditure in acquiring nursery.............................................................................136
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[¶30-123] Solution 123......................................................................................................................136
Relocation expenses..........................................................................................................................136
[¶30-124] Solution 124......................................................................................................................137
Substantiation; car expenses..............................................................................................................137
[¶30-125] Solution 125......................................................................................................................138
Travelling and entertainment expenses..............................................................................................138
[¶30-126] Solution 126......................................................................................................................139
Traveller accommodation; capital works; depreciating assets...........................................................139
[¶30-127] Solution 127......................................................................................................................141
Interest deductibility..........................................................................................................................141
[¶30-128] Solution 128......................................................................................................................142
Environmental protection expenses; legal expenses; penalties..........................................................142
(1) Clean-up expenses for pre-existing site pollution of $300,000.....................................................142
(2) Legal fees defending action brought by environmental group of $350,000..................................143
(3) Legal costs of defending director against criminal prosecution of $50,000..................................143
(4) Penalty imposed by Environment Protection Authority of $40,000.............................................144
Trading Stock....................................................................................................................................145
Category A: Solutions 129 to 139......................................................................................................145
[¶30-129] Solution 129......................................................................................................................145
Stock valuation..................................................................................................................................145
[¶30-130] Solution 130......................................................................................................................146
Stock valuation..................................................................................................................................146
[¶30-131] Solution 131......................................................................................................................147
Stock valuation, manufacturing.........................................................................................................147
[¶30-132] Solution 132......................................................................................................................148
Stock valuation, manufacturing.........................................................................................................148
[¶30-133] Solution 133......................................................................................................................148
Private use; debt settlement; valuation; obsolescence........................................................................148
[¶30-134] Solution 134......................................................................................................................149
Stock valuation..................................................................................................................................149
[¶30-135] Solution 135......................................................................................................................150
Valuation of trading stock..................................................................................................................150
[¶30-136] Solution 136......................................................................................................................150
Obsolescence.....................................................................................................................................150
[¶30-137] Solution 137......................................................................................................................151
Private use; gifts................................................................................................................................151
[¶30-138] Solution 138......................................................................................................................151
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Prepaid stock.....................................................................................................................................151
[¶30-139] Solution 139......................................................................................................................152
Land; characterisation as trading stock..............................................................................................152
Category B: Solution 140..................................................................................................................153
[¶30-140] Solution 140......................................................................................................................153
Valuation; cost of goods sold; obsolescence; foreign exchange.........................................................153
Depreciation......................................................................................................................................157
[¶30-141] Solution 141......................................................................................................................157
Decline in value and other deductions...............................................................................................157
[¶30-142] Solution 142......................................................................................................................158
Decline in value deduction; balancing adjustment on disposal..........................................................158
(1) Deductions claimable on the truck for the tax year ended 30 June 2018......................................158
(2) Assessability of the gain on the disposal of truck.........................................................................159
[¶30-143] Solution 143......................................................................................................................159
Determining decline in value rate......................................................................................................159
[¶30-144] Solution 144......................................................................................................................160
Decline in value deduction where prior non-business use.................................................................160
[¶30-145] Solution 145......................................................................................................................161
Depreciating assets (including plant).................................................................................................161
Items of ‘plant’ under ITAA97 former Div 42 definition...................................................................161
[¶30-146] Solution 146......................................................................................................................162
Balancing adjustment on disposal; decline in value deduction..........................................................162
Decline in value deductions...............................................................................................................164
[¶30-147] Solution 147......................................................................................................................164
Small business entity—Low-cost assets............................................................................................164
[¶30-148] Solution 148......................................................................................................................164
Cost of depreciating asset..................................................................................................................164
[¶30-149] Solution 149......................................................................................................................166
Capital works.....................................................................................................................................166
[¶30-150] Solution 150......................................................................................................................167
Low-value depreciating asset pools...................................................................................................167
[¶30-151] Solution 151......................................................................................................................167
Small business entity—General small business pool.........................................................................168
[¶30-152] Solution 152......................................................................................................................168
Disposal of a depreciable asset..........................................................................................................168
(1) Income tax consequences of the disposal.....................................................................................169
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(2) Alternative scenario: taxable purpose only 90%...........................................................................169
(3) CGT consequences of the disposal...............................................................................................169
[¶30-153] Solution 153......................................................................................................................170
Decline in value; repairs; capital works.............................................................................................170
[¶30-154] Solution 154......................................................................................................................171
Decline in value; repairs; disposal.....................................................................................................171
(1) Decline in value on Toyota Hi-Ace Deluxe van...........................................................................171
(2) Balancing adjustment on disposal of Toyota Hi-Ace Deluxe van on 1 February 2015.................171
(3) Decline in value on Nissan truck..................................................................................................172
[¶30-155] Solution 155......................................................................................................................172
Decline in value deductions; balancing adjustment on disposal.........................................................172
(1) Decline in value deductions for Toyota Camry for 2017/18.........................................................172
(2) Balancing adjustment on disposal of Toyota Camry....................................................................173
(3) Decline in value deductions for Honda Accord for 2018/19.........................................................174
[¶30-156] Solution 156......................................................................................................................174
Disposal; depreciable cost.................................................................................................................174
(1) Cost of the Ford truck for depreciation purposes (Subdiv 40-C)..................................................174
(2) Calculation of balancing adjustment for Volvo truck...................................................................175
(3) Calculation of decline in value for Ford truck..............................................................................175
[¶30-157] Solution 157......................................................................................................................175
Depreciable cost; finance cost...........................................................................................................175
[¶30-158] Solution 158......................................................................................................................176
Disposal; replacement; cessation of business.....................................................................................176
(1) Effect of insurance recovery on assessable income......................................................................177
(2) Decline in value deduction for new machine for tax year ended 30 June 2019............................177
(3) Effect if Buzz Manufacturing ceases business on 1 July 2018.....................................................178
(4) Alternative scenario: new machine used only 90% for income-producing purposes....................178
Taxation of Individuals......................................................................................................................180
[¶30-159] Solution 159......................................................................................................................180
Offset for superannuation contribution for low income/non-working spouse....................................180
[¶30-160] Solution 160......................................................................................................................181
Medical expenses tax offset...............................................................................................................181
[¶30-161] Solution 161......................................................................................................................182
Dependant (invalid and carer) tax offset (DICTO)............................................................................182
[¶30-162] Solution 162......................................................................................................................183
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Taxation of minors.............................................................................................................................183
[¶30-163] Solution 163......................................................................................................................184
Private health insurance tax offset.....................................................................................................184
Income thresholds..............................................................................................................................184
Private health insurance tax offset available......................................................................................185
Medicare levy surcharge....................................................................................................................185
[¶30-164] Solution 164......................................................................................................................185
Beneficiary rebate..............................................................................................................................185
Barbara’s entitlement to a beneficiary rebate.....................................................................................185
[¶30-165] Solution 165......................................................................................................................186
Personal services income (PSI)..........................................................................................................186
Tax implications of the PSI regime....................................................................................................186
[¶30-166] Solution 166......................................................................................................................187
Primary producer averaging...............................................................................................................187
[¶30-167] Solution 167......................................................................................................................188
Salary packaging...............................................................................................................................188
[¶30-168] Solution 168......................................................................................................................189
Termination of employment...............................................................................................................189
Employment termination payment (ETP) of $450,000......................................................................190
Taxable component............................................................................................................................190
Superannuation payment of $34,500.................................................................................................191
[¶30-169] Solution 169......................................................................................................................191
Senior Australians and pensioners tax offset; tax file number............................................................191
[¶30-170] Solution 170......................................................................................................................192
Overseas employment........................................................................................................................192
[¶30-171] Solution 171......................................................................................................................194
PAYG instalments..............................................................................................................................194
[¶30-172] Solution 172......................................................................................................................195
Taxable income/tax refund.................................................................................................................195
[¶30-173] Solution 173......................................................................................................................196
Salary packaging...............................................................................................................................196
(1) Car fringe benefit.........................................................................................................................196
(2) Car parking fringe benefit............................................................................................................197
(3) Share investment..........................................................................................................................198
(4) Child care.....................................................................................................................................198
[¶30-174] Solution 174......................................................................................................................199
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Zone Rebate.......................................................................................................................................199
[¶30-175] Solution 175......................................................................................................................200
Sale of business; tax planning............................................................................................................200
(1) Trading stock................................................................................................................................200
(2) Debtors.........................................................................................................................................200
(3) Plant.............................................................................................................................................200
(4) Premises.......................................................................................................................................201
(5) Goodwill......................................................................................................................................201
(6) Small business retirement exemption...........................................................................................202
(7) GST and sale of a going concern..................................................................................................202
(8) Financing the acquisition.............................................................................................................202
(9) Structure of purchasing entity......................................................................................................202
[¶30-176] Solution 176......................................................................................................................203
Personal services income...................................................................................................................203
Consequences of the PSI regime applying.........................................................................................204
Overall effect on Leanne Byrnes (individual) using Medi-Labs (PSE)..............................................205
Category C: Solutions 177 to 182......................................................................................................205
[¶30-177] Solution 177......................................................................................................................205
Taxable income; offsets.....................................................................................................................205
[¶30-178] Solution 178......................................................................................................................207
Tax refund; ETP; superannuation......................................................................................................208
[¶30-179] Solution 179......................................................................................................................210
Taxation of individuals......................................................................................................................210
[¶30-180] Solution 180......................................................................................................................212
Schedule 1: net rental from property..................................................................................................212
Schedule 2: capital gain on disposal of property (CGT event A1 happened).....................................213
Schedule 3: depreciation....................................................................................................................213
Schedule 4: motor vehicle running expenses (Div 28 and 900).........................................................214
[¶30-181] Solution 181......................................................................................................................214
Taxation of minors.............................................................................................................................214
(1) Taxable income............................................................................................................................214
(2) Tax payable..................................................................................................................................215
(3) Distribution of trust income.........................................................................................................216
[¶30-182] Solution 182......................................................................................................................216
Partnerships.......................................................................................................................................219
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[¶30-183] Solution 183......................................................................................................................219
Salary; interest...................................................................................................................................219
[¶30-184] Solution 184......................................................................................................................219
Income determination; uncontrolled partnership income...................................................................219
[¶30-185] Solution 185......................................................................................................................220
Creation and existence of a partnership.............................................................................................220
[¶30-186] Solution 186......................................................................................................................221
Net partnership income......................................................................................................................221
[¶30-187] Solution 187......................................................................................................................221
Definition of a partnership.................................................................................................................221
[¶30-188] Solution 188......................................................................................................................222
[¶30-189] Solution 189......................................................................................................................223
Profit and loss sharing.......................................................................................................................223
(1) Net partnership income and distribution to partners Arnold and Barrett......................................223
(2) Net partnership loss and distribution to partners..........................................................................223
(3) Net partnership loss, salaries and distribution..............................................................................224
[¶30-190] Solution 190......................................................................................................................224
Variation of partnership interests; assignment...................................................................................224
(1) Shares of partnership income†.....................................................................................................225
(2) Loan of $50,000 for 61/365 days @ 8%.......................................................................................225
(3) Salary to partner’s wife................................................................................................................225
(4) Assignment of part of partnership interest....................................................................................225
[¶30-191] Solution 191......................................................................................................................227
Tax and common law concepts; uncontrolled partnership income.....................................................227
[¶30-192] Solution 192......................................................................................................................228
Taxable income; distribution.............................................................................................................228
[¶30-193] Solution 193......................................................................................................................229
Distribution of partnership loss..........................................................................................................230
[¶30-194] Solution 194......................................................................................................................230
Partners’ salary..................................................................................................................................230
[¶30-195] Solution 195......................................................................................................................231
Disposal of partner’s interest in partnership......................................................................................231
(1) Trading stock................................................................................................................................231
(2) Depreciable assets........................................................................................................................232
15
(3) Capital gains................................................................................................................................232
(4) Accounting basis..........................................................................................................................233
(5) GST..............................................................................................................................................233
[¶30-196] Solution 196......................................................................................................................233
Net partnership income; distribution to partner.................................................................................233
Alternative approach to calculating s 90 net partnership income:......................................................234
[¶30-197] Solution 197......................................................................................................................235
[¶30-198] Solution 198......................................................................................................................238
Primary production partnership; individual’s tax return.....................................................................238
Trusts.................................................................................................................................................242
[¶30-199] Solution 199......................................................................................................................242
Trustee-beneficiary income...............................................................................................................242
[¶30-200] Solution 200......................................................................................................................243
Trust losses; exempt income..............................................................................................................243
[¶30-201] Solution 201......................................................................................................................244
Revocable trust..................................................................................................................................244
[¶30-202] Solution 202......................................................................................................................244
Prescribed person; eligible income....................................................................................................244
[¶30-203] Solution 203......................................................................................................................245
Trust losses pattern of distributions test.............................................................................................245
[¶30-204] Solution 204......................................................................................................................246
Foreign income; shares; corpus; non-resident beneficiaries...............................................................246
(1) Net income of the trust for the year ended 30 June 2019.............................................................246
15 July resolution..............................................................................................................................247
Establishing present entitlement........................................................................................................247
(2) Bonus shares................................................................................................................................248
(3) Non-resident beneficiary..............................................................................................................250
(4) Power to revoke trust...................................................................................................................250
(5) Payment out of corpus..................................................................................................................251
(6) Deceased trust estate....................................................................................................................251
(7) Application of income for non-resident beneficiary’s benefit.......................................................251
(8) Foreign tax credit.........................................................................................................................252
[¶30-205] Solution 205......................................................................................................................252
16
Classes of income..............................................................................................................................252
Tim’s tax liability...............................................................................................................................252
Julie’s tax liability..............................................................................................................................253
[¶30-206] Solution 206......................................................................................................................253
Deceased estates................................................................................................................................253
[¶30-207] Solution 207......................................................................................................................255
Present entitlement............................................................................................................................255
[¶30-208] Solution 208......................................................................................................................257
Net trust income; distribution............................................................................................................257
(1) Net income of trust estate.............................................................................................................257
(2) Assessment of payments and amount accumulated (assuming beneficiaries do not receive income
from any other source).......................................................................................................................257
(3) Inter vivos settlement...................................................................................................................258
[¶30-209] Solution 209......................................................................................................................258
Family Trust Elections.......................................................................................................................258
(1) Is Monic a member of Jim’s family or family group?..................................................................258
(2) Is the company, Sims Pty Ltd, a member of Jim’s family group?.................................................258
[¶30-210] Solution 210......................................................................................................................259
Trust losses; income injection test.....................................................................................................259
Application of the income injection test to deny recovery of losses in the Loss Trust.......................260
[¶30-211] Solution 211......................................................................................................................261
Net trust income; trust law distribution..............................................................................................261
[¶30-212] Solution 212......................................................................................................................263
Assessment of trust distributions.......................................................................................................263
Step 1: Determine the ITAA36 Div 6 position without reference to Div 6E......................................263
Step 2: Calculate each beneficiary’s ‘adjusted Div 6 percentage’......................................................263
Step 3: Apply ITAA97 Subdiv 115-C to the capital gains derived by the trust..................................264
Step 4: Apply ITAA97 Subdiv 207-B to the franked distributions derived by the trust.....................264
Step 5: Apply Div 6E to re-calculate the assessable amounts under Div 6........................................265
Step 6: Determine the final result after applying, Div 6, Subdiv 115-C, 207-B and Div 6E..............266
[¶30-213] Solution 213......................................................................................................................266
Net trust income; distribution............................................................................................................266
(1) Taxable net income......................................................................................................................266
(2) Assessment of distribution...........................................................................................................267
[¶30-214] Solution 214......................................................................................................................268
Deceased estate; net trust income; distribution..................................................................................268
(1) Net income of trust estate.............................................................................................................268
17
(2) Assessment of trust income..........................................................................................................269
[¶30-215] Solution 215......................................................................................................................270
Inter vivos trust and deceased estate..................................................................................................270
Income prior to death.........................................................................................................................271
Settlement on 30 June 2017...............................................................................................................271
Income received after Napier’s death................................................................................................272
Companies and Distributions.............................................................................................................273
[¶30-216] Solution 216......................................................................................................................273
Distribution income...........................................................................................................................273
[¶30-217] Solution 217......................................................................................................................274
Maximum franking percentage..........................................................................................................274
[¶30-218] Solution 218......................................................................................................................274
Off-market share buy-backs; frankable distribution component........................................................274
[¶30-219] Solution 219......................................................................................................................275
Off-market share buy-backs...............................................................................................................275
[¶30-220] Solution 220......................................................................................................................275
Calculating the benchmark franking percentage................................................................................275
[¶30-221] Solution 221......................................................................................................................276
Distributions; overseas shareholders..................................................................................................276
[¶30-222] Solution 222......................................................................................................................277
Distribution income...........................................................................................................................277
[¶30-223] Solution 223......................................................................................................................277
Classes of income..............................................................................................................................277
[¶30-224] Solution 224......................................................................................................................278
Calculating franking credits and franking debits...............................................................................278
[¶30-225] Solution 225......................................................................................................................278
Treatment of excess franking offsets for company taxpayers............................................................278
[¶30-226] Solution 226......................................................................................................................280
Continuity of ownership; same business tests....................................................................................280
(1) Continuity of ownership test........................................................................................................280
(2) Business Continuity Test..............................................................................................................280
Conclusion.........................................................................................................................................281
[¶30-227] Solution 227......................................................................................................................281
Breach of benchmark franking rule...................................................................................................281
[¶30-228] Solution 228......................................................................................................................282
18
Carry-forward losses..........................................................................................................................282
[¶30-229] Solution 229......................................................................................................................283
Consolidation.....................................................................................................................................283
[¶30-230] Solution 230......................................................................................................................284
Distributions; franking credits; rebates..............................................................................................284
[¶30-231] Solution 231......................................................................................................................285
Franking account; maximum franking credit; franking deficit tax.....................................................285
[¶30-232] Solution 232......................................................................................................................286
Franking account...............................................................................................................................286
[¶30-233] Solution 233......................................................................................................................287
Dividend imputation; effect on shareholders.....................................................................................287
Trough Superannuation Fund............................................................................................................287
Stable Ltd..........................................................................................................................................288
WC Kwan..........................................................................................................................................288
S Smith..............................................................................................................................................288
[¶30-234] Solution 234......................................................................................................................288
Permitted departure from the benchmark rule....................................................................................288
[¶30-235] Solution 235......................................................................................................................289
Franking account...............................................................................................................................289
[¶30-236] Solution 236......................................................................................................................290
Franking account; franking deficit tax...............................................................................................291
[¶30-237] Solution 237......................................................................................................................292
Franking account; franking deficit tax...............................................................................................292
[¶30-238] Solution 238......................................................................................................................294
Dividend imputation; effect on various shareholders.........................................................................294
[¶30-239] Solution 239......................................................................................................................296
Private company—taxable income; tax payable................................................................................296
[¶30-240] Solution 240......................................................................................................................300
Anti-streaming rules..........................................................................................................................300
(1) Single distribution streaming by a non-resident controlled company...........................................301
(2) Share buy-back—limited franking surplus...................................................................................301
(3) Share buy-back — excess credits.................................................................................................301
[¶30-241] Solution 241......................................................................................................................301
Private company—taxable income; tax payable................................................................................302
Tax treatment of deductibility of overseas travel expenses................................................................303
[¶30-242] Solution 242......................................................................................................................304
19
Taxable income; tax payable; FBT....................................................................................................304
Fringe benefits...................................................................................................................................305
[¶30-243] Solution 243......................................................................................................................306
Taxable income; tax effect accounting...............................................................................................306
[¶30-244] Solution 244......................................................................................................................308
Taxable income; tax effect accounting...............................................................................................308
Administration and Assessment.........................................................................................................311
[¶30-245] Solution 245......................................................................................................................311
Time for lodging objection.................................................................................................................311
[¶30-246] Solution 246......................................................................................................................312
Tax payable; dates.............................................................................................................................312
[¶30-247] Solution 247......................................................................................................................314
Payment of instalments......................................................................................................................314
[¶30-248] Solution 248......................................................................................................................315
Variation of instalment rate; credits; penalties...................................................................................315
[¶30-249] Solution 249......................................................................................................................316
Uniform penalty regime; ‘reasonably arguable’................................................................................316
[¶30-250] Solution 250......................................................................................................................317
Self-assessment; reasonable care.......................................................................................................317
(1) Action available to Aust Toy to correct the error..........................................................................318
(2) Penalties that may be imposed by the Commissioner for the error made by Aust Toy in
determining its taxable income..........................................................................................................318
(3) Amendment of assessment and imposition of penalties...............................................................319
[¶30-251] Solution 251......................................................................................................................319
Revised estimates; penalties..............................................................................................................319
[¶30-252] Solution 252......................................................................................................................320
Penalty tax.........................................................................................................................................320
[¶30-253] Solution 253......................................................................................................................321
Amended assessments; penalties.......................................................................................................321
[¶30-254] Solution 254......................................................................................................................321
Private rulings; penalties....................................................................................................................321
[¶30-255] Solution 255......................................................................................................................322
Private rulings....................................................................................................................................322
[¶30-256] Solution 256......................................................................................................................323
Amended assessment.........................................................................................................................323
[¶30-257] Solution 257......................................................................................................................324
Amended assessment; appeals; penalties...........................................................................................324
20
(1) Action Lee may take in respect of the amended assessment.........................................................324
(2) Other action available to the Commissioner of Taxation..............................................................325
[¶30-258] Solution 258......................................................................................................................325
Tax file numbers................................................................................................................................326
[¶30-259] Solution 259......................................................................................................................326
PAYG withholding; personal services income...................................................................................326
[¶30-260] Solution 260......................................................................................................................327
Objections; appeals............................................................................................................................327
[¶30-261] Solution 261......................................................................................................................328
Commissioner’s rights of access........................................................................................................328
[¶30-262] Solution 262......................................................................................................................330
Self-assessment..................................................................................................................................331
[¶30-263] Solution 263......................................................................................................................332
Tax agent’s liability...........................................................................................................................332
[¶30-264] Solution 264......................................................................................................................333
Tax audit and penalties......................................................................................................................333
[¶30-265] Solution 265......................................................................................................................334
Self-assessment; repairs.....................................................................................................................334
[¶30-266] Solution 266......................................................................................................................335
Advice on disallowed claims.............................................................................................................335
(1) Taxation assessor’s interpretation.................................................................................................335
(2) Disputing the ATO decision.........................................................................................................336
(3) Time of payment..........................................................................................................................336
[¶30-267] Solution 267......................................................................................................................337
Powers to amend an assessment........................................................................................................337
[¶30-268] Solution 268......................................................................................................................337
Objections to assessments; appeals....................................................................................................338
Amount at issue and its importance...................................................................................................338
Privacy...............................................................................................................................................339
Costs..................................................................................................................................................339
Rights of appeal.................................................................................................................................339
Time..................................................................................................................................................339
[¶30-269] Solution 269......................................................................................................................339
Objection and appeal.........................................................................................................................340
Claims disallowed.............................................................................................................................340
Home office—interest.......................................................................................................................340
21
Home office—contents insurance......................................................................................................340
Medical expenses...............................................................................................................................341
[¶30-270] Solution 270......................................................................................................................341
Access by Commissioner...................................................................................................................341
[¶30-271] Solution 271......................................................................................................................342
Access by Commissioner...................................................................................................................342
[¶30-272] Solution 272......................................................................................................................343
Assessment; objection; freedom of information; substantiation........................................................343
Assessable Income
Category A: Solutions 1 to 33
[¶30-001] Solution 1
Derivation
This question is concerned with the issue of derivation. Income is not assessable in the hands
of a taxpayer for the purposes of ITAA97 s 6-5 unless it is derived. On the basis of Carden’s
case (C of T (SA) v Executor, Trustee & Agency Co of South Australia Ltd (1938) 63 CLR
108) and Henderson v FC of T 70 ATC 4016, income is not assessable until it has ‘come
home to the taxpayer’. For people who earn a salary this is usually when the amount is paid
to them. However, s 6-5(4) provides that income or money shall be derived by a person when
otherwise dealt with on his or her behalf or as he or she directs.
(1)
Since Brown had earned the salary and had directed $5,000 of the amount to be credited to
his account, the whole amount would be ‘derived’ for the purposes of s 6-5 during the year
ended 30 June 2019.
(2)
Under the second set of circumstances, the amount of $8,000 was not derived in the 2018/19
tax year since it had not been paid to the employees. This is because the amount of $8,000
was not credited to their accounts by the company until 2 July 2019.
Compensation; damages
22
Workers compensation
Payments made for workers compensation are generally fully assessable under ITAA97 s 6-5,
as the payments replace lost earnings during a period of disability. However, a fixed sum
received to compensate for the loss of a limb, an eye, etc., is not assessable.
Reimbursement of medical expenses

This would not be income as ordinarily understood. However, it would appear to be a benefit
given by Carpet Ltd in relation to the employment of, or services rendered by, Wilson. As
such, the question arises whether it would be assessable under ITAA97 s 15-2. It would be a
benefit that, but for para (g) of the definition of ‘fringe benefit’ in FBTAA s 136(1), would be
a fringe benefit within the meaning of that Act. Accordingly, ITAA97 s 15-2 would not
apply.
While it would appear to be an expense payment fringe benefit for the purposes of FBTAA
s 20, it would be an exempt benefit having regard to the provisions of s 58J(1) of that Act.
Damages for personal injury

Damages for personal injury would not be assessable under the provisions of ITAA97 s 6-5.
(For Carpet Ltd the payment would not constitute a fringe benefit, as it is an exempt benefit
under FBTAA s 58J.)
The damages would not represent a capital gain for the purposes of ITAA97 Pt 3-1, having
regard to the provisions of s 118-37, which exempts from capital gains tax any sum received
by way of compensation or damages for any injury suffered by Wilson to his person or in his
vocation.
(See Taxation Ruling TR 95/35, which outlines the ATO approach to compensation payments
for personal injury.)
Derivation; doubtful debts
The income for the year would be determined on an accruals basis, see Carden’s case (C of T
(SA) v Executor, Trustee & Agency Co of South Australia Ltd (1938) 63 CLR 108).
Therefore, the increase in receivables would be regarded as income.
$ $
Sales receipts 4,000,000
Add: Closing balance accounts receivable 1,250,000
Less: Opening balance accounts receivable 1,000,000 250,000
23
ASSESSABLE INCOME $4,250,000
The provision for doubtful debts has no effect in determining assessable income. However, if
one assumes that the decrease in the provision for doubtful debts is due to a deduction being
allowed because of the writing off of a bad debt pursuant to ITAA97 s 25-35, then there
would be a reduction in the net assessable amount from $4,250,000 to $4,200,000.
Derivation
As a self-employed person operating as the sole principal with few employees, Dr Green
would determine her income on a cash basis: see Carden’s case (C of T (SA) v Executor,
Trustee & Agency Co of South Australia Ltd (1938) 63 CLR 108) and FC of T v Firstenberg
76 ATC 4141.
Consequently, her taxable income for the year would be:
$ $
Amounts received from Medicare 40,000
Cash received from patients in 2018/19 150,000
190,000
Less: Expenses –
Salaries 50,000
Other expenses 40,000 90,000
TAXABLE INCOME $100,000
Dr Green’s situation can be contrasted with the facts in Henderson v FC of T 70 ATC 4016,
where the practice employed 295 people. In that situation the Court held that the accruals
basis of income derivation was appropriate.
Compensation
Normally, amounts received as a result of a restriction on the right to work would be regarded
as being on capital account and not taxable (see Bennett v FC of T (1947) 75 CLR 480 and
Scott v C of T (NSW) (1935) 35 SR (NSW) 215). This is because the loss of the right to work
is seen as a loss of a capital asset.
From a capital gains tax point of view, the question is whether the (capital gains tax (CGT)
provisions will apply. The decision of the High Court in Hepples v FC of T 91 ATC 4808
indicated such payments would not be subject to the CGT provisions prevailing at the time.
However, it is likely that a payment for a restrictive covenant would come within the
24
provisions of ITAA97 s 104-35. In particular, the section states that CGT event D1 occurs if
you create a contractual right or other legal or equitable right in another entity.
Consequently, by entering into a restrictive covenant, Furlong will have created a contractual
right in favour of the purchaser. The time of the event is when the contract is entered into or
when the right is created.
At the same time, the purchaser will have acquired an asset for an amount equal to the
amount paid (plus any other related costs) for the restrictive covenant.
Furlong’s capital gain will be the amount received ($50,000) less any incidental costs
incurred in creating the contractual right in favour of the purchaser.
Superannuation Benefits
Any other termination payment is termed an ‘employment termination payment’ and comes
under the provisions contained in ITAA97 Div 82 and 83.
A superannuation benefit is defined in s 307-5(1) to include a payment made from a

superannuation fund to a fund member or to another person after the fund member’s death.
The tax treatment of a superannuation benefit depends on:
•
the age of the taxpayer
•
whether the amount is a lump sum or an income stream, and
•
whether any part of the amount comprises a tax free component or a taxable component.
The tax free component of any superannuation payment made to the taxpayer comprises the
contributions segment and the crystallised segment (ITAA97 s 307-210 and 307-220).
The contributions segment includes contributions made from 1 July 2007 which have not
been included in the assessable income of the fund. This would include amounts such as non-
concessional contributions. The crystallised segment is determined by assuming that the full
value of the superannuation interest is an eligible termination payment paid just before 1 July
2007. It would include the following components under ITAA97 s 307-225:
•
concessional component
•
post-June 1994 invalidity component
•
undeducted contributions component
•
25
CGT-exempt component, and
•
pre-July 1983 component.
The taxable component of any superannuation payment is the value of the taxpayer’s interest
in the fund less the tax free component (ITAA97 s 307-215).
Where the taxpayer is over 60 years of age and receives a superannuation benefit from a
taxed source, the benefit is not assessable income and is not exempt income (ITAA97 s 301-
15). However, as Banks is less than 60 years of age, but has attained the preservation age,
s 301-20 provides that the taxable component is taxed at 0% up to low rate cap amount, and
at 15% on the remainder.
As Banks has some prior service to July 1983 of 365 days, part of the superannuation
payment would be a ‘tax free component’ (ITAA97 s 307-225).
This is determined by taking the pre-July 1983 days of service relative to the total days of
service.
Therefore, the tax free component is:
365 days/13,514 days × $ 300,000 = $8102
Also, the tax free component includes the amount of undeducted contributions made by the
taxpayer since July 1983 of $40,000.
This comprises the contribution part in respect of contributions made to the fund since 1 July
2007 (s 307-220) and the crystallised segment (s 307-225), which is outlined above.
Therefore, the taxable component = $291,898 − $40,000 = $251,898
Section 301-20 provides that the taxable component is taxed as follows:
•
$205,000 no tax
•
$46,898 taxed as assessable income. However, this amount of the component that exceeds the
cap of $205,000 is subject to tax up to a maximum rate of 15%.
It should be noted that the low rate cap is indexed annually in line with full-time adult
average weekly ordinary time earnings (AWOTE) (ITAA97 s 960-285).
Employee termination payments and
superannuation benefits
26
For the superannuation benefits see solution to Question 6 above.
Where the taxpayer is under the preservation age, the tax free component of the
superannuation benefit is not assessable and not exempt income (ITAA97 s 301-30). The
remaining amount is assessable income, but a tax offset is available to ensure that amount is
not taxed at more than 20% (ITAA97 s 301-35).
The tax free component comprises the crystallised segment (s 307-225) which includes:
•
pre-July 1983 component
•
post-June 1983 component
•
•
undeducted contributions
•
concessional component, and
•
CGT-exempt component.
In the case of Foreman, this includes the pre-July 1983 component of the superannuation
interest which is based on the pre-July 1983 service component relative to the total period of
service.
This is calculated as:
(730 days of service pre-July 1983/13879 days of total service) × $400,000 = $21,039
This amount is tax free.
There is also a tax free component in respect of the undeducted contributions made by
Foreman of $38,000 (ITAA97 s 307-210 and 307-220).
As Foreman is below the preservation age, the remaining amount of $340,961 ($400,000 –
$21,039 – $38,000) is taxed as assessable income to Foreman. ITAA97 s 301-35 provides
that Foreman would be able to claim a tax offset to ensure that the amount is taxed at a
maximum rate of 20%.
Taxation of the approved early retirement

scheme payment
As indicated above, from 1 July 2007, the taxation of employee termination payments comes
under the provisions contained in ITAA97 Div 82 and 83.
An employment termination payment may be a life benefit where it is paid to the employee as
a consequence of the termination of the person’s employment, or a death benefit termination
27
payment where it is paid to another person as a result of another’s persons death in
consequence of the termination of employment (ITAA97 s 82-130).
However, s 82-135 states that the tax free amounts received as part of any genuine
redundancy or early retirement scheme are not employee termination payments.
Subdivision 83-C deals with the taxation of redundancy and early retirement scheme
payments.
There are a number of requirements for a payment to come within the redundancy provisions.
The main requirements are that the employee is dismissed before the age of 65 and that it is a
genuine redundancy (see Taxation Ruling TR 2009/2, which provides an outline of the
conditions which must be met for an ETP (employment termination payment) to qualify as a
genuine redundancy payment).
A redundancy payment comprises a tax free and an assessable amount (ITAA97 s 83-170).
The tax free amount for 201,819 is determined as the base amount + (service amount × years
of service).
The base amount is $10,399 and the service amount is $5,200 for the year 2018/19.
As Foreman has 38 years of completed service, the tax free amount is:
$10,399 + (38 × $5,200) = $207,999
Consequently, the amount of $100,000 received by Foreman as a redundancy payment is tax

free.
Exempt income
It is assumed that the UK–Australia double tax agreement does not provide an exemption
from tax liability for Howard in the United Kingdom. It is also assumed that Howard’s
liability for tax in the UK is the equivalent of A$8,000.
The provisions of ITAA36 s 23AG only apply to income earned overseas, unless it is
received:
•
as an aid or charitable worker employed by a recognised non-government organisation
•
as a government aids worker, or
•
as a specified government worker deployed overseas (s 23 AG(1AA) see TR2013/7).
28
Consequently, the income received by Howard from working overseas is not exempt. The
amount earned overseas is assessable income and added to Howard’s Australian-source
income to determine the tax payable.
The assessable income therefore includes Australian-source income and foreign source
income, including tax deducted overseas ($6,000) in respect of that income.
Therefore, the tax on his Australian income is determined as:
Total income = $75,000

Australian tax payable (including Medicare levy of
= $17,422
2%)
$17,422
Total tax for year ended 30 June 2019 =
less a credit for the overseas tax of
$6,000
= $11,422*
*Generally, the foreign tax offset is based on the amount of the foreign tax paid. However,
this is limited to the amount of the Australian tax that would be payable on the overseas
income (ITAA97 s 770-75).
Source; exempt income
The assessable income of Mary Fellows for the year ended 30 June 2019 will be:
(1) Assessable pursuant to ITAA97 s 6-5 $49,300

Assessable pursuant to ITAA97 s 6-5 (Not exempt pursuant to ITAA36
(2) $30,000
s 23AG(1AA))
(3) Dividend assessable under ITAA36 s 44(1) $10,000
(4) Gross-up for franking credit (ITAA97 s 207-20) $4,285
(5) Overseas dividend (+ withholding tax) $1,000
$94,585
As there are no deductions, assessable income equals taxable income.
Australian tax payable is as follows:
$ $
Tax payable on $94,585 22,456.45
Plus: Medicare levy (2%) 1,891.70
TAX PAYABLE 24,348.15
Less: Credit for withholding tax 150
Imputation credit(1) 4,285
29
Overseas tax on foreign salary(2) 5,000 9,435
TAX PAYABLE $14,913.15
Notes:
(1) Section 207-20 entitles a resident to a tax offset for the franking credit.
(2) Generally, the foreign tax offset is based on the amount of the foreign tax paid. However,
this is limited to the amount of the Australian tax that would be payable on the overseas
income (ITAA97 s 770-75).
[¶30-010] Solution 10
Employee share schemes
(a) The relevant provisions concerning employee share schemes (ESS) are contained in
ITAA97 Div 83A. Division 83A applies where an employee acquires an ‘employee share
scheme interest’ under an ESS at a discount. This includes rights to acquire a share.
An ‘employee’ also includes a director, an office holder and an associate of an employee.
The rights granted to Lord would be regarded as an ESS. An ESS interest is defined as a
beneficial interest in a share in a company, or a right to acquire a beneficial interest in a
company (s 83A-335).
Normally, any discount which is received by an employee as part of an ESS is taxed at the
time of acquisition. The discount is measured as the difference between the market value of
the ESS interest less any amount paid by the employee (s 83A-25(1)).
Consequently, the assessable discount would be:
$
Market value of rights: 200,000 × 50c 100,000
Less: Consideration paid 10,000
$90,000
The sum of $90,000 would be included in Lord’s income in the 2018/19 tax year.
It is important to note that the determination of the discount occurs when the rights are
acquired. This is 1 July 2018.
The legislation provides in Subdiv 83A-C for deferred taxation on an ESS in certain
circumstances. In particular, deferred taxation is allowed where the ESS interest is acquired
at a discount and where there is a real risk that the shares might be forfeited. A deferred
taxation of the benefit is also available where the ESS interest is attributable to a salary
sacrifice agreement and the employee receives no more than $5,000 worth of shares.
30
This deferral would not apply to Lord as the rights were worth more than $5,000.
Section 83A-35 provides a discount of $1,000 where a number of conditions are satisfied.
However, as the shares are not offered to more than 75% of the employees the discount does
not apply to Lord.
When the rights are exercised Lord will be deemed to acquire the shares at the value of the
rights when issued, ie 50 cents, plus the amount paid to acquire the shares.
(b) When the shares are disposed of, the CGT provisions will apply. From a CGT
perspective, Lord will be paid for the shares (s 83A-30).
The cost of the shares for CGT purposes will be:
$
Market value of rights (at time of acquisition) 100,000
Cost of shares: 200,000 × $1 200,000
Cost of disposal 1,550
$301,550
The capital gain will be calculated as follows:
$
Capital proceeds 440,000
Less: Cost base 301,550
Capital gain for the year of income 2018/19 $138,450
As the acquisition of the rights occurred less than 12 months prior to the sale of the shares,
the taxpayer would not be eligible for the CGT discount of 50% on the gain (see ITAA97
Subdiv 115-A), and the gain would be $138,450.
[¶30-011] Solution 11
Business or hobby
This question involves consideration of the issue of whether the amounts are assessable as the
proceeds of a business. If such activities are regarded as a business, they will be assessable
under ITAA97 s 6-5. However, if such an activity is regarded as a hobby, then the amount
will not be assessable.
It is necessary to look at factors such as:
•
the commercial nature of the activities
•
the frequency of the transaction
•
31
size and scale of activities
•
existence of a profit motive
•
time put into such activities, and
•
whether the activities are systematic and organised.
The determination of whether such an activity is a business or a hobby is a question of fact

and depends on an assessment of the various factors which may have different importance or
weighting. (See Martin v FC of T (1953) 90 CLR 470, Ferguson v FC of T 79 ATC 4261 and
Stone v FC of T 2005 ATC 4234.)
It may seem that, notwithstanding the scale and frequency of Jones’s activity, it would not
constitute a business and the amounts would not be assessable. If the activity is seen as a one-
off situation, this may be so. However, the fact that Jones was invited to appear on another
show and received $5,000 could indicate that he has commenced a business. If this is the
case, the amounts received would be assessable income. In Taxation Ruling TR 2005/1 the
Commissioner indicates that no one factor is decisive in determining whether a business is
being carried on. Rather, it is necessary to look at all the factors and circumstances relating to
the activities by the taxpayer.
[¶30-012] Solution 12
Compensation; unliquidated damages
If the compensation payment is not assessable as ordinary income under ITAA97 s 6-5, it
may be assessable under s 15-30 or 70-115. Section 15-30 states that a taxpayer’s assessable
income includes any amount received as compensation by way of insurance or indemnity,
and s 70-115 includes as assessable income any insurance or indemnity for loss of trading
stock.
On this basis, compensation for the trading stock would be assessable (s 70-115). Similarly,
s 40-285 would bring to account the proceeds attributable to the plant.
If the amount of compensation was in excess of the adjustable value of the plant, to the extent
of amounts allowed and allowable in assessments for income tax, it would be assessable (s
40-285).
However, if the compensation is below the adjustable value of the depreciating assets, a
deduction for the difference arises (s 40-285(2)). To the extent that compensation exceeded
the initial cost of the asset, it may be necessary to take the CGT provisions into account if the
CGT event happened before 11.45 am EST on 21 September 1999. However, if the asset was
acquired after this time and the asset is used wholly for taxable purposes, a balancing
adjustment would occur and there would be no capital gain (ITAA97 s 40-285 and s 118-24).
32
If the disposal of the depreciating assets is seen as a regular incident of the taxpayer’s
activities, the profit (in excess of the balancing adjustment) may be assessable as income
under s 6-5. (See FC of T v GKN Kwikform Services Pty Ltd 91 ATC 4336.)
Compensation for the building would be of a capital nature. Where deductions had been
claimed under ITAA97 Div 43, there would not be a ‘clawback’ on the deductions claimed if
consideration exceeded the unamortised cost (ie such amounts would not be regarded as
assessable income). If the amount received was below the unamortised cost a balancing
deduction is allowable under s 43-40.
For capital gains tax purposes, the loss or destruction of the building wholly or partly
represents CGT event C1 (s 104-20(1)).
On the basis of Wales v Tilley [1943] AC 386, where compensation was received for amounts
which represent income and capital, an apportionment can be made of the respective amounts
based on the facts. However, where a lesser sum is received in lieu of wholly unliquidated
claims in respect of items of a capital and revenue nature, it is not possible to make an
apportionment. (See McLaurin v FC of T (1961) 104 CLR 381.) In such situations the amount
would be capital in nature and not assessable as income.
However, the advantage outlined in McLaurin’s case is nullified by the CGT provisions. The
cancellation, surrender or release of a right would give rise to CGT event C2. Where this
arises, s 104-25 states that you make a capital gain if the capital proceeds from the ending are
more than the asset’s cost base. (See FC of T v CSR Ltd 2000 ATC 4710.)
Furthermore, s 20-25(3) provides that where a taxpayer disposes of a right to receive an

amount as recoupment of a loss or outgoing, any amount received for the disposal is taken to
be recoupment of the loss or outgoing. Where this amount is not specified, such as in the case
of unliquidated damages, s 20-25(4) states that the amount is taken to be a recoupment of the
loss or outgoing to whatever extent is reasonable.
[¶30-013] Solution 13
Work expenses; car allowance;
reimbursement
(1)
The $5,000 car allowance is assessable under ITAA97 s 6-5. However, if Felicity Canon was
provided with a reimbursement of a car expense that would, but for FBTAA s 22, be an
expense payment fringe benefit, the amount of the reimbursement would be assessable under
ITAA97 s 15-70.(see TR92/15 which outlines the difference between an allowance and a
reimbursement)
The reimbursement of the parking expenses does not constitute assessable income to Canon.
However, the amount would be an expense payment benefit for the purpose of FBT (FBTAA
s 20) and subject to FBT payable by the employer. Since half of the expenses were incurred
for business, the ‘otherwise deductible’ rule (s 24) means that only half of the parking fee
33
would be subject to FBT—so long as the taxpayer complies with the substantiation
requirements.
(2)
The allowance would be assessable under ITAA97 s 6-5.
(3)
The amount would be assessable under ITAA97 s 15-70. Canon would then be able to claim
a deduction for the appropriate business travel.
If Canon elects to use the cents per kilometre method no substantiation records are required
(ITAA97 s 28-35). Alternatively, she could elect to use the log book method, but both a log
book and odometer records would need to be maintained (s 28-100).
[¶30-014] Solution 14
Remuneration; allowances
The salary, entertainment allowance, travel allowance and telephone allowance are all
assessable under ITAA97 s 6-5 or ITAA97 s 15-2. Grant’s assessable income is $95,750
($80,000 + $10,000 + $5,000 + $750).
The reimbursement of work-related expenses would not constitute income to Grant under s 6-
5. However, the reimbursement of accommodation and meal expenses would be an expense
payment benefit which is taxable to the employer under FBTAA s 20; but s 24 would reduce
the FBT liability on the basis of the ‘otherwise deductible’ rule, assuming the substantiation
requirements are complied with.
An exemption may apply in respect of the reimbursement of the expenses for accommodation
where the accommodation is provided as a result of the employee being required to live away
from home. However, to qualify for the exemption it is necessary that the employer obtains a
declaration from the employee on an approved ‘living away from home declaration’ form
indicating the reason for living away from home, the time involved and the normal residence
of the taxpayer.
[¶30-015] Solution 15
Annuities
An annuity which is first payable after 1 July 1983 is assessable under ITAA36 s 27H.
However, s 27H excludes from assessable income that part of the annuity which represents
the ‘deductible amount’ (ie the amount representing the return of the taxpayer’s own capital).
The deductible amount is determined under s 27H(2) by reference to the following formula:
34
where:
A is the share of the annuity received by the taxpayer

B is the undeducted purchase price of the annuity, ie that part of the purchase price for which
the taxpayer has not received a deduction
C is the residual capital value of the annuity (if any), ie the capital amount payable on
termination of the annuity
D is the number of years the annuity can be expected to be payable. This is determined by
reference to the life expectation of the taxpayer as determined by actuarial life tables. The
annuity life tables for an annuity payable on or after 1 January 2017 indicate that Hudson at
the age of 60 has a life expectancy of 23.37 years.
On this basis the deductible amount is:
Therefore, for each $30,000 received, the deductible amount is $11,981. As a result, the
assessable income would be $30,000 − $11,981 = $18,019. This amount is taxed at the
taxpayer’s marginal rate.
[¶30-016] Solution 16
Residence; source of income
(1)
While a taxpayer’s residence is usually determined by a taxpayer’s domicile (place of birth) a
taxpayer may establish another place of residence as evidenced by their normal or usual place
of abode. This is often referred to as where the taxpayer normally ‘eats, drinks and sleeps’.
See Levene v IR Commrs [1928] AC 217.
Some of the issues which require consideration here are:
•
Where is the taxpayer physically located during the year?
•
With what frequency and regularity does the taxpayer visit the country concerned?
•
Does the taxpayer maintain a place of abode in Australia?
•
Are there any business and family ties to Australia?
•
What are the taxpayer’s daily habits and way of life?
A determination of a taxpayer’s residence is a question of fact based on the objective

circumstances.
35
On the facts, it is clear that Jack was a resident of Australia for the last three months of the
2017/18 tax year, as he resided in Australia during that time and had the intention of
remaining in Australia. (See the definition of ‘Australian resident’ in ITAA97 s 995-1(1) and
note its link to the definition of ‘resident of Australia’ in ITAA36 s 6(1).) Taxation Ruling TR
98/17 also provides some guidance on the issue of a taxpayer’s residence.
The ruling states that the determination of a taxpayer’s residence is a question of fact which is
determined on a year by year basis. The ruling states that the following factors should be
considered in determining the residence of a taxpayer:
•
their intention or purpose of presence
•
family and business/employment ties
•
maintenance and location of the taxpayer’s assets, and
•
social and living arrangements.
However, the ruling indicates that no one factor is decisive, and the weight given to each
factor depends on the circumstances.
What about the nine months on contract working in Saudi Arabia? During that time Jack did
not reside in Australia. However, it is necessary to determine his ‘permanent place of abode’
at the time.
Contrast Jack’s circumstances with the facts in FC of T v Applegate 79 ATC 4307. In

Applegate’s case the taxpayer’s intention was to remain overseas for an indefinite period of
time. The taxpayer’s wife accompanied him; he left no assets in Australia and obtained a
residence permit in Vila. By contrast, Jack only intended to be absent from Australia for
approximately nine months of the year; his wife and son remained in Australia; his bank
account was in Australia; and his accommodation in Saudi Arabia was of a temporary nature.
(Also see Harding v FCT [2019] FCAFC 29)
After contrasting the two situations, it would be difficult to conclude that Jack’s permanent
place of abode was anywhere but Australia. Jack was a resident of Australia for the whole
year.
(2)
What was the source of Jack’s income:
(a)
the place where he contracted for the work—Australia
(b)
the place where he performed the work—Saudi Arabia, or
(c)
the place where he was paid for the work—Cyprus?
The courts in FC of T v French (1957) 98 CLR 398 and FC of T v Mitchum (1965) 113 CLR
401 concluded that the identification of the source of income was, in each case, a conclusion
of fact (the practical hard matter of fact test) and, in a case of wages for work, the place of
36
performance of that work would be the source of the wages. In this case the source of income
would be Saudi Arabia.
Pursuant to ITAA97 s 6-5, income earned by residents both within Australia and from
overseas is assessable income. Section 23AG will not apply to exempt the income from
Australian tax as the activities do not qualify for the exemptions contained in s 23AG(1AA).
However, where tax is paid on the overseas income a foreign tax offset is available.
Generally, the foreign tax offset is based on the amount of the foreign tax paid. However, this
is limited to the amount of the Australian tax that would be payable on the overseas income
(ITAA97 s 770-75).
[¶30-017] Solution 17
Residence; source of income
The first issue is to determine whether Kate Morris is a resident or non-resident for
Australian tax purposes (see Solution 16, above).
On the basis of FC of T v Jenkins 82 ATC 4098, FC of T v Applegate 79 ATC 4307 and

Harding v FCT 2019 FCAFC 29 it is likely she is a non-resident, as her permanent place of
abode is New York, having leased her Australian home and moved to New York for five
years.
As a non-resident Morris is only assessable on Australian-source income (ITAA97 s 6-5(3)

and 6-10(3)). As the $10,000 rental income has an Australian source it is assessable under
s 6-5(3) at non-resident rates of tax, namely $10,000 at 32.5% = $3,250. However, as Morris
is a non-resident, ITAA36 s 128D specifically excludes fully franked dividends from being
included in her assessable income.
The combined effect of s 128B(3)(ga) and 128D is to exempt from dividend withholding tax
fully franked dividends received by a non-resident and exclude them from assessable income.
It is regarded as non-assessable non-exempt income under ITAA97 s 6-23 pursuant to Subdiv
11-B and ITAA36 s 128D.
The interest expense is not deductible because it was incurred in relation to gaining or
producing non-assessable non-exempt income (ITAA97 s 8-1(2)(c)).
[¶30-018] Solution 18
Derivation of income
(1)
On the basis of Carden’s case (C of T (SA) v Executor, Trustee & Agency Co of South
Australia Ltd (1938) 63 CLR 108) and Henderson v FC of T 70 ATC 4016, income is not
assessable until it has ‘come home to the taxpayer’. For people who earn a salary this is
usually when the amount is paid to them. Consequently, the taxable income of an employee is
37
determined on the cash basis; that is, income is returned in the year of actual, or constructive,
receipt.
In this case the employee would be assessed on the $6,000 in the 2018/19 tax year, even
though long service leave did not commence until the 2019/20 tax year. Section 83-80
ITAA97, makes the payment assessable upon receipt.
(2)
Part III Div 16E deals with the assessability of certain security payments. These include
qualifying securities, of which the loan of $20,000 by the finance company would be one.
Under s 159GP(1) a qualifying security arises where it is issued after 16 December 1984 and
the expected term of duration will exceed 12 months and the sum of payments (other than
interest) under the security will exceed the purchase price.
Although the interest of $2,400 is only payable at the end of two years, s 159GQ(1) requires
the interest to be divided into accrual periods of six months. The implicit interest rate would
be calculated using the formula:
This formula gives an interest rate of 2.8737%. The interest for each of the four six-monthly
accrual periods would then be:
Accrual period Opening balance Accrual amount

1 20,000 575
2 20,575 591
3 21,166 608
4 21,774 626
Total interest $2,400
The finance company would include interest of $1,166 in assessable income for the income
year ended 30 June 2018 and $1,234 in assessable income in the income year ended 30 June
2019. It is irrelevant that the $2,400 is not received until 1 July 2019.
(3)
For a business operating on the accruals basis, amounts received in advance for future lessons
may be treated as unearned income if the accounting procedures of the business conform with
that practice—for example, the unearned sums are recorded in a suspense account. Refer to
Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314.
If the judo school followed this practice, it would be assessable on $105,000 for the 2018/19
tax year. This is provided the judo instruction school was liable to refund the $5,000 if the
participants did not proceed. If there was no liability to make a refund they would be
assessable on the whole amount of $110,000.
(4)
Taxable income for a jewellery shop would normally be determined on the accruals basis; so
the $6,500 would be assessable in the 2018/19 year, and not in the year of actual receipt.
The credit card discount would be an allowable deduction.
38
(5)
Based on the decision in Henderson v FC of T 70 ATC 4016 the taxable income of a large
trading concern would be determined on the accruals basis. The $1,200 interest charged
would be assessable in 2018/19, the year in which the interest was charged, and not the year
in which the payment was received.
[¶30-019] Solution 19
Retirement income
(1)
The retirement gratuity would be treated as an employment termination payment (ETP) and
be included as assessable income under s 82-10. Given that Marlow has reached his
preservation age of 55, as he was born before 1 July 1960 (see Superannuation Industry
(Supervision) Regulations 1994) the amount of $10,000 is taxed at a maximum rate of 15%.
(2)
The $3,000 received in lieu of annual leave is assessable in full under s 83-10. Where the
amount is received as part of a genuine redundancy or early retirement scheme s 83-15 states
that a tax offset is available to ensure the annual leave payments are taxed at no more than
30%.
(3)
As Marlow has reached his preservation age, but is below the age of 60, the taxable
component of the superannuation payout of $280,000 is assessable income (ITAA97 s 301-
20). The first $205,000 is taxed at 0%. The remaining amount is taxed at no more than 15%.
However, as the whole of the lump sum has been ‘rolled over’, it is a roll-over
superannuation benefit. Section 306-5 provides roll-over relief where the superannuation
lump sum is paid to an entity to purchase a superannuation annuity from the entity.
[¶30-020] Solution 20
Scholarship
The amount received by the employee is assessable under ITAA97 s 6-5(2). The exemption
under s ITAA97 s 51-10 would not apply because the student was still employed (ie ‘will (or
will if required) render, or continue to render, services’ to his employer). (See Case N28, 81
ATC 154; Case E3, 73 ATC 9.)
[¶30-021] Solution 21
Lease incentives and benefits
Based on the decisions in FC of T v Cooling 90 ATC 4472 and FC of T v Montgomery 99
ATC 4749 and Taxation Ruling IT 2631 lease incentives are assessable income as income.
39
Where they are in the form of cash they will be seen as ordinary income under ITAA97 s 6-5.
Although such receipts are not part of the normal business they are nevertheless seen as an
exploitation of the company’s capital position. Therefore the sign-on bonus is assessable
under s 6-5 as ordinary income.
Where business benefits are of a non-cash nature then ITAA36 s 21A may apply in
determining the income derived by a taxpayer. However, the taxable value of such benefits
may be reduced by the operation of the otherwise deductible rule. Section 21A(3) provides
for a reduction in the taxable value of the non-cash business benefit. This occurs where the
nature of the benefit would have been an allowable deduction to the recipient of the benefit.
In the case of a lease benefit this would arise where the benefit provided to the lessee would
have been an allowable deduction to the lessee if it had been incurred by the lessee. Based on
Taxation Ruling IT 2631 this would cover benefits such as rent-free periods and free fit-outs
(where the lessee retains ownership of the fit-out).
However, the two tickets to the Australian Open and related benefits would not be caught
under s 21A due to the fact that the lessor would not be able to obtain a tax deduction for the
cost of providing the benefits under ITAA97 s 32-5 (s 21A(4)).
The relocation costs would be caught under s 21A, however, insofar as they relate to the cost
of moving trading stock they would not be assessable. This is due to the operation of the
otherwise deductible rule.
The costs of the lease termination would be assessable under s 21A as the otherwise
deductible rule does not apply.
[¶30-022] Solution 22
Employment benefits
The taxpayer would be assessed on $93,000 (his salary of $90,000 and entertainment
allowance of $3,000). He would not be assessed on the value of the company car because his
employer is liable to FBT (ITAA36 s 23L).
[¶30-023] Solution 23
Various receipts relating to employment
The salary of $175,000 would be assessable as income under ITAA97 s 6-5. However, a
question arises as to whether the $25,000 sign-on incentive is an amount paid to Mary to join
Mining Australia Ltd or a payment to leave her previous employer(see Blank v FCT HCA
42). If it was a payment to join the new employer it would be assessable under s 15-3 as a
return to work payment. However, if it was a payment to leave her previous employer it
would be an employment termination payment (ETP). Under s 82-130 an ETP is a payment
made in consequence of the termination of the person’s employment which is received no
40
later than 12 months after the termination of the employment. As Mary is below preservation
age, the taxable component which is within the ETP cap of $200,000 and is taxed at no more
than 30% plus Medicare.
The settling-in allowance would not be a fringe benefit but rather income under s 6-5 or s 15-
2.
The productivity bonus would be assessable income under s 6-5. However, as it was not paid
until July 2019 it would not be derived until the following year in 2019/20 (see Carden’s case
(C of T (SA) v Executor, Trustee & Agency Co of South Australia Ltd (1938) 63 CLR 108).
Even though Mary asked that the bonus amount be redirected to an offset loan account with
her partner, this would not change the assessable nature of the amount, since s 6-5(4) states
that where you redirect income, you are taken to have derived it as soon as it is applied with
or dealt with on your behalf. This would occur in July 201.
[¶30-024] Solution 24
Accident compensation
Sick pay: $4,000—fully assessable (ITAA97 s 6-5(2)).
Proceeds from the private sickness and accident policy are assessable, as the purpose of the
policy was to provide an indemnity against the income loss arising from the inability to earn
income. The benefits are of a revenue character and assessable under s 6-5(2). The benefits
are also assessable under s 15-30. (See FC of T v Darcy Peter Smith 81 ATC 4114.)
Guaranteed sum for loss of a leg: $120,000—not assessable (the premium on such a policy is
not deductible) and specifically excluded from CGT (see s 118-37(1)). It is also specifically
excluded as an ETP pursuant to the definition of ‘employment termination payment’ in
ITAA97 s 82-135.
Retirement gratuity: The payment would normally be regarded as an ETP and come under
ITAA97 Div 82 and 83. However, s 82-135 states that amounts received for personal injury
are not taxable as an ETP.
Third party insurance settlement: not assessable and excluded from CGT by ITAA97 s 118-
37.
Social security disability support pension: not assessable (s 52-10 item 6.2).
[¶30-025] Solution 25
Termination of employment
41
While the leave payment is an ETP, the payment in lieu of annual leave accrued post-17
August 1993 ($4,200) is fully assessable under ITAA97 s 83-10. No tax offset is allowed as
the payment was not made as part of an early retirement scheme or genuine redundancy
under s 83-15.
(a) Superannuation Payment

The sum of $350,000 paid from the Trans Engineering Superannuation Fund is a
superannuation benefit under ITAA97 s 307-5(1). The main provisions are contained in Div
307. A superannuation benefit is defined in s 307-5(1) to include a payment made from a
superannuation fund to a fund member or to another person after the fund member’s death.
The tax treatment of a superannuation benefit from 1 July 2007 depends on:
•
•
•
contributions segment and the crystallised segment (s 307-210 and 307-220).
concessional contributions. The crystallised segment is determined by assuming that the full
value of the superannuation interest is paid just before 1 July 2007 and includes the following
components under ITAA97 s 307-225:
•
•
•
•
•
in the fund less the tax free component (s 307-215).
As King has some service prior to July 1983, part of the superannuation payment would be a
‘tax free component’ (s 307-225).
This is determined by taking the pre-July 1983 days of service relative to the total days of
service.
42
Therefore, the tax free component is calculated as follows:
2,159 days/14,973 days × $350,000= $50,467
There is also a tax free component representing the undeducted contributions of $30,000
made to the fund by King since 1 July 1983. Therefore, the total tax free component is
$50,467 + $30,000 = $80,467.
This leaves a taxable component of $350,000 − $80,467 = $269,533
As King is under the preservation age and the payments come from a taxed source, under
s 301-30 the remaining amount of $269,533 is assessable income. A tax offset applies to
ensure that the tax on the payment is not more than 20% (s 301-35).
(b) Employment Termination Payment

(ETP)
The payment of $20,000 would be an ETP under ITAA97 s 82-130. However, it does not
qualify as a genuine redundancy payment so there is no concessional relief under ITAA97
Subdiv 83-C (see Taxation Ruling TR 2009/2, which provides an outline of the conditions for
an ETP to qualify for a genuine redundancy payment). Section 82-140 provides that the part
of the payment relating to pre-July 1983 service is tax free. This amount is determined under
s 82-155 as:
Therefore, the tax free component is calculated as:
2,159 days/14,973 days × $20,000 = $2,883
The remaining amount of $17 117 is taxed under s 82-10 as assessable income. There is a tax
offset to ensure the amount is taxed at a maximum rate of 30% (s 82-10(4)).
[¶30-026] Solution 26
Mutuality
The principle of mutuality means that a taxpayer cannot derive income from payments made
to itself.
Consequently, amounts received from members as subscriptions or payments to a club (or

association) do not form part of the assessable income of the club. This also extends to other
payments received by the club from members, such as from restaurant operations and gaming
activities.
43
The principle of mutuality does not extend to amounts received by the club from non-
members where the receipts arise in the nature of trade or business dealings (Sydney Water
Board Employees’ Credit Union Ltd v FC of T 73 ATC 4129). However, if the contributions
are simply made to a common fund for the benefit of all members, then the proceeds are not
assessable (see also Coleambally Irrigation Mutual Co-operative Ltd v FC of T 2004 ATC
4835).
The amount of profit which is assessable would depend on the golf club maintaining accurate
records to determine the nature of receipts and whether they came from non-members. To
some extent, this problem is solved by the Commissioner accepting a basis of apportionment
based on the records of visits made by non-members to the club. Since the records of the club
indicate that 40% of green fee profits were from non-members, $32,000 would be assessable.
Similarly, 50% of the restaurant profits ($20,000) and 75% of the gaming profits ($75,000)
would be assessable income.
[¶30-027] Solution 27
Royalties
ITAA97 s 15-20 states that the assessable income of a taxpayer includes an amount received
as or by way of royalty within the ordinary meaning of that term, if the amount is not
assessable as ordinary income under s 6-5.
As a result, a royalty which is within the common law meaning of the term would be included
as ordinary income under s 6-5.
The main characteristics of a royalty from a common law perspective are that:
•
the payment is made to the person who grants the right
•
the amount of the payment is based upon the use of the right, and
•
the payment is made when the right is exercised.
For this reason, the fee of $65 paid (for every motor)to NY Marine would be a royalty within
the terms of s 6-5. The amount of $75,000 paid to NY Marine to cover the initial expenses is
not a royalty payment within the meaning of s 6-5.
However, insofar as the payment of $75,000 was made to cover expenses in relation to the
provision of technical expertise, such an amount may still be assessable as a royalty under
s 6-5 where the amount paid was of an ordinary income nature (eg if NY Marine was in a
continuous business operation of selling marine engines and providing technical expertise on
their operation). Section 15-20 would only bring the payment to account as income where it
was not ordinary income but was within the scope of the ordinary meaning of royalty and was
of a capital nature.
44
Where such amounts are a royalty, they are subject to the withholding tax provisions.
Because there is a double tax agreement with the United States, a 10% withholding tax rate
applies.
If NY Marine had a permanent establishment in Australia, withholding tax would not apply.
Instead, NY Marine would be taxed on its Australian-source income (ie the royalty) at
ordinary tax rates.
[¶30-028] Solution 28
Alienation of personal services income
This question is concerned with the ability of a taxpayer to divert income which is
attributable to personal exertion.
The legislation dealing with the alienation of personal services income (PSI) is found in
ITAA97 Pt 2-42 Div 84 to 87.
Division 85 limits the entitlement of individuals to deductions relating to their PSI, and Div
86 states the consequences of individuals diverting PSI to other entities. Section 84-5 states
that ordinary income or statutory income is PSI if the income is mainly a reward for personal
effort or skills. Division 87 sets out the circumstances in which an individual or entity can
escape the PSI rules because a ‘personal services business’ (PSB) is being conducted. (See
also Taxation Ruling TR 2001/7, which deals with the meaning of PSI, and Taxation Ruling
TR 2001/8, which deals with PSB.)
The effect of these provisions is that diverted income may be included in the assessable
income of the individual who performed the service. However, the provisions do not apply
where the entity pays the individual as an employee or where the entity is carrying on a PSB.
Section 87-5 contains a useful flow chart showing the operation of the PSB rules. In
particular s 87-15 indicates that a taxpayer will be carrying on a PSB if it meets one of the
PSB tests contained in s 87-15(2). These are:
(a)
the results test under s 87-18
(b)
the unrelated clients test under s 87-20
(c)
the employment test under s 87-25
(d)
the business premise test under s 87-30.
The results test is met where the taxpayer meets the following criteria for at least 75% of the
PSI in the year:
1.
The income arises from the production of a result.
45
2.
The taxpayer is required to provide their own tools and equipment.
3.
The taxpayer is liable to remedy any defect in respect of the work undertaken.
Where the results test is not satisfied, an 80% rule applies. This rule operates as follows.
Where 80% of the PSI is from one client, the income will be subject to the PSI rules (unless
the taxpayer has a ‘personal services business determination’ from the Commissioner
indicating it is a PSB (s 87-60, see below)). If 80% or more of the income is not from one
entity then the taxpayer must satisfy one of the tests outlined in (a) to (c) above.
The unrelated clients test requires the taxpayer to have derived income from the provision of
services to two or more entities which are not associates of the provider and the services are
provided as a result of the provider making offers to the public to provide such services.
The employment test is met by the taxpayer where 20% of the principal work is performed by
other entities.
The business premises test requires the taxpayer to maintain separate business premises to
derive the income. Furthermore, the premises must be occupied exclusively by the taxpayer
and physically separate from any premises used for private purposes.
Section 87-60 allows a taxpayer to apply to the Commissioner for a ‘personal services
business determination’ where the Commissioner will consider the nature of the taxpayer’s
activities and issue a determination where the taxpayer’s activities are a PSB.
Where the taxpayer is not carrying on a PSB, the amount of PSI may be reduced by
deductions to which the personal services entity (PSE) is entitled. However, Subdiv 86-B
limits the deductions available to PSEs which are not carrying on a PSB. In particular, the
deductions are limited to the amounts which the individual could have claimed if the income
had been earned by the individual taxpayer. From the facts of the case, it would seem that
Coleman would not be undertaking a PSB and the income would be PSI. As a result, the
Commissioner may apply s 86-15 in Coleman’s circumstances and include the diverted
income as part of Coleman’s ordinary income for the year.
As the cash basis is the most appropriate method for an individual, for the 2018/19 tax year
Coleman could be assessed on the $73,500 received by Electronics Ltd and would be entitled
to any deductions allowed by the Act in earning that income.
[¶30-029] Solution 29
Bonus; restraint of trade
If Swindon signs the contract, the match payments will be assessable under ITAA97 s 6-5 as
ordinary income and the bonus, if paid, would also be assessable under s 6-5 or ITAA97 s 15-
2. See FC of T v Stone 2005 ATC 4234 and Taxation Ruling TR 1999/17.
46
The lump sum received for agreeing to play football exclusively for the Collingwood
Football Club is an assessable capital gain. By signing an agreement not to play with any
other club, Swindon has created a contractual or other right giving rise to CGT event D1.
Consequently, ITAA97 s 104-35 would bring to account a capital gain from the proceeds of
creating the right, ie $50,000 (less any associated costs).
[¶30-030] Solution 30
Miscellaneous
(1)
As the lump sum payment is compensation for libel unrelated to any personal services or
business activity of the recipient, the amount received would not be income under ordinary
concepts and usages so ITAA97 s 6-5 would not apply. Compensation for libel received by a
person and not a company is excluded from CGT (s 118-37).
(2)
An honorarium would generally be fully assessable under either s 6-5 or ITAA97 s 15-2 as a
gratuity for services rendered. However, in Case Z16, 92 ATC 183 the Administrative
Appeals Tribunal (AAT) held that an honorarium of $100 paid to an elected district officer of
a friendly society was not assessable because there was no obligation to make the payment,
the activities of the taxpayer bore no relevance to any income-producing vocation or calling,
and the honorarium did not bear any relation to the time and energy the taxpayer expended on
voluntary work for the society. The payment was made to help defray travelling costs rather
than for services rendered.
Because the AAT treated the $100 honorarium as not assessable, the taxpayer was unable to
deduct $3,510 for car expenses claimed against the honorarium.
(3)
The receipt of a lump sum legacy of $10,000 is not income within the meaning of the Act and
thus not assessable. It is also not a capital gain for the purposes of Pt 3-1 (s 128-15(3)).
(4)
The general principle seems to be that compensation awarded for personal injury would not
be assessable unless paid in such a form as to constitute a receipt of income. Workers
compensation payments payable weekly or at intervals clearly fall into the assessable income
category and would be assessable under s 6-5. But what of an amount received in a lump
sum? In this question the payment has been deferred so that the recipient has received a lump
sum representing the aggregate of weekly payments. The amount would therefore be
assessable. (Refer to Case K34, (1959) 10 TBRD 187 and Taxation Ruling TR 95/35.)
(5)
The insurance proceeds would not be assessable under the general provisions of the Act
because the plant has not been installed ready for use.
The loss of the asset constitutes CGT event C1 (s 104-20(1)) and a capital gain would arise if
the insurance proceeds exceeded the cost base. Roll-over relief under s 124-70 would be
denied by s 124-75(4) because the asset was not used in the business.
(6)
The compensation would be assessable income because it arises out of a commercial contract
entered into for the purpose of making a profit (s 6-5).
(7)
47
Compensation received by the lessor would be assessable income under s 15-25 provided that
the lessee is using the property to produce assessable income. The compensation is deductible
to the lessee under s 25-15.
(8)
Four weeks’ wages in lieu of notice would come within the definition of an ETP under s 82-
130. As such, the amount would be taxed under s 82-10 at the appropriate ETP rates
depending on the taxpayer’s age.
[¶30-031] Solution 31
Non-resident manufacturer; imported
goods
The profits of the non-resident manufacturer would appear to be assessable income under
ITAA97 s 6-5(3). Prior to 14 September 2006 the amount of Australian profit arising from
such activities was determined in accordance with ITAA36 s 38, with s 41 indicating the
circumstances when goods are determined to be sold in Australia although the contract of sale
is not made in Australia. From that date, ITAA36 Pt III Div 2 Subdiv C was repealed and
those provisions are no longer operative.
As no legislation has been enacted to replace the repealed provisions, it is necessary to rely
on relevant case law relating to source of income (see Nathan v FC of T (1918) 25 CLR 183).
Generally, while the source of income has been seen in the past as dependent on where the
contract was made, it may be argued that the source of the income arising from the
transaction is where the work was undertaken. In this respect it is necessary to determine
whether the contract, or the provision of the goods, was the relevant transaction which gave
rise to the source of the income; in other words, the substance of the transaction should be
examined (see Cliffs International Inc v FC of T 85 ATC 4374).
Where there is a business of importing goods into Australia for sale in Australia, it is likely
that the substance of the transaction would indicate that the activities arising from the sale of
the goods is sourced in Australia.
Also, consideration should be given to the provisions of any relevant double tax agreement to
which Australia is a party. For example, Art 5(1) of the UK/Australia double tax agreement
provides that the industrial or commercial profits of a United Kingdom enterprise are exempt
from Australian tax, unless the enterprise carries on trade or business in Australia through a
permanent establishment in Australia. It would not seem that the activities of the sales
representative would constitute a permanent establishment in Australia.
However, if the parties were not dealing at arm’s length, the Commissioner may apply the
provisions in Div 815 to cancel any transfer pricing benefit arising from the transaction.
[¶30-032] Solution 32
48
Assessable income: various kinds of receipts
(1)
The payment would be an ETP under s 82-130. This includes a payment received in
consequence of the termination of the person’s employment or after another person’s death in
consequence of the other person’s employment.
In the case of death benefits for dependants, where there is any pre-July 1983 service, the part
of the payment relating to this service is not taxable. However, where the remaining amount
is paid to a dependant, an amount up to $200,000 is not assessable income and is not exempt
income (s 82-65). Any excess is taxed at the top marginal rate of 45%.
(2)
The cash prize would be assessable income under s 6-5, since it is an amount granted directly
to the taxpayer as a product of his income-producing activities. (See Case V6, 88 ATC 140.)
(3)
The scholarship would be assessable income under s 6-5. ITAA97 s 51-10 specifically
excludes such receipt from exemption because the scholarship contains a bonding condition.
(4)
The receipts by the grazier would be assessable income under ITAA97 s 15-20 as the
amounts received would be ‘as or by way of royalty’ (see Case H9, 76 ATC 39).
(5)
Royalties are assessable income (s 15-20), but the taxpayer is entitled to a foreign tax offset
under ITAA97 s 770-70. However, s 770-75 states that this offset is limited to the amount of
the Australian tax payable on the income.
(6)
This type of receipt has been held to be assessable.
In FC of T v Cooling 90 ATC 4472, the Full Federal Court held that the leasing of premises is
an act in the course of a taxpayer’s business activity; ie it is a commercial transaction, profit
from which is income according to ordinary concepts and assessable under ITAA97 s 6-5. In
FC of T v Montgomery 99 ATC 4749, the Full High Court held that a lease incentive paid to a
law firm was assessable. Even though the amount was not received in the ordinary course of
carrying on its business, it nevertheless arose as a result of the firm exploiting its capital and
was therefore ordinary income.
Section 104-35 could also apply. In this case, as the taxpayer is a future tenant and may be
commencing a new business, such a payment may constitute an assessable capital gain under
s 104-35 by creating a contractual or other right giving rise to CGT event D1. As the taxpayer
may be assessable under s 6-5 and Pt 3-1 of the CGT provisions, the capital gain is reduced
by the amount assessable under s 6-5 (s 118-20).
(7)
This amount would be assessable income under s 6-5. The amount would be income under
ordinary concepts as a return for services rendered.
(8)
The retiring allowance would be an ETP under s 82-130. The tax effect would depend upon
the composition of that sum as apportioned into the pre-1 July 1983 component and the post-
30 June 1983 component, unless any part was a bona fide redundancy component.
49
The part that relates to service pre-July 1983 is tax free (s 82-140). The remaining amount is
taxable. If the taxpayer has reached their preservation age, the amount due to post-June 1983
service is taxable, but at no more than 15%. Otherwise, the amount is taxed at no more than
30% (s 82-10). The fact that the payment is made over three years does not alter the tax
treatment.
(9)
Compensation for loss of a capital asset is not assessable under ITAA97 s 6-5. However, the
loss of the asset due to the fire may have CGT implications if the warehouse was acquired
after 20 September 1985 (s 104-20(1)), although the taxpayer could elect to use the CGT roll-
over provisions (s 124-70) if the requirements of s 124-75 are met.
[¶30-033] Solution 33
Assessable income: miscellaneous examples
(1)
ITAA36 s 21A is likely to apply. As property has been provided in connection with a
business relationship, it is a ‘non-cash business benefit’ (s 21A(5)) and its assessable arm’s
length value is $1,800.
Could ITAA97 s 6-5 also apply? In this case, yes, because the benefit is capable of being
converted into money (ie sold by the retailer in her ordinary course of business). This is the
difference between this case and FC of T v Cooke & Sherden 80 ATC 4140.
The lounge suite was received as a result of the taxpayer’s income-producing activities and as
such its value represents assessable income in terms of s 6-5. (See Case V6, 88 ATC 140.)
The taxpayer will be assessed on the $1,800.
(2)
The compensation received will be assessable in full under s 6-5. The compensation was
received for cancellation of a contract made in the ordinary course of business and did not
affect the conduct of the taxpayer’s business. It was one of many contracts held by the
taxpayer and, as such, compensation for its loss cannot constitute a capital item. See Allied
Mills Industries Pty Ltd v FC of T 89 ATC 4365 and Van den Berghs Ltd v Clark [1935] AC
431.
If the compensation receipt had been of a capital nature, and the contract had been entered
into on or after 20 September 1985, a capital gain may have arisen, as the right to sue for
damages is an asset and the awarding of compensation results in the disposal of that asset
pursuant to s 104-25 (CGT event C2). Consequently, that part of the compensation not
assessable under another section of the Act, less any legal costs incurred, would be subject to
CGT under s 104-25 (see Taxation Ruling TR 95/35). This is because CGT event C2 would
occur as the rights under the contract would have been abandoned, surrendered or forfeited.
In FC of T v CSR Ltd 2000 ATC 4710 it was held that a $100,000,000 lump sum paid by an
insurance company to settle an outstanding claim was not ordinary income. However, it was
assessable under the CGT provisions, as the insured taxpayer had given up a right.
50
(3)
Does s 15-15 apply? It will if Harber acquired the property for a profit-making purpose, in
which case Harber’s wife will be deemed to have acquired the property with the same profit-
making purpose, and on the sale of the property she will be assessed on the profit.
If Harber was not carrying on or carrying out a profit-making undertaking or plan, his gift of
the property to his wife will constitute a disposal of a pre-CGT asset to his wife, post-CGT,
for a nil consideration. Mrs Harber will be taken to have acquired the property at its market
value of $420,000 (s 112-20). When the land is disposed of on 1 February 2019, Mrs Harber
will be assessed on the discount capital gain (ie [$700,000 − $420,000] × 50%) (s 115-10).
(4)
The payment of club subscriptions is deductible to the employer (s 26-45(3)); however, the
employer is liable for FBT in respect of the expense payment benefit of $1,200 for the golf
club fees.
Keen, as the recipient, would not be taxed on this subscription because ITAA36 s 23L
provides an exemption from income tax for income derived by way of the provision of a
fringe benefit.
(5)
The income will be assessable in Australia under ITAA97 s 6-5. Swanson will be entitled to a
foreign tax offset for the lesser of the $300 paid as tax to the US State Government or the
Australian tax payable in respect of the foreign income (ITAA97 s 770-10).
Category B: Solutions 34 to 42
[¶30-034] Solution 34
Capital gain; business
As the farm was acquired before 20 September 1985, CGT will not apply. The sale of the
farm would be the realisation of a capital asset and no amount would be assessable under
ITAA97 s 6-5.
For the remaining transactions, the fundamental question is whether Bart will be taxed under
s 6-5 on income from carrying on a business, or taxed under the CGT provisions.
On one view, the fact that Bart commissioned a builder, consulted an accountant, engaged in
a level of activity greater than that needed for a main residence, obtained strata titles, leased
some of the units and purchased more land with the intention of building more units after he
sold the initial units suggest that he was commencing a new business. Consequently, the
proceeds would be assessable as ordinary income under s 6-5.
It seems that Bart commenced his activities with the intention of providing funds for his
retirement and by way of investment. His intention is relevant insofar as a court might hold
that there was no intention to commence a business. However, the court would examine
51
Bart’s statements in the light of the objective evidence. On balance, and pursuant to the
decisions of Whitfords Beach Pty Ltd v FC of T (1982) 150 CLR 355; 82 ATC 4031 and FC
of T v Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363, Bart may be assessed as
carrying on a business under s 6-5.( See TR 92/3)
As Bart has purchased more land with the intention of building more units, these activities
add weight to the argument that he is carrying on a business. If this is so, the proceeds from
the sale of the four units will be assessable under s 6-5, and the cost of constructing the units
would be deductible. However, some of the costs would have to be apportioned to take
account of the fact that part of the expenditure related to his private residence.
The other view would be that Bart was not carrying on a business but merely taking the steps
necessary to realise the assets obtained to their best advantage (Scottish Australian Mining
Co Ltd v FC of T (1950) 81 CLR 188). The short-term lease is an inconclusive factor. It may
be construed as an interim measure undertaken before disposal of property, or it may indicate
that Bart was contemplating establishing a wider business.
If Bart was not carrying on a business, the CGT provisions of Pt 3-1 would apply. Under the
CGT provisions, all the capital costs associated with his activities would be included in the
cost base of the asset. In applying the CGT provisions, the roll-over relief for strata title
conversions should be noted (s 124-10; 124-190).
[¶30-035] Solution 35
Compensation; unliquidated damages
The amount of $500,000 received as compensation may constitute income according to
ordinary concepts and come within ITAA97 s 6-5.
As a general rule, amounts received in connection with the cancellation or variation of trade
or other commercial contracts made in the course of carrying on business are in the nature of
income (C of T (NSW) v Meeks (1915) 19 CLR 568 and Heavy Minerals Pty Ltd v FC of T
(1966) 115 CLR 512). However, the compensation could be of a capital nature.
In Van den Berghs Ltd v Clark [1935] AC 431; 19 TC 390, Lord Macmillan offered two tests
to distinguish between income and capital. One test was whether the agreement formed part
of the fixed framework within which the circulating capital operated. The other test was
whether the agreement was merely incidental to the working of the profit-making apparatus
or an essential part of the mechanism itself.
In Van den Berghs Ltd, the taxpayer entered into an agreement with a Dutch company which
determined the way in which profits would be shared and territory determined. After some
disagreement, the agreement was cancelled and Van den Berghs received £450,000 for
agreeing to terminate the agreement.
The House of Lords held that the compensation was capital in nature because Van den
Berghs surrendered its rights under the contract. Furthermore, the contracts which were
cancelled were not commercial contracts but contracts which affected the profit-making
52
structure of its activities. The contracts determined what the company could or could not do.
An analysis of the company’s situation revealed that the agreement represented the fixed
framework within which Van den Berghs conducted its business.
Therefore, to determine whether the compensation received by BPH is of an income or

capital nature, it is necessary to see whether the cancelled agreement relating to the purchase
of computers was part of its profit-making structure.
If BPH was able to find an alternative supplier of computers, it may be argued that the
agreement did not relate to or affect BPH’s profit-making structure. If the agreement did not
affect the fixed framework in which BPH carried on its business, it would be of a revenue
nature. However, if the supply of computers to BPH was a critical part of their business
operation, it could be argued that the compensation was of a capital nature. The decision in
Californian Oil Products (In Liq) v FC of T (1934) 52 CLR 28 supports this view. In this
case, the taxpayer entered into a five-year contract with an overseas oil company which gave
it the sole right to distribute the company’s oil products in Australia. Subsequently, the
overseas oil company sought to terminate the agreement and paid Californian Oil an amount
as compensation for the termination of the contract. The Court held that the amount received
as compensation for rescission of the contract was of a capital nature since it was
compensation for abandoning its only business.
Consequently, it is necessary to determine how important the computer contract was to BPH.
Although it appears that BPH was able to make alternative arrangements with another
supplier, it seems that there were difficulties in the compatibility of the new equipment with
that which was previously sold by BPH. If this forced a significant change in the company’s
products range, it could be argued that this related to the firm’s profit-making structure and
was capital in nature.
The facts also indicate that some of the compensation claimed by BPH was to cover the
increased costs of buying computers from another supplier. Given that this relates to a
circulating asset, it could be argued that this part of the compensation was on revenue
account.
It should be noted that the amount of $500,000 paid represents an undissected lump sum
payment in settlement of all claims. Pursuant to the decisions in Allsop v FC of T (1965) 113
CLR 341 and McLaurin v FC of T (1961) 104 CLR 381, these amounts may be of a capital
nature and may therefore be assessable under s 20-20(2) as a recoupment of a loss or
outgoing. Furthermore, where an amount is received for disposing of a right to recoupment
for a loss or outgoing which is not specified, such as in the case of unliquidated damages,
s 20-25(4) may bring to account as income the recoupment to whatever extent is reasonable.
However, the amount may also be assessable under the CGT provisions if it is in respect of
unliquidated damages which are of a capital and income nature. This result is obtained
because the breach of contract creates the right to sue for damages. When the right is settled
an assessable capital gain may arise pursuant to s 104-25(1) since the taxpayer has given up a
chose in action represented by the right to sue for damages in respect of the breach of
contract. This view would be supported by the decision in FC of T v CSR Ltd 2000 ATC
4710, where it was held that the CGT provisions applied where the taxpayer accepted a lump
sum as settlement in respect of an outstanding claim for damages.
53
Finally, mention should be made of s 118-20, which deals with the relationship of the taxing
powers of the CGT provisions to other provisions in ITAA97. In this respect, s 118-20 would
reduce the capital gain if an amount was assessable income under s 20-25(4).
[¶30-036] Solution 36
Compensation; restrictive covenant
The comments in relation to the income/capital distinction in Solution 35 are also applicable
to this question. However, in this case the question to be determined is whether Gypsum’s
reason for existence or sole business was the development of the mining lease near
Kalgoorlie.
In Meeks’s case (C of T (NSW) v Meeks (1915) 19 CLR 568), Griffith CJ states at p 580:
‘In my opinion, damages received as compensation for non-performance of a business

contract stand on the same footing as the profits for the loss of which the damages are paid.’
Given that the amount of compensation was determined by reference to the commission that
would have been payable to Rothbank under the terms of the original contract, it is difficult
to argue that the compensation represents anything else but the amount that would ordinarily
have been part of assessable income. However, if the loss of reputation caused damage to
Rothbank’s capital or profit-making structure, it may be argued that the compensation is
capital in nature. (See FC of T v Spedley Securities Ltd 88 ATC 4126.)
The terms of the release agreement are critical in this case. In contrast to McLaurin’s case,
the taxpayers in this case know the basis of the calculation of the amount and what it
represents. Consequently, the damages payment is liquidated and hence could be apportioned.
If it is accepted that the compensation for the loss of contract was of an income nature, it
would be assessable to Rothbank under ITAA97 s 6-5.
If the compensation is received by way of indemnity, s 20-20 may bring the amount to
account as an assessable recoupment if the losses suffered by Rothbank are not within the
scope of s 6-5. Also, if the compensation was of a capital nature, s 104-25 may apply because
Rothbank has received consideration for disposing of an asset (its right to sue for damages).
This view is supported by the decision in FC of T v CSR Ltd 2000 ATC 4710, where an
amount received under a deed of settlement for the taxpayer seeking damages was held to be
assessable pursuant to the CGT provisions.
The agreement also contains a restrictive covenant. It would appear that the value of the
consideration in return for the restrictive covenant would be assessable as a capital gain.
Section 104-35 brings the consideration received for entering into the restrictive covenant
into the CGT net. The creation of a contractual right would give rise to CGT event D1.
[¶30-037] Solution 37
54
Derivation; allowable deduction
The amount of $375,000 constitutes assessable income of Pest Rid. This result follows from
the general proposition that income arising from commercial undertakings must be brought to
account on an accruals basis (see Rowe & Son Pty Ltd 71 ATC 4157 and Carden’s case
(1938) 63 CLR 108).
However, no income arises until services have been rendered (Arthur Murray (NSW) Pty Ltd
v FC of T (1965) 114 CLR 314). Consequently, as no work has been performed in relation to
the advance bookings, no income from the advance bookings would be derived for the year
ended 30 June 2019. Only $375,000 invoiced for services rendered would be assessable
income for that year.
It may be considered that the income would not have been derived until the guarantee period
had expired and any remedial work had been completed. But Pest Rid’s situation may be
contrasted with that in Arthur Murray, where no dancing lessons were provided in respect of
the fees received in advance. With Pest Rid, the substantial work had been completed and the
remedial work was only incidental to the derivation process. Besides this, the remedial and
warranty work was only a contingent possibility. Therefore, it would not delay the time at
which the income was derived.
The question arises, however, whether Pest Rid may be able to claim a deduction for the
provision raised to cover the warranty costs. A taxpayer does not actually have to pay out
money to have ‘incurred’ a loss or outgoing. Provided the outgoing can be estimated with
some precision, and provided that an unpaid liability exists, a deduction may be available. In
RACV Insurance Pty Ltd v FC of T 74 ATC 4169, the fact that past experience indicated that
motor vehicle accidents occurred and that the resultant liability could be reasonably estimated
led the Court to conclude that a deduction was available for the provision for unreported
claims. But this principle has not been extended beyond the insurance industry, including
self-insurers (Australia and New Zealand Banking Group Ltd v FC of T 94 ATC 4026).
Generally, the decisions of FC of T v James Flood Pty Ltd (1953) 88 CLR 492 and New
Zealand Flax Investments Ltd v FC of T (1938) 61 CLR 179 would support the view that a
provision raised in respect of future expenditure would not be ‘incurred’ for the purposes of
ITAA97 s 8-1(1). Therefore, the $18,750 would not be deductible for the year ended 30 June
2019.
[¶30-038] Solution 38
Residence; exempt income
Residents of Australia are liable for income tax on income derived from all sources, whereas
non-residents are only liable for Australian income tax on income derived from sources in
Australia. The country in which a taxpayer is a resident is a question of fact and degree (IR
Commrs v Lysaght [1928] AC 234; 13 TC 511). Even though Browning is going overseas for
two years, this in itself may not make him a non-resident. The definition of Australian
resident in ITAA97 s 995-1(1) refers the reader to ITAA36 s 6(1) which provides that where
a taxpayer has been in the country continuously or intermittently for more than half of the
55
year the taxpayer will be a resident unless he or she can satisfy the Commissioner that his or
her usual place of abode is outside Australia. In the year of income Browning was in
Australia until 31 December 2018, being 184 days, plus the days that he visited due to illness
in the family. Thus, under the legislation, he will be deemed a resident unless he can prove
the contrary to the Commissioner.
Whether or not his permanent place of abode is outside Australia is another factor in
determining Browning’s residency status. In Applegate’s case, it was held that ‘permanent’
does not mean ‘forever’ (FC of T v Applegate 79 ATC 4307. Also see Harding v FCT [2019]
FCAFC 29) Consequently, he does not have to leave Australia with the intention of never
returning to be declared a non-resident. However, the fact that his appointment is only for
two years, after which it is expected that he will return to Australia, that his furniture is stored
and that he has not sold his house, on face value, indicate that he will return. (See Peel v IR
Commrs (1928) 13 TC 443.)
Taxation Ruling IT 2650 outlines the factors to be considered in determining whether a

person leaving Australia ceases to be a resident.
Some of these factors are:
•
the intended and actual length of stay in the overseas country
•
any intention to return home at some point of time
•
the abandonment of any residence or place of abode in Australia
•
the duration and continuity of the individual’s presence in the overseas country, and
•
the durability of association that the individual has with a particular place in Australia.
The ruling indicates that the weight to be given to each factor depends on the circumstances
and no one factor is conclusive.
On balance, for the year of income under consideration, it is likely that Browning is a
resident. Consequently, he would be assessed on the $50,000 salary received from the
Melbourne office (ITAA97 s 6-5). He would also be assessed on the $80,000 earned by way
of his salary in New York, which had been subject to US federal tax. However, he would
receive a tax offset for the tax paid in the US up to the amount that would otherwise be
payable in Australia (ITAA97 s 770-10).
The rent on the house in Malvern would be assessable under ITAA97 s 6-5, on either view of
Browning’s residency, as income from property with an Australian source.
[¶30-039] Solution 39
Exempt income; FBT; s 21A
56
As Cooper is a resident of Australia, pursuant to ITAA97 s 995-1(1), s 6-5 states that she is
assessable on all sources of income derived inside and outside of Australia. It does not matter
that her salary is paid to a bank account in New Zealand, as s 6-5(4) will deem it to have been
derived. Tips and gratuities paid by parties other than the employer to the employee which
arise from services provided in relation to an employment contract are assessable under
general principles. Consequently, the $5,000 paid to Cooper by EXI will be assessable under
s 6-5.
It may be argued that the benefits come within s 15-2. There may be some difficulty in
concluding that an indirect business or service relationship exists. It is likely that the arm’s
length value of the airline tickets and vouchers for the holiday may be assessable to the
recipient of the gift despite the fact that it cannot be converted to cash.
As Cooper may be viewed as an employee of Castell Ltd, the Commissioner may seek to
apply the FBT provisions. The FBT provisions will apply where an employer or an associate
of the employer has provided a fringe benefit. Although there is a contractual relationship
between Cooper’s employer and EXI, this would not of itself constitute sufficient grounds to
hold that the required association was present. For FBT to apply, it would seem that the
benefit would have to be provided by the third party to the employee at the request of the
employer, unless that third party was an associate of Castell.
It may also be argued that the benefit is assessable under ITAA36 s 21A as a non-cash
business benefit. Section 21A(5)(b) states that non-cash business benefits arise where benefits
are provided ‘indirectly to a business relationship’. The section is silent as to what constitutes
a ‘business relationship’ and between whom the relationship needs to exist. The fact that
Cooper is performing services for EXI, in the capacity of an employee of Castell, suggests
that a business relationship does not exist.
[¶30-040] Solution 40
Business income; derivation
(1)
The building was acquired before 20 September 1985 and so CGT is not applicable. That part
of the $2,000,000 received which is in excess of the purchase price ($2,000,000 minus
$600,000) would be a tax free capital gain unless the taxpayer was in the business of buying
and selling buildings.
(2)
As far as the $2,000,000 payable in quarterly instalments with interest is concerned, it is
generally accepted that the interest on the unpaid balance is assessable when it is received
while the principal is not (Secretary of State in Council of India v Scoble [1903] AC 299).
(3)
The excess of the $1,500,000 over the purchase price of the building will be of a capital
nature. However, by structuring the sale in a manner whereby Mytec will receive 10% of the
gross rentals received by Compac, the remaining proceeds of the sale may be tainted in the
sense of being given the characteristics of a revenue item.
(4)
57
The $600,000 per annum will be of a capital nature. One of the leading cases in this area is
Jones v IR Commrs [1920] 1 KB 711. In this case, Rowlatt J stated (at pp 714–715):
‘A man may sell his property for a sum which is to be paid in instalments, and when that is
the case the payments to him are not income.’
The essential point is that the fact that repayments are periodic does not in itself give the
receipts a revenue nature.
(5)
The excess (ie $1,800,000 − $600,000 = $1,200,000) over the cost of the asset will be of a
capital nature. The right to occupy one floor of the building for two years with nine months
rent-free will most probably be non-assessable. From Mytec’s point of view, since no rent is
paid, no deduction will be available.
ITAA36 s 21A, which deals with non-cash business benefits, will apply. However, because
the ‘otherwise deductible’ rule will apply (s 21A(3)), the value of the benefit may be zero. In
addition, it could also be argued that the section requires ‘an arm’s length value’. On the face
of it, where the parties are at arm’s length and nothing has been paid there is no value.
In Taxation Ruling IT 2631 the Commissioner indicated that, by virtue of the ‘otherwise
deductible’ rule, rent-free periods will not be assessable under s 21A.
(6)
The free fit-out would attract the operation of s 21A if the property involved in the fit-out
passed to Mytec. (See Selleck v FC of T 97 ATC 4856 and Lees and Leech Pty Ltd v FC of T
97 ATC 4407.)
[¶30-041] Solution 41
Superannuation payments and employee
termination payments
(1) Superannuation payments
The payment received by Nelson from the company-sponsored superannuation fund upon the
termination of employment would constitute a ‘superannuation benefit’. A superannuation
benefit is defined in ITAA97 s 307-5(1) to include a payment made from a superannuation
fund to a fund member or to another person after the fund member’s death.
The tax treatment of a superannuation benefit from 1 July 2007 depends on:
•
•
58
•
contributions segment and the crystallised segment (ITAA97 s 307-210 and 307-220).
concessional contributions.
The crystallised segment is determined by assuming that the full value of the superannuation
interest is an eligible termination payment paid just before 1 July 2007. It would include the
following components under ITAA97 s 307-225:
•
•
•
•
•
in the fund less the tax free component (s 307-215).
The tax free component is determined by reference to the pre-July 1983 days of service
relative to the total days of service. If Nelson had a service period of 13,362 days, 730 of
these relate to pre-July 1983 service.
As a result, the tax free component of the superannuation benefit is calculated as follows: 730
days/13,362 days × $550,000 = $30,047
There is also a tax free component in respect of the undeducted contributions of $30,000. As
Nelson is less than 60 years of age but has reached preservation age, the remaining amount of
$489,953 is taxed as follows:
The first $205,000 is tax free and the balance of $284,953 is taxed at no more than 15%.
(2) Early retirement scheme

ITAA97 s 83-170 provides that payments made as part of an early retirement scheme in the
2018/19 year of income are tax free up to the limit of $10,399 plus $5,200 per year of
completed service. Payments in excess of this limit are assessable as an ETP.
As Nelson has completed 37 full years of service, the early retirement payment of $25,000
will be exempt from tax (ITAA97 s 83-170).
59
(3) Long service leave
The provisions of ITAA97 Subdiv 83-B govern the taxation of unused long service leave
payments. Essentially, the section provides that:
•
any unused long service leave accrued pre-16 August 1978 is brought to account, but only to
the extent of 5%, as assessable income and is taxed at marginal rates
•
the amount of unused long service leave which accrued between 16 August 1978 and 17
August 1993 is included as assessable income but is taxed at a rate not exceeding 30% plus
the Medicare levy, and
•
the amount of unused long service leave which accrued from 17 August 1993 is included as
assessable income and taxed at marginal rates.
As Nelson does not have any long service leave which had accrued prior to 17 August 1993
the whole amount of the long service leave payment is taxed as assessable income at
Nelson’s marginal rate. If the payment is received as part of a bona fide redundancy the
amount is taxed at no more than 30% (ITAA97 s 83-65 to 83-115).
(4) Other benefits

The gold watch and the cheque for $1,000 are more likely to be ‘mere’ gifts as they are not
paid by her former employer or an associate. Having regard to the definition of ‘employment
termination payment’ in ITAA97 s 82-130, the payment is not likely to come within the
provisions due to the non-monetary nature of the benefit. However, the payment might come
under s 15-2 as being a gift received for employment or services rendered. Where this is the
case it is the value to the taxpayer which is included in assessable income.
If the employer was associated with the provision of the gift it may be subject to fringe
benefits tax as a property benefit. Also, FBT may apply to Leisure Ltd as the term ‘employer’
is defined as a current or future employer. If Leisure Ltd provided the benefits to Nelson
because of the intended employer/employee relationship, the watch may be a property fringe
benefit. The tax would be levied on Leisure Ltd, as that company provided the fringe benefit.
The $1,000 would be unlikely to be income unless paid in anticipation of services to be

rendered (s 15-2). It could be argued that the $1,000 is an ETP. The definition in ITAA97
s 82-130, only refers to a payment made to the taxpayer in consequence of termination of
employment. It does not matter whether the payment is made from an existing employer or
future employer. As Nelson is less than 60 years of age, but has attained preservation age, the
amount may be included as assessable income (s 82-10). However, a tax offset is available
where the amount is less than the employment termination cap ($205,000 in 2018/19). This
tax offset ensures that the amount is taxed at a maximum rate of 15%.
[¶30-042] Solution 42
60
Employee share acquisition
The relevant provisions concerning employee share schemes (ESSs) are contained in ITAA97
Div 83A. Division 83A applies where an employee acquires an ESS interest under an ESS at
a discount. An ‘employee’ also includes a director, an office holder and an associate of an
employee.
The rights granted to Nash would be regarded as an ESS (shares or rights acquired under an
ESS). An interest is defined as a beneficial interest in a share in a company or a right to
acquire a beneficial interest in a company (s 83A-335).
Normally any discount which is received by an employee as part of an ESS is taxed at the
time of acquisition. The discount is measured as the difference between the market value of
the ESS interest less any amount paid by the employee (s 83A-25(1)).
Therefore, in the year Cynthia Nash acquired the shares she will be assessed on the difference
between the market value of shares acquired and the consideration paid for those shares.
(1)
As Cynthia Nash acquired the shares on 10 December 2018, the amount included under Div
83A would be calculated as follows:
Calculation: $ $
Value of shares: 10,000 × $2 20,000
Less: Amount paid: 10,000 × $1.85 18,500
Amount assessable 1,500
Where an employee is assessable under Div 83A on the value of any shares issued under an
ESS they may be eligible for a $1,000 exemption, pursuant to s 83A-35. Such a discount is
available where:
•
the sum of the taxpayer’s taxable income, reportable fringe benefits and reportable
superannuation benefits is less than $180,000
•
the employee is employed by the company issuing the shares which are of an ordinary nature
•
the scheme is only offered in a non-discriminatory way to at least 75% of the company’s
employees who are residents
•
the shares are not at risk of forfeiture
•
the shares are held for three years or until cessation of employment.
As Nash disposed of the shares within three years of acquisition she would not qualify for
this exemption.
Therefore the assessable amount would be $1,500.
61
If Cynthia sells the shares on 15 June 2019
for $4 per share there would be a capital gain of $19,900 calculated as follows:
$ $
Value of shares: 10,000 × $4 40,000
Less: Cost base (cost of shares under Div 83A) plus 20,000
Cost of disposal 100
CAPITAL GAIN 19,900
(2)
Where the discount on an ESS is included as assessable income in the year of acquisition then
the first element of the cost base of the share is the market value at the time of acquisition (s
83A-30).
If Cynthia subsequently sells the shares for $4 each after holding them for three years, she
will be liable for CGT on the following amount:
$ $
Capital proceeds for shares: 10,000 × $4 40,000
Less: Cost base (cost of shares under Div 83A) plus 20,000
Cost of disposal 120
CGT discount of 50%* (50% × $19,880) 9,940
CAPITAL GAIN 9,940
* See s 115-5 to 115-50
(3)
Under Subdiv 83A-C where the share, or interest is acquired is at a real risk of forfeiture or is
obtained under a salary sacrifice arrangement the tax is deferred until a later taxing point.
This deferral point may occur at the earliest time when there is:
•
no risk that the employee will forfeit the share
•
when the employee ceases employment, or
•
seven years after the employee acquired the share.
However, where the taxpayer disposes of the shares within 30 days of the acquisition the date
of disposal is the taxing point.
If there are no risks associated with the share, or limits on disposal, the discount on the share
or interest in the share would be assessable income when the right was acquired. However, as
there are restrictions on the disposal of the shares by Cynthia Nash the taxing point would
occur when the restrictions cease.
The deferred taxing point would occur on 10 December 2022 and the determination of
assessable income would be the market value of the share on 10 December 2022 (which is $7
per share) reduced by any costs incurred by Nash in their acquisition.
62
Capital Gains
[¶30-043] Solution 43
Indexed cost base; netting gains and losses
The disposal of shares (a CGT asset) which were acquired after 19 September 1985 will
trigger CGT event A1 (ITAA97 s 104-10). Because the shares were acquired before, an the
CGT event happened after, 11.45 am EST on 21 September 1999, Henry Applegate has the
choice of including in assessable income the capital gain that results from either:
•
calculating the capital gain with a cost base which includes indexation frozen at 30
September 1999, or
•
calculating the capital gain without indexation and then reducing the notional capital gain by
the relevant CGT discount (50% for individuals s 115-5; 115-10; 115-15; 115-20; and 115-
25).
As a result of this choice, Henry needs to calculate the capital gain using both methods to
determine which gives the least tax payable.
Any capital losses are applied against the capital gains before the net capital gain is reduced
by the CGT discount or other concession (s 102-5(1)).
According to the indexation method, the calculations are as follows:
(1)
Sale of RSC shares
1 April 1987 acquired 2,000 shares in RSC at $4.25
Indexed cost base = 1.493* × cost of shares
Indexed cost: $4.25 × 1,000 × 1.493 = $6,345
2 December 2018 sale proceeds: 1,000 shares at $8 per share = $8,000
CAPITAL GAIN = $8,000 – $6,345 = $1,655
63
Note: The Australian Bureau of Statistics (ABS) changed the consumer price index (CPI)
reference base in September 2012 from 1989/90 to 2011/12. Thus, all CPI rates have been
reset and the previous rates no longer apply.
(2)
Sale of PHB shares
1 June 1993 acquired 1,000 shares in PHB at $14.
No indexation applies as shares were sold at a loss.
Cost of shares sold:

$ $
500 × $14 7,000
250 × $14 3,500 10,500
Sales proceeds:
500 × $13 6,500
250 × $12 3,000 9,500
CAPITAL LOSS $(1,000)
(3)
Because a capital loss arises from the sale of PHB shares, this may be offset against the
capital gain on the RSC shares. This gives a net capital gain as follows:
$
Gain on RSC shares 1,655
Loss on PHB shares (1,000)
NET CAPITAL GAIN $655
According to the discount method, the capital gain on disposal of the shares in RSC is as
follows:
$
Cost base (1,000 shares × $4.25) 4,250
Notional capital gain 3,750
Less: Capital loss from PHB (1,000)
Subtotal $2,750
Less: CGT discount 50% (1,375)
NET CAPITAL GAIN $1,375
As the capital gain from the use of the indexation method is lower than the capital gain from
the use of the discount method, Henry should choose to use the indexation method and be
assessed on the net capital gain of $655.
[¶30-044] Solution 44
64
Calculation of tax payable
Because Maria has satisfied the conditions in ITAA97 Subdiv 152-A, her net capital gain is
computed by applying the method statement in s 102-5(1).
The first two steps require Maria to apply any current year capital losses (Step 1) and any
unapplied net capital losses (Step 2) against the capital gain she has made during the current
year. Step 3 is the application of the CGT discount percentage, while Step 4 brings into the
calculation the small business concessions under Div 152.
Applying these steps, Maria’s net capital gain for the 2018/19 tax year is calculated as
follows:
$
Capital gain 150,000
Less: prior years’ losses (30,000)
120,000
Less: 50% CGT discount (60,000)
60,000
Less: 50% small business concession (30,000)
Assessable capital gain $30,000
This capital gain may be further reduced by the small business retirement exemption under
Subdiv 152-D if Maria retires, or small business roll-over under Subdiv 152-E if Maria uses
the proceeds to acquire replacement active assets (s 152-210).
[¶30-045] Solution 45
Apportionment
According to ITAA97 s 112-30, the cost base of the land sold is determined by apportioning
the cost base of the two hectares purchased between the one hectare disposed of and the one
hectare retained, as follows:
The cost base of the land sold is thus $146,000.
As the land was acquired before 21 September 1999 and the CGT event happened after 11.45
am EST on 21 September 1999, and the land was held by Rachael for at least 12 months, she
has the choice of including in assessable income the capital gain that results from either:
(1)
September 1999, or
65
(2)
25).
Because of this choice, Rachael needs to compute the capital gain using both methods to
determine which method gives the lower capital gain.
Indexation method
$
Indexed cost of land: $146,000 × 1.342* 195,932
Plus: Costs of disposal 2,000
Indexed cost base 197,932
Proceeds of sale 220,000
Less: Indexed cost base (197,932)
CAPITAL GAIN (indexation method) $22,068
Discount method
$
Less: cost base ($146,000 + $2,000) (148,000)
CAPITAL GAIN (discount method) $36,000
Because the capital gain using the indexation method (ie $22,068) is lower, Rachael should
choose to use the indexation method to determine her capital gain for the 2018/19 tax year.
[¶30-046] Solution 46
CGT events
(1)
CGT event B1. With this question, CGT event B1 would happen on 1 August 2018 because
Graham had use and enjoyment of the holiday house before title to the property passed, rather
than CGT event A1, which does not take place until 30 April 2019 when Graham signed the
contract to actually buy the house from Stephanie.
(2)
CGT event D2. With this question, CGT event D2 would happen on 1 September 2018, and
Samantha has a taxable capital gain of $38,500 (ie $40,000 – $1,500) for the option.
66
However, when Newcastle Property Developments exercises the option on 1 January 2019
the capital gain from CGT event D2 is disregarded. On disposal of the land, CGT event A1
will occur. The capital proceeds for CGT Event A1 for Samantha are $838,500 (ie $800,000
+ $38,500), while the first element in Newcastle Property Developments’ cost base for the
land will be $840,000.
(3)
CGT events F1, F3 and F4. With this question, there are several CGT events relating to
leases occurring such as CGT events F1, F3 and F4. First, on 31 March 2017, CGT event F1
(ie the granting of a lease) will happen, and Victoria will have a capital gain of $19,500 (ie
$20,000 – $500) in the 2017/18 tax year. Second, on 1 August 2018, CGT event F3 (ie the
lessor pays the lessee to get the lease charged) will happen and Victoria will have incurred a
capital loss of $4,000 in the 2018/19 tax year. Third, on 1 August 2018, CGT event F4 (ie the
lessee receives payment for changing the lease) will happen and the cost base of Stephen’s
lease will be reduced to $16,000 (ie $20,000 – $4,000).
(4)
CGT event H1. With this question, CGT event H1 would occur on 1 June 2019, and Jodie
has a taxable capital gain of $5,000 for the forfeited holding deposit (which would be reduced
by any costs associated with the contract).
[¶30-047] Solution 47
Sale of a small business
Given that Bob Giles sold his newsagency after 11.45 am EST on 21 September 1999, the
small business concessions in ITAA97 Div 152 should be considered.
The four available small business concessions contained in Div 152 are:
(1)
the 15-year exemption
(2)
the 50% reduction
(3)
the small business retirement concession, and
(4)
the small business roll-over.
Since Bob has owned the business for less than 15 years, the 15-year exemption concession
would not be applicable. However, for the 2018/19 tax year, if either: (1) all of the conditions
in Subdiv 152-A are met, or (2) Bob is deemed to have a small business entity under ITAA97
s 328-110 (ie Bob carries on a business and satisfies the $2,000,000 aggregated turnover test),
Bob would be entitled to the small business 50% reduction. Depending on his situation and
age, Bob could also be entitled to the small business retirement concession, where the
proceeds of the sale of a small business are used for retirement. Relief can be claimed by a
person aged 55 or older, up to a lifetime maximum limit of $500,000. If the retiree is aged
under 55, then the capital proceeds must be rolled over to a superannuation fund or an
approved deposit fund to be preserved until the superannuation preservation age (s 152-305).
67
If Bob was to remain in business, then he might choose the small business roll-over
concession. Subdivision 152-E provides capital gains roll-over relief to owners of a small
business where there is a disposal of an active asset or active assets and the proceeds are
reinvested in a replacement active asset(s) acquired within the period commencing one year
before and two years after the happening of the last CGT event in the year the taxpayer
obtains the small business roll-over (s 152-410). It should be noted that the recent Small
Business Concession in Division 328G for small businesses concerning business restructure
would not apply. This occurs where there is a change in the legal structure of the business
with no change in the ultimate legal ownership of the asset.
[¶30-048] Solution 48
CGT events
(1)
CGT event F1. A capital gain will arise if the premium for the lease is greater than the cost
of granting the lease (ITAA97 s 104-110(3)).
(2)
CGT event C2. The expiry of a lease extinguishes your ownership of an intangible asset (the
lease). The intangible asset is property because of the rights attached to the lease agreement.
(3)
CGT event F3 applies where a lessor pays the lessee to have the term of the lease varied or
waived. The amount paid by the lessor is a capital loss. The amount received by the lessee
could result in a capital gain (CGT event F4).
(4)
CGT event D1. M has entered into a contractual agreement with another entity (his
employer) under which his employer acquires the rights under that agreement. M’s capital
gain is the difference between the $50,000 capital proceeds and any incidental costs in
relation to the event.
(5)
CGT event H2. In this situation, there is no disposal of any property owned by Company B
or adjustment to the cost base of an asset. Company B has received money as a result of an
act, transaction or event in relation to a CGT asset that it owns.
(6)
On the grant of the option, CGT event D2 happens. However, as the option was exercised,
the capital gain in respect of the option is disregarded for CGT purposes. Where this event
straddles a year of income, any capital gain recorded in the year of the option would need to
be adjusted by an amended assessment if the option is exercised. In this instance, if the option
was exercised before X lodged her income tax return for the 2018/19 tax year, she could
disregard any capital gain from the granting of the option in her 2018/19 tax return.
[¶30-049] Solution 49
Disposal of residence and business
Sale of main residence
68
Provided that Brian Lester’s main residence had not been used for any income-producing
purpose, any capital gain on disposal of the residence (CGT event A1) is exempt from capital
gains tax (ITAA97 s 118-110).
Sale of gift shop
Since the gift shop was acquired post-19 September 1985 and sold for a consideration greater
than its cost base (or indexed cost base), CGT applies (CGT event A1) for Brian. Because the
gift shop was acquired before 11.45 am EST on 21 September 1999 and the CGT event
happened after that time, and Brian had held the shop for at least 12 months, Brian has the
choice of including in assessable income the capital gain that results from either:
(1)
September 1999, or
(2)
25).
Because of this choice, Brian needs to calculate the capital gain using both methods to
determine which method gives the lower CGT liability.
Indexation method:
$
Less: Indexed cost base: 450,000 × 1.143* (514,350)
Discount method:
$
Less: cost base (450,000)
Less: CGT discount (50%) (195,000)
Since the capital gain using the discount method is lower than for the indexation method, the
capital gain from the sale of the gift shop should be $195,000 for Brian.
69
Note that so long as Brian satisfies the basic conditions for small business CGT relief under
either Subdiv 152-A or s 328-110, then, under Subdiv 152-E, Brian could be entitled to the
small business 50% active asset concession. As Brian would adopt the discount method, the
$195,000 capital gain would be further reduced by this concession. Hence, the CGT liability
for the sale of the shop would be $97,500 (ie $195,000 – ($195,000 × 50%)). Finally, because
Brian controls the business, he may be eligible for the CGT small business retirement
exemption of $500,000. This would effectively render the $97,500 gain on the sale of the
shop tax free. If Brian is under 55 years of age just before receiving the capital proceeds from
the sale of the shop, the capital gain must be rolled over as an ETP (s 152-305).
Restrictive covenant
Over and above the sum received for the disposal of the goodwill of the business, Brian has
also received money for signing a restrictive covenant. The $70,000 for the restrictive
covenant is a capital gain for the purposes of s 104-35. Section 104-35 would operate because
CGT event D1 has been triggered by Brian’s creating a contractual right or other legal right
in another entity. The time of the event is when Brian entered into the contract. A capital gain
arises if the capital proceeds (ie $70,000) exceed the costs of creating that right.
The practical effect of Brian’s entering into a restrictive covenant is that he has created a
legal or equitable right (ie the right to work) which is disposed of and vested in another
person, the purchaser. This would give rise to a capital gain to Brian. The capital gain is the
capital proceeds ($70,000) less any incidental costs incurred (nil). The CGT discount does
not apply to CGT event D1 (s 115-25(3)).
Under Subdiv 152-E, if Brian commences another business he could be eligible for small
business roll-over relief for the capital gain. However, several conditions must be met by
Brian (s 152-410). Alternatively, since Brian controls the business, he may be eligible for the
$500,000 CGT retirement exemption where he treats the proceeds as a retirement benefit
(which is then regarded as the CGT-exempt component of an ETP, pursuant to Subdiv 152-
D). This is also subject to the 55 years of age restriction (s 152-305).
[¶30-050] Solution 50
Cost base; capital gains tax (CGT)
Because Simone Hunter bought the factory building on 1 July 2014 and it is an income-
producing asset, it would qualify for capital works deductions at the rate of 2.5% per annum
(ITAA97 s 43-25) = $30,000 per annum (ie $1,200,000 × 2.5% = $30,000). For the purposes
of computing the capital gain on disposal, the cost base is reduced by $150,000 to account for
the capital works deductions available for Simone in the five years leading up to the sale of
the factory building on 30 June 2019 (ie $30,000 × 5 years = $150,000) (s 110-45).
Simone needs to calculate the capital gain using the CGT discount (50% for individuals)
method (s 115-5; 115-10; 115-15; 115-20; 115-25; and 115-100(a)(i)) as follows:
$
Capital proceeds 1,900,000
70
Less: reduced cost base (ie $1,200,000 – $150,000) (1,050,000)
850,000
CAPITAL GAIN $425,000
Therefore, Simone Hunter’s capital gain on the factory building for the 2018/19 tax year
would be $425,000.
[¶30-051] Solution 51
Cost base; acquisition
Part (1)
(a)
Statement is incorrect—the capital proceeds are taken to be the market value at the time of
the gift (ITAA97 s 116-30).
(b)
Statement is incorrect—the whole of the capital gain will be assessed in the year of disposal
(CGT event A1 has happened s 116-20).
(c)
Statement is correct (s 102-5; 102-10(2)).
(d)
Statement is incorrect—a foreign resident’s liability for CGT in relation to CGT events that
happen on or after 12 December 2006 is based on whether the relevant asset is ‘taxable
Australian property’. The following assets are taxable Australian property (ITAA97 s 855-
15):
(i)
taxable Australian real property
(ii)
an indirect interest in Australian real property
(iii)
a business asset of a permanent establishment in Australia
(iv)
an option or right to acquire any of the CGT assets in items (i) to (iii), or
(v)
a CGT asset that is deemed to be Australian taxable property where a taxpayer, on ceasing to
be an Australian resident, makes an election under ITAA97 s 104-165.
(e)
Statement is incorrect—s 118-5(a) specifically excludes cars as they are an exempt CGT
asset.
Part (2)
As the CGT asset was acquired before 21 August 1991 the cost base for John Henderson is
$90,000, and includes the purchase price, the solicitor’s fees on acquisition and sale, and the
cost of enhancing the value of the asset as reflected in the value of the asset at the time of the
CGT event. If the asset had been acquired after 20 August 1991, the repairs would also be
71
included in the cost base since they are non-capital costs of ownership of the asset (s 110-
25(4)).
Part (3)
For the purposes of determining any CGT liability, Jones will be deemed to have acquired the
building on 1 December 2017. Section 109-5 provides that where an asset is acquired under a
contract the time of acquisition (and disposal) is the time of the making of the contract. Note
that different rules apply where the asset is the taxpayer’s main residence (s 118-130(2)).
[¶30-052] Solution 52
Share options
ITAA97 s 130-40 applies where Allright Ltd issues to its shareholders rights to acquire shares
for no consideration.
The rights are taken to be acquired by Alex McKenzie at the time of acquisition of her
original shares, namely 1 March 1985 (s 130-45). As the rights are therefore pre-CGT there
will be no capital gains tax when the rights are exercised and, in fact, the exercising of the
rights is not taken to be a disposal of the rights for CGT purposes and any capital gain or
capital loss from the exercising of the rights is disregarded (s 130-40(7)).
When Alex exercises her right to acquire shares she is taken to have acquired the new shares
at the time she exercises her right, that is to say 15 November 2018 (s 130-45(2)).
The amount paid as consideration for the acquisition of the new shares will be an amount
equal to the sum of the market value of the rights at the time of exercise ($40) and the amount
paid in respect of their exercise ($100). The total of $140 is the cost base of the new shares
for CGT purposes (s 130-40(6)).
On disposal of all her shares on 15 December 2018 (CGT event A1), Alex will not be
assessed on the capital gain on the 500 shares she acquired before 20 September 1985. Alex
will be assessed on the capital gain on disposal of her post-CGT shares, as follows:
$
Capital proceeds 100 shares @ $1.75 per share 175
Less: Cost base* 100 shares @ $1.40 per share (140)
CAPITAL GAIN $35
*There is no indexation or CGT discount because the shares are sold within 12 months of
acquisition.
The net capital gain for the 2018/19 tax year is therefore $35 unless there is a capital loss
from other transactions that can be offset against the gain on the shares.
72
[¶30-053] Solution 53
Main residence
ITAA97 s 118-110 provides an exemption from CGT for a dwelling acquired after 19
September 1985 which is used as the taxpayer’s main residence. (However a taxpayer is not
eligible for such a concession if at the time the CGT event occurs they are a non resident
S118-110(3))
Where part of the residence is used for income-producing purposes and a CGT event
happens, then s 118-190 will bring part of the proceeds to account as a capital gain or loss.
The amount is determined by reference to the time the dwelling was used for business
purposes and the proportion of the dwelling which was used as a ‘non-residence’.
Therefore, if Peter Edwards later disposes of the home there will be an apportionment of the
capital gain (or capital loss) attributable to the time it was used for professional purposes,
based on the area of the home used (see Taxation Ruling IT 2673). The cost of converting the
home to enable it to be used for Edwards’ physiotherapy practice will form part of the cost
base of the asset for CGT purposes.
[¶30-054] Solution 54
Partial main residence exemption
Only a partial main residence exemption is available for Graham Taylor in respect of his
Adelaide flat because it was not used as his main residence for the whole ownership period
(ITAA97 s 118-185).
The capital gain is reduced (ie adjusted pro rata) by reference to the period that Graham used
the flat as his main residence.
Graham first needs to compute the capital gain using the CGT discount (50% for individuals)
method (s 115-5; 115-10; 115-15; 115-20; 115-25; 115-100(a)(i)) as follows:
$
160,000
Finally, Graham’s capital gain is reduced (adjusted pro rata) based on the period that Graham
used the flat as his main residence. Thus, the reduced capital gain is computed as follows:
73
[¶30-055] Solution 55
Separate CGT assets
Hi-Tech Ltd has disposed of two CGT assets as follows:
(1)
the land, which was purchased before the CGT provisions came into operation on 19
September 1985, and
(2)
the building, which is a separate asset under ITAA97 s 108-55 because it was constructed in
1989.
The disposal of two CGT assets would trigger CGT event A1 (s 104-10). However, because
the land was acquired before 20 September 1985 any capital gain or capital loss on its
disposal is disregarded (s 104-10(5)(a)).
The building is a post-CGT asset having been acquired on 10 January 1989 (s 109-5) and on
its subsequent disposal CGT event A1 happens. Because there is a disposal of two separate
CGT assets, the capital proceeds must be apportioned (s 116-40).
An apportionment of the proceeds between the land and the building at the time of the sale,
based on the information supplied, would be as follows:
Asset Amount
$
Land 4,200,000
Building 3,500,000
$7,700,000
Since Hi-Tech Ltd acquired the building at or before 11.45 am EST on 21 September 1999,
indexation of its cost base (frozen at 30 September 1999) is used to calculate the capital gain.
It should be noted that the CGT discount is not available for companies.
The indexed cost base of the building (frozen at 30 September 1999) is $3,100,000 × 1.329*
= $4,119,900.
As the capital proceeds of the building ($3,500,000, see s 116-40) are less than the indexed
cost base ($4,119,900), there would be no capital gain for Hi-Tech Ltd. Nor would there be a
capital loss for Hi-Tech Ltd because the capital proceeds exceed the cost base of the asset.
74
[¶30-056] Solution 56
Restrictive covenant
The tax consequences are as follows:
Susan Kelly has created an asset, being a contractual or other right in another entity (ie Laser
Products). Hence, ITAA97 s 104-35 would apply because CGT event D1 has happened. The
time of the event is when the contract was entered into. Section 104-35(2) provides that a
capital gain arises if the capital proceeds from creating the right are more than the incidental
costs incurred in relation to that event.
Because the amount received was $220,000, and the incidental costs were $1,100, Susan
would have made a capital gain of $218,900 (ie $220,000 – $1,100) on 1 August 2018
Laser Products would have acquired a CGT asset (ie its rights under the agreement with
Susan) on 1 August 2018. If the only costs incurred by Laser Products were $5,500 in non-
deductible legal fees in preparing the agreement, it would incur a capital loss of $225,500 (ie
$220,000 + $5,500) when the agreement expires on 1 August 2023. On the expiry of the
asset, CGT event C2 happens (s 104-25). The capital proceeds will be nil, so the capital loss
is equal to the amount paid for the restrictive covenant (see Taxation Determination TD
95/54).
[¶30-057] Solution 57
Trademarks
Consistent with ITAA97 s 104-35, there is a creation of a contractual or other right, giving
rise to CGT event D1. In this respect Company A will have granted a right to use the
trademark to companies B, C and D. Consequently, any proceeds would be brought to
account as a capital gain (adjusted for any incidental costs that relate to the event). Therefore,
Company A could be liable for capital gains tax on the disposal of a CGT asset (ie the right to
use the trademark).
[¶30-058] Solution 58
Options; necessary connection with
Australia
Emilio Gonzalez’s transaction will attract CGT. The purchase of land by a non-resident
constitutes the acquisition of an asset which has the ‘necessary connection’ with Australia
(ITAA97 s 855-20). The date of purchase is the date of the contract.
75
Moreover, the granting of an option to acquire taxable Australian real property is, in itself,
taxable Australian property (ITAA97 s 855-15). It gives rise to CGT event D2 and a capital
gain of $10,000 in the tax year ended 30 June 2019. The capital proceeds are $10,000 and the
cost base is limited to the costs incurred in the granting of the option (s 104-40). A capital
gain from CGT event D2 is not a discount capital gain (s 115-25(3)).
If the option is exercised, the granting of the option and disposal of the property are treated as
a single transaction and, because the option binds Emilio Gonzalez to dispose of the property,
the capital proceeds for granting the option ($10,000) form part of the capital proceeds for
disposal of the land (s 104-40(5); 116-65).
If the option is exercised in the 2019/20 tax year, the capital gain on the grant in the 2018/19
tax year is reversed by the taxpayer requesting an amended assessment for the 2018/19 tax
year.
The income from sale of the crop is assessable under s 6-5(3).
[¶30-059] Solution 59
Capital proceeds; business; compensation
There are two distinct views on the transactions which have taken place. One view is that the
preliminary letters of agreement represent a disposal of assets for CGT purposes, and that the
disposal of the interest and half of the land in return for a restrictive covenant constitutes
another CGT event. The other view is that the preliminary letters were merely part of an
executory contract which was never finalised. Accordingly, there is no initial disposal of the
land to make CGT event D1 happen. (See Elmslie v FC of T 93 ATC 4964.)
The preliminary letters of agreement state that BMP would acquire half of the land Ezi Haul
purchased in February 2018and that half of the building would be leased back to Ezi Haul.
The letters of agreement would have to be examined carefully to determine whether they
constituted a contract in themselves or the conditions precedent to performance of the
contract.
(1)
If the preliminary letters of agreement constituted a contract, and thus a disposal of the asset,
the following consequences would arise. Ezi Haul would have disposed of part of its
beneficial ownership of the land (ITAA97 s 104-10). It would have received another asset,
being the right to lease the property in return, as consideration. The cost base of the asset
disposed of would be $1,400,000 plus incidental expenses. The gain would be determined by
the value of the right to the lease less the indexed cost base.
One issue that should be determined is the value of the 20-year lease. Comparable open
market, arm’s length transactions can be used as a guide. It should be noted that if the
76
taxpayer does not adopt a market value for the value of the lease to determine the cost base,
the Commissioner can substitute a market value (s 116-30).
On this basis, although BMP is described as having paid Ezi Haul $3,600,000 for its interest
in the project, half of the land acquired by Ezi Haul and the restrictive covenant given by Ezi
Haul, BMP would in fact have paid the company $3,600,000 for its interest in the project, its
right to the 20-year lease and the restrictive covenant.
The value of the right to the lease on cancellation would appear to be equal to the value of the
right as established at the time of the disposal of the half interest in the land. This would not
give rise to a capital gain. The value of Ezi Haul’s interest in the project and the value of the
restrictive covenant would then have to be determined.
Compensation received for entering into a restrictive covenant will be caught for CGT
purposes under s 104-35. Ezi Haul will be taken to have created a right in another entity
giving rise to CGT event D1 occurring (the right to conduct its business). Hence, the creator
of the asset, Ezi Haul, will be assessed on the difference between the amount received for
creating the asset and any incidental costs of the asset’s disposal.
(2)
On the basis that the preliminary letters were merely part of an executory contract that was
never finalised, and that the interest in the land was not disposed of, the three assets disposed
of would be the land, the restrictive covenant, and the interest in the project. Once again, the
last two assets are expected to each have a zero cost base and Ezi Haul would be assessed on
the capital proceeds received. The cost base of the land would be $1,400,000 plus incidental
costs. Ezi Haul should obtain a market valuation of the land. The company will then have
disposed of its half interest in the land for half of that market value. The capital gain would
be the difference between that value and the cost base referred to earlier.
[¶30-060] Solution 60
Business income; capital gains tax (CGT)
(1) The eight hectares acquired in 1982
The CGT provisions apply where a CGT event happens to a CGT asset acquired on or after
20 September 1985. As the parcel of eight hectares was acquired before 20 September 1985,
the disposal of that land will not attract the operation of the CGT provisions (ITAA97 s 104-
10(5)(a)). However, where a profit is made on the disposal of an asset acquired before 20
September 1985, the application of s 15-15 should be considered.
Section 15-15 includes in assessable income the profit arising from the carrying on or
carrying out of a profit-making undertaking or plan. It is similar to the second limb of
ITAA36 s 25A, which included the profit arising from the carrying on or carrying out of any
profit-making undertaking or scheme. While the mere realisation of a capital asset does not
constitute a profit-making scheme (Scottish Australian Mining Co Ltd v FC of T (1950) 81
CLR 188), it is unclear what steps can be taken before the development and sale of land
becomes a profit-making plan.
77
Considering the decisions of Scottish Australian Mining and FC of T v Whitfords Beach Pty
Ltd 82 ATC 4031 together, it appears that a simple subdivision of land previously used to
carry on a business would not constitute a profit-making plan. Further, the fact that, in his
decision to sell, Neil was influenced by the declining profitability of the business supports the
conclusion that the sale is unlikely to be caught by ITAA97 s 15-15.
(2) The two hectares acquired on 1 October 1989
The CGT provisions will apply to the two hectares of land because they were acquired after
19 September 1985. The disposal of the two hectares of land will cause CGT event A1 to
happen. The cost base is computed as follows:
$
Amount paid for acquisition (s 110-25(2)) 40,000
Incidental costs of acquisition (s 110-25(3))
– stamp duty (s 110-35(4)) 800
– legal fees (s 110-35(2)) 1,600
Incidental costs of disposal
– 2/10 of agent’s commission (s 110-35(2)) 2,400
– 2/10 of legal fees (s 110-35(2)) 480
Amount of capital expenditure incurred in increasing the value of the asset which is
reflected in the state of the asset at the time of the CGT event, ie 2/10 of subdivision 32,000
costs (s 110-25(5))
$77,280
The fact that the land’s market value increased significantly following the subdivision
indicates that the expenditure increased the value of the land. Assuming that each hectare of
land is equally valuable, the capital proceeds on disposal ($1,200,000) must be apportioned,
as only one-fifth of the sale price relates to land acquired on or after 20 September 1985 (s
116-40).
For the purpose of calculating the capital gain, the date on which the disposal (CGT event
A1) took place will be 1 July 2018—the time of making the contract (s 104-10(3)). The CGT
calculation is as follows:
$ $
Consideration: $1200,000 × 0.2 240,000
Indexed cost base:
$42,400 × 1.245* 52,788
$32,000 × 1.000** 32,000
$2,880 × 1.000*** 2,880 (87,668)
68.7
* (s 960-275)
55.2
68.7
** (s 960-275)
68.7
78
68.7
*** (s 960-275)
68.7
The CGT discount option should also be considered, because CGT event A1 (s 104-10)
occurred (ie sale of land) after 11.45 am on 21 September 1999 (ie in July 2013).
Consequently, the capital gain is calculated as follows:
$
Consideration 240,000
Cost base (77,280)
Because the capital gain using the CGT discount method (ie $81,360) is lower, Neil Jones
should choose to use this method to determine his capital gain for the 2018/19 tax year.
Although the contract provided that half of the purchase money would be payable at a later
date (ie 31 March 2019) this would not defer the time at which the CGT liability occurred,
because s 104-10(3)(a) would deem the CGT event to occur at the time of making the
contract. However, any interest payable to Neil on the outstanding balance would be regarded
as income under s 6-5(2), but only when it is received.
Finally, as Neil has a small business and disposed of the two hectares of land after 11.45 am
EST on 21 September 1999, the small business concessions in Div 152 should also be
considered. Given that Neil has owned the two hectares of land for more than 15 years (ie he
originally purchased the land on 1 October 1989), the 15-year exemption concession could
apply. Specifically, Neil may be able to disregard the capital gain of $81,360 entirely (s 152-
105; 152-110). The 15-year exemption applies to Neil in the following circumstances:
•
the basic conditions for CGT small business relief are satisfied
•
Neil has continuously owned the land for the 15-year period leading up to the CGT event,
and
•
at the time of the CGT event, Neil is either: (a) over 55 years of age and the CGT event
happened in connection with his retirement; or (b) he was permanently incapacitated.
[¶30-061] Solution 61
79
Shares
(1) Dates of acquisition of bonus shares
WBC bonus shares
The time of acquisition of bonus shares issued on or before 30 June 1987 is the date of
acquisition of the original shares, ie 1 January 1985 (see Income Tax (Transitional
Provisions) Act 1997 s 130-20(2)). Thus, the CGT provisions do not apply.
CSR bonus shares
The time of acquisition of bonus shares issued out of a share premium reserve—irrespective
of the time of issue—is the date of acquisition of the original shares (s 130-20(3)). The
amount applied to pay up the bonus shares issued from a share premium reserve is not a
dividend.
Therefore, one-sixth of the bonus shares in CSR are taken to be acquired on 1 March 1991.
The remaining five-sixths are taken to be acquired on 1 August 1984.
(2) Net capital gain on sales
Since James has sold the shares after 11.45 am EST on 21 September 1999, he has the choice
of including in assessable income the capital gain that results from either:
(1)
September 1999, or
(2)
50% (the CGT discount for individual taxpayers).
Under the indexation method, the capital gain for James would be calculated as follows:
Cost Indexation Indexed Capital Capital

Shares
base † factor cost base proceeds gain/(loss)
IAG (500 @ $3) 1,500 N/A 1,500 1,000 (500)
CSR (1,000 @ $2.143) 2,143 1.166* 2,499 5,333 2,834
CSR bonus shares (83 @ $2.143) 178 1.166* 208 442 234
*68.7 (ITAA97 s 960-275)
58.9
80
It is assumed that five-sixths of the bonus shares came from shares purchased
CSR:
1 August 1984 and one-sixth from shares purchased 1 March 1991.
No CGT consequences arise, as the bonus shares are taken to be acquired before 20
WBC:
September 1985.
†Calculation of cost base of shares:
IAG:
CSR: Cost of original shares (s 130-20(3))
(a) Pre-CGT—original shares and bonus shares
(b) Post-CGT—original shares and bonus shares
Based on the discount method, the capital gain for James is computed as follows:
Shares Cost base Capital proceeds Capital gain/ (loss)

$ $ $
IAG 1,500 1,000 (500)
CSR 2,143 5,333 3,190
CSR (bonus shares) 178 442 264
CAPITAL GAIN (discount
$1,477
method)
Since the capital gain from the CGT discount method ($1,477) is lower than the capital gain
from the indexation method ($2,568), James should choose to be assessed according to the
CGT discount method and would include $1,477 in his assessable income for the 2018/19 tax
year.
[¶30-062] Solution 62
Partnership—sale of assets
(1) Partnership interest
ITAA97 s 106-5 states that any capital gain or loss from a CGT event happening in relation
to a partnership, or one of its CGT assets, is made by the partners individually. Furthermore,
each partner’s gain or loss is calculated by reference to the partnership agreement, or by
partnership law if there is no agreement.
81
When partners leave a partnership they dispose of their interests in the partnership assets and
the remaining partner(s) acquire these interests (s 106-5(3)). Thus, it is necessary to
determine the consideration paid in respect of the partner’s interest in each partnership asset.
The onus is on Sandison to determine any capital gain (or loss) from the disposal of his
interest in each partnership asset.
Because Sandison had sold his share in the business after 11.45 am EST on 21 September
1999, and assuming that either: (1) the conditions in Subdiv 152-A are met; (2) he is deemed
to have a small business entity under ITAA97 s 328-110; or (3) the asset is an asset of a
partnership which is a small business entity, and Sandison is deemed to be a partner in that
partnership entity under s 328-110, in determining the capital gain Sandison can avail himself
of the small business 50% reduction (s 152-205) as well as the 50% CGT discount (Subdiv
115-A).
Assuming that Sandison elects to use the CGT discount method instead of the CGT
indexation method, the capital gain from disposal of his share of the business is computed as
follows:
$
Less: capital loss from shares (see the CGT calculation below) (13,152)
Gain after applying loss 386,848
193,424
Less: 50% small business concession (96,712)
Assessable capital gain $96,712
However, Sandison can claim an exemption from the assessable capital gain of $96,712
because the proceeds of the sale of his small business will be used for retirement purposes.
To claim this relief, Sandison would have to be aged 55 or older, or if he is aged under 55,
then the capital proceeds would have to be rolled over into a superannuation fund or an
approved deposit fund (ADF) to be retained until he reaches the superannuation preservation
age (s 152-305).
(2) Restrictive covenant
Where a restrictive covenant is entered into upon the sale of a business, CGT event D1
occurs, as a contractual right or other legal right is created in another entity. A capital gain
arises where the capital proceeds from creating the right are more than the incidental costs
relating to that event. As the incidental costs are likely to be zero, the capital proceeds of
$50,000 for the taxpayer from entering into a restrictive covenant are assessable as a capital
gain. However, as Sandison intends to retire, he might be able to claim an exemption from
the assessable capital gain of $50,000 where the proceeds of the sale of his small business are
used for retirement purposes. To claim this relief, Sandison would have to be aged 55 or
older, or, if he is aged under 55, the capital gain would have to be rolled over into a
superannuation fund or an ADF to be preserved until the superannuation preservation age (s
152-305).
82
(3) Family home
Provided that no part of the taxpayer’s main residence is used for income-producing
purposes, s 118-110 operates to exempt the whole of the main residence of a taxpayer from
CGT.
(4) Shares
On disposal of the post-CGT shares, CGT event A1 happens (s 104-10). The taxpayer makes
a capital gain if the capital proceeds are more than the cost base (or indexed cost base) and a
capital loss if the capital proceeds are less than the reduced cost base (s 104-10(4)). Since the
shares were acquired before 11.45 am on 21 September 1999 and CGT event A1 occurred
after that time, Sandison can choose to:
(a)
calculate the capital gain with a cost base which includes indexation frozen at 30 September
1999, or
(b)
calculate the capital gain without indexation and then reduce the notional capital gain by
50%.
(a) Indexation method

Description Date of Date of Cost Indexation Indexed Capital Capital
of shares acquisition disposal base factor cost price proceeds gain/ (loss)
4,000
1.9.89 14.12.18 64,000 1.268* 81,152 84,000 2,848
Actex Ltd
4,000
1.10.95 14.12.18 32,000 — — 16,000 (16,000)
BTR Ltd**
NET CAPITAL LOSS ($13,152)
** The cost base is not indexed because there was a loss on disposal of the shares.
As per the indexation method, there is a net capital loss of $13,152 on the disposal of the
shares, which may be offset against other capital gains (see the CGT calculation above for the
disposal of Sandison’s share of the business).
(b) CGT Discount method calculation:
83
Shares Cost base Capital proceeds Capital gain/(loss)
$ $ $
Actex Ltd 64,000 84,000 20,000
BTR Ltd 32,000 16,000 (16,000)
NOTIONAL CAPITAL GAIN $4,000
Based on the discount method, there is a notional capital gain of $4,000. Sandison would be
entitled to the 50% CGT discount, as the shares were held for more than 12 months, and
would be assessed on a capital gain of $2,000.
Given that Sandison has the option of choosing either the indexation method or the discount
method, he should choose the indexation method, where there is no capital gain and a net
capital loss of $13,152 to be offset against any other capital gains.
[¶30-063] Solution 63
Collectables; shares
•
Jewellery. Seeing that Kim Richardson’s grandmother died after 19 September 1985, but had
acquired the jewellery (inherited by Kim) before 20 September 1985, as the beneficiary Kim
will be taken to have acquired the jewellery at the date of her grandmother’s death (October
1998) for a consideration equal to the market value of the jewellery at that date ($114,000
ITAA97 s 128-15).
•
Sale of flat. Because the South Yarra flat was owned by Kim and used as her main residence
from the date of acquisition, no capital gain will accrue to her on disposal of the flat (s 118-
110).
•
Bonus shares. Since the bonus shares were issued from an untainted share capital account,
the bonus shares are not assessable as a dividend. Subdivision 130-A applies. The bonus
shares are taken to be acquired at the date of acquisition of the original shares (s 130-15). The
cost base of the bonus shares is determined by taking the cost of the original shares and
spreading it over the number of original shares and bonus shares together.
•
Disposal of assets. As the collectable assets (ie jewellery and painting) and the BHP shares
were acquired before 11.45 am on 21 September 1999 and the CGT event A1 occurred after
that time and the assets were held for 12 months, Kim can choose to:
–
1999 (‘the indexation method’), or
–
calculate the capital gain without indexation and then reduce the notional capital gain by 50%
(‘the discount method’).
Disposal of collectable assets

84
According to the indexation method, the CGT calculations are as follows:
Jewellery $
Indexed cost base $30,000 × 1.013* (30,390)
Painting
Cost base 16,500
Capital proceeds —
CAPITAL LOSS ($16,500)
Furthermore, the loss on the painting can be offset against the capital gain from the other
collectable, the jewellery, as follows:
$
Capital gain on disposal of jewellery 89,610
Less: Capital loss on disposal of painting (16,500)
NET CAPITAL GAIN FROM DISPOSAL OF COLLECTABLE ASSETS
$73,110
(indexation method)
According to the discount method, the CGT calculations are as follows:
Jewellery $
Cost base (30,000)
NOTIONAL CAPITAL GAIN 90,000
Less: Capital loss on disposal of painting (16,500)
Subtotal 73,500
NET CAPITAL GAIN FROM DISPOSAL OF COLLECTABLE ASSETS
$36,750
(discount method)
Because the capital gain on collectables by the discount method is lower than the capital gain
on collectables by the indexation method, Kim should choose to be assessed under the
discount method and would include $36,750 in her assessable income.
Disposal of BHP shares
According to the indexation method, the CGT calculations are as follows:
$
Indexed cost base $72,000† × 1.013* 72,936
85
Add: 75c per share brokerage (no indexation) 1,650
Subtotal 74,586
Capital proceeds ($39.75 × 2,200) 87,450
† Cost base of shares:
Numberof shares Cost$

Original 2,000 72,000
Bonus 200 NIL
2,200 $72,000
According to the discount method, the CGT calculations are as follows:
$
Cost base (73,650)
NOTIONAL CAPITAL GAIN 13,800
NET CAPITAL GAIN (discount method) $6,900
Because the capital gain on the BHP shares by the discount method is lower than the capital
gain on the BHP shares by the indexation method, Kim should choose the discount method
and would include $6,900 in her assessable income.
Assessable income amount
$
Net capital gain from disposal of collectable assets 36,750
Capital gain from disposal of shares 6,900
[¶30-064] Solution 64
Shares—bonus issue
(1)
The 1,000 shares were acquired pre-CGT, because the relevant acquisition date is the date of
entering into the contract of purchase (ITAA97 s 109-5).
(2)
The gift of 2,000 shares is acquired on 25 December 1988—the date of the donor’s gift to the
donee (Case V156, 88 ATC 1005). Wally’s cost base would be $5.50 per share ($11,000 s
112-20).
(3)
86
Given that the 1 for 10 bonus issue is made from a share premium reserve, the bonus issue is
not a dividend for tax purposes.
Pursuant to s 130-20, the cost base of Wally’s shares is to be spread over the existing shares
and bonus shares.
One hundred bonus shares will be pre-CGT, being ‘grandfathered’ to the 1,000 original pre-
CGT shares, and 200 bonus shares will be post-CGT, being associated with the gift of 2,000
shares on 25 December 1988.
(4)
The implications of the sale of shares on 26 September 1989 will depend upon whether Wally
can specifically identify the scrip sold (by certificate number).
If not, the Commissioner will accept ‘first in first out’ (FIFO) as a reasonable basis of
identification, and will also accept the taxpayer’s selection of the identity of the shares sold
(Taxation Determination TD 33). Assuming that FIFO is adopted, the 1,200 shares sold will
comprise the 1,000 original shares, the 100 bonus shares relating to the original shares and
100 of the post-CGT shares.
If this were the case, Wally’s liability for CGT is computed as follows:
$ $
Capital proceeds 100 shares @ $8.50 850
Cost base 100 @ $5* 500
Incidental costs of disposal 100 @ $0.25 25 (525)
$325
*Cost base $
2,000 shares at $5.50 11,000
200 bonus shares NIL
2,200 shares $11,000
As the shares were sold within 12 months of acquisition, there is no indexation for inflation.
(5)
Because Wally acquired the shares before 11.45 am EST on 21 September 1999 and sold
them after that time, Brown can choose to:
(a)
1999, or
(b)
calculate the capital gain without indexation and then reduce the notional capital gain by
50%.
(a) Indexation method
$
Capital proceeds 2,100 shares @ $10.50 22,050
Indexed cost base for the 2,100 shares @ $5 per share is $10,500 × 1.342* 14,091
87
CAPITAL GAIN $7,959
*68.7 (s 960-275)
51.2
(b) Discount method
$
Less: Cost base 10,500
Less: 50% CGT discount 5,775
CAPITAL GAIN $5,775
As the capital gain is lower using the discount method, Wally should select the discount
method and be assessed on a capital gain of $5,775 for the 2018/18 tax year.
[¶30-065] Solution 65
Partnership—admission, retirement
(1) Admission of partner
By admitting K to the partnership, each of the other three partners disposed of one-quarter of
their rights as among themselves. Therefore, each partner will recognise as assessable income
a gain of $208,333 in the year ended 30 June 1997.
X, Y and Z will each calculate his/her capital gain as follows:
$
Capital proceeds ($1,000,000 × ⅓) 333,333
Portion of cost base (25% × $500,000) (125,000)
ASSESSABLE CAPITAL GAIN $208,333
K acquires an asset which is a one-quarter interest in aggregate of the partnership net asset for
a cost base of $1,000,000.
When a partnership is created, the partners enter into a contractual agreement which sets out
the rights and obligations between themselves. These mutual rights and obligations are the
essence of a partnership. Partners also have a beneficial interest in the aggregate underlying
assets of the partnership, but no definite interest in any individual asset. In Taxation Ruling
IT 2540, the ATO adopted the view that a partner has an identifiable interest in each
88
partnership asset rather than an interest in the aggregate of the partnership’s net assets and
that title to partnership assets is legally vested in the partners, not in the partnership.
ITAA97 s 106-5 states that any capital gain or loss from a CGT event occurring in relation to
a partnership, or one of its CGT assets, is made by the partners individually. Additionally, s
106-5(3) refers to a CGT event happening in relation to a taxpayer’s interest in a partnership
asset of a partnership in which the taxpayer is a partner and the acquisition of that interest by
the remaining partner(s). Any net capital gain accrues to the partner who owned the asset and
no net capital gain can form part of ITAA36 s 90 ‘net partnership income’. Thus, on a CGT
event happening in relation to an interest or part interest in a partnership, each partner must
account for his or her interest in the partnership assets; and, where a partner disposes of a
post-CGT asset, that partner will be required to show any resulting net capital gain in his or
her return, subject to the CGT indexation method or CGT discount method (if applicable).
In this question, there is only one underlying partnership asset, the regional office complex.
There is no need, therefore, to trace through and analyse the change in a number of
partnership assets for the purpose of determining the portion of CGT liability.
(2) Retirement of partner
When X leaves the partnership on 25 July 2015, he disposes of his interest in the partnership,
which has a cost base of $375,000, calculated as follows:
$
Amount paid on entry into partnership 500,000
Less: Disposal to K (125,000)
TOTAL $375,000
Therefore, X derives a capital gain of $1,125,000 (ie $1,500,000 – $375,000).
However, X may be eligible for exemption from CGT due to the relief provisions on small
business retirement disposals (contained in ITAA97 Division 152 Where the taxpayer is
under 55 and contributes an amount equal to the assets CGT gain to a complying
superannuation fund (s152-30, the proceeds from the sale of the business are exempt.
The main requirements are as follows:
•
the taxpayer’s roll-over asset is an asset disposed of where the net assets do not exceed
$5,000,000, and
•
the roll-over asset is an active asset.
However, the amount is capped at $ 500,000 for any one individual.
The cost base of acquiring a further one-twelfth interest in the partnership by Y, Z and K
would be $500,000 each, (ie ⅓ × $1,500,000).
(3) Admission of new partner
89
By admitting T into the partnership on 12 September 2018, each existing partner effectively
disposes of a one-twelfth interest in partnership property. To calculate the assessable capital
gain for each partner, it is first necessary to determine their respective cost bases.
Y and Z each have a cost base of $875,000 that is calculated as follows:
$
Amount paid on entry into the partnership 500,000
Less: Disposal to K (125,000)
375,000
Add: Acquisition from X 500,000
TOTAL $875,000
Therefore, Y and Z will each derive a capital gain of $481,250, being calculated as follows:
K has a cost base of $1,500,000 calculated as follows:
$
Capital contribution on entry to the partnership 1,000,000
Add: Acquisition from X 500,000
$1,500,000
Thus, K will derive a capital gain of $325,000 (ie $700,000 – (¼ × $1,500,000)).
Finally, T will have acquired a 25% interest in partnership property having a cost base of
$2,100,000.
[¶30-066] Solution 66
Partnership
On the formation of the partnership, Ben will be taken to have acquired a 50% interest in the
freehold property and Bill a 50% interest in the goodwill and work in progress contributed by
Ben.
Since Bill acquired the business premises before 20 September 1985, he will not incur any
CGT liability and will retain an asset, namely a 50% interest in the property, as a pre-20
September 1985 CGT asset. Ben’s interest in the business premises will be acquired post-19
September 1985. If the premises are later disposed of (or another CGT event happens) then
Ben will incur a CGT liability if his share of the proceeds is greater than the cost base. (A
CGT discount would apply if the property is held for at least 12 months before a CGT event
happens to the CGT asset.)
90
Given that Ben commenced business before 20 September 1985, any goodwill in the form of
clientele that he contributes to the partnership is a pre-20 September 1985 asset.
Bill’s interest in the goodwill is a post-19 September 1985 asset, as ITAA97 Div 109
provides that where an asset is acquired under a contract (the basis upon which A would have
acquired his interest in the goodwill), the time of acquisition shall be the time of the making
of the contract.
A possible difficulty arises for Ben in that the value of goodwill of the Bill and Ben
partnership may increase so that, upon a subsequent disposal of his interest in goodwill, he
will be required to determine what goodwill interest has been disposed of and its CGT
consequences. The question which arises is whether the goodwill augmentation constitutes an
extension of original goodwill, in which case it continues as a pre-20 September 1985 asset,
or whether the Bill and Ben partnership goodwill is a separately created goodwill.
In Taxation Ruling TR 1999/16, the Commissioner states that goodwill is either pre-CGT or
post-CGT, that it cannot be characterised as partly pre-CGT goodwill and partly post-CGT
goodwill. If a new business operation or activity introduced by a taxpayer is an expansion of
an existing business, any goodwill built-up in conducting the expanded business is merely an
expansion of the existing goodwill of the business. However, if an introduced business
activity is a new business, the goodwill attaching to that business is a new asset separate from
the goodwill of the existing business. In this case there does not appear to be any new
business, so the expansion of goodwill would remain a pre-CGT asset for Ben.
If the work in progress is regarded as trading stock, it will be assessable under s 70-90 and
will be specifically excluded from CGT (s 118-25).
Where there is a disposal of a partner’s interest in a partnership, the partner may be eligible
for small business relief under Div 152, where the conditions in Subdiv 152-A are satisfied.
[¶30-067] Solution 67
Main residence; non-residence
As the Burwood property was David’s main residence and had not been used for income-
producing purposes, ITAA97 s 118-140 allows David to treat both the Burwood and
Camberwell residences as his main residence for a period of six months prior to the date of
disposal of the Burwood home on 1 October 2018. Under s 118-130, where land or a
dwelling which is the taxpayer’s main residence is acquired or disposed of under a contract,
and legal ownership does not pass until a later time, then CGT is to be calculated on the basis
of legal ownership. The basis of legal ownership is usually when the contract for acquisition
and disposal is completed. In David’s case this would be the settlement dates. David would
have acquired the Camberwell property on 1 February 2019 and disposed of the Burwood
property on 1 October 2018.
This will mean that the proportion of the capital gain attributable to the time that the
Burwood property was not David’s main residence will be subject to CGT.
91
Because David originally acquired the Burwood property on 1 March 2007, the CGT
discount method will apply.
Using the CGT discount method, the capital gain is computed as follows:
$
Less: Cost base (150,000)
In fact, the proportion of the capital gain that is assessable is 2/151 † × $350,000 = $4,635.
† Two months (1.8.18 to 1.10.18) out of a total of 151 months’ ownership. This is on the
basis that the Burwood home remained the main residence until 1 February 2019 when
settlement took place for the Camberwell home, and that David then changed his residence to
the Camberwell home. It became his main residence thereafter.
As David is posted overseas and will cease to use his main residence, he can elect for s 118-
145 to apply. As an income-producing use will be made of the dwelling while he is away, s
118-145 permits the main residence exemption to apply for a period of up to six years while
David is absent from occupancy.
The fact that David does not re-occupy the Camberwell dwelling, but rather disposes of it on
his return to Australia after an absence of less than six years, does not affect the exemption,
because he did not have another main residence during his period of absence from Australia.
It should be noted that if David disposed of the residence while overseas, and he is deemed
by his absence to be a non-resident, then the CGT exemption relating to his Australian
residence will not apply (see s 118-113(3) and also the decision in Harding v FCT [2019]
FCAFC 29).
[¶30-068] Solution 68
Residence; composite use
Where a dwelling acquired after 19 September 1985 is used as a main residence by a
taxpayer, ITAA97 s 118-110 provides an exemption with respect to the property so no capital
gain or loss arises from a CGT event happening.
Moreover, where there is adjacent land which is used for private or domestic purposes, then s
118-120 allows an exemption where the land on which the dwelling is located, plus the
adjacent land, does not exceed two hectares.
However, at the time the land was strata titled, the main residence exemption would not apply
to that part of the land, and the subsequent disposal of the land occupied by the villa units
would attract CGT (CGT event A1), unless Jill elected to use the strata title conversion roll-
92
over relief provisions of s 124-10 and 124-190. Assuming she did not elect to use the roll-
over relief provisions, CGT event A1 would happen as there would be a disposal of the land
occupied by the villa units having regard to the provisions of s 104-10.
Because Jill acquired the villa units after 21 September 1999 and sold them on 4 September
2018, she must apply the CGT discount method to calculate her capital gain.
As per s 112-30, the calculation of the cost base of the land occupied by the villa units would
be determined by apportioning the cost base of the land at the time the land was strata titled.
The cost base is apportioned according to the following formula:
A similar apportionment is required for the incidental costs. The cost of the buildings as well
as the land must be included in the apportionment as expenditure on stamp duty and legal
costs were associated with both the land and buildings.
$31,200 × (400,000/400,000 + 1,200,000 + 350,000) = $6,400
Consequently, the cost base of the land would be $95,000 + $6,400 = 101,400
The total cost base of the villa units is computed as follows:
Total CostBase ($)
Cost of the land—1.3.98 95,000
Incidental costs of acquisition—1.3.98 6,400
Legal and other costs associated with strata title conversion—May
2,200
2018
Cost of building the units—August 2017 350,000
Cost of disposal of the units 2,344
$455,944
Applying the CGT discount method, Jill’s capital gain for the 2018/19 tax year is calculated
as follows:
$
Capital proceeds for two units @ $ 500,000 each 1,000,000
CAPITAL GAIN – Discount Method 72,028
[¶30-069] Solution 69
Leases
93
(1) Lease premium
While obtaining a lease does not represent the disposal of part of the property under the CGT
provisions, CGT event F1 occurs. The premium paid ($40,000) is the capital proceeds
(ITAA97 s 104-110(3); 116-20(2)). Furthermore, the cost base of the lease would only
include the expenditure incurred by the lessor in granting the lease. This would normally be
limited to any stamp duty and legal costs associated with the preparation of the lease.
Therefore, the lease premium would be a capital gain under s 104-110 to Comp-Paq.
With respect to Ezi Haul, upon expiry of the lease on 20 December 2019, CGT event C2
occurs and the lease premium paid (plus any incidental costs incurred by Ezi Haul in the
granting of the lease) would be a capital loss under s 104-25.
(2) Rent and rent-free period
The rent-free period would not attract tax within the general provision of s 6-5(2) because no
monetary benefit has been provided. Moreover, ITAA36 s 21A would not apply, as the
benefit would be exempt by reason of the fact that the lessee would have been able to claim a
deduction for the benefit provided (s 21A(3)). (Also see Taxation Ruling IT 2631.)
If there had been a cash inducement to enter into the lease of premises, the cash would be
ordinary income under ITAA97 s 6-5 (FC of T v Montgomery 99 ATC 4749). The payment
would also give rise to CGT event D1, however, as the sum is assessable under s 6-5, s 118-
20 will reduce the capital gain to zero to prevent double taxation.
The rent received of $32,000 per month would be assessable income to Comp-Paq under s 6-
5.
(3) Partitions
Where the partitions are owned by the lessor, there will not be any benefit to the lessee, as
there has not been a transfer of property and the lessee would have been able to obtain a
deduction for any lease or rental payment made for the use of the partitions. If ownership of
the partitions is not transferred, Comp-Paq will be able to depreciate them under Div 40.
If ownership of the partitions is transferred to the lessee, the lessee may be assessable under s
21A on the market value of the partitions provided. However, the lessee would be able to
claim depreciation on them under Div 40.
Bearing in mind the decision in Lees & Leech Pty Ltd v FC of T 97 ATC 4407, it could be
argued that where the property in the fittings passes to the lessee at the end of the lease
period, the taxable value is minimal.
Category C: Solution 70
[¶30-070] Solution 70
94
Death; roll-over relief; valuation
The death of the father will not result in any CGT liability (ITAA97 s 128-10), however, the
beneficiaries (ie Bill and Fred) are taken to have acquired the inherited assets and a
subsequent CGT event could have CGT consequences. Because their father built the hotel in
1976 it is a pre-CGT asset, together with the licence to sell alcohol (site goodwill). However,
their father extended the hotel in 1989 at a cost of $150,000. This extension is a separate asset
from the original building, acquired post-CGT (s 108-55(2)). Therefore, on the father’s death,
the brothers acquired the pre-CGT assets at a consideration equal to their market value at the
date of the father’s death (s 128-15(4)), while the post-CGT extension to the hotel was
acquired at a value equal to the deceased’s indexed cost base or reduced cost base at the date
of death (s 128-15(4)).
Based upon the information provided in the question, the cost base of the hotel to the brothers
for CGT purposes at the date of their father’s death would be computed as follows:
Extension to hotel building*: $150,000 × 1.077** = $161,550

Hotel at market value excluding market value
= $1,170,000
of extension: $1,500,000 – $330,000
Site goodwill (license to sell alcohol) = $300,000
* For a building acquired after 7.30 pm on 13 May 1997, the cost base and indexed cost base
are reduced to the extent of any net deductions allowable for expenditure included in the cost
base, such as ITAA97 Div 43 deductions. Since the extension to the hotel was undertaken in
1989, ITAA97 s 110-45 does not affect the Lemans’ situation.
The Mornington Peninsula property is a post-CGT asset and would be acquired at its indexed
cost base at the time of the father’s death as follows:
Does the transfer of an asset into a partnership constitute a CGT event? If CGT event A1 is to
apply there must be a change of ownership (s 104-10). As it is the partners and not the
partnership who own the assets for CGT purposes (s 106-5), there has not been any disposal
of any assets associated with the hotel—they are still owned jointly by Fred and Bill as
partners.
Does the transfer of the land to Leman Pty Ltd constitute a disposal so that CGT event A1
would apply? In this case, as the company is a separate legal entity and can own an asset in
its own name, there is a disposal pursuant to s 104-10.
Can Fred and Bill elect that roll-over relief should apply under Div 122?
95
In this case ‘yes’, because the transaction satisfies the requirements of s 122-20 and s 122-25.
These requirements are: the consideration in respect of the disposal consists only of non-
redeemable shares in the company; the market value of the shares is substantially the same as
the market value of the roll-over assets; Fred and Bill beneficially own all the shares in the
company immediately after the CGT event; and they beneficially own the shares received as
consideration in the same proportion as they held an interest in the asset. (As the land was
transferred before 3 April 1992, it is not necessary to consider whether the land is trading
stock of the company.) If Fred and Bill elect that roll-over relief is to apply, the other CGT
provisions do not apply to the disposal of the asset and the company is taken to have acquired
the asset at its indexed cost base (or reduced cost base) to the taxpayer at the time of disposal.
Is the disposal of land by Leman Pty Ltd a realisation of its capital asset (Scottish Australian
Mining Company Ltd v FC of T (1950) 81 CLR 188) or a step in the carrying on of a business
(FC of T v Whitfords Beach Pty Ltd 82 ATC 4031)? In Scottish Australian Mining the
company had mined land for over 45 years and only after exhaustion of the mine was the land
subdivided and realised at a profit. It was held that the sale of land was not assessable under
ITAA36 former s 25(1) or 26(a) as the taxpayer was not in the business of selling land or
carrying out a profit-making undertaking or scheme. Today CGT must be considered. In
Whitford’s Beach the company changed its articles of association to reflect the property
development intention of the company. The subdivision and realisation of the land
constituted the carrying on of a business and the profit on disposal was assessable under
ITAA36 former s 25(1).
Reference should also be made to other leading cases in this area such as FC of T v Myer
Emporium Ltd 87 ATC 4363 and Westfield Ltd v FC of T 91 ATC 4234 (also see TR92/3).
(It should be noted that if the land is held for the purpose of sale after 30 June 1997, it will
become trading stock for the purposes of ITAA97 s 70-30. Where this occurs, the taxpayer is
deemed to have sold the item at arm’s length to someone else at either cost or market value
(at the taxpayer’s option) and to have immediately reacquired the item for the same amount.
In the case of land acquired as a beneficiary in a deceased person’s estate, s 70-30(4)
provides that the cost is the market value when the taxpayer acquired it. Consequently, any
disposal of the land after 30 June 1997 will mean that the trading stock provisions will apply
and ITAA36 s 25A will be inoperative.)
The conclusion reached on the nature of the transaction will, in turn, determine the answer to
the taxation of the company’s activities. If you took the view that the land transferred to
Leman Pty Ltd becomes trading stock of the company, because the sole purpose of the
company is to acquire the land with the intention of developing and selling it, then you would
only have to consider the CGT consequences of the restrictive covenant and deal with
ITAA97 s 6-5(2), 8-1(1) and 70-90 with respect to the subdivision and disposal of the land.
However, if you took the view that the activities were a realisation of a capital asset and the
land was rolled over into the company, then (1), (2) and (3) below would apply.
(1)
The disposal of land to private owners would attract CGT (CGT event A1 happens)
96
The company acquired all the land for $1,551,000. In the September quarter of 1992 it sold
half this land to private owners.
CGT Calculation:
$
Half of acquisition cost base
811,949
½ × $1,551,000 = $775,500 × 1.047*
Half of subdivision costs indexed
150,000
½ × $300,000 = $150,000
Indexed cost base 1,066,949
Capital proceeds
3,000,000
50 × $60,000
CAPITAL GAIN $1,933,051
(2) The option is itself a CGT asset (ITAA97 s 108-5)
The granting of the option to buy the land triggers CGT event D2, with a cost base equal to
the expenditure in granting the option (assumed nil in this case). The capital gain is $75,000
and will be assessable in the 1992/93 tax year.
When the option is exercised in September 1993, the grant of the option and the disposal of
the underlying asset are treated as a single transaction (s 104-40(5)). This will mean the
capital gain associated with the granting of the option in the 1992/93 tax year will be
disregarded and an amended assessment lodged for the 1992/93 year of income.
The capital gain is calculated as follows:
$
Half of acquisition cost base 829,785
½ × $1,551,000 = $775,500 × 1.070*
Half of subdivision costs indexed 153,000
½ × $300,000 = $150,000 × 1.020**
Indexed cost base 1,087,785
$3,000,000 + option of $75,000
CAPITAL GAIN $1,987,215
97
(3)
The agreement restricting the type and nature of any building to be constructed upon the land
is a form of restrictive covenant
Leman Pty Ltd has acquired a right under this agreement (the right to sue if the agreement is
broken), triggering CGT event D1. As no agreement has yet been broken, there has been no
disposal of that right and no CGT consequences (s 104-35).
When Fred disposes of half his interest in the partnership, he is disposing of a post-CGT asset
(his interest in a partnership asset: s 106-5) and so CGT event A1 happens.
The building was acquired by the partnership in June 1990, and Fred’s share of the cost base
of the land and buildings is 50% of ($161,550 + $1,170,000) = $665,775. The cost base of the
50% interest he disposed of is $332,888. Where Fred elects to calculate the capital gain with
a cost base frozen at 30 September 1999, the indexed cost base is $400,464 ($332,888 ×
1.203 (ie 68.7/57.1)), the capital proceeds are $650,000 and the capital gain is therefore
$249,536 (ie $650,000 – $400,464).
However, if Fred elects to calculate the capital gain without indexation and then reduce the
notional capital gain by 50%, the assessable capital gain is computed as follows:
$
CAPITAL GAIN – discount method $158,556
Since the discount capital gain method results in a lower capital gain for the building, Fred
should choose to use that method for the calculation of the capital gain. However, Fred may
be entitled to the small business active asset concession under Subdiv 152-E for the building
if all of the conditions in that subdivision are satisfied. Because Fred would use the CGT
discount method, the $158,556 capital gain would be further reduced by the concession.
Hence, the CGT liability for the sale of the building would be $79,278 (ie $158,556 –
($158,556 × 50%)).
The site goodwill of the hotel (the licence to sell alcohol) was also acquired post-CGT and is
an asset separate from the land and buildings. In FC of T v Krakos Investments 96 ATC 4063,
Hill J recognises four different aspects of goodwill (site, personal, name and monopoly). Site
goodwill attaches to the land or location of the hotel and is a separate item of property which
can be transferred. Personal goodwill, which depends upon some personal characteristic of
the owner of the goodwill, does not attach to property and cannot be transferred.
As the personal goodwill cannot be transferred, can it be a CGT asset under s 108-5? The
definition of CGT asset in s 108-5 includes any kind of property or a legal or equitable right.
As the site goodwill is property and can be transferred, the CGT provisions may apply, but
they are unlikely to apply to the personal goodwill.
Disposal of Fred’s share of the site goodwill
98
If Fred elects to calculate the capital gain on the site goodwill with a cost base frozen at 30
September 1999, the amount subject to CGT is computed as follows:
Cost base: 70% × ½ × $350,000 = $122,500

$
Indexed cost base: $122,500 × 1.203* 147,368
CAPITAL GAIN – CGT indexation method $202,632
notional capital gain by 50%, the assessable capital gain is calculated as follows:
$
CAPITAL GAIN – CGT discount method $113,750
As the discount capital gain method gives the lower capital gain in this instance, Fred should
choose to use that method to calculate the capital gain for the site goodwill.
Fred should then seek small business relief under Div 152 in relation to his share of the site
goodwill subject to CGT. The small business 50% reduction might be relevant here. This
would reduce Fred’s assessable capital gain to $56,875 (ie 50% of $113,750).
The roll-over relief provisions of s 126-5 are not available because the assets have not been
transferred to Fred’s spouse.
A change in the constitution of the partnership is taken by s 40-295(2) to be a disposal of the

old partner’s depreciated property to the new partnership. Therefore, unless Fred and Mary
jointly elect that s 40-340(3) apply, a value must be attributed to the depreciable assets.
If the adjustable value of the depreciable assets was (say) $420,000 and Mary paid $105,000
for a 25% share of these assets, then no adjustment is necessary. However, where the sale
proceeds exceed the adjustable value (but not the original cost), the difference is assessable
pursuant to s 40-285(1) and included in the net partnership income of the old partnership. The
decline in value deduction allowable to the new partnership is calculated at the higher value.
A capital gain will only arise where the capital proceeds exceed the indexed cost base of the
asset and the CGT event occurred at or before 11.45 am EST on 21 September 1999.
Disposal of trading stock
Similarly, on the change of ownership there is a notional disposal of trading stock at market
value by all old partners to all new partners (s 70-100). However, because Fred and Bill will
continue to retain more than a 25% ownership in the new partnership, if all partners agree,
notice can be given to the Commissioner that trading stock be valued as if there had been a
99
continuing business (s 70-100(4) to (6)). In such a case, s 70-90 would not apply. Without a s
70-100 election, Fred is taken to have disposed of half his interest in his share of trading
stock for its market value.
Disposal of wildlife paintings
In December 2018, Fred disposed of his collection of wildlife paintings (a collectable asset,
see s 108-10). Fred could have realised $350,000 for the paintings but elected to sell them to
his brother at a loss. Is it an arm’s length transaction? If not, s 116-30(2) will deem the capital
proceeds to be market value. Assuming that $350,000 is the market value, where Fred elects
to calculate the capital gain with a cost base which includes indexation frozen at 30
September 1999, the capital gain is calculated as follows:
$
Indexed cost base: $120,000 × 1.077* (129,240)
notional capital gain by 50%, the assessable capital gain is arrived at as follows:
$
Less: Cost base (120,000)
Because the CGT discount method gives the lower capital gain, Fred should choose to use
that method for the calculation of the capital gain on disposal of the wildlife paintings.
100
Fringe Benefits
References to legislative provisions in this Chapter are to the Fringe Benefits Tax Assessment
Act 1986 (FBTAA) unless otherwise stated.
Notes
(1) From 1 April 2017 the FBT rate is 47%.
(2) The gross-up rate for Type 1 benefits is 2.0802 and for Type 2 benefits 1.8868.
Car benefits: Where the statutory formula is used a flat statutory rate of 20% applies for
(3)
all distances travelled.
Temporary residents are only able to claim concessions for Living away from home
(4)
allowances (LAFHA) if they maintain a home in Australia for their own use.
The taxable value of any LAFHA is the amount of the fringe benefit reduced by any
exempt accommodation component and any exempt food component. However, there are
tests to be satisfied to determine eligibility under s 31. In particular:
– the employee must maintain an Australian home (s 31C)
– the fringe benefit can only relate to all or part of the first 12 months during which the
employee is required to live away from home (s 31D), and
– the employee must comply with certain declaration requirements (s 31F).
Note that there are also eligibility requirements for employees on a fly-in, fly-out and
drive-in, drive-out basis of employment (s 31E).
The exempt accommodation and exempt food components must comply with the
substantiation requirements in s 31G.
Under s 31H, the exempt food component is the amount of the allowance for food
reduced by the applicable statutory food total. The applicable statutory food total is the
total of the statutory food amounts for family members reduced by any amount that might
be reasonably expected to be their total food costs had they remained living at their
normal residence.
The reasonable food amount for an adult for the FBT year ending 31.03.2019 is outlined
in Taxation Determination TD 2018/3. For one adult this amount is $265 per week. (If
the employee is posted overseas, the amount varies based on the country concerned.)
Where there is more than one adult, or there are also children, the reasonable food
amount is adjusted as outlined in the determination.
(5) Airline benefits are now assessed as a property benefit under Div 11 or as a residual
101
benefit under Div 12. The taxable value of an airline benefit is 75% of the stand-by value
(less any employee contribution).
On a domestic route the stand-by value is 50% of the carrier’s lowest economy fare. For
international travel it is of the lowest of any international carrier’s standard economy fare.
[¶30-071] Solution 71
Car fringe benefit
The provision of a car would be a car fringe benefit under s 7(1). The value of the car is
determined by use of:
•
the statutory formula method—s 9(1), or
•
the operating cost method—s 10(2).
As the car is provided by means of a lease agreement, which includes GST on the lease
payments, there is a Type 1 benefit and the gross-up factor is 2.1463.
The statutory formula basis applies unless the taxpayer elects otherwise or the statutory
formula produces a lower taxable value than the operating cost basis. Using the s 9(1)
statutory formula, the value of the car benefit would be determined as:
where:
• the statutory fraction = 20%
• the base value of the car = $30,000
• the number of days the car fringe benefit was provided = 365
• the number of days in that year of tax = 365, and
• the employee’s contribution = NIL.
The grossed-up taxable value is $6,000 × 2.0802 = $12,481. FBT under the statutory formula
method is $12,481 × 47% = $5,866.
If the operating cost method is used, the following formula is applied (assuming that
appropriate log books are kept and that the substantiation requirements are met):
[C × (100%) − BP)] − R
= [$12,600 × (100% − 50%)] − 0
= $12,600 × 50% = $6,300
where C = the operating cost of the car during the holding period
BP = the percentage of business use (see s 10(2)), and
R= the recipient’s contribution.
102
Therefore, the grossed-up taxable value is $6,300 × 2.0802 = $13,105, and the FBT is
$13,105 × 47% = $6,159.35.
It should be noted that as the car is leased, it is not necessary to include depreciation and an
imputed interest charge in the operating costs.
[¶30-072] Solution 72
Expense payment benefit; entertainment
allowance
The entertainment allowance is assessable income under either ITAA97 s 6-5(2) or s 15-2.
The reimbursement of telephone expenses is an expense payment benefit (FBTAA s 20) and
is subject to FBT. The taxable value may be reduced to the extent that the reimbursement
relates to an amount which would otherwise be deductible (s 24).
The reimbursement of the private calls would be subject to FBT. However, the $80 relating to
business calls would be subject to the ‘otherwise deductible’ rule and, assuming the
substantiation provisions are complied with, would not be subject to FBT.
Assuming the employer is able to claim an input tax credit for the telephone expenses, the
gross-up rate would be 2.0802.
The grossed-up taxable value would then be $200 × 2.0802 = $416.04 for the private calls.
The FBT payable on the benefits is $416.04 × 47% = $195.53.
[¶30-073] Solution 73
Loan fringe benefit; ‘otherwise deductible’
rule
The low-interest loan would be a loan fringe benefit under s 16. The taxable value is the
difference between a notional amount of interest (at a statutory interest rate) and any interest
accruing on the loan (s 18). Because the loan is the provision of a financial benefit, the
interest is not subject to GST and the gross-up rate is 1.9608. Therefore, as the statutory rate
for the FBT year beginning 1 April 2018 is 5.2% (see Taxation Determination TD 2018/2),
the grossed-up taxable value would be:
$75,000 × (5.2% − 3.2%) × 1.8868 = $2,830.20
*As it is a financial benefit it is a Type 2 benefit and the gross-up rate is 1.8868.
$75,000 × 2% × 1.8868 = $2,830.20 for the year ending 31 March 2019.
103
However, to the extent that $20,000 of the loan is used to buy income-producing property, s
19 allows a reduction in the taxable value based on the ‘otherwise deductible’ rule.
Therefore, the grossed-up taxable value of the loan benefit is:
($75,000 − $20,000) × 2% × 1.8868 = $2075.48
The FBT is: $2075.48 × 47% = $975.47
[¶30-074] Solution 74
Residual fringe benefit
(1)
The trip to Cairns could either be an expense payment benefit (s 20) or a property fringe
benefit (s 40). An expense payment benefit arises where an employer pays or reimburses
expenses paid by an employee. However, as the employer has provided a benefit in the form
of property being an airline ticket, it may also be a property benefit.
As the employer would be able to claim an input tax credit in respect of the benefit, the gross-
up factor would be 2.0802. Therefore, the taxable value would be $2,000 × 2.0802 =
$4,160.40, and the FBT is $4,160.40 × 47% = $1,955.38.
(2)
If the trip to Cairns is related to work activities, and assuming there is no entertainment or
private element in the trip, the amount would not be subject to FBT and the employer would
be able to claim a deduction for the expenses incurred. There would be no sum assessable to
Wilson.
[¶30-075] Solution 75
Living away from home allowance benefit;
travel for overseas employees
(1) Living away from home allowance
(LAFHA)
As Wilson was posted to London, it would be assumed that he is living away from home and
has satisfied the requirements under s 31F by way of a declaration to the employer that he is
living away from home.
A fringe benefit is provided where an employer pays an employee an allowance to

compensate for extra expenditure incurred while living away from home (s 30). This may be
104
contrasted with a situation where the employee is temporarily away from home for a short
period. Generally, if an employee is away from home for less than 21 days the allowance
would be seen as a travelling allowance and subject to tax in the employee’s hands as income
(see Miscellaneous Taxation Ruling MT 2030).
The taxable value of any LAFHA is the amount of the fringe benefit reduced by any exempt
accommodation component and any exempt food component. However, there are certain tests
to be satisfied to determine eligibility under s 31. In particular:
•
the employee must maintain an Australian home (s 31C)
•
the fringe benefit can only relate to all or part of the first 12 months that the employee is
required to live away from home (s 31D), and
•
the employee must comply with certain declaration requirements (s 31F).
Note that there are also eligibility requirements for employees on a fly-in, fly-out or drive-in,
drive-out basis of employment (s 31E).
For Wilson to receive the benefits of a LAFHA concession concerning the exempt
accommodation and exempt food components, he must comply with the substantiation
requirements in s 31G. However, under s 31 the taxable value of any LAFHA is the amount
of the LAFHA reduced by the exempt accommodation component and the exempt food
component.
While the amount spent on accommodation is exempt, the exempt food component is
determined under s 31H.
Under s 31H the exempt food component is the amount of the allowance reduced by the
applicable statutory food total. The applicable statutory food total is the total of the statutory
food amounts for family members reduced by any amount that might be reasonably expected
to be their total food costs had they remained living at their normal residence.
The reasonable food component for an adult is outlined in Taxation Determination TD

2018/3. For one adult who is posted overseas to London it is $437 per week. Where there is
more than one adult or children the reasonable food amount is adjusted as outlined in the
determination.
The taxable value under s 31 is the amount of the allowance reduced by the exempt
accommodation component and the exempt food component.
Under s 136(1), the exempt accommodation component is the amount spent on

accommodation, as substantiated under s 31G. However, the exempt food component has the
meaning given to it under s 31H.
As the LAFHA was to cover accommodation and Wilson’s increased food costs the amount
of the allowance to cover his accommodation would be exempt. However, it is necessary to
determine whether the amount of the allowance related to the increased food costs is within
the limits of what is determined to be reasonable.
105
On the basis of Taxation Determination TD 2018/3, the reasonable food component for one
adult living in London is $437 per week. This amounts to $5,681 for the 13 weeks.
Therefore, the taxable value of the food component which is excessive is:
This is a Type 2 benefit, and the FBT would be:
(2) LAFHA as a fringe benefit

If the posting is extended for six months, the amount received as a LAFHA would be a fringe
benefit. However, the amount spent on accommodation would be an exempt benefit. The
exempt food benefit would be determined on the basis outlined above.
The return flight home would be a property or residual benefit.
Where an employee is posted overseas and is provided with travel for a holiday, the taxable
value is reduced by 50% (s 61A) based on the cost of an economy airfare back to Australia.
However, where the travel is to the employee’s home country for a holiday, the taxable value
is reduced by 50% of the actual travel costs (if this exceeds the cost of an economy airfare).
Since Wilson’s travel was to his home country, the benefit is reduced by 50% to $1,000.
International travel is not subject to GST. Therefore the gross-up factor is 1.8868.
Consequently, the grossed-up taxable value would be $1,000 × 1.8868 = $1,886.80 and FBT
would be $1,886.80 × 47% = $886.79.
[¶30-076] Solution 76
In-house property fringe benefit
The purchase of a non-portable computer would be an in-house property fringe benefit
(FBTAA s 136(1)). Assuming that it is property purchased for resale, the taxable value is the
arm’s length price paid by that person less any amount paid by the employee (s 42). The FBT
liability would then be based on the grossed-up value of the benefit. However, as the amount
paid by Wilson was more than the cost to Blake Ltd, it would not be subject to FBT.
Where there is a property benefit arising from property that the employer normally sells to
the public, then there is a reduction in the taxable value by $1,000 (so long as the benefit is
not provided by way of a salary sacrifice arrangement s 62).
[¶30-077] Solution 77
106
Residual benefits
As Yourlife Insurance Co Ltd has reimbursed Walker for her membership of Highflier
Airlines frequent flyer program, the $100 is an expense payment benefit (FBTAA s 20) and
the sum would be subject to FBT. As the cost of the frequent flyer membership would
include GST, then Walker’s employer would be able to claim a GST input tax credit for the
reimbursement. The gross-up rate would therefore be 2.0802. The grossed-up taxable value
would be $100 × 2.0802 = $2,080.20. This sum is reduced by an amount which would be
‘otherwise deductible’ to Walker.
The joining fee would have been exempt from FBT if it was a one-off and below the $300
threshold for minor benefits (s 58P) or where the membership had resulted from aircraft
lounge membership (s 58Y).
The value of the trip to Cairns will not constitute a fringe benefit as defined by s 136 because
the benefit was not provided by the employer, an associate of the employer, or any person
who has made an arrangement with the employer or associate of the employer.
For Walker to be assessed on the value of the benefit received, the benefit must arise either
directly or indirectly out of an employer-paid transaction; the benefit must be capable of
being transferred to another person; and the benefit must be used for private purposes.
As the benefit was not provided by the employer (or associate), the benefit arising from the
conversion of the frequent flyer points does not come within the definition of a fringe benefit.
Taxation Ruling TR 1999/6 confirms this view and also states that such benefits do not
constitute assessable income in the taxpayer’s hands under ITAA97 s 6-5(2) or s 15-2.
However, if the benefit arises because of a business relationship between the provider and the
employer it is likely to be included as assessable income under ITAA97 s 6-5 or s 15-2.
The facts of this question should be contrasted with the facts in Payne v FC of T 96 ATC
4407. In Payne’s case the taxpayer applied to join the airline’s frequent flyer program and
personally paid the membership fee without receiving any reimbursement from her employer.
Although the free flights provided to Payne for use by her parents under her frequent flyer
scheme were from points accrued from employer-paid work-related travel, the Court held that
the reward tickets and benefit received were not assessable to the taxpayer under either
ITAA97 s 6-5(2) or ITAA36 s 26(e) (s 26(e) has been repealed and replaced with s 15-2).
ITAA97 s 6-5(2) did not apply, because as the tickets were not transferable, and could only
be used by Payne or members of her family, they were not money or convertible to money.
ITAA36 s 26(e) also did not apply, as Payne was provided with the tickets because she was
entitled to them under the frequent flyer program rather than as a result of her employment.
Note that Payne’s employer did not pay for her to participate in the frequent flyer scheme and
therefore did nothing to provide the benefit.
[¶30-078] Solution 78
107
Employee test
It is important to determine whether the person is an employee or contractor. FBTAA s
136(1) states that employee means a current, future or former employee. However, current
employee is defined as a person who receives or is entitled to receive wages. Consequently,
where an employee receives salary or wages which are subject to the PAYG provisions as
salary or wages (TAA Sch 1 s 10-5(1)), they would come within the definition of employee
for FBT. It seems that employee under the PAYG provisions means employee at common
law (Taxation Ruling TR 2005/16).
Taxation Ruling TR 2005/16 ‘Income tax: Pay As You Go—withholding from payments to
employees’ provides some guide as to when an employee is an employee and not a
contractor.
Some of these factors are:
(a)
the terms and conditions in the contract
(b)
the degree of control exercised over the person undertaking the work
(c)
whether the worker operates on their own account or in the business of the taxpayer
(d)
whether the nature of the contract is to achieve a required result
(e)
whether the work can be delegated
(f)
whether the worker bears the risk or liability for any work performed.
As noted above, the ruling indicates that an employee relationship requires the person
performing the work for the other to be substantially subject to the control and direction of
the other person. The presence of a right to control how, where, when and who is to carry out
particular work points strongly to employee status (the ‘control test’).
If the control test is inconclusive, then a person can be regarded as an employee where her or
his activities are integrated into the principal’s business organisation. A ‘consultant’ satisfies
the integration test if the relationship with the principal is a continuing one, or if the
consultant’s activities are restricted to providing services for one principal, or the benefits
arising from the work flow to the principal rather than the consultant.
There is some uncertainty in the case law on the issue. This has been clarified somewhat by
the High Court decision in Hollis v Vabu Pty Ltd 2001 ATC 4508, which confirmed the view
that bicycle couriers were common law employees.
While the control test remains a relevant criterion and is still the appropriate test to apply in
the first instance, it is not the sole criterion. Following the High Court decision in Stevens v
Brodribb Sawmilling Co Pty Ltd (1986) Aust Torts Reports ¶80-000; (1986) 160 CLR 16, it
seems that the Court should examine the totality of the relationship between the parties.
Mason J said (at Aust Torts Reports 67, p 446; CLR 24):
108
‘the existence of control, while significant, is not the sole criterion by which to gauge
whether a relationship is one of employment. The approach of this Court has been to regard it
merely as one of a number of indicia which must be considered in the determination of that
question … Other relevant matters include, but are not limited to, the mode of remuneration,
the provision and maintenance of equipment, the obligation to work, the hours of work and
provision for holidays, the deduction of income tax and the delegation of work by the
putative employee.’
Application of these principles to the facts of each case in the question results in the
following conclusions.
(1) Cosmetic product consultants

The facts given in this question are based on the case Commr of Pay-roll Tax (Vic) v Mary
Kay Cosmetics Pty Ltd 82 ATC 4444, where it was held that the consultants were
independent contractors. As the consultants were not required to do anything and were not
under any obligation to remain active, the element of control was not present. Further, the
agency agreement did not oblige the consultant to comply with any provisions in the sales
manual. The only stipulation was that if a beauty consultant did not place an order for
products having a retail value of $200 every 90 days, then the agreement terminated. The
integration test was not helpful in this case, because on the one hand, as the consultants were
employed part-time and free to work as much or as little as they pleased, they were not
integrated into the taxpayer’s business, yet on the other hand the taxpayer was entirely reliant
on the consultants to sell its product.
The facts in the Mary Kay Cosmetics case should be contrasted with the facts in Narich Pty
Ltd v Commr of Pay-roll Tax (NSW) 82 ATC 4359, where the ‘lecturers’ who conducted
Weight Watchers classes did so by the lecturers’ handbook and were required to sign a
written agreement which read: ‘If the lecturer fails or refuses to carry out her duties or
obligations as a lecturer in a proper manner or the weight of the lecturer exceeds her goal
weight the company may terminate her engagement without notice’. In the Narich case the
consultants were held to be employees for pay-roll tax purposes.
(2) Part-time interviewers engaged by a

research company
The provision of materials, the strict requirements not to depart from those materials, the
prohibition on delegation and the prohibition from performing other work while on an
assignment, all signify a degree of control over the interviewer and point to an employer–
employee relationship. Further, in a case based on similar facts, the interviewers were not
conducting their own businesses when they accepted assignments, but were performing their
tasks as part of the business which engaged them (Roy Morgan Research Centre Pty Ltd v
Commr of State Revenue (Vic) 97 ATC 5070).
(3) Couriers engaged by a courier company

109
Based on the High Court decision in Hollis v Vabu Pty Ltd 2001 ATC 4508, which held that
the bicycle couriers were common law employees, it would seem that bicycle couriers are
employees for the purposes of ITAA97. Although the decision related to a claim for injuries
and was a civil case, the outcome is still relevant in determining who is an employee for
taxation purposes.
The facts in the case revealed:
•
the lack of discretion for couriers to accept or reject work
•
the identification of the courier with the business of the courier’s firm
•
the administration of pay and conditions, consistent with an employment relationship
•
the provision of equipment (ie a bike), consistent with an employment relationship, and
•
the scope for actual exercise of control by the courier firm over the individual couriers’
performance of their activities.
It would seem that where couriers are employed in a similar situation, they are likely to be
regarded as employees and not contractors for the purposes of the PAYG provisions. This
view has been confirmed by a fact sheet published by the ATO in 2003 (‘PAYG withholding
guide no 2—How to determine if workers are employees or independent contractors’).
Consequently, employers of bicycle couriers would be required to withhold payments from
‘wages’ based on the PAYG provisions.
Although the case related to couriers, the wider ramifications in other situations should not be
ignored. In particular, employers would need to assess their Superannuation Guarantee
obligations.
The courts have distinguished between payments made to persons engaged to produce a
given result (held not to be a salary or wage) and payments made to a person engaged under a
contract of service (held to be a salary or wage). It would seem that Hollis v Vabu Pty Ltd
2001 ATC 4508 has largely resolved this issue by stating that couriers are common law
employees. Certainly the Commissioner has adopted this view.
See also Neale v Atlas Products (Vic) Pty Ltd (1955) 94 CLR 419; World Book (Australia)
Pty Ltd v FC of T 92 ATC 4327.
[¶30-079] Solution 79
Employee benefits, expense payment
benefits, ‘otherwise deductible’ rule,
LAFHA and property benefits
110
(1)
The reimbursement is an expense payment fringe benefit (FBTAA s 20).
The taxable value of the fringe benefit is subject to the ‘otherwise deductible’ rule (s 24). The
taxable value ($400) is reduced by the ‘notional deduction’ as defined. That is, as Phillips
would have obtained a deduction for the $400 if he were not reimbursed, the taxable value of
the fringe benefit is reduced to nil.
(2)
$600 is an expense payment fringe benefit (s 20(a)).
The taxable value of the fringe benefit is reduced by the recipient’s contribution (s 23). The
recipient’s contribution is defined in s 136(1) as the amount paid by the employee in respect
of the provision of the fringe benefit, ie $200.
The taxable value before application of the ‘otherwise deductible’ rule is $400. As the
amount that would be deductible to Phillips if he had incurred the expense himself is $300,
the taxable value of the fringe benefit is therefore $100.
Where the employer is able to claim a GST input tax credit for part of the telephone bill, the
gross-up rate would be 2.0802. Therefore the $100 benefit (after consideration of the
otherwise deductible rule and the amount contributed by Phillips) would be grossed up by
2.0802. (It should also be noted that the contribution by the employee is a taxable supply and
is subject to GST.) Consequently, the grossed-up taxable value and FBT payable is:
(3) As Phillips owns his own car and the company reimburses the ‘car expenses’ on a cents
per kilometre basis, the amount of the reimbursement is included as assessable income to
Phillips under ITAA97 s 15-70. The amount of assessable income under s 15-70 ITAA 36
would be $2,800.
Where Phillips receives a car allowance, it is included in the definition of salary and wages in
s 136(1) and TAA Sch 1 s 12-35. Salary and wages are excluded from being fringe benefits
by para (f) of the definition of ‘fringe benefit’ in FBTAA s 136(1). Therefore, ABD gets a
deduction under ITAA97 s 8-1 for the $2,200 allowance as a cost of employment; FBT is not
applicable. However, Phillips should include the $2,200 allowance in his assessable income
pursuant to ITAA97 s 15-2. ABD is required to deduct PAYG tax instalments from the
allowance before payment to Phillips. Phillips can claim deductions for business travel
expenditure, subject to the substantiation requirements (ITAA97 Div 900). Alternatively, as
his business travel is less than 5,000 km, his deduction may be calculated on a cents per
kilometre basis without the need to maintain substantiation documents.
(4)
$750 is an expense payment fringe benefit the taxable value of which is subject to the
‘otherwise deductible’ rule (FBTAA s 24). Each item is looked at separately. The conference
registration costs would not be capital in nature and thus are subject to the ‘otherwise
deductible’ rule. The travel and accommodation costs would also be deductible to Phillips;
consequently, no FBT would be payable.
111
It should be noted that as the travel to Sydney was for less than six nights and the purpose of
the trip was solely business, Phillips does not have to maintain travel records, although
written evidence of expenditure must be obtained. The benefit may also be an exempt benefit
where it is covered by a ‘no private use declaration’ under s 20A. This occurs where the
employee declares that there is no private benefit in respect of the benefits provided due to
the work-related nature of the reimbursement.
(5)
The $1,000 per week is a living away from home allowance (LAFHA) under FBTAA s 30. It
should be noted that from 1 October 2012 changes to the LAFHA system apply to any
LAFHA benefits provided to from that date (see solution to Question 75 and note (4) in the
‘Notes’ section at the beginning of this topic). In particular, the taxable value of any LAFHA
is the amount of the fringe benefit reduced by any exempt accommodation component as
defined in s 136(1) and any exempt food component defined in s 31H.
As the allowance is to cover increased food costs while living away from home, there is no
adjustment to the ‘applicable statutory food total’ in s 31H(2) which reduces the exempt food
component by any amount that the taxpayer might reasonably be expected to have spent on
food had they remained at home. However, there are tests to determine eligibility under s 31
(see solution to Question 75).
Rental costs
As the $800 per week relates to rent only, the taxable value of the LAFHA is reduced by this
amount, being the exempt accommodation component.
Food costs
The exempt food component is $265 per week. Therefore no FBT will be payable on the
remaining $200 that is available to cover Phillips’ increased food costs (see Taxation
Determination TD 2018/3).
The exempt food and accommodation components need to be substantiated (s 31G) and a
declaration must be made to the employer verifying the fact the taxpayer maintains a home in
Australia (s 31C). Furthermore, this concession only applies for a maximum of 12 months (s
31D).
(6)
It is assumed that the goods purchased and sold as part of the employer’s business constitute
an ‘in-house property fringe benefit’ (s 42) and that the discounts are given on ABD’s normal
sale price. Under s 42 the taxable value of an in-house property benefit is the lower of the
cost to ABD and the arm’s length price the employee would expect to pay.
$
(a) Normal sale price of books sold to Phillips
under the staff plan = 2,142.86
Cost to ABD (s 42(1)) 2,142.86/1.25 1,714.29
Less: Amount paid by Phillips (1,500.00)
112
TAXABLE VALUE OF FRINGE BENEFIT 214.29
(b) Normal sale price of books sold to Phillips
under the executive plan = 5,000.00
Cost to ABD (s 42(1)) 5,000/1.25 4,000.00

Less: Amount paid by Phillips (2,500.00)
TAXABLE VALUE OF FRINGE BENEFIT 1,500.00
Taxable value of benefit on book purchases 1,714.29
Exempt component (first $1,000: s 62) (1,000.00)
TAXABLE VALUE OF FRINGE BENEFIT 714.29
If the employer is able to claim a GST input credit on the books sold to the employee, the
gross-up rate is 2.0802 and therefore the grossed-up taxable value is 2.0802 × $714.29 =
$1,485.86 and the FBT is $698.35.
(7)
Based on Taxation Determination TD 95/63, the taxable value of the benefit is the residual
payment less any employee contribution. This follows the decision in Granby v FC of T 95
ATC 4240. Since Phillips has not paid any consideration for the vehicle, the taxable value of
the property fringe benefit based on the residual price is $15,000. The grossed-up taxable
value is therefore $15,000 × 2.0802 = $31,203 and the FBT is $14,665.41.
(8)
If the statutory formula method in s 9(1) is used:
The grossed-up taxable value is $12,000 × 2.0802 = $24,962 and the FBT is $11,732.32.
(As a GST input credit can be claimed on the car, it is a Type 1 benefit and the gross-up rate
is 2.0802.)
If the operating cost method is used, the taxable value is determined by:
C × (100 − BP) − R
where C = the operating costs
BP = business percentage
R= contribution by employee
An opportunity cost related to the imputed interest on the funds used to purchase the car
should also be included. For the FBT year beginning 1 April 2018, the rate of interest is 5.2%
per annum (TD 2018/2). Therefore, the imputed interest is $60,000 × 5.2% = $3,120 (based
on the market value of the car).
Total costs are: ($21,250 + 1,200 + Imputed interest $3,120) = $25,570
113
Adjusting for the Business/private use
$25,570 × (100% – 8,000/18,000) – 0 = $14,205.55
As a GST input credit can be claimed, the grossed-up taxable value is:
$14,205.55 × 2.0802 = $29,550.38 and the FBT is $29,550.38 × 47% = $13,888.69.
(9)
On the basis that the trip was for the purpose of attending the sales conference, and that
Phillips is carrying out his duties as an employee while travelling, the cost of his trip (except
that part, being $250, relating to entertainment for himself) is not subject to FBT.
The taxable value of the entertainment provided to Phillips is $250 (assuming that this is not
meal entertainment), the grossed-up taxable value is $471 ($250 × 1.8868; no GST input
credits are available as no Australian GST would be payable in New York), and the FBT
payable is $221.69.
However, the costs of the trip that are attributable to his wife are deductible (ITAA97 s 26-
30) but would be regarded as an expense payment benefit (FBTAA s 20) and subject to FBT.
If it is assumed that half the costs were attributable to Phillips’ wife, the grossed-up taxable
value is $6,000 × 1.8868 = $11,320.08, and the FBT payable is $5,320.77. (As the trip was
overseas, no GST would be payable, and the gross-up rate would be 1.8868.)
It may be argued that the accommodation component does not provide a benefit to Phillips’
wife as there is no incremental cost incurred in respect of another person staying in the room.
If this argument is successful, the taxable value of the benefit provided to Phillips’ wife is
reduced by the accommodation component, which is $2,500.00.
[¶30-080] Solution 80
Employee benefits; miscellaneous
Airfare and overnight accommodation
The cost of flying Mary to Sydney for the job interview and providing her with overnight
accommodation is an exempt benefit under FBTAA s 58E.
It should be noted, however, that the definition of employee in s 136(1) includes past, present
and future employees. Therefore, other benefits provided by Empress Ltd to Mary prior to her
becoming an employee may come within the scope of the FBT provisions.
Mary’s salary
The annual salary of $84,000 is assessable income and assessable to Mary under ITAA97 s 6-
5. It is not subject to FBT.
114
Toyota Corolla and other car benefits
(i)
Toyota Corolla
The provision of the Toyota Corolla would be a car fringe benefit under s 7(1). The taxable
value of the car is determined by use of either:
•
the statutory formula method—s 9(1), or
•
the operating cost method—s 10(2).
As the car is provided by means of a lease agreement, which includes GST on the lease
payments, there is a Type 1 benefit and the gross-up factor is 2.0802.
However, as the car has only been provided for a period of six months or 26 weeks, the
number of kilometres travelled needs to be annualised to determine the relevant statutory rate
(s 136(1)). In this case the annualised number of kilometres is 14,000 and the statutory rate is
20%.
The statutory formula method applies unless the taxpayer elects otherwise or it produces a
lower taxable value than the operating cost method. Using the statutory formula, and having
regard to the recent amendments to s 9(1), the taxable value of the car benefit would be
determined as:
where:
• the statutory rate = 20%
• the base value of the car = $25,000
• the number of days the car was provided to the employee = 183
• the number of days in that year of tax = 365, and
• the amount of the recipient’s payment = NIL.
The grossed-up taxable value is $2,500 × 2.0802 = $5,200.50.
FBT liability under the statutory formula method is $5,200.50 × 47% = $2,444.23.
Since there are no details of a log book, the operating cost method can be used but the
component BP in the formula will be taken to be 0%. Therefore, in order to calculate the
taxable value under this method, we would need to know the other operating costs. However,
since the lease payments alone are greater than the taxable value calculated using the
statutory formula method, any choice to use the operating cost method would be voided by s
10(5).
(ii)
Use of car park
115
As there is no commercial car park within one kilometre of Mary’s employment, the
provision of a car park does not qualify as a car parking benefit under s 39A. However, if a
commercial car park was available within one kilometre of her work premises and Empress
qualifies as a small business employer (see Division 328ITAA97), the provision of the car
park may be an an exempt fringe benefit under s 58GA see ID 2002/25.
Relocation allowance
The relocation allowance is assessable income to Mary under ITAA97 s 15-2. It does not
qualify as an exempt benefit under the provisions of s 58B, 58F and 61B as it is an allowance
and not a payment by Empress Ltd of the expenditures or a reimbursement to Mary.
Therefore, the relocation allowance is not subject to FBT.
Temporary accommodation
The cost of temporary accommodation for a reasonable time period upon relocation is an
exempt benefit. Since the period was only four weeks, this would be exempt under s 61C.
Financial Review newspaper

The provisions of newspapers relevant to the employer’s job are exempt from FBT under s
58H.
Therefore, Empress Ltd should be advised that FBT liability ($2,444.23) arises only in
respect of the Toyota Corolla provided to Mary.
[¶30-081] Solution 81
Employee benefits; miscellaneous
Return airfare to India
The provision of a return airfare to India to an employee of the airline (including his wife)
would be an in-house property fringe benefit under FBTAA s 40 or an in-house residual
benefit under FBTAA s 45. Where the benefit is provided to an employee of an airline the
taxable value is determined by s 42.
The taxable value of the benefit is 75% of the stand-by value of the benefit. Under s 42(1),
the stand-by value of an international trip is 50% of the lowest published economy fare.
As the lowest published fare is $1,800 the taxable value would be 75% of the stand-by value.
The stand-by value is 50% of the lowest of any carrier’s single economy airfare.
Consequently, the taxable value is 75% × ($1,800 × 50%) = $675.
116
However, there would be an exemption of $1,000 under s 62 so that the taxable value of the
benefit would be nil.
Gold watch
The receipt of the gold watch would only be a fringe benefit if it was provided to Venka by
his employer, an associate of the employer or a third party under an arrangement with the
employer or an associate of the employer. On the facts, that is not the case. As a result, the
question arises as to whether it is a gift in return for services by Venka to the travel agency or
for his personal qualities (Hayes v FC of T (1956) 96 CLR 47; Scott v FC of T (1966) 117
CLR 514). If it was in respect of services, the benefit may be included as assessable to Venka
under ITAA97 s 15-20. However, the taxable value is only the value of the benefit to the
taxpayer. Consequently, this may not be equal to the market value of the watch.
Trip to Cairns
The trip to Cairns would be an expense payment benefit, as the cost of the conference was
paid for by the employer. However, under s 24 the taxable value is reduced where the benefit
is work-related due to the operation of the otherwise deductible rule. The cost to Venka of
keeping up to date in his profession would normally be an allowable deduction under
ITAA97 s 8-1 (see FC of T v Finn (1961) 106 CLR 60).
Emergency assistance
The emergency assistance would be an exempt benefit under s 58N.
Frequent flyer points

The use of the frequent flyer points would not be a fringe benefit if the points accrued to
Venka under an arrangement between Venka and the airline providing the points, ie under an
arrangement in which Venka’s employer had no involvement (see Taxation Ruling TR
1999/6).
However, if Venka’s employer was part of the arrangement, then a nexus between the
employer and the employee would exist in relation to the benefit provided.
[¶30-082] Solution 82
Non-cash business benefits
There is no employee/employer relationship between the parties and therefore FBT is not
applicable. However, ITAA36 s 21A relating to non-cash business benefits should be
considered.
117
The tax implications for Hi-Tech Ltd of alternative purchase options include:
(1) 15% discount on normal price

ITAA36 s 21A does not apply where the parties are dealing at arm’s length, and it is normal
for such a discount to be offered on the normal price.
Retail value $50,000

Purchase price* $42,500
Net discount 15%
*Available as a deduction over the estimated useful life of the forklift (ie depreciation:
ITAA97 s 40-25).
(2) 10% discount and a safety guard

Where the taxpayer receives a non-cash business benefit, ITAA36 s 21A(2) states that the
benefit shall be brought to account at its arm’s length value (reduced by the taxpayer’s
contribution). ITAA36 s 21A(5) states that the arm’s length value is the amount the recipient
could have been expected to pay where the parties were dealing at arm’s length.
Consequently, where discounts of 10% are normally offered to customers, the arm’s length
value of the forklift is $45,000 and there would be no benefit. However, the safety guard
would be assessable at the arm’s length value. Therefore, while the retail value of the guard
may be $6,000 if the parties are dealing at arm’s length, and it is normal to offer a discount of
10% on such items, the assessable amount would be $5,400.
Hi-Tech would be entitled to deductions of $45,000 for decline in value over the effective life
of the forklift, and $5,400 over the effective life of the guard if the guard was a separate
depreciating asset. If the guard is part of the forklift, Hi-Tech is entitled to a decline in value
deduction for $50,400 over the effective life of the forklift.
(3) Travel voucher

Although there is a non-cash business benefit the amount is not deductible to the provider by
virtue of ITAA36 s 21A(4). Consequently, the $5,000 is not assessable to Hi-Tech.
(4) Omega watch

In each case, the watch would represent a non-cash business benefit for the purposes of
ITAA36 s 21A. However, since the benefit is received as an inducement to purchase an item
of plant, ITAA36 s 51AK would apply and the depreciable value of the forklift would be
reduced by $1,500.
[¶30-083] Solution 83
118
Car benefit; superannuation; property
benefit
Motor vehicle
As a commercial traveller, Brown would incur travel expenses incidental and relevant to the
earning of his salary. These expenses would be deductible under ITAA97 s 8-1(1) and may
include the cost of meals and hotel expenses where the employer does not reimburse them.
Brown is provided with a fully maintained company car to carry out his employment duties.
Despite the fact that the car is an essential requirement to carry out his duties as an employee,
it is a fringe benefit because it is available to Brown for private use.
The taxable value of the motor vehicle fringe benefit can be calculated under either of the
following methods:
(1)
the statutory formula method, or
(2)
the operating cost method.
The statutory formula method (s 9(1))

The taxable value is determined by the following formula:
•
The statutory rate is 20%.
•
The base value of the car is $22,500.
•
Assume the car was available for private use all year.
•
Assume that Brown’s contribution was nil.
As a GST input tax credit is available on the car, the gross-up rate is 2.0802 for the period
from 1 April 2018 to 31 March 2019.
The FBT is $9,360.90 × 47% = $4,399.62.
Actual operating cost method (s 10(2))

119
•
The running costs are $8,000 per year plus imputed interest (5.2% of ‘depreciation value’ of
vehicle, ie $22,500 × 5.2% = $1,170) plus imputed depreciation (25% of ‘depreciated value’
of vehicle, ie $22,500 × 25% = $5,625).
The depreciation is based on an effective life of the car of eight years. The depreciation is
based on the diminishing value method, where the diminishing value percentage is 2.
Therefore the total running cost is:
$8,000 + $1,170 + $5,625 = $14,795
•
Percentage private use is: 5,000/20,000 = 25%.
•
Assuming total running costs are $14,795, the taxable value of the fringe benefit is:
$14,795 × 25% =$3,699
As a GST input tax credit may be claimed on the car expenses, the gross-up factor is 2.0802.
The grossed-up taxable value is therefore $3,699 × 2.0802 = $7694.65.
The statutory formula method applies unless the taxpayer elects otherwise or the statutory
formula method produces a lower taxable value. However, as the operating cost method in
this case is a lower taxable value, Oceanfilms is likely to choose this method. Consequently,
the fringe benefits tax payable would be:
$7,694.65 × 47% = 3,616.49
The employer may choose either method to calculate the FBT liability. There is no
requirement to use the same method on each car provided. However, unless the taxpayer
elects otherwise or the statutory formula method produces a lower taxable value, it is
assumed that the taxpayer is using the statutory formula method.
Entertainment allowance
An ‘allowance’ is included in the definition of salary and wages in FBTAA s 136(1) and
TAA Sch 1 s 12-35 and is therefore excluded from the definition of a fringe benefit under
FBTAA s 136(1). The allowance will be assessable income of the employee under ITAA97 s
6-5(4) or s 15-2.
The allowance is deductible to the employer provided the employee includes the allowance in
assessable income. PAYG amounts must be withheld from the allowance. The employee will
generally be precluded from claiming entertainment expense deductions under ITAA97 s 32-
5.
Superannuation
120
The definition of ‘fringe benefit’ (FBTAA s 136(1)) specifically excludes superannuation
contributions as long as they are made to a complying superannuation fund.
Overdraft facility
This would be a loan fringe benefit under s 16.
Average balance = $8,000.
Assume interest on average balance at 3.7% equates to actual interest incurred (that is, ignore
compounding factor). Interest incurred is 3.7% × $8,000 = $296.
The taxable value of the benefit under s 18 is determined by reference to a notional rate of 5.2
% (see Taxation Determination TD 2018/2):
Therefore the taxable value of the overdraft is:
(Benchmark rate of 5.2% less concessional rate of 3.7%) =$8,000 × 1.5% =$120
Taxable value of the loan fringe benefit: $120.
As the loan is a provision of a financial service, no GST is payable, and the gross-up rate
remains at 1.8868. The grossed-up taxable value is $120 × 1.8868 = $226.41.
FBT is $226.41 × 47 % = $106.41.
‘In-house’ benefit provided

This is a property benefit under s 40 and under the definition in s 136(1) it would be regarded
as an ‘in-house’ benefit. Assuming that Oceanfilms purchases the property for resale and is
not a manufacturer, the taxable value under s 42 is the arm’s-length price less the amount
paid by the employee.
$ $
Normal sale price of camera and film equipment (800) 1,333
(0.6)
Cost price of camera and film equipment to employer 1,333\1.3 1,025
(1,025 − 800)
Taxable value is cost to employer less amount paid by Brown
= $255
Less: exemption component (1,000)
Taxable value of fringe benefit NIL
Liability for fringe benefits tax
Oceanfilms Ltd’s liability for FBT is:
FBT on motor vehicle 3,616.49
FBT on overdraft facility 106.41
FBT LIABILITY $3,722.90
121

[¶30-084] Solution 84
Car benefit; expense payment benefit;
residual benefit
The salary of $85,000 is not subject to FBT. It is not a ‘fringe benefit’ under s 136(1); it is
regarded as income under ITAA97 s 6-5(2).
The entertainment allowance of $4,000 is included in the definition of salary and wages in
FBTAA s 136(1) and TAA Sch 1 s 12-35, is excluded from being a fringe benefit, and is
assessable income under ITAA97 s 6-5(2).
The provision of a motor vehicle is a fringe benefit under FBTAA s 7(1). As a GST input
credit may be claimed, the gross-up rate is 2.0802.
(1)
If the statutory formula method under s 9(1) is used, the taxable value is:
(2)
If the operating cost basis under s 10(2) is used, the taxable value is based on actual running
costs plus an imputed interest charge of 5.2% (ie $26,000 × 5.2% = $1,352): $12,750 +
$1,352 × % private use
The grossed-up taxable value is $8,058.28 × 2.0802 = 16,762.83
FBT is $16,762.83 × 47% = $7,878.53
Therefore the statutory method would be used.
The superannuation benefit is not a ‘fringe benefit’ within the definition in s 136(1) if paid to
a complying superannuation fund.
Subscriptions to professional magazines and use of the airport lounge membership are
specifically exempt from FBT (s 58Y). Subscriptions to the professional association are
expense payment fringe benefits subject to the ‘otherwise deductible’ rule (s 24).
The mobile phone is specifically exempt from FBT if the phone is primarily for use in the
employee’s employment (s 58X).
122
On the assumption that the computer is used solely for business purposes while at home, no
FBT would be payable. Although there is an expense benefit payment based on the amount
paid, the taxable value is reduced to nil because of the otherwise deductible rule.
The trip to Hawaii would appear to be a property benefit (s 40) provided to Plum. As it is an
overseas benefit and not subject to GST it is a Type 2 benefit and the gross-up rate is 1.8868.
The grossed-up value is $1,750 × 1.8868 = $3,301.90.
FBT is $3,301.90 × 47% = $1,551.89.
[¶30-085] Solution 85
Property benefit; car benefit
FBT liability for Fashion Clothing Limited for FBT year ended 31 March 2017:
Factory worker—Ms A
Ms A has been provided with an in-house property fringe benefit. As the firm manufactures
the clothing and sells identical property by wholesale, FBTAA s 42(1)(a)(i) applies and the
taxable value of the benefit is determined by reference to the lowest wholesale price of the
goods reduced by Ms A’s contribution.
Taxable value: $2,400 – $1,200 = $1,200

Less: $1,000 exemption per employee (s 62) = $200
The grossed-up value is $200 × 1.8868 = $377.366
FBT is $377.36 × 47% = $177.35
The benefit is a Type 2 benefit (ie the gross-up rate is 1.8868) as Fashion Clothing Ltd
neither acquired nor imported the clothing (FBTAA s 149A definition of ‘GST creditable
benefit’). Manufacturers generally use the Type 2 gross-up rate for items they manufacture.
Accountant—Mr B
Mr B receives a car fringe benefit. As a GST input credit can be claimed, the gross-up rate is
2.0802.
Unless the firm elects to use the operating cost method, FBT will be determined by applying
the statutory formula.
However, as the car has not been held for more than four years at the beginning of the FBT
year, the base value is not reduced to two-thirds of the cost price. See Taxation
Determination TD 94/28.
123
Therefore, under s 9(1) the taxable value is determined as follows:
*Where the statutory rate is 20%.
FBT is $10,983.45 × 47% = $5162.22.
Director/shareholder—Ms C
Unless it is an effective salary sacrifice arrangement, ITAA97 s 6-5(4) would apply, rather
than FBT, as Ms C has directed that income which she would normally have derived as salary
be ‘dealt with on her behalf or as she directs’. In this case Ms C would be assessed on the
$10,000.
If FBT were to apply, the taxable value would be the salary forgone of $10,000 (now
received in the form of an expense payment benefit). The grossed-up value would be $10,000
× 1.8868 = 18,868 and the FBT would be $18,868 × 47% = $8,867.96. (Because the
provision of the loan is a financial service, there is no GST payable. Consequently, the FBT
gross-up rate is 8868 for the period of the loan.)
[¶30-086] Solution 86
Deductions; FBT liability
Deductions available to Didget
•
Salary to Higgins (ITAA97 s 8-1(1))
•
Running costs and decline in value of motor vehicle (ITAA97 s 8-1(1))
•
Entertainment allowance (ITAA97 s 32-30 item 1-8) (the entertainment allowance will
appear on Higgins’ payment summary and be assessable to her)
•
Telephone (ITAA97 s 8-1(1))
•
Subscription to professional association (ITAA97 s 8-1(1))
•
Superannuation contributions (ITAA97 Subdiv 290-B)
•
Decline in value on the television (ITAA97 s 40-25)
•
124
Lease costs of notebook computer (ITAA97 s 8-1(1))
•
FBT paid (ITAA97 s 8-1(1))
FBT liability of Didget

(1)
Car fringe benefit (FBTAA s 7):
(a) Statutory value (FBTAA s 9)
Grossed-up taxable value is $3,600 × 2.0802 = $7,488.72. A GST input tax credit may be
claimed on the car expenses, and the gross-up factor is 2.0802 for the FBT year.
(b) Operating cost method (s 10)
The operating costs comprise:
Depreciation $18,000 × 25% = $4,500

Other running costs = $8,685
Plus (imputed interest charge of (5.2% × $18,000)) = $936
Total running costs are $14,121
Based on a business usage of 70%, the private benefit is 30% of the operating costs.
Therefore, the taxable value is $14,121 × 30% = $4,236.
Grossed-up taxable value = $4,236 × 2.0802 = $8,811.72.
FBT is $8811.72 × 47% = $4,141.50.
(If the car is provided through a lease agreement that is subject to GST, the employer may be
able to claim an input tax credit. Consequently, the gross-up factor after this time for the
provision of a car benefit, using the operating cost method, would be 2.0802. However, there
would be no depreciation charge or imputed interest in calculating the operating costs.)
Didget may elect to use either method. However, the statutory method will be used because
this method provides the lower taxable value (s 10(5)).
(2)
Superannuation contributions paid by the employer to a complying superannuation fund are
not subject to FBT, being specifically excluded from the definition of fringe benefit in s
136(1).
(3)
Telephone expenses: The payment of the telephone expense is an expense payment benefit
and the taxable value is $280. As the telephone expenses are subject to GST, the employer
will be able to claim an input tax credit. Therefore the grossed-up taxable value should be
125
based on a gross-up factor of 2.0802. (As a result, the employer will need to keep adequate
records to enable an appropriate apportionment to be made.)
Grossed-up taxable value is $280 × 2.0802 = $582.45.
FBT is $582.45 × 47% = $273.75.
Taxable value may be reduced if Higgins provides her employer with a declaration detailing
the deductible part of the expenditure. It is unlikely that a reduction will be obtainable for
telephone rental as it is considered a private expense. A reduction is more likely to be made
for telephone costs in the form of calls relating to work. However, if there was a designated
telephone line used only for work purposes then the benefit, in the form of the amount paid
for the rental, would not be a fringe benefit due to the operation of the ‘otherwise deductible’
rule.
(4)
Professional subscription: Professional subscriptions are an exempt benefit (s 58Y).
(5)
Television: If the television remains the property of Didget it is not likely to be taxable to the
extent it is used for work-related purposes. Any private use would be a residual benefit.
If the television is given to Higgins, however, a property benefit is being provided, equal to
the cost of the television. While the television may be used for work purposes, the otherwise
deductible rule does not apply as the cost of the television is not an immediate deduction to
Higgins; rather, it is subject to the depreciation provisions in Div 40 of the ITAA97.
Therefore, an FBT liability of $850 × 2.0802 × 47% = $831.03 would arise.
(6)
USA trip: The benefit is a property benefit under s 40 or a residual benefit under s 45 and is
subject to FBT. The grossed-up taxable value is $3,650 × 1.8868 = $6,886.82, and the FBT is
$6,686.82 × 47% = $3,236.80. (As the travel is external to Australia, no GST is payable on
the benefit. So the 2.0802 gross-up rate does not apply.)
(7)
While the purchase of a notebook computer and transfer of ownership to an employee is
exempt from FBT under s 58X where it is used primarily for work purposes, the provision of
the notebook to an associate of the employee (her daughter) is not exempt. However, it
should be noted that the computer is leased by Didget and provided to Higgins’ daughter.
Therefore, it would be a residual fringe benefit under s 45, provided for 11 months at $100
per month.
As the lease payments are subject to GST, the gross-up factor would be 2.0802. Hence the
grossed-up value of the benefit is 11 × 100 × 2.0802 = $2,288, and the FBT would be 47% ×
$2,288 = $1,075.36.
(8)
$1,000 reduction in the aggregate taxable value of certain fringe benefits: s 62 provides that
the aggregate taxable value of certain in-house fringe benefits is to be reduced by $1,000 per
employee.
126
For the benefit to be an in-house benefit the provider of the property (employer or associate)
must carry on a business of providing identical or similar property to outsiders. In this
question, except for the television, the fringe benefits provided to Higgins do not fall into the
category of in-house benefits. As the taxable value of the television is less than $1,000, no
FBT will be payable on the provision of the television.
Didget’s FBT liability is:
$
Motor vehicle $3,519.69
Superannuation —
Telephone 273.75
Professional membership —
Television —
USA trip 3,236.80
Computer 1,075.36
FBT $8105.60
|
Deductions
[¶30-087] Solution 87
127
Borrowing expenses
ITAA97 s 25-25 provides that a taxpayer may obtain a deduction for expenses incurred in
borrowing money where the money is used to produce assessable income. Expenses of $100
or less may be written off in the first year; however, where the expenses are more than $100,
they are spread over the period of the loan, not exceeding five years.
On this basis, Speedy Transport Ltd would therefore receive a deduction as follows:
commencing from the date on which the money was borrowed. Thus, for the period 1 April to
30 June 2019, the deduction would be $311 (ie 91 days × $3.42 = $311).
[¶30-088] Solution 88
Capital works
The expenditure incurred on the construction would be capital in nature and thus not
deductible under ITAA97 s 8-1(1). However, a capital works deduction would be available at
the rate of 2.5% on the cost of the building, commencing on the day on which the building is
first used for income-producing purposes after completion of construction. The deduction
would be $1,027 computed as follows (s 43-210):
The higher rate of 4% pa applicable to industrial buildings commenced after 26 February

1992 is unlikely to apply to a warehouse, unless the storage is within the premises in which
the company carries on its main activities or in premises adjoining them (s 43-150(b)(v)).
A deduction may also be claimed for any fittings, etc., which are a depreciable asset (ITAA97
s 40-25 and 40-30).
[¶30-089] Solution 89
Bad or doubtful debts
For a debt to be deductible under the provisions of ITAA97 s 25-35, it is necessary that the
debt is bad (not merely doubtful), and has been written off as a bad debt during the year in
which the deduction is sought. A write-off by way of adjustment after the end of the year is
insufficient. The debt must also have been brought to account as assessable income, or relate
to money which has been lent in the ordinary course of a business of lending money by a
taxpayer who carries on a money lending business.
128
For these reasons, the estimated bad debts and estimated doubtful debts would not be
deductible, but the $5,000 written off during the year would be (See Point v FCT 1970 ATC
4021).
[¶30-090] Solution 90
Repairs; maintenance; capital works
In order for a repair to be deductible under ITAA97 s 25-10, it must not be an improvement,
an initial repair, or a repair undertaken to the entirety. (See FC of T v Western Suburbs
Cinemas (1952) 86 CLR 102, Rhodesia Railways Ltd v Bechuanaland Protectorate Income
Tax Collector [1933] AC 368 and Lindsay v FC of T (1961) 106 CLR 377.)
Repairs to the roof of $1,400 appear to be deductible, assuming that the work was only to
part of the roof using materials equivalent to those originally used.
Painting of the surgery, etc. of $2,800 would also be deductible as the expenditure satisfies
the provisions of s 25-10.
Replacement of the vinyl floor of $2,500 would not be a repair; it is the replacement of a
depreciable item—capital expenditure that could be regarded as a repair to the entirety. Paul
Berger could instead claim a deduction under s 40-285(2) equivalent to the difference
between the undeducted cost of the old vinyl flooring and the consideration (if any) received
on its disposal, and claim depreciation on the new flooring (see ID 2002/330).
Resealing the carpark of $7,100 would not satisfy the requirements of s 25-10. It is an
improvement of the entirety and, as such, would be capital in nature and not deductible
outright. However, as the resurfacing is a structural improvement, the capital expenditure can
be written off at the rate of 2½% pa from the date that the carpark is first used for income-
producing purposes (s 43-20(3)(a) and 43-25(1)). Given that this was done on 10 April 2019,
the amount allowable as a deduction in the 2018/19 tax year is $45 computed as follows (s
43-210):
Gardening expenses (eg the removal of a dead tree for $500) would not be regarded as a
repair, but should come within the normal deduction provisions of s 8-1(1) and be fully
deductible to the taxpayer.
[¶30-091] Solution 91
General Deductions; legal expenses; lease
expenses
129
Busy Jeans can claim deductions for the tax year ended 30 June 2019 as follows.
•
Recurrent lease costs incurred by a taxpayer for leasing an income producing property are
deductible under ITAA97 s 8-1 as a normal operating expense.
•
Section 25-20(1)(a) also provides a deduction for any expenditure incurred by a tenant who is
carrying on a business in the preparation, registration or stamping of a lease.
•
The one-off expenditure incurred by way of a lease premium to obtain the lease would be of a
capital nature and not deductible under s 8-1(1) or 25-20. However, the lease premium would
form part of the cost base for CGT purposes (ITAA97 Div 132 s 132-10).
•
The monthly rental is deductible under s 8-1(1) as a normal operating cost necessarily
incurred in carrying on a business (see Tweddle v FCT 1942 180 CLR 1).
[¶30-092] Solution 92
Non-deductible non-cash business benefits
A deduction that is normally allowable to a business taxpayer may be reduced where ‘non-
cash business benefits’ are provided to induce a taxpayer to purchase specific items of plant
or equipment or to receive particular services (ITAA36 s 51AK). If the benefit is a ‘private
benefit’ (ie not to be used solely for the purpose of deriving assessable income):
•
the taxpayer will be treated as having paid the full arm’s length price for the benefit, and
•
the cost of the main item is reduced accordingly.
Thus, April Wong will be treated as having paid $4,500 for the digital camera and $500 for
the gold bracelet. Depreciation for the digital camera under ITAA97 Div 40 will be based on
a cost of $4,500. The deemed payment for the gold bracelet of $500 is not deductible under s
8-1 as it is not incurred for the purpose of gaining or producing assessable income, nor does
the bracelet qualify for depreciation under Div 40 because it is not used for a taxable purpose.
[¶30-093] Solution 93
Tax expenses
In accordance with ITAA97 s 25-5, taxpayers can claim a deduction for expenditure (other
than expenditure of a capital nature) incurred in connection with the management or
administration of their income tax affairs or compliance with obligations imposed by law
relating to another taxpayer’s income tax affairs (Felcetta v FCT 2004 ATC 4514). This
would include the expenses for:
130
•
lodging the 2017/18 income tax return of $500, and
•
preparation and lodgement of an objection to a notice of assessment of $600.
Furthermore, it should be noted that fees paid for professional advice regarding the operation
of the income tax law are only deductible under s 25-5 when paid to a recognised
professional tax adviser (see s 25-5(2)(e)).
The expenditure incurred on GST advice on business arrangements of $400 would not be
deductible under s 25-5 because it does not relate to the income tax affairs of the taxpayer.
However, the expenditure could be deductible under s 8-1(1).
Finally, the expenditure which relates to income tax advice on the creation of the family trust
of $200 would not be deductible, because s 25-5(4) precludes a deduction for capital
expenditure.
[¶30-094] Solution 94
Misappropriation
(1)
ITAA97 s 25-45 allows a deduction for a loss incurred through theft, stealing, embezzlement,
larceny, defalcation or misappropriation by an employee or agent in the year in which it is
ascertained, provided the amount had been included in the taxpayer’s assessable income.
(2)
If a partner had misappropriated the money, a deduction would not be allowed in these
circumstances since the loss would not have been attributable to an employee or agent (s 25-
45(b) Case 15/2004).
[¶30-095] Solution 95
Research and development expenditure
Companies that incur research and development (R&D) expenditure may be able to claim a
tax concession by way of tax offset rather than a deduction. For tax years commencing after
30 June 2011, the R&D tax incentive provides for an ITAA97 s 13-1 tax offset for the
following expenditure:
(1)
R&D expenditure (eg labour, contractors, consumables, services, hired equipment, software
and feedstock inputs to experimental production trials) under s 355-205
(2)
the decline in value of R&D assets (ie tax depreciation on tangible depreciating assets used
partly or exclusively to undertake R&D activities) under s 355-305 and 355-520
(3)
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balancing adjustments for these R&D assets under s 355-315 and 355-580
(4)
R&D expenditure incurred by an associate in an earlier year under s 355-480, and
(5)
R&D expenditure with an unassociated Research Service Provider (RSP) or as a contribution
to a Cooperative Research Centre (CRC) under s 355-580.
The sum of expenditure on the first four items must exceed $20,000 pa to be eligible for the
tax offset. However, there is no minimum expenditure prerequisite for RSP expenditure or
CRC contributions.
Entities with an aggregated turnover of less than $20m that are not controlled by any exempt
entity may be eligible for a refundable tax offset at 43.5% on these expenditures. All other
eligible entities may be entitled to a non-refundable tax offset at 38.5% on these expenditures.
Note: The 2018/19 Budget announced proposed changes to the L&D Tax Offset, which are
contained in the Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair
Share of Tax in Australia and Other Measures) Bill 2018, introduced to the Parliament on 18
September 2018 and not yet enacted at the time of this update.
If enacted, the amendments will apply from 1 July 2018 and will change the way in which the
R&D Tax Offset is calculated, as follows:
•
Small Companies: R&D entities with an aggregated turnover for the income year of less than
$20m will be entitled to a refundable tax offset in respect of their notional deductions at a rate
equal to their corporate tax rate plus a minimum premium of 13.5%. In practice, this means
that base rate entities (subject to the 27.5% corporate rate) will be entitled to an R&D tax
offset calculated at 41% of the total value of their notional deductions, while general rate
entities (subject to the 30% corporate rate) will be entitled to a 43.5% tax offset, calculated in
the same way.
•
Large Companies: R&D entities with an aggregated turnover for the income year of more
than $20m will be entitled to a non-refundable tax offset in respect of their notional
deductions at a rate equal to their corporate rate for the year plus an ‘intensity premium’ of:
–
4% for notional deductions of up to 2% of the R&D entity’s expenditure for the income year;
–
6.5% for notional deductions above 2% and up to 5% of the R&D entity’s expenditutre for
the income year;
–
9% for notional deductions above 5% and up to 10% of the R&D entity’s expenditure for the
income year; and
–
12.5% for notional deductions above 10% of the R&D entity’s expenditure for the income
year.*
Source: Barkoczy, Foundations of Taxation Law, 2019, ¶30.5.
Outboard Ltd, if its aggregated turnover is less than $20m, should be able to claim a
refundable tax offset of $239,250 (ie $550,000 × 43.5%). However, if Outboard Ltd has an
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aggregated turnover of more than $20m, it can only claim a non-refundable tax offset of
$211,750 (ie $550,000 × 38.5%).
[¶30-096] Solution 96
Capital works
Normally, the cost of demolishing the old building of $75,000 for Posit Ltd would be
regarded as capital in nature and thus not deductible under ITAA97 s 8-1(1) (s 8-1(2)). (See
Mount Isa Mines Limited v FC of T 92 ATC 4755.) However, where an eligible building (ie
one which qualifies for a capital works deduction under Div 43) is demolished within its
write-off period, the taxpayer may claim a deduction equal to the amount by which the
unclaimed deduction (undeducted construction expenditure) is greater than any salvage value
(Subdiv 43-H).
The new warehouse for Posit Ltd would qualify as an eligible building and a deduction would
be allowed equal to 2½% of the cost of the building of $3,400,000. This cost would also
include architects’ fees, cost of excavation, etc., but would not extend to demolition costs.
The warehouse is not likely to qualify as an industrial building and attract the higher rate of
4% pa (s 43-150(b)(v)).
The amount which may be claimed by Posit Ltd as a deduction is based on the period during
which, after completion of construction, the building is first used for income-producing
purposes. Assuming that at the time of completion (ie 2 June 2019) it was used to produce
income, a deduction would be allowed (s 43-210) of $3,726, computed as follows:
[¶30-097] Solution 97
Past years’ losses
A tax loss is incurred in any tax year if the taxpayer’s allowable deductions (other than
unrecouped losses carried forward from an earlier year) exceed the assessable income and net
exempt income (if any) of the current year. The amount of the loss is the amount of the
excess (ITAA97 s 36-10).
In terms of Grant Mahogany’s 2017/18 tax year, the tax loss would be calculated as:
$150,000 − ($100,000 + $5,000) = $45,000. The superannuation expenses of $10,000
incurred by Grant during the 2017/18 tax year are ignored because, under s 26-55, a tax loss
cannot be produced or increased by personal contributions to superannuation funds.
For Grant Mahogany’s 2018/19 tax year, his taxable income would be calculated (after
offsetting the 2017/18 prior year tax loss of $45,000 against the 2018/19 net exempt income
of $6,000 as required by s 36-1 to 36-45) as follows:
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$
Assessable income (ie sales) 220,000
Less: allowable deductions—
• business expenses 100,000
• gift expenses 3,000
• superannuation expenses 10,000 (113,000)
Excess assessable income 107,000
2018/19 net exempt income 6,000
Less: 2017/18 prior year tax loss (45,000) (39,000)
TAXABLE INCOME for 2018/19 $68,000
[¶30-098] Solution 98
Entertainment and other expenditure
(1) Entertainment and other expenses
The entertainment expenses of $12,000 would not be deductible under ITAA97 s 32-5 unless
they qualify under s 32-45 as an outgoing incurred by the taxpayer for the purpose of
promoting or advertising to the public, goods or services provided by a business carried on by
the taxpayer, or were incurred in providing a fringe benefit (s 32-20). Such expenditure
should still satisfy the provisions of s 8-1(1) if it is to be deductible; ie there must be a nexus
between the expenditure and the income (see Ronpibon Tin (1949) 78 CLR 47) or the
expenditure must be necessarily incurred in carrying on a business to gain or produce such
income (see FC of T v Snowden & Willson Pty Ltd (1958) 99 CLR 431).
Where such expenditure is on capital account, it would not satisfy the provisions of s 8-1(1).
To the extent that the entertainment expenditure is incurred in launching a new product, it
could be capital in nature if it relates to the business entity or structure (see Sun Newspapers
Ltd & Associated Newspapers Ltd v FC of T (1938) 61 CLR 337). However, if product
launches are frequent and common for the type of business Tasman Ltd operates, it would not
be capital in nature and would be deductible under s 8-1.
(2) Staff motivation expenses

Expenditure of $2,500 on a staff motivation seminar is deductible under s 8-1(1) as
expenditure incurred in carrying on a business. While it may not come within s 8-1(1)(a)
because of the lack of a connection between the expenditure and the income, it would qualify
under s 8-1(1)(b) as expenditure necessarily incurred in carrying on a business for the
purpose of gaining or producing such income. In determining what is necessary, the decision
in FC of T v Snowden & Wilson would suggest that the expenditure need not be incurred out
of legal necessity, but rather because it is prudent to do so.
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It would appear to be an exempt training seminar for the purposes of s 32-35 and, as such, the
expenditure would not be disallowed under s 32-5. Eligible seminars lasting at least four
hours would be deductible (TD 93/195). Therefore, $2,500 would be deductible under s 8-1.
(3) Gymnasium expenditure

Expenditure of $120,000 on a gymnasium attached to the work premises could be precluded
as entertainment expenditure under s 32-5. However, the provision of an in-house recreation
facility is excluded from s 32-5 where it is located on the premises of the taxpayer and is
mainly operated for use by employees of the taxpayer. Thus, the expenditure would be
deductible (s 32-30, item 1-5).
If the gymnasium is a building, then a deduction may also be claimed under Div 43 at 2½%
pa. If expenditure is incurred on gymnasium equipment, it may be depreciated under s 40-
25(1) and s 40-25(7)(a).
(4) Meals in executive dining room

The expenditure of $7,000 on meals in the executive dining room would be deductible as the
entertainment of employees is tax deductible if it provides a fringe benefit to the employee (s
32-20). If the facility was an in-house dining facility, as defined in s 32-55, then the
expenditure would still be deductible and would remain an exempt fringe benefit under s 41
of the Fringe Benefits Tax Assessment Act 1986.
If Tasman Ltd provides food and drink to non-employees it could:
(a)
claim the cost as deductible (although under ITAA97 s 32-70 an amount of $30 will be
included as income in respect of each meal provided to a non-employee), or
(b)
choose not to claim the cost of the meal as a deduction.
The election should be exercised by the taxpayer on an annual basis.
(Also refer to Taxation Ruling TR 97/17 regarding the concept of entertainment as it relates
to the provision of food and drink.)
[¶30-099] Solution 99
Foreign exchange losses; decline in value;
loan costs
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(1) Foreign exchange losses and decline in
value
As per ITAA97 s 775-30, foreign currency losses are normally treated as allowable
deductions if they are made as a result of a forex realisation event (see s 775-40 to 775-60 for
the five main types of forex realisation events). However, an important exception to the
general rule applies where, for example, there are short-term forex realisation losses (s 775-
75). In such cases, the foreign currency loss is treated as having the same character as the loss
on the asset to which the foreign currency right or obligation relates. Thus, if the asset
acquired by the taxpayer is a ‘depreciating asset’, the forex loss will affect the cost (or
opening adjustable value) of the asset (s 775-75(1), Item 3).
The taxation treatment of Tower Ltd’s forex loss of $25,000 (ie $225,000 − $200,000) should
be considered under Div 775. As the computer was purchased by the taxpayer for use as a
depreciating asset in its business during the 2017/18 tax year, the exception in s 775-75(1)
Item 3 would apply. This means that the forex loss of $25,000 should be added to the original
cost of the computer. Thus, the cost of the computer under Div 775 would be $225,000 (ie
original cost of $200,000 + forex loss of $25,000 = $225,000) and the decline in value
deduction for Tower Ltd under Div 40 for the 2017/18 tax year using the diminishing value
method under s 40-70 would be $9,247 (ie $225,000 × 30 days/ 365 days × 200% ÷ 4 years).
(2) Loan costs

The $2,000 costs incurred by Tower Ltd in establishing the loan to purchase the computer
would be deductible under s 25-25 over a four-year period commencing from the date on
which the money was borrowed. Moreover, the interest paid on the loan would be deductible
under s 8-1(1) on the basis of FC of T v Munro (1926) 38 CLR 153 as the computer
represents an income-producing asset.
On this basis, Tower Ltd would therefore receive a deduction as follows:
$2,000 ÷ 1,461 days = $1.37 per day, commencing from the date on which the money was
borrowed. Thus, for the period 1 April to 30 June 2019, the deduction would be $124 (ie 91
days × $1.37 = $124).
[¶30-100] Solution 100

Car expenses
(1)
In order to claim a deduction for car travel expenses a taxpayer must be able to substantiate
the claim. ITAA97 Div 28 outlines the different methods available to a taxpayer for claiming
business-related car expenses and Div 900 outlines the rules for substantiation.
136
On the basis of 12,000 km of business use, Timothy could claim a deduction based on one of
the following methods (provided he has satisfied the substantiation rules for the method
selected):
Cents per Kilometre Method (Subdiv 28-C)—limited to a =

5,000 × 0.68*
claim based on 5,000 km of travel only (s 28-25(2)) $3,400
12,000 km ÷ 20,000 =
Log Book Method (Subdiv 28-F)
km × $15,000 $9,000
*Based on the 2018/19 standard rate for all cars regardless of engine capacity.
Thus, the maximum deduction Timothy could claim would be $9,000 on the basis that he
used a log book and kept accurate odometer records.
(2)
The substantiation requirements for the log book method are outlined in s 28-100. The log
book must be kept for a continuous period of 12 weeks in the first year of the claim to
establish the business usage (s 28-120). Thereafter, a new log book must generally be kept
every five years (s 28-115(2)). Odometer records must also be maintained which record
among other details the odometer reading at the beginning and end of the year to establish the
total kilometres travelled (s 28-140). Additionally, s 900-70(1) requires written evidence of
expenditure incurred in running the car other than expenditure on fuel and oil (s 900-70(3)).
Under the cents per kilometre method, the taxpayer is not required to keep a log book.
[¶30-101] Solution 101

Overseas travel
Part of the total expenditure incurred on the trip of $14,000 would be deductible under
ITAA97 s 8-1(1). The actual apportionment would depend upon the degree of prevalence
attached to each purpose of the trip. The portion of the expenditure incurred by the managing
director in visiting overseas clients and existing agencies would be deductible under s 8-1(1)
according to general principles of deductibility (see Ronpibon Tin NL v FC of T (1949) 78
CLR 47). The expenditure relating to establishing a new agency in San Francisco may relate
to the firm’s business structure and should therefore be regarded as capital expenditure and
not deductible (see Sun Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 61
CLR 337). The private sightseeing for the managing director is providing a fringe benefit to
her, therefore, this part of the expenditure would be deductible to Power Ltd under s 8-1(1).
However, Power Ltd would be required to pay FBT on the grossed-up value of the amount
allowable as a deduction under s 8-1(1) for private sightseeing.
Expenses relating to the managing director’s spouse would also represent a fringe benefit and
are thus deductible to Power Ltd under s 8-1(1) because it has provided an associate of an
employee with a fringe benefit (s 26-30(3)). Power Ltd would be required to pay FBT on the
grossed-up value of the amount allowable as a deduction for the expenditure incurred in
respect of the managing director’s spouse.
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[¶30-102] Solution 102
Bad debts
Bad debts written off are only deductible where the taxpayer has previously brought those
debts to account as assessable income (ITAA97 s 25-35). As Stanley Newton has not brought
these debts to account, he is not entitled to a deduction for either the debts written off or the
debts estimated to be bad (See Point v FCT 1970 ATC 4021).
The acquisition of book debts post-19 September 1985 and their subsequent disposal at a loss
would represent a capital loss that can be offset against any current year capital gains (if any),
with the excess being carried forward and offset against subsequent capital gains.
[¶30-103] Solution 103

Fines; tax avoidance
The expenditure of $4,500 incurred in acquiring directors for straw companies would not be
deductible to the extent that they are incurred in the furtherance of, or directly in relation to,
activities where the taxpayer has been convicted of an indictable offence (s 26-54). Such
losses are also excluded from the cost base or reduced cost base of a CGT asset.
A fine payable under an Australian law, such as the $50,000 paid by the promoter under the
Crimes (Taxation Offences) Act 1980 (Cth), is not deductible (see Madad Pty Ltd v FC of T
84 ATC 4739; and ITAA97 s 26-5).
[¶30-104] Solution 104

Business deductions, Interest deductibility,
borrowing costs
Issue 1 Business deductions on s 8-1 (2)
The implications of business versus hobby need to be considered as Tony has a view to profit
by 2020/21; however business takings in 2018/19 were expected to be low, and improving in
2019/20. Given that his intention was to start the business, at what point in time did it
commence?
•
Possibly 1/7/18 when the loan was taken from the bank
•
138
Deductions can be allowed with a view to generating income in a future year (see Steel
(1990)) if there is a sufficient nexus. Is the preliminary expenditure or recommencement
allowable? (See Softwood Pulp and Paper and Griffin Coal Mining cases.)
Expenditure was necessarily incurred in carrying on a business (s 8-1) and not of a capital
nature.
Until 31 December 2018, Tony’s current source of income is from tax advising, and he also
has rental income from his Melbourne home from 1 January 2019. (See Ferguson, Ronpibon
Tin, and Charles Moore cases—the character of the expenditure is relevant.) Also the non-
commercial loss rules in Div 35—are the conditions satisfied to offset the losses against
salary income in 2018/19? Assessable income below $250,000 and must satisfy one of the
four conditions.
Income from the business was generated in the 2018/19 year, so the nexus is established.
Issue 2 Interest s 8-1

Assuming the business commenced on 1/7/18 based on the decision in Steel, (see Steel,
Brown and Placer Pacific) the deductibility of the interest under s 8-1, for 2018/19 tax year is
$14,000.
Annual deduction $200,000 × 7% = $14,000.
Issue 3 Borrowing costs s 25-25

The borrowing costs/loan establishment fee = $500.
1 year (totally repaid) $500/1826 days = $0.27 per day.
1/7/18 to 30/6/19 is 365 days × $0.27 per day = $100 for a five-year loan (at $100 per year).
Issue 4 Legal expenses s 8-1

If Tony is operating on a cash basis, $2,000 is deductible in the 2018/19 tax year when paid
(see Carden’s case).
Payment of pollution costs: Is it of a capital nature or a normal business risk, and hence
deductible? (See Broken Hill Theatres Herald and Weekly Times cases.)
Issue 5 Workshop expenses s 8-1

Work-related expenses for the travel and accommodation—see Fletcher and Ronpibon Tin
cases. Dominate purpose of travel was work related $2,500 for 2018/19 tax year.
139
Issue 6 Repairs s 25-10
$25,000 rectifying defects that existed on the farm house at settlement time. Consider initial
repairs Law Shipping case where it was held that initial repairs were not deductible.
[¶30-105] Solution 105

Research and development expenditure
Companies that incur expenditure related to R&D carried out on their behalf by another
institution may be able to claim a tax concession by way of tax offset rather than a deduction.
For tax years commencing after 30 June 2011, the R&D tax incentive provides for an
ITAA97 s 13-1 tax offset for R&D expenditure with an unassociated Research Service
Provider (RSP) or as a contribution to a Cooperative Research Centre (CRC) under s 355-
580.
It should be noted that there is no minimum expenditure requirement for RSP expenditure or
CRC contributions.
XYZ Ltd incurred R&D expenditure with an unassociated RSP (ie Monash University). If its
aggregated turnover is less than $20m (and assuming it is not controlled by any exempt
entity), it should be able to claim a refundable tax offset of $652,500 (ie $1,500,000 ×
43.5%). However, if it has an aggregated turnover of more than $20m, it can only claim a
non-refundable tax offset of $577,500 (ie $1,500,000 × 38.5%).
Note: Refer to note on 2018/19 R&D proposed legislative amendments at Solution 95.
[¶30-106] Solution 106

Commercial debt forgiveness
Special rules apply to counteract the effective duplication of tax deductions that would
otherwise arise from the forgiveness of commercial debt. The tax legislation is contained in
ITAA97 Div 245. Div 245 counteracts the effective duplication by reducing certain balances
(that are otherwise available to reduce taxable income) by the ‘net forgiven amount’ of a
debt.
In order to determine whether Div 245 applies to Shirley’s circumstances, the following
issues need to be considered.
Is there a commercial debt?
140
Given that Shirley would be able to claim a tax deduction for the interest on the loan under
ITAA97 s 8-1, the loan is a commercial debt (s 245-10).
What is the net forgiven amount?

To determine the net forgiven amount, Shirley must:
(1)
calculate the value of the debt (the general rules for doing this are contained in s 245-55—
they basically mean the arm’s length market value of the debt at the time the debt is forgiven.
Separate rules apply when the debt forgiven is a non-recourse debt (s 245-60) or a parked
debt (s 245-61)) (see also Tasman Group Services Pty Ltd v FCT 2009 ATC 20-130 and ID
2007/167).
(2)
calculate what (if any) consideration was given for the forgiveness (s 245-65). Again,
different rules can apply to different kinds of debt
(3)
subtract the consideration from the value to arrive at the ‘gross forgiven amount of debt’ (if
the value is equal to or less than the consideration, Div 245 will not apply s 245-75), and
(4)
reduce the gross forgiven amount by certain amounts which, as a result of the forgiveness,
will be taken into account in arriving at the debtor’s taxable income (eg a forgiveness could
result if the cost base of an asset is reduced: s 245-85).
Consequently, the value of Shirley’s debt is $1,500,000. The consideration given by Shirley
to Merlot Finance Pty Ltd for the forgiveness of her debt is $1,200,000 (ie $1,500,000 ×
80%). The gross forgiven amount is $300,000 (ie $1,500,000 − $1,200,000). Finally, the net
forgiven amount is also $300,000 (assuming no further reductions).
Is the duplication of deductions eliminated?

The net forgiven amount must now be applied to decrease any available balances which could
be used to reduce Shirley’s taxable income. Specifically, the balance of $400,000 (ie 2017/18
deductible revenue losses) is now reduced under s 245-115 to $100,000 (ie $400,000 −
$300,000).
To sum up, because Div 245 applies, Shirley can only carry forward $100,000 of the 2017/18
deductible revenue losses into future tax years, where appropriate.
[¶30-107] Solution 107

Primary production, horticultural plants
Although Trevor Walsh is engaged in the business of primary production, the initial costs of
clearing the land, top dressing and fertilising, and acquiring and planting the initial ‘mother
stock’ of plants are all expenditure of a capital nature. Since these expenses add to the profit-
141
yielding structure of the business they are not deductible under ITAA97 s 8-1(1). (See Sun
Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 61 CLR 337.) However, as
Trevor is engaged in the business of horticulture as defined in s 40-520(2) and 40-535(1) and
owns the plants, Subdiv 40-F allows a deduction for the write-off of capital expenditure
incurred in establishing a horticultural business.
Subdivision 40-F does not actually define what constitutes the cost of establishing
horticultural plants. However, the explanatory memorandum to the Act indicated that the cost
of acquiring and planting the ‘mother stock’ of plants and the cost of top dressing and
fertilising the land preparatory to the plantation of the plants would be expenditure which
qualifies for the Subdiv 40-F deduction. The initial cost of clearing the land does not qualify
(s 40-555(3)).
Section 40-545(2) and (3) set out the annual write-off rate and the maximum write-off period
for plants with an effective life greater than three years. For plants with an effective life of 12
years, the annual write-off is 17% over a maximum write-off period of five years and 323
days. The write-off and effective life commences at the time when the plants can first be used
for ‘commercial horticulture’ (s 40-545(3)(a)).
The deductible write-off for horticultural plants for Trevor for the 2018/19 tax year is
computed as follows (s 40-545(2)):
Establishment expenditure x write-off days in the income year/365 x write-off rate
Section 40-540 allows Trevor an immediate deduction of the capital expenditure incurred on
a water facility used in a primary production business after 12 May 2015. The total capital
cost of the dam ($22,000) and the automatic watering system ($30,000) $52,000 where
certain conditions regarding the use of the water facilities are satisfied is deductible in the
2018/19 tax year.
[¶30-108] Solution 108

Legal expenses
Super Sports Ltd’s business depends upon the existence of the agreement and the exclusive
rights which it grants. It follows that the legal costs incurred in preserving the agreement are
outgoings of a capital nature and are therefore not deductible under ITAA97 s 8-1. (See
Broken Hill Theatres Pty Ltd v FC of T (1952) 85 CLR 423; 9 ATD 306, FC of T v
Consolidated Fertilizers Ltd 91 ATC 4677 and Sun Newspapers Ltd & Associated
Newspapers Ltd v FC of T (1938) 61 CLR 337.) (See also IT 2656 and GHI v FCT 1997 ATC
2099.)
However, ITAA97 s 40-880 (‘blackhole expenditure’) provides a deduction over five years
for capital expenditure that is otherwise not deductible and that related to a business that is,
was, or is proposed to be carried on for a taxable purpose (ie the purpose of producing
142
assessable income), provided that the deduction is not expressly denied by some other
provision. The deduction is allowed in equal proportions over a period of five income years
commencing in the year in which the expenditure is incurred. Thus, Super Sports Ltd should
be able to claim legal expenses of $300,000 as a deduction under s 40-880. The amount of
deduction for the 2018/19 tax year should be $60,000 (ie $300,000 × 20%). (See TR 2011/6.)
[¶30-109] Solution 109

Legal expenses
(1)
The issue of debentures was undertaken to ‘borrow money’. According to ITAA97 s 25-25,
legal costs incurred in borrowing money used to produce assessable income are deductible.
The deduction is spread over the period of the loan, the period of repayment, or five years,
whichever is the least—in this instance, five years (1,826 days). The amount deductible for
the tax year ended 30 June 2019 is computed as follows:
$5,000 ÷ 1,826 days = $2.74 per day, commencing from the date on which the money was
borrowed. Thus, for the period 1 November 2018 to 30 June 2019, the deduction would be
$666 (ie 242 days × $2.74 = $663).
For the 2018/19 tax year the deduction is therefore $663.
(2)
The expenditure of $800 incurred on amendments to a company’s articles are of a capital
nature and the expenditure is therefore not deductible under s 8-1(1). (See Sun Newspapers
Ltd & Associated Newspapers Ltd v FC of T (1938) 61 CLR 337.)
However, ITAA97 s 40-880 provides a deduction over five years for capital expenditure that
is otherwise not deductible and that related to a business that is, was or is proposed to be
carried on for a taxable purpose (ie the purpose of producing assessable income), provided
that the deduction is not expressly denied by some other provision (‘blackhole expenditure’).
The deduction is allowed in equal proportions over a period of five income years starting in
the year in which the expenditure is incurred. Thus, ABC Ltd should be able to claim the
$800 for amendments to the company’s articles of association as a deduction under s 40-880.
The amount of deduction for the 2018/19 tax year should be $160 (ie $800 × 20%). (See TR
2011/6)
[¶30-110] Solution 110

Superannuation contributions and
associated interest and borrowing costs
143
An employer is entitled to a deduction for all contributions made to a complying
superannuation fund for the purpose of providing superannuation benefits for their employees
if the relevant conditions in ITAA97 Subdiv 290-B are met. The amount of the employer’s
deduction is not limited, since the age-based limits which applied for pre-2007/08 tax years
have been abolished. Therefore, in terms of Sally Cooper’s employees, she will be able to
claim the full amount of the superannuation contributions of $76,000 as a deduction assuming
that the conditions contained in Subdiv 290-B are satisfied.
Furthermore, a self-employed person is entitled to a deduction for personal superannuation

contributions if the conditions in ITAA97 Subdiv 290-C are met. There is no limit on the
amount of the deduction, as the age-based limits which applied in pre-2007/08 tax years have
been eliminated. However, excess contributions tax is payable if the deductible contributions
(called ‘concessional contributions’) made for or by the person in the year exceed the annual
cap of $25,000 (for the 2018/19 tax year, s 291-20(1)), regardless of age. Thus, Sally will be
able to claim the full amount of her personal superannuation contributions of $24,000 as a
deduction, because they are below the 2018/19 annual cap of $25,000.
Finally, from the 2007/08 tax year, deductions for interest and borrowing costs associated
with superannuation contributions can only be claimed if a deduction can be claimed for the
contributions under Subdiv 290-B for employees (ITAA97 s 26-80). Hence, the proportion of
the ‘financing costs’ that are related to Sally’s personal superannuation contributions are not
deductible. However, she would be entitled to claim as deductions the following interest and
borrowing costs related to her employees:
Interest expense:
Borrowing costs:
[¶30-111] Solution 111

Repairs
Non-capital repairs made to plant or premises, etc., used solely for the purpose of producing
assessable income, are deductible under ITAA97 s 25-10. The $780,000 is not deductible for
Quick Fix Properties Pty Ltd as it is not spent on repairs, but rather on capital improvements.
Improvements made to plant or premises are capital in nature and may be depreciated. (See
FC of T v Western Suburbs Cinemas (1952) 86 CLR 102). In Lurcott v Wakely and Wheeler
[1911] 1 KB 905 it was stated:
Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal as

distinguished from repair is reconstruction of the entirety … the question of repair is in every
case one of degree and the test is whether the act to be done is one which in substance is the
renewal or replacement of defective parts or the renewal or replacement of substantially the
whole.
144
In this respect it is necessary to distinguish between:
•
initial repair
•
repairs to whole or part, and
•
improvement.
Some of the major cases that involve repairs are summarised as follows.
•
W Thomas & Co Pty Ltd v FC of T (1965)115 CLR 58, where it was held that a building was
the relevant entity. Walls and floors were only subsidiary parts of the whole.
•
FC of T v Western Suburbs Cinemas (1952) 86 CLR 102, where the roof was only a
subsidiary part of the whole. However, where there is an improvement the repair is not
deductible under ITAA97 s 25-10.
•
Rhodesia Railways Ltd v Bechuanaland Protectorate Income Tax Collector [1933] AC 368:
repairs alone to a railway line were to only part of a whole. Modern building materials may
be equivalent to old materials, even though not the same, as was the case with the use of
concrete sleepers instead of wood. Taxation Ruling TR 97/23 at p 49 states:
It is restoration of a thing’s efficiency of function (without changing its character) rather than
exact repetition of form or material that is significant.
•
Law Shipping Co Ltd v IR Commrs (1924) 12 TC 621, where the cost of repairs to a ship
shortly after it had been purchased were disallowed for being expenditure of a capital nature
for the reason that the repairs improved the value of the ship, which had been purchased in a
state of disrepair.
•
Odeon Associated Theatres Ltd v Jones (HM Inspector of Taxes) [1972] 1 All ER 681; (1972)
48 TC 257, where the cost of repairs to a cinema purchased in a run-down condition were not
disallowed as capital expenditure for the reason that those costs did not affect the value of the
cinema. The Commissioner does not consider this UK case to be authority in Australia
(Taxation Ruling TR 97/23).
[¶30-112] Solution 112

Industry levy
Given that the proposed legislation affected the whole of the tobacco industry, not just the
interests of Smoking Gun Ltd, and did not pose a threat to the existence of the taxpayer’s
business, but only affected the way in which Smoking Gun Ltd conducted its business, the
levy expenditure of $400,000 is arguably on revenue account and is not of a capital nature.
145
In paying the $400,000 levy, Smoking Gun Ltd did not gain an enduring advantage; it merely
maintained its existing position in the marketplace. Given that the expenditure was incidental
to the carrying on of the taxpayer’s business and was not undertaken to maintain or preserve
an existing capital asset, it is fully deductible under ITAA97 s 8-1(1).
If the legislation had proposed a total ban on the sale of cigarettes, then the expenditure may
well have been of a capital nature and not deductible. The economic results achieved by the
transaction may also be considered in this case in deciding whether the expenditure is
desirable or appropriate from the point of view of the business ends of the business (see
Gwynvill Properties Pty Ltd v FCT 1986 ATC 4512).
The revenue/capital distinction can also be considered in these cases (see FC of T v

Rothmans of Pall Mall (Aust) Ltd 92 ATC 4508 and contrast with Ward & Co Ltd v Commr
of Taxes (NZ) [1923] AC 145 and Broken Hill Theatres Pty Ltd v FC of T (1952) 85 CLR
423).
[¶30-113] Solution 113

Prepaid expenditure of a tax shelter
arrangement
Max King’s investment in the olive grove venture has all of the attributes of a tax shelter
arrangement. Accordingly, prepaid expenditure incurred in relation to a tax shelter
arrangement is required to be spread over the period in which the services are provided if the
payment is for doing a thing that is not wholly within the expenditure year (ITAA36 s
82KZME). So, Max is required to apportion his deduction for the olive grove venture over
the 2018/19 and 2019/20 tax years according to the following formula:
Max calculates his deductions for the olive grove venture as follows:
Tax year Deduction

2018/19 (ie 1 May 2019 to 30 June 2019) $15,000 × 61/365 = $2,507
2019/20 (ie 1 July 2019 to 30 April 2020) $15,000 × 304/365 = $12,493
Therefore, over the 2018/19 and 2019/20 tax years, Max King is entitled to a total deduction
of $15,000 apportioned as above.

[¶30-114] Solution 114
146
Deductions for income-producing rental
property
Interest expense of $28,000 on the loan
As the rental property was used for income-producing purposes at all times during the
2018/19 tax year, the interest expense incurred by Holly to purchase the property is
deductible under ITAA97 s 8-1 on the basis of FC of T v Munro (1926) 38 CLR 153.
However apportionment is required as the loan was taken out on 1 September 2018 to 30
June 2019 (303 days in the tax year). $28,000 × 303/365 = $23,244 deductible.
Borrowing expenses of $10,000

Because the borrowing expenses are of a capital nature, no deduction is allowed for them
under s 8-1 (Sun Newspapers Ltd v FC of T (1938) 61 CLR 337). However, a specific
deduction is allowed under s 25-25 for borrowing expenses (such as loan charges, legal
expenses and stamp duty) incurred in relation to a loan which is used for income-producing
purposes. The borrowing expenses are deductible over the period of the loan or five years,
whichever is the shorter period, beginning with the year in which they are incurred. If
borrowing expenses incurred in any year are $100 or less, they are deductible in that year.
Thus, the deduction available for Holly under s 25-25 for the 2018/19 tax year is $10,000 ÷
1,826 days (corresponding to 5 years) = $5.48 per day commencing from the date on which
the money was borrowed.
Thus, for the period 1 September 2018 to 30 June 2019, the deduction would be $1,660 (ie
303 days × $5.48 = $1,659).
Roof replacement expense of $22,000

Initial repairs to an income-producing property are not deductible under s 25-10 as such
repairs are generally capital in nature (Law Shipping Co Ltd v IR Commrs (1924) SC 74).
Hence, the $22,000 cost of replacing the roof by Holly will not be deductible for the 2018/19
tax year. However, Holly could still claim a deduction under s 43-20 for capital
improvements to an income-producing building. The deduction available to Holly for the
2018/19 tax year under s 43-210 would be $457 (ie $22,000 × .025 × 303 days ÷ 365 days).
Bedroom painting expense of $1,200

As long as the need to repaint the bedroom did not arise at the time the house was purchased
by Holly on 1 September 2018 (ie an initial repair) but arose out of everyday wear and tear of
the rental property, the bedroom painting expense of $1,200 should be fully deductible to
Holly under s 25-10 in the 2018/19 tax year (W Thomas and Co v FC of T (1931) 45 CLR
53).
147
Replacement cost of $4,000 for the laundry
floor
Notwithstanding the fact that the wooden floor was in need of replacement in the best
possible way, the use of a concrete material would suggest that an improvement to the
property has been achieved by Holly during the 2018/19 tax year, not a repair that is
deductible under s 25-10 (FC of T v Western Suburbs Cinemas Ltd (1952) 86 CLR 102). In
Case N61, 81 ATC 325 it was found that the replacement of a rotten wooden floor in a block
of flats with a better, longer-lasting and more moisture resistant concrete floor was an
improvement and not deductible under s 25-10. However, Holly could still claim a deduction
under s 43-20 for capital improvements to an income-producing building. The deduction
available to Holly for the 2018/19 tax year under s 43-210 would be $25 (ie $4,000 × .025 ×
91 days ÷ 365 days).
Purchase of gas water heater of $5,200

A deduction is available to Holly under the Uniform Capital Allowance System (ie Div 40)
for the decline in value of a depreciating asset (ie the gas water heater) which is used for a
taxable purpose (ie the production of assessable income in the form of rent). The deduction
for the decline in value of the gas water heater for the 2018/19 tax year under s 40-70 based
on the diminishing value method would be $148 (ie $5,200 ÷ 10 years × 52 days ÷ 365 days
× 200%).
[¶30-115] Solution 115

Environmental impact assessments
(1)
As the expenditure on the environmental impact study undertaken by Professional Builders is
incurred prior to the commencement of the income-earning activity, it is of a capital nature
and not deductible under ITAA97 s 8-1(1), even though it was a necessary prerequisite that
the study be undertaken before the local council would approve the project (s 8-1(2)).
However, because the expenditure was incurred on an environmental assessment study in

relation to an income-producing project of the taxpayer, the expenditure is deductible under s
40-840.
The cost of the environmental impact assessment study is allocated to a project pool and an
annual deduction is calculated in accordance with the following formula (s 40-830) post 9
May 2006:
148
The deduction becomes available from the first income year in which the project starts to
operate. Thus, the deduction for Professional Builders for the 2018/19 tax year is computed
as follows:
(2)
As Bob Jones has no income-producing project to which the study relates, he is unable to
claim a deduction for the $2,500 study under s 40-840, and no deduction would be allowable
under s 8-1(1) because the expenditure is not related to any income-producing activity, and is
purely of a private nature.
(3)
The abandonment of the project will not deny Professional Builders a deduction and, in fact,
even though the income-producing project was abandoned before the end of the current year
in which the expenditure was incurred on the environmental impact assessment study, the
expenditure of $50,000 would be fully deductible in the 2018/19 tax year (s 40-840).
[¶30-116] Solution 116

Miscellaneous deductions
(1)
As the funds are used for income-producing purposes, the stamp duty on the mortgage is
deductible under ITAA97 s 25-25.
(2)
Deductible under s 8-1(1) as a cost incurred in carrying on a business.
(3)
Deductible under s 25-5 provided the fee was paid to a recognised professional tax adviser
(defined in s 995-1(1)). Costs in objecting to an income tax assessment would be an expense
in the management of tax affairs.
A deduction would not be allowed if the expenditure incurred by the taxpayer had been in
connection with an offence against an Australian or foreign law (s 25-5(2)(d)).
(4)
Deductible under the rules set out in (3) above.
(5)
Deductible under s 8-1(1) as a business-related expense. Note that s 25-5 would not apply
because it relates only to income tax affairs.
(6)
The answer would depend upon the nature of the tax to which the lobbying was directed. If it
was income tax, which itself is not deductible, then the expenditure in lobbying would also
not be deductible. It is unlikely s 25-5 could apply because lobbying for a change in taxation
laws does not appear to fall within the ambit of s 25-5(1). If the lobby aimed to alter a form
of taxation which was deductible expenditure, then the nature of the benefit becomes the key
issue. If the resulting change in legislation is of an enduring benefit to the company, then the
expenditure would be of a capital nature and not deductible. If the expenditure was incurred
for the purpose of earning profits in the normal course of business rather than being incurred
149
with the object of securing an advantage for the enduring benefit of the trade then the
expenditure would be deductible.
(7)
The loss is deductible under s 8-1(1 see Charles Moore & Co (WA) Pty Ltd v FC of T (1956)
11 ATD 147). Any recovery of the loss from insurance would be assessable.
(8)
The lump sum paid for the transfer of licences is an expense of a capital nature and would not
be deductible.
(9)
Bad debts would be deductible under s 8-1(1) as an expense incurred in gaining assessable
income. Section 25-35 would also apply if the qualifying tests were met.
[¶30-117] Solution 117

Miscellaneous deductions
(1)
Subscriptions paid by a self-employed taxpayer to a club are not deductible as recreational
club expenses (ITAA97 s 26-45(1); s 32-5).
(2)
Fines paid are not deductible (s 26-5).
(3)
The expenditure is of a capital nature and is thus not deductible, as it was incurred in ceasing
business, rather than expenditure incurred in the course of carrying on business (see Modern
Permanent Building and Investment Society (in liq) v FC of T (1958) 98 CLR 187).
(4)
The bonus is deductible to the employer under ITAA97 s 8-1. For the employee, the bonus is
income assessable under either s 6-5 or s 15-2, with the payment being an allowable
deduction to the employee if the charitable institution qualifies under ITAA97 Div 30. Under
s 6-5(4), income is taken to have been received by the employee as soon as it is dealt with as
the employee directs.
(5)
Interest paid on the overdraft is deductible under s 8-1, as the funds were used in the business
to derive assessable income. The fact that the security offered for the loan was of a private
nature does not affect the deductibility of the interest. The purpose of the loan is the most
important factor (see Munro v FC of T (1926) 38 CLR 153).
(6)
The amount is deductible under s 8-1(1), as expenditure was incurred in the carrying on of a
business for the purpose of gaining or producing assessable income.
(7)
The legal costs are deductible in the year the costs were incurred under s 25-30.
[¶30-118] Solution 118

Various deductions
150
The following advice is given to Sylvia Chan about the tax deductibility of her expenses for
the 2018/19 tax year:
(a)
Interest expenses of $3,500 incurred on a margin loan account used to buy/sell income-
producing Australian shares: As the margin loan account is used by Sylvia to buy/sell
income-producing shares that pay dividends, the $3,500 interest expenses are fully deductible
under ITAA97 s 8-1 on the basis of FC of T v Munro (1926) 38 CLR 153.
(b)
Brokerage fees of $420 incurred in relation to share trading on the margin loan account with
the stockbroker: The deductibility of the $420 brokerage fees is considered under s 8-1. The
brokerage fees have been incurred by Sylvia for the purpose of gaining or producing
assessable income, so they would pass the first positive limb of s 8-1 (see Ronpibon Tin NL
& Tongkah Compound NL v FC of T (1949) 78 CLR 431). However, it is possible that the
brokerage fees would be capital in nature as these expenses have been incurred once and for
all and/or add to the profit-yielding structure of a capital asset, being the shares (see Sun
Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 61 CLR 337), so they would
not pass the negative limbs. In fact, the nature of Sylvia’s share trading activities is as a long-
term investor, so the $420 brokerage fees would form part of the cost base of the shares for
CGT purposes (ITAA97 s 110-25).
(c)
Tax fees of $280 incurred in preparing the 2017/18 tax return (the tax return was prepared
by a registered tax agent): Because the tax fees of $280 were incurred in preparing the
previous year’s (ie 2017/18) tax return by a registered tax agent, they would be fully
deductible under ITAA97 s 25-5 as expenses incurred to manage Sylvia’s income tax affairs.
(d)
Donations of $140 paid to the Salvation Army: Since the $140 donation paid to the Salvation
Army is a gift of $2 or more to a public benevolent institution, it is fully deductible to Sylvia
under ITAA97 s 30-45.
[¶30-119] Solution 119

Overseas travel
(1) Deductibility of expenditure on overseas
travel
Of significant concern would be the issue of whether Parker’s expenditure was capital in
nature. To the extent that he is seeking to set-up a new business and establish overseas
agencies, it could be argued on the basis of the ‘business entity’ test in Sun Newspapers Ltd
& Associated Newspapers Ltd v FC of T (1938) 61 CLR 337 that the expenditure is capital in
nature. To the extent that Parker spends time on existing client matters, that part of the
expenditure should be deductible under ITAA97 s 8-1(1). An apportionment of such
expenditure would be necessary. (See Ronpibon Tin NL and Tongkah Compound NL v FC of
T (1949) 78 CLR 47.)
151
Airfare of $7,700
Parker’s airfare would be deductible under s 8-1(1) to the extent that the travel overseas had a
business purpose and was not of a private or capital nature. The airfare may need to be
apportioned. The holiday in Monaco would be considered to be of a private nature and thus
not deductible.
Case R13, 84 ATC 168 and Case R115, 84 ATC 758 state that apportionment should not be
on a time basis but rather on the basis of the predominance attached to the business or private
nature of the expense. If the dominant purpose of travel was work/business related then the
private portion may be apportioned accordingly. The courts tend to avoid apportioning
expenses, leaving this to the AAT and the Commissioner. However, a relevant case for the
disallowance of expenses incurred on overseas travel is Cunliffe v FC of T 83 ATC 4380.
Concerning the question of apportionment, the decision in Ronpibon Tin NL (above) would
suggest that any apportionment should be made upon the facts of the case. However, Parker’s
wife’s airfare would not be deductible because of s 26-30 relating to accompanying spouse
travel. As Parker is a self-employed person, FBT does not apply to his spouse’s airfare and
the exception of s 26-30(3) does not apply.
Accommodation of $6,000
The cost of Parker’s accommodation would be deductible under s 8-1(1) if it related to

existing clients. The costs incurred while creating new business would not be deductible as
they would be capital in nature. The total cost of accommodation for him and his wife would,
however, need to be apportioned, as his wife’s component would not be deductible. The
decisions in Case R2, 84 ATC 106 and Case V39, 88 ATC 335 suggest that the AAT will
allow apportionment on the basis of the marginal cost per night as a result of a spouse’s
presence rather than on a 50:50 basis.
Entertainment of $4,000
Entertainment expenditure would not be deductible under s 32-5.
Local travel of $1,500
The cost of local travel should be apportioned between business, private and capital.
Interviewing prospective clients and visiting companies in the hope of establishing some
consulting or agency arrangement is of a capital nature and thus expenditure relating to such
activities would not be deductible to Parker. Expenditure incurred in interviewing existing
clients is, however, of a revenue nature and deductible to Parker under s 8-1(1).
Monaco holiday of $3,000
Expenditure on the holiday would not be deductible under s 8-1(1) because it is of a private
nature. Even if it were deductible under s 8-1(1), it would be excluded under s 32-5 as
expenditure incurred on entertainment.
(2) Documentary evidence required

152
ITAA97 s 900-80 lists the substantiation requirements for business travel expenditure. The
effect of the substantiation rules is that as the travel was for six nights or more the expenses
are not deductible unless a travel diary or similar document is maintained by Parker. The aim
of the travel diary is to demonstrate the business activity component of the overseas travel.
Taxation Ruling MT 2038, which relates to FBT travel diaries, states that a detailed travel
itinerary which included relevant details and was prepared in advance of the trip would be
acceptable as a travel diary. Parker would be required to endorse that the itinerary was
followed or record any variations that occurred.
Parker would also need to obtain written evidence (eg receipts, invoices) in support of all of
the expense claims made (Subdiv 900-E).
[¶30-120] Solution 120

Legal costs
The $60,000 legal costs incurred by Briar in its defence against a competitor’s claim under
the Competition and Consumer Act 2010 would not be deductible under ITAA97 s 8-1 due to
its capital nature. The expense is incurred in preserving and protecting Briar’s business.
Stopping an action against them will protect the profit-yielding structure of the business.
In Sun Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 61 CLR 337 a
Sydney newspaper publisher paid another publisher an amount in consideration for their
agreement not to establish a competing evening paper. It was held in Sun Newspapers that the
expenditure was incurred for the purpose of preserving and protecting the taxpayer’s business
and was of a capital nature even though no new asset or right was brought into existence by
the expenditure.
Reference should also be made to the decisions in Hallstroms Pty Ltd v FC of T (1946) 72
CLR 634 and Broken Hill Theatres Pty Ltd v FC of T (1952) 9 ATD 423. In the Hallstroms
case the taxpayer, a manufacturer of refrigerators, sought a deduction for legal costs incurred
in opposing an extension of a competitor’s patent which it wanted to use. The legal costs
were held to be deductible because they were not made for the purpose of acquiring an asset
or adding to the profit-yielding subject. Rather, the expenditure was made not in order to
secure an actual asset but to enable them to carry on the same business unrestricted by a
particular difficulty in the right to use the patent. This case appears to have limited
application now in Australia. However, in Broken Hill Theatres, where the taxpayer incurred
costs in opposing the grant of a licence to a competitor to open a new picture theatre in
Broken Hill, it was held that the legal costs were not deductible as they were capital in nature.
Certainly the expenditure was not recurrent.
The computation of the lump sum regarding anticipated profits over the following years does
not change the capital nature of the expenditure. A substance over form argument could be
made.
[¶30-121] Solution 121

153
Thin capitalisation; outward investing
entities (non-banks)
A thin capitalisation regime, contained in ITAA97 Pt 4-5 Div 820, applies in Australia. It
includes special rules for outward investing entities such as Aussie Graphics.
Introductory steps
•
Aussie Graphics has debt deductions, being interest payable at 12% pa on the bank loan (s
820-40). This is calculated as $672,000 (ie $5,600,000 at 12% interest pa).
•
Aussie Graphics falls within the Div 820 thin capitalisation rules as it represents an
Australian controller of an Australian controlled foreign entity (ie NZ Graphics) for the
whole income year, and it is neither a financial entity nor an authorised deposit taking
institution for all of the tax year (s 820-85).
Final steps
•
Compute the Aussie Graphics adjusted average debt for the 2018/19 tax year in accordance
with the s 820-85(3) method statement.
If the Aussie Graphics bank loan of $5,600,000 was stable throughout the 2018/19 tax year,
its adjusted average debt for the 2018/19 tax year would simply be $5,600,000. Aussie
Graphics does not have any controlled foreign entity debt, since NZ Graphics does not have
any inter-company debt due to Aussie Graphics.
•
Compute the Aussie Graphics safe harbour debt for the 2018/19 tax year in accordance with
the method statement in s 820-95.
This would be $3,120,000 (ie $12,000,000 − $4,000,000 − $2,800,000 = $5,200,000 × 3/5).
•
Compute the Aussie Graphics arm’s length debt for the 2018/19 tax year in accordance with s
820-105.
This represents the maximum amount of tax deductible debt that Aussie Graphics could
reasonably have borrowed from commercial lending institutions giving attention to
designated assumptions and factors. Probably, this should be less than $3,120,000 on an asset
base of $12,000,000. Thus, assume the Aussie Graphics arm’s length debt is $3,000,000 after
applying s 820-105.
•
Compute the Aussie Graphics worldwide gearing debt for the 2018/19 tax year in accordance
with the method statement in s 820-110(1).
154
This would be $3,527,974, calculated as follows:
Step 1: ($5,600,000 + $2,000,000) ÷ $3,600,000 = $2.11
Step 2: Repealed
Step 3: $2.11 + 1 = $3.11
Step 4: $2.11 ÷ $3.11 = 0.6784565
Step 5: 0.6784565 × $5,200,000 = $3,527,974
Step 6: $3,527,974 + $0 = $3,527,974
•
Compare Aussie Graphics’ adjusted average debt (ie $5,600,000) with its maximum
allowable debt (ie $3,120,000). If the adjusted average debt exceeds the maximum allowable
debt, the excess will be disallowed (s 820-115).
•
Compute the disallowed amount of debt for the 2018/19 tax year in accordance with s 820-
115.
The amount of Aussie Graphics’ interest expense to be disallowed will be calculated

according to the following formula:
As a result of applying the thin capitalisation rules in Div 820 to Aussie Graphics’ balance
sheet for the 2018/19 tax year, the taxpayer will only be allowed an interest deduction of
$374,400 (ie $672,000 − $297,600).
[¶30-122] Solution 122

Borrowing costs
Deductibility of expenditure in acquiring
nursery
(1)
The outlay by the partnership for the nursery, goodwill and plant of $1,050,000 is of a capital
nature and not deductible for tax purposes under ITAA97 s 8-1. However, a depreciation
deduction would be allowed for plant used in the nursery business to produce assessable
income. It should be noted that a capital works write-off is also available on income
producing buildings under Div 43.
(2)
155
The interest cost, $41,819 (ie $600,000 × 12% × 212 days/365 days), would be deductible to
the partnership in full on the basis of the Federal Court decision in FC of T v Carberry 88
ATC 5005. It was successfully argued in Carberry’s case that the borrowed money related
solely to the acquired business and therefore the interest was fully deductible. The interest
expense did not need to be apportioned between business and private (home mortgage) use.
Mark and Sally Green could claim that the $450,000 they received on the sale of their private
residence was applied to acquire the new residence ($320,000), and that the partnership had
been established for the purpose of running the nursery. As the purchase of the property had
been made with two distinct purposes in mind, all borrowings related to the business would
be deductible.
The interest cost would be deductible under s 8-1(1) as an expense incurred in producing
assessable income. In Ure v FC of T 81 ATC 4100 the principle was established that the
deductibility of interest is determined by the purpose for which the money is applied. Ure’s
case also held that where money is borrowed partly for the purpose of producing assessable
income, and partly for other purposes, there should be an apportionment to allow a deduction
only for that part related to the production of assessable income.
Based on the decision in Carberry’s case, interest is not apportionable on the amount of land
occupied by the house (half a hectare out of two hectares, being 25%) or the value of the
house in relation to the total acquisition price ($320,000 of $1,050,000, being 30.48%), but is
fully deductible as a business expense.
(3)
The stamp duty and establishment costs of the loan would also be deductible to the
partnership on the basis that the loan was solely for business purposes. Section 25-25 would
apply to spread the deduction over the period of the loan, period of repayment, or five years,
whichever is the shorter (presumably $600 per year for five years). For the tax year ended 30
June 2019, the partnership could claim a deduction of $348, computed as follows:
[¶30-123] Solution 123

Relocation expenses
On the basis that the employees were brought-out to Australia from the UK to supervise and
install equipment to allow ICR Ltd to manufacture products in a new market, such
expenditure could be of a capital nature under ITAA97 s 8-1. However, if the expenditure
was related to an extension of ICR Ltd’s existing products it would probably be revenue in
nature.
The expenditure is of a capital nature if it relates to ICR Ltd’s profit-yielding structure and
not to the income-earning process. This conclusion is supported by Sun Newspapers Ltd &
Associated Newspapers Ltd v FC of T (1938) 61 CLR 337 and the application of the business
entity test.
156
In this respect, one should determine:
•
the character of the advantage sought
•
the manner in which it is enjoyed, and
•
the means adopted to obtain it.
If the new range of all-weather carpet is viewed as the company’s embarkation upon a new
product range which significantly alters the products available, one might argue it is capital in
nature. However, if it is seen as an extension of the existing product range, it could be seen as
not related to the profit-yielding structure, but rather as an act undertaken in the normal
course of business. Insofar as the all-weather carpet seems to represent an extension of its
existing range of products, it may be viewed as revenue in nature.
If the expenditure is considered to be of a revenue nature, the cost of airfares ($100,000),

hotel fees ($14,000), settling-in allowance ($12,000), salaries ($180,000) and accommodation
($40,000) would all be deductible for ICR Ltd under s 8-1(1). Moreover, the cost of the
holiday ($32,000) is deductible if it is part of the revenue account (under s 32-30), but subject
to FBT as an expense payment benefit if the technicians on assignment from the parent
company are considered to be employees of ICR Ltd rather than consultants.
[¶30-124] Solution 124

Substantiation; car expenses
Where David Cullen’s car travelled 24,000 km and business use is 21,600 km the following
car expense calculations can be made:
(1)
Log book method:
$
Finance costs 2,859
Registration 600
Petrol 3,400
Maintenance 1,100
Depreciation 9,041
$17,000
Business percentage
Log book deduction 90% × $17,000 = $15,300
(2)
Cents per kilometre method: 5,000 km maximum at 68 cents per kilometre (based on the rate
for 2018/19) = $3,400.
157
Hence, it would be advantageous for David Cullen to select the log book method based on
this scenario.
Where Cullen’s business use is only 16,800 km, the answer would change as follows:
(1)
Log book
Log book deduction 70% × $17,000 = $11,900
(2)
Cents per kilometre method 5,000 km maximum at 68 cents per kilometre (based on the rate
for 2018/19) = $3,400.
It would still be advantageous for David Cullen to select the log book method based on this
alternative scenario.
[¶30-125] Solution 125

Travelling and entertainment expenses
The travelling and entertainment allowance would be assessable under ITAA97 s 15-2 as
income. Rachael would then need to substantiate any deduction she claimed. For the travel
allowance, no deduction is allowable unless the taxpayer can substantiate her claim by
appropriate written evidence (ITAA97 s 900-80).
The written evidence requirements are contained in ITAA97 Subdiv 900-E. Under Subdiv
900-E Rachael is required to support her claim for a deduction by providing as evidence of
her expenditure either:
•
evidence from the supplier such as a receipt or an invoice (s 900-115)
•
a record maintained a dairy record by her in situations where either:
–
an expense is of $10 or less and the total of such small expenses is $200 or less (s 900-125),
or
–
an expense is unable to be substantiated in the normal way, for example because a ticket
purchased to attend a business function had to be handed in on entry (s 900-130), or
•
evidence on a payment summary (s 900-135).
If the travel is for six or more consecutive nights, Rachael would also be required to keep a
travel record in which is recorded the nature of the activity, the day and approximate time it
began, how long it lasted and where the activity took place (s 900-80 and 900-150).
158
There are two exceptions to these rules. If the travel allowance relates solely to travel in
Australia and is reasonable, no written evidence or travel records are required if the
expenditure does not exceed an allowance considered reasonable by the Commissioner of
Taxation (s 900-50). If the allowance relates to travel outside Australia, is reasonable and the
claim does not exceed the allowance, no written evidence of food, drink or incidental
expenses is required. Written evidence of accommodation expenses is still required, and if the
accommodation is for six or more nights in a row then travel records are also required (s 900-
55).
Where the substantiation requirements are satisfied, the cost of accommodation while visiting
clients would be deductible.
The cost of the meals incurred in entertaining clients would not be deductible (s 32-5), but the
cost of meals while away from home in the course of earning income are deductible.
The car expenses would be deductible if Rachael had written evidence of the expenses and a
record of the odometer reading. Rachael would need to have kept a log book record for at
least 12 continuous weeks to establish any business usage (Subdiv s 28-G, 28-H and 900-E).
The only telephone calls that may be claimed are those to clients and to the office. Written
evidence of the cost incurred and some record to indicate the nature of the calls which were
business-related would be required of Rachael as substantiation.
[¶30-126] Solution 126

Traveller accommodation; capital works;
depreciating assets
Happy Valley Hotels commenced construction of the building after 26 February 1992 and the
building, consisting of more than 10 units, is used wholly or mainly for traveller
accommodation, so it is entitled to write-off the construction expenditure under Div 43 at the
rate of 4% pa (ITAA97 s 43-95).
Construction expenditure is so much of the capital expenditure incurred on the construction

of the building which is used wholly or mainly for traveller accommodation.
Expenditure on associated facilities such as the office and accommodation for a shareholder’s
private use (s 43-175(2)) are ineligible for the 4% write-off under s 43-145. However, capital
expenditure on the office would qualify for the lower write-off of 2½% pa under s 43-140
because it is used for income-producing purposes.
Preliminary expenses, such as architects’ fees, are included as part of construction

expenditure. However, the cost of the land, site clearance, landscaping, driveways and car
parking are not part of the building, although some costs may qualify for a 2½% write-off as
structural improvements.
The cost of the building is calculated as follows:
159
$
Building costs 3,500,000
Architects’ fees 200,000
$3,700,000
To determine the cost of qualifying capital expenditure, 2/20 of the cost is deducted for the
office complex and accommodation provided to the shareholder ($185,000 for the office and
$185,000 for shareholder accommodation).
The qualifying capital expenditure is $3,330,000 (ie $3,700,000 − $370,000). The building
was used for a taxable purpose from 15 August 2018 to 30 June 2019 (ie 320 days).
However, because Happy Valley Hotels leased 15 units to a company for four months, the
entire motel has not been used as short-term traveller accommodation for the entire year.
From 1 March 2019 to 30 June 2019 (ie 122 days), only 30 units were used in the prescribed
manner as short-term traveller accommodation.
Therefore the 15 leased units do not qualify for the 4% write-off, but instead qualify for the
2½% write-off because they were used in producing assessable income (s 43-140).
The deduction for the building for the 2018/19 tax year is calculated as follows:
(Refer s 43-210.) Portion of your CE × Days used × 0.025 or .04/365.
In addition to the deduction for the building, Happy Valley Hotels is able to claim
depreciation on the cost of furniture and fittings in the motel units used to produce assessable
income and in the office, and a 2½% write-off for expenditure on structural improvements.
To compute depreciation on the depreciable asset (s 40-30), Happy Valley Hotels would need
either to work out the ‘effective life’ of the furniture and fittings or to rely on the
Commissioner of Taxation’s determination of effective life (s 40-95), which is 20% pa if the
diminishing value method is selected (s 40-70).
The furniture and fittings are depreciating assets under ITAA97 s 40-30. Moreover, they were
first used for a taxable purpose (s 40-25(7)) on 15 August 2018, and have an estimated
effective life (ITAA97 s 40-95) of nine years. On this basis, the amount of depreciation
allowable for Happy Valley Hotels in the 2018/19 tax year using the diminishing value
method is $177,291 (ie $910,000 × 320 days ÷ 365 days × 200% ÷ 9 years).
Although the expression ‘structural improvement’ is not defined, the cost of site clearing and
landscaping would not be treated as integral to the construction of a structure and thus would
not qualify as deductions (s 43-20(4)).
However, the cost of the sealed driveways and car parking would qualify for a 2½% write-off
under s 43-20(3) as structural improvements.
The amount allowable in 2018/19 would be computed as follows:
160
[¶30-127] Solution 127
Interest deductibility
(1)
The deductibility of interest expenditure is determined according to ITAA97 s 8-1. To be
deductible under s 8-1, interest expenditure must be characterised as an outgoing that is
incurred for the purpose of gaining or producing assessable income or is necessarily incurred
in carrying on a business of gaining or producing assessable income, and must not be of a
capital, private or domestic nature.
Normally, the character of interest expenditure is determined by the ‘use to which the
borrowed funds are put’ (eg Munro v FC of T (1926) 38 CLR 153, Fletcher v FC of T (1991)
173 CLR 1, and Kidston Goldmines Ltd v FC of T 91 ATC 4538). Moreover, in Taxation
Ruling TR 2000/2, the Commissioner argues that the deductibility of interest expenditure on a
further borrowing of money under a redraw facility depends upon the use to which the
redrawn funds are put. This is consistent with case law such as Munro’s case.
Similar to Taxation Ruling TR 2000/2, the Commissioner of Taxation argues that where the
original borrowing is for non-income-producing purposes and the taxpayer uses the redrawn
funds wholly or partly for income-producing purposes, that part of the accrued interest
attributable to the redrawn funds used for income-producing purposes is deductible.
Similarly, where the original borrowing is for income-producing purposes and the taxpayer
uses the redrawn funds wholly or partly for non-income-producing purposes, that part of the
accrued interest attributable to the redrawn funds used for non-income-producing purposes is
not deductible.
In this question, Ron Jones has a redraw facility from the Commonwealth Bank. On the basis
of Munro v FC of T (1926) 38 CLR 153 and Taxation Ruling TR 2000/2, the ‘use test’ must
be applied to the facts of this case. Therefore, on the basis of the ‘use test’, Ron can deduct
under s 8-1 the interest expenditure accrued on the outstanding loan principal of $272,000
that is related to the Sydney apartment from the date that property is available for rental.
Those borrowed funds are used at that time for income-producing purposes. However, since
the new borrowing of $100,000 is used as a deposit on a personal residence in Brisbane, the
interest on that borrowing will not be deductible under s 8-1, because it is incurred for a non-
income-producing purpose.
(2)
The use of the new borrowing of $100,000 to purchase Australian shares that pay fully
franked dividends represents an income-producing purpose. Thus, the interest incurred on the
$100,000 borrowing would be deductible under s 8-1 in this situation.
[¶30-128] Solution 128
161
Environmental protection expenses; legal
expenses; penalties
(1) Clean-up expenses for pre-existing site
pollution of $300,000
To qualify for a deduction under ITAA97 s 8-1, a loss or outgoing must fall within either of
the two ‘positive limbs’ and must not fall within any one of the four ‘negative limbs’.
Under the positive limbs, it must be determined whether the expenditure was incurred too
early in the income-producing process (Softwood Pulp & Paper v FC of T 76 ATC 4439;
Griffin Coal Mining Co v FC of T 90 ATC 4870). Costs incurred before commencement of a
business are not deductible. Has the business commenced? In this case, it seems that Toxic
Chemicals were preparing the site for use, and the expenditure was necessarily incurred for
the purpose of producing their assessable income. The fact that actual production never
commenced may not prevent the gaining of a deduction for the $300,000 under s 8-1 (see
Steele v FC of T 99 ATC 4242).
However, is the clean-up expenditure of a capital nature? In Sun Newspapers Ltd v FC of T

(1938) 61 CLR 337, the guidelines for distinguishing between capital and revenue
expenditure were laid down. It was found that where expenditure is incurred in establishing,
replacing and enlarging the profit-yielding structure of the business, it is capital in nature, and
this should be contrasted with expenditure that is incurred in operating the business, which is
revenue in nature. This test is often referred to as the ‘business entity’ test.
In the present case, it could be argued that the clean-up expenditure of $300,000 is of a
capital nature, as it relates to the profit-yielding structure of Toxic Chemicals’ business.
Moreover, it is likely to be ‘one-off’ expenditure (see Vallambrosa Rubber Co Ltd v Farmer
(1910) 5 TC 529) and bring into existence an advantage for the enduring benefit of Toxic
Chemicals’ business (see British Insulated & Helsby Cables v Atherton [1926] AC 205),
further pointing to the clean-up expenditure being of a capital nature.
While the expenditure is of a capital nature and is therefore not deductible under s 8-1,
Subdiv 40-H (40-755) provides a deduction for expenditure to the extent that it is incurred
wholly or mainly for carrying on ‘environmental protection activities’. These activities can
include treating, cleaning up, removing or storing waste resulting from the taxpayer’s earning
activities, the site of the taxpayer’s earning activities, or a site where an entity was carrying
on any business that the taxpayer has acquired and carries on substantially unchanged as its
earning activity (s 40-755(2) to (4)). Hence, Toxic Chemicals could be able to claim a
deduction for the clean-up costs under Subdiv 40-H.
(2) Legal fees defending action brought by

environmental group of $350,000
162
The deductibility of the $350,000 legal expenses will depend on the nature of what they relate
to. If legal expenses are necessarily incurred in carrying on a business, they are deductible
under s 8-1. For example, in Herald & Weekly Times v FC of T (1932) 48 CLR 113, the Court
found that legal expenses incurred in defending the company against defamation lawsuits
were deductible. The Court held that defending defamation charges was a necessary part of
carrying on a newspaper business. Also consider FC of T v Chapman 89 ATC 4246; in this
case the Court held that legal costs incurred in opposing objections to renewal of a planning
consent to operate a quarry were deductible.
Toxic Chemicals incurred the legal costs in defending themselves against the environmental
group, which were trying to stop the development in order to protect the wetland habitat.
Defending their right to continue developing the toxic chemical plant is fundamental to the
carrying on of the taxpayer’s business. Therefore, the $350,000 would be deductible under
the positive limbs of s 8-1.
However, are the legal costs of a capital nature? Do the legal costs relate to the profit-
yielding structure of the business or the process of operating the business? In the present case,
it could be argued that the legal costs incurred by Toxic Chemicals of $350,000 are of a
capital nature as they relate to the profit-yielding structure of the company’s business, not
necessarily the process of operating it. In addition, it is likely that the legal costs are ‘once
and for all’ (see Vallambrosa Rubber Co Ltd v Farmer (1910) 5 TC 529), and bring into
existence an asset or advantage for the enduring benefit of Toxic Chemicals’ business (see
British Insulated & Helsby Cables v Atherton [1926] AC 205, further suggesting that the
legal costs are of a capital nature and not deductible under s 8-1.
(3) Legal costs of defending director against

criminal prosecution of $50,000
Was the expenditure of $50,000 necessarily incurred in the carrying on of the business of
Toxic Chemicals? Note the decision in Magna Alloys & Research Pty Ltd v FC of T 80 ATC
4542, where the taxpayer claimed deductions for legal expenses that it incurred in defending
directors and agents against charges of criminal conspiracy and certain other offences. These
charges arose in relation to allegations that agents of the taxpayer were inducing employees
of various organisations to buy the taxpayer’s goods by offering gifts or prizes.
The Full Federal Court found the legal costs to be deductible, as the criminal proceedings in
respect of which the outgoings were incurred arose out of the day-to-day business activities
of the taxpayer. The legal costs did not involve the acquisition of any enduring or tangible
asset. Rather, they represented expenditure incurred in carrying on the taxpayer’s business,
which were seen as being of a revenue character.
In the present case, the assault of an environmental protester by a company director is not
likely to be viewed as aiding the production of assessable income of Toxic Chemicals’
business. The resulting legal fees of $50,000 incurred by the company to defend its director
are not likely to meet the requirements of the second positive limb of s 8-1. The facts in the
question can be distinguished from those of Magna Alloys in that the director’s act which led
to the legal proceedings did not arise from the day-to-day business activities of Toxic
Chemicals.
163
(4) Penalty imposed by Environment
Protection Authority of $40,000
Section 26-5 provides that a taxpayer is not entitled to deduct an amount payable by way of
penalty under an Australian law. This is because a penalty is imposed as a punishment, and
the offender should not be able to indirectly benefit from an offence by gaining a tax
deduction for it. Moreover, in Herald & Weekly Times v FC of T (1932) 48 CLR 113 it was
found that a penalty is inflicted on the offender as a personal deterrent; it is not incurred in his
character of a trader. Therefore, Toxic Chemicals cannot claim a deduction for the $40,000
penalty.
Trading Stock
[¶30-129] Solution 129
Stock valuation
164
Under ITAA97 s 70-35, the value of all trading stock on hand at the beginning and end of the
year of income is taken into account in determining the taxpayer’s assessable income. Where
the value of the closing stock at the end of the year exceeds the value of the opening stock at
the beginning of the year, the difference is assessable income (s 70-35(2)). Where the value
of the opening stock exceeds the value of the closing stock, the difference is a deduction (s
70-35(3)).
Section 70-45 provides that the value of trading stock on hand can be determined by using:
•
cost price
•
market selling value, or
•
replacement price.
Furthermore, a different valuation process can be used to value each individual item of stock.
(1)
On the assumption that Widget wishes to minimise its taxable income, it should value the
trading stock on hand at the end of the year at the lowest value possible. This would mean
using the following stock values:
$
Unit X Cost 1,200
Unit Y RP 800
Unit Z MSV 800
CLOSING STOCK VALUE $2,800
(2)
Where the company has carry-forward losses and wishes to offset those losses against income
of the current year, Widget should maximise the value of closing stock in order to utilise and
offset the carry-forward losses against assessable income. Therefore, the value of the closing
stock would be:
$
Unit X MSV 1,600
Unit Y MSV 1,100
Unit Z RP 1,000
CLOSING STOCK VALUE $3,700
[¶30-130] Solution 130

Stock valuation
(1)
Under ITAA97 s 8-1, Buick Traders would be able to claim a deduction in respect of
purchases of trading stock. Section 70-25 provides that expenditure incurred in the purchase
of trading stock is not of a capital nature. Even though $150,000 remains unpaid at the end of
165
the year, for the purposes of s 8-1 it would still have been incurred and therefore would be
deductible.
Section 70-15 would not apply to limit the deduction because all the trading stock is on hand.
(See Taxation Ruling IT 2670 for the meaning of ‘trading stock on hand’.) Essentially,
trading stock is treated as being on hand where the taxpayer has the power to dispose of the
trading stock.
Therefore, the deduction available for purchases would be $1,100,000.
(2)
Under s 70-35(3), a deduction would be available where the value of the closing stock is less
than the value of the opening stock.
Normally, if a company wishes to reduce its taxable income it will minimise the value of
closing stock. Consequently, the value would be:
Stock Value($) Quantity Closing value($)

A 2 5,000 10,000
B 3 4,000 12,000
C 6 6,000 36,000
D 6 4,000 24,000
VALUE OF CLOSING STOCK $82,000
As the value of closing stock is less than the value of opening stock, Buick Traders would be
able to claim a deduction equal to $130,000 − $82,000, ie $48,000.
(3)
A company that had carry-forward losses at the beginning of the year would normally
maximise the value of closing stock in order to offset the carry-forward losses against
assessable income. Buick would accordingly value the closing stock as follows:
Stock Value($) Quantity Closing stock($)
A 4 5,000 20,000
B 5 4,000 20,000
C 8 6,000 48,000
D 10 4,000 40,000
If this approach is adopted, the value of opening stock still exceeds the value of closing stock.
Buick would be able to claim a deduction of $2,000 (ie $130,000 − $128,000) instead of
$48,000 ($130,000 − $82,000); that is, their taxable income is $46,000 higher.
[¶30-131] Solution 131

Stock valuation, manufacturing
(1)
166
In Philip Morris Ltd v FC of T 79 ATC 4352, it was held that for manufacturers an absorption
or full cost method was appropriate to value closing stock under the cost price method.
This means that closing stock should include an appropriate share of overheads. On this basis,
the value of stock manufactured is:
$
Factory overheads 120,000
Raw materials 180,000
Direct labour 200,000
$500,000
As the cost of storage would not be seen as part of the cost of bringing the stock to its
existing condition, it should not be regarded as an inventoriable cost (see Taxation Ruling IT
2350).
On the basis that 100,000 lights were manufactured, with an equivalent of 1,000 finished
units and 2,000 half-completed units still on hand, the value of closing stock should be
determined on the basis of an equivalent manufacture of 99,000 full units equal to $5.05 per
unit.
Therefore, the value of closing stock is:
$
1,000 finished units at $5.05 5,050
2,000 half-finished units at $2.525 5,050
(2)
Where the stock is obsolete, a taxpayer may elect to write down its stock to a value below its
cost, market selling value or replacement price (ITAA97 s 70-50). However, such a write-
down is dependent upon the value you elect being reasonable (s 70-50(b)).
[¶30-132] Solution 132

Stock valuation, manufacturing
Under s 70-45 there are three ways in which a taxpayer may value its trading stock. These are
cost, market selling value, and replacement value. However, if Exco decides to use the cost
method based on the decision in Phillip Morris v FC of T 79 ATC 4352 and Taxation Ruling
IT 2350 cost is the full absorption cost. This includes the cost of labour and raw materials
plus factory overhead. However, it does not include training costs or retooling costs. Also, the
cost of storage and distribution are not part of the cost of trading stock.
Therefore the total absorption cost relating to the new switch gear is $1,103,250.
167
This relates to 75,000 units and gives an average cost of $14.71 per unit. However, in
determining the value of closing stock, the quantity would be reduced due to the necessary
write-off of 5,000 damaged units (s 70-50).
The stock which had not been delivered would still be regarded as stock on hand (see All
States Frozen Food v FC of T 90 ATC 4175).
Consequently, the value of closing stock would be:
(7,000 + 5,000 units) × $14.71 per unit = $176,520 (using the cost basis) plus 5,000 units of
damaged stock at $5 per unit (using the market selling value) = $201,520.
[¶30-133] Solution 133

Private use; debt settlement; valuation;
obsolescence
(1)
Goods taken from stock for personal use would come within the provisions of ITAA97 s 70-
110. This section provides that if you stop holding an item as trading stock, but still own it,
you are treated as if:
(a)
just before it stopped being trading stock you sold it to someone else for its cost, and
(b)
you immediately bought it back for the same amount.
Consequently, there would be a disposal of the stock for $900 (see TD 2018/10).
(2)
As the stock has been disposed of outside the ordinary course of business, Milton will be
assessed on the market value of the item of trading stock on the day of its disposal (s 70-90).
What is the ‘market value’? Given that the stock was in satisfaction of a debt of $1,100, this
sum may appear to be its market value. However, s 70-90 requires the market value to be
brought to account as assessable income and this amount is $1,200.
(3)
Section 70-35 requires taxpayers who carry on any business to value all their trading stock at
the beginning and end of the year of income because the values of opening and closing
trading stock are taken into account in ascertaining the taxpayer’s taxable income.
In valuing trading stock, the taxpayer has an option to value each article of trading stock at its
cost price, market selling value or replacement price (s 70-45).
Milton can elect to value the stock of 20 sports coats at cost $2,800 (20 × $140), market
selling value (value unknown) or at replacement price $2,600 (20 × $130).
168
(4)
As the value of trading stock has fallen to below cost, market selling value or replacement
price, due to special circumstances, the taxpayer may elect to value trading stock at an
amount which is reasonable (s 70-50).
Market selling value of stock does not mean the amount realisable as a forced sale of stock;
rather it means a sale in the ordinary course of the taxpayer’s business (Australasian Jam Co
Pty Ltd v FC of T (1953) 88 CLR 23).
[¶30-134] Solution 134

Stock valuation
(1)
ITAA97 s 70-35 provides that where the value of stock on hand at the end of the year exceeds
the value of stock on hand at the beginning of the year, the excess is assessable income. Thus,
if under s 70-45 the taxpayer has elected to value stock at cost price, then the amount
assessable under s 70-35 will be $19,000.
(2)
Sections 70-40 and 70-45 state that a retailer has only one method for valuing opening stock
and three methods for valuing closing stock. Opening stock must be valued at the same value
as closing stock of the previous year; closing stock may be valued at ‘cost price’, ‘market
selling value’ or ‘replacement price’.
(3)
A retailer has the option at the end of each year to value each article of trading stock by one
of the methods outlined in s 70-45.
(4)
Stock can only be valued at less than cost price, market selling value or replacement price
where it is obsolete, or other special circumstances exist, and the value elected is reasonable
(s 70-50).
(5)
A primary producer also must value opening stock at the same value as the previous year’s
closing stock. When it comes to valuing closing stock, then, except in the case of horse
breeding stock, the primary producer may value all of his or her livestock at ‘cost price’,
‘market selling value’ or ‘replacement price’ (the same as non-primary producer taxpayers).
[¶30-135] Solution 135

Valuation of trading stock
All harvesting and processing expenses incurred by the grower, plus recurring annual
expenses associated with the fruit rather than the tree or the soil (such as the cost of putting
ripening bags over the bunches of bananas) must be included in the calculation of the cost
price. The cost of the containers is part of trading stock where ownership passes to the
purchaser. (Returnable containers would not form part of trading stock: Taxation Ruling TR
98/7.)
169
Only the cost of research into banana diseases would be excluded in determining Barnes’
total harvesting and processing expenses. This cost, however, may be deductible to Barnes
under ITAA97 s 8-1.
Barnes’ total harvesting and processing costs are $90,000, ie:
The cost of his stock on hand at 30 June 2018 is:
(See Taxation Determination TD 93/47.)
[¶30-136] Solution 136

Obsolescence
To minimise tax liability Pharmico Ltd should aim to value its trading stock at the end of the
income year at the lowest value possible.
ITAA97 s 70-45 gives the taxpayer the option of valuing each article of trading stock at the
end of the year of income at its cost price, market selling value, or the price at which it can be
replaced.
In Pharmico’s situation the lowest closing value for trading stock would be achieved by
opting to value trading stock at the cost price of $2 per unit. However, given the nature and
quality of the stock on hand, not all the stock is in a saleable condition.
The ATO considers that the term ‘obsolescence’ in s 70-50 refers to stock which is either:
•
going out of use, going out of date, becoming unfashionable or becoming outmoded (ie
becoming obsolete), or
•
out of use, out of date, unfashionable or outmoded (obsolete stock Taxation Ruling TR 93/23
para 4).
The 200 items which have passed their ‘use by’ date are obsolete stock. The taxpayer should
choose that value which is reasonable (s 70-50). As these 200 items are legally unsaleable
and cannot be sold for scrap or recycled, the taxpayer would be justified in assigning a nil
valuation to this stock (Taxation Ruling TR 93/23).
Further, as industry experience suggests that 2,500 of the 3,000 items with a ‘use by’ date of
30 September 2018 will be sold by that date, 2,500 items of trading stock should be valued at
170
cost price under s 70-45 and the remaining 500 items valued at a reasonable nominal amount
while they remain saleable (s 70-50).
[¶30-137] Solution 137

Private use; gifts
(1)
Taking goods for one’s own use comes within ITAA97 s 70-110 and the taxpayer would be
treated as disposing of the stock at its cost and immediately reacquiring it at its cost.
Therefore, there would be a disposal of the stock for $1,100.
(2)
As the gift of stock is a transaction not in the course of ordinary trading, s 70-90 would apply
and the father is assessable on the market value of the stock at the date of disposal ($17,500).
[¶30-138] Solution 138

Prepaid stock
Although Smartgirl has paid $32,000 for 200 suits at $160 per suit, the deduction under
ITAA97 s 8-1 in 2018/19 will be reduced to $16,000 because s 70-15 defers deductions under
s 8-1 for expenditure on trading stock until the stock has become trading stock on hand. As
only 100 suits at a cost of $160 per suit were delivered and became trading stock on hand of
Smartgirl, only $16,000 is deductible in the 2017/18 tax year.
As 65 suits are unsold they are trading stock on hand at the end of the year and their elected
value under s 70-45 (cost price, market selling value or replacement price) is assessable under
s 70-35(2).
The value of closing stock ($10,400 if the taxpayer elected to value closing stock at cost
price) will be deductible in 2019/20 when it becomes opening stock of that year. The
remaining $16,000 will be deductible under s 8-1 in 2019/20 when the additional 100 suits
are delivered to Smartgirl.
[¶30-139] Solution 139

Land; characterisation as trading stock
Insofar as Bob is disposing of the family farm it may be argued that it is a simple mere
realisation of a capital asset as in Scottish Australian Mining Co Ltd v FC of T (1950) 81 CLR
188. However, the large subdivision of the land is likely to be more indicative of the fact that
Bob has embarked on a business activity as a land developer. This situation is similar to the
decision in FC of T v Whitfords Beach Pty Ltd 82 ATC 4031 where a passive holding of land
was transformed into a business activity of land development. As this was held to be a
171
business activity in Whitfords Beach the proceeds of the sale was income under ordinary
concepts. In the case of Bob Jonas, the land has probably changed its status from being
farmland to being trading stock. In FC of T v St Hubert’s Island Pty Ltd 78 ATC 4104 it was
held that land can be trading stock.
Also, the fact that Bob has purchased more land suggests that he has begun a business as a
land developer and the land is trading stock.
Where this occurs ITAA97 s 70-30 states that where a taxpayer starts holding as trading stock
an item that is already owned by them, which previously was not held as trading stock, the
taxpayer is treated as if:
(1)
just before the item became trading stock the taxpayer had sold it at arm’s length for
whichever the taxpayer elects of its cost or market value just before it became trading stock,
and
(2)
the taxpayer had immediately bought it back for the same amount.
Consequently if Bob chooses to use the cost value the land would be treated as trading stock
and have a cost of $400,000/200 = $2,000 per block. Alternatively, if market value is chosen
then the market value for each block would be $10,000,000/200 = $50,000 for each block.
Where the taxpayer chooses the market value option in the case of the pre-CGT farmland the
deemed disposal of the land and reacquisition at its market value will not cause any liability
to taxation and the difference between the original cost and market value would be tax free
unless the provisions of ITAA97 s 6-5 and 15-15 apply (see above).
Whichever method is chosen, the deemed reacquisition of the land would be an allowable
deduction under ITAA97 s 8-1 as an outgoing to acquire trading stock.
Section 70-30(2) states that the election of the cost or market value must be made by the
taxpayer by the time the taxpayer lodges their tax return for the year when the taxpayer
begins to hold the land as trading stock or within a reasonable time of the taxpayer realising
that it is trading stock or a time that the Commissioner allows. Note also that where the land
had been acquired after 19 September 1985 then the taxpayer would realise a capital gain
based on the difference between the asset’s cost and the market value of the land.
As Bob has sold 10 blocks of land this would be included as assessable income under s 6-5 as
ordinary income. The amount of profit on the sale of each block will depend on whether the
cost or market value option is chosen.
In regard to the block of land that was given to his daughter, s 70-90 states that where a
disposal of trading stock is made outside of the taxpayer’s ordinary business (such as a gift)
then the assessable income of the taxpayer includes the market value of the trading stock on
the date of disposal. Therefore, Bob would be deemed to have sold the land for its market
value of $200,000 and this would be ordinary income under s 6-5. Again the profit would
depend on whether the taxpayer had chosen the cost or market value option at the time the
land became trading stock. Section 70-95 would deem Bob’s daughter to have acquired the
land at a price equal to its market value of $200,000.
172
As Bob has purchased another 80 hectares of land with the intention of further subdivision,
the land again is likely to be treated as trading stock and the above provisions would apply.
The amount paid for the land plus any incidental costs would form part of the cost of the
trading stock.
Category B: Solution 140

[¶30-140] Solution 140
Valuation; cost of goods sold; obsolescence;
foreign exchange
(1)
The taxpayer may use any of the following methods as allowed by ITAA97 s 70-45:
•
cost price
•
market selling value, and
•
the price at which the stock can be replaced (replacement price).
Any of these methods can be used in any year on any item of stock.
The value of closing stock must be the value of opening stock for the succeeding year.
(2) Cost of goods sold:

$ $
Opening stock 160,000
Purchases 900,000
Freight on stock 9,000
Insurance on stock—delivery 4,000
Customs clearance fees 2,000 915,000
1,075,000
Closing stock 200,000
COST OF GOODS SOLD $875,000
Note: Assumes that no part of the administrative expenses is attributable to the bringing of
the stock to its existing condition and location.
(3)
(a) The three methods available to value stock on hand under s 70-45 are as follows:
•
Cost price is viewed as full absorption cost (see Taxation Ruling IT 2350); ie all costs
associated with bringing the stock into its existing condition and location.
173
Cost price in a retail business will include the following:
–
cost price
–
inwards freight cost
–
inwards insurance costs
–
customs/excise duties, and
–
inwards delivery charges.
Acceptable methods for determining cost price are FIFO, average cost, standard cost (if kept
up to date) and retail inventory (where mark-ups and mark-downs in selling prices have been
adjusted), but not LIFO (last in first out) or base stock methods.
•
Market Selling Value (MSV) is the current selling value of the stock in the taxpayer’s
particular selling market in the ordinary course of business (ie a retailer’s MSV is the current
retail value, a wholesaler’s MSV is the current wholesale value).
•
Replacement Price (RP) is the price at which the taxpayer can buy the stock in its normal
buying market on the last day of the year of income.
(b)
Leisure Sport should minimise closing stock, in order to maximise cost of goods sold, in
order to minimise taxable income.
Unit Method used $
A Cost 60,000
B RP 25,000
C Cost 30,000
D RP 40,000
E Cost 20,000
CLOSING STOCK $175,000
(c)
The value of closing stock should be increased, if possible, to the extent that the $200,000
accumulated loss could be absorbed.
(d)
As Unit A has become obsolete, valuing it by cost price, MSV or RP is no longer appropriate.
In accordance with s 70-50, if the stock is obsolete or if other special circumstances prevail,
the value of that stock can be lower than cost price, MSV or RP. As Unit A has become
obsolete, its scrap value of $5,000 would appear to be an appropriate value. The taxpayer
may write down the stock to a reasonable value based on the obsolescence, or any other
special circumstances.
$
Closing stock value as in (b) 175,000
Less: Cost value of A 60,000
174
115,000
Plus: Scrap value of A 5,000
NEW CLOSING STOCK VALUE $120,000
(4)
The Commissioner’s view is that stock in transit is ‘on hand’ provided the property in the
goods has passed to the taxpayer.
This view was upheld in All States Frozen Foods Pty Ltd v FC of T 90 ATC 4175. If a Bill of
Lading has passed to the taxpayer then the decision indicates that the goods in transit are
goods on hand for the purposes of the Income Tax Assessment Act. Accordingly, the goods
in transit must be included in the taxpayer’s closing stock calculation.
In Taxation Ruling IT 2670, the Commissioner’s view is that trading stock will be trading
stock on hand if the taxpayer is in a position to dispose of the stock on its own behalf.
From the information given, it seems that the stock is not ‘on hand nor is there evidence that
title in the trading stock has passed to them or that they can deal with it’. Therefore, Leisure
Sport will not be entitled to a s 8-1 deduction for the purchase price in the 2017/18 year of
income and the elected s 70-45 valuation of the unsold stock which is in transit will not be
part of the value of the firm’s closing stock.
As the ‘stock in transit’ had not been ‘on hand’, then s 70-15 would have denied the
deduction under s 8-1 until the stock was ‘on hand’.
(5)
As the cost price is the sum of all costs associated with bringing the stock into its existing
condition and location, the value of the new leisure suits includes costs in relation to the
devaluation of the Australian dollar. Therefore, the cost price of the leisure suits is:
$
Original cost 20,000
Devaluation of A$ 1,500
$21,500
|
175
Depreciation
[¶30-141] Solution 141
Decline in value and other deductions
The computer and its associated delivery and installation costs are capital expenses and are
therefore not deductible under ITAA97 s 8-1 (see British Insulated & Helsby Cables v
Atherton [1926] AC 205 and Sun Newspapers Ltd v FC of T (1938) 61 CLR 337). However,
as the computer is a depreciating asset under s 40-30, a capital allowance deduction is
available for Mary McDonald.
While Taxpayers may make an estimate of the effective life of a depreciating asset, based on
the estimated period that the asset can be used for producing assessable income, the
176
Commissioner of Taxation in TR 2018/4 outlines the effective lives of depreciating assets
that may also be used by the taxpayer.
Based on TR2018/4 the computer, has an effective life of four years.
Under the provisions of s 40-65 the taxpayer may choose to determine the decline in the
value of the depreciating asset by using the prime cost method (s 40-75) or the diminishing
value method (s 40-70).
Under s 40-75 the decline in value of a depreciating asset using the prime cost method is:
Cost/effective life × days held/365
However if the diminishing value basis is used , then pursuant to the provisions of s 40-70,
the decline in the value of the asset is determined by the following formula:
Base value/effective life × days held/365 × 200%
As the taxpayer will seek to maximise the allowable deduction in the early part of the asset’s
life the diminishing value method will normally be used.
The cost of the depreciating asset consists of all of the costs incurred in bringing the asset to
the location plus costs of installation, but not including structural alterations (see s 40-180–s
40-190).
Using this method, the amount allowable in the 2018/19 tax year is $919, which is computed
as follows:
$
Computer 5,000
Delivery fee 200
Installation fee 300
Depreciable cost $5,500
Decline in value $5,500 × 122 days/365 days × 200%/4 = $919.
The expenditure in acquiring the computer software is depreciable under Div 40 over 5 years
(s 40-95(7)) using the prime cost method set out in s 40-75(1). Thus, the deduction for the
computer software for the 2018/19 tax year is $133 (ie $2,000 × 122/365 × 100%/5 =
$134).The amount of $500 spent on the maintenance agreement for the computer is fully
deductible under s 8-1 as an income-producing expense for Mary (see Ronpibon Tin NL v FC
of T (1949) 78 CLR 47).
The total amount deductible to Mary McDonald in the 2018/19 tax year is summarised as
follows:
$
Decline in value of computer 919
Decline in value of software 134
177
Maintenance 500
$1,553
However, pursuant to the small business provisions contained in Division 328, Mary may be
able to write off the computer immediately. Section328-180(3) provides that where a
depreciable asset costs less than $20,000 and was acquired after 7.30 pm on the 12 May
2015, and is first used, or installed ready for use, by 30 June 2019, the taxpayer is entitled to
an immediate deduction. (For depreciating assets acquired between 29 January 2019 and 30
June 2019, this has been increased to $25,000).Consequently, an immediate write-off relating
to the cost of the computer and related software would be allowed. Where there is any private
usage, the deduction is limited to the work component.
[¶30-142] Solution 142

Decline in value deduction; balancing
adjustment on disposal
(1) Deductions claimable on the truck for
the tax year ended 30 June 2018
Based on the prime cost method, the annual decline in value of Micro Engineering’s truck is
computed as follows (s 40-75(1)):
The prime cost decline in value for the truck for the tax year ended 30 June 2019 is computed
as follows:
$
Cost of truck 60,000
Less: decline in value for 2017/18 tax year (as calculated above) (15,000)
Opening adjusted value at 1.7.18 45,000
Full depreciation limit 30.6.19 15,000
Actual depreciation deduction allowed for the tax year ended 30.6.19 (ie $15,000 ×
12,493
304 days/365 days*)
* The truck was sold on 30 April 2019, so the deduction must be apportioned (s 40-75(1)).
(2) Assessability of the gain on the disposal

of truck
178
Any gain on the disposal of Micro Engineering’s truck must be computed in accordance with
ITAA97 Subdiv 40-D as follows:
$
Less: 2017/18 decline in value (15,000)
Less: 2018/19 decline in value (up to 30.4.19) (12,493)
Adjusted value at 30.4.19 32,507
Termination value of the truck (s 40-300) (35,000)
Assessable balancing charge for Micro Engineering’s truck (s 40-285(1)) $2,493
[¶30-143] Solution 143

Determining decline in value rate
As Custom Design has chosen to use the diminishing value method, the decline in value is
based on the formula ITAA97 s 40-70(1):
For the Ford Falcon the depreciation is $10,705 computed as follows:
For the BMW the depreciation is $5,111, computed as follows:
*Although the BMW cost $81,000, the 2018/19 depreciation cost limit for a car is $57,581.
The total decline in value allowed in respect of both motor vehicles for the 2018/19 tax year
is summarised as follows:
$
Ford Falcon 10,716
BMW 5,111
$15,827
[¶30-144] Solution 144
179
Decline in value deduction where prior non-
business use
The deduction for the decline in value of Dr Susan Freeman’s office furniture for the 2018/19
tax year would be $1,496, computed (using the diminishing value method under s 40-70) as
follows:
2017/18 tax year

$
Cost price (opening value) as at 1 July 2017 6,000
Less: decline in value
(ie $6,000/4 × 365/365 × 200%) (3,000)
Adjustable value as at 30 June 2018 $3,000
2018/19 tax year
$
Opening adjustable value as at 1 July 2018 3,000
Less: deduction for decline in value
(ie $3,000/4 × 365/365 × 200%) (1,500)
Adjustable value as at 30 June 2019 $1,500
However, pursuant to the small business provisions in Division 328, Dr Freeman may be
eligible to claim a deduction for the depreciable assets based on pooling. As a result, under s
328-190 assets contributed to a pool in the first year may be depreciated at 15%. In the
second year the rate is 30%. Also, for the year ending 30.06.19 she may claim a deduction for
the balance of any depreciation pool where the balance of the pool is less than $20,000. See
sections 328-180 and s 328-210.
[¶30-145] Solution 145

Depreciating assets (including plant)
A ‘depreciating asset’ is an asset that has a limited effective life and can reasonably be
expected to decline in value over the time it is used (ITAA97 s 40-30(1)). The following
examples illustrate the application of the definition to different items.
(1)
Land is specifically excluded from the definition of depreciating asset.
(2)
Trading stock is specifically excluded from the definition of depreciating asset.
(3)
Intangible assets are generally excluded from the definition of depreciating asset, but s 40-
30(2) sets out the following exceptions, which do therefore count as depreciating assets:
(a)
mining, quarrying or prospecting rights
(b)
180
mining, quarrying or prospecting information
(c)
items of intellectual property
(d)
in-house software
(e)
IRUs
(f)
spectrum licences, and
(g)
data transmitter licences.
Items of ‘plant’ under ITAA97 former Div

42 definition
The definition of ‘depreciating asset’ also covers the meaning of ‘plant’ (used under ITAA97
former Div 42) in addition to other assets that are wasting in nature. The classical definition
of ‘plant’ was given by Lindley LJ in Yarmouth v France (1887) 19 QBD 647:
‘in its ordinary sense plant includes whatever apparatus is used by a business man for
carrying on his business—not his stock-in-trade which he buys or makes for sale; but all
goods and chattels, fixed or moveable, live or dead, which he keeps for permanent
employment in his business.’
While the Lindley definition is still referred to, Australian decisions suggest that one must
consider the function of the item. If the function of an item is to provide a setting or
environment within which income-producing activities are conducted (for example, an office
building), the item will not qualify as ‘plant’ for the purposes of the Act. If the function of an
item is to provide a means or apparatus, whereby income is to be produced (eg a machine or
equipment), the item is ‘plant’.
Application of these principles may result in the classification of the remaining items in the
question as follows:
(4)
A ship used as a floating restaurant would not be a depreciating asset because, while it is used
in connection with the taxpayer’s business, it is not an apparatus employed in the commercial
activities of the taxpayer, but rather a structure within which the taxpayer’s business is
carried on (Benson (Inspector of Taxes) v Yard Arm Club Ltd [1979] 2 All ER 336).
(5)
A portable building used as sleeping quarters for employees is a depreciating asset where it is
designed and constructed in connection with a nomadic type of business (Quarries Ltd v FC
of T (1961) 106 CLR 310).
(6)
Electrical wiring in a factory is part of the general equipment of the building and is not a
depreciating asset in its own right. Indeed, a building would be incomplete without electrical
wiring and its function does not go beyond making the building a suitable general setting for
181
a range of possible activities (Imperial Chemical Industries of Australia and New Zealand
Ltd v FC of T 70 ATC 4024).
(7)
Roller doors on a factory. In Carpentaria Transport Pty Ltd v FC of T 90 ATC 4590 Davies J
held that the AAT erred in law in holding that motorised roller shutter doors were not plant
because they formed an integral part of a building structure. The judge concluded that the
meaning of ‘plant’ was extended by the legislation to include ‘machinery’, so ‘machinery is
depreciable whether or not it forms an integral part of a building or is a part of the setting in
which business is carried on’ (p 4593). However, in Case Y52, 91 ATC 460, depreciation was
not allowed on manually operated roller doors because, unlike motorised roller doors, they
were not machinery and as they did ‘not perform any function with regard to the taxpayer’s
operations’ they were not depreciable plant (p 463).
(8)
Kitchen cupboards in a rental property. If these were built-in, they form part of the setting of
the rental property and are not a depreciating asset (Case 11/97, 97 ATC 173), which the
AAT allowed decline in value of wardrobes that were not built-in.
[¶30-146] Solution 146

Balancing adjustment on disposal; decline
in value deduction
Any gain on the disposal of Cynthia Williams’ Commodore should be computed in
accordance with ITAA97 Subdiv 40-D (using diminishing value method under s 40-70) as
follows:
$
Cost of car (1.10.16) 38,500
(7,225)
(ie $38,500 × 274 days/365 days × 200%/8 years)
(7,818)
(3,936)
Adjusted value at 1.3.19 19,531
Termination value (s 40-300) 14,000
Deductible balancing charge (s 40-285(2)) $5,531
However, because Cynthia’s decline in value deductions for the Commodore have been
reduced under s 40-25(2) due to a non-taxable purpose (ie private use), the deductible
balancing charge must also be reduced in line with the formula in s 40-290(2) as follows:
182
In the case of Cynthia’s Commodore, the decline in value in the asset and the deductions for
such decline are as follows:
Deduction Reduction
Tax year Decline invalue ($)
$ $
2016/17 7,225* 5,7 80** 1,445
2017/18 7,818 6,254** 1,564
2018/19 3,936* 3,148** 788
TOTALS $18,979 $15,182 $3,797
*Pro rata for part-year use.
**80% of decline in value.
The total decline in value of the Commodore is $18,979, and the sum of reductions is $3,797.
Therefore, the balancing adjustment amount must be reduced by 20% (ie $3,797/18,979 ×
100%).
The adjusted deductible balancing charge on Cynthia’s Commodore is $4,425(ie $5,531 × (1

− 0.20)).
Decline in value deductions

(1) Decline in value on Commodore 1.7.18 to 28.2.19
(ie $3,936 × 80%) (s 40-25(2)) $3,148
$
(2) Decline in value on Volvo –
Cost of car (1.3.19) 52,000
(ie $52,000 × 122 days/365 days × 200%/8 years) (4,345)
Adjusted value at 30.6.19. 47,655
Actual deduction allowed for 30.6.19
(ie 80% of $4,345 ) (s 40-25(2)) $3,476
[¶30-147] Solution 147

Small business entity—Low-cost assets
(1)
Small business entities are entitled to deduct amounts for most of their depreciating assets in
accordance with the special depreciation regime contained in ITAA97 Subdiv 328-D. Small
183
business entities that choose this system are not subject to the depreciation provisions
contained in ITAA97 Div 40 (ITAA97 s 328-175).
Pursuant to the small business provisions contained in Div 328, Black’s Lawn Mowing may
be able to write off the mower immediately. Section 328-180(4) provides that where a
depreciable asset costs less than $20,000 and was acquired after 7.30 pm on the 12 May
2015, and is first used, or installed ready for use, by 30 June 2019, the taxpayer is entitled to
an immediate deduction. Consequently, an immediate write-off relating to the cost of the
mower would be allowed in the 2018/19 income year.
(2)
If the lawnmower is used only 90% for business purposes by Black’s Lawn Mowing Service
during the 2018/19 tax year, then the deduction is limited to the taxable purpose proportion of
the asset’s cost (s 328-180). Thus, based on this scenario, the company will be entitled to
claim a deduction for the lawnmower of only $4050 (ie $4,500 × 90%) in the 2018/19 tax
year. (However, see comment on immediate write-off provisions in (1) above.)
[¶30-148] Solution 148

Cost of depreciating asset
For the purpose of ITAA97 Div 40, the decline in value of a depreciating asset is calculated
on the basis of the ‘cost’ of the asset. The cost of a depreciating asset held by the taxpayer
consists of the following two elements (s 40-175):
•
the first element of cost, ie the consideration provided by the taxpayer to hold the asset,
including incidental expenses incurred to acquire the asset (eg stamp duty): s 40-185, and
•
the second element of cost, ie generally the consideration provided by the taxpayer to bring
the asset to its present condition and location from time to time: s 40-190.
In terms of Fine Yarn’s purchase of a new dye machine, a number of observations can be
made:
•
The purchase price of the new machine of $240,000 would be included as a first element cost
of the new machine (s 40-185).
•
The removal cost of the old machine of $2,800 would not be included as a first element cost
of the new machine, because it was not a cost incurred to hold the new machine (s 40-185).
Moreover, the removal cost of the old machine would not be included as a second element
cost of the new machine as it does not contribute to the new machine’s present condition and
location (s 40-190).
•
Normally, the depreciable asset’s cost does not include the cost of structural alterations to a
building used to house the depreciable asset. But where special foundations are needed and
form an integral part of the depreciable asset, they could be regarded as a depreciable item.
Thus, the cost of strengthening the floor ($4,300) could be included as a second element cost
184
of the new machine as it contributes to the new machine’s present condition and location (s
40-190).
•
The insurance and transport costs of the new machine ($1,700) represent costs paid to bring
the machine to its present condition and location and would be included as a second element
cost of the new machine (s 40-190).
•
The installation and testing costs of the new machine ($2,400) would be included as a second
element cost of the new machine (s 40-190) because they contribute to the new machine’s
present condition.
Accordingly, the cost of the new dye machine under Div 40 for Fine Yarn Ltd is summarised
as follows:
$
Purchase price 240,000
Strengthening floor 4,300
Insurance and transport 1,700
Installation and testing 2,400
COST FOR DEPRECIABLE PURPOSES $248,400
[¶30-149] Solution 149

Capital works
Buildings are not usually regarded as ‘depreciating assets’ for the purpose of ITAA97 Div 40
unless they form an integral part of the operation (see Wangaratta Woollen Mills v FC of T
69 ATC 4095). However, income-producing buildings may be written off by means of a
capital works deduction under Div 43. Where construction commenced:
•
after 19 July 1982 and before 22 August 1984, the rate is 2½% pa
•
after 21 August 1984 and before 16 September 1987, the rate is 4% pa, or
•
after 15 September 1987, the rate is 2½% per annum unless construction is pursuant to a
contract entered into on or before 16 September 1987.
The 4% per annum write-off for industrial buildings that commenced construction after 26
February 1992 does not apply to a warehouse unless it was adjacent to the manufacturing site
and was used as temporary storage for raw materials and finished goods.
On this basis, the buildings may be written off at the following rates:
Mulgrave 2½% pa
Dandenong 2½% pa
Bayswater 2½% pa
185
Knoxfield 2½% pa
While the date the construction commenced usually determines the annual deduction rate, the
actual tax write-off period commences on the day that the building is first used for any
purpose after completion of construction. However, the deduction is only available during the
period when the premises are being used, or maintained ready for use, for income-producing
purposes.
For capital works commenced before 1 July 1997, to qualify for the deduction the
construction must have been intended to be used by the taxpayer for the purpose(s) outlined
in s 43-90 at the time the construction was completed. (The table in s 43-90, when read in
conjunction with s 43-75(2), preserves the position under former ITAA36 Div 10D.) For
capital works commenced after 30 June 1997, the table in ITAA97 s 43-140 only indicates
that the taxpayer’s area must be used either for producing assessable income or carrying on
research and development activities to qualify for the deduction. There is no reference to the
taxpayer’s intention at the time of completion of construction.
Assuming the buildings were used upon completion, the write-off by way of capital
allowance for the year ended 30 June 2019 for Warwick Johnson is calculated as follows:
Mulgrave 2½% × 365 days/365 days × $2,000,000 $50,000

Dandenong 2½% × 365 days/365 days × $2,500,000 $62,500
Bayswater 2½% × 365 days/365 days × $3,600,000 $90,000
Knoxfield 2½% × 91 days/365 days × $5,200,000 $32,410
TOTAL CAPITAL WORKS DEDUCTION $234,910
[¶30-150] Solution 150

Low-value depreciating asset pools
(i)
The deduction for depreciating assets under the Pooled asset provisions is determined by
multiplying the opening balance of the pool by 15%. Where assets are added to the pool
during the year the amount is 15% irrespective of the date when the asset was acquired in the
year. Consequently the decline in value deduction of Stephen Smith’s low-value pool for the
2018/19 tax year is computed as follows:
$
15% of the taxable use percentage of the cost of the laser printer allocated to the
1,080
pool during the year (ie $9,000 × 80% × 15%)
Add: 30% of the closing pool balance for the 2017/18 tax year (ie $30,000 × 30%)
9,000
Total decline in value deduction for the 2018/19 tax year $10,080
However, pursuant to the small business provisions contained in Division 328, and s328-185,
as the cost of the printer is less than $20,000, it may be claimed as an immediate deduction
under s 328-180 (4) relating to the proportion of business use. (For depreciating assets
acquired from 29 January 2019 until 30 June 2019 this has been increased to $25,000).
186
(ii)
The closing balance of Stephen Smith’s low-value pool for the 2018/19 tax year is calculated
as follows:
$
Closing balance for the 2017/18 tax year 30,000
Add: the taxable use percentage of the cost of the laser printer
(ie $9,000 × 80% = $7,200) 7,200
Less: the decline in value of the assets in the pool for the 2018/19 tax year (10,080)
Closing balance of the low-value pool as at 30 June 2019 $27,120
However, pursuant to the small business provisions in Division 328, for the year ending
30.06.19, Smith may claim a deduction for the balance of any depreciation pool where the
balance of the pool is less than $20,000. See s 328-180 and s 328 -210.
[¶30-151] Solution 151

Small business entity—General small
business pool
(1)
Depreciation deductions in the general small business pool for Spencer Electrics Pty Ltd for
the 2018/19 tax year
Asset Depreciationcalculation Deduction$
Opening balance of pool—$15,000 $15,000 × 30% 4,500
Office computer purchase—$6,000* $6,000 × 15% 900
General office equipment purchase—$7,000* $7,000 × 90% × 15% 945
Office photocopier (cost addition amount)—
$500 × 15% 75
$500*
Total depreciation deductions $6,420
*The small business provisions contained in Division 328 provide that where depreciating
assets purchased during the year cost less than $20,000, the total amount may be claimed as
an immediate deduction under s 328-180 (4). (For depreciating assets acquired from 29
January 2019 until 30 June 2019 this has been increased to $25,000.)
Where there is any private usage, the amount that may be claimed is reduced by the private
usage.
**Also, if the opening balance of the depreciation pool is less than $20,000, then the taxpayer
can claim a deduction for the balance of the pool. See s 328-180(6).
(2)
Closing balance of the general small business pool for Spencer Electrics Pty Ltd for the
2018/19 tax year
$
187
Opening balance of pool—1 July 2018 15,000
Add—additions during the year ($6,000 + ($7,000 × 90%) = $12,300) 12,300
Add—cost addition amounts ($500) 500
Less—depreciation deductions under ITAA97 s 328-190 (from above) (6,420)
Less—disposal proceeds ($1,600 + ($2,100 × 90%) = $3,490) (3,490)
Closing balance of the general small business pool for the 2018/19 tax year $17,890
As noted above as the opening balance of the pool is less than $ 20 000 the taxpayer may
claim a deduction for the entire balance of the pool (328-180(6)
[¶30-152] Solution 152

Disposal of a depreciable asset
(1) Income tax consequences of the disposal
The adjusted value of the drilling machine for Panatech Ltd at the time of disposal would be
calculated as follows:
$
Cost of drilling machine (1.7.17) 160,000
Less: Decline in value (ie $160,000 × 365 days/365 days × 200%/5 years) (64,000)
Less: Decline in value (ie $96,000 × 77 days/365 days × 200%/5 years) (8,100)
Adjusted value at 15.9.18 $87,900
Given that the drilling machine is wholly used for taxable purposes (ie the production of
assessable income) during the time that it is declining in value, an assessable balancing
adjustment amount arises (ITAA97 s 40-285) and no capital gain or loss arises (s 118-24).
Thus, Panatech Ltd would have to include $82,100 (ie $170,000 − $87,900) in its assessable
income for the 2018/19 tax year (s 40-285(1)).
(2) Alternative scenario: taxable purpose

only 90%
The adjusted value of the drilling machine at the time of disposal (ie 15 September 2018)
would be $87,900 as in (1) above. However, since the drilling machine has been only partly
used for taxable purposes (ie 90% for production of assessable income) and partly for non-
taxable purposes (ie 10% not for production of assessable income) during the time that it was
declining in value, the balancing adjustment amount calculated under s 40-285(1) is reduced
by the proportion of non-business use of the asset (s 40-290). Hence, the assessable balancing
adjustment should be $73,890 (ie $82,100 × (1 − 0.10)).
(3) CGT consequences of the disposal

188
Where a depreciating asset is used wholly for income producing purposes, s 40-285 provides
that the CGT provisions do not apply.
However, where there is a non-taxable use of the asset, the CGT event K7 also arises with
respect to the drilling machine. The CGT event occurs at the time of the event (ie 15
September 2018: s 104-235). According to CGT event K7, if the termination value exceeds
its cost, the excess, as reduced to reflect non-business use, constitutes a capital gain (s 104-
240). Hence, the capital gain according to CGT event K7 would be $1,000 (ie ($170,000 −
$160,000) × 10%).
In summary, Panatech Ltd would have to include the following amounts in its assessable
income for the 2018/79 tax year (assuming a taxable purpose of only 90%):
$
Balancing adjustment of drilling machine 73,890
Capital gain on disposal of drilling machine 1,000
TOTAL AMOUNT INCLUDED IN ASSESSABLE INCOME FOR 2018/19 TAX
$74,890
YEAR
[¶30-153] Solution 153

Decline in value; repairs; capital works
Fair Dinkum Publishing Ltd’s printing press is a depreciating asset (ITAA97 s 40-30) with an
estimated effective life of 10 years. It can be depreciated at the rate of 15% per annum in
accordance with the diminishing value method (s 40-70) or at the rate of 10% per annum
under the prime cost method (s 40-75).
Whether the installation of the new filters qualifies as a repair under s 25-10 depends upon
whether the work is the restoration of part of some income-producing property rather than the
reconstruction of the entirety, and is not an improvement. The installation of new filters to a
printing press would not be a reconstruction of the entirety, but as the new filters have a
greater filtering capacity and longer life, they would be classified as an improvement (FC of
T v Western Suburbs Cinemas Ltd (1952) 86 CLR 102). As an improvement the expenditure
would be capitalised and the decline in value claimed under Div 40.
The modifications to the building would not represent a repair because the expenditure is of a
capital nature (s 25-10(3)). For a building, or part of a building, to qualify as a depreciating
asset for capital allowance purposes, the structure must play an active part in the
manufacturing process rather than only providing the setting for business operations.
In Wangaratta Woollen Mills v FC of T 69 ATC 4095, the vat pit and the ventilation system
were an essential part of the taxpayer’s business and an active tool in preventing spoilage of
material and enabling the removal of volatile liquids. McTiernan J said at p 4101 that they
‘would be completely unnecessary in almost every other industry and quite useless to any
buyer except a dyer’. The unique features of the dye-house meant that it was in the nature of
a tool in the taxpayer’s trade so that the building, except for the external wall and roof which
189
provided the setting for the business operations, was a depreciating asset and could be written
off.
Whether the floor drainage and installation of exhaust ducts in a building housing a printing
press have the same unique features as a dye-house is a matter of debate. If the modifications
are a depreciating asset, then a deduction by way of decline in value is allowable under s 40-
25(1). If the modifications are not a depreciating asset, then Div 43 would enable the
expenditure to be deducted as an improvement to an income-producing building at the rate of
4% pa, because the building is being used for industrial activities. The deduction would
commence from 20 December 2017, the date the work was completed.

[¶30-154] Solution 154
Decline in value; repairs; disposal
(1) Decline in value on Toyota Hi-Ace
Deluxe van
The Toyota Hi-Ace Deluxe van would qualify as a depreciable asset under ITAA97 s 40-30.
Hence, Div 40 of the Act would apply. Nigel’s van should be depreciated at the rate of 33.3%
(ie 200% ÷ 6 years) using the diminishing value method (s 40-70).
Depreciation using DVM Improvement Adjusted value

$ $ $
31.8.16 to 30.6.17
(305 days/365 days) 12,500* 32,500
1.7.17 to 30.6.18 12,833** 6,000 25,667
(365 days/365 days)
1.7.17 to 1.2.19
(216 days/365 days) 5,063*** 20,604
*Decline in value for the period 31.08.16 to 30.06.17:
($45,000 × 305 days/365 days × 200%/6 = $12,500)
**Decline in value for the period 1.7.17 to 30.6.18:
([($32,500 + $6,000) × 365 days/365 days × 200%/6] = $12,833)
***Depreciation for the period 1.7.18 to 1.2.19:
190
($25,667 × 216 days/365 days × 200%/6 = $5,063)
This tax treatment assumes that the new engine is a capital improvement and not a repair.
Thus, the cost of the new engine is a second element cost (s 40-190) and has been capitalised
and incorporated into the total value of the van for depreciation purposes.
(2) Balancing adjustment on disposal of

Toyota Hi-Ace Deluxe van on 1 February
2015
As the termination value (trade-in on disposal) of $16,000 for the Toyota Hi-Ace Deluxe van
is less than its adjusted value of $20,603, a deductible balancing adjustment of $4,603 (ie
$20,603 − $16,000) arises for the 2018/19 tax year (s 40-285(2)).
(3) Decline in value on Nissan truck

The Nissan truck, which was acquired on 1 February 2019, would qualify as a depreciable
asset under s 40-30. Hence, Div 40 of the Act would apply. The truck should be depreciated
at the rate of 40% (ie 200% ÷ 5 years) using the diminishing value method (s 40-70)
computed as follows:
Depreciation using Adjusted

DVM value
$ $
1.2.18 to 30.6.19:$54,000 × 151 days/365 days ×
8,935
200%/5
The maximum deduction available to Nigel for the 2018/19 tax year is summarised as
follows:
$
Decline in value on Toyota van 5,063
Balancing adjustment on disposal of Toyota van 4,608
Decline in value on Nissan truck 8,935
$18,606
[¶30-155] Solution 155

Decline in value deductions; balancing
adjustment on disposal
191
(1) Decline in value deductions for Toyota
Camry for 2017/18
The decline in value deduction for Dr Christopher Young’s Toyota should be calculated in
accordance with ITAA97 Subdiv 40-B as follows:
$
Cost of Toyota (1.9.16) 35,000
(7,311)
(6,922)
(4,793)
Adjusted value at 1.6.18 $15,974
However, as the Toyota was only used 60% for a taxable purpose (ie an income-producing
purpose), the decline in value deductions must be apportioned (s 40-25(2)) as follows:
•
actual decline in value deduction for 2016/17 tax year—$4,387 (ie $7,311 × 60%)
•
actual decline in value deduction for 2017/18 tax year—$4,153 (ie $6,922 × 60%), and
•
actual decline in value deduction for 2018/19 tax year—$2,876 (ie $4,793 × 60%).
(2) Balancing adjustment on disposal of

Toyota Camry
Since the termination value (ie trade-in on disposal) of the Toyota ($20,000) is greater than
the adjusted value ($15,974) as at 1 June 2019, an assessable balancing adjustment of $4,026
(ie $20,000 − $15,974) arises (s 40-285(1)). However, because Dr Young’s deductions for the
decline in value of the Toyota have been reduced under s 40-25(2) due to a non-taxable
purpose (ie private use), the assessable balancing charge must also be reduced in accordance
with the formula in s 40-290(2), computed as follows:
192
In the case of Dr Young’s Toyota, the decline in value of the asset and the deductions for that
decline are as follows:
Decline in value Deduction Reduction

Tax year
$ $ $
2016/17 7,311* 4,387** 2,925
2017/18 6,922 4,153** 2,769
2018/19 4,793* 2,876** 1,917
TOTALS $19,026 $11,415 $7,611
*Pro rata for part-year use.
**60% of decline in value.
The total decline in value of the Toyota is $19,026, and the sum of reductions is $7,611.
Thus, the balancing adjustment amount must be reduced by 40% ($7,611 ÷ $19,026 × 100%).
Hence, the adjusted deductible balancing charge on Dr Young’s Toyota is $2,415 (ie $4,026
× (1 − 0.40)).
(3) Decline in value deductions for Honda

Accord for 2018/19
The decline in value deduction for Dr Young’s Honda motor vehicle should be determined
according to ITAA97 Subdiv 40-B as follows:
$
Cost of Honda (1.6.19) 60,000
Depreciation cost limit for car (s 40-230) 57,581*
(1,183)
(ie $57,581 × 30/365 days × 200%/8 years)
Opening adjusted value at 1.7.19 $56,389
* The depreciation cost limit for 2018/19 is $57,581.
Because the Honda is only used 70% for a taxable purpose (ie the production of assessable
income), the decline in value deduction must be apportioned (s 40-25(2)). Thus, the actual
decline in value deduction for Dr Young’s Honda for the 2018/19 tax year is $828 (ie $1,183
× 70%).
[¶30-156] Solution 156

Disposal; depreciable cost
193
For Mint Ltd, the Ford truck would qualify as a depreciating asset under ITAA97 s 40-30 and
Div 40 would therefore apply. With an estimated effective life of eight years, the truck is
depreciable at the rate of 25% per annum (ie 200% ÷ 8 years) under the diminishing value
method (s 40-70).
(1) Cost of the Ford truck for depreciation

purposes (Subdiv 40-C)
$
On-road cost:
Stamp duty 9,000
Delivery fee 2,000
$141,000
If the insurance cost of $6,000 relates to ‘in-transit’ insurance then it should be included in
the cost base of the Ford truck. However, if it is an annual insurance fee (as it is assumed
here), it is fully deductible under s 8-1 in each year which it is incurred. The registration fee
of $5,500 is also deductible under s 8-1 in the year that it is incurred.
(2) Calculation of balancing adjustment for

Volvo truck
$
Trade-in value of old Volvo truck (termination value) 19,000
Adjusted value (11,000)
Assessable amount (s 40-285(1)) $8,000
(3) Calculation of decline in value for Ford

truck
$
Less: decline in value (ie $141,000 × 335/365 × 200%/8 years) (32,352)
(1.8.18 to 30.6.19 = 335 days)
Adjusted value at 30 June 2019 $108,648
NET DEDUCTION FOR 2018/19 TAX YEAR AFTER BALANCING
ADJUSTMENT
(ie $32,352 − $8,000) $24,352
[¶30-157] Solution 157

194
Depreciable cost; finance cost
Normally, buildings do not qualify as ‘depreciating assets’ under ITAA97 Div 40 and are
therefore not depreciable. However, a capital works deduction can be claimed according to
Div 43 for an income-producing building.
There is scope for an argument that the factory building does qualify as a depreciating asset
because it is specially designed to provide a dust-free and uniform temperature environment
(see Wangaratta Woollen Mills Ltd v FC of T 69 ATC 4095). However, exhaust fans and air
conditioning units installed within the building are probably responsible for such an
environment. Thus, fans and air conditioning units, but not the building, would be
‘depreciating assets’ for the purposes of the Act. However, the industrial building may
qualify under Div 43.
As construction of the factory commenced on 20 August 2014 and it is used for industrial
activities (defined in s 43-150), the building is being used in the 4% manner (s 43-145).
However, the deduction cannot start until construction is completed even if the building is
used before completion (s 43-30). In this question the deduction can commence from
1 March 2017 when the building is available for use for a particular purpose (s 43-160). So, a
deduction can be claimed for the factory for 122/365 days.
While the depreciating assets were installed on 1 March 2019, they were not installed ready
for use until 1 May 2019, so they can only be depreciated for 61/365 days. Note that, if a
depreciating asset has been purchased and/or replaced in storage, this is not sufficient to
establish installation ‘ready for use’.
Summary of deductions for Com Power for the tax year ended 30 June 2019
Item Calculation Deduction$

Factory $3,340,000* × 4% × 122/365 44,655
Floor reinforcement $70,000 × 10% × 61/365
(extra cost of strengthening floor to carry particular
1,169
items of a depreciating asset is generally depreciable)
Light fittings $180,000 × 20% × 61/365 6,016
Floor installations $230,000 × 10% × 61/365 3,843
Internal plumbing
$190,000 × 20% × 61/365 6,350
and fittings
Internal partitions $110,000 × 20% × 61/365 3,676
Air conditioning $230,000 × 20% × 61/365 7,687
Interest on
$1,800,000 × 7% × 242/35 83,539
borrowings
TOTAL DEDUCTIONS FOR THE 2018/19 TAX YEAR $156,935
*Electrical wiring would not qualify as a depreciating asset (FC of T v ICI Australia Ltd 72
ATC 4213), but would be treated as part of the construction cost of the building for Div 43
purposes.
195
[¶30-158] Solution 158
Disposal; replacement; cessation of business
(1) Effect of insurance recovery on
assessable income
Buzz Manufacturing must calculate the balancing adjustment for the disposal of the destroyed
machine according to ITAA97 Subdiv 40-D as follows:
$
Insurance recovery (termination value) 28,000
Less: Depreciated value of machine (adjusted value) (20,000)
Excess $8,000
Normally, as the machine is wholly used for taxable purposes (ie the production of assessable
income) during the time that it has been declining in value, an assessable balancing
adjustment amount arises (s 40-285) and no capital gain or loss arises (s 118-24). Thus, Buzz
Manufacturing would have to include the excess of $8,000, in its assessable income for the
2018/19 tax year (s 40-285(1)). However, a balancing adjustment offset is also available for
involuntary disposals under s 40-365. Specifically, if Buzz Manufacturing acquires a
replacement asset, the $8,000 balancing adjustment can be offset against the cost of the
replacement asset in the year in which the replacement asset is first used or is installed ready
for use, or the opening adjustable value of the replacement asset (in later years). Hence, the
$8,000 balancing adjustment may not have to be included in the assessable income of Buzz
Manufacturing for the 2018/19 tax year.
(2) Decline in value deduction for new

machine for tax year ended 30 June 2019
The decline in value deduction for Buzz Manufacturing’s new machine must be calculated
with reference to ITAA97 Subdiv 40-B. In particular, the diminishing value method (s 40-70)
was elected to be used by Buzz Manufacturing. Because the machine has an effective life of
seven years, the diminishing value depreciation rate is approximately 28.6% per annum (ie
200%/7 years).
$
Cost of new machine (1.7.18) 25,000*
Less: Decline in value
(ie $25,000 × 365 days/365 days × 200%/7 years) (7,143)
Opening adjusted value at 1.7.18 $17,857
* (ie $33,000 − $8,000 balancing adjustment of old machine = 25 000)
196
Thus, Buzz Manufacturing can claim a decline in value deduction of $7,143 for the new
machine for the 2018/19 tax year.
(3) Effect if Buzz Manufacturing ceases

business on 1 July 2018
Suppose Buzz Manufacturing ceases business on 1 July 2019 and sells the new machine for
$26,500. The adjusted value of the new machine at the time Buzz Manufacturing ceases
business on 1 July 2019 is $17,857 (see (2) above). The taxpayer must compute the balancing
adjustment for the disposal of the new machine according to Subdiv 40-D as follows:
Termination value of new machine $26,500

Less: Adjusted value of new machine ($17,857)
Excess $8,643
Because the machine is wholly used for taxable purposes (ie the production of assessable
income) during the time that it has been declining in value, an assessable balancing
adjustment amount arises (s 40-285), and no capital gain or loss arises (s 118-24). Thus, Buzz
Manufacturing would have to include the excess of $8,643, in its assessable income for the
2018/19 tax year (s 40-285(1)).
(4) Alternative scenario: new machine used

only 90% for income-producing purposes
If Buzz Manufacturing used the new machine only 90% for income-producing purposes, this
would change the results in (2) and (3) above. Specifically, the depreciation allowance on the
new machine would have to be reduced by the part of the decline in value that is attributable
to the use for a purpose other than a taxable purpose (s 40-25(2)). Thus, as the new machine
is used 10% for private purposes, only 90% of its decline in value is deductible. On this basis,
the decline in value deduction for the new machine for the 2018/19 tax year would be $6,429
(ie 90% × $25,000 × 365 days/365 days × 200%/7 years).
The balancing adjustment of the new machine at the time of disposal (ie 1 July 2019) is
$8,643 as computed in (3) above. However, because the new machine was only partly used
for taxable purposes (90% for the production of assessable income) and partly for non-
taxable purposes (10% for private purposes) during the time that it was declining in value, the
balancing adjustment amount calculated according to s 40-285(1) is reduced by the
proportion of non-business use of the asset (s 40-290). The assessable balancing adjustment
amount according to s 40-290 should be $7,779 (ie $8,643 × (1 − 0.10)).
CGT event K7 also arises with respect to the machine because it is only partly used for
taxable purposes. The CGT event occurs at the time of the event (which is 1 July 2019: s 104-
235). In terms of CGT event K7, if the termination value exceeds its cost, the excess, as
reduced to reflect non-business use, represents a capital gain (s 104-240). The capital gain
according to CGT event K7 should be $150 (ie ($26,500 − $25,000) × 10%).
197
In summary, Buzz Manufacturing would have to include the following amounts in its
assessable income for the 2018/19 tax year (assuming that the new machine is used 90% for
income-producing purposes):
Balancing adjustment of machine $7,779

Capital gain on disposal of machine $150
TOTAL AMOUNT INCLUDED IN ASSESSABLE INCOME FOR 2018/19 TAX
$7,929
YEAR
|
198
Taxation of Individuals
[¶30-159] Solution 159
Offset for superannuation contribution for
low income/non-working spouse
A resident taxpayer may be entitled to an offset for contributions made to a complying
superannuation fund or RSA for the benefit of the taxpayer’s resident non-working or low-
income earning spouse, aged 65 or under. (Or aged 70 and under, if the spouse satisfies a
work test; over 70 years of age the contributions cannot be accepted.) See ss 290-230 and
290-235(1)(a) indicate additional conditions which relate to the taxpayer’s spouse. The offset
is 18% of the lesser of:
•
$3,000 reduced by the amount (if any) by which the total income of the individual’s spouse
exceeds $37,000, and
•
the sum of the spouse contributions made by the individual in the income year.
Consequently, the maximum offset is $540 and the offset is not available where the total of
the spouse’s assessable income, reportable fringe benefits and reportable employer
superannuation contributions exceeds $40,000 for 2018/19.
Paul is entitled to an offset of $432 calculated as follows:
•
Determine the difference between the sum of Marie’s total income and $37,000 threshold
($39,000 – $37,000 = $2000).
•
Reduce the maximum contribution of $3000 by the excess of $2000 to give $1,000.
•
The offset is 18% of $1,000 = $180.
The amount of $180 is less than the $540 maximum, so the offset is restricted to $180.
Note that from the 2017/18 tax year, a spouse contributions tax offset will not be available
where:
•
the taxpayer’s spouse has exceeded his or her non-concessional contributions cap of
$100,000 for the 2018/19 tax year or
•
199
before the start of the 2018/19 tax year, the taxpayer’s spouse had a total superannuation
balance that was equal to or exceeded the general transfer balance cap of $1.6 million for the
2018/19 tax year.
[¶30-160] Solution 160

Medical expenses tax offset
As none of the expenses arise in the course of earning Brian Wallis’ assessable income, no
deduction is allowable under ITAA97 s 8-1(1). A claim may arise by way of medical expense
tax offset if the expenditure qualifies under ITAA36 s 159P.
The medical expenses tax offset has been means tested from 1 July 2012. There are two
levels of the rebate:
Level 1: Single taxpayers with adjusted taxable incomes for rebates (ATIR) of $90,000 or
less and families with a combined ATIR below $180,000 will be able to claim 20% of net
medical expenses over the Level 1 threshold ($2,377 for 2018/19).
Level 2: Single taxpayers with ATIR above $90,000 and families with a combined ATIR
above $180,000 will be able to claim 10% of net medical expenses over the Level 2 threshold
($5,609 for 2018/19).
The family threshold for levels 1 and 2 will increase by $1,500 per child for families with
each dependent child after the first.
A tax offset for medical expenses is available to a resident taxpayer who has incurred net
medical expenses, in respect of himself or herself and resident dependants. The terms
‘medical expenses’ and ‘dependant’ are defined in s 159P(4).
For the 2013/14 to 2018/19 income tax years, the amount that would otherwise be paid as
medical expenses will not be treated as medical expenses under s 159P(1B) unless the
payment:
•
relates to an aid for a person with a disability; or
•
relates to services rendered by a person as an attendant of a person with a disability; or
•
relates to aged care provided by an approved provider of a person who is approved as a care
recipient or is a continuing care recipient within the meaning of the Act.
Consequently, the only expense that qualifies in 2018/19 for the tax offset is the walking aid
for Brian’s sixteen-year-old disabled daughter, at the cost of $2,840. Brian’s medical
expenses total $2,840. As this sum is also net of reimbursement, Brian would be entitled to a
medical expense tax offset calculated at the rate of 10% of the excess net medical expenses
over $5,609. As Brian’s medical expenses are below $5,609 he cannot claim a tax offset in
the 2018/19 tax year.
200
[¶30-161] Solution 161
Dependant (invalid and carer) tax offset
(DICTO)
The dependant (invalid and carer) tax offset (DICTO) may be available for contributing to the
maintenance of an eligible dependant who is unable to work due to invalidity, or alternatively
where that dependant is unable to work due to caring obligations for an invalid relative. An
invalid dependant must be in receipt of a disability support or invalidity service pension,
while a dependant carer must be in receipt of a carer allowance or carer payment under the
Social Security Act 1991. It is also noted that taxpayers eligible for the DICTO must not be in
receipt of disqualifying payments such as Family Tax Benefit Part B and must not exceed the
income limit for Family Tax Benefit which is $100,000 in 2018/19.
The DICTO provisions are contained in Subdiv 61-A (ss 61-5 to 61-45) of ITAA97. As
indicated, DICTO is only available for a dependant who is unable to work due to invalidity or
carer obligations. The taxpayer and their dependant must generally be Australian residents.
However, a foreign resident spouse or child may qualify if the taxpayer has domicile in
Australia.
The dependant carer must be:
•
caring for the taxpayer’s child, brother or sister or the taxpayer’s spouse’s brother or sister
(over the age of 16) and receiving a carer allowance or carer payment in respect of the care
they provide in relation to that person; or
•
wholly engaged in providing care to the taxpayer’s child, brother or sister or the taxpayer’s
spouse’s brother or sister (over the age of 16) who receives:
•
a disability support pension;
•
a special needs disability support pension; or
•
an invalid service pension.
However, a taxpayer cannot claim DICTO if:
•
they are claiming DICTO in respect of their spouse, and the taxpayer (or their spouse) is
eligible to receive Family Tax Benefit Part B (s 61-25);
•
the eligible dependant has an ATIO over $11.150 ; or
•
the taxpayer’s ATIO is more than $100,000 (s 61-20).
201
The maximum DICTO available to a taxpayer for the 2018/19 tax year is $2,717. However,
according to s 61-45 of ITAA97, where the dependant’s ATIO is in excess of $282, the
maximum DICTO is reduced by $1 for every complete $4 of ATIO received by the eligible
dependant in excess of $282.
Therefore, the amount of the DICTO can be calculated as follows:
In other words, the more ATIO the eligible dependant derives, the lower the DICTO. Where
the eligible dependant derives ATIO of $11,150 or more, the taxpayer is no longer eligible
for DICTO.
Note that cents are ignored in the calculation because the maximum rebate is reduced by $1
only for each complete $4 of ATIO.
As George and Jenny satisfy the tests of the DICTO and are not excluded based on their
ATIO and non-receipt of FTB the offset will be reduced as per the formula above.
[¶30-162] Solution 162

Taxation of minors
As Grace is less than 18 years of age at 30 June 2019, she is considered a ‘prescribed person’
for the purposes of Division 6AA of ITAA36 (ss. 102AA-102GA).
The first step is to classify the income derived by Grace as either:
•
excepted assessable income; or
•
eligible taxable income.
(a)
Excepted assessable income
The $6,000 wage income represents income earned by Grace. The $400 of deductions that
relate solely to this income means her total income is $5,600. This income is taxed at normal
tax rates and as $5,600 is less than the tax-free threshold of $18,200, the tax payable is nil
and there is no claim for the LITO.
(b)
Eligible taxable income
202
The $5,000 distribution from the family trust represents eligible taxable income. Eligible
taxable income is subject to the special rates of tax contained in Division 6AA of ITAA36.
As $5,000 is greater than $1,308, the tax payable on the amount of $5,000 is a flat 45%.
Hence, the tax payable comes to $2,250.
Grace is not subject to the Medicare levy as her total taxable income is less than the Medicare
levy threshold. Furthermore, Grace is not subject to the low income rebate as, from 2011/12,
this offset can no longer be applied against ‘eligible taxable income’. This is also the same
with the low and middle income tax offset which is available from 2018/19, but cannot be
applied in this case.
Hence, the overall tax payable is $2250.
[¶30-163] Solution 163

Private health insurance tax offset
Tom Maher is entitled to a tax offset for private health insurance pursuant to ITAA97 s 61-
205, subject to Subdiv 61-G conditions being met. These include the requirement that the
premium be paid in respect of a ‘complying health insurance policy’, such as one that
provides hospital cover and/or ancillary cover, and also that the premium be paid in the same
income year that it is claimed as an offset.
Since 1 July 2012 the private health insurance tax offset has been income and age tested
(Fairer Private Health Insurance Incentives Act 2012, Fairer Private Health Insurance
Incentives (Medicare Levy Surcharge) Act 2012 and Fairer Private Health Insurance
Incentives (Medicare Levy Surcharge—Fringe Benefits) Act 2012). Entitlement to the offset
is determined according to the Health Insurance Act 1973.
The 25.415% private health insurance tax offset is reduced for individuals earning more than
$90,000, or families earning more than $180,000. The offset cuts out completely for singles
earning more than $140,000 and families earning more than $280,000. An individual’s
entitlement to the offset is now tested against their income for Medicare levy surcharge
purposes.
Three tiers of private health insurance tax offset entitlement apply (see tables below).
Income thresholds
Base Tier Tier 1 Tier 2 Tier 3
$ $ $ $
Singles 0–90,000 90,001–105,000 105,001–140,000 Over 140,000
Families 0–180,000 180,001–210,000 210,001–280,000 Over 280,000
Private health insurance tax offset available

203
Based Tier Tier 1 Tier 2 Tier 3
Aged under 65 25.415% 16.943% 8.471% 0%
Aged 65–69 29.651% 21.180% 12.707% 0%
Aged 70 or over 33.887% 25.415% 16.943% 0%
Medicare levy surcharge

Base Tier Tier 1 Tier 2 Tier 3
Rates 0% 1% 1.25% 1.5%
Note: These rebate rates are for premiums paid between 1 July 2018 and 31 March 2019. The
rebate is indexed every 31 March and the new figures are released by the Department of
Health. The income tiers for the private health insurance rebate have been temporarily frozen
at the 2014/15 rates for the 2015/16 to 2018/19 tax years.
From 1 July 2012, the Medicare levy surcharge has increased for singles and families who
fall within tiers 2 and 3 and do not hold appropriate private health insurance cover.
Therefore Tom is entitled to a tax offset of $377.78:
Henry also satisfies the conditions in Subdiv 61-G and is entitled to a tax offset of $210.95:
[¶30-164] Solution 164

Beneficiary rebate
Barbara’s entitlement to a beneficiary
rebate
Under s 160AAA, the recipient of a Commonwealth government pension, allowance or
benefit, known as a ‘rebatable benefit’, is entitled to a beneficiary rebate. Rebatable benefits
include Newstart allowance, mature age allowance and specified Commonwealth education
and training payments.
The beneficiary rebate is designed to ensure that a taxpayer who receives a fully rebatable
benefit for the whole year and has no other taxable income will pay no tax for the year. The
beneficiary rebate is calculated using the following formula:
204
Where the amount of the 2018/19 rebate benefit is $37,000 or less, the upper threshold for the
lowest marginal tax rate is:
Where A = the amount of rebatable benefit received by the taxpayer during the year rounded
to the nearest $.
Where the amount of the 2018/19 rebate benefit is $37,000 or more, the upper threshold for
the lowest marginal tax rate is:
Where A = the amount of rebatable benefit received by the taxpayer during the year rounded
to the nearest $.
Barbara’s beneficiary rebate will be:
[$32,400-$6,000] × 0.15 + 0 (rebatable benefit is less than $37,000) = $3960
[¶30-165] Solution 165

Personal services income (PSI)
Tax implications of the PSI regime
The contract would appear to satisfy the results test (ITAA97 Pt 2-42 s 87-15). Three
conditions need to be satisfied in relation to at least 75% of Consultant Co’s PSI. (The 75%
requirement does not include any income received by Robert Black or Consultant Co in their
capacity as employee nor as an office holder, for example a director of a company.) (See
generally Taxation Ruling TR 2005/16.)
(1)
Payment is based on completion of a task—the development of a product for use in the
department’s IT system. There is a degree of flexibility in how the work is to be done and the
entity appears free to engage people or hire plant to achieve the result.
(2)
It is possible that Consultant Co would provide its own tools and equipment necessary to
perform the work but, if the government department supplies minor tools and equipment, the
condition will still be met. It is a question of fact and degree to qualify as an independent
contractor. (In Hollis v Vabu Pty Ltd 2001 ATC 4508, the High Court found that the
provision and maintenance of bicycles was not enough of a capital outlay to indicate the
status of an independent contractor. See generally Taxation Ruling TR 2000/14.)
(3)
205
It is highly likely that Consultant Co would be liable for the cost of rectifying any defective
work, regardless of whether Consultant Co carries out the defective work itself or does so
after the task is completed (s 87-18). Where physical rectification is not possible, the
condition would still be satisfied where the government department has the right to claim for
damages in respect of the faulty work. See Taxation Ruling TR 2001/8: the Commissioner of
Taxation will look to the substance of the agreement to determine whether a liability really
exists.
In the case of Skiba v FC of T 2007 ATC 2467, it was held that the PSI of a company which
provided engineering services was properly attributable to the director of the company who
performed the services as the company failed to satisfy the results test. See also Prasad v FC
of T 2015 ATC 10396 and Douglass 2018 ATC 10481.
In Nguyen v FC of T 2005 ATC 2304, the AAT held that a computer consultancy firm did not
satisfy the results test as the terms of its contracts were not consistent with those that could
reasonably be expected in the case of an independent contractor. Further there was no
evidence that it was customary of entities providing the services of IT personnel to be paid on
the basis of a result.
A similar result was discovered in the case of Taneja v FC of T 2009 75 ATR 111 where
income derived by a company from the services of a computer analyst was assessable to the
analyst personally as the company did not satisfy the results test. Also in the cases of Cooper
v FC of T 2010 78 ATR 669 and Russell v FC of T 2011 FCAFC 10 it was found that the
results test in s 87-18(3)(a) was not satisfied.
When determining whether the results test has been satisfied, the Commissioner of Taxation
will also have regard to the contractual statements between parties to ensure that they convey
the real contractual position and are not just ‘window dressing’ (see Taxation Ruling TR
2001/8). Consequently, in the case of IRG Technical Services Pty Ltd v DFC of T 2007 ATC
5326 two taxpayer entities, each of which was controlled by a different engineer, failed to
satisfy the results test as the contracts were not a ‘reflection of substantial reality’.
However, it should be noted that it is not essential that the terms and conditions of the ‘work’
to be performed are specifically included in a written contract. In determining whether Robert
Black satisfies the results test, the custom and practice in the IT industry will be taken into
consideration and based on the facts given the PSI regime would not apply to this contract.
[¶30-166] Solution 166

Primary producer averaging
Where a taxpayer who is a primary producer avails himself or herself of the averaging
provisions, and the taxable income in the current year exceeds the average income, then the
taxpayer receives an offset. The offset is determined by reference to the difference between
the tax on the taxable income at ordinary rates and the tax on the taxable income at the
average rate. The average is based on the average of taxable income over a maximum period
of five years.
206
On this basis the average income is calculated as follows:
The tax payable on $32,000 is $2,622. This gives a comparison rate of 8.19375%
($2,622/$32,000). The amount of tax that would be paid on the current year’s income of
$50,000 at the comparison rate of 8.19375% is $4,096.88. Apart from the averaging
provisions, the tax payable on $50,000 at ordinary 2018/19 rates would be the higher amount
of $7,797. Jenny is therefore entitled to an averaging adjustment under ITAA97 Subdiv 392-
C.
Jenny’s gross averaging amount, for the purposes of the formula in s 392-75, is:
As all of Jenny’s income is taxable primary production income, and the amount is more than
$10,000 (non-farm income), she will be entitled to a tax offset of the whole difference of
$3,700.12.
Note: As Jenny commenced primary production in 1986, 2015 is unlikely to be her first
averaging year, so averaging has been calculated over a five-year period. Suppose that Jenny
commenced primary production in 2015. A minimum period of two years is required for
averaging, in which the taxable income of the second year is not less than the taxable income
of the first year (ITAA36 s 151 and 158). In this case, 2016 could not be the first averaging
year, because the taxable income of $15,000 was less than the taxable income in 2015
($20,000). The first averaging year would be 2017, with the average income being $25,000
[($15,000 + $35,000) ÷ 2], because the taxable income in 2017 ($35,000) was greater than
the taxable income in 2016 ($15,000).With effect from the 2016/17 tax year, primary
producers will be able to access income tax averaging 10 income years after choosing to opt
out. After the basic 10 year opt-out period has concluded taxpayers will be treated as new
primary producers in applying the basic conditions. An election should be lodged with the tax
return in this regard.
[¶30-167] Solution 167

Salary packaging
The tax effectiveness of these benefits to Bill if provided on a salary sacrifice basis is set out
below.
Employee—Bill Jones—savings
Salary
Item No packaging $
packaging $
Total remuneration cost (TRC) 109,500 109,500
Less employer superannuation (No FBT) 9,500 15,500
207
100,000 94,000
Less packaged items
Laptop—primarily for work use (exempt—No FBT) 3,300
Car—running costs ($8,145 + $2,616) 10,761
Car—FBT ($33,390 × 20% x 365/365 × 2.0802 × 47%) 6529
Electricity 2,000
Electricity—FBT (remote area concession—taxable
value $2,000 is reduced by 50% s 60(4) FBTAA) × 978
2.0802 × 47%)
Interest 5,200
Interest—FBT (taxable value $5,200 reduced by 50%
0 2,306
concession × 1.8868 × 47%)
Adjusted remuneration 100,000 62,926
Less tax on earnings excluding Medicare (2018/19
24,497 11,998
rates)
Net income after tax 75,503 50,928
Superannuation 9,500 15,500
Less: contributions tax of 15% (1,425) (2,325)
Add Net superannuation 8,075 13,175
Less costs if expenses not packaged
Additional superannuation required to increase to
6,000
$15,500 (no contributions tax if paid directly)
Interest 5,200
Electricity 2,000
Car—running costs ($8,145 + $2,616) 10,761
Laptop 3,300 0
Net income after tax (including superannuation) 56,317 64103
Annual increased remuneration—tax saving $7,786

[¶30-168] Solution 168
Termination of employment
Mary Adams
Calculation of tax payable/refund for the year ended 30 June 2019
Employment termination payment (ETP) of $450,000.
208
Employment termination payment (ETP) of
$450,000
Taxable component
The taxable component of a life benefit termination payment is the amount of the payment
after deducting the tax free component (s 82-145). The taxable component is included in
assessable income but the employee is entitled to a tax offset that puts a ceiling on the tax rate
that may apply (s 82-10(2)–(4)).
The tax rate depends on the age of the employee and the amount received with the tax offset
ensuring as a general rule:
•
tax does not exceed 15% on the amount up to the ETP cap amount ($205,000 for the 2018/19
tax year, indexed annually (s 82-160)) if the taxpayer has reached preservation age (currently
55 years) on the last day of the income year, and
•
tax does not exceed 30% up to the ETP cap amount if the taxpayer is below preservation age.
In all other cases, tax is payable at the top marginal rate of 45% to the extent that the
taxpayer’s taxable income (including the lump sum) exceeds $180,000 (whole of income cap
amount—not indexed).
Medicare levy is also added where appropriate.
The tax free component only comprises the pre-July 1983 segment.
Number of pre-July 1983 days/Total number

Therefore the pre-July 1983 segment =
of days of employment
= 4,748/17,532
= 0.270819 × $450,000
= $121,868
The taxable component = $450,000 − $121,868
= $328,131
Taxable income 328,131
Tax on first $180,000 @15% 27,000.00
Balance ($328,131 – $180,000) taxed at
66,658.95
45% ($148,131 × 45%)
Tax liability 93,658.95
Add: Medicare levy ($328,131 × 2%) 6,562.62
Tax payable $100,221.57
Superannuation payment of $34,500

209
The taxable component of the superannuation benefit received by Mary may consist of two
elements:
1.
An element taxed in the fund, and
2.
An element untaxed in the fund (this is basically where 15% tax has not been paid when
contributions were made to the fund).
Generally, however, it consists of an element taxed in the fund (s 307-275).
The tax free component will remain tax free.
The tax treatment of superannuation member benefits paid from complying superannuation
plans is set out in ITAA97 Div 301. The tax treatment depends on:
•
The age of the recipient
•
Whether the benefit is a superannuation lump sum or income stream, or
•
Whether the taxable component contains an element taxed in the fund or an element untaxed
in the fund.
Note that as Mary is aged 68 (over 60), assuming the payment is paid from an element taxed
in the fund, and given that it was a complying superannuation fund, then regardless of
whether it was a lump sum or income stream the entire $34,500 would be tax free (s 307-
275).
[¶30-169] Solution 169

Senior Australians and pensioners tax
offset; tax file number
Bob Brown
Statement of taxation liability for year ended 30 June 2019
$ $
Income:
Social security pension 9,290
Bank interest 120
Dividends—unfranked 343 9,827
—franked 52
—imputation credit ($52 × 1/70/30) 22
Less: allowable deduction: bank charges 27
210
Tax on taxable income 0.00
Less: Non-refundable tax offsets
Senior Australians and pensioners tax offset (2018/19) 2,230.00
Tax offset for low income earners
445.00 2,875
Tax offset for low and middle income earners 200
Tax payable Nil
Less: Refundable tax offsets and credits
Franking credit 22.00
TFN credit 58.00
TAX REFUND $80.00
There is no Medicare levy because Bob’s taxable income is below the Medicare levy
threshold for 2018/19.
[¶30-170] Solution 170

Overseas employment
Salary income earned by Sheila Good while working in Singapore is exempt from Australian
tax (ITAA36 s 23AG and 23AG(1AA) provided:
•
It is aid or charitable work as an employee of a recognised non-government organisation;
•
the work involves the delivery of Australian official development assistance (except if the
worker’s employer is an Australian government agency); or
•
it is work of a government employee deployed as a member of a disciplined force.
The exemption from Australian tax will not apply where the income is exempt from income
tax in the foreign country only because of one or more of the following (ITAA36 s.
23AG(2)):
•
the income is exempt under a double taxation agreement (DTA) or a law of a country that
gives effect to a DTA
•
the foreign country exempts from income tax, or does not provide for the imposition of
income tax on, income derived in the capacity of an employee, income from personal services
or similar income
•
a law or international agreement, to which Australia is a party, dealing with privileges and
immunities of diplomats or consuls or of persons connected with international organisations
applies.
211
Alternatively, where the earnings would have also been exempt in the foreign country for
another reason, such as, the existence of another agreement or memorandum of understanding
as well as the operation of a DTA, the exemption will still apply in these cases. (Taxation
Ruling TR 2013/7 contains guidance on the application of these restrictions) See also
Coventry v FCT 2018 ATC 10472 and Grant v FCT 2007 ATC 2557). This is the situation in
Sheila’s case. It also appears to be an ‘approved project’, so the exemption applies.
Taxable income: $ $
Rent received in Australia 9,000
Non-exempt foreign interest
1,000 10,000
(interest received $900, plus withholding tax $100)
Less: Expenditure incurred exclusively in deriving this income 1,550
Gift to charity 200 1,750
For the purposes of determining the tax payable on the income which is not exempt under
ITAA36 s 23AG, the following formula applies (s 23AG(3)):
Notional gross tax is the tax (in whole dollars) that would be payable (including the Medicare
levy, but not including any tax offsets) on the amount that would be total taxable income if
the exempt income was assessable income, ie on $93,250 ($96,000 − $2,750).
Notional gross taxable income is the amount (in whole dollars) that would be the total taxable
income if the exempt amount was assessable income.
Other taxable income in the formula is $8,432. This amount differs from the $8,250 taxable
income in the calculation above because the gift to the charity comes off as an apportionable
deduction of $18, rather than as a deduction of $200.
Tax payable on the non-exempt income is calculated as follows:
$21,999.50 (including Medicare levy) × $8,432 $1,988.80

$93,250
Less: Credit for foreign tax on interest 100
Low income tax offset
445 745
Low and Middle income tax offset 200
TAX PAYABLE ON NON-EXEMPT INCOME $1,243.80
Note:
Calculation of the apportionable deduction
212
Where:
1 Notional gross taxable income is the total income less all the deductions namely $96,000 (ie
$86,000 + $1,000 + $9,000) − $2,750 (ie $1,000 + $50 + $1,500 + $200) = $93,250.
2 Other taxable income is other assessable income (rent $9,000 + foreign interest $1,000 =
$10,000) less allowable deductions attributable to this assessable income ($1,550) = $8,450.
The gift deduction is excluded from this calculation so $8,450 − $18 = $8,432.
[¶30-171] Solution 171

PAYG instalments
As an individual with investment or business income, Tim Hall will have to pay tax by
PAYG instalments. The legislation is found in TAA Sch 1 Pt 2-10. Tim Hall has lodged his
tax return for the 2017/18 year and his PAYG for the 2018/19 year can now be determined.
Tim Hall may be an annual payer if the following conditions are satisfied (TAA Sch 1 s 45-
140(1)):
•
the taxpayer’s most recent notional tax notified by the Commissioner of Taxation is less than
$8,000
•
the taxpayer is not required to be registered for GST
•
the taxpayer is not a partner in a partnership that is registered or required to be registered for
GST
•
if the taxpayer is a company, the company is not a participant in a GST joint venture under
Division 51 of the Act
•
if the taxpayer is a company, it is not part of an instalment group (as defined in s 45-145) or
participating in GST joint ventures.
As Tim meets all these conditions, he can pay annual instalments at the end of the first
quarter of the income year. If he has been brought into the PAYG system for the first time
part-way through the income year, he can pay at the end of the first quarter for which an
instalment would normally be due. Taxpayers who cease to be eligible to pay PAYG on an
annual basis will commence paying PAYG instalments from the first quarter of the following
income year (rather than the quarter they became ineligible).
One option for working out the PAYG instalment amount is to work out the notional tax.
That is, annual payers can pay an amount equal to the notional tax, which will be notified to
them before the end of the income year (s 45-115(2) Commissioner’s instalment rate).
Notional tax equals an amount based on the previous year’s tax on business and investment
income, without an uplift factor.
213
Pursuant to TAA Sch 1 s 45-325(1), notional tax is the adjusted tax on adjusted taxable
income for the base year, reduced by the adjusted tax on adjusted withholding income.
(1)
Adjusted taxable income = total assessable income less allowable deductions from the most
recent assessment:
$
Total assessable income 39,000
Less: donation 5,000
ADJUSTED TAXABLE INCOME $34,000*
* Note: The interest that was subject to TFN withholding does not count as adjusted
withholding income.
(2)
Adjusted tax on adjusted taxable income at 2018/19 rates:
$
Tax on $34,000 3,002
Less: DICTO 2,717
low income rebate
445
Low and middle income tax offset 200
Plus: Medicare levy ($34,000 × 2%) 680
NOTIONAL PAYG TAX INSTALMENT (for 2018/19) $680
[¶30-172] Solution 172

Taxable income/tax refund
Calculation of Ted Mansfield’s tax liability for the 2018/19 tax year.
Assessable income: $ $
Salary 92,000
Dividends 3,820
Gross-up for franking credit ($3,820 × 1/70/30) 1,637
Total income 97,457
Less: Deductions 5,780
TAXABLE INCOME 91,677
Tax payable on $91,677 (2018/19 rates) 21,417.49
Less: Offsets
DICTO offset* 1,262
Franking credit
1,637 3,403.85
*Low and middle income tax offset 504.85
18,013.64
Add: Medicare levy ($91,677 × 2%) 1,833.54
19,847.18
214
Less: Credit for PAYG withheld from salary 21,672.00
TAX REFUND $1,824.82
* DICTO
Maximum tax offset available (2018/19) 2,717
Reduced for Shiree’s ATIO Less ¼ of ($6,100 – $282) (ignore cents) 1,454
DICTO
1,262
*Low and middle income tax offset = $91677 (1,677 × 0.015) = $25.15
($530 − 25.15= $504.85)
Note: there is no entitlement to a LITO as taxable income exceeds $66,667.
[¶30-173] Solution 173

Salary packaging
Tax effectiveness of these benefits to Peter if provided on a salary sacrifice basis
(1) Car fringe benefit

‘Car benefit’ is defined in FBTAA s 7(1). A car can be valued by either using the statutory
formula method (s 9) or operating cost method (s 10).
Under the statutory formula method (contract entered into after 10 May 2011)
TV = $55,000 × 0.20 × 365/365 − 0 = $11,000
Gross-up $11,000 × 2.0802 = $22,882.2 × 0.47 = $10,754 (rounded) FBT payable
(GST input tax credit is available as the car was purchased after 23.5.01)
Under the operating cost method
TV will depend on the actual % of business use. This requires a logbook.
If BP = 65% (15,000 km/23,000 km)
TV = ($1,500 × 12) + $2,000 × 35% (private use) − 0
= $7,000 × 2.0802
= $14,561.40 × 0.47
= $6,844 (rounded) FBT payable
(ie operating cost method provides lower FBT)
The salary to be sacrificed for this benefit will comprise:
A GST input tax credit applies. Therefore, the cost of the car to Compweb is reduced by
1/11th.
$
Cost to employer:
Lease and running costs ($20,000 − 1/11th) 18,182
+ FBT payable (operating cost method) 6,844
215
TOTAL SALARY SACRIFICE $25,026
Cost to employee:
Net salary sacrificed = $25,026 × 0.61 (1 – 0.39)* 15,265.86
Less: Benefit to employee:
Lease + running costs (GST inc) 20,000
ADVANTAGE (Tax Saving) $4,734
*As Peter’s marginal tax rate is 37% and he is subject to the Medicare levy at 2% (= 39%
total) his take home pay is 61% (1 – 0.39) of his gross earnings.
(2) Car parking fringe benefit

Car parking benefit arises under FBTAA s 39A. Under the statutory formula method (s 39F):
TV = $10 × 365/365 × 240 days = $2,400

Grossed-up $2,400 × 2.0802 = $4,882.48 × 47% FBT = $2,346
Cost to employer:
Rent (net of GST) $4,545
FBT $2,346
Total salary
$6,891
sacrifice
Cost to employee:
Net salary sacrificed $6,891 × 0.61 = $4,203.51
Benefit to
employee:
Current car parking = $5,000 (if Peter wants to park at work) or $2,400 (if Peter wants to
fees park at the parking station nearby)
Therefore, there is a saving of $796.49 ($5,000 – $4,203.51 ) if Peter wants to park at work
and a detriment of $1,803.51 ($4,203.51 – $2,400) if Peter wants to park at the nearby
parking station.
(3) Share investment

Upfront taxation would be the default position. Generally, any discount to the market value of
employee share scheme (ESS) interests in shares or rights provided under an ESS is taxed
upfront on acquisition. That means that the market value of the discount must be included in
an employee’s assessable income for that income year.
A $1,000 tax exemption is available to taxpayers participating in an ESS who pay tax
upfront, if they have a taxable income (after adjustments) of $180,000 or less, and the
employee and the scheme meet certain conditions.
The conditions for the upfront concession are:
216
the employee must be employed
•
the scheme must be offered to at least 75% of permanent employees
•
the shares or rights provided must not be at real risk of forfeiture
•
the shares or rights must be required to be held by the employee for three years or until the
employee ceases employment, and
•
the employee must not receive more than 10% ownership of the company, or control more
than 10% of the voting rights in the company, as a result of participating in the scheme.
In Peter’s case any discount is included in the year a share or right is acquired (ITAA97 Div
83A). He will be entitled to a $1,000 tax exemption as his taxable income is less than
$180,000 and assuming he and the share scheme meet the conditions above. The tax saving
for Peter is $1,000.
(4) Child care

This is an expense payment fringe benefit (FBTAA s 20) (not provided on employer’s
premises). However, it is GST-free supply so it becomes a Type 2 benefit.
FBT payable = $12,000 × 1.8868 × 0.47

= $10,641
Cost to the employer:
Child care (no GST) $12,000
FBT 10,641
Total salary sacrifice $22,641
Cost to the employee:
Net salary sacrificed = $22,641 × 0.61
= $13,811.01
Detriment to employee = $12,000 − $13,811.01
= $1811.01
Note that because FBT is levied at the top marginal rate plus Medicare, there will normally
be a detriment to salary sacrifice benefits that do not attract concessional FBT treatment
unless the employee is on the top marginal tax rate (which is not the case for Peter).
Therefore, the car, the car parking (if Peter wishes to park at work) and shares would be the
most tax effective of the benefits when provided on a salary sacrifice basis not the child care.
[¶30-174] Solution 174
217
Zone Rebate
Section 79A provides for a rebate of tax for taxpayers residing in isolated areas, identified as
Zone A or Zone B. Residents of Zone A are granted a rebate ‘in recognition of the
disadvantages … of … uncongenial climatic conditions, isolation and high cost of living’.
Zone B comprises areas which are less badly affected than Zone A and accordingly the rebate
for Zone B is lower.
The zones are defined geographically in Schedule 2, ITAA36. Ordinary Zones A and B cover
the areas of mainland Australia and Tasmania including the west, north and centre of
Australia. Within each Ordinary Zone are Special Zone categories which are available to
taxpayers who reside in particularly isolated areas. For example, a Special Zone A area would
include Norfolk Island while a Special Zone B area would include King Island in Tasmania.
In general, the residence test is satisfied if the taxpayer resides in the zone (not necessarily
continuously) for more than half of the tax year (at least 183 days). In counting the 183 days,
non-continuous stays are added together. A day includes a fraction of a day (see Taxation
Ruling TR 94/27).
From the 2015/16 tax year the zone rebate will exclude workers who ‘fly in fly out’ and
‘drive in and drive out’ (FIFO) of a zone to live and perform their duties when their usual
place of abode is actually outside the zone. Consequently, while the days in the zone may
constitute more than 183 days, FIFO workers will not be entitled to the zone rebate.
For each of the four zones, the rebate consists of a basic amount plus a percentage of the
‘relevant rebate amount’. The relevant rebate amount for 2018/19 includes:
•
amounts for dependants who are unable to work as a result of invalidity or carer obligations,
who are entitled to the DICTO of $2,717 (subject to a maximum ATI of $11.150 in 2018/19)
•
amount of any notional tax offset of $1,607, and
•
any notional child or student rebate of $376 (subject to a dependant’s maximum ATI of
$1786) s 79A(2).
John’s zone rebate is calculated as follows:
Maximum DICTO available ($2,717 – (1⁄4 × ($4111 – $282)) (ignore cents) 1,759
Sole parent rebate 1,607
Notional dependant rebate—one student 376
Notional child rebate—first child, not being a student 376
Relevant rebate amount 4,118
Ordinary Zone A rebate is $338 + 50% of $4,118 = $2,397.
[¶30-175] Solution 175

218
Sale of business; tax planning
(1) Trading stock
The sale of Russell’s business will result in a disposal of trading stock not in the ordinary
course of business, so Russell will be assessable on the market value of the stock on the date
of disposal and Jones will be deemed to have acquired the stock for that value (ITAA97 s 70-
90; 70-95).
Market value may not be the $70,000 agreed to by Russell and Jones.
(2) Debtors
It is undesirable for Russell to sell his debts to Jones. It is recommended that Russell either
collect the debts himself, or ask Jones to collect them for him for a fee as his agent. This
approach would result in Russell being entitled to a deduction for any bad debts and for the
collection fee.
If the parties proceeded with the sale of debts, any bad debts would not be deductible to Jones
as the debts have not been included in Jones’ income as required by s 25-35. Jones would
obtain a capital loss on disposal of the asset debtors, but this capital loss is not deductible
outright and can only be offset against a capital gain.
(3) Plant
The tax consequences will depend upon the adjusted value of Russell’s plant and equipment
and the date of acquisition of each asset.
Assuming all assets were acquired post-CGT, if any asset realised a price greater than its
initial cost, then Russell might be liable for capital gains tax on the difference between the
capital proceeds (termination value) and the indexed cost base of the asset. Note that GST
input tax credits are excluded from all elements of the cost base and reduced cost base of an
asset (ITAA97 s 103-30; see CGT Event K7 where the asset is not used 100% for income-
producing purposes).
Alternatively, for assets which are sold after 21 September 1999, CGT can be calculated as
50% of the nominal gain (being the difference between the capital proceeds and the cost
base) provided the asset has been held for 12 months.
However, if the asset was used 100% for income-producing purposes and if the asset is
realised below its adjustable value, Russell would be entitled to a tax deduction of the residue
(insufficient depreciation has been allowed) (s 40-285(2)(b)). If termination value exceeds
adjustable value, the residue is assessable (s 40-285(1)(b)). In this latter case, Russell is
retiring from business and the amount assessable under s 40-285(1)(b) is not being used to
reduce the value of other assets (s 40-340 or 40-345).
219
Jones is generally deemed to have acquired the asset for its full purchase price. Consequently,
it is in Russell’s interest to have a low value attributed to plant and equipment, while from
Jones’ viewpoint the higher the value the greater will be his depreciation deduction.
(4) Premises
When was the building constructed? If construction of the non-residential building used for
income-producing purposes commenced after 19 July 1982, then the ITAA97 Div 43
deduction allowable to Russell will pass to Jones.
If the building was acquired by Russell after 19 September 1985, and the sale price exceeded
its indexed cost base, a capital gain would arise. This gain is assessable to Russell unless he
has capital losses to offset against the capital gain. (Alternatively, as the building qualifies as
an active asset, Russell can avail himself of the CGT small business concessions of the 50%
discount, the 15-year exemption and the 50% active asset reduction).
(5) Goodwill
When did Russell acquire the business? If it was acquired before 20 September 1985, the sum
attributed to goodwill is a tax free capital gain. If the business was established post-CGT,
then a 50% exemption for the disposal of active assets by small business taxpayers may
apply, provided certain basic conditions are satisfied (Div 152). In some cases, a capital gain
attributable to goodwill on the sale of a business may be exempt under the former goodwill
concession, despite the taxpayer electing to apply a small business roll-over for goodwill
(Sherlinc Enterprises Pty Ltd v FC of T 2004 ATC 2022).
The net asset value must be less than $6,000,000. This exemption may be in addition to the
15-year exemption or 50% discount available for assets sold after 21 September 1999.
(6) Small business retirement exemption

As Russell is retiring, if he satisfies the conditions of ITAA97 Subdiv 152-D (ie aggregate
turnover in the current year was less than $2 million) he may elect to treat any capital gain
arising from disposal of an active asset of his small business as a retirement benefit rather
than a capital gain. The amount that can be treated as a retirement benefit is limited to the
CGT-exempt amount. Note that from 1 July 2016, the $2 million aggregate turnover test
increased to $10 million (except for CGT small business concessions where it remains at $2
million), while the corporate tax rate has decreased from 28.5% to 27.5% and the small
business tax offset has increased from 5% to 8% with the aggregate turnover test of $5
million.
If Russell was aged below 55 he must contribute to a complying superannuation fund, ADF
or RSA, an amount equal to the asset’s CGT-exempt amount. The CGT-exempt amount
cannot exceed the lifetime limit of $500,000 (s 152-315). If Russell is 55 or over it can be
paid directly to him. The small business retirement exemption may be utilised before or after
the small business asset roll-over.
220
(7) GST and sale of a going concern
A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act) Subdiv 38-J makes
supplies of going concerns GST-free, if certain conditions are satisfied. This involves Russell
and Jones agreeing in writing that the supply is a going concern, where Jones is registered for
GST and where Russell provides to Jones ‘all the things that are necessary for the continued
operation of an enterprise’. Note that the agreement need not be signed by both parties (see
Midford v DFC of T 2005 ATC 2189; Case 12/2009, 2009 ATC ¶1-016; and SDI Group Pty
Ltd v FC of T 2012 ATC ¶10-282) see also MSAUS Pty Ltd as Trustee for the Melissa Trust
and Commissioner of Taxation [2017] AATA 1408. Russell must also carry on the enterprise
until the day of the supply (GST Act s 38-325(2); see also Debonne Holdings Pty Ltd v FC of
T 2006 ATC 2467; and GST Ruling GSTR 2002/5). This exemption will also allow Jones to
avoid unnecessary stamp duty as the purchase price will be a GST-exclusive amount.
Likewise, Jones will not have to finance the GST component and wait for the ITC (input tax
credit).
(8) Financing the acquisition

Currently, Jones has a $100,000 non-deductible interest expense in the form of his home
mortgage. Jones should use some of his cash to pay off the mortgage on his home and borrow
the balance required to finance the acquisition of business assets, particularly the premises.
The interest expense is then tax deductible (ITAA97 s 8-1).
(9) Structure of purchasing entity

The purchasing vehicle for the business depends upon a range of factors including desired
degree of control over the business and property, asset protection, the risk associated with the
business, and Jones’ family relationships, including children. Given the age of the children
and a desire for flexibility in tax planning, a discretionary trust with a corporate trustee may
be the most appropriate structure.
It should be noted that since 1 July 2007, the eligibility for the small business CGT
concessions has been aligned with the eligibility for a range of other concessions available to
small businesses, including concessions relating to trading stock, depreciation, FBT, GST and
PAYG instalments. Essentially, the eligibility is based upon a $2,000,000 aggregate turnover
test (for non-CGT concessions it is the $10,000,000 aggregate turnover test). However,
satisfying the alternative eligibility tests (eg net assets less than $6 million) in Div 152 will
still enable access to the small business CGT concessions if the aggregate turnover exceeds
$2,000,000.
[¶30-176] Solution 176

Personal services income
221
Medi-Labs’ $49,000 fee revenue is derived from Leanne’s personal services as a
pharmaceutical consultant and therefore may be susceptible to the alienation of the personal
services income (PSI) regime (ITAA97 s 84-5; Taxation Ruling TR 2001/7). Accordingly, if
the regime applies, Medi-Labs would have to attribute the fee revenue received to Leanne
and, consequently, she will be assessed on the amount attributed (ITAA97 s 86-1).
If Medi-Labs establishes that it is running a personal services business (PSB), the PSI regime
will not apply (ITAA97 s 86-15(3)). Medi-Labs will be running a PSB if it satisfies one of the
following tests (ITAA97 s 87-15):
•
the results test under ITAA97 s 87-15
•
the unrelated clients test under ITAA97 s 87-20
•
the employment test under ITAA97 s 87-25
•
the business premises test under ITAA97 s 87-30.
The unrelated clients test, employment test and business premises test all have a threshold
condition that no one client may pay the personal services entity (PSE) 80% or more of the
PSI (s 87-15(3); Taxation Ruling TR 2001/8 para 146). In this case, as Medi-Labs receives
100% of the PSI from the Commission, it therefore fails the threshold. Accordingly, Medi-
Labs cannot rely on the unrelated clients test, employment test or business premises test.
(Note in addition to the threshold requirement, there are other conditions which will need to
be satisfied (ITAA97 Div 87). These conditions have not been discussed as the threshold
condition has been failed.)
It also appears Medi-Labs will fail the results test. To pass the results test, Medi-Labs will
need to establish that at least 75% of Leanne’s PSI was for producing a result where she
provides the necessary tools of the trade to produce the result and that she assumes liability
for costs in rectifying defects (s 87-18). It is also important to take into account industry,
custom and practice when considering this test. In the case of Skiba v FC of T 2007 ATC
2467, it was held that the PSI of a company which provided engineering services was
properly attributable to the director of the company who performed the services as the
company failed to satisfy the results test. A similar result was discovered in the case of
Taneja v FC of T 2009 ATC ¶10-112, where income derived by a company from the services
of a computer analyst was assessable to the analyst personally as the company did not satisfy
the results test. Similarly, in the cases of Cooper v FC of T 2010 ATC ¶10-130 and Russell v
FC of T 2011 ATC ¶20-240 it was found that the results test in s 87-18(3)(a) was not
satisfied. See also Prasad v FC of T 2015 ATC 10396 and Douglass 2018 ATC 10481.
The characteristics of Leanne’s position indicate that she is an employee. As such, it will be
deemed that Medi-Labs was not carrying on a PSB (see Taxation Ruling TR 2001/8
generally).
Overall, it is a question of fact and degree to qualify as an independent contractor (Hollis v

Vabu Pty Ltd 2001 ATC 4508). It should be noted that contactors who operate through
interposed entities where there is little, if any, business infrastructure or plant and equipment
used to derive income of the entity, could also be caught by the anti-avoidance rules under Pt
222
IVA. (See Taxation Ruling TR 2005/16 regarding the criteria used in distinguishing
independent contractors from employees, ie the control and integration tests.) The PSI regime
applies to Leanne and her company.
Consequences of the PSI regime applying

The PSI received by Medi-Labs will be attributed to Leanne (s 86-15(1)). As Medi-Labs
distributed a salary to Leanne, PSI attributed will be reduced by the amount of salary already
paid (s 86-15(4)). This deduction is conditional on Medi-Labs distributing Leanne’s salary
before the end of the 14th day of the PAYG payment period. This adjustment is made to
avoid double taxation as salary constitutes ordinary income (ITAA97 s 6-5). In addition,
Medi-Labs is under the obligation to withhold PAYG from Leanne’s gross salary.
It is possible to offset Medi-Labs’ allowable deductions against Leanne’s PSI. The amount of
reduction is derived by applying the method statement in s 86-20. The application of the
method statement to this scenario is as follows:
Step = $330, annual pharmacist

PSI deductions
1 registration fees
Step
Entity maintenance deductions = $200 of bank account fees
2
Step
Medi-Labs’ assessable income other than PSI = $0
3
Step
Subtract amount at Step 3 from Step 2 = $200
4
Step
If Step 4 greater than $0 amount of reduction = Steps 1 and 4
5
Step If Step 4 not greater than $0 amount of reduction (not
= Step 1
6 applicable in this case)
Therefore, Step 5 applies and $530 will be offset against the PSI attributed (s 86-20(1)). The
general requirement for a PSE not running a PSB to deduct a loss or outgoing is generally
limited to those available as an employee (ITAA97 s 86-60). Additionally, a PSE may also
deduct ‘entity maintenance deductions’ which are, for example, bank fees and tax related
expenses deductible under s 25-5 (ITAA97 s 86-65). It should be noted that other outgoings
may be deducted when specifically allowed by ITAA97 Subdiv 86-B. (See Taxation Ruling
TR 2003/10.)
Overall effect on Leanne Byrnes

(individual) using Medi-Labs (PSE)
Leanne includes $18,470 for her personal services in her income tax return. The calculation
follows:
Leanne’s PSI received by PSE $49,000

Less: salary payments by the PSE $30,000
223
$19,000
Less: reduction by method statement (s 86-20(1)) $530
PSI attributed to Leanne $18,470
The PSI attributed to Leanne will be added to her taxable income and taxed at her marginal
rate of tax. The effect on Medi-Labs is that the fees received will not form assessable income
or exempt income to the extent that it is Leanne’s PSI (ITAA97 s 86-30; Taxation Ruling TR
2003/6 generally).
Category C: Solutions 177 to 182

[¶30-177] Solution 177
Taxable income; offsets
Albert Jones
Statement of taxation liability for the year ended
30 June 2019
Assessable income $ $

Salary 45,500
Dividend (grossed-up for franking)
($500 + ($500 × 1/70/30 × 50%)) 607 46,107
Less: Allowable deductions—
Premium on personal accident policy 150
Self-education expenses ITAA36 s 82A ($4,750 − $250) 4,500 4,650
Tax payable on $41,457 @ 2018/19 rates 5,020.53
Add: Medicare levy ($41,457 × 2%) 829.14
5,849.67
Less: Tax offsets—
DICTO1 403.27
Medical expense tax offset2 195.60
Dividend imputation credit ($250 × 1/70/30)3 107.00
Low income tax offset4
378.00 1,417.18
Low and medium income tax offset5 333.31
TAX PAYABLE5 $4,432.49
Less: Tax withheld 6,334.50
TAX REFUND DUE $1,902.01
Notes:
224
(1) The Dependant Invalid Carer Tax Offset (DICTO) may be available for contributing to
the maintenance of an eligible dependant who is unable to work due to invalidity, or
alternatively where that dependant is unable to work due to caring obligations for an invalid
relative. An invalid dependant must be in receipt of a disability support or invalidity service
pension, while a dependant carer must be in receipt of a carer allowance or carer payment
under the Social Security Act 1991. It is also noted that taxpayers eligible for the DICTO
must not be in receipt of disqualifying payments such as Family Tax Benefit Part B and must
not exceed the income limit for Family Tax Benefit of $100,000 for the 2018/19 tax year.
Consequently Albert qualifies for the DICTO:
Maximum DICTO available 2018/19 $2,717

Less reduction for Anne’s ATIO (1/4 × ($1500 – 282) $304
$2,413
(days caring for Anne from 1 May to 30 June 2019) × 61/365
Rebate allowable $403.27
(2) Medical expense tax offset:
A tax offset for medical expenses is available to a resident taxpayer who has incurred net
medical expenses, in respect of himself or herself and resident dependants. The terms
‘medical expenses’ and ‘dependant’ are defined in s 159P(4).
For the 2013/14 to 2018/19 income tax years the amount that would otherwise be paid as
medical expenses will not be treated as medical expenses under s 159P(1B) unless the
payment:
• relates to an aid for a person with a disability; or
• relates to services rendered by a person as an attendant of a person with a disability; or
• relates to age care provided by an approved provider of a person who is approved as a care
recipient or is a continuing care recipient within the meaning of the Act.
Consequently the only expense which qualifies in 2018/198 is the disability aid for Anne at
the cost of $3,355 as expenditure that can qualify for the tax offset.
Tax offset 20 cents in the dollar on amount in excess over $2,377 (2018/19):
= $3,355 – 2,377
20% × $978 = $195.60
Note that from 1 July 2012 the medical expenses tax offset is means tested. Single taxpayers
with adjusted taxable incomes for rebates (ATIR) of $90,000 or less and families with a
combined ATIR below $180,000 will be able to claim 20% of net medical expenses over the
Level 1 threshold ($2,377 for 2018/19).
(3) Imputation credits are truncated as per ATO instructions.
225
(4) Low income tax offset (LITO) 2018/19
$445 − ($41,457 − $37,000 × .015)
$445 − $67 = $378 (ignore cents)
(5) Low and medium income tax offset (LMITO) $200 + ($41,457 − 37,000) × 0.03 =
$333.71
(6) Family Tax Benefit:
On the facts provided, it is unlikely that Albert Jones would qualify for a Family Tax Benefit.
Although Albert’s taxable income is below the higher income threshold for Family Tax
Benefit, it is questionable whether Albert is responsible for the care of his son, Jim,
particularly as Jim lives with his mother. Where a child is a dependant of two or more
persons who do not live together, Family Tax Benefit can be apportioned. But, as Jim resides
with Jenny, he would not have resided with Albert for the minimum time (10%) to enable
Albert to claim any Family Tax Benefit.
[¶30-178] Solution 178

Tax refund; ETP; superannuation
Bill Mantle
Statement of taxation liability year ended
30 June 2019
Income: $ $
Salary 1 July 2018 to 30 September 2019 12,000
Lump sum re annual leave 2,500
Lump sum re long service leave1
— attributable to service between 16.8.78 and 17.8.93 0
— attributable to service after 17.8.933 13,000
Retirement gratuity (taxable post component)2 9,277
Superannuation annuity4 0
Total assessable income 36,777
Less: Deductions 750
Gross tax on taxable income 3,387.13
Less: Tax offsets —
Tax offset for leave payments1 0.00
Retirement gratuity $371.08
Low income tax offset3 445.00
226
Low and Middle Income Tax offset 200
1016.08
2,371.05
Add: Medicare levy 2% of taxable income 720.54
Total tax payable 3,091.59
Tax withheld 11,875.00
TAX REFUND4 $8,783.41
Notes:
(1) Tax offset for leave payments
Bill Mantle started work in October 1980 with Contract Builders (and therefore has no pre-16
August 1978 eligible service). He retired on 30 September 2018 and received $13,000 for
unused long service leave.
The total number of days of unused long service leave is 75, and the number of days of long
service leave unused after 17 August 1993 is 60.
The tax payable by Bill in respect of the $13,000 unused long service leave is determined as
follows:
Step 1: Calculate pre-15 August 1978 component—nil. Therefore, the whole of the payment
relates to post-15 August 1978.
Step 2: Calculate the unused long service leave for the pre-18 August 1993 period and the
post-17 August 1993 period using the formula (ITAA97 s 83-95(2)). Bill’s total long service
days are 115 (40 used and 75 unused). The number that accrued in the period 1/10/80 to
17/8/93 is 115 × 4,704/13,879 = 33.89.
Therefore, the number of days that accrued in the period 18/8/93 to 30/9/18 is 81.11.
The amount of the payment that relates to the period 1/10/80 to 17/8/93 is (33.89 − 40)/75 ×
13,000 = $0 and the amount of the payment that relates to the period 18/8/93 to 30/9/18 is
$13,000.
$13,000 received for long service leave will be included as assessable income and taxed at
Bill’s marginal rate (plus Medicare levy).
Step 3: The payment made for unused long service leave between 16 August 1978 and 17
August 1993 is an exception which will be subject to a maximum of 30% tax.
Post-15 August 1978 component less post-17 August 1993 component
= $13,000 − $0
= $0 excess.
227
The excess amount of the $13,000 is nil so there will not be any tax offset entitlement.
(2) Retirement gratuity
As the retirement gratuity was paid in consequence of Bill’s termination of employment, it is

an ETP under s 82-130 ITAA97. As an ETP the retirement gratuity must be segregated into
its pre-July 1983 and post-June 1983 components. There would not be any other components.
10,000 − 723 = $9,277 post-30 June 1983 taxable component (s 82-145).
Bill is aged 68, so maximum of 15% tax applies on $9,277 (= $1,391.55).
The amount of $9,277 is assessable in full, although the taxpayer is entitled to a tax offset to
reduce the effective tax to a maximum rate of 15%. As Bill’s marginal rate is 19%, there is an
entitlement to a tax offset of $371.08 ($9,277 × 19% − 15%).
(3) Low income tax offset (LITO) 2018/19.
As Bill’s taxable income of $36,027 is less than $37,000, he is entitled to the full LITO of
$445 in 2018/19.
(4) The superannuation benefit: The tax treatment of superannuation member benefits paid
from complying superannuation plans is set out in ITAA97 Div 301. The tax treatment
depends on:
• the age of the recipient
• whether the benefit is a superannuation lump sum or income stream, or
• whether the taxable component contains an element taxed in the fund or an element
untaxed in the fund.
It is noted that Bill is aged 68. Assuming the payment is paid from an element taxed in the
fund, given that it was a complying superannuation fund, regardless of whether it was a lump
sum or income stream, the entire $15,600 would be tax free (s 301-10).
[¶30-179] Solution 179

Taxation of individuals
Sarah Staples
Statement of taxable income year ended
30 June 2019
228
Assessable income1, 2
$ $
Superannuation pension3 0
Dividends: –unfranked 1,254
–franked 2,132
–imputation credit 914
HS Property Fund4 131
JF Growth Trust5 520 4,951.00
Less: Allowable deduction—
Expenses incurred in earning assessable income 295.00
Tax payable on taxable income 0
Less: Tax offsets
Low income tax offset6 445.00
Low and middle income tax offset 200.00

645.00
Add: Medicare levy7 0
Less: Foreign income tax offset 1.58 0
TAX PAYABLE $0
Add: Imputation credit 914.00
TAX REFUND DUE $914.00
Notes:
(1) Disposal of shares: As the shares in HRS Ltd were acquired in June 1985, before the
introduction of CGT, their subsequent disposal does not give rise to any CGT liability.
(2) Acquisition and disposal of rights: Rights issued to a shareholder for no consideration are
deemed to be acquired at the date of the original shares for a zero cost base. As the original
shares were acquired before 20 September 1985, no CGT liability will arise on disposal of the
rights.
(3) Superannuation pension: The tax treatment of superannuation member benefits paid from
complying superannuation plans is set out in ITAA97 Div 301. The tax treatment depends on:
• the age of the recipient
• whether the benefit is a superannuation lump sum or income stream, or
• whether the taxable component contains an element taxed in the fund or an element
untaxed in the fund.
It is noted that as Sarah is aged 66 years and assuming the payment is paid from an element
taxed in the fund, given that it was a complying superannuation fund, regardless of whether
the pension was a lump sum or income stream, the entire $16,742 would be tax free and no
tax is payable.
229
(4) Capital units in HS Property Fund: The building allowance and depreciation are deducted
from the net distribution to determine the taxable income. However, where the trustee of a
unit trust makes a non-assessable distribution to a unit holder, CGT event E4 happens.
The effect of CGT event E4 is that the unit holder’s cost base is reduced by the non-
assessable distribution. When the cost base is reduced to zero, any further non-assessable
distribution will result in a capital gain (s 104-70). In this instance, the tax deferred
depreciation and the Div 43 capital works deduction constitute a non-assessable distribution.
(5) Cash distribution from JF Growth Trust: The gross distribution, including the foreign tax
paid, forms part of assessable income. Sarah is entitled to claim a credit against the
Australian tax liability for her share of foreign taxes paid by the trustee. The net capital gain
is taxable. However, Sarah would receive a tax offset for foreign tax paid equal to the lower
of the foreign tax paid or the Australian tax payable on the dividends, subject to a de minimis
of $1,000. Therefore, the maximum foreign income tax offset is $1.58 as given.
(6) Tax offset for low income earners (s 159N):
Maximum tax offset allowable for 2018/2019 $445.00
Maximum low and middle income tax offset $200.00
(7) Tax offsets and Medicare levy: Generally, the tax offsets available to Sarah can only
reduce her tax payable, excluding Medicare levy, to nil (s 4-10(3)). The tax offsets cannot
reduce the Medicare levy. However, in Sarah’s case her taxable income is below the 2018/19
threshold so no levy is payable. Unused amounts of imputation credits can be refunded (s 67-
25) and foreign income tax offsets can reduce the Medicare levy if any. The taxpayer may
also be entitled to a senior Australians and pensioners tax offset, which is also non-
refundable.
[¶30-180] Solution 180

Bill Able
Statement of taxable income for the year ended
30 June 2019
Assessable Income $ $ $
One third share of net partnership income 100,000
Net income from tenanted property (Sch 1) 102
Life assurance annuity 10,000
Less: Deductible amount
(16,000/19.09) (838) 9,162
Dividends: –Franked 50
230
–Imputation credit ($50 × 1/70/30) 21
–Unfranked 50
Capital gain on disposal of property (Sch 2) 12,048 121,433
Less: Deductions—
Personal disability insurance premium 350
Depreciation (Sch 3) 7,967
Motor vehicle running expenses (Sch 4) 2,265 10,582
Schedule 1: net rental from property

$ $
Rent from tenanted property 6,200
Less: Allowable expenses—
Electrician –repairs during tenancy 200
Interest –243/274* days of $5,500 4,878
Insurance –243/274* days of $450 399
Rates –243/274* days of $700 621 6,098
$102
*Interest, insurance and rates are only deductible during the period the property was available
for rent (ie 9 months but was actually tenanted from 1 August 2018 to 31 March 2019).
Schedule 2: capital gain on disposal of

property (CGT event A1 happened)
$ $
Less: Cost price 100,000
Acquisition costs (stamp duty) 4,600
Costs to enhance value of asset not an allowable deduction—
Painting (initial repair) 1,200
Plumbing—sewerage connection 1,400
Non-capital costs of ownership incurred before tenancy (s 110-25(4))
—
Interest—31/274 days of $5,500 622
Insurance—31/274 days of $450 51
Rates—31/274 days of $700 79
Disposal costs 4,200 112,152
Net capital gain $12,048
Note: There is no CGT discount or indexation of the cost base because the property was
acquired and sold within 12 months.
231
Schedule 3: depreciation
$
Professional library—throughout year
($290 × 100%) (s 40-80(2)) 290
Motor vehicle
(2018/2019) $57,581 cost limit × 365/365 × 200%/10 years
× ⅔ business use (s 40-70) 7,677
$7,967
Schedule 4: motor vehicle running expenses

(Div 28 and 900)
$
Fuel 1,800
Servicing 500
Repairs 150
Insurance 510
Registration 420
3,380
Business percentage based on kilometers travelled
16,000/24,000 = 67% Therefore as the requirements for the log book method are satisfied the
deduction = $3,380 × 67% = $2,265
[¶30-181] Solution 181

Taxation of minors
(1) Taxable income
Tom Francis
Statement of taxable income for the year ended
30 June 2019
$ $ $
Excepted assessable income
Income from paper round 2,950
Income from working at 2,100
232
restaurant
Restaurant tips 243
Interest from Tom’s bank
217
account
Dividend from shares in
143 5,653
BHP3
Less: Deductions1—
Repairs to bicycle (½ × $102) 51
Wet weather clothing (½ × $110) 55
Bicycle helmet (½ × $62) 31
Depreciation of bicycle2 70
Bank charges on Tom’s bank account 5 212
EXCEPTED TAXABLE INCOME 5,441
Eligible assessable income
Interest from bank account established by grandfather 471
Income as beneficiary from an inter vivos trust 7,000 7,471
Less: Deductions—
Bank charges on account established by
4
grandfather
ELIGIBLE TAXABLE INCOME 7,467
TOTAL TAXABLE INCOME $12,908
Notes:
(1) Claim for expenses: In preparing Tom Francis’ tax return, his tax agent may wish to
request a ruling from the ATO on the deductibility of the replacement jeans, wet weather
clothing and bicycle helmet.
The damage to Tom’s jeans, although resulting from a work-related activity, may not be
allowable, as the repairs are to conventional clothing. The initial cost of wet weather clothing,
although a necessary consequence of his work, may be of a capital nature, with any
replacement clothing being allowable. The bicycle helmet, although a work requirement is
not exclusively for work as all cyclists are required by law to wear helmets. An
apportionment on a business/private time basis may be necessary.
Case V79, 88 ATC 550 appears to take a more lenient approach and allow a deduction
because of the distinct occupational character of the expenditure, although in that case the
clothing was used exclusively for work. Both items may be deductible because the clothing is
necessary and peculiar to the taxpayer’s occupation and protects him from the risk of
personal injury. In this instance, on the basis that the bicycle, helmet and wet weather
clothing are used only 50% for business, only 50% of the expenditure is claimed.
(2) Depreciation of bicycle:
Cost $350—1 September 2017
Full years depreciation for 2018/19 tax year—$350 × (200%/5) = $140
233
As the bicycle is used 50% for income-producing purposes, the depreciation allowable is
50% of $140 = $70
(3) Dividend: Include the gross dividend $100 plus the franking credit ($100 × 1/70/30 =
$43) as assessable income.
(2) Tax payable

$ $
Tax on eligible taxable income $7,467 at 45% 3,360.15
Tax on excepted taxable income ($5,441) at ordinary rates 0
3,360.15
Less: Tax offsets
Imputation credit 43.00
Tax paid by trustee s ($7,000 ×
3,150.00
45%) 100(2)
3,193.00
TAX PAYABLE $167.15
Note: As Tom Francis’ taxable income does not exceed the Medicare low income threshold
for 2018/19 tax year, no Medicare levy is payable. The low income tax offset and the low and
middle income tax offset are not available on the unearned income of minors. . Minors with
income from working can, however, apply the low income rebate and low and middle income
tax offset to their wages, which effectively increases their tax-free income but Tom has no tax
payable on this income as he is below the tax free threshold.
(3) Distribution of trust income

The allocation of money from an inter vivos trust to a minor is eligible assessable income.
Such income attracts high rates of tax (see Income Tax Rates Act 1986 s 13; Sch 11). In Tom
Francis’ case, the trustee will be taxed on the share of net trust income to which Tom is
presently entitled but under a legal disability (ITAA36 s 98) at a rate of 45% on the amount
of $7,000 allocated to Tom. As Tom has other income, his share of net trust income is added
to his other income in determining his total taxable income, and he receives a credit for the
tax paid by the trustees on his behalf (ITAA36 s 100(2)).
[¶30-182] Solution 182

Tim Starr
Statement of taxation liability for the year ended
234
30 June 2019
Income $ $
Salary 35,000
Rental from shop 13,680
Directors’ fees 3,500
Annuity from uncle’s estate 2,050
Dividend from UK company (gross amount) 200
Entertainment allowance1 800
Share of profits from partnership 5,115
Dividend (franked $70 + ($70 × 1/70/30) + unfranked $30) 130 60,475.00
Less: Deductions—
Premium on sickness and accident policy for self2 325
Rates 1,680
Insurance 850
Repairs3—painting 2,185
Capital works deduction for floor ($1,200 × 2.5%) 30
Interest on mortgage 5,540 10,610.00
TAXABLE INCOME $49,865.00
Tax payable on taxable income (2018/19 rates) $7,753.13
Less: Tax offsets—Dependant Invalid Carer4 788.00
Foreign income tax offset (withholding tax) 30.00
Imputation credit 30.00
Low income tax offset6
252.00 1630.00
Low and Middle income tax offset $530
6,123.13
7,120.43
Less: Tax instalments paid (as per payment summary) 7,900.00
TAX REFUND $779.57
Notes:
(1) Entertainment expenses incurred by Tim are not an allowable tax deduction (s 32-5).
(2) Deductible under the first limb of s 8-1(1) (FC of T v DP Smith 81 ATC 4114).
(3) The replacement of part of a rotten wooden floor with a cheaper concrete floor was
denied as a repair in Case L47, 11 TBRD 271 and Case N61, 81 ATC 325. However, it was
allowed in Case H24, 8 TBRD 93. The former two judgments are followed in this instance
(see Div 43 capital works deduction).
The trimming back of a shop awning is not a repair where the awning is in good condition
and is not in need of repair (Case J47, 9 TBRD 244).
235
(4) The dependant (invalid and carer) tax offset (DICTO) may be available for contributing
to the maintenance of an eligible dependant who is unable to work due to invalidity, or
alternatively where that dependant is unable to work due to caring obligations for an invalid
relative. An invalid dependant must be in receipt of a disability support or invalidity service
pension, while a dependant carer must be in receipt of a carer allowance or carer payment
under the Social Security Act 1991. It is also noted that taxpayers eligible for the DICTO
must not be in receipt of disqualifying payments such as Family Tax Benefit Part B and must
not exceed the’ income limit for Family Tax Benefit of $100,000 in 2018/19.
Consequently Tim qualifies for the DICTO.
Maximum DICTO available 2018/2019 2,717

Less reduction for Sara’s ATIO (1/4 × ($8,000 – 282)) 1,929
Rebate allowable $788
(5) Low income tax offset 2018/2019:
$445 − (($49,865 − $37,000) × .015)
$445 − $193 = $252 (ignore cents)
Note that Tim Starr is not eligible for Family Tax Benefit Part B as stated in the question.
236
Partnerships
[¶30-183] Solution 183
Salary; interest
In determining the net income of the partnership for the purposes of ITAA36 s 90, payments
by way of salary and interest on partnership capital are regarded as a distribution of
partnership profit and should be added back to determine the net income of the partnership.
However, if there is a loan to the partnership rather than an advance of partnership capital and
the funds are used by the partnership in producing its assessable income, the interest paid on
the loan is treated as an allowable deduction and is not added back to determine the net
partnership income. On the basis that the interest is paid on a bona fide loan from James, then
the net income of the partnership may be determined as follows:
$ $
Partnership income
95,000
Add back: Salaries
Lucas 90,000
125,000
James 35,000
PARTNERSHIP NET INCOME $220,000
Having regard to the payment of salaries, the distribution of the $220,000 would result in the
partners having taxable incomes of:
Lucas $90,000 + $47,500 = $137,500

James $35,000 + $47,500 + $7,250 (interest) = $89,750
[¶30-184] Solution 184

Income determination; uncontrolled
partnership income
237
Where a partner (who is not a company, a trustee, or person aged under 18 years) does not
have real and effective control over the disposal of his or her share of partnership income,
ITAA36 s 94 may apply (see Robert Coldstream Partnership v FC of T (1943) 68 CLR 391).
Section 94 imposes a penalty by taxing such uncontrolled income at an effective top marginal
rate reduced by the taxpayer’s average rate of tax.
Tax on $45,000 = $6,172 (2018/19 rates)
Average rate = $6,172 ÷ $45,000 = 13.72%
Top marginal rate = 45% (2018/19)
Therefore, the uncontrolled income of $45,000 is taxable at a further rate of 45% − 13.72% =
31.28%.
This gives an extra tax payable of 31.28% × $45,000 = $14,076.
The tax payable by each partner is:
Tom: $
Tax on taxable income of $45,000 6,172.00
Plus: Medicare levy (2% × $45,000) 900.00
Mary:
Plus: Further tax on uncontrolled partnership income 14,076.00
Medicare levy (2% × $45,000) 900.00
[¶30-185] Solution 185

Creation and existence of a partnership
The first issue is to determine whether there is a partnership at general law as well as for tax
purposes. Under tax law a partnership is defined as ‘(a) an association of persons (other than
a company or a limited partnership) carrying on a business as partners or in receipt of
ordinary income or statutory income jointly; or (b) a limited partnership.’ (ITAA97 s 995-
1(1))
However, under the general law definition of a partnership, the parties must be carrying on a
business. If the parties are deriving rental income from a single income-producing property, it
is highly questionable as to whether they are carrying on a business. In Taxation Ruling TR
93/32 the Commissioner of Taxation does not consider that rental income from a single
property constitutes carrying on a business; the taxpayer would have to derive income from a
number of properties or from a block of apartments to suggest that there may be a business
activity. Taxation Ruling TR 93/32 states that where co-ownership is a partnership for income
238
tax purposes only, the income/loss from the rental property is derived from co-ownership of
the property and not from the distribution of partnership profits/losses. Consideration should
also be given to Tax Ruling TR 94/8 where the Commissioner of Taxation lists the factors
that determine whether a partnership exists (eg registered business name, extent of capital
contributions and business records).
The Commissioner of Taxation is supported in this ruling by the case FC of T v McDonald 87

ATC 4541, where the court held that a husband and wife who invested in income-producing
property as joint tenants were not carrying on a business. At general law, their relationship
was one of co-ownership. Any profit or loss sharing agreement was a private or domestic
arrangement.
As it is unlikely that Paul and Natalie Seymore are carrying on a business, there is no
partnership at general law. The Commissioner of Taxation is likely to determine the
taxpayer’s share of the profits and losses on the basis of their legal interests in the property.
As the taxpayers are joint tenants, the income and losses will be taken to be distributed
equally according to their capital contribution, not in accordance with the partnership
agreement, because there is no partnership at general law.
[¶30-186] Solution 186

Net partnership income
(1)
Partnership income/(loss) for the year ended 30 June 2019.
$
Operating loss (1,800)
Dividend 900
Franking credit 300
Net partnership loss ($600)
(2)
Even though a partnership is in a loss situation, where a grossed-up dividend has been
included in the loss calculation, a partner would still be entitled to a tax offset representing
their share of the franking credit.
Smith, Riley and Lexus as partners can each claim a deduction in their personal income tax
returns of $200 ($600 ÷ 3) as their share of the partnership loss. They are also entitled to a tax
offset of $100 each ($300 ÷ 3) representing their proportionate share of the franking credit.
[¶30-187] Solution 187

Definition of a partnership
It should be noted that a partnership for tax purposes is different from the common law
concept of partnership. The common law concept of a partnership is one of a relationship
239
which exists between persons carrying on business in common with a view to profit. The
definition of a partnership for tax law in ITAA97 s 995-1(1) is that of an association of
persons carrying on business as partners or in receipt of ordinary income or statutory income
jointly, but does not include a company. In this sense, the definition extends the common law
concept of partnership by treating an association of persons in receipt of ordinary and
statutory income jointly as partners for tax purposes.
Where there is a partnership at common law, the partners’ interest in the profit or loss of a
partnership is calculated on the basis of the partnership agreement. Where there is no
partnership at common law but there is a partnership for tax purposes, the share of the profit
or loss of the partnership is based on the interest of the partners in the property which
produces the income. (An assessment will be made on the merits of the case—see Taxation
Ruling IT 2316.) Taxation Ruling TR 93/32 states that where co-ownership is a partnership
for income tax purposes only, the income/loss from the rental property is derived from co-
ownership of the property and not from the distribution of partnership profits/losses.
Because Viola and Bill Coleman are not carrying on business and are only receiving income
from their property investment, they are not partners under general common law and
therefore, for tax purposes, their respective share of the income will be based on their share in
the property. Consequently, even though the partnership agreement may provide that all
losses would be borne by Bill, for tax purposes Bill and Viola will share the losses evenly
because they co-own the property (FC of T v McDonald 87 ATC 4541; see also Case X48, 90
ATC 384, Cripps v FC of T 99 ATC 2428, Yeung v FC of T 88 ATC 4193, ARM
Constructions Pty Ltd v FC of T 87 ATC 4790 and Taxation Ruling TR 94/8). The tax
implications would be different if the ownership of six flats constituted the carrying on of a
business. In that case, partnership losses would be apportioned according to the partnership
agreement.
[¶30-188] Solution 188

As interest on a partner’s capital is not an allowable deduction, it must be added back to
determine the partnership’s net income (ITAA36 s 90). Consequently, the net income of the
Mann and Johns partnership would be $130,000 ($120,000 + $10,000). If the partnership
agreement provided that Mann would receive 60% of the income, then their shares of net
partnership income would be:
Mann $120,000 × 60% + $10,000 = $82,000

Johns $120,000 × 40% = $48,000
NET PARTNERSHIP INCOME $130,000
If Johns had only been a resident for six months, then that part of the net income attributable
to him from an overseas source would be exempt from Australian tax for the period he was a
non-resident, i.e. $40,000 (foreign source income) × 40% (John’s share) × ½ (6 months of the
year)= $8,000.
240
Therefore, of the $48,000 net income of the partnership which was John’s share, $8,000
would be exempt. His assessable income would therefore comprise $40,000 from Australian
sources.

[¶30-189] Solution 189
Profit and loss sharing
(1) Net partnership income and distribution
to partners Arnold and Barrett
$
Partnership profit after Barrett’s salary 30,000
Add back: Salary to Barrett 60,000
Distributed as follows:
$
Arnold (50% of $30,000) 15,000
Barrett (50% of $30,000 + $60,000) 75,000
$90,000
(2) Net partnership loss and distribution to

partners
$
Partnership loss after Barrett’s salary (80,000) loss
Add back: Salary to Barrett 60,000
NET PARTNERSHIP LOSS ($20,000) loss
Distribution as follows:
Arnold (50% of $20,000) (10,000)
Barrett (50% of $20,000) (10,000)
($20,000) loss
Guidelines for the ATO’s treatment of partnership salary arrangements are set out in
Taxation Ruling TR 2005/7. The ruling confirms that a payment of a salary to a partner is not
taken into account as an allowable deduction in calculating the net partnership income or loss
under ITAA36 s 90. Therefore the salary payment cannot result in, or even contribute to, a
partnership loss.
241
In the case of Scott v FC of T 2002 ATC 2077, amounts treated as salaries paid to members of
a family partnership involved in processing tax returns were in reality advance drawings by
the working partners. Consequently, the salaries were not deductible and could not give rise
to losses.
The partner’s interest in the net income will include the partnership salary to the extent that
there is available income only. If partnership profits are currently insufficient to cover salary,
the salary maybe met from profits of future years. Consequently, any salary drawn by a
partner in a particular year that exceeds their interest in the partnership net income will not be
assessable to the extent of the excess. However, an advance of future profits will be
assessable to the partner when sufficient profits are available.
For such an agreement to be effective for income tax purposes in an income year, the
agreement must be entered into before the end of that income year.
(3) Net partnership loss, salaries and

distribution
$
Partnership loss after salaries (4,500)
Add back salaries:
Arnold 22,500
Barrett 12,000
Arnold (50% of ($4,500) + $22,500 salary) 20,250
Barrett (50% of ($4,500) + $12,000 salary) 9,750
$30,000
[¶30-190] Solution 190

Variation of partnership interests;
assignment
Assume that the earning of partnership income was spread equally over 12 months.
Therefore:
$
Partnership income 1 July 2018 to 28 February 2019 66,667
Partnership income 1 March 2019 to 30 June 2019* 33,333
Partnership income $100,000
* This would require the preparation of separate partnership income tax returns for the
periods 1 July 2018 to 28 February 2019 and 1 March 2019 to 30 June 2019.
242
(1) Shares of partnership income†
$
Evans (50% × $66,667) + (33.3% × $33,333) 44,445
Downing (50% × $66,667) + (33.3% × $33,333) 44,445
New partner (33.3% × $33,333) 11,110
$100,000
†Partnership income share figures have been rounded up.
(2) Loan of $50,000 for 61/365 days @ 8%

Interest expense of $668 is an allowable deduction to the partnership, and partnership income
for the period 1 May 2019 to 30 June 2019 consequently decreases to $32,665.
Shares of partnership income*:
$
Evans (50% × $66,667 + 33.3% × $32,665) + $668 interest 44,890
Downing (50% × $66,667 + 33.3% × $32,666) 44,221
New partner (33.3% × $32,666) 10,889
$100,000
*Partnership income share figures have been rounded up.
(3) Salary to partner’s wife

$
Partnership income per accounts 100,000
Joanne’s salary (25,000)
75,000
Add:
Joanne’s salary disallowed under s 26-35(1) +5,000
Adjusted partnership income $80,000
If the partnership income and the salary to Joanne are spread on a monthly basis evenly over
the year, the partnership income for the period 1 July 2018 to 28 February 2019 would be
$53,333, and for the period 1 March 2019 to 30 June 2019 would be $26,667.
(4) Assignment of part of partnership

interest
243
An assignment of part of Evans’ interest in the partnership to his wife gives rise to a change
in the ownership of an asset or assets, and that change will be treated as a disposal of the
asset(s) by Evans and an acquisition of the asset(s) by the trustee (Evans) who holds the
asset(s) on behalf of his wife (CGT event A1).
Taxation Ruling IT 2540 and ITAA97 s 106-5 and 108-5(2) provide that in the case of a
partnership asset each partner is to be treated as owning an asset (ie the partner’s interest in
the asset). Accordingly a change in a partner’s interest in a partnership, including a change by
assignment of a partner’s interest, will result in a change in the ownership of the partner’s
interest in each asset of the partnership. Therefore, where an asset of the partnership is
acquired after 19 September 1985, the individual interest of a partner in each post-CGT
partnership asset will be subject to the provisions of ITAA97 Pt 3-1.
Therefore, in very broad terms, the assignment of half of Evans’ partnership interest would
give rise to a taxable gain in respect of the assets acquired by the partnership after 19
September 1985 if the capital proceeds ($20,000) exceeded one-half of the cost bases of the
interests held by Evans in those partnership assets. Consequently, if the assets are post-CGT
assets, the assignment of the partnership interest will not provide any substantial tax benefit
as would any pre-CGT interests.
However, the following points must be noted.
•
As many partnership assignments are not at arm’s length, the capital proceeds deemed to be
received are the market value of the assigned assets, even if consideration were given, as in
this case (ITAA97 s 116-30(2)(b)).
As Evans’ assignment to his wife is not an arm’s length transaction, for CGT purposes the
capital proceeds deemed to be received by Evans for disposal of part of his interest in the
partnership assets are the market value of that interest at the time of disposal (see Reynolds v
Commissioner of State Taxation (WA) 86 ATC 4528).
•
Evans’ assignment of his partnership interest to his wife on 1 June 2019 will be effective
from 1 March 2019, when the new partnership was formed, and not just for June 2019. This
contentious issue was finally resolved in FC of T v Galland 86 ATC 4885. The basis for
taking the whole period of the current partnership and not just the period from the date of the
assignment is that a partner’s share in the net income of a partnership is not ascertained, and
hence not derived, until the end of the income year when the partnership accounts are able to
be prepared. Taxation Ruling IT 2501 provides that valid assignments on all fours with the
decisions in FC of T v Everett 80 ATC 4076 and Galland will be acceptable for tax purposes
and not subject to the anti-avoidance rules.
However, the Commissioner of Taxation has warned that where the relevant deed of
assignment contains a revocation clause exercisable either by the assignor or the partners,
other than the assignor, the view is taken that ITAA36 s 102 applies, and the assignment
should not be seen as effectively alienating the income for tax purposes from the partner
seeking to assign the interest.
244
Taxation Ruling IT 2608 should also be considered with regards to the allocation of expenses
and the deduction allowable to an assignor where the partner has assigned a share of the
interest in a partnership.
•
For a capital gain on assets that have been held for greater than 12 months after 11.45 am
EST on 21 September 1999, ITAA97 Div 115 provides for a discount of 50%. This occurs
where the taxpayer elects not to use the indexed cost base (frozen at 30 September 1999) in
calculating the capital gain.
•
The small business 50% reduction may also apply where the CGT event occurs after 11.45
am EST on 21 September 1999. However, to qualify for this concession the conditions of
ITAA97 s 152-5 must be satisfied. One condition is that the CGT asset must be an ‘active
asset’ as defined in ITAA97 s 152-40, and an interest in an entity is not necessarily an active
asset (s 152-40(4)(a)). Arguably, a partnership may not be viewed as an entity, as it is the
partners who have an interest in the underlying assets of the partnership.
Alternatively, an asset of the partnership that is considered a small business entity, must still
be an ‘active’ asset to qualify for the CGT concession. Note that there are no small business
concessions available that involve the assignment of partnership rights.
[¶30-191] Solution 191

Tax and common law concepts;
uncontrolled partnership income
$
Partnership profit after salaries 30,000
Salaries to Jane and Joe ($20,000 x2) 40,000
$
Joe Wilson (50% of $30,000 + $20,000) 35,000
Jane Wilson (50% of $30,000 + $20,000) 35,000
$70,000
If a partner does not have real or effective control over disposal of his or her share of
partnership income, then that part of the share for which there is no effective control (called
‘uncontrolled partnership income’) may be subject to further tax pursuant to ITAA36 s 94. In
considering the conduct of the operations and management of the partnership, where Jane is
the silent partner it would appear that Jane does not have real and effective control (see
Robert Coldstream Partnership v FC of T (1943) 68 CLR 391).
Jane Wilson’s taxable income of $35,000 includes $7,500 (that is, ½ of $15,000 profits after
allowing for $15,000 of the $30,000 partnership profits being reinvested in the business)
uncontrolled partnership income which will be liable to a special further tax. For the 2018/19
year the rate of further tax on uncontrolled partnership income is 45% (reduced by the
average rate of ordinary tax applicable to the taxpayer’s total taxable income.
245
Therefore, Jane’s tax liability is calculated as follows.
Section 94 imposes a penalty by taxing such uncontrolled income at an effective top marginal
rate reduced by the taxpayer’s average rate of ordinary tax.
Tax payable at 2018/19 rates on $35,000 = $3,192
Average rate = $3,192 ÷ $35,000 × 100% = 9.12%
Top marginal rate = 45%
Therefore, the uncontrolled income of $7,500 is taxable at a further rate of 45% − 9.12% =
35.88%.
This gives an extra tax payable of 35.88% × $7,500 = $2,691.00.
The tax payable by Jane Wilson is:
$
Plus: Further tax on uncontrolled partnership income 2,691.00
5,883.00
Plus: Medicare levy (2% × $35,000) 700.00
TOTAL TAX PAYABLE 6,583.00
Joe Wilson will not be liable to further tax as he has effective control of his share of
partnership income. His liability will therefore be:
[¶30-192] Solution 192

Taxable income; distribution
(1)
The partnership net taxable income is $120,000 for 2018/19 as this is the figure given prior to
any internal transactions allowing for partners interest, salary superannuation payments and
prior year losses.
Interest on partners’ capital and the salary paid to a partner are not allowable deductions to
the partnership. At law a person cannot enter into a contract with himself or herself and
therefore a partnership cannot legally employ a partner.
Any agreement by a partnership to pay a salary to a partner is merely a part of the agreement
to share the profits of the partnership: the payment is not an allowable deduction to the
246
partnership (see ITAA36 s 92 and Case S75, 85 ATC 544). Interest paid by a partnership
upon a partner’s capital is reated in the same manner.
As a partner is not an employee of the partnership, the partnership cannot claim a deduction
for superannuation contributions made in respect of a partner (ITAA97 s 290-60).
A partnership cannot carry forward past year losses (see ITAA97 Div 36); they are
distributed to the partners in the year the partnership incurred the loss and either deducted
from the partner’s other income in the partner’s individual tax return (s 92) or carried forward
in their hands to be offset against future assessable income.
(2)
Distribution of taxable income based upon partnership agreement for 2018/2019:
$ $
Caitlin Adams: Superannuation contribution 3,000
Salary 20,000
Share of residue 31,000 54,000
Fred Adams: Interest on capital 2,000
Dorothy Adams: Interest on capital 2,000
$120,000
[¶30-193] Solution 193

As Maranda is a non-resident it is necessary to first divide the net income into that
attributable to Australian sources and non-Australian sources.
$ $
Receipts relating to Australian source income $15,000
Less Expenses
Purchases of stock 7,000
Shop rates 850
Business insurance 1,500
Part-time wages 4,000
Other expenses 2,100
Salary to Peter 15,000 $30,450
Net Australian source income/loss ($15,450)
Receipts relating to foreign source income $8,400
Purchases of stock 1,500
Other expenses 1,000
Ex-Australian import duties 880
Salary to Maranda 10,000 13,380
Net foreign source income/loss ($4,980)
Total Partnership Income/loss ($20,430)
247
Distribution of partnership loss
As indicated in Taxation Ruling TR 2005/7, the payment of partners’ salaries is only a means
of allocating partnership profits and consequently cannot result in, or even contribute to, a
partnership loss. See the case of Scott v FC of T 2002 ATC 2077. Consequently, the salary is
not an allowable deduction for the purposes of calculating the s 90 Partnership income.
The allocation of a salary to a partner as part of the net partnership income is only possible
where there are available profits. Where there are insufficient profits to meet partners’ salary
entitlements as is the case here, salaries can be drawn from future year profits. Where salaries
aredrawn in excess of profits, partners are not assessed on the excess in the current year but
will be assessed in future years when profits become available. For agreements of this type to
be effective for income tax purposes, they must be established before the end of the income
year. Consequently, the real partnership loss is $4,570 ($2,285 for each partner) and the
salaries of $15,000 and $10,000 are still paid to the partners in advance of profits.
Total Partnership Income/loss ($20,430)

Add back salaries:
Peter $15,000
Maranda $10,000 $25,000
Net Partnership Loss ($4,570)
Distributed as Follows:
Peter (50% of $4,750) $2,285
Maranda (50% of $4,750) $2,285
Loss ($4,570)
[¶30-194] Solution 194

Partners’ salary
(1)
The two main sections which allow the Commissioner of Taxation to amend a salary
payment, ITAA97 s 26-35(1) and ITAA36 s 109, do not apply to a salary paid to a partner.
For ITAA97 s 26-35 to apply the payment must be made to a related entity as defined in s 26-
35(3). While the term covers a payment to a relative or other person associated with a partner,
s 26-35(3) states that ‘a partner in a partnership is not a related entity of the partnership’.
Section 109 only applies to a private company.
As a partnership is not a separate and distinct entity, a partner cannot be an employee of a

partnership (See Ellis v Joseph Ellis & Co [1905] 1 KB 324). Consequently, any agreement
to pay a salary to a partner is merely a means of distributing net partnership income; the
salary is not deductible (see Taxation Ruling TR 2005/7).
Where the salary paid is reasonable for the services rendered and has its origin in the terms of
a written partnership agreement, the Commissioner of Taxation’s practice is to accept the
distribution of net partnership income in accordance with the partnership agreement.
248
However, if a salary is excessive for the services rendered and results in overall tax
minimisation, or is paid under an agreement which purports to be retrospective, the
Commissioner of Taxation may tax the partners on the basis that ‘the net income of the
partnership should be distributed according to the basic agreement between the partners for
the sharing of profits and losses’.
However, where partners’ salaries exceed the amount of net partnership income, the
Commissioner of Taxation’s practice is to apportion the salaries between the partners so that
no partner may claim a loss (refer to Taxation Ruling TR 2005/7). This was the situation in
Case S75, 85 ATC 544.
In Case S75, a salary was paid to one partner who worked in the partnership, after which the
residual partnership loss was apportioned 50:50 between the two partners. There was no
written partnership agreement. The Board of Review confirmed the Commissioner of
Taxation’s action in assessing one partner on the whole of the net partnership income (as the
net partnership income was less than the salary paid to that partner) and disallowed the other
partner his share of the partnership loss.
(2)
Any reduction in a partner’s salary would alter the distribution of the residual share of net
partnership income. Karen would be assessed on a salary of $20,000, but her share of residual
net partnership income would also increase to reflect the decreased salary.
[¶30-195] Solution 195

Disposal of partner’s interest in partnership
On disposal of Toni’s interest in the partnership to her cousin Cleo there is a dissolution of
the old partnership and a creation of a new partnership.
(1) Trading stock

On the change in ownership there is a notional disposal of trading stock at market value by all
old partners to all new partners (ITAA97 s 70-90; 70-100).
Consequently, at the time of the change in the partnership the market value of the stock
($150,000) must be included in the assessable income of the old partnership and the new
partnership will be deemed to have acquired the stock at that value.
However, because Julia and Maria will continue to retain more than a 25% ownership in the
new partnership, if all parties agree, written notice can be given to the Commissioner of
Taxation that all parties elect to value trading stock as if there had been a continuing business
(value trading stock at the cost price elected for tax purposes), so s 70-90 would not apply.
The effect of this election is that trading stock continues to be valued at its tax elected value
($120,000) and not at its market value ($150,000), and there is no unrealised book profit to be
assessed on the transaction. Any profit on disposal of trading stock will be deferred until the
trading stock is sold in the ordinary course of business (s 70-100(4) to (9)).
249
(2) Depreciable assets
A change in the constitution of the partnership may result in a balancing adjustment as if
there was an actual disposal of the old partnership’s depreciated assets from the old
partnership to the new partnership. Consequently, a value must be attributed to the
depreciable assets. This value forms the basis for depreciation deductions for the new
partnership and is taken into account in ascertaining whether there is any assessable income
(profit) or deduction (loss) on disposal of the assets of the old partnership.
If the assets are valued at their adjusted value ($110,000) so that the termination value is the
same as the adjusted value, then no adjustments are necessary. However, if the assets are
valued at their book value ($130,000), a balancing adjustment of $20,000 under s 40-285(1)
will transpire and be included in the net partnership income of the old partnership and the
depreciation allowable to the new partnership is calculated on a cost of $130,000.
As a practical matter, the Commissioner of Taxation will usually accept the adjustable value
of an item of depreciable property as being a fair and reasonable value of that property for tax
purposes.
(3) Capital gains

On disposal of her interest in the partnership, Toni is disposing of her underlying interest in
the partnership assets. As all assets were acquired on or after 1 July 1994, they are post-CGT
assets. If all tangible assets are disposed of at their book value, then the difference between
Toni’s interest in the assets ($84,000) and the disposal price ($100,000) would be payment
for her share of goodwill ($16,000).
As the disposal by Toni occurs after 11.45 am on 21 September 1999, ITAA97 s 115-5 to
115-50 enable her to choose a discount on the capital gain of 50% without the benefit of
indexation. A small business 50% reduction may also apply where the CGT event occurs
after 11.45 am EST on 21 September 1999.
However, to qualify for the concession, the conditions of ITAA97 s 152-5 must be satisfied.
One condition is that the CGT asset must be an ‘active asset’, as defined in ITAA97 s 152-40,
and an interest in an entity is not necessarily an active asset (s 152-40(4)(a)). (Arguably, a
partnership maynot be viewed as an entity as it is the partners who have an interest in the
underlying assets of the partnership.) See Question 190 at ¶10-190.
On the other hand, an asset of the partnership that is considered a small business entity, must
still be an ‘active’ asset to qualify for the CGT concession.
(4) Accounting basis

Where receipts are treated differently in relation to various members of the partnership it is
advisable that book debts not be sold. The old partnership would then continue to exist for the
purposes of collecting its book debts and generally winding up its affairs. Tax returns would
continue to be lodged for the old partnership with respect to the book debts collected.
250
(5) GST
Distribution on the dissolution of a partnership is part of the carrying on of a partnership
enterprise. The making of an in-kind distribution is treated as a supply in the course of an
enterprise that the partnership carries on, regardless of whether the partnership is continuing
or is under a general dissolution. As there is no winding up of the partnership in this case, the
change in membership does not give rise to any supplies or acquisitions from one partnership
to another partnership (GST Ruling GSTR 2003/13).

[¶30-196] Solution 196
Net partnership income; distribution to
partner
Partnership of Martin & Kay
Calculation of net partnership income for the year ended 30 June 2019
Income
$ $
Property investments 50,000
Less: Associated expenses—agent’s commission, rates, legal expenses
7,500 42,500
(assumed all allowable deductions)
Used car trading 120,000
Less: Associated expenses (assumed all allowable deductions) 108,500 11,500
54,000
Less: Other business expenses1 nil
Interest on partner’s advance2 (assume cash basis of recording) 500 500
Calculation of Martin’s share of net partnership income as per partnership agreement
$ $
Net partnership income 53,500
Add: Interest on current account —Martin3 300
53,800
Represented by: Salary —Martin 15,000
Interest on capital account —Martin 1,000
—Kay 1,000
Share of partnership income4 —Martin 70% 25,760
—Kay 30% 11,040 $53,800
Notes:
251
(1) A partnership is not entitled to a deduction for premiums paid by it in respect of policies
on the lives of the partners as they are not employees of the business.
(2) Interest on advance is deductible in calculating the net income of the partnership (s 8-
1(1)), and is assessable income to the lender.
(3) A partner’s salary, interest on capital and interest on drawings are not allowable
deductions. They are only the means by which the partners have agreed to share the profits.
(4) If the life assurance premium payment was a condition of the partnership agreement, the
$3,000 would be taken into account in determining the share of each partner’s net partnership
income (see Solution 192 at ¶30-192).
Alternative approach to calculating s 90 net

partnership income:
Partnership of Martin & Kay
Accounting net profit for year ended 30 June 2019
$ $
Property income 50,000
Trading income 120,000 170,000
Less:
Expenses–
Property 7,500
Used car trading 108,500
Life assurance policy—Martin 3,000
Salaries—Martin 15,000
Interest—Kay’s advance 500
Interest—Martin’s capital 1,000
Interest—Kay’s capital 1,000
Less: Interest on Martin’s current account (300) 136,200
NET PROFIT $33,800
Net partnership income for year ended 30 June 2019
$ $
Net profit 33,800
Add back:
Martin’s salary 15,000
Interest on capital –Kay 1,000
–Martin 1,000
Life assurance –Martin 3,000 20,000
53,800
Less: Interest on overdrawn current account—Martin 300
252
Martin’s share of net partnership income is $41,460, determined thus:
$
Salary 15,000
Interest on capital 1,000
Share of partnership income 25,760
41,760
Less: Interest on drawings 300
$41,460
[¶30-197] Solution 197

David & Wendy Taylor
Trading as Allhours
Statement of partnership net income for the year ended 30 June 2019
$ $
Income:
Sales –Cash1 186,925
–Credit2 31,885
Goods taken from stock 3,200 222,010
Less: Deductions—
Cost of goods sold3, 4 159,713
Motor vehicle running expenses5 2,364
Power (80% × $1,470) 1,176
Rates (60% × $517) 310
Insurance (100% business use) 1,250
Telephone (90% × $704) 634
Trade Association fees 284
Bank charges 595
Repairs and maintenance6 290
Interest on loan7 5,500
Depreciation—see Schedule8 5,695 177,811
Notes:
1. Cash sales: $
Sales as per cash book 150,170
Add: Drawings from the till 5,600
253
Cash purchases from the till 31,155
$186,925
2. Credit sales:
Debtors at end (30 June 2019) 3,010
Credit sales from cash book 32,800
35,810
Less: Debtors at beginning (1 July 2018) 3,925
$31,885
3. Cost of goods sold:
Stock at beginning (1 July 2018) 9,120
Add: Purchases –Cash 31,155
–Credit ($128678 + $510 increase in
129,188
creditors)
169,463
Less: Stock at end (30 June 2019) 9,750
$159,713
4. Credit purchases:
Creditors at end (30 June 2019) 7,010
Payments to creditors 128,678
135,688
Creditors at beginning (1 July
Less: 6,500
2018)
$129,188
5. Motor vehicle running expenses:
Utility $1,260—90% business 1,134
Sedan $2,050—60% business 1,230
$2,364
6. Repairs and maintenance:
Pest control—a s 8-1(1) deduction 150
Thermostat for refrigerator—s 25-10 140
$290
7. Interest on loan:
Total repayment on loan 8,500
Less: Reduction in principal (capital) 3,000
Interest paid a s 8-1(1) deduction $5,500
Depreciation
8.
Schedule:
Original cost$ Opening adjusted value$
Refrigerator units 14,600 3,580
254
Fittings 7,800 2,965
Small electrical appliances 3,900 754
Holden utility (90%
16,500 1,550
business)
Holden sedan (60%
42,200 10,350
business)
Additions:
Combination freezer
4,000
1.8.2018
Air conditioner 1.10.2018 1,200
Disposal:
Combination freezer
8,000 1,480
1.8.2018
Note: All hours could opt to account for the assets under simplified depreciation rules which
form part of the small business entities test effective from the 2007/08 tax year (ITAA97
Subdiv 328-D).
Allhours satisfies the eligibility criteria, namely:
•
carrying on business during the year, and
•
having an aggregate business turnover in the previous income year of less than $10,000,000
(from 2017/18)
Accrual accounting is employed for the purposes of the previous calculations.
Pooling of depreciable assets is provided for in Subdiv 328-D, dealing with capital
allowances for small business entities (s 328-185).
All the assets of Allhours with an effective life of less than 25 years would be allocated to a
general small business pool and depreciated at the rate of 30% on a diminishing value basis.
Any additions to the pool during the year would be depreciated at a rate of 15% and
thereafter at 30%. The value of any assets disposed of before the end of the income year must
still be allocated to the pool.
$
Opening pool balance (s 328-190) 16,384*
Add: Acquisitions made during the year 5,200
21,584
Less: proceeds of all asset disposals 500
255
21,084
Less: depreciation on opening balance of the pool (30% × $16,384) 4,915†
16,169
Less: depreciation on assets acquired (15% × $5,200) 780†
Closing pool balance (s 328-200) $15,389
* The opening pool balance of $16,384 as per s 328-195(3) is the total of the taxable purpose
portions of the adjusted values of the depreciating assets in the ‘Depreciation Schedule’ (ie
note 8 above).
$
Combination freezer: $1,480 × 100% 1,480
Refrigerator units: $3,580 × 100% 3,580
Fittings: $2,965 × 100% 2,965
Small electrical appliances: $754 × 100% 754
Holden utility: $1,550 × 90% 1,395
Holden sedan: $10,350 × 60% 6,210
$16,384
† Depreciation for the year = $4,915 + $780 = $5,695
Note: An immediate write-off of assets costing $20,000 or less in the year of first use or
installation ready for use is available from 12 May 2015 to 30 June 2020.
Estimate of taxable use pursuant to s 328-205 has already been accounted for—for the
Holden Utility (90% business) and the Holden sedan (60% business), when these assets were
allocated to the opening balance of the small business pool.
[¶30-198] Solution 198

Primary production partnership;
individual’s tax return
(1)
John & Jill Street
Statement of partnership net income for year ended 30 June 2019
$ $
Gross profit from cattle1 1,790
Less: Deductions–
Hay 2,700
Veterinary fees 600
Repairs and servicing of farm equipment 1,495
Repasturing 1,000
Regravelling of driveways2 950
256
Depreciation (as per schedule)3 3,358 (10,103)
NET PARTNERSHIP LOSS ($8,313)
Distribution of net partnership loss:
Jill Street 70% ($5,819)

John Street 30% ($2,494)
Notes:
(1) Cattle trading account
Per head Total

Number
$ $
Gross sales 30 450 13,500
Stock on hand 30.6.2019 109 397.16* 43,290
Losses by death 2 —
141 56,790
Stock on hand 1.7.2018 71 43,000
Purchases (at cost) 20 600 12,000
Natural increase 50 —
141 $55,000
GROSS PROFIT $56,790 − $55,000 = $1,790
* Calculation of cost price of stock on hand at 30 June 2019:
Number $
Opening stock 71 43,000
Purchases 20 12,000
Natural increase at selected value $20 50 1,000
141 $56,000
Average cost $56,000 divided by 141 = $397.16.
(2) Regravelling of a driveway is generally a normal maintenance expense in operating a

farm. However, if this expense is incurred shortly after the acquisition of the farm, the ‘initial
repair’ argument could be applied to deny the deduction under s 25-10.
If a deduction was denied under s 8-1(1) because the expenditure was of a capital nature, the
expenditure on regravelling the driveway may qualify for a 2.5% pa write-off as a structural
improvement. Although the term ‘structural improvement’ is not defined, a sealed driveway
is an example of a structural improvement (s 43-20(3)). A private ruling should be sought
from the ATO to determine whether regravelling qualifies as a structural improvement under
Div 43. It is also considered that this expenditure would not qualify for deduction under s 40-
880 as pre-business expenditure.
257
Similarly, it is assumed that all the farm equipment was in working order when the farm was
acquired so that the repairs and servicing result from normal wear and tear and did not
constitute expenditure to bring the equipment up to the standard required for a working farm.
Expenditure of the latter type is not deductible outright and must be capitalised.
(3) Depreciation schedule (Non-Small Business Taxpayer)
Acquired Cost $ Life

Decline $
Boundary fences 1.7.2018 5,000 12 417
Farm equipment 1.7.2018 12,000 7 1,714
Farm sheds 1.7.2018 4,000 20 200
Utility 1.9.2018 5,500 —
2,331
Acquisitions made during the year $
($5,500 × 303/365 × 25% × 90% business use) 1,027
Add:
depreciation on other assets acquired
boundary fences $5,000 × 100%/12 = 417

2,331
farm equipment $12,000 × 100%/7 = 1,714
farm sheds $4,000 × 100%/20 = 200

Total depreciation $3,358
(2)
John Street
Statement of taxable income for the year ended 30 June 2019
Income $ $
Salary 50,758
Travel allowance 570 51,328
Travel (1,350 km @ 68 cents at 2018/19 rates)1 918
Depreciation (see Schedule)2 1,295
Heating and lighting of home office 82
Share of net partnership loss 2,494 4,789
Gross tax payable on taxable income (at 2018/19 rates) 6,672.18
Less: Low income tax offset3 302.00
Low and Middle income tax offset 4 486.17
NET TAX PAYABLE $5,884.01
Add: Medicare levy (2% × $46,539 930.78
6814.79
Less: Tax instalments as per payment summary 13,840.00
TAX REFUND DUE $7,025.21
258
Notes:
(1) Travel
As business-related travel is less than 5,000 km, the claim is made on the basis of kilometres
travelled multiplied by car expense rate for 2018/19 (68 cent maximum rate for cents per
kilometre method regardless of engine capacity). This allowance is likely to differ from the
allowance paid by the employer.
(2) Depreciation Schedule
WDV Rate Depreciation

$ % $
Professional library 2,340 18 421
Additions throughout 2018/2019* 874 100 874
$1,295
* Assuming that each textbook cost less than $300, the taxpayer can depreciate each book at
100% (ie non-business asset) and will not have to allocate the asset to a low-value pool (s 40-
425(4)).
(3) Low income tax offset 2018/19 $445 – ($46,539 – $37,000 × 0.015) 143 = $302.
(4) Low and middle income earner Tax offset for incomes between $37,000 and $48,000 =
$200 rebate+3 cents for each $1 above $37,000 = $200+ ($46539 – 37,000 × .03) $286.17 =
$486.17
Note: John is not entitled to the small business tax offset in 2018/19 as he made a loss on his
partnership business.
Trusts
[¶30-199] Solution 199
Trustee-beneficiary income
The net income of the trust under ITAA36 s 95 is:
$
Rental income 38,000
Unfranked dividends 25,000
259
Franked dividends 6,000
Gross-up of franked dividends ($6,000 × 1/70/30)* 2,571
Interest 1,648
NET TRUST INCOME $73,219
(1) As a beneficiary presently entitled and not under any legal disability, Anne Briggs would
receive ($73,219/3) = $24,406.33, and be assessed on this amount under s 97.
*Note: assume the standard corporate tax rate applies.
As she has no other income for the year ended 30 June 2019, her tax liability is as follows:
$ $
Taxable income 24,406.33
Gross tax payable 1,179.14
Share of imputation credit: ⅓ × $2,571 857.00
Low income offset 445.00
1,502.00
Low and Middle Income Tax offset 200.00
Refundable imputation credit $322.86
Net amount payable $165.26
(2) Tom Briggs would also be taxed on his share of trust income under s 97. As Tom’s other
income amounted to $2,100, his tax liability is:
$ $
Share of trust income 24,406
Other income 2,100.00
Gross tax payable 1,578.14
Less: Tax offsets —
Share of imputation credit: ⅓ × $2,571 857.00
Low income offset 445.00
1,502.00
Low and Middle Income Tax offset 200.00
$76.14
Add: Medicare levy ($26,506 × 2%) $530.12
Net amount payable $606.26
(3) As Mary is presently entitled but under a legal disability, the trustees would pay tax on
her share of the income ($24,406) under s 98. However, because she is a minor (ie under the
age of 18, and not an ‘excepted person’ under s 102AC(2)), she is a prescribed person
receiving eligible income for the purposes of ITAA36 Pt III Div 6AA. The trustees would be
taxed on this income at the top marginal rate (ie 45% plus Medicare levy).
260
The trustees would be assessed as follows on Mary’s share of net trust income:
$ $
Taxable income 24,406.00
Gross tax payable at Div 6AA rates
Gross tax payable ($24,406 × 45%) 10,982.70
Less: Tax offsets (rebates)—
Share of imputation credit: ⅓ × $2,571 (s 207-50(1)(b)) 857.00 10,125.70
Tax payable by trustee $10, 613.82
Note: that there is no entitlement to a low and middle income tax offset , where minors are in
receipt of unearned income. Income from an inter vivos trust is eligible income.
[¶30-200] Solution 200

Trust losses; exempt income
On the basis of these results, there would have been no distribution in 2017/18. As trusts
cannot distribute losses, the loss would be carried forward in the trust to offset against any
subsequent trust income.
As deductions in 2018/19 exceed assessable income by $1,800, this excess is subtracted from
net exempt income ($7,800 − $1,800 = $6,000 net exempt income) (ITAA97 s 36-15(4)). The
carried forward tax loss from 2017/18 is then subtracted from the net exempt income ($6,000
− $4,000 = $2,000) and the balance, $2,000, is exempt income in the hands of the
beneficiaries when distributed.
Therefore, A’s share of exempt income is $1,000, and B’s share of exempt income is $1,000.
Consequently, there is no other income for distribution in the 2018/19 tax year and there are
no losses to carry forward to the 2019/20 tax year.
[¶30-201] Solution 201

Revocable trust
(1)
(a) One-half of the net trust income, $20,000, will be assessable income to Terry Alenson’s
wife.
(b)
Terry Alenson, the creator of the trust, will be assessed on his other income of $35,000.
(c)
The trustee will be assessed as follows:
$
Tax on $35,000 + $20,000 (ie $55,000) 9,422.00
Less: Tax assessed on creator’s income ($35,000) 3,192.00
261
Tax assessed against the trustee under s 102 $6,230.00
(2)
ITAA36 s 102 is activated because Terry Alenson was the creator (settlor) of the trust. To
avoid the application of s 102, Terry should have had a ‘nominal’ settlor, a person unrelated
to the family or any objects of the trust, create the trust by giving a nominal sum, say $10, to
the trustee to constitute the original trust property. Once the trust had been created Terry
Alenson could transfer funds to the trust without the risk of the Commissioner of Taxation
invoking s 102. (See Truesdale v FC of T 70 ATC 4056, where Menzies J was satisfied that
the nominal settlor had paid the initial gift of $20 from his own funds and was not reimbursed
by the real settlor.) As further indicated in Hobbs v FC of T (1957) 98 CLR 151, the High
Court held that s 102 did not apply to contingent interests in income. The High Court has also
held that the payment of money to a trustee to be held on the terms of a pre-existing trust
does not amount to the creation of a trust (Truesdale v FC of T 70 ATC 4056).
[¶30-202] Solution 202

Prescribed person; eligible income
The tax payable by Cara Louise for the year ended 30 June 2019 is calculated in accordance
with ITAA36 Div 6AA (s 102AA to 102AGA), which deals with the derivation of unearned
income by minors. Because Cara is under 18 and is not employed full-time, she is a
prescribed person under s 102AC. Therefore, when the eligible income exceeds $1,307, tax is
payable on the whole of the eligible taxable income at the top marginal rate of 45%. In
addition the low income rebate does not apply to the unearned income of minors. Eligible
income essentially refers to unearned income received from an inter vivos trust. (Certain
kinds are excluded: see s 102AE.)
As Cara is a beneficiary presently entitled, but under a legal disability, the trustee will be
liable to pay the tax (s 98). However, as Cara also derives income from a salary, she must
lodge a tax return showing her income from both the trust and part-time work.
The tax paid by the trustee on her share of net trust income is deducted from the income tax
assessed against her via (s 100(2)) credit.
Therefore:
$
Tax on $6,000 × 45% 2,700
Tax on $4,000 at ordinary rates nil
Gross tax payable* 2,700
Net tax $2,700
Less: tax paid or payable by trustee (s 100(2)) $2,700
Tax payable by Cara nil
* No Medicare levy is payable because the taxable income is below the threshold level.

262
[¶30-203] Solution 203
Trust losses pattern of distributions test
The pattern of distributions test applies to non-fixed trusts and applies independently to both
income and capital. Broadly s 269-65(1) requires that the same group of individuals must
have received distributions of more than 50% of both income and capital of the trust in a year
prior to the loss year, the income year the loss is recouped and any intervening years over a
seven-year period. The test only applies if a non-fixed trust has distributed income or capital
in the year in which the prior year tax loss is to be claimed (or within two months of the year
end) and a distribution of income or capital was made in one of the previous six years.
The section 269-60 test requires that the trust must have distributed more than 50% of any
distributions of income or capital either directly or indirectly to the same individuals for their
own benefit in each year during the test period. As the test is separately applied to income
and capital distributions, capital distributions need not be made to the same individuals who
received income distributions when applying the greater than 50% criteria. Consequently,
where the income and capital beneficiaries differ, as in this case, the test needs to be satisfied
twice. It should be noted that the Commissioner of Taxation takes the view that certain
persons who may not be beneficiaries may still receive a distribution as defined, provided the
distribution was carried out after 8 June 2017 (see TD 2017/20).
To comply with s 269-70, beneficiaries who receive different percentages of income and
capital distributions in different years are required to take into account the smallest
percentage of such distributions. Consequently, in applying the pattern of distribution test to
the Smith discretionary trust it is necessary to compare income distributions made in the 2013
and 2019 tax years since these are the only years during the test period in which distributions
were made. The lowest percentage of income distributions in these two years will be the
percentage of distributions taken into account:
Income Beneficiary 2013 tax year 2019 tax year Lowest percentage
Ralph 20% 40% 20%
Kelly 35% 25% 25%
Grace 45% 35% 35%
Total Income 100% 100% 80%
Capital Beneficiary
Jonathan 15% 30% 15%
Evan 45% 50% 45%
Fabian 40% 20% 20%
Total Capital 100% 100% 80%
Therefore the trust passes the pattern of distributions test as 80% of the same persons
received income distributions over the test period (ie 80% > 50%) and the trading loss of
$450,000 for the year ended 30 June 2018 can be carried forward to be offset against trust
income of 2018/19 tax year or future years. Likewise, the test is also passed for the capital
distributions over the test period (ie 80% > 50%) and the capital loss of $250,000 for the year
263
ended 30 June 2018 can be carried forward to be offset against trust capital for the 2018/19
tax year or future years.
[¶30-204] Solution 204

Foreign income; shares; corpus; non-
resident beneficiaries
(1) Net income of the trust for the year
ended 30 June 2019
Income: $ $
Warehouse rental 27,500
Villa units rental 22,400
Fully franked dividends 2,100
Gross-up under s 207-55(1)a 900
Bonus sharesb 600
Securities: interest 5,000 58,500
Expenses:
Mortgage interest paidc 32,000
NET INCOMEd $26,500
Notes:
(a) $2,100 × 1/70/30 (s 202-60(2)) assume standard corporate tax rate.
(b) As the bonus issue was made to all shareholders from a tainted share capital account, it
will not be treated as a payment out of the company’s ‘share capital account’, so paragraph
(d) of the definition of dividend in ITAA36 s 6(1) will not exclude the payment being a
dividend. The receipt of bonus shares from a tainted share capital account would be included
as an assessable unfranked dividend (s 44(1)). The value of the unfranked dividend is $600,
being $1 per share on the 600 bonus shares.
(c) Mortgage interest: $320,000 @ 10% = $32,000 (see generally Taxation Ruling TR
2003/9).
(d) There is no deduction available under ITAA97 Div 43 because the factory warehouse and
villa units were both constructed before the deduction for income-producing buildings
became operative.
15 July resolution
264
The Commissioner of Taxation may assess a trustee to trust income to which no beneficiary
is presently entitled. However, as a matter of practice, the Commissioner of Taxation does
not exercise this power if the beneficiaries, though not presently entitled to income at year-
end, become so entitled within two months of the year-end. However, this practice has no
legislative force and cannot be relied on (see Case R105, 84 ATC 692).
Therefore, provided the 15 July resolution establishes the beneficiaries’ present entitlements,
they (and not the trustee) will be assessed to the trust’s net income of $26,500.
Establishing present entitlement

ITAA36 s 101 provides that where a trustee of a trust has a discretion to pay or apply income
of a trust estate to or for the benefit of specified beneficiaries, a beneficiary in whose favour
the trustee exercises his or her discretion shall be deemed to be presently entitled to the
amount paid to the beneficiary or applied for his or her benefit by the trustee in the exercise
of that discretion.
Consequently, it is necessary to determine whether the resolution and book entry to the trust
accounts are sufficient to establish present entitlement.
A beneficiary is presently entitled to income when the income is legally available for
distribution and:
•
he or she is entitled to immediate payment of the income, or
•
if under a legal disability, he or she would succeed in an action to recover the income but for
the legal disability.
On the basis that the trustees’ resolution creates a ‘present entitlement’ by providing the
beneficiaries with a right to immediate payment (or would but for their legal disability), the
beneficiaries would be taxed on the income which the trustees resolved to distribute to them.
(See FC of T v Whiting (1943) 68 CLR 199, Montgomerie v Commr of IR (NZ) (1965) 14
ATD 102 and Taylor v FC of T 70 ATC 4026.)
Distinguish this from the case of Pearson v FC of T 2006 ATC 4352, where the trustee of a
discretionary trust was not entitled to the net income of the unit trust as there was no
provision in the trust deed to make the trustee presently entitled nor did the unit holders have
any legal right to demand payment of undistributed net income and as the sole unit holder the
trustee could have brought the unit trust to an end.
It is also noted that the beneficiaries are ‘specifically entitled’ to the franked distribution, that
is, they will receive an amount equal to the ‘net financial benefit’ referable to the franked
distribution in the trust (see Subdiv 207-B).
However, the date of payment of the income is not relevant to the question of present
entitlement in this instance.
Beneficiaries Distributions$ Rate of tax Tax payable on $5,300 excluding
265
payable Medicare levy $
Tom’s marginal
Tom 5,300 (32.5%) 1,722.50*
rate
Mary’s marginal
Mary 5,300 (0%) 0*
rate
Fiona’s
Fiona 5,300 (19%) 1,007*
marginal rate
Jane 5,300 Div 6AA rate (45%) 2,385 *
John 5,300 Div 6AA rate (45%) 2,385 *
$26,500.00
* Tom, Mary and Fiona are each entitled to a franking offset of $180 ($900/5) under ITAA97
s 207-35(3). Tom and his solicitor as trustees are entitled to a franking rebate of $180 under s
207-35(4) in respect of Jane and John as minors. (Jane and John will pay tax at 45%, the top
marginal rate in 2018/19.)
Tom and Fiona will also be entitled to a partial low income tax offset (LITO) and Low and
Middle Income Tax Offset (LMITO).
(2) Bonus shares

Under the terms of the Trust Deed the bonus shares are capital in nature. But,
notwithstanding the terms of the trust deed, the bonus shares would, under s 44(1), still
represent assessable dividend income of the trust for tax purposes.
As a result, the net income of the trust for tax purposes will exceed its distributable income.
The question arises whether the excess is assessable to the trustee or the beneficiaries.
Under the quantum view, beneficiaries should not be assessed on income to which they are
not entitled. Therefore, the trustee would be assessable on the excess under s 99A, unless the
Commissioner of Taxation exercised his discretion to apply s 99.
The alternative approach is the proportionate view. Under this approach, beneficiaries are
assessable to the excess in proportion to their shares in the distributable income of the trust
(see Case R32, 84 ATC 298 at p 311 and Hill J in Davis v FC of T 89 ATC 4377).
In Richardson v FC of T 97 ATC 5098, Merkel J stated (at p 5113) that in his view s 97(1)
required that the ‘principle of construction be employed to ensure that when trust income
exceeds the trust’s taxable income a proportionate approach is adopted to determining the
distribution of assessable income to beneficiaries presently entitled under s 97(1). But, when
the trust’s taxable income exceeds the trust income a quantum approach is to be adopted to
determine the distribution of assessable income in relation to the beneficiary presently
entitled to the trust income under s 97(1). In the latter case the deficiency will be
undistributed ‘income’ to which no beneficiary is presently entitled and will be taxable
income of the trustee under s 99 or 99A of the Act’.
Likewise, in other cases where there is no entitlement to beneficiaries to the assessable

income of the trust estate, the income will also be assessed to the trustee. In the case of
266
Cajkusic v FC of T (No 2) 2006 ATC 4752 the beneficiaries of a family trust were not
presently entitled to any part of the income of the trust estate because there was no
distributable income due to the availability of past losses. Consequently, the net income of
the trust was properly assessable to the trustee under s 99A of the Act.
In practice, the Commissioner of Taxation will apply the view that beneficiaries are taxed on
their share of ‘net income’ under s 95. This was the ATO approach in Zeta Force Pty Ltd v
FC of T 98 ATC 4681. In that case, the Commissioner of Taxation taxed the beneficiary on
its share of the net taxable income of the trust estate, even though the amount was greater
than the amount of trust income actually distributed to it. Sundberg J upheld that this was the
correct approach, thereby endorsing the ‘proportion’ view of Hill J in Davis v FC of T. In the
case of Bamford v FC of T 2008 ATC ¶10-022, the AAT also held that the proportionate
approach applied to all beneficiaries presently entitled, whether they received rewards
expressed as amounts or as proportions of trust income. The ATO has indicated that it will
generally apply the proportionate approach.
In the Full Federal Court decision in Bamford it was held that the proportionate approach
applied regardless of how the trustee’s resolution to distribute income is made. This outcome
was confirmed by the High Court in FC of T v Bamford; Bamford v FC of T 2010 ATC ¶20-
170 where it was held that the natural meaning to give to the word ‘share’ was ‘proportion’
rather than ‘part’ or ‘portion’.
The Commissioner of Taxation has issued a Decision Impact Statement in relation to

Bamford’s case and has also issued a Practice Statement that explains the ATO approach
where deliberate attempts are made to exploit the provisions of Div 6 by the re-
characterisation of an amount for trust purposes (see Practice Statement PS LA 2010/1).
(3) Non-resident beneficiary

If Fiona was a non-resident, the trustees would be assessable under s 98(4) on her share of the
income of the trust attributable to sources in Australia. Section 98A states that a non-resident
is assessable on his or her individual interest in the net income of the trust estate which is
attributable to sources in Australia. However, her tax liability on this income would be
reduced by the amount of tax paid by the trustees pursuant to s 98(4).
In determining the trustees’ liability for tax on Fiona’s share of net trust income, each
component of the income distributed needs to be considered. The trustees are required to
deduct dividend withholding tax on the share of the unfranked dividend (the bonus issue)
allocated to Fiona. The rate of withholding tax will depend upon Fiona’s country of residence
and whether Australia has a treaty agreement with that country.
After payment of withholding tax the unfranked dividend is not included in assessable
income (s 128D; see also Taxation Ruling IT 2680).
The non-resident beneficiary’s share of franked dividend income is not subject to withholding
tax due to s 128B(3)(ga) which excludes franked dividends from the operation of s 128B.
Section 128D then excludes from assessable income the franked dividend that would have
been subject to withholding tax but for the operation of s 128B(3)(ga).
267
As the non-resident beneficiary is not entitled to a tax offset, ITAA97 s 207-70 will operate
to remove the effect of the grossing up of the dividend income in the trust net income due to
the franking credit.
The trustees are therefore not assessed on the franked dividend or gross-up attributable to
Fiona’s share of net trust income.
Alternatively, if the securities are ITAA36 s 128F debentures, then no withholding tax is
payable. If they are not, and withholding tax is payable, s 128D excludes the interest from
assessable income.
The calculation would then be
The trustees will also be required to pay withholding tax on the unfranked dividend and
withholding tax on the interest of $100 ($5,000/5 × 10% withholding tax).
(4) Power to revoke trust

Tom is not the settlor, Tom’s father is. Accordingly, Tom’s ability to revoke the trust does
not invoke the operation of s 102.
However, if Tom had been the settlor, s 102 would operate, and the trustees would be
assessed on trust income allocated to Jane and John at an amount equal to the difference
between the tax actually paid by the settlor and the sum of tax that would have been payable
but for the trust (refer to Solution 201). (See Truesdale v FC of T 70 ATC 4056.)
(5) Payment out of corpus

Section 99B(1) would, on the face of it, operate to include the $3,000 in the assessable
income of John for the year ended 30 June 2019. However, s 99B(2)(a) would operate to
nullify s 99B(1) on the basis that the amount represents corpus of the trust estate which would
not have represented assessable income if derived by a resident taxpayer.
(6) Deceased trust estate

As a general rule, until the administration of a deceased trust estate is complete, the trust’s
income will be assessed to the trustees under s 99. This is the natural extension of the rule
that a beneficiary cannot be presently entitled to income of the estate until the residue is
determined (that is, until all debts are paid or provided for).
Naturally, if the trustees pay an amount of income to a beneficiary, that beneficiary will be
presently entitled to the income and assessed accordingly. Therefore, it is necessary to
establish whether the administration of a deceased estate is complete before the taxation
implications can be determined. (See FC of T v Whiting (1943) 68 CLR 199.)
268
Normally the ATO accepts that a trust estate would be under a period of administration for up
to three years after the date of the deceased’s death.
If Tom Gordon’s father died on 1 July 1989 the estate would no longer be regarded as being
within the period of administration. Where the Commissioner of Taxation exercises his
discretion under s 99(2) the undistributed trust income would be taxed to the trustees under s
99 rather than s 99A.
Under a deceased estate the income distributed to Jane (17) and John (15) is excepted
assessable income (s 102AE(2)(c)) and will be subject to normal tax rates, not Div 6AA rates.
The trustees will be assessed separately on the share of trust income earned by Jane and John,
but as their share is below the tax threshold for 2018/19 of $18,200 no tax is payable (see
Taxation Ruling IT 2622).
(7) Application of income for non-resident

beneficiary’s benefit
On the basis that Rachel had a present entitlement to the income at the time it was applied for
her benefit; the trustees will be assessed to the $2,000 under s 98(4).
Rachel will remain presently entitled to the income even though it was applied for her benefit
during the year (s 95A(1)).
As a non-resident beneficiary is presently entitled, the trustees will be assessed on the $2,000
at a flat tax rate of 32.5% = $650 (assuming it is not dividend, interest or royalty income).
(8) Foreign tax credit

On the basis that $425 represents the after-tax dividend, the amount included in calculating
the s 95 net trust income will be $500 (the dividend received, ie $425, plus the 15%
withholding tax, ie $75). On distribution of net trust income, each resident beneficiary
allocated a share of the UK dividend will also receive a share of the foreign income tax offset
(see ITAA97 Div 770 and s 770-75).
However, Rachel, being a non-resident, will not be assessed on foreign source income by
Australian revenue authorities (s 98A(1)(b)).
[¶30-205] Solution 205

Classes of income
Hill Family Trust
Net income of trust according to s 95 for year ended 30 June 2019
269
$
Australian dividends 3,300
Gross-up under s 202-60(2) ($3,300 × 1/70/30) 1,414
Dividend from USA 3,400
Gross-up for withholding tax (see ITAA97 Div 770, s 770-10):
600
$8,714
Distribution as per the trustee resolution
Share of income Tax payable (excluding Medicare levy)
$ $
Tim (aged 17 years) 4,357 953.65
Julie (aged 22 years) 4,357 NIL
Tim’s tax liability

Tim being an Australian resident but aged 17 years is presently entitled to trust income but
under a legal disability. Consequently, any tax payable by the trustee will be at ITAA36 Div
6AA rates (ie $4,357 × 45% = $1,960.65). This will be reduced by Tim’s half share of the
franking credit ($707) and the foreign income tax offset ($300). There will be no entitlement
to a low income tax offset (LITO or LMITO) onwards, where minors are in receipt of
unearned income (income from an inter vivos trust is eligible income). The trustee will not be
entitled to a refund of any franking credits unless the trustee is assessed under s 99 which is
not the case. Therefore, the trustee will pay $953.65 on account of Tim.
Julie’s tax liability

Julie is a beneficiary who is presently entitled and not under any legal disability. However, as
a non-resident she is only liable for tax on Australian-source trust income. The distribution to
her consists of an Australian sourced fully franked dividend. As it is fully franked there is no
withholding tax obligation and it represents exempt income for Australian tax purposes when
received by a non-resident (s 128B(3)(ga) and s 128D). The balance of the income allocated
to Julie is from a foreign source and therefore she does not have any liability for Australian
tax on this income.
[¶30-206] Solution 206

Deceased estates
The treatment of the outstanding debts will vary depending upon whether the income was
derived by Small before or after his death.
270
If Small was returning business income on the accruals basis, the income would be derived at
the invoice date. As the income was derived before Small’s death it would be included in the
Form I tax return of the deceased lodged by the executor of his estate.
If Small was returning his business income on the cash basis, the income is derived when
received. As the income is received after Small’s death, s 101A will apply. Under s 101A the
$5,000 in outstanding accounts will be deemed to be income to which no beneficiary is
presently entitled. The amount will be included in the Form T trust return lodged by the
trustee.
Given that Small is an accountant, the High Court decision in Single v FC of T (1964) 110
CLR 177 would be followed. That is, fees received after the death of a professional sole
practitioner or partner whose returns are filed on a cash basis would be caught by s 101A.
This includes not only fees subsequently received for completed work for which an account
was rendered, but also subsequent receipts for the work incomplete at the date of death.
The income will be aggregated with other amounts to which no beneficiary is presently
entitled and, in the absence of special provisions to the contrary, will be assessed to the
trustee under s 99 rather than s 99A as it would be unreasonable to apply s 99A in the opinion
of the Commissioner of Taxation as it is a deceased estate.
The property income and dividend income would also be assessable in the hands of the
trustee. If administration of the estate was not completed and the trustee was unable to make
a distribution of the income, then the trustee would be taxed under s 99 or 99A as income to
which no beneficiary is presently entitled. Assuming that the Commissioner of Taxation
exercises his discretion under s 99A (2), the income would be taxed at normal rates under s
99. It is noted that Public Compliance Guidelines 2018/4 applies to smaller and less complex
estates, such as this, to enable the trustee to wind up the estate without the concern of funding
the deceased pre death liabilities from their own assets.
Tax rates on income can also be affected where the deceased dies more than three years
before the end of the relevant year of income. (See Trustee for the Estate of EV Dukes v FC
of T 2002 ATC 2079.)
$
Rent on property 30,000
Fully franked dividend 640
Gross-up under s 202-60(2) ($640 × 1/70/30) 274
$30,914
The tax payable at ordinary rates on a taxable income of $30,914 is $2,415.66. The trustee
would be entitled to a franking credit of $274 under ITAA97 s 202-60 and a low income
rebate under ITAA36 s 159N of $445 and a low and middle income tax offset of $200 giving
a net tax payable of $1,696.66 (excluding Medicare levy).
271
If ITAA36 s 101A applied to the outstanding debts of $5,000, this sum would have been
aggregated with the rental and dividend income. The income to which no beneficiary is
presently entitled would be:
$
Outstanding debts 5,000
Rent on property 30,000
Fully franked dividend 640
Gross-up under s 202-60(2) 274
Section 99 income $35,914
TAX PAYABLE $3,365.66 − ($274 + $445 + 200) = $2,446.66
If the administration of the estate is complete and the trustee has affected a resolution to
create a present entitlement to the income on the part of the beneficiaries, then the above
amounts will be assessed to the beneficiaries at normal rates. (See Taxation Ruling IT 2622
regarding taxation treatment in the period of administration.) Assuming they have no other
income, the tax payable would be:
Share of Low income Low and Middle

Tax
Income imputed credit earner rebate Income Tax
payable(1)
(2) (3) Offset(3)
$
$
$ $ $
Ravenna 10,304.66 0 91.33 445 200
Julie (aged
10,304.66 0 91.33 445 200
21)
Angela
10,304.661 0 91.33 445 200
(aged 16)
Notes:
(1) Section 102AG(2) provides that Div 6AA does not apply to ‘excepted trust income’,
which includes income derived from a deceased estate. Therefore, even though Angela is a
minor, her share of the trust’s income will be assessed at normal tax rates and she would also
be entitled to the low income earner rebate and the low and middle income tax offset in
addition in 2018-19. Taxable income is below the tax free threshold of $18,200, so no tax is
payable.
(2) The imputation credit can be offset against a tax liability on other taxable income in the
current year or refundable.
(3) The unused low income earner rebate and low and middle income tax offset is lost. A
refund cannot be claimed for the $445 or $200 as it can only be offset against tax payable of
which there is none.
[¶30-207] Solution 207
272
Present entitlement
A number of the issues in this question have been addressed in Solution 204, in particular the
implications of:
•
the resolution and book entries took place on 16 August. However, it has been held that a
book entry is not sufficient to create a present entitlement to income. A resolution by the
trustee ensures the creation of an indefeasible interest (see Montgomerie v Commr of IR (NZ
1965) 14 ATD 102)
•
the net income of the trust for tax purposes exceeding the distributable income (see FC of T v
Bamford; Bamford v FC of T 2010 ATC ¶20-170), and
•
the rate of tax applicable to income distributed to a minor (Steven). Under the provisions of
ITAA36 Div 6AA (s 102AA to 102AGA), unearned income derived by minors is generally
subject to higher rates of tax.
The remaining issue is whether the beneficiaries will be assessed to the income that was
reinvested in the business.
A beneficiary’s assessable income will include the share of the income of the trust to which
he or she is presently entitled (s 97 and 98). Therefore, it is irrelevant whether that income is
distributed to the beneficiary once present entitlement is established (see FC of T v Whiting
(1943) 68 CLR 199).
As Andrew, Jean and Emma Tobin are all presently entitled to their share of trust income and
are not under any legal disability they will each include their share of s 95 net trust income as
assessable income in their individual income tax return (s 97). However, Steven Tobin, aged
16, is under a legal disability so the trustee will be assessed on his share of net trust income
under s 98.
The assessment is:
Share Amount Assessable Tax*

Andrew Tobin 37.5% $67,500 to beneficiary under s 97 $13,484.50
Jean Tobin 37.5% $67,500 to beneficiary under s 97 $13,484.50
Emma Tobin 12.5% $22,500 to beneficiary under s 97 $172.00**
Steven Tobin 12.5% $22,500 to trustee under s 98 $10,125.00***
Net Trust Income $180,000
*Assumes no other income, and excludes Medicare levy.
**$817 tax less $445 low income earner rebate + $200 low and middle income tax offset =
$172.
***$10,575.00. Minor subject to Div 6AA tax rate and no low income earner rebate or low
and middle income tax offset , as it is unearned income (45% tax).
273
The answer above follows the ‘share’ or ‘proportion’ view (see Zeta Force Pty Ltd v FC of T
98 ATC 4681 and FC of T v Bamford; Bamford v FC of T 2010 ATC ¶20-170). The
Commissioner of Taxation’s current practice is to apply the proportion view, and this practice
was upheld by Sundberg J in Zeta Force. (The Full Federal Court in FC of T v Prestige
Motors Pty Ltd as Trustee of the Prestige Toyota Trust 98 ATC 4241 also supported the
‘proportionate’ approach.)
Also, in the case of FC of T v Bamford; Bamford v FC of T 2010 ATC ¶20-170, the High
Court held that the proportionate approach applied regardless of how the trustee’s resolution
to distribute income is made. That is whether by reference to dollar amounts, or to fractions
or proportions of trust income. The High Court indicated that the natural meaning to give to
the word ‘share’ was ‘proportion’ rather than ‘part’ or ‘portion’ (see TD 2012/22).

where deliberate attempts are made to exploit the provisions of Div 6 by the
recharacterisation of an amount for trust purposes (Practice Statement PS LA 2010/1).The
Commissioner of Taxation also released a further Decision Impact Statement following the
decision in Lewski v FCT 2017 ATC 20- 630 indicating that distributions may vary
depending on whether income entitlements are expressed as a percentage share or a specific
amount, and whether the variation resolution reflects adjustments made by the
Commissioner.
[¶30-208] Solution 208

Net trust income; distribution
(1) Net income of trust estate
Estate of the late John Spencer
Net income of trust estate for year ended 30 June 2019
$
Profit from grazing property 30,000
Dividends (grossed-up for franking) ($25,000 + ($25,000 × 1/70/30) 35,714
Interest on debentures 11,000
As John Spencer died before 20 September 1985, assets of the estate that pass to a legal
representative or beneficiary are deemed to be acquired pre-CGT and, consequently, on
subsequent disposal the assets (ie the shares) will not attract CGT.
274
(2) Assessment of payments and amount
accumulated (assuming beneficiaries do not
receive income from any other source)
Spencer’s widow’s share of net trust income is $36,000. She will be assessed on the $36,000
under ITAA36 s 97 and this sum will be taxed in her hands at ordinary marginal tax rates.
Wendy, by virtue of s 101, will be deemed presently entitled to the trust income applied for
her benefit ($9,000). As Wendy is over 18 years of age she is not a ‘prescribed person’ and,
as she is presently entitled to trust income and not under any legal disability, the $9,000
applied for her benefit will be assessed to Wendy at ordinary marginal tax rates (s 97).
Wendy will be entitled to an imputation credit for her share of the trust distribution
representing franked dividends. However, as Wendy’s income is below the tax free threshold
in 2018/19 ($18,200), no tax is payable and the excess imputation credits are refundable
(ITAA97 s 67-25). Wendy’s income is also below the Medicare levy threshold.
Justin, by virtue of ITAA36 s 101, will also be deemed presently entitled to the trust income
applied for his benefit ($7,500). As Justin is also over 18 years of age, he is not a ‘prescribed
person’, and he is presently entitled to trust income and not under any legal disability, the
$7,500 will be assessed at ordinary marginal tax rates (s 97). As with Wendy, no tax is
payable and the excess imputation credits are refundable (Justin’s income is also below the
Medicare levy threshold).
It is important to note that beneficiaries who have a present entitlement that want to disclaim
their interest in the discretionary trust must do it promptly and correctly to be effective. See
Ramsden v FC of T 2005 ATC 4136 and Pearson v FC of T 2005 ATC 4119.
The balance ($24,214) is accumulated trust income. This income is assessed to the trustee
under s 99. (As there is no element of tax avoidance and the trust income arises from a
deceased estate, the Commissioner of Taxation would most likely use his discretion to tax the
trustee under s 99 and not s 99A.) The trustee will be entitled to an imputation credit for the
share of this trust income represented by franked dividends.
(3) Inter vivos settlement

If the trust had been created by a settlement inter vivos the accumulated trust income would
be assessed to the trustee under s 99A and taxed at the top rate of 45% unless the
Commissioner of Taxation exercises his discretion to tax the trustee under s 99. Spencer’s
widow, Wendy, and Justin would be assessed in exactly the same way as for a deceased
estate.
[¶30-209] Solution 209

Family Trust Elections
275
(1) Is Monic a member of Jim’s family or
family group?
As the test individual, Jim’s family group includes his family, specified former family
members, entities (including companies) covered by an interposed entity election and entities
owned by Jim’s family.
Therefore, Monic, as Jim’s former spouse, is not a member of Jim’s family. Jim’s family
includes himself, his spouse, his parents, his spouse’s parents, grandparents, siblings,
nephews and nieces (ITAA36 Sch 2F s 272-95). The term spouse also includes a de facto
spouse, but not a former spouse (ITAA36 s 6(1)).
Although Monic is not a member of Jim’s family, she will still qualify to be a member of
Jim’s family group as she is his ex-wife (s 272-90(2A)). However, distributions to former
spouses are exempt from family trust distribution tax (imposed at the rate of 47% of the
amount or value of the income or capital distributed or to which the entitlement relates).
(2) Is the company, Sims Pty Ltd, a member

of Jim’s family group?
The company, Sims Pty Ltd, owned by Jim and Monic will be, in relation to a conferral or
distribution, a member of Jim’s family group provided that the company has made an
interposed entity election to that effect and the election is in force at the time of a conferral or
distribution (s 272-90(4)).
With regards to a conferral or distribution, a company can be a member of an individual’s

family group without an interposed entity election, but only where the test individual, or his
family or the trustees of one or more family trusts, have fixed entitlements to all the income
and capital of the company.
Therefore, Monic has an entitlement to a share of the income and capital of Sims Pty Ltd. As
Monic is not a member of Jim’s family, Sims cannot be a member of Jim’s family group
unless an interposed entity election is made (s 272-90(5)). The interposed entity election
should indicate that Sims be included in the family group of Jim’s, specified in the family
trust election (s 272-85).
A family trust election must specify the year from the beginning of which the trust becomes a
family trust (s 272-80). The specified income year may be a year before the one in which the
election is made provided that the following conditions are met at all times from the
beginning of the specified income year until 30 June in the income year preceding the
election:
•
the entity passes the family control test, and
•
276
any conferral of present entitlement or any actual distributions of income or capital of the
trust made by the trustee during that period have been made to individuals specified in the
election or to members of that individual’s family group (s 272-80(4A); 272-85(4A)).
The election must also specify an individual as the individual whose ‘family group’ is the
subject of the election. The election should also include other information required by the
Commissioner of Taxation, such as, the name and address of the trust and the beneficiaries (s
272-80(3)).
Note: If a family trust election is revoked, the interposed entity election is automatically
revoked (s 272-85(5B)). An interposed entity election cannot be made in respect of more than
one family trust unless the individual specified in each family trust election is the same
person. In the 2018-19 Budget it was proposed that amendments be made to extend the
specific anti-avoidance rules that apply to closely held trusts that engage in circular or “round
robin’ type of arrangements with regards to their trust distributions.
[¶30-210] Solution 210

Trust losses; income injection test
Application of the income injection test to
deny recovery of losses in the Loss Trust
The requirements of ITAA36 Sch 2F Div 270, s 270-10(1)(b) are met because under the
scheme:
•
the Loss Trust has derived assessable income (because of the allocation of the net income by
the Income Trust)
•
the Income Trust (the outsider) has provided a benefit to the Loss Trust by allocating net
income to the Loss Trust (this has given a right to the Loss Trust and is also something that
has resulted in the Loss Trust deriving assessable income), and
•
the Loss Trust has provided a benefit to the Income Trust by loaning back an amount equal to
its income allocation.
The requirements of s 270-10(1)(c) are satisfied on the basis that the net income allocation
has been made to the Loss Trust so that the income tax will not be payable on that net
income. The Income Trust has retained use of the income through the low-interest loan on
terms that are not commercial. It is reasonable to conclude that the assessable income was
derived by the Loss Trust and the benefits were provided by the two trusts to each other,
wholly or partly because of the prior year loss deductions in the Loss Trust. The connection
would appear to be more than merely incidental.
277
The income injection test will operate to increase the net income of the Loss Trust to equal
the amount of the net income allocation from the Income Trust. Where the test is failed, no
deduction is allowable in the income year (2018/2019) against the ‘scheme assessable
income’ with the result that the net income of the Loss Trust is increased to equal at least the
amount of the scheme assessable income of $500,000 (s 270-15). In addition, to the extent
that any deduction is incurred in deriving the scheme assessable income, the deduction is not
allowable. However, other deductions of the trust are not affected and the trust losses may be
carried forward to future years.
It should be noted that, even if the loan back of the net income allocation was on commercial
terms, the scheme could still be subject to the income injection test, ie where the distribution
has been made by the Income Trust to the Loss Trust wholly or partly, but not merely
incidentally, because a deduction is allowable to the Loss Trust for the losses (eg so that
income tax would not be payable on the income of the Income Trust).
For example, in the case of Eldersmede v FC of T 2004 ATC 2129, the AAT found that the
income injection test was applied to disallow trust loss deductions resulting from a complex
series of transactions involving a group of related trusts. Because of the disallowance, the
ultimate beneficiaries were assessable on an additional amount of taxable income.
Also, in the case of Corporate Initiatives Pty Ltd v FC of T 2005 ATC 4392, a trust loss
scheme was caught under the income injection test where a trustee resolved to make a
distribution equal to the accumulated tax losses of the recipient. However by not calling for
the payment of funds distributed (but not actually paid) to it, the recipient provided a benefit
to that trust estate. Allowing the trust to retain use of those distributions meant that the
benefit was received under the scheme, given that the scheme operated to produce that effect.
‘Scheme’ has the same meaning as that in ITAA36 Pt IVA and ‘benefit’ is broadly defined to
include money or other property, services, the release or waiver of a debt and any benefit or
advantage.
[¶30-211] Solution 211

Net trust income; trust law distribution
(1)
As in the case of a company where net taxable income differs from the reported net profit, the
‘net income’ of a trust estate calculated in accordance with the terms of the trust deed
(distributable trust income) is likely to differ from the ‘net income’ of the trust estate
calculated pursuant to ITAA36 s 95 for taxation purposes.
Discrepancies between the accounting and taxation ‘net income’ of the trust will occur where,
for example:
•
items of assessable income, such as capital gains, are treated as corpus under trust law or the
trust deed
•
expenses according to trust law or the trust deed are either non-deductible for taxation
purposes or deductible to a lesser extent
•
278
taxation law provides for special incentives which are deductible but not recognised as
expenses for accounting purposes
•
the basis used for valuing trading stock or depreciating assets for trust accounting purposes is
different from the basis used for income tax purposes, and
•
imputation credits are included in calculating net income for tax purposes but not accounting
net income.
(2)
Where the taxable ‘net income’ as calculated under s 95 ($40,000) exceeds the distributable
net income ($30,000), it remains to be determined under which section, and to what extent,
the trustee (or the beneficiary who is presently entitled and not under any legal disability) is
assessable for tax.
Two possibilities arise:
(a)
the beneficiary is taxed on $40,000 (his share of net trust income), or
(b)
the beneficiary is only taxed on the $30,000 received, since the trustee is not able to distribute
any more than that sum, and the residue of $10,000 is taxed to the trustee under s 99 or 99A.
The problem centres on the word ‘share’ in s 97. Does ‘share’ mean proportion of the net
income of the trust or the actual amount?
One view is that a beneficiary can only be ‘presently entitled’ within the meaning of s 97 to
such amount (quantum) of income as he is entitled, or will be entitled, to receive. This view
implies that the word ‘share’ in s 97 does not mean a proportion but rather ‘an amount’ or ‘an
allocated amount’. This view would mean that the beneficiary, Bert Graham, could not be
assessed on an amount greater than the amount to which he is presently entitled ($30,000).
This means that the excess ($10,000) would be assessable to the trustee under s 99A, unless
the Commissioner of Taxation exercises his discretion to apply s 99.
Support for this view can be found in Case L55 (1960) 11 TBRD 327 (No 1 Board) and in
obiter dicta in Taylor v FC of T 70 ATC 4026 (per Kitto J at p 4030), Richardson v FC of T
97 ATC 5098 (Merkel J at p 5113) and FC of T v Prestige Motors Pty Ltd as Trustee of the
Prestige Toyota Trust 98 ATC 4241.
The Commissioner of Taxation will accept returns on the basis that once the share for the
beneficiary is determined, the entire taxable income is assessed under either s 97 or 98 as the
case may be. The other view is that if the word ‘share’ means proportion of net income, then
the beneficiary, Bert Graham, will be taxed on his share (100%) of the $40,000 s 95 net
income. This view assumes that the function of the first part of s 97 is merely to determine
the proportionate interest of a beneficiary in the income of the trust, and once this proportion
has been determined it is applied to the net income of the trust estate as calculated under s 95.
Each beneficiary is then assessed on his or her proportion of the ‘net income of the trust
estate’ as determined by s 95, whether it be greater or less than the distributable income.
This approach was adopted by the AAT in Case C36, 71 ATC 156 and Case E69 (1954) 5
TBRD 429 and followed by Hill J in Davis v FC of T 89 ATC 4377 and by Sundberg J in
Zeta Force Pty Ltd v FC of T 98 ATC 4681.
279
In the case of FC of T v Bamford; Bamford v FC of T 2010 ATC ¶20-170, the High Court
held that the proportionate approach applied regardless of how the trustee’s resolution to
distribute income is made. That is whether by reference to dollar amounts, or to fractions or
proportions of trust income. The High Court indicated that the natural meaning to give to the
word ‘share’ was ‘proportion’ rather than ‘part’ or ‘portion’ (see TD 2012/22).

where deliberate attempts are made to exploit the provisions of Div 6 by the re-
characterisation of an amount for trust purposes (see Practice Statement PS LA 2010/1).
(3)
As with (2) above, there are two views on assessment where s 95 net trust income ($30,000)
is less than distributed accounting trust income ($40,000). The two views are:
(a)
the beneficiary will only be taxed on his share of s 95 net trust income ($30,000); the excess
($10,000) accrues to corpus, and
(b)
the beneficiary is taxed under s 97 on $30,000 and the beneficiary is taxed under s 99B(2) on
the remaining $10,000 when derived.
Following the Bamford decision, the proportionate approach would apply and Bert Graham
would be taxed on the entire $40,000 as his share of income. Note that where a trustee pays a
‘non-assessable part’ to a beneficiary in respect of an interest or units in a trust, CGT event
E4 happens. The effect of CGT event E4 is that the beneficiary’s cost base is reduced by the
‘non-assessable part’. When the beneficiary’s cost base is reduced to zero, any further
distribution of a ‘non-assessable part’ will result in a capital gain (ITAA97 s 104-70(5)). The
time of this event is at the end of the income tax year or at the time another CGT event
applies to the trust interest (s 104-70(3)). CGT Event E4 cannot produce a capital loss while
any gains on units or interests acquired before 20 September 1985 are disregarded. See
Taxation Determination TD 93/170, TD 93/171 and TD 2003/28.

[¶30-212] Solution 212
Assessment of trust distributions
The assessment of the distributions received by each of the beneficiaries for the 2018/19 tax
year, taking into account the trust streaming arrangements, can be determined through a six-
step process. See also the Explanatory Memorandum to the Tax Laws Amendment (2011
Measures No 5) Bill (2011) (Cth).
Step 1: Determine the ITAA36 Div 6

position without reference to Div 6E
280
The respective shares of trust and taxable income of each beneficiary are:
Present Section 97 proportion/ share of

Beneficiary Div 6 percentage
entitlement income
Alex $100,000 26.3%($100,000/$380,000) $210,526*
Barbara $0 0%($0/$380,000) $0
Callum $40,000 10.5%($40,000/$380,000) $84,210
Daisy $240,000 63.2%($240,000/$380,000) $505,264
Total $380,000 100% $800,000
Note: Figures are not rounded
Step 2: Calculate each beneficiary’s

‘adjusted Div 6 percentage’
No beneficiary is specifically entitled to $200,000 of the discount capital gain and the May
$140,000 franked distribution ($60,000 franking credit attached). However, only the franked
distribution is included in the (trust law) income of the trust.
Excluding amounts to which beneficiaries are specifically entitled, the ‘adjusted income’ of
the trust is $340,000 ($200,000 rental income + $140,000 franked distribution). The adjusted
Div 6 percentage of that ‘adjusted income’ for each beneficiary is therefore:
Beneficiary Present entitlement to ‘adjusted income’ Share of ‘adjusted income’

Alex $100,000 29.4% ($100,000/$340,000)
Barbara $0 0% ($0/$340,000)
Callum $0 0% ($0/$340,000)
Daisy $240,000 70.6% ($240,000/$340,000)
Total $340,000 100%
Step 3: Apply ITAA97 Subdiv 115-C to the

capital gains derived by the trust
Subdivision 115-C allocates capital gains to a beneficiary based on their specific entitlement
plus their adjusted Div 6 percentage above. All columns in the table below relate to the
$400,000 discount capital gain except Barbara’s, which relates to the $200,000 capital gain.
Concept/section Alex Barbara Callum Daisy

Specific entitlement (s 115-227(a)) $200,000 $200,000 N/A $0
Adjusted Div 6 percentage share (s 115-227(b)) $58,800 $0 N/A $141,200
Share of capital gain amount (s 115-227) $258,800 $200,000 N/A $141,200
Total capital gain $400,000 $200,000 N/A $400,000
Fraction of the gain (s 115-225(1)(b)) 64.7% 100% N/A 35.3%
Tax related to the gain (s 115-225(1)(a)) $200,000 $100,000 N/A $200,000
281
Attributable gain (s 115-225(1)) $129,400 $100,000 N/A $70,600
Does beneficiary gross up? (s 115-215(3)) Yes No N/A Yes
Extra capital gain (s 115-215(3)) $258,800 $100,000 N/A $141,200
Barbara is specifically entitled to the whole of the (gross) capital gain of $200,000 because
she received all of the ‘net financial benefit’ (s 115-228; 207-58) relating to the gain after the
trustee applied losses for trust purposes in a way consistent with the application of capital
losses for tax purposes.
Alex, Barbara and Daisy can now use any capital losses or net capital losses to reduce these
extra capital gains. Since the extra capital gain made by Alex and Daisy was made in respect
of a discount capital gain of the trust and they are individuals they can apply the CGT
discount to any remaining amount (s 115-215(4)(a)).
Step 4: Apply ITAA97 Subdiv 207-B to the

franked distributions derived by the trust
Under Subdiv 207-B franked distributions are allocated to a beneficiary based on their
specific entitlement plus the adjusted Div 6 percentage. Each beneficiary is assessed on their
attributable franked distribution and their share of franking credits under s 207-35(4)(b). In
the table below all columns relate to the $140,000 franked distribution except for the Callums
column, which relates to the $40,000 net franked distribution.
Concept/provision Alex Barbara Callum Daisy

Specific entitlement (s 207-55(4)(a)) $0 N/A $140,000 $0
Adjusted Div 6 percentage share (s 207-55(4)(b)) $41,160 N/A $0 $98,840
Share of the franked distribution amount (s 207-55
$41,160 N/A $140,000 $98,840
table)
Fraction of the distribution (s 207-37(1)(b)) 29.4% N/A 100% 70.6%
Tax related to the distribution s 207-37(1)(a)) $140,000 N/A $40,000 $140,000
Franking credit (s 207-35(4)(b)(i)) $17,640 N/A $60,000 $42,360
Attributable franked distribution (s 27-35(4)(b)(ii)) $41,160 N/A $40,000 $98,840
Step 5: Apply Div 6E to re-calculate the

assessable amounts under Div 6
The beneficiaries assessable amounts under s 97 are adjusted by Div 6E based on the
amounts calculated under s 102UY.
•
The Div 6E income of the trust estate is $200,000 because the $180,000 attributable to the
franked distribution is disregarded. The Div 6E net income is also $200,000.
•
Alex’s Div 6E present entitlement is $58,840 (s 102UY(4)) being his present entitlement to
trust income minus his share of the franked distributions ($100,000 − $41,160 = $58,840).
282
Alex’s share of the capital gain of the trust is not part of the trust income and therefore not
part of the calculation.
•
Barbara and Callum have no Div 6E present entitlement as their only entitlement is to capital
gains and franked distributions respectively.
•
Daisy’s Div 6E present entitlement is $141,160 (calculated under s 102UY(4)) as her present
entitlement to trust income is $240,000 less her share of the franked distributions of $98,840
($240,000 − $98,840 = $141,160).
After applying Div 6E the adjusted amounts assessable under Div 6 are:
Div 6E present Section 97 assessable

Beneficiary Share of Div 6E income
entitlement income
29.4%
Alex $58,840 $58,840
($58,840/$200,000)
Barbara $0 0% $0
Callum $0 0% $0
70.6%
Daisy $141,160 $141,160
($141,160/$200,000)
Step 6: Determine the final result after

applying, Div 6, Subdiv 115-C, 207-B and
Div 6E
The table below assumes that beneficiaries have no other net capital gains/losses and are
eligible for the franking credits. The total amount received from trust is $680,000 (trust
income $380,000 plus $300,000 of capital contributions to Alex and Barbara).
Concept/provision Alex Barbara Callum Daisy Total

Adjusted s 97 assessable amount $58,840 $0 $0 $141,160 $200,000
Net capital gain (s 102-5) $129,400 $100,000 $0 $70,600 $300,000
Attributable franked distribution (s 207-
$41,160 $0 $40,000 $98,840 $180,000
37(1)(a))
Franking credit (s 207-35(4)(b)(i)) $17,640 $0 $60,000 $42,360 $120,000
Total assessable income $247,040 $100,000 $100,000 $352,960 $800,000
Amount received from trust $300,000 $100,000 $40,000 $240,000 $680,000
[¶30-213] Solution 213

Net trust income; distribution
283
(1) Taxable net income
Sharp Family Trust
Statement of taxable net income for the year ended 30 June 2019
$ $
Net business income 72,000
Less accounting depreciation shortfall on the Range Rover
3,038
68,962
Loss on rental property 1,200
Loss carried forward from 2018 7,940 9,140
NET TRUST INCOME (s 95) $59,822
*Depreciation rate = 200% (post May 2006)
Notes:
(1) Fully paid-up bonus shares issued after 30 June 1998 from an untainted share capital
account are not a dividend (see para (d) of the s 6(1) definition of ‘dividend’) and for CGT
purposes are taken to have been acquired at the time when the shareholders acquired the
original shares that gave rise to the bonus issue (ITAA97 s 130-20(3)). As the original shares
were acquired before 20 September 1985, there is no CGT on the disposal of the bonus
shares. ITAA97 s 15-15 would also not apply in this case because the taxpayer did not have a
profit-making intention when the original shares were acquired.
(2) There is a further tax deduction relating to the Wantirna property which is not calculable
from the information provided.
As the property is income-producing and the house was constructed in 2013 (the question
states that the house was five years old when acquired in August 2018) the new owner (P
Sharp Holdings Pty Ltd as trustee for the Sharp Family Trust) is entitled to a deduction of
2.5% pa on the original eligible construction cost of the building.
The trustee would need to obtain this information from the original owner of the building.
(3) Trust distribution for s 95 purposes
$ $
Net trust income (s 95) 59,822
Less: Applications of trust funds—
School fees Jill Sharp 7,500
Overseas holiday John Sharp 2,890 10,390
$49,432
284
Distributed and/or credited to loan account
$
Paul Sharp—one-third 16,477.66
Pauline Sharp—one-third 16,477.66
John Sharp—one-sixth 8,238.34
Jill Sharp—one-sixth 8,238.34
(2) Assessment of distribution

Paul Sharp is a beneficiary presently entitled to trust income (s 97), and as such he will
include his share of net trust income ($16,477) in his own tax return and the sum received
will be assessable to him.
Pauline Sharp is also a beneficiary presently entitled to trust income (s 97). Her share of net
trust income ($16,477) will be included in her tax return and assessable to her. The family
maintenance payment is exempt income (ITAA97 s 51).
John Sharp is a ITAA36 s 98 beneficiary and a ‘prescribed person’. The income distributed
($8,238) and the income deemed distributed ($2,890 for an overseas holiday) are assessable
to the trustee under s 98. As John is a prescribed person and the income is from an inter vivos
trust the trustee will be assessed at the Div 6AA rates (s 102AD; 102AG).
The income from a part-time holiday job would be assessed in John’s hands as ‘excepted
assessable income’ (s 102AE(2)(a)) and taxed at ordinary rates.
As John has employment income in addition to trust income, John must lodge a tax return (s
100). The income from both sources is aggregated and tax calculated, but John is entitled to a
credit for the tax already paid by the trustee (s 100(2)), which prevents any double taxation.
Minors are subject to Div 6AA tax rates and no low income earner rebate or low and middle
income tax offset is applicable as it is unearned income.
Jill Sharp is a s 98 beneficiary and also a ‘prescribed person’. Both the income distributed
($8,236) and income deemed distributed ($7,500 for school fees) are assessable to the trustee
(s 102AD; 102AG).
As Jill is a beneficiary of two trusts, she must also lodge a tax return (s 100) and obtain a
credit for the tax paid by the trustees on the trust income received by her under s 100(2).
Again as she is a minor the income is subject to Div 6AA tax rates and no low income earner
rebate or low and middle income tax offset is applicable as it unearned income.
[¶30-214] Solution 214

Deceased estate; net trust income;
distribution
285
(1) Net income of trust estate
Estate of the late Philip Law
Calculation of net income for the year ended 30 June 2019
$ $
Income:
Interest on debentures 13,000
Rent 55,000
Dividend ($2,000 + $2,000 × 1/70/30) 2,857 70,857
Write-off of extension to office building* 160
Rates and taxes 4,800
Wages 10,000
Minor repairs 1,200
Legal expenses 160 16,320
* Extension of office building completed on 2 January 2019 (2.5% of $13,000 for 180/365
days).
(2) Assessment of trust income

Wife:
Receives $27,268.50 of trust income and is assessed on this sum under ITAA36 s 97. The
$27,268 will be included with any other income she has received, and she will pay tax at
ordinary marginal rates.
Son (aged 17):
The son receives $13,634.25 of the net trust income. As the son is under 18 years of age and
not an ‘excepted person’ as at 30 June, he will be a ‘prescribed person’ and Div 6AA must be
considered in assessing his tax liability (s 102AC). As the trust arises from a deceased estate,
rather than an inter vivos arrangement, income distributed from the deceased estate to the son
as a beneficiary who is presently entitled to trust income is ‘excepted trust income’ and not
taxable at the rate of tax applicable to Div 6AA income (s 102AG(2)). The trustee will
therefore be assessed under s 98, with tax payable at the ordinary marginal tax rates, less the
low income earner rebate under s 159N and the low and middle income tax offset.
Daughter (aged 20):
The daughter is contingently entitled to $13,634.25 of trust income. As she is a beneficiary

not presently entitled to trust income, and the trust arises from a deceased estate, it is likely
the Commissioner of Taxation will assess the trustee under s 99 rather than s 99A, unless the
Commissioner believes the trust is part of a tax avoidance scheme.
286
The situation of the contingent beneficiary (the daughter) in this question should be
contrasted with the facts in Taylor v FC of T 70 ATC 4026. In Taylor’s case, the infant
beneficiary (a son) was the principal beneficiary of the settlement. Income arising from the
fund from the date of its settlement until the date the infant attained the age of 21 years could
only be used for the absolute benefit of the infant, either by payment to the parent for the
son’s maintenance, education and support or by being accumulated and invested for the
absolute benefit of the infant on attaining 21 or, on death before 21, to his personal
representative absolutely.
In Taylor’s case the specific terms of the trust meant that the infant beneficiary was
absolutely and indefeasibly entitled to the trust income. As such, the infant beneficiary was
presently entitled to the trust income, although under a legal disability. Consequently, the
trustee was assessed on the infant beneficiary’s trust income under s 98 and not s 99A.
Likewise, beneficiaries may be presently entitled even if, under the terms of the trust, the
entitlement is only to have money applied for their benefit and not paid directly to them (see
Sacks v Gridiger 90 ATC 4299).
Each beneficiary, or the trustee on behalf of a beneficiary, would be entitled to a dividend

imputation credit for his or her share of the fully franked dividend. It is also noted that the
beneficiaries are ‘specifically entitled’ to the franked distribution, that is, they will receive an
amount equal to the ‘net financial benefit’† referable to the franked distribution in the trust
(see Subdiv 207-B).
A ‘net financial benefit’ is defined as anything of economic value (including property and
services) (s 974-160).
[¶30-215] Solution 215

Inter vivos trust and deceased estate
Dear Claude and Jean,
I have reviewed the information you have provided in respect of the trusts for which you are
joint trustees and advise as follows. Your obligations as trustees under the Income Tax
Assessment Act 1936 (Cth) are outlined in s 254. In brief, this section requires you to:
•
prepare and lodge the tax returns outlined below with each return being separate and distinct
from the others
•
retain adequate money to pay any tax due on the income earned by the trust which you can
later recover through the trust, and
•
in your representative capacity, be assessed and pay any tax due on the returns.
On the basis of the information supplied, you will have to lodge a Form T trust return for
Napier’s 2017 settlement and a separate Form T trust return for his estate. In addition, you
287
will need to lodge a Form I return for income earned by Napier for the financial year up until
his death. The net income from each return is as follows:
Individual return (Form I) $

Fees received before death 40,000
Less: Allowable deductions for expenses paid before death 14,000
NET INCOME $26,000
Settlement return (Form T) $
Gross income 18,000
Less: Expenses Nil
NET INCOME $18,000
Estate return (Form T)
Fees received after death 20,000
Dividends:
Fully franked 15,000
Franking credit ($15,000 × 1/70/30) 6,428
Unfranked 5,000
NET INCOME $46,428
The assessment for tax in respect of each of these returns is as follows.
Income prior to death

As trustees you will be liable to pay the tax on the net income of $26,000 earned by Napier
prior to his death. The rate of tax payable in respect of his income will be at the ordinary
marginal tax rates applicable to Napier if he had still been alive.
Settlement on 30 June 2017

The Form T lodged in respect of this trust will need to identify the beneficiaries and the
amount of trust income allocated to each beneficiary or accumulated as trust income.
This settlement established an inter vivos trust. The terms of the trust deed enable you to
accumulate trust income at your discretion, but if you decide to distribute trust income it must
be applied equally between Joseph Napier, aged 24 years, and Sancia Napier, aged 22, at 30
June 2018.
Pursuant to s 101, the $10,000 paid to Vani for the education and maintenance of Joseph and
Sancia is deemed to be income to which Joseph and Sancia are presently entitled. In the case
of Joseph, the $5,000 applied for his benefit, plus the $3,000 paid directly to him, is
assessable income in his hands (s 97). The $8,000 must be included in a tax return lodged by
Joseph and he will be taxed on this sum plus any other net income he may have earned from
other sources during the year. You will need to advise him of the income and his liability to
pay tax on it.
288
Sancia is also deemed to be presently entitled to the income applied for her benefit and it is
assessable income in her hands (s 97) as she is also over 18 years. The $5,000 must be
included in a tax return lodged by Sancia and she will be taxed on this sum plus any other net
income she may have earned from other sources during the year.
Because Sancia has a vested and indefeasible interest in her share of trust income, the $3,000
accumulated in the trust for her benefit until age 21 will now be assessable to her under s 97
as she is now aged 22 years.
The undistributed income, $2,000, will be assessed to you as the trustees under s 99 as it is a
deceased estate.
Income received after Napier’s death

The $20,000 received from Napier’s surveying practice after his death is assessed to you as
the trustees under s 101A. The income is deemed to be income to which no beneficiary is
presently entitled. As such this sum will be included in assessments issued to you as the
trustees under s 99A or 99. The latter is the usual section for deceased estates where the
Commissioner of Taxation has exercised his discretion.
Section 101A does not apply to the dividend income but this income, $26,428 ($20,000 plus
$6,428 imputation credit), will be assessed to the trustees under s 99 as the undistributed sum
of a deceased estate in the period of administration. As trustees you are entitled to receive an
imputation credit of $6,428. It is also noted that the trustees are ‘specifically entitled’ to the
franked distribution, that is, they will receive an amount equal to the ‘net financial benefit’
referable to the franked distribution in the trust (see Subdiv 207-B).
The proceeds from goodwill and disposal of other assets constitute tax free capital accruing to
the corpus of the trust estate. Napier had commenced his business in 1970 before the
introduction of CGT, and the other assets realised their adjusted value.
289
Companies and Distributions
Note: Recent legislative amendment—base rate entities—27.5% tax rate
The Treasury Laws Amendment (Enterprise Tax Plan) Act 2017 amended the Income Tax
Rates Act 1986 s 23(2)(a) to reduce to 27.5% the rate applicable to base rate entities from the
year starting 1 July 2016. Previously, companies with an annual aggregated turnover of less
than $2 million in FY 2015/16 and $10 million in FY 2016/17 were classified as small
business entities and were subject to a 28.5% rate.
Base rate entities are companies that meet both the following requirements:
(a)
Have an aggregated turnover that is less than the aggregated turnover threshold for the year
($50 million for the FY 2018/19) (Income Tax Rates Act 1986 s 23AA), and
(b)
No more than 80% of their assessable income corresponds to base rate entity passive income
(this replaces the “carrying on a business” requirement that initially applied).
The concept of base rate entity effectively replaces that of small business entity from 1 July
2017 onwards.
This amendment affects the calculation of franking credits by changing the applicable gross-
up rate stated in the maximum franking credits formula (Income Tax Assessment Act 1997 s
202-60). The applicable gross-up rate refers to the corporate tax gross-up rate of the entity
making the distribution for the income year in which the distribution is made. Now, when a
base rate entity pays a franked distribution, the franking credits must be calculated based on
the 27.5% rate. In these cases, the maximum franking credit formula (Income Tax Assessment
Act 1997 ss 202-60(2) and 995-1) will be:
Corporate entities not qualified as base rate entities remain subject to the 30% general
corporate rate. For these companies, the maximum franking credit formula (Income Tax
Assessment Act 1997 ss 202-60(2) and 995-1) remains as:
290
[¶30-216] Solution 216
Distribution income
Maria Fernandez will become a resident of Australia for tax purposes from 1 January 2019.
For the period during which she was a non-resident in the tax year 2018/2019, she is assessed
on Australian-source income only. However, the fully franked distribution from BHP
received on 1 October 2018 is not subject to withholding tax (ITAA36 s 128B(3)(ga)), and
under 128D, as a non-resident, Maria’s assessable income does not include that income.
Therefore, Maria’s assessable income for the 2018/19 tax year is calculated as follows:
$
Partly franked distribution from ANZ 4,000
Grossed up for franked portion: s 207-20(1) (ie $4,000 x 60%=$2,400 × 30 ÷ 70) 1,029
Unfranked distribution from Fosters 3,200
Fully franked distribution from Westpac 4,500
Grossed up for franking: s 207-20(1) (ie $4,500 × 30 ÷ 70) 1,929
ASSESSABLE INCOME $14,658
Note: See note about base rate entities at the start of this section.
[¶30-217] Solution 217

Maximum franking percentage
Assuming that Gamma Pty Ltd is not a base rate entity, the maximum franking credit that it
can attach to its distribution is calculated according to the formula set out in ITAA97 s 202-
60(2) as follows:
Hence, the maximum franking credit available for Gamma’s shareholders on the $100,000
frankable distribution is $42,857 (ie $100,000 × (30% ÷ 70%)).
* See note about base rate entities at the start of this section.
[¶30-218] Solution 218
291
Off-market share buy-backs; frankable
distribution component
For an off-market share buy-back, the difference between the purchase price and that part of
the purchase price that is debited against amounts standing to the credit of the company’s
share capital account is treated as a dividend paid to the shareholder out of the company
profits on the day of the buy-back (ITAA36 s 159GZZZP). So Frank Smith will be treated as
receiving an assessable dividend of $12 (ie $21 − $9 = $12) from Boom Pty Ltd for the
2018/19 tax year.
A remaining issue is what component of Frank Smith’s assessable dividend of $12 is

frankable? According to ITAA97 s 202-45, where a share buy-back is taken to be a dividend
under s 159GZZZP, the excess (if any) of the purchase price over the market value is treated
as unfrankable. Accordingly, only $11 of the dividend component paid to Frank Smith is
frankable, as the remaining $1 represents the amount by which the buy-back consideration
exceeded the market value of the share (ie $21 − $20 = $1).
[¶30-219] Solution 219

Off-market share buy-backs
The taxation consequences of an off-market share buy-back are dealt with in ITAA36 Div
16K Subdiv C (s 159GZZZP to 159GZZZQ). Taking this legislation into account, the tax
position of Mathew Winters for the 2018/19 tax year, if he accepts Knight Ltd’s off-market
share buy-back offer, is summarised as follows:
•
$12 of the buy-back amount will be a dividend (s 159GZZZP) and it may be franked by
Knight Ltd
•
the balance of the buy-back amount of $12 will, subject to s 159GZZZQ(2), be taken into
account in determining whether Mr Winters has derived a capital gain or incurred a capital
loss on the transaction (s 159GZZZQ(1) and 159GZZZQ(3))
•
so, Mr Winters will have incurred a capital loss of $8 per share (ie $20 original purchase
price — the $12 balance of buy-back amount) or a $4,000 capital loss in total (ie 500 shares ×
$8 per share)
•
however, given the fact that the market value of the shares under s 159GZZZQ(2) will be
taken by the Commissioner to be $26.50, the deemed consideration for the buy-back will be
increased by $2.50 to $26.50, and
•
thus, Mr Winters’ available capital loss will be reduced by $2.50 from $8 per share to $5.50
per share (ie $20 − $14.50) or a $2,750 capital loss in total (ie 500 shares × $5.50 per share).
292
[¶30-220] Solution 220
Calculating the benchmark franking
percentage
Assuming that Waterworks is not a base rate entity for the 2018/19 year, the maximum
franking credit that it can attach to its distribution is computed according to the formula set
out in ITAA97 s 202-60(2), as follows:
Hence, the maximum franking credit available for Waterworks’ shareholders on the $160,000
frankable distribution is $68,571 (ie $160,000 × (30% ÷ 70%)).
Moreover, the franking percentage for a frankable distribution is calculated using the formula
in s 203-35(1) as follows:
Thus, Waterworks’ franking percentage under s 203-35 for the 2018/19 franking period is
87.50% (ie $60,000 ÷ $68,571 × 100). If the company makes anymore frankable distributions
during the 2018/19 franking period, they should also be franked to 87.50%, or else penalties
could arise.
* See note about base rate entities at the start of this section.
[¶30-221] Solution 221

Distributions; overseas shareholders
(1) Assessability of distributions for the 2018/19 tax year
As a non-resident of Australia, Miranda is, subject to ITAA36 s 128D, only assessed on

distributions paid out of Australian-source profits (s 44(1)(b)). However, since the
introduction of the distribution imputation system, the tax treatment of distributions received
by non-residents from Australian sources depends more on the franking provisions than on s
44(1)(b).
Unfranked distributions are subject to withholding tax and then excluded from assessable
income by the operation of s 128D. Franked distributions are not subject to withholding tax (s
128B(3)(ga)) and are excluded from assessable income as if they had been subject to
withholding tax (s 128D).
293
Miranda would not be assessed on any of the distributions she received as a non-resident.
(2) Alternative scenario: Miranda Johnston becomes a resident
If Miranda moved to Australia on 1 January 2019, she would become an Australian resident
from that date. Distributions received from Australian sources while she was a non-resident
would not be assessable (see (1) above).
Miranda’s assessable distributions are computed as follows:
$
Distribution from Kalgoorlie Gold Ltd 1,600
Distribution from CSR Ltd, grossed up for franking credit, ie $1,200 + ($1,200 × 30
1,714
÷ 70)
ASSESSABLE DISTRIBUTIONS $3,314
[¶30-222] Solution 222

Distribution income
Assuming that none of the entities below were base rate entities in the 2018/19 year, Harry
Holmes’s assessable distribution income for the 2018/19 tax year would be calculated as
follows:
$
Rio Ltd $3,400 + $600 withholding tax 4,000
AB Life Assurance Ltd franked $2,400 + ($2,400 × 30 ÷ 70 × 75%) 3,171
Gold Ltd 1,600
ASSESSABLE DISTRIBUTION INCOME $8,771
Note: See note about base rate entities at the start of this section.
[¶30-223] Solution 223

Classes of income
Assuming that all distributions were received from non-base rate entities, Irene Wong’s net
tax payable for the 2018/19 tax year would be calculated as follows:
Income: $ $
Salary 75,000
Net rental income 7,000
Distribution ($2,500 + franking gross-up $1,071 (ie $2,500 × 30 ÷ 70)) 3,571
294
Gross tax payable on taxable income (2018/19 rates) 19,357.57
Plus: Medicare levy (2% × $85,571) 1,711.42
21,068.99
Less: Imputation credit (1,071.00)
Less: PAYG withholding credit (17,300.00)
[¶30-224] Solution 224

Calculating franking credits and franking
debits
The rules governing franking accounts are contained in ITAA97 Div 205. Consequently, the
transactions for Giggles Pty Ltd would result in the following treatment for franking account
purposes for the 2018/19 tax year (considering that Giggles Pty Ltd is not a base-rate entity in
2018/19). (See note about base rate entities at the start of this section.)
Transaction Treatment of transaction in franking account

This represents a franking credit of $30,000 in
PAYG instalment of $30,000
the franking account (s 205-15, table item 1)
This represents a franking credit of $45,000 in
Income tax payment of $45,000
the franking account (s 205-15, table item 2)
FBT payment of $34,500 Not applicable
GST payment of $22,500 Not applicable
This represents a franking credit of $1,800
Distribution of $21,000; franking
percentage of 20% (ie $21,000 × 30 ÷ 70 × 20%) in the franking
account (s 205-15, table item 3)
This represents a franking credit of $3,375
Distribution of $10,500; franking
percentage of 75% (ie $10,500 × 30 ÷ 70 × 75%) in the franking
This represents a franking credit of $900
Distribution of $7,500; distribution of
$5,250 has a franking percentage of 40% (ie $5,250 × 30 ÷ 70 × 40%) in the franking
This represents a franking debit of $9,000
Distribution of $21,000 paid to shareholders
(ie $21,000 × 30 ÷ 70) in the franking account (s
205-30, table item 1)
[¶30-225] Solution 225
295
Treatment of excess franking offsets for
company taxpayers
Because Excess Pty Ltd’s trading income is $50,000, it qualifies as a base rate entity for the
purposes of the reduced corporate tax rate of 27.5% (see Income Tax Rates Act 1986 ss 23AA
and 23(2)(a)). Note: See note about base rate entities at the start of this section.
As franking tax offsets are usually non-refundable to company taxpayers, these excess
franking offsets might otherwise be lost. However, special rules (effective from 1 July 2002)
treat a company’s excess franking offsets as a tax loss for the relevant tax year (ITAA97 s 36-
55). For Excess Pty Ltd, this means that the $3,250 of excess franking offsets received in the
2018/19 tax year can be converted to a tax loss and be potentially used in future tax years by
the company.
The procedure for converting excess franking offsets of a company to a deemed tax loss is
detailed in the method statement in s 36-55(2) as follows:
(1)
calculate the amount (if any) that would have been the company’s tax loss for that year,
ignoring any net exempt income of the company
(2)
divide the company’s excess franking offsets for the tax year by the corporate tax rate
(3)
add the results of steps (1) and (2), and
(4)
subtract the company’s net exempt income for the year.
If the result is positive, the company has a tax loss for the year of that amount. If not, it has
no tax loss for the year.
Applying the method statement to Excess Pty Ltd’s excess franking offsets of $3,250 for the
2018/19 tax year results in the following answer:
•
the result in Step 1 is nil
•
the result in Step 2 is $11,818 (ie $3,250 ÷ 27.5%)
•
the result in Step 3 is also $11,818 (ie $0 + $11,818), and
•
the result in Step 4 is $11,318 (ie $11,318 − $500).
Thus, Excess Pty Ltd is deemed to have a tax loss of $11,318 for the 2018/19 tax year. The
company could utilise this tax loss in future tax years under the tax loss carry-forward rules in
Div 36, subject to the continuity of ownership test (s 165-12) or by satisfying the same
business test (s 165-13, under the new Business Continuity Test of s 165-210 ITAA97—see
note below).
296
Note: The Treasury Laws Amendment (2017 Enterprise Incentives No. 1) Act No. 7, 2019
(Royal Assent 01 March 2019) modified the corporate losses rules by introducing a new
Business Continuity Test. The amendment effectively supplements the Same Business Test
with a Similar Business Test (s 165-210 and 165-211 ITAA97) for the purposes of working
out whether a company’s tax losses and net capital losses from previous income years can be
used as a tax deduction in a current income year.
The Similar Business Test (s 165-211 ITAA97) applies for tax years starting on or after 1 July
2015 and is intended to be more flexible and more achievable, requiring that a company’s
current business is similar to (but not identical to, as it was under the Same Business Test) its
former business. It must be noted, however, that the focus remains on the identity of the
business as well as on the continuity of business activities and use of assets. For example, the
Similar Business Test is likely to be satisfied if a company develops a new product within the
same business activity (e.g. a textile manufacturer who produced shirts now produces jeans).
If substantial new transactions are entered into, or if a new type of business is being carried
on, then the Similar Business Test is not satisfied.
[¶30-226] Solution 226

Continuity of ownership; same business
tests
(1) Continuity of ownership test
To satisfy this test, shares carrying more than 50% of all voting, dividend and capital rights
are to be beneficially owned at all times during the ‘ownership test period’ by one or more
persons who individually or together held shares carrying similar rights at all times during the
loss year. The ‘ownership test period’ is the period from the start of the loss year to the end of
the income year in which the loss is claimed (ITAA97 s 165-12).
An examination of the changes in shareholdings from 2017 to 2019 indicates that the
continuity of ownership test is satisfied for the loss incurred in 2018, but is not satisfied in
respect of the loss incurred in 2016. Therefore, Special Pty Ltd can, under this test, claim a
deduction for the 2017 loss of $22,000 as an offset to its $35,000 taxable income in 2018, but
is not entitled to claim for the 2016 loss.
(2) Business Continuity Test

Where a company fails to satisfy the continuity of ownership test, a prior year loss is
deductible if the company carries on, at all times during the year of recoupment, the same
business, or a business similar to the business it carried on immediately before the change in
beneficial ownership of shares which disqualified it from satisfying the business continuity
test (s 165-13; 165-210). See note at Solution 225 above concerning the March 2019
amendments affecting business continuity tests. To the ATO, ‘same business’ means,
ordinarily, the identical business (Taxation Ruling TR 1999/9). Where the company fails the
297
same business test, it may still be able to deduct a prior year loss if it passes the Similar
Business Test of s 165-211.
In this case, however, as Special Pty Ltd changed its business from travel agency to hotel-
motel owner in July 2018, the losses incurred in 2016/2017 cannot be deducted against later
earnings in the reconfigured business, which fails the similar business test.
Conclusion
Only the 2018 tax losses can be carried forward and offset against 2019 income. Special Pty
Ltd would be taxed on a taxable income of $13,000 (ie $35,000 taxable income—$22,000 tax
loss) for the tax year ended 30 June 2019.

[¶30-227] Solution 227
Breach of benchmark franking rule
The first distribution of $200,000 (franked to 60%) establishes Antiques Ltd’s benchmark
franking percentage of 60% for the 2018/19 franking period (ITAA97 s 203-35). The
company should have franked all subsequent distributions to shareholders during the 2018/19
franking period to 60% to avoid any penalties being applied (s 203-50).
However, Antiques Ltd did not do this and franked the $240,000 distribution to 50% (ie
under-franked the distribution by 10%) and franked the $280,000 distribution to 80% (ie
over-franked the distribution by 20%). This conduct will give rise to penalties being applied
to the company according to s 203-50. These penalties are calculated by reference to the
difference between the franking credits actually allocated and the benchmark percentage. The
penalties are summarised as follows (s 203-50(1)):
•
over-franking tax, if the franking percentage for the distribution exceeds the benchmark
franking percentage, or
•
a franking debit (ie penalty debit), if the franking percentage for the distribution is less than
the benchmark franking percentage.
The amount of the over-franking tax or franking debit is computed using the following
formula (s 203-50(2)):
Thus, Antique Ltd’s $240,000 distribution, which is franked to only 50%, will result in a
franking debit being entered in the company’s franking account during the 2018/19 franking
298
period as a direct result of under-franking the $240,000 distribution. As Antiques Ltd is not a
base rate entity, it is subject to the 30% corporate rate. Therefore, the amount of the debit will
be $10,286 (ie 10% × $240,000 × 30 ÷ 70: s 203-50(2)).
Moreover, for Antique Ltd’s $280,000 distribution, which is franked to 80%, this will result
in over-franking tax being incurred by the company during the 2018/19 franking period as a
direct outcome of over-franking the $280,000 distribution. The amount of the over-franking
tax in this case will be $24,000 (ie 20% × $280,000 × 30 ÷ 70: s 203-50(2)).
[¶30-228] Solution 228

Carry-forward losses
(1)
For a company to claim a deduction for past years’ losses, it must satisfy either the continuity
of ownership test (ITAA97 s 165-12) or the business continuity test (s 165-13; 165-210; 165-
211; also see note to Solution 225, above concerning the March 2019 amendments affecting
business continuity tests).
The continuity of ownership test requires shares carrying more than 50% of all voting,
dividend and capital distribution rights to be beneficially owned by persons at all times
during the ‘ownership test period’. The ‘ownership test period’ is the period from the start of
the loss year to the end of the income year in which the loss is claimed (s 165-12(1)).
In the year of recoupment of the tax losses, Bill Plunkett and Tom Katt held 1 million shares
out of a total allotment of 1.75 million shares or beneficially owned 57% of the voting,
dividend and capital distribution rights. They beneficially owned 100% of the shares at the
start of each of the loss years. The continuity of ownership test is satisfied.
Because the continuity of ownership test was also satisfied in the 2017 and 2018 tax years,
the loss carried forward from 2015 would, in part, have been applied against the income from
2017 and 2018 to reduce the 2015 loss to $70,000. The losses carried forward to 2019 total
$145,000 (ie $70,000 + $75,000). These losses are available to reduce Twinkle’s 2019
taxable income to $55,000 (ie $200,000 − $145,000).
(2)
The continuity of ownership test would still be satisfied in this case. Section 165-205
provides that, if the beneficial owner dies, for s 165-12 purposes Plunkett’s beneficial
ownership is deemed to continue provided the shares are held by the trustee of Plunkett’s
estate, or are beneficially owned by a beneficiary of the estate.
(3)
Upon death, the assets of the deceased are held in trust by the trustee appointed under the
provisions of the deceased’s will. The deceased’s wife would acquire the shares as a
beneficiary of his estate and s 165-205 would apply so the beneficial ownership of shares is
deemed to continue.
(4)
299
The continuity of ownership test would be satisfied here. Plunkett and Katt would hold 100%
of the shares carrying all voting rights and 57% of all dividend and capital rights at all times
during the ‘ownership test period’. The answer would be the same as in (1) above.
(5)
There would be no effect provided the continuity of ownership test was satisfied. Twinkle
would no longer be carrying on the same business (s 165-210), however this test is only used
where a company fails to satisfy the continuity of ownership test.
(6)
As part of the introduction of the consolidation regime, the group loss transfer rules in Subdiv
170-A no longer apply, except in certain cases relating to foreign bank branches. Therefore,
Twinkle’s losses cannot be transferred to Star for tax purposes during the 2018/19 tax year.
[¶30-229] Solution 229

Consolidation
This answer assumes that neither company is a base rate entity. See note regarding base rate
entities at the start of this section.
Normally, the joined group’s allocable cost amount (ACA) for the joining entity indicates the
group’s cost of acquiring the membership interests in that entity. In particular, it is calculated
based on the multi-step formula summarised in ITAA97 s 705-60.
The major elements of the relevant steps of s 705-60 as applying to J Co for consolidation
purposes for the 2018/19 tax year are summarised as follows:
$
Step 1: Cost of the membership interests in the joining entity (ITAA97 s 705-
65).
For J Co, assuming: the market value is greater than or equal to the cost base,
and ignoring indexation:
• 80% interest, and 8,000,000
• 20% interest 20,000,000
Step 2: Add the value of the joining entity’s liabilities at the joining time
(ITAA97 s 705-70).
For J Co:
• Trade creditors, and 15,000,000
Tax effect of provision for annual leave (ie $15,000,000 − (30% ×
• 10,500,000
$15,000,000)).
Step 3: Add undistributed frankable profits accruing to the joined group before
Nil
the joining time (ITAA97 s 705-90).
• Amount under this step for J Co = nil.
Note: this is not the same as retained earnings (ie J Co has been in a loss
situation and has paid no company tax, therefore, undistributed ‘frankable’
profits = nil).
Step 4: Subtract distributions of certain profits made to the head company Nil
(either directly or indirectly through interposed entities) that did not accrue to
300
the joined group before the joining time (ITAA97 s 705-95).
• Amount under this step for J Co = nil.
Step 5: Subtract an amount for losses accruing to the joined group before the
joining time (ITAA97 s 705-100).
For J Co:
• 80% × $10,000,000 = $8,000,000. (8,000,000)
Step 6: Subtract an amount for losses transferred to the head company (ITAA97
s 705-110).
For J Co:
• No losses post-joining time. Nil
Step 7: Subtract an amount for certain deductions to which the head company is
entitled (ITAA97 s 705-115).
• Amount under this step for J Co = nil. Nil
Step 8: If the amount remaining is positive, it is the ACA. Otherwise the ACA
$45,500,000
is nil (ITAA97 s 705-60).
After applying the multi-step formula in s 705-60, the ACA with respect to J Co for
consolidation purposes for the 2018/19 tax year is $45,500,000.
[¶30-230] Solution 230

Distributions; franking credits; rebates
Considering the operating income of $1,600,000, it is possible to say that Courier Pty Ltd is a
base rate entity and the applicable rate will be 27.5% (Income Tax Rates Act 1986 ss 23AA
and 23(2)(a))—see note about base rate entities at the start of this section).
The taxable income and tax payable for Courier Pty Ltd in terms of the 2018/19 tax year is
computed as follows:
Courier Pty Ltd

$ $
Statement of taxable income for the tax year ended 30 June 2019
Operating income 1,600,000
Franked distributions from public companies(not base rate entities) 150,000
Franking credit (gross-up) for public companies ($150,000 x 30/70) 64,286
Unfranked distributions from public companies 100,000 1,914,286
Operating expenses 900,000
Interest on borrowings to acquire shares 100,000 (1,000,000)
Gross tax payable: $914,286 @ 27.5% 251,429
Less: Tax offset for franking credit (ITAA97 s 207-20(2)) (64,286)
NET TAX PAYABLE $187,143
301
Assumptions and explanations
(1) Whether the distribution is franked or unfranked, the cash distribution is included in the
assessable income of Courier Pty Ltd. The franked distribution is also grossed up for the
franking credit (ITAA97 s 207-20(1)) and Courier Pty Ltd is entitled to a tax offset (s 207-
20(2)) for the franking credit. Notwithstanding the 27.5% base rate entity tax rate, the
franking credit attached to the franked distributions from public companies which are not
base rate entities is calculated based on the 30% rate. This is because the formula on the
ITAA97 s 202-60(2) refers to the “applicable gross-up rate”, which means the corporate tax
gross-up rate of the entity making the distribution for the income year in which the
distribution is made. Therefore, the franking credit in this solution ($600,000) is calculated by
multiplying the amount of frankable distribution of $1,400,000 x 30/70, not x 27.5/72.5. The
amount of the franking credit of $600,000 then generated a Franking Credit Tax Offset
(ITAA97 s 207-20). Also see the note about base rate entities at the start of this section.
(2) Courier is not entitled to a tax offset under s 207-20(2) on the unfranked distributions
received from resident companies.
[¶30-231] Solution 231

Franking account; maximum franking
credit; franking deficit tax
Immediately prior to the proposed payment of the dividend on 30 June 2019, Frankers Pty
Ltd franking account for the 2018/19 tax year would be represented as follows (ie only
franking credits to this point in time):
Frankers Pty Ltd Debit Credit Balance
Franking Account for the tax year ended 30 June 2018 $ $ $

1.7.18 Opening balance - - Nil
21.7.18 PAYG instalment - 25,500 25,500
21.10.18 PAYG instalment - 22,170 47,670
21.1.19 PAYG instalment - 22,170 69,840
21.4.19 PAYG instalment - 22,170 92,010
1.6.19 Dividend received - 60,990 153,000
Notes
(1)
Given that Frankers is a base rate entity (see Income Tax Rates Act 1986 ss 23AA and 23(2)
(a)—see note about base rate entities at the start of this section), its corporate tax rate would
be 27.5%. Therefore, applying ITAA97 s 202-60(2), the maximum franking credit equals the
amount of the frankable distribution × 27.5/72.5 ie $350,000 × 27.5/72.5 = $132,759. This
represents the maximum amount of income tax that could have been paid on profits
underlying the distribution. On payment of the dividend a franking account debit of $132,759
302
will be recorded (ITAA97, s 205-30) reducing the franking account balance to $ 20,241
credit. Because this entry will be made on 30 June 2019, at the end of the period it is assumed
to be the first and last distribution for the period.
(2)
If the distribution on 30 June 2019 had a franking credit of $100,000 this would result in a
franking debit of $100,000 to the franking account reducing the balance to $53,000 credit
which can be carried forward to the 2019/20 tax year. The company has under-franked the
dividend in this instance in the first and only distribution.
(3)
If the amount of the franking credit stated in a distribution statement exceeds the maximum
franking credit, it is taken to be the amount of the maximum franking credit (ITAA97 s 202-
65). Therefore, the dividend will be deemed to be franked to $132,759.
[¶30-232] Solution 232

Franking account
Given that Weed Pty Ltd is not a base rate entity (see note about base rate entities at the start
of this section), its franking account for the 2018/19 tax year is calculated as follows:
Weed Pty Ltd Debit Credit Balance

1.7.18 Opening balance — — 10,000
Refund of income tax for the 2016/17 tax year of $2,200 =
1.8.18 2,200 — 7,800
debit of $2,2001
Distribution from Grass Ltd of $1,200 with a franking
10.9.18 percentage of 100%: $1,200 × 30 ÷ 70 × 100% = credit of — 514 8,314
$5142
Annual tax instalment for the 2017/2018 tax year of $5,000
21.10.18 — 5,000 13,314
= credit of $5,0003
Distribution from Clover Ltd of $1,400 with a franking
15.11.18 percentage of 50%:$1,400 × 30 ÷ 70 × 50% = credit of — 300 13,614
$3002
Company paid a franked distribution to its shareholders of
1.5.19 $12,000 with a franking percentage of 100%: $12,000 × 30 5,143 — 8,471
÷ 70 × 100% = debit of $5,1434
Distribution from the Victa Trust of $1,800 with a franking
15.6.19 percentage of 90%: $1,800 × 30 ÷ 70 × 90% = credit of — 694 9,165
$6945
30.6.19 Closing balance6 — — 9,165
Notes
(1) A franking debit arises if a company receives a refund of income tax. The amount of the
franking debit is reduced on an attribution basis if a company is not a franking entity for the
303
whole of the relevant income year (ITAA97 s 205-30, item 2 in the table). It is assumed here
that Weed Pty Ltd was a franking entity during the 2018/19 tax year.
(2) A franking credit arises if a company receives a franked distribution from another resident
company. The amount of the franking credit is based on the franking credit on the distribution
(s 205-15, item 3 in the table).
(3) A franking credit arises if a company pays income tax. The amount of the franking credit
is based on the amount of tax paid by the company (s 205-15, item 2 in the table).
(4) A franking debit arises if a company franks a distribution. The amount of the franking
debit is the amount of the franking credit on the distribution (s 205-30, item 2 in the table).
(5) A franking credit arises if a company receives a franked distribution indirectly from a
partnership or a trust. The amount of the franking credit is based on the company’s share of
the franking credit on the distribution (s 205-15, item 4 in the table).
(6) The closing balance of the franking account as at 30 June 2019 (ie $9,165) is carried
forward and represents the opening franking account balance on 1 July 2019 for the 2019/20
franking period.
[¶30-233] Solution 233

Dividend imputation; effect on
shareholders
The tax treatment of the receipt by shareholders of a fully franked distribution from Peak Ltd
(which is not a base rate entity for the year 2018/19—see note about base rate entities at the
start of this section) for the tax year ended 30 June 2019 is summarised as follows:
Trough Superannuation Fund

The distribution received by Trough Superannuation Fund is grossed up for the franking
credit:
The Fund will be assessed on this amount at the tax rate of 15%. However, the Trough
Superannuation Fund is entitled to a franking credit of $2,571 (ie $6,000 × 30 ÷ 70) for the
distribution received, and this credit can be offset against its tax liability in the same tax year.
Any excess credit is refundable.
Stable Ltd
304
Given that Stable Ltd is an Australian resident public company which is not a base rate entity,
the cash distribution of $9,000 is fully assessable and the distribution must be grossed up for
the franking credit and included in assessable income. The amount of the franking credit is
$3,857 (ie $9,000 × 30 ÷ 70). The total amount to be included in Stable Ltd’s assessable
income is $12,857 (ie $9,000 + $3,857). Stable Ltd will also be entitled to a tax offset of
$3,857 for the franking credit, which effectively means that it pays no tax on the fully franked
distribution.
The receipt of a 100% franked distribution also gives rise to a credit entry in the franking
account of Stable Ltd, from which the company can pay a franked distribution to its
shareholders. The amount of the credit entry in Stable Ltd’s franking account would be
$3,857.
WC Kwan
Miss Kwan is a non-resident of Australia. Because the distribution of $3,000 paid by Peak
Ltd was fully franked, there will be no withholding tax payable by Peak Ltd (ITAA36 s
128B(3)(ga)). The distribution is excluded from assessable income as if it had been subject to
withholding tax (s 128D) and Miss Kwan will not be entitled to any franking credit (ITAA97
Subdiv 207-C).
S Smith
Mr Smith is an Australian resident, so he will be assessed not only on the amount of the
distribution received, but also the amount of Australian tax paid by Peak Ltd on the profits
out of which the distribution was paid. Specifically, he is assessed on the grossed-up
distribution ($3,000 + ($3,000 × 30 ÷ 70)) = $4,286.
Mr Smith will be entitled to a franking credit of $1,286 for the tax paid by Peak Ltd and this
credit can be offset against any income tax liability in the same year. Any excess credit is
refundable to the taxpayer.
[¶30-234] Solution 234

Permitted departure from the benchmark
rule
Allure Pty Ltd must apply to the Commissioner of Taxation for permission to depart from its
established benchmark franking percentage of 75% (ITAA97 s 203-55(2)). It should include
all relevant information in support of its application. Specifically, Allure’s application should
address the following factors, which must be considered by the Commissioner of Taxation in
making a decision (s 203-55(3)).
•
Allure’s reasons for wanting to depart or proposing to depart from the benchmark rule
305
•
the extent of the departure or proposed departure (the greater the departure, the greater the
onus on the company to justify it)
•
whether Allure has formerly sought to exercise the Commissioner’s power to permit the
departure in the past (assuming the previous applications resulted from circumstances within
the company’s control; if so, the onus on the company to justify a departure will increase if
the company applies for a variation relatively frequently)
•
whether a member of Allure will be disadvantaged by the departure or proposed departure (eg
because the member will receive a distribution with a lower franking percentage than the
distribution received by another member)
•
whether a member of Allure will receive franking benefits in preference to other members of
the company due to the departure (in such a case, the departure may be inspired by a desire to
stream franking credits inappropriately), and
•
any other factors that the Commissioner considers to be relevant.
In the case of Allure, these would be considered extraordinary circumstances because they
are unforeseeable and arise out of circumstances beyond the control of the taxpayer. The
Commissioner of Taxation would consider all the relevant circumstances in deciding whether
to permit Allure to depart from the established benchmark franking percentage of 75% for the
$500,000 distribution.
Finally, if Allure were to apply for permission to depart from its established benchmark
franking percentage in a subsequent franking period, the later application would not be
prejudiced as the taxpayer had made the application during the 2018/19 franking period.
[¶30-235] Solution 235

Franking account
River Ltd’s franking account for the 2018/19 tax year is calculated as follows:
River Ltd
Debit Credit Balance
Franking Account for the tax year ended 30 June 2019
$ $ $
Refund of income tax for the 2016 tax year of $5,000 =
10.7.18 5,000 — 7,000
debit of $5,0001
Payment of June 2018 PAYG instalment:
21.7.18 — 150,000 157,000
$150,000 = credit of $150,0002
28.10.18 Payment of September 2018 PAYG instalment: — 155,500 312,500
306
$155,500 = credit of $155,5002
Payment of an interim distribution of $720,000.The
distribution had a 100% franking percentage:
1.11.18 308,571 — 3,929
$720,000 × 30 ÷ 70 = debit of $308,5713
Payment of December 2018 PAYG instalment:
28.2.19 — 155,500 159,429
$155,500—credit of $155,5002
Receipt of a distribution from an Australian public
company of $25,000. The distribution had a franking
5.3.19 percentage of 90%: — 9,643 169,072
$25,000 × 30 ÷ 70 × 90% = credit of $9,6434

Payment of March 2018 PAYG instalment:
28.4.19 — 155,500 324,572
$155,500 = credit of $155,5002
Paid a final distribution of $751,000.The distribution
had a 100% franking percentage:
1.5.19 321,857 — 2,715
$751,000 × 30 ÷ 70 = debit of $321,8573
30.6.19 Closing balance5 — — 2,715
Notes
(1) A franking debit arises if a company receives a refund of income tax. The amount of the
franking debit is reduced on an attribution basis if a company is not a franking entity for the
whole of the relevant income year (ITAA97 s 205-30, item 2 in the table). It is assumed here
that River Ltd was a franking entity during the 2018/19 tax year.
(2) A franking credit arises if a company pays a PAYG instalment. The amount of the
franking credit is based on the amount of tax paid by the company (s 205-15, item 1 in the
table).
company. The amount of the credit is based on the franking credit on the distribution (s 205-
15, item 3 in the table).
(5) The closing balance of the franking account as at 30 June 2019 (ie $2,715) is carried
forward and represents the opening balance of the franking account on 1 July 2019 for the
2019/20 franking period.
[¶30-236] Solution 236

Franking account; franking deficit tax
307
Given that Storm Ltd is not a base rate entity for the 2018/19 tax year, its franking account
for the 2018/19 tax year is computed in the following way:
Storm Ltd
Debit Credit Balance
Storm Ltd Franking Account for the tax year ended
$ $ $
30 June 2019
Payment of June 2018 PAYG instalment:
21.7.18 — 250,000 330,000
$250,000 = credit of $250,0001
Receipt of a distribution from an Australian
resident company which is a base rate entity
of $320,000.
30.9.18 The distribution had a franking percentage of — 97,103 427,103

80%:
$320,000 × 27.5 ÷ 72.5 × 80% = credit of

$97,1032
Payment of September 2018 PAYG
instalment:
28.10.18 — 250,000 677,103
$250,000 = credit of $250,0001
Payment of December 2018 PAYG
instalment:
28.2.19 — 250,000 927,103
$250,000 = credit of $250,0001
Payment of March 2019 PAYG instalment:
28.4.19 — 250,000 1,177,103
$250,000 = credit of $250,0001
Paid a final distribution of $3,200,000.
The distribution had a 100% franking

31.5.19 percentage: 1,371,428.50 — (194,325.50)4
$3,200,000 × 30 ÷ 70 = debit of
$1,371,428.503
30.6.19 Closing balance — — (194,325.50)5
Notes
franking credit is based on the amount of tax paid by the company (ITAA97 s 205-15, item 1
in the table).
15, item 2 in the table). In this case, as the company making the distribution is a base rate
308
entity, the amount of the franking credit is calculated based on the 27.5% corporate rate
(ITAA97 s 202-60(2))—see note about base rate entities at the start of this section).
As Storm Ltd is not a base rate entity, the amount of the debit (corresponding to the franking
credits allocated to the distribution) is calculated based on the 30% rate (ITAA97 s 202-
60(2)).
(4) A company’s franking account is in deficit at a particular time to the extent that the sum
of the franking debits in the account exceeds the sum of the franking credits in the account at
that time (s 205-40(1)). Thus, Storm Ltd has a franking deficit of $194,325.50 on 31 May
2019.
(5) Because Storm Ltd has a franking deficit (ie $194,325.50), it is required to pay franking
deficit tax. Franking accounts are maintained on a tax paid basis, so the amount of the
franking deficit tax payable is the same as the amount of the relevant franking deficit. Hence,
Storm Ltd will have to pay $194,325.50 franking deficit tax on the 30 June 2019 closing
balance of its franking account. There will also be a penalty for excessive over-franking,
because the franking deficits tax liability of $194,325.50 is greater than 10% of the total
franking credits arising in Storm Pty Ltd’s franking account for the 2018/19 tax year. Under
ITAA97 s 205-70, Storm Ltd loses the entitlement to offset 30% of the amount of the
franking deficit tax (ie 30% × $194,325.50 = $58,298) against its tax payable.
[¶30-237] Solution 237

Franking account; franking deficit tax
Given that none of the entities concerned is a base rate entity for the 2018/19 year, the
franking account of Circuits Ltd for the 2018/19 tax year is calculated as follows:
Circuits Ltd Debit Credit Balance
Payment of June 2018 PAYG instalment: $1,750 = credit
21.7.18 — 1,750 2,750
of $1,7501
Receipt of a distribution from Metropolitan Ltd, an
Australian public company, of $3,500. The distribution
1.10.18 — 1,500 4,250
had a franking percentage of 100%: $3,500 × 30 ÷ 70 =
credit of $1,5002
Payment of September 2018 PAYG instalment: $1,750 =
28.10.18 — 1,750 6,000
credit of $1,7501
Payment of December 2018 PAYG instalment: $1,750 =
28.2.18 — 1,750 7,750
credit of $1,7501
Payment of tax outstanding for the 2016/2017 tax year of
4.3.18 — 1,500 9,250
$1,500 = credit of $1,5003
309
Payment of March 2019 PAYG instalment: $1,750 =
28.4.18 — 1,750 11,000
credit of $1,7501
Paid a final distribution of $77,000. The distribution had
1.5.18 a 80% franking percentage: $77,000 × 30 ÷ 70 × 80% = 26,400 — (15,400)
debit of $26,4004
Received a distribution from Country Trust, an
Australian resident non-discretionary trust of $5,000. The
15.6.18 — 1,929 (13,471)6
distribution had a franking percentage of 90%: $5,000 ×
30 ÷ 70 × 90% = credit of $1,9295
30.6.18 Closing balance — — (13,471)7
Notes
franking credit is based on the amount of tax paid by the company (ITAA97 s 205-15, item 1
in the table).
15, item 3 in the table).
(3) A franking credit arises if a company pays income tax. The amount of the franking credit
is based on the amount of tax paid by the company (s 205-15, item 2 in the table).
(5) A franking credit arises if a company receives a franked distribution indirectly from a
partnership or a trust. The amount of the franking credit is based on the company’s share of
the franking credit on the distribution (s 205-15, item 4 in the table).
(6) A company’s franking account is in deficit at a specific time to the extent that the sum of
the franking debits in the account exceeds the sum of the franking credits in the account at
that time (s 205-40(1)). Thus, Circuits Ltd has a franking deficit of $15,400 on 1 May 2019,
which is reduced to $13,471 on 15 June 2019.
(7) Because Circuits Ltd has a franking deficit (ie $13,471), it is required to pay franking
deficit tax. As franking accounts are maintained on a tax paid basis, the amount of the
franking deficit tax payable is the same as the amount of the relevant franking deficit. Thus,
Circuits Ltd will have to pay $13,471 franking deficit tax on the 30 June 2019 closing
balance of its franking account. There will also be a penalty for excessive over-franking as
the franking deficits tax liability of $13,471 is greater than 10% of the total franking credits
arising in the Circuits Ltd franking account for the 2018/19 tax year. Under ITAA97 s 205-
70, Circuits Ltd loses the entitlement to offset 30% of the amount of the franking deficit tax
(ie 30% × $13,471 = $4,041) against its tax payable.
[¶30-238] Solution 238
310
Dividend imputation; effect on various
shareholders
The Australian tax liabilities or refunds (if any) for Neil, Donna, Nova Pty Ltd, Hunter Super
and Shanghai Finance Co Ltd respectively for the 2018/19 tax year are calculated in the
following way:
Australian tax liability for Neil Owen, a resident individual
Assessable income $
Salary (ITAA97 s 6-5) 110,000
Franked distribution (ITAA36 s 44(1)(a)) 2,800
Franking credit (ITAA97 s 207-20(1)) 1,200
Assessable income 114,000
Less: allowable deductions 0
Tax on taxable income at 2018/19 rates ($114,000) 29,677
Add: Medicare levy (ie 2% × $114,000 – as Neil is covered by private health
2,280
insurance, Medicare Levy Surcharge does not apply)
Subtotal 31,957
Less: tax offsets (franking credit: s 207-20(2)) (1,200)
Australian tax liability for Donna Smith, a resident individual
Assessable income $

Interest income (s 6-5) 5,000
Tax on taxable income ($9,000) 0
Add: Medicare levy (not applicable as below threshold) 0
Subtotal 0
Less: tax offsets
Franking credit (ITAA97 s 207-20(2)) (1,200)
REFUND* ($1,200)
* Individual taxpayers are entitled to a refund of their excess franking credits under ITAA97
(s 67-25).
Australian tax liability for Nova Pty Ltd
311
Nova is a resident private company that has no other income for the 2018/19 year. If Nova
Pty Ltd does not have any other income for the 2018/19 year, it qualifies as a base rate entity
and the applicable tax rate will be 27.5% (Income Tax Rates Act 1986 ss 23AA and 23(2)(a)).
Assessable income $
Franking credit (ITAA97 s 207-20(1))* 1,200
Notes
(1) See note regarding base rate entities at the start of this section.
(2) The franked distribution received from Coldstream Pty Ltd is grossed up for the franking
credit (ITAA97 s 207-20(1)) and Nova Pty Ltd is entitled to a tax offset (s 207-20(2)) for the
franking credit. Notwithstanding the 27.5% base rate entity tax rate that applies to Nova Pty
Ltd, the franking credit attached to the franked distribution from Coldstream Pty Ltd, which
is not a base rate entity, is calculated based on the 30% rate. This is because the formula on
the ITAA97 s 202-60(2) refers to the “applicable gross-up rate”, which means the corporate
tax gross-up rate of the entity making the distribution for the income year in which the
distribution is made. Therefore, the franking credit in this solution ($1,200) is calculated by
multiplying the amount of frankable distribution of $2,800 x 30/70, not x 27.5/72.5. The
amount of the franking credit of $1,200 then generates a Franking Credit Tax Offset
(ITAA97 s 207-20).

Tax on taxable income ($4,000 @ 27.5%) 1,100
REFUND ($100)
Australian tax liability for Hunter Super
Hunter Super is a complying resident superannuation fund
Assessable income $
Tax on taxable income ($4,000 @ 15%) 600
REFUND** ($600)
** Since 1 July 2000, complying superannuation funds have been entitled to a refund of their
excess franking credits (s 67-25).
Australian tax liability for Shanghai Finance Co Ltd
312
Shanghai Finance Co Ltd is a non-resident company. Since the distribution paid by
Coldstream Pty Ltd was fully franked, there will be no withholding tax payable by the
company (ITAA36 s 128B(3)(ga)). The distribution is excluded from assessable income
under s 44(1)(b) as if it had been subject to withholding tax (s 128D) and Shanghai Finance
Co Ltd will not be entitled to any franking credit (ITAA97 Subdiv 207-C).

[¶30-239] Solution 239
Private company—taxable income; tax
payable
Auto Parts Pty Ltd
Calculation of taxable income (reconciling the net $ $

profit as per profit and loss statement and taxable
income) for the tax year ended 30 June 2019
Net profit as per Profit and Loss Account 892,480
Accounting profit on disposal of
Less: (4,000)
factory land1
888,480
Items deducted but not allowed for tax
Add:
purposes or requiring adjustment
Loss on collection of debtors2 500
R&D expenditure 100,000
Depreciation (as per accounts) 600,000
Legal expenses (as per accounts) 740
Amortisation of payment for restraint
50,000
of trade3
Repairs and maintenance4 30,720 781,960
1,670,440
Add: Net capital gain5 3,500
Franking credit ($6,000 × 30 ÷ 70)6 2,571
1,676,511
Deduct: Allowable deductions—
Depreciation (see depreciation schedule
526,450
below)
Deduction for plumbing fixture for
24
employees’ lunch room7
Legal expenses: 60
Cost of obtaining loan (ITAA97 s 25-
313
25)8
spread over 5 years

Business-related costs for alteration to
68
articles of association ($340 ÷ 5)9
Deduction for alteration to factory10 504
(527,106)
TAXABLE INCOME $1,149,405
Gross tax payable on taxable income of $1,149,405 @
316,086
27.5%
Less:
Tax offset—franking credit on franked
(2,571)
distribution (ie $2,571)11
R&D tax offset12 (23,100)
Depreciation schedule
Depreciation
Item Cost ($) Tax allowed ($)
rate
Plant 2,600,000 17% pa 442,000
15% pa (balance
Motor vehicles 124,000 of adjustable 12,400
value)
Furniture 116,000 13% pa 15,080
469,480
Additions made on 1 October 2017:
380,000 × 20% ×
Plant 56,844
273 ÷ 365 days
Additions made on 31 December 2017:
Furniture for
2,520 × 10% × 182 ÷
employees’ 126
365 days
lunch room
TOTAL DEPRECIATION ALLOWED FOR TAX PURPOSES $526,450
Notes
(1) The gain on disposal of factory land is assessable under ITAA97 Pt 3-1. The asset was
sold within 12 months of acquisition.
(2) The loss on collection of debtors is not deductible by Auto Parts because the debts were
not brought to account by Auto Parts as assessable income (s 25-35). The loss would be a
capital loss for Pt 3-1 purposes (also see note 5 below).
(3) Expenditure to prevent or eliminate competition, even for a short time, is not deductible
under s 8-1(1) as it is treated as an outgoing of a capital nature (Broken Hill Theatres Pty Ltd
314
v FC of T (1952) 85 CLR 423). However, s 104-25 treats the amount paid for creating the
contractual right of a restrictive covenant plus any incidental cost of creating the asset as a
capital loss. The capital loss will arise on the expiry of the covenant.
(4) The initial repair of factory roof acquired from James Smith: A long line of Australian
and English court decisions has upheld the 1923 decision of the English House of Lords in
Law Shipping Co Ltd v IR Commrs (1924) 12 TC 621 that, if an asset was in disrepair at the
time of its acquisition, the cost of repairs to remedy those defects is of a capital nature and
non-deductible.
However, an English decision in 1972 (Odeon Associated Theatres Ltd v Jones [1972] 1 All
ER 681) held that repairs (emphatically differentiated from improvements) effected
subsequently to an item acquired in workable but poor condition are expenses on revenue
account and deductible. The situation is different, however, where the condition of an item at
the time of purchase is such that without fairly immediate repair it would be incapable of
being put to commercial use.
The Odeon case has yet to be tested in Australia, but Taxation Ruling TR 97/23 considers
that Odeon Theatres ‘is not authority for the proposition that an initial repair is not of a
capital nature, as that proposition is inconsistent with the High Court authority in W Thomas
and Co’ (W Thomas and Co Pty Ltd v FC of T (1965) 115 CLR 58). If the roof was replaced
on a factory that had been acquired some years ago, a deduction for repairs might have been
allowed, following the decision in Case L13 (1960) 11 TBRD 80. In that case, the Board
allowed as a repair the use of concrete roof tiles to replace a 70-year-old galvanised iron roof.
In this question, the following items have been treated as capital expenditure, rather than
being allowed as repairs under s 25-10:
$
Replacement of factory roof (but see argument above) 21,600
Demolition of redundant building 5,400
Conversion of storeroom to lunch room 3,720
$30,720
(5) The gain on disposal of factory land ($4,000) is offset against loss on disposal of debtors
($500). In both cases, CGT event A1 happens.
(6) From 1 July 2002, Auto Parts Pty Ltd is entitled to a franking credit to the extent that
distributions are franked (s 207-20(1)).
(7) A tax deduction applies for capital expenditure incurred on alterations or improvements to
a non-residential building used for the purpose of producing assessable income (Div 43). The
plumbing fixtures for the employees’ lunchroom may qualify for the deduction if classified as
an alteration or improvement under s 43-20(1). The deduction will be at the rate of 2½% pa,
unless the extension was to a building that is used wholly or mainly for ‘industrial activities’
as defined in s 43-150. In this latter case the write-off is at the rate of 4% pa. Assuming that
the building was used throughout the entire year for ‘industrial activities’, then the write-off
is as follows:
315
(8) The cost of arranging a loan is deductible where the funds are used for business purposes.
Section 25-25 requires that the cost be apportioned for that part of the year in which the loan
was used in the business and then over the period of the loan or five years, whichever is the
shorter.
(9) Legal expenses incurred in altering the company’s articles are not deductible under s 8-
1(1) since they are an expense of a capital nature (Sun Newspapers Ltd v FC of T (1938) 61
CLR 337). However, a deduction over five years is available under ITAA97 s 40-880.
(10) A tax deduction applies to capital expenditure on the construction of a new non-
residential building used for the purpose of producing assessable income. The replacement of
the factory roof may qualify for the deduction if classed as an alteration or improvement
under s 43-20(1). The deduction is at the rate of 2½% pa, unless the extension was to a
building that is used wholly or mainly for ‘industrial activities’ as defined in s 43-150. In this
latter case the write-off is at the rate of 4% pa. Assuming that the building was used
throughout the entire year for ‘industrial activities’, then the write-off is:
(11) From 1 July 2002, Auto Parts Pty Ltd is entitled to a tax offset to the extent that
distributions are franked (s 207-20(2)).
(12) Only expenditure on direct wages exclusively for R&D activities and expenditure on
plant wholly attributable to R&D qualify for the incentive. Market research does not qualify.
The calculation of the R&D incentive is as follows:
$
Direct wages 40,055
Plant and equipment decline in value: $80,000 × 273 days ÷ 3 years (ie eligible for
an effective life write-off for the decline in value of the asset while it is used for 19,945
R&D purposes)
$60,000
Because Auto Parts’ turnover is more than $20 million, it is entitled to a non-refundable tax
offset of $23,100 (ie 38.5% × $60,000 in 2018/19 see Tax Laws Amendment (Research and
Development) Act 2013).
Note: The 2018/19 Budget announced proposed changes to the L&D Tax Offset, which are
contained in the Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair
Share of Tax in Australia and Other Measures) Bill 2018, introduced to the Parliament on 18
September 2018 and not yet enacted at the time of this update.
If enacted, the amendments will apply from 1 July 2018 and will change the way in which the
R&D Tax Offset is calculated, as follows:
316
•
Small Companies: R&D entities with an aggregated turnover for the income year of less than
$20m will be entitled to a refundable tax offset in respect of their notional deductions at a
rate equal to their corporate tax rate plus a minimum premium of 13.5%. In practice, this
means that base rate entities (subject to the 27.5% corporate rate) will be entitled to an R&D
tax offset calculated at 41% of the total value of their notional deductions, while general rate
entities (subject to the 30% corporate rate) will be entitled to a 43.5% tax offset, calculated in
the same way.
•
Large Companies: R&D entities with an aggregated turnover for the income year of more
than $20m will be entitled to a non-refundable tax offset in respect of its notional deductions
at a rate equal to their corporate rate for the year plus an ‘intensity premium’ of:
–
4% for notional deductions of up to 2% of the R&D entity’s expenditure for the income year;
–
6.5% for notional deductions above 2% and up to 5% of the R&D entity’s expenditure for the
income year;
–
9% for notional deductions above 5% and up to 10% of the R&D entity’s expenditure for the
income year, and
–
12.5% for notional deductions above 10% of the R&D entity’s expenditure for the income
year.*
*Source: Barkoczy, Foundations of Taxation Law, 2019, ¶30.5.
While market research does not qualify for the R&D incentive, part of the expenditure could
be deductible under s 8-1(1) if it is not of a capital nature. However, because the research was
undertaken to explore new markets it is of a capital nature (Sun Newspapers Ltd v FC of T
(1938) 61 CLR 337) and is therefore not deductible.
[¶30-240] Solution 240

Anti-streaming rules
(1) Single distribution streaming by a non-
resident controlled company
The conduct of Overseas Ltd during the 2018/19 tax year could represent dividend streaming.
In such cases, the Commissioner of Taxation can apply sanctions under ITAA97 Subdiv 204-
D. Specifically, the Commissioner of Taxation can debit the franking account of Overseas
Ltd for the 2018/19 tax year and deny imputation benefits to the Australian resident minority
shareholders in respect of the franked distribution (s 204-26 to 204-55).
However, it should be remembered that if the non-resident majority shareholder merely

deferred distributions to contribute more equity capital for its subsidiary but, ultimately, takes
317
franked distributions, this conduct may not represent streaming under Subdiv 204-D and no
sanctions would apply.
(2) Share buy-back—limited franking

surplus
The franked distribution of Charleston Ltd on 1 January 2019 could constitute dividend
streaming. In such circumstances, the Commissioner of Taxation can apply sanctions under
Subdiv 204-D. In particular, the Commissioner of Taxation can debit the franking account of
the company for the 2018/19 tax year and deny imputation benefits to the taxable Australian
resident shareholders in relation to the franked distribution (s 204-26 to 204-55). However, it
should be noted that, where there remains sufficient franking credits in Charleston Ltd’s
franking account during the 2018/19 tax year to frank distributions to its remaining
shareholders, streaming would not occur, unless there are other unique features present.
(3) Share buy-back — excess credits

The conduct by Richmond Ltd may represent dividend streaming under Subdiv 204-D. In this
case, avoiding wastage of franking credits is not a matter of concentrating scarce credits:
there may well be sufficient credits to frank distributions to other members. In such
circumstances, the Commissioner of Taxation can apply penalties under Subdiv 204-D. For
example, the Commissioner of Taxation can debit the franking account of the company for
the 2018/19 tax year and deny imputation benefits to the taxable Australian resident
shareholders in relation to the franked distribution (s 204-26 to 204-55).
This type of transaction could result in a proportionately greater interest in Richmond Ltd
being held by shareholders less able to benefit from imputation credits, and a value shift in
favour of the shares not bought back. In these cases, the discussion in para 3.34 of the
Explanatory Memorandum accompanying the New Business Tax System (Imputation) Bill
2002 regarding deferral strategies might also be relevant.
[¶30-241] Solution 241

Private company—taxable income; tax
payable
Toys Galore Pty Ltd
$ $ $
Statement of tax liability for the tax year ended 30
June 2018
Operating Profit 416,600
Less: Revenue not assessable
318
Accounting profit on sale of fixed assets (8,500)
408,100
Add
Expenses not deductible or requiring adjustment
back:
Depreciation 58,000
Loss on sale of fixed assets 2,500
Provision for long service leave 8,000
Bad and doubtful debts 6,000
Legal expenses 7,200
Repairs 5,700
Overseas travel 20,000 107,400
515,500
Depreciation adjustment on disposal of motor vehicle
3,000
(ITAA97 s 40-285)
Depreciation (includes deduction for factory extension) 52,000
Long service leave 4,500
Bad debts 5,000
Overseas travel 5,000
Legal expenses
—retainer 6,000
—lease (ITAA97 s 25-20) 500
—borrowing expenses ($700/5 x 91/365 days ITAA97 s
35 6,535
25-25)
Repairs
—machinery 2,000
—motor vehicle1 2,500 4,500
Replacement of tools 1,200 (81,735)
433,765
Add: Assessable income—
Depreciation adjustment on disposal of lathe and drill
9,000
press ($3,000 + $6,000) (s 40-285)
Franking credit—fully franked distribution from
Australian subsidiary which is not a base rate entity 3,429
($8,000 × 30 ÷ 70)2
Franking credit—50% franked distribution from
Australian resident public companies which are not base 429 12,858
rate entities ($2,000 × 30 ÷ 70 × 0.5)3
Net tax payable
Gross
$446,623 × 27.5%4 $122,821.32
tax
319
Less: Offsets—
Franking credits (ie $3,429 + $429) (3,858)
Notes
(1) Repairs to motor vehicles: As FBT is payable on the director’s motor vehicle, the
company is entitled to deduct the full cost of $2,500 for repairs to motor vehicles, even
though the director’s vehicle is used 50% for private purposes.
(2) Franked distribution from Australian subsidiary which is a general rate entity, therefore
the gross-up operation is based on the 30% rate. Hence, the franking credit included in Toys
Galore’s assessable income would be $3,429. Toys Galore is entitled to receive a franking
credit to the extent that distributions are franked (s 207-20(1)).
(3) Partly franked distribution from Australian resident public companies which are general
rate rate entities, therefore gross-up operation is based on the 30% rate. Hence, the franking
credit included in Toys Galore’s assessable income would be $429. Toys Galore is entitled to
receive a franking credit to the extent that distributions are franked (s 207-20(1)).
(4) As Toys Galore’s annual turnover is less than $50 million, it is classified as a base rate
entity for the tax year 2018/19, and therefore it is subject to the 27.5% corporate rate (Income
Tax Rates Act 1986 ss 23AA and 23(2)(a)—see note about base rate entities at the start of this
section).
Tax treatment of deductibility of overseas

travel expenses
Because the purpose of the director’s trip to the United States in September 2018 was to
obtain new agencies, the expenditure of $15,000 is of a capital nature and is not deductible
under ITAA97 s 8-1 (Sun Newspapers Ltd v FC of T (1938) 61 CLR 337). If the purpose of
the trip had been to maintain or improve business relations with existing agencies, then the
expenditure would have been deductible under s 8-1 (ie an expense of a revenue nature).
The marketing manager’s trip to Singapore appears to be business-related and incidental to

the production of company income. The expenditure associated with his wife accompanying
him would not be deductible, unless his wife is an employee and it could be shown that her
presence was necessary and incidental to the company earning assessable income (s 26-30),
or the company was liable for FBT on the benefit provided to the wife as an associate of an
employee (s 26-30(3)).
As the Singapore trip satisfies the conditions of deductibility under s 8-1, the Commissioner
of Taxation is likely to assess Toys Galore for FBT on the benefit provided to the marketing
manager’s wife as an associate of an employee. If so, then the cost of the wife’s trip to
Singapore is also deductible.
This solution assumes that FBT would be payable and is included in other expenses (all
deductible) and claims the full cost of $5,000 for the Singapore trip as a tax deduction.
320
[¶30-242] Solution 242
Taxable income; tax payable; FBT
Trim and Terrific Pty Ltd
Income $ $
Customer fees 5,500,000
Annual subscriptions (excluding subscriptions paid in
1,120,000
advance)1
Sale of sports gear 300,000
Sales of health food and drink 225,000
Advertising 110,000
Distribution from wholly-owned subsidiary—Trim and Terrific
70,000
(100% franked)
Franking credit on distribution from wholly-owned subsidiary
26,552
—Trim and Terrific ($70,000 × 27.5 ÷ 72.5)2
7,351,552
Less: Deductions—
Wages3 4,100,000
Superannuation 300,000
Rental 880,000
Cost of goods sold 400,000
Advertising 250,000
Legal costs of lease agreement4 9,000
FBT 143,500
Airfares and accommodation 220,000
Staff canteen 74,000
Tax advice provided to staff 40,000
Car hire for employee 7,000
Payment of employees’ HELP 24,780
Supply of uniform to staff 48,220
Taxi fares 4,000 (6,500,500)
Gross tax payable $851,052 × 27.5%5 $234,039
Franking credit for Trim and
Terrific (Queensland) Pty Ltd (26,552)
(ITAA97 s 207-20(2))
Subtotal $207,487
Less: PAYG instalments (240,000)
REFUND ($32,513)
Notes
321
(1) The annual subscriptions paid in advance have been excluded from assessable income on
the basis of the principle in Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314.
This requires that the payments are only brought to account as income in the taxpayer’s
accounts when earned; that is, they are placed into a suspense account when paid and
recorded as income when earned.
(2) Considering that Trim and Terrific’s Queensland wholly-owned subsidiary is a base rate
entity, it is taxed under the 27.5% corporate rate (Income Tax Rates Act 1986, s 23(2)(a)).
Therefore, the dividends received from this subsidiary will be grossed-up based on the 27.5%
rate ($70,000 × 27.5 ÷ 72.5) (ITAA97 s 202-60(2)), resulting in franking credits of $ 26,552.
(3) Wages = $4,000,000 + $100,000 owing = $4,100,000 is deductible under s 8-1. See the
meaning of ‘incurred’ in s 8-1 and FC of T v James Flood (1953) 88 CLR 492.
(4) Legal costs in the preparation of a lease are fully deductible under ITAA97 s 25-20.
Note also that the gift of $50,000 to the local football club is not deductible under ITAA97
Div 30 because the football club is not a prescribed recipient for tax purposes under ITAA97
s 30-15.
Note: Provision for holiday pay $220,000 is not deductible as it is not incurred pursuant to
the provisions of ITAA97 s 8-1 and FC of T v James Flood (1953) 88 CLR 492.
(5) As Trim and Terrific’s annual turnover is less than $50 million, it is classified as a base
rate entity for the tax year 2018/19, and therefore it is subject to the 27.5% corporate rate
(Income Tax Rates Act 1986 ss 23AA and 23(2)(a)).
Fringe benefits
FBT would be payable on the following items:
•
tax advice provided to staff, unless the employee would have been entitled to a tax deduction
for the tax advice if the expenditure had been incurred by the employee rather than by the
employer (the otherwise deductible rule)
•
hire car for employee when private vehicle was involved in an accident
•
entertainment of staff at restaurants (ITAA97 s 32-20; FBTAA s 37AC note that the New
Zealand branch staff are not employees; therefore, the entertainment that relates to them is
not subject to FBT and is therefore not deductible), and
•
payment of HELP fee for an employee or associate (ITAA97 s 26-20(2); FBTAA s 20).
Given that FBT is payable on these particular benefits, the company is entitled to a deduction
in respect of these benefits.
Excluded from FBT are the following items:
322
•
taxis to take staff home after 11 pm in the week prior to Christmas: specifically exempt
(FBTAA s 58Z), and
•
subsidising the canteen (an ‘eligible dining facility’, FBTAA s 136(1)): exempt under
FBTAA s 41 as an exempt property benefit.
[¶30-243] Solution 243

Taxable income; tax effect accounting
Green Pty Ltd
$ $
Operating profit before tax1 750,000
Gain on sale of land 100,000
Operating profit and extraordinary item 850,000
Add: Goodwill 30,000
(Assessable Income) Provision —warranties2 100,000
—obsolete stock 75,000
—doubtful debts 30,000
—holiday pay and long
60,000
service leave
Accounting
—plant 600,000
depreciation
—buildings 50,000
Borrowing costs3 2,000 947,000
1,797,000
Tax decline in
Less: —plant 750,000
value
(Deductions) —buildings 25,000
Borrowing costs3 198
CGT—Deduct indexation component on sale
29,400
of land4
Carry-forward losses 220,000
FBT paid in 2018/19 26,000 (1,050,598)
Tax on taxable income ($746,402 × 27.5%)5 $205,260.55
Less: R&D tax offset6 (39,981.72)
Notes
323
(1) Because FBT is payable on entertainment of employees, the sum of $4,600 is deductible
(ITAA97s 32-20), and no adjustment to operating profit before tax is required for this
particular item.
(2) Warranties = Total sales of $5,000,000 × 2% = $100,000.
(3) The costs associated with the loan are deductible over the period of the loan or five years,
whichever is the shorter period (s 25-25). Because the period of the loan exceeds five years,
the allowable deduction is calculated as follows:
(4) Since Green Pty Ltd acquired the land in 1992, i.e. before 11.45 am EST on 21 September
1999 and held the asset for at least 12 months, the indexed cost base frozen at 30 September
1999 is used to compute the capital gain. The CGT discount method is not available to
company taxpayers.

Cost: $200,000
Indexation factor: 1.147*
Indexed cost base: $200,000 × 1.147 (229,400)
* 68.7/59.9
Hence, the CGT indexed component on sale of land is $29,400.
(5) As Green Pty Ltd’s annual turnover is less than $50 million, it is classified as a base rate
entity for the tax year 2018/19, and therefore it is subject to the 27.5% corporate rate (Income
Tax Rates Act 1986 ss 23AA and 23(2)(a)).
(6) The refundable R&D tax offset of $41,360.40 is attributable to $76,000 labour costs and
$96,000 plant costs (ie eligible for an effective life write-off for the decline in value of the
asset while it is used for R&D purposes).
$
Eligible labour costs: 76,000
Eligible plant costs: $96,000 x 242/365 x 25% 15,912
91,912
Since Green’s turnover is less than $20m, the company is entitled to a refundable tax offset of
$39,981.72 ($91,912 x 43.5% in 2018/19 see Tax Laws Amendment (Research and
Development) Act 2013).
Note: See note on R&D Tax Offset 2018/19 proposed amendments at Solution 239.
[¶30-244] Solution 244

324
Taxable income; tax effect accounting
(1)
Reconciliation of accounting and taxable income
Ezi-Lease Ltd
$ $
Reconciliation of accounting and taxable income for the tax year
ended 30 June 2019
Operating profit 5,550,000
Add: Accounting gain on sale of property 750,000
Operating profit and extraordinary items 6,300,000
Add: Permanent differences
Entertainment expenses 25,000
Legal expenses 21,250
Goodwill 200,000
CGT indexation1 (500,000) (253,750)
Accounting profit adjusted for permanent differences 6,046,250
Add: Timing differences
Workers’ compensation2 8,955
Holiday pay3 310,212
Long service leave4 12,426
Doubtful debts5 80,091
Borrowing costs (ITAA97 s 25-25)6 360,199 771,883
6,818,133
Less: Timing differences
Workers’ compensation (15,600)
Holiday pay (288,000)
Long service leave4 (36,000)
Doubtful debts5 (121,500) (461,100)
Accounting adjusted for permanent and timing differences 6,357,033
Less: Carry-forward loss7 (900,000)
TAXABLE INCOME $5,457,033
(2)
Tax liability for the tax year ended 30 June 2019
As Ezi-Lease Ltd’s turnover is less than $50 million for the tax year 2018/19, it qualifies as a
base rate entity for the 2018/19 tax year, and is therefore subject to the 27.5% corporate rate
(Income Tax Rates Act 1986 ss 23AA and 23(2)(a)). Income tax expense is a function of
accounting profit adjusted for permanent differences as follows:
$
$6,046,250 @ 27.5% 1,662,718.70
Adjustment for carry-forward loss $900,000 @ 27.5% (247,500)
INCOME TAX EXPENSE 1,415,218.70
Income tax payable is a function of taxable income as follows:
$
325
Taxable income $5,457,033
Tax payable (tax rate 27.5%) 1,500,684
INCOME TAX PAYABLE $1,500,684
Accounting Journal entry: $
DR income tax expense 1,415,218.70
DR future income tax benefit 85,465.30
CR provision for income tax payable $1,500,684
Notes
(1) Because Ezi-Lease acquired the land in February 1990, i.e. before 11.45 am EST on 21
September 1999 and held it for at least 12 months, the indexed cost base frozen at 30
September 1999 is used to compute the capital gain. The CGT discount method is not
available to company taxpayers. Thus, the cost of $2,250,000 indexed by 1.222* gives an
indexed cost base of $2,749,500.
The gain on sale of land for tax purposes is $250,500 (ie $3,000,000 − $2,749,500). A gain of
$750,000 has already been included in accounting profit, so $500,000 ($750,000 − $250,000)
must be subtracted in computing the taxable income.
*68.7/56.2
(2) Workers compensation

$ $
Payment 15,600 Opening balance 29,601
Closing balance 22,956 Provision 8,955
38,556 38,556
A deduction is allowed for workers compensation paid, but not for provisions made.
(3) Holiday pay
$ $
386,448 386,448
A deduction is allowed for holiday pay paid, but not for provisions made.
(4) Long service leave
$ $
126,489 126,489
A deduction is allowed for long service leave payments, but not for provisions made.
(5) Doubtful debts
$ $
326
Bad debts 121,500 Opening balance 180,054
260,145 260,145
A deduction is allowed for bad debts written off, but not for provisions made.
(6) Borrowing expenses: costs associated with the loan are deductible over the period of the
loan or five years, whichever is the shorter period (s 25-25). The amount deductible in the
2018/19 tax year is computed as follows:
The timing difference between the accounting and tax treatment is $450,000 − $89,801 =
$360,199.
(7) Assuming that the previous year’s loss has not already been taken-up as a future income
tax benefit.
Administration and Assessment

[¶30-245] Solution 245
Time for lodging objection
Under TAA s 14ZU, Jones may lodge an objection in writing with the Commissioner stating
fully and in detail the grounds on which he relies. To be valid, the objection must be lodged
with the Commissioner within four years after the service of the notice of assessment (TAA s
14ZW). Therefore, the objection must be lodged by 14 November 2022. However, if Jones is
a taxpayer without complex tax affairs, or is a ‘small business entity’ taxpayer (SBE)
327
(ITAA97 Div 328) the time is reduced to two years (ITAA36 s 170(1)) and the objection
would need to be lodged by 14 November 2020.
Pursuant to s 170(1) in order to qualify as a taxpayer with no complex affairs, the taxpayer
must:
•
not carry on business (other than as an SBE taxpayer), or
•
be an individual in a partnership that carries on business (other than an SBE taxpayer), or
•
not be an individual in the capacity of a trustee of a trust estate, or
•
not be the beneficiary of a trust estate, unless the trust is an SBE taxpayer for the year or the
trustee is a full self-assessment taxpayer for that year.
The first day of the objection period is the day after the service of the Notice of Assessment.
Assessment made by post is deemed to arrive when it is delivered in the ordinary course of
post.
Section 14ZW(2) does allow an extension of this time. Where the four-year period has
expired, Jones should lodge his objection with the Commissioner with a written request that
the Commissioner regard the objection as having been lodged. This would require Jones to
provide reasons why the objection was not lodged in time (s 14ZW(3)). Under TAA s 14ZX
the Commissioner may accept or reject the late objection and is required to give Jones notice
of the decision.
The reasons why the Commissioner will give an extension of time to object are contained in
Practice Statement PS LA 2003/7. Valid reasons would be, for example:
•
sickness of the taxpayer, or
•
the taxpayer was overseas at the time the assessment was served, or
•
the taxpayer has an arguable case, or
•
evidence of negligence by the taxpayer’s agent.
Individual resident taxpayers with no complex affairs must lodge an objection within two
years after service of the notice of assessment (TAA s 14ZW(1)(aa)).
[¶30-246] Solution 246

Tax payable; dates
(1)
328
Yeo’s obligations to pay PAYG instalments of company tax are based on the rules contained
in TAA Sch 1 Pt 2-10, s 45-1 to 45-640.
Section 45-15 states that a liability to pay instalments arises if the Commissioner gives the
taxpayer an instalment rate. Section 45-20 states that, where a taxpayer is liable to pay an
instalment for a period (even if it is a nil amount), the taxpayer must notify the Commissioner
of the amount of her or his instalment income. This must be done in the approved form and
on or before the day when the instalment is due. Section 45-50 states that the liability for the
first instalment is payable:
•
for the instalment quarter in which the Commissioner first gives you an instalment rate, or
•
if at the end of the quarter you become an annual payer—for the income year in which the
Commissioner gives you an instalment rate.
The taxpayer can choose to be an annual payer (ie pay in one instalment) if:
•
the taxpayer is not registered and is not required to be registered for GST
•
the taxpayer is not a partner in a partnership which is required to be registered for GST, or
•
the most recent notional tax notified by the Commissioner is less than $8,000.
As the taxable income of Yeo is $19,000, the notional tax for the year is less than $8,000. If
Yeo is not required to be registered for GST it would only be required to make one instalment
payment. Section 45-70 states that the annual instalment payment is due on or before the 21st
day of the fourth month after the end of the income year. For the year ending 30 June 2019
the instalment would be due on or before 21 October 2019.
(2)
If Yeo had a taxable income of $6,000,000, then it would be liable to make quarterly
instalments. The first instalment will be payable in the first quarter when the Commissioner
gives the taxpayer an instalment rate. As Yeo has an income year ending 30 June 2019, s 45-
60 states that the quarterly instalments are as follows:
Quarter ending Instalment due
30 September 28 October
31 December 28 February
31 March 28 April
30 June 28 July
However, where the taxpayer is required to pay GST monthly, the due dates are:
21 October
21 January
21 April
21 July respectively.
329
Note: From 1 January 2017, companies with a GST turnover exceeding a threshold of $20m
are required to pay their GST instalments on a monthly basis. The threshold amount is the
‘base assessment instalment income’ as determined by the Commissioner (s 45-320). This is
so much of the taxpayer’s assessable income which the Commissioner determines is
instalment income.
The threshold amount is tested at a particular point in time being the monthly payer
requirement test day, ie the ‘MPR test day’. This is normally the first day of the third month
of the previous income year (s 45-138).
Under s 45-110, the amount of the PAYG instalment for the quarter is determined as follows:
Where the instalment rate is the most recent instalment rate given to the taxpayer by the
Commissioner of Taxation (or notified by the taxpayer to the Commissioner), the instalment
income is defined in s 45-120 as including the taxpayer’s ordinary income derived during the
period.
The Commissioner calculates the instalment rate for the taxpayer under s 45-320 as:
To derive the base assessment instalment income, it is necessary to determine the taxpayer’s
base year, which is the last income year for which an assessment has been made.
The notional tax is determined under s 45-325 as:
Section 45-330 states that the adjusted taxable income for the base year is the taxpayer’s total
assessable income for the base year reduced by any net capital gain deductions (other than for
losses except to the extent that there are carry-forward losses available to be used in
subsequent years). The adjusted withholding income is the assessable income from which
PAYG withholding deductions have been (or should have been) made (except for PAYG
withholding due to a failure to quote a TFN or ABN).
Section 45-340 states how the adjusted tax is calculated. This is a four-step process; for
companies it is calculated by determining the tax payable on the adjusted taxable income (or
the adjusted withholding income, if appropriate).
While the due dates for Yeo’s tax payments are as outlined above, the actual amount of the
PAYG instalments would depend on the taxpayer’s instalment rate (notified by the
Commissioner or chosen by the taxpayer) applied to the instalment income. Where Yeo’s
estimated sales for the year are $25,000,000 and where an instalment rate of 8% has been
notified to Yeo, then the relevant instalments would be as follows (assuming sales are made
evenly throughout the year, that there is no other ordinary income and GST is not payable
monthly):
330
$
28 October 2018 $500,000
28 February 2019 $500,000
28 April 2019 $500,000
28 July 2019 $500,000
However, if GST is payable monthly the due dates would be:
First instalment 21 October 2018

Second instalment 21 January 2019
Third instalment 21 April 2019
Fourth instalment 21 July 2019
The first instalment would be:
It should be noted that Yeo is not eligible to pay instalments based on GDP-adjusted notional
tax as its instalment income is greater than $2,000,000.
However, where this occurs s 45-405 allows the PAYG instalments to be based on the
adjusted taxable income increased by a GDP adjustment of 6% for the 2018/19 income year.
[¶30-247] Solution 247

Payment of instalments
TAA s 45-50 states that the company would be required to make quarterly instalments.
Under s 45-110, the amount of each quarterly instalment is calculated on the basis of the
following formula:
* Instalment income includes the taxpayer’s ordinary income derived during the period (s 45-
120).
The instalment rate is the most recent notified to the taxpayer by the Commissioner (s 45-15)
or chosen by the taxpayer (s 45-205). Given that National believes an instalment rate of 6% is
more appropriate, it may choose that rate. However, s 45-210 requires National to notify the
Commissioner of the varied rate. Consequently, the quarterly payments required to be made
by National will be determined by using this rate and applying it to the instalment income
accrued during the period.
331
On the basis of $6,000,000 of ordinary income and an instalment rate of 6%, assuming that
sales are spread evenly over the year and GST is not payable monthly, the quarterly payments
would be:
and they would be due on:
•
21 October 2018
•
21 January 2019
•
21 April 2019, and
•
21 July 2019.
However, if National has less than $2,000,000 in instalment income in the year 2018/19, it
has the option of paying the PAYG instalments on the basis of an amount calculated on their
GDP-adjusted notional tax (s 45-405).
In this case, the adjusted taxable income for the base year is determined by a GDP adjustment
of 4% for the year ending 30 June 2019.
[¶30-248] Solution 248

Variation of instalment rate; credits;
penalties
As Domestic believes that its ordinary income is likely to be less, it can revise the amount of
instalment for each quarter to reflect the change.
Section 45-205 enables the taxpayer to choose a varied instalment rate, and s 45-210 requires
the taxpayer to specify that rate in the notice about the instalment income under s 45-20. This
rate must then continue to be used by the taxpayer in the remaining quarters unless the
taxpayer chooses a different rate and informs the Commissioner (s 45-205(4)). Consequently,
Domestic may choose to vary its instalment rate.
Based on the company’s revised estimates the remaining two instalments will be:
Where a taxpayer revises its instalment rate downwards, s 45-215 enables Domestic to claim
a credit for previous instalments which have been overpaid. If the first two-quarters of
income were $3,000,000, the credit is calculated as follows:
332
Step 1. The earlier instalments: $90,000 × 2 = $180,000.
Step 2. There are no earlier variation credits.
Step 3. Multiply the previous instalment income by the new instalment rate:
$3,000,000 × 4% = $120,000.
Step 4. Subtract Step 3 from Step 1: $180,000 − $120,000 = $60,000.
Step 5. Where (4) is positive, this is the amount of the variation credit which may be claimed
by Domestic.
Where a taxpayer chooses to vary an instalment rate and the varied instalment rate is too low,
s 45-230 states that a general interest charge penalty may be applied. This occurs where the
varied rate is less than 85% of the ‘benchmark instalment rate’ for the year.
[¶30-249] Solution 249

Uniform penalty regime; ‘reasonably
arguable’
The courses of action available to Pipe Co are determined by the uniform penalty regime set
out in TAA Sch 1 (Div 284 to 286).
The uniform penalty regime focuses on a standard penalty system relating to:
•
statements and schemes
•
late lodgement of returns, and
•
failure to meet specified obligations.
The shortfall amount, as defined in TAA Sch 1 s 284-80, is the amount by which the relevant
liability, or the payment or credit, is less or more than it would otherwise have been. Section
284-90 states that where a shortfall amount occurs, a base penalty amount will apply, using
the specified table contained in the section. In particular, where the taxpayer does not adopt a
reasonably arguable position, a base penalty of 25% of the shortfall amount will apply.
The taxpayer must provide some evidence to support the view that the taxpayer has examined
the issue and that the position adopted is reasonably arguable.
A matter is reasonably arguable if:
it would be concluded in the circumstances, having regard to relevant authorities, that what is
argued for is about as likely to be correct as incorrect, or is more likely to be correct than
incorrect. (TAA Sch 1 s 284-15).
Some of the relevant authorities include ITAA97, Explanatory Memoranda and court
decisions.
333
Also see Miscellaneous Taxation Ruling MT 2008/2 which indicates that for a position to be
reasonably arguable the area must involve a contentious area of tax law and the taxpayer’s
position must be reasonably arguable in a court of law. The test does not require that the
taxpayer’s position is the better view, instead the ruling adopts a view that the position
adopted is ‘about as likely as not’.
An example of this might be evidence by way of case analysis. The decision in FC of T v

Hyteco Hiring Pty Ltd 92 ATC 4694 would give weight to the taxpayer’s view. This case was
concerned with the assessable nature of profits arising from the disposal of forklifts which
had been used for hiring purposes in the taxpayer’s business. In this case, the Judges held that
it would have been incorrect to characterise the business of the taxpayer as comprising the
hiring and selling of forklifts. Rather, the Court held that the profit arising from the sale of
forklifts was on capital account, and was not assessable income.
Given this case precedent, it is suggested that Pipe Co would be able to claim that it had
adopted a reasonably arguable position in treating the profit arising from the sale of surplus
manufacturing equipment as not assessable.
If this claim was accepted, no penalty would be imposed by the Commissioner of Taxation.
However, if a penalty is applied, the Commissioner is required, pursuant to TAA Sch 1 s 298-
10, to provide written notice of the penalty and reasons why the taxpayer is liable to the
penalty.
[¶30-250] Solution 250

Self-assessment; reasonable care
(1) Action available to Aust Toy to correct
the error
Because of the numerical error in determining the value of closing stock, Aust Toy’s taxable
income would have been understated by $546,000. As a result, Aust Toy should seek to lodge
an amended return and notify the Commissioner of the error in order to avoid penalties.
(2) Penalties that may be imposed by the

Commissioner for the error made by Aust
Toy in determining its taxable income
If the taxpayer had exercised reasonable care in the preparation of the return, there would be
no penalty under the penalty provisions contained in TAA Sch 1 s 284-90. The ‘reasonable
care’ test requires the taxpayer to exercise the care that a reasonable, ordinary person would
be likely to have exercised in the circumstances of the taxpayer to fulfil the taxpayer’s tax
obligations. Miscellaneous Taxation Ruling MT 2008/1 contains a current view as to what
334
reasonable care means and contains some examples of situations where there is a lack of
reasonable care.
The standard of reasonable care considers a taxpayer’s personal circumstances such as their
knowledge, educational experience and skill in understanding the tax laws. Also the exercise
of reasonable care requires that a business taxpayer put in place an appropriate record-
keeping system. It would seem that where an employee makes a careless error a penalty
would not apply where the taxpayer can demonstrate that the record-keeping procedures are
designed to prevent such errors. This would require an examination of the nature and size of
the firm’s operation, the presence of internal audit checks and the training of staff.
Where Aust Toy has not taken reasonable care in the preparation of its tax return it is
necessary to determine why the error occurred. Where the error was due to a lack of
reasonable care, a penalty of 25% of the shortfall amount may be imposed (s 284-90). Under
s 284-90(1), where the tax shortfall exceeds the greater of 1% of the tax payable or $10,000
then the taxpayer must also have a reasonably arguable position (see Miscellaneous Taxation
Ruling MT 2008/2 and Solution 249). However, where the error was due to reckless
preparation of the tax return, a penalty of 50% of the shortfall amount may be imposed (s
284-90).
Where the taxpayer has made a false and misleading statement and a tax shortfall occurs any
penalty relating to a tax shortfall caused by a false or misleading statement may be remitted
where for example:
1.
It is an isolated mistake.
2.
The mistake was honest and not intended.
3.
The taxpayer has a good history of compliance.
4.
The event is not unusual or extraordinary given the taxpayer’s history.
Penalties may apply even though there is no tax shortfall but where the taxpayer makes a
false or misleading statement which is material (see TAA Sch 1 s 284-90 Items 3A to 3C).
Essentially there is a penalty of $4,200 (based on 20 penalty units, where the current penalty
unit is $210 (Crimes Act 1914 s 4AA) for infringements occurring on or after 1 July 2017) for
a failure to take reasonable care and $8,400 for recklessness (based on 40 penalty units).
Where there is voluntary disclosure before an audit occurs, s 284-85 and 284-225 provide
that the penalty will be reduced by 80%.
The taxpayer will be liable for a ‘shortfall interest charge’ under the provisions in TAA Sch 1
Subdiv 280-B. It applies where there is an under-assessment of income tax. The penalty
applies from the due date of the original assessment to the day before the original assessment
was amended. It is based on the base interest rate for the day plus 3% divided by the number
of days in the year (TAA Sch 1 s 280-105). The taxpayer is also liable for a general interest
charge from the date of the amendment under TAA s 8AAB. The general interest charge is
based on the monthly average yield of 90-day Bank Accepted Bills plus seven percentage
points.
335
(3) Amendment of assessment and
imposition of penalties
Where the error in the return lodged by Aust Toy was not discovered until an audit by the
Commissioner, the penalties which may be applied would depend on the reason for the
understatement of the income (see above). However, Aust Toy may be eligible for a
remission of the penalty if a written voluntary disclosure was made during the audit. TAA
Sch 1 s 284-225 provides for a remission of 20% of the penalty. Interest penalties under TAA
s 8AAB also apply.
[¶30-251] Solution 251

Revised estimates; penalties
Where the final return had been lodged by Echo, with the incorrect claim of $200,000
($220,000 less $20,000 depreciation), the company would be subject to penalties based on the
shortfall amount. The shortfall amount is the amount by which the relevant liability, or the
payment or credit, is less or more than it would otherwise have been (TAA Sch 1 s 284-80).
Where reasonable care was taken in determining the taxable income, no penalty applies (see
Miscellaneous Taxation Ruling MT 2008/1). However, if no reasonable care was taken, a
penalty of 25% of the shortfall amount applies (s 284-90(1)). Reasonable care requires a
taxpayer to exercise the care that a reasonable person might use. This requires a degree of
compliance which reflects the taxpayer’s knowledge, education, experience and skill. It also
requires that the taxpayer has taken reasonable care in keeping appropriate records and
systems to ensure compliance with their obligations under the Act.
Where the shortfall amount exceeds $10,000 or 1% of the return tax, and is caused by a
question of law, a second test is applied (under s 284-90(1)) as to whether the taxpayer’s
position is ‘reasonably arguable’. A taxpayer’s position is reasonably arguable if the
taxpayer’s treatment of the item giving rise to the shortfall amount is about as likely ‘to be
correct as incorrect, or is more likely to be correct than incorrect’ (TAA s 284-15), having
regard to the relevant authorities.
Section 298-20 provides the Commissioner of Taxation with power to remit the whole or part
of the penalty tax imposed for a false or misleading statement. In particular, a remission of
penalties may be made where an isolated book keeping error was made, the mistake was
unintended and the taxpayer had a good compliance history. See solution to Question 250
above.
In addition to the above penalty, the Commissioner may impose a ‘Shortfall Interest Charge’
penalty under TAA Sch 1 Subdiv 280-B and an interest penalty under TAA Sch 1 s 298-25
based on the general interest charge (TAA s 8AAA to 8AAH). Also pursuant to TAA Sch 1 s
298-10, the Commissioner is required to give written notice to the taxpayer of the penalty and
the reasons for it.
336
Based upon the fact that it had made an incorrect claim, Echo could make a voluntary
disclosure of the error to the Commissioner of Taxation. TAA Sch 1 s 284-225 provides for
an 80% reduction of the penalty tax applicable, where the taxpayer notifies the Commissioner
of Taxation in writing of the error before being informed of a tax audit.
[¶30-252] Solution 252

Penalty tax
If there was no disclosure of the error, a penalty would apply based on the shortfall amount
caused by the lack of compliance with the law. See solution to Question 251 above.
In addition, an interest penalty based on the ‘shortfall interest charge’ would be payable
under TAA Sch 1 Subdiv 280-B. The penalty, which is 4% lower than the general interest
charge, commences from the day of the original assessment to the day before the assessment
is amended.
A further penalty of a general interest charge under TAA s 8AAB is payable commencing on
the day the taxpayer receives the amended assessment. The Commissioner is required under
TAA Sch 1 s 298-10 to give the taxpayer written notice of the penalties and reasons for them.
Alternatively, the Commissioner may prosecute under TAA s 8K. For a company the penalty
which may be imposed under this Act is calculated as five times the maximum fine that could
be imposed on a natural person (TAA s 8ZF).
The Taxation Administration Act 1953 also allows a jail sentence to be imposed on company
officers and managers who are guilty of committing such an offence (TAA s 8Y). However,
the use of such provisions is rare, and usually relates to a situation of substantial evasion of
tax where the Commissioner wishes to record a criminal conviction against the taxpayer.
In considering the potential scope of s 8K, it is also necessary to take into account the
provisions of the Criminal Code Act 1995 (Cth) (the Criminal Code), in particular, the aiding
and abetting provisions at s 11.2.
[¶30-253] Solution 253

Amended assessments; penalties
The Commissioner may amend an assessment at any time where the taxpayer has avoided tax
and the avoidance is due to fraud or evasion (ITAA36 s 170(1)). Where the avoidance is not
due to fraud or evasion, then the Commissioner can amend an assessment within four years
after the day on which the Commissioner gives notice of assessment to the taxpayer (s
170(1)). This four-year period may be extended where the Commissioner applies to the
Federal Court for the period to be increased. This may occur where the Commissioner has
already begun an investigation into the taxpayer’s affairs and the investigation has not been
completed, or if the taxpayer agrees to an extension of time.
337
Note: There is a two-year amendment period for individual resident taxpayers with no
complex tax affairs (s 170(1)). Whether Joe Robinson comes into this category is determined
by the criteria set out in Solution 245.
As part of the amended assessment, the Commissioner of Taxation may impose penalties
caused by the tax shortfall under Div 284 of the TAA. See solution to Question 251 above.
[¶30-254] Solution 254

Private rulings; penalties
Under TAA Sch 1 s 359-10 Wyseco may apply for a private ruling from the Commissioner of
Taxation as to how the income tax law applies to the transaction. An application may be in
respect of a transaction that has been carried out, is being carried out, or is proposed (s 359-
25). (See CTC Resources NL v FC of T 94 ATC 4072.)
The application for a private ruling must be made in a form approved by the Commissioner.
It should provide such information and such documents as are required by the Commissioner
(s 359-35).
Where the Commissioner has received an application, s 359-35 requires the Commissioner to
comply with the application, although s 357-105 allows the Commissioner to request further
information where necessary to enable a ruling to be given.
Where the ruling is favourable, the taxpayer would not need to disclose the amount as
income. If the taxpayer receives a ruling which states that the amount is assessable and the
taxpayer disregards it there is no penalty for not complying with the private ruling.
If Wyseco is dissatisfied with a private ruling, TAA s 14ZW allows the taxpayer to object to
it. Subsection 14ZW(1A) states that the objection must be lodged before the end of:
•
the 60-day period after notice of the ruling is received by the rulee, or
•
the four-year period after the last day allowed to the rulee for lodging a return in relation to
the year of income to which the ruling relates (where the taxpayer does not have complex
affairs, such as a small business entity, the time is reduced to two years), whichever is later.
[¶30-255] Solution 255

Private rulings
The circumstances in which a taxpayer may apply for a private ruling are set out in TAA Sch
1 Div 359. Schedule 1 s 359-5 states that the Commissioner may, on application, make a
written ruling on the way in which the Commissioner considers a relevant provision applies
in relation to a particular scheme. A scheme is defined very broadly under ITAA97 s 995-
338
1(1) as any arrangement, or any scheme, plan or proposal, action course of action or course of
conduct. TAA Sch 1 s 359-10 states that the ruling must be in the approved form (a standard
form is available from the ATO website).
The taxpayer or their agent may make a private ruling request in respect of a current or future
transaction. However, in making a request for a ruling it is important that the taxpayer
discloses all the relevant circumstances relating to the scheme otherwise the ruling provided
may be invalid or the Commissioner may seek extra information which may delay the issue
of the ruling.
Once a private ruling is made the Commissioner is then required to notify the applicant of the
ruling. This may be in written form or electronically. In providing a private ruling TAA Sch 1
s 359-20 states that the ruling must state that it is a private ruling and indicate the parties to
whom it applies. It must also specify the relevant scheme and the relevant provision to which
it applies.
While the Commissioner must make a ruling in response to a request TAA Sch 1 s 359-35
provides that he may decline to do so if the ruling may prejudice or unduly restrict the
administration of the tax law or the matter sought to be ruled on is already being considered
by the Commissioner. Where this occurs the Commissioner is required to notify the taxpayer
of the reasons why the ruling request has been denied.
Where the private ruling is unfavourable, TAA Sch 1 s 359-60 states that the taxpayer may
object to the ruling in accordance with the normal objection procedures contained in TAA Pt
IVC. However, this does not apply where an assessment has been issued relating to the same
period to which the ruling relates.
While a private ruling may address the taxpayer’s uncertainty as to whether the expenditure
on the machinery may be claimed as a repair, the question arises as to whether seeking a
private ruling is an appropriate course of action. Certainly if the ruling request is favourable
this would justify the application. However, if the request is unfavourable then the taxpayer is
faced with the question of whether they should pursue the matter further through the appeals
process.
Another problem arises where a ruling has not been issued by the time the taxpayer is
required to lodge their tax return for the year and the taxpayer is affected by the matter
relating to the ruling request. Where this occurs then a decision will need to be made as to
how the matter should be treated. Where the taxpayer has not received a response within 60
days of the application for the ruling s 359-50 enables the taxpayer to provide a written
request for a ruling to be made. The 60-day period may be extended if the taxpayer is
requested to provide further information or other factors outlined in s 359-50(2) apply. This
may not provide much comfort to a taxpayer who is left not knowing how the issue should be
treated in the return if the time for lodgement passes before a ruling request is received.
The other possibility would be for the taxpayer to make a judgment on the issue, and where
appropriate claim the expenditure on the repair as a deduction pursuant to ITAA97 s 25-10.
However, if the taxpayer receives an amended assessment due to the Commissioner taking a
different view on the matter, they may be liable for a tax shortfall penalty under TAA Sch 1
Div 284. In this case it would be necessary for the taxpayer to demonstrate that they had
taken reasonable care in coming to such a decision (or where appropriate that they had a
339
reasonably arguable position on the matter). Where there was a lack of reasonable care, or the
lack of a reasonably arguable position, s 284-90 states the tax shortfall penalty would be 25%
of the tax shortfall.
[¶30-256] Solution 256

Amended assessment
Initially, Harris may seek to obtain the reason for the amended assessment from the ATO
which dealt with her return.
There is some precedent to indicate that there should be a disclosure of the reasons as to how
the Commissioner exercised his administrative power (Bailey v FC of T 77 ATC 4096). The
courts have also indicated that the Commissioner may be required to provide the taxpayer
with details of the assessment and those documents which are needed for the taxpayer to
prepare his or her case (Robinson v DFC of T 84 ATC 4277).
Harris could consider using the freedom of information legislation to gain access to her tax
return. The decision in Murtagh v FC of T 84 ATC 4516 indicates that it may be possible for
her to gain access to the records relating to her tax return. In that case, the taxpayer sought a
review of the Commissioner’s refusal to provide the taxpayer with information relating to her
tax return. The AAT held that disclosure of the information would not affect the ATO, the
document was not exempt from disclosure and was not subject to legal privilege.
In Walker v FC of T 95 ATC 2001, a group of taxpayers was able to gain access to ATO file
notes under the Freedom of Information Act 1982 (Cth) relating to various tax officers’
consideration of the relevance of various provisions of the Income Tax Assessment Act 1936
(Cth) to the taxpayers’ situation. The AAT concluded that the Act and its interpretation are
matters of public interest and it cannot be contrary to public interest to disclose the views of
ATO officers on the application of the law to facts leading to an assessment.
While the taxpayer may be entitled to internal working papers of the ATO in situations where
the case turns on documents which contain purely factual information (Murtagh’s case and
Walker’s case), the AAT may take a different view where the case involves an investigation
of tax avoidance or evasion (Re Kingston Thoroughbred Horse Stud & ATO 86 ATC 2030).
Where the taxpayer seeks a review of the decision by the AAT, the AAT may convene a
preliminary conference between the taxpayer and a representative of the ATO in order to
clarify and, if possible, resolve the matter. If the matter is not resolved then the
Commissioner is obliged under TAA s 14ZZF to lodge with the AAT:
•
a copy of the reasons for the objection
•
the assessment notice, and
•
any document which is necessary for the review of the decision.
340
[¶30-257] Solution 257
Amended assessment; appeals; penalties
(1) Action Lee may take in respect of the
amended assessment
Under TAA s 14ZW, Lee has four years after the service of the original assessment to lodge
an objection with the Commissioner in respect of the amended assessment, or 60 days after
service of the notice of the amended assessment, whichever is the later. In this case the date
of the original service provides a longer time to lodge an objection.
Where an assessment is served on the taxpayer by post, it is deemed to be served on the

taxpayer at the time it would be delivered in the ordinary course of mail deliveries. If the
original assessment dated 6 November 2018 is received in the ordinary course of mail
deliveries on 7 November 2018, the four-year time limit commences on 8 November 2018,
the day after service. Therefore, Peter would have until 7 November 2022 to lodge an
objection. However, TAA s 14ZW provides that a taxpayer may request an extension of time
for the lodgement of an objection where the relevant time period has expired. Practice
Statement PS LA 2003/7 outlines some of the relevant factors that will be considered in
granting an extension.
This will involve such matters as:
•
the reasons for the delay, such as the taxpayer being ill or overseas
•
the circumstances of the delay
•
whether the taxpayer has an arguable case
•
evidence of negligence by the taxpayer, and
•
any prejudice to the taxpayer by giving an extension.
If the taxpayer is a taxpayer with no complex affairs (see ITAA36 s 170(1)), then the
objection period is reduced to two years. However as Lee is not a SBE taxpayer he would not
qualify under these provisions. See solution to Question 245 above.
It should be noted that TAA s 14ZV provides that Lee may only object to matters contained
in the amended assessment.
(2) Other action available to the

Commissioner of Taxation
341
The following penalties may be applied:
•
interest penalties based on the shortfall interest amount and a general interest charge (see
TAA Sch 1 Subdiv 280-B and s 8AAA to 8AAH), and
•
penalties based on the shortfall amount (TAA Sch 1 s 284-80).
The actual penalty imposed will depend on the amount of the shortfall and the reason for it.
For example, where the shortfall was due to the taxpayer’s lack of reasonable care the penalty
is 25% of the shortfall amount (TAA s 284-90). However, if the shortfall amount was due to
any of the following reasons, the penalty under s 284-90 would be:
•
intentional disregard of law—75% of the shortfall amount
•
recklessness—50% of the shortfall amount, or
•
no reasonably arguable position—25% of the shortfall amount.
Where the Commissioner imposes penalties TAA Sch 1 s 298-10 requires the Commissioner
to provide the taxpayer with written notice of the penalties and the reason for them.
[¶30-258] Solution 258

Tax file numbers
Edwards is not required to provide a tax file number (TFN). If she does not quote a TFN to
her employer on a TFN declaration form, the employer must withhold tax from her salary at
the top marginal rate of tax (ie 45% + Medicare levy). The employer must give Edwards 28
days’ notice to quote the number.
If the tax file number is not provided within 28 days, tax must be withheld by the employer at
the top marginal rate (ITAA36 s 202CB).
Following the receipt of the taxpayer’s tax file number, MTV Ltd must include it on
Edwards’ payment summary.
[¶30-259] Solution 259

PAYG withholding; personal services
income
342
The PAYG system applies to certain payments, and in particular payments for work or
services. It replaces the former provisional tax regime. The relevant provisions are contained
in the TAA Sch 1 Pt 2-5 (s 10-1 to 20-80).
Under these provisions, Space Room Ltd is required to withhold an amount from payments
made to Carzo if he receives a salary, wage or commission as an employee. While the term
‘employee’ is a common law concept, Taxation Ruling TR 2005/16 indicates that the term
‘employee’ has its ordinary meaning. Whether a person is an employee is a question of fact
and should be determined by the circumstances and especially key indicators based on case
law.
No one indicator is determinant of the outcome. Rather it is a matter of considering all the
factors and the totality of the relationship between the parties. Some of the indicators are:
1.
Control by the person who engages another person to perform the work.
2.
Whether the worker operates on their own account or in the business of the payer.
3.
The result test—where the substance of the contract is to produce a result, it is likely to be
evidence of a non-employee relationship.
4.
The risk factor—where the individual bears little or no risk associated with the work, they are
likely to be an employee.
5.
Where the individual is provided with the tools and equipment to perform the tasks, they are
likely to be an employee.
The ruling also indicates that a person who holds an ABN may be considered an employee.
The ruling states that the payer does not need to have regard to the personal services income
measures in ITAA97 Pt 2-42 in determining whether an individual is an employee. An
example of where an individual is an employee is where a master/servant relationship exists,
ie where the person providing the labour is under the control and direction of the person
engaging the services. (See World Book Australia Pty Ltd v FC of T 92 ATC 4327; Deluxe
Red and Yellow Cabs v FC of T 98 ATC 4466; Hollis v Vabu Pty Ltd 2001 ATC 4508;
Commissioner of Pay-roll Tax (Vic) v Mary Kay Cosmetics Pty Ltd 82 ATC 4444.)
If Carzo is regarded as an employee of Space Room Ltd, TAA Sch 1 s 12-35 requires Space
Room Ltd to withhold an amount from the salary or wages which it pays to him. The amount
required to be withheld is determined under TAA s 15-10 by reference to the withholding
schedules under TAA s 15-25 and the relevant regulations. In the case of salaries and wages
this is based on progressive tax rates. If no TFN is provided, the rate of tax to be deducted is
47% (being the top marginal rate of 45% plus Medicare Levy of 2%).
If Carzo is not an employee, but rather receives the payment as a payment for a supply as a
result of an enterprise carried on in Australia, then under TAA s 12-190 Space Room Ltd will
not be required to withhold any amount where Carzo has provided Space Room Ltd with a
tax invoice for the supply which contains his ABN. If Carzo does not provide a tax invoice
and ABN, tax must be withheld at the 47% rate.
343
[¶30-260] Solution 260
Objections; appeals
(1)
Under the provisions of TAA s 14ZU and 14ZW, if Sophie wishes to object to the assessment
she must object in writing to the Commissioner within two years after service of the notice of
the original assessment, or 60 days after service of the notice of the amended assessment,
whichever is the later. In this respect the two-year period provides a longer objection time.
However, if Sophie is a taxpayer with complex tax affairs (ITAA36 s 170(1)) this is increased
to four years.
The objection should state fully and in detail the grounds on which she wishes to object to the
assessment (TAA s 14ZU).
Where an assessment is served on the taxpayer by post it is deemed to be delivered to the

taxpayer at the time it would be delivered in the ordinary course of mail. However, the period
for objection excludes the day on which it is delivered. Assuming that the original assessment
received on 16 October 2019 was regarded as having been duly received in the ordinary
course of mail, the first day of the objection period would be 17 October 2019 and Sophie
would have until 16 October 2021 if she is a taxpayer with no complex tax affairs (see
ITAA36 s 170(1)) or 16 October 2023 to lodge her objection to the assessment. Where the
date for objection falls on a Saturday, Sunday or public holiday, the next working day is
taken to be the due date.
Since the assessment is an amended assessment Sophie may object to the amended
assessment within the later of 60 days after receipt of the amended assessment (which is 4
December 2019) or two years (if a taxpayer with no complex affairs) after the receipt of the
original assessment. In this case, the later time limit is 16 October 2021 (if she is a taxpayer
with no complex affairs) or 16 October 2023 (if she is a taxpayer with complex affairs).
It should be noted that s 14ZW allows the Commissioner to grant an extension of time for the
lodgement of an objection. Practice Statement PS LA 2003/7 provides some guidelines as to
the relevant factors to be considered in granting extra time.
This will involve such matters as:
•
the reasons for the delay, such as the taxpayer being ill or overseas
•
the circumstances of the delay
•
whether the taxpayer has an arguable case
•
evidence of negligence by the taxpayer, and
•
any prejudice to the taxpayer by giving an extension.
344
(2)
Where the notice is sent to the previous address it would still be deemed to have been
delivered to Sophie in the ordinary course of mail if Sophie had not notified the ATO of her
change of address. (See ITR36 reg 39.)
Consequently the same time period as above applies, ie Sophie would need to lodge an
objection by 16 October 2021 (or 16 October 2023). However, the Commissioner may, under
TAA s 14ZX, extend the time period for an objection. Therefore, Sophie should lodge the
objection with the Commissioner together with a written application for an extension of time.
The application should contain details of reasons why the objection was not lodged by the
due date (s 14ZW).
Practice Statement PS LA 2003/7 contains an outline of the factors that may be considered
by the Commissioner in extending the objection period. As outlined above these include the
reasons for the delay, such as illness, absence overseas, and whether the taxpayer had an
arguable case. If Sophie is dissatisfied with the Commissioner’s decision on the extension of
time request, then s 14ZX(4) allows her to ask the AAT to hear the matter. This application
must be made directly to the Tribunal and be accompanied by an $920 application fee.
Where the amount in dispute is less than $5,000, the matter will be heard by the Small
Taxation Claims Tribunal (in this case, the application fee is $91).
[¶30-261] Solution 261

Commissioner’s rights of access
The taxation officer would be seeking right of access under TAA53 s 353-10 and s 353-15.
Provided the taxation officer is duly authorised by the Commissioner (s 353-15(2)) that
officer is entitled to full and free access to all buildings, places, books, documents, and other
papers for the purposes of the Act (s 353-15(1)). However a number of principles developed
from recent cases concerning the operation of ITAA36 s 263 (currently TAA53 s 353-15)
have established that:
1.
ITAA36 s 263 (now TAA53 s 353-15) did not allow the removal of items from the taxpayer’s
premises. The Commissioner or his duly authorised officers may make copies of relevant
documents (Note: by analogy to ITAA36 s 263, it is understood that TAA53 s 353-15 does
not confer any statutory power to an ATO auditor to seize or remove any materials from a
person’s premises other than taking samples and the like).
2.
The authority to enter a taxpayer’s premises may be evidenced by a ‘wallet card’ which
indicates that the bearer is an authorised tax officer and able to exercise all the powers under
ITAA36 s 263 (now TAA53 s 353-15).
3.
A tax officer is not able to enter a taxpayer’s premises if they do not produce to the occupier
authorisation as required under ITAA36 s 263 (now TAA53 s 353-15).
4.
345
The taxation officer can access a taxpayer’s premises without prior warning. However, in
normal situations where there is no fear of documents being removed or altered, notification
would normally be expected of the request for access.
5.
ITAA36 s 263 (now TAA53 s 353-15) enables the taxation officer to undertake a roving
inquiry and access any relevant information believed relevant to the inquiry.
6.
Access under ITAA36 s 263 (now TAA53 s 353-15) enables the officer to gain access to
passwords, etc., to enable access to electronically-stored information.
7.
In limited situations the taxpayer may be able to claim legal privilege in respect of certain
documents.
8.
The occupier of the premises is required to give the taxation officers facilities and assistance
for the purpose of the exercise of powers under the section.
ITAA36 s 263 (now TAA53 s 353-15) overrides the contractual or fiduciary duties of
confidentiality that a tax agent has to his or her client. Provided the taxation officer has given
a clear statement that his or her visit is for ‘a purpose under the Act’ (‘for the purposes of a
taxation law’, as in TAA53 s 353-15(1), the tax agent is obliged to provide the officer with
‘all reasonable facilities and assistance’ for the effective exercise of powers under s 263 (s
263(3)) (TAA53 s 353-15(3)).
It is unlikely that ITAA36 s 263 (now TAA53 s 353-15) permits access to documents that are
subject to legal professional privilege unless the taxpayer has waived that privilege. In the
case of JMA Accounting Pty Ltd v Carmody 2004 ATC 4916, it was held that in determining
whether legal privilege applied to a document, it may be appropriate for a tax officer to look
at the document in order to determine whether legal privilege applied and whether it may be
copied.
The taxation officer is not obliged to forewarn anyone of a pending visit (see FC of T v
Citibank Ltd 89 ATC 4268; Allen, Allen and Hemsley v DFC of T 89 ATC 4294) and the tax
agent cannot use lack of notice as a defence against complying with the requirements of
ITAA36 s 263 (now TAA53 s 353-15). The positive cooperation of the occupier of the
building is mandatory. Nevertheless the tax agent should refrain from volunteering
information.
If information is not forthcoming under s 263, s 264 (now TAA53 s 353-10 and s 353-15)
gives the Commissioner power to require persons to provide information and evidence and
produce documents. Section 264 (now TAA53 s 353-10) does, however, require written
notice and provision of reasonable time for compliance with that notice. (Ganke v DFC of T
(No 1) 75 ATC 4097. See also FC of T v ANZ Banking Group Ltd 79 ATC 4039; (1979) 143
CLR 499; Perron Investments Pty Ltd v DFC of T 89 ATC 5038; FC of T v Coombes (No 2)
99 ATC 4634.)
In Perron Investments Pty Ltd v DFC of T 89 ATC 5038, the Full Federal Court confirmed
that s 264 (now TAA53 s 353-10) was subject to legal professional privilege. Nevertheless, s
264 gives the Commissioner very wide powers to access information (Deloitte Touche
Tohmatsu v DFC of T 98 ATC 5192).
346
The Commissioner has issued the ‘Taxpayers’ charter—fair use of our access and
information gathering powers’ and also an ‘Access and Information Gathering Manual’
which outlines the Commissioner’s views and practice relating to access to information.
In the Manual the Commissioner states that there are three main kinds of accountants’
documents namely:
1.
Source documents such as those prepared in the recording of a transaction, this would include
ledger accounts, journals.
2.
Non-source documents such as current audit files.
3.
Restricted source documents such as advice papers given by the accountant on past or current
transactions.
The Commissioner has indicated that he will always seek access to source documents
pursuant to his powers under s 263 (now TAA53 s 353-15). However, in the case of non-
source documents, access would only be sought where there is fraud or evasion or some
illegal activity which is suspected. In the case of restricted source documents the
Commissioner has indicated that he would not seek access other than in exceptional
circumstances.
In White Industries Australia Ltd v FC of T 2007 ATC 4441, the taxpayer sought to challenge
the ATO from gaining access to certain accounting documents. It was held that such a right
of challenge was available under the Judiciary Act 1903 (Cth) s 39.
[¶30-262] Solution 262

Self-assessment
(1)
Since the land was acquired before 20 September 1985, the profit on the sale of land would
not come within the CGT provisions. However, regard should be given to ITAA97 s 15-15.
Because the land was acquired for the purpose of future expansion and the disposal of the
land was by a single sale, it is not likely to be a profit arising from the carrying on or carrying
out of a profit-making undertaking or plan (Elsey v FC of T 69 ATC 4115; McClelland v FC
of T 70 ATC 4115).
However, on the basis of the decision in FC of T v The Myer Emporium Ltd 87 ATC 4363, it
may be argued that the profit on the sale is assessable under ITAA97 s 6-5(2). This argument
derives from the comment in Myer Emporium that, where a profit arises from the sale of
property which is disposed of in the ordinary course of business, or where the purpose of
entering into the transaction is to make a profit, the profit is assessable. This view is given
support by Taxation Ruling TR 92/3.
In order for Polymer to show that the profit is not assessable under s 6-5(2), it would need to
prove that the sale of land was not part of its ordinary business operations, and that there was
347
no profit-making purpose at the time the company decided to dispose of the land. In this
respect, the objective evidence would be examined to establish the taxpayer’s purpose.
Insofar as the land was sold to overcome a liquidity problem, Polymer may be able to argue
successfully that there was no profit-making purpose involved at the time of disposal.
(2)
If Polymer is unsure as to what course of action it should take, it could ask for a private ruling
from the Commissioner on the matter. Section 359-10 enables a taxpayer to apply for a
private ruling on the way in which the taxation law applies to a particular transaction or
arrangement.
Where a ruling is given, the Commissioner takes this to be the correct interpretation of the
law. While there is no longer a shortfall penalty for non-compliance with a private ruling
under TAA Sch 1 Div 284, the Commissioner may issue an amended assessment in respect of
the profit to include the amount as income. Also penalties may be imposed by way of a
shortfall interest charge and general interest charge (see TAA Sch 1 Subdiv 280-B and s
8AAA to 8AAH).
(3)
Where Polymer has sought a private ruling which indicates that the profit is not taxable, there
is no need to disclose the profit. However, if Polymer has received a private ruling from the
Commissioner which indicates that the profit is assessable income, Polymer will need to
decide whether the amount should be disclosed as income. Where the taxpayer disregards a
private ruling there is no longer a penalty under the tax shortfall provisions in TAA Sch 1 Div
284. However, the taxpayer may still receive an amended assessment in respect of the
contentious item as the Commissioner may choose to include the profit made as assessable
income.
Where the taxpayer has sought a private ruling which has not been received by the time the
taxpayer must lodge its final tax return, at which time it self-assesses its income under the
self-assessment provisions in ITAA36 s 166A, the taxpayer may choose not to include the
amount as income. If the taxpayer subsequently receives an amended assessment which
included the amount as income, the taxpayer may be subject to penalties of a ‘shortfall
interest charge’ and a ‘general interest charge’ under the TAA (Sch 1 Subdiv 280-B and s
8AAA to 8AAH).
(4)
Where Polymer does not seek a ruling and does not disclose the profit as income, the
Commissioner may, if he considers that the profit is income, issue an amended assessment
(ITAA36 s 170(1)).
The penalty will depend on whether the shortfall amount exceeds the higher of $10,000 or
1% of the return tax, or resulted from a dispute over a question of fact. If either of these
conditions applies, Polymer would need to demonstrate that it had taken ‘reasonable care’ in
coming to the conclusion that the profit was not assessable. The reasonable care test requires
a taxpayer to reach a conclusion that a reasonable, ordinary person would be likely to have
reached in the circumstances of the taxpayer. TAA Sch 1 s 284-90 provides that if reasonable
care is not exercised, a penalty of 25% of the shortfall amount will apply. Where the taxpayer
has not taken reasonable care and the non-disclosure was due to the taxpayer’s recklessness
348
or intentional disregard of the law, a penalty of 50% and 75% of the shortfall would apply
respectively (s 284-90).
Where the shortfall amount exceeds the higher of $10,000 or 1% of the income tax, and is
caused by a dispute over a question of law, Polymer must be able to prove that the position it
adopted was reasonably arguable. A position is reasonably arguable if having regard to the
relevant authorities and the matter in relation to which the law is applied, it would be
concluded that what is argued for is ‘as likely to be correct as incorrect or is more likely to be
correct than incorrect’ (TAA Sch 1 s 284-15).
Miscellaneous Taxation Ruling MT 2008/2 outlines some of the possible indicators of a

reasonably arguable position. The Ruling states that the issue must be one which involves a
contentious area of law. Also the position adopted must be reasonably defensible in a court of
law.
Where the taxpayer’s position is not reasonably arguable, TAA Sch 1 s 284-85 enables the
Commissioner to apply a penalty of 25% of the shortfall amount (s 284-90).
Polymer may also be liable for payment of interest based on the shortfall interest charge and
the general interest charge where the assessment is amended to increase the amount of tax
payable (see TAA Sch 1 Subdiv 280-B and s 8AAA to 8AAH).
Where penalties are applied the Commissioner is required to give the taxpayer written notice
of the penalties and the reasons for them (TAA Sch 1 s 298-10).
[¶30-263] Solution 263

Tax agent’s liability
A tax agent who is negligent or in breach of contract may be sued at common law (see Sacca
v Adam 83 ATC 4326; Markham v Lunt 84 ATC 4010).
The facts given in the question are similar to the situation in Markham v Lunt. From the
judgment of Pidgeon J in Markham’s case, Tony and his firm have been negligent by failing
to lodge Alan’s taxation return in a manner which did not result in penalties being imposed. If
Tony was having difficulty in obtaining the information required to complete the preparation
of Alan’s tax return then it was his duty, as part of the contract, to apply to the Commissioner
for an extension of time to lodge the return. Alternatively, if no further extensions could be
granted, then Tony should have advised Alan that he was risking the imposition of penalties
unless he supplied the required information.
As the question does not suggest that either of the above events occurred, Tony and/or his
firm are liable for the civil damages sustained by Alan. The damages would be the amount of
any additional tax, penalty and general interest charge imposed by the Commissioner.
Alan’s claim for damages for the additional tax, penalty and interest penalties (the shortfall
interest charge and general interest charge) imposed as a result of the omission of $25,000 of
consulting income from his return will depend upon whether Tony was negligent in the
349
omission of the income. By signing this return Alan has declared that he has disclosed all his
income. If this statement is false, Alan is liable for any penalties that are imposed by the
Commissioner. However, if the error has arisen as a result of his tax agent’s negligence, Alan
has a right to damages under common law. The damages would be the loss sustained by Alan
(see Walker v Hungerfords 88 ATC 4920).
Alan’s claim for damages for losses incurred from entering into a tax minimisation
arrangement is more difficult to sustain. Provided that the tax agent has exercised due care
and skill in the advice given to Alan in respect of the tax arrangement and communicated the
risks involved, then Alan knew of the risks and of the possibility that a deduction would be
denied. In these circumstances Alan, with full knowledge of the risks involved, made the
decision to enter the arrangement and cannot therefore obtain damages from his tax agent
merely because the attempt to obtain a tax advantage was unsuccessful (Markham v Lunt 84
ATC 4010; Doug Sim Enterprises Pty Ltd v Patrick Wan & Co 88 ATC 4078).
[¶30-264] Solution 264

Tax audit and penalties
(1)
By including the item of expenditure in his tax return without making reasonable enquiries as
to the deductibility of the expenditure, such as consulting a tax adviser, the ATO or a
reference text, Tom is not deemed to have taken reasonable care to comply with the
requirements of TAA Sch 1 s 284-75(1).
Consequently, a penalty of 25% of the shortfall amount could be applied (TAA Sch 1 s 284-
90), and interest penalties for late payment of tax may also be imposed. The interest penalty
is based on the ‘shortfall interest charge’ and ‘general interest charge’ (see TAA Sch 1
Subdiv 280-B and s 8AAA to 8AAH). However, where the tax shortfall is due to a false or
misleading statement the Commissioner may remit the penalty (see solution to Question 251).
Where penalties are imposed the Commissioner is required to notify the taxpayer of them and
the reasons for them (TAA Sch 1 s 298-10).
(2)
Where a taxpayer voluntarily discloses to the Commissioner part or all of a shortfall once an
audit has commenced, the 25% penalty attracted by the taxpayer’s actions will be reduced by
20% (ie to 20%), provided that the taxpayer’s disclosure is in writing and the disclosure saves
the Commissioner a significant amount of time (TAA Sch 1 s 284-225).
(3)
Section 284-90 allows the Commissioner to impose a penalty of 25% of the shortfall amount
because Tom failed to take reasonable care to comply with the Act before lodging his return.
However, the application for a private ruling in relation to the transaction can be taken to
mean that the taxpayer has voluntarily disclosed to the Commissioner all or part of the
shortfall amount before an audit.
350
As the shortfall amount is greater than $1,000, the penalty of 25% under s 284-225(3) is
reduced by 80%. If the shortfall amount had been less than $1,000, no penalty would have
been attracted.
[¶30-265] Solution 265

Self-assessment; repairs
(1)
Although the company may wish to claim a deduction under ITAA97 s 8-1(1) or 25-10, it is
not likely that it would be successful.
While the expenditure may satisfy s 8-1(1), it is likely to be excluded by s 8-1(2)(a) as being
of a capital nature. Also, the expenditure would not satisfy s 25-10 since the resurfacing and
strengthening of the floor would be regarded as capital in nature (FC of T v Western Suburbs
Cinemas Ltd (1952) 86 CLR 102). However, Exco Ltd may be able to claim a 2½% pa
deduction pursuant to Div 43 on the cost of the capital expenditure on the improvement to the
building. The deduction would be 49/365 × $250,000 × 2½% = $839 in the 2018/19 tax year.
If Exco was unsure of the deductibility of the expenditure, TAA Sch 1 s 359-10 would allow
Exco to apply for a private ruling on the matter. However, if a private ruling is received
which denies the deductibility of the expenditure, and Exco claims a deduction, it may be
subject to an amended assessment and penalty of a ‘shortfall interest charge’ and a ‘general
interest charge’. There is no longer a penalty under TAA Sch 1 Div 284 based on a tax
shortfall for not complying with a private ruling.
(2)
Because Exco claimed the amount of the expenditure as a deduction and subsequently
received an amended assessment which disallowed the deduction, penalties may be imposed
by the Commissioner.
Where the taxpayer has not taken reasonable care, s 284-90 provides that a penalty of 25% of
the shortfall amount (ie $250,000 − $839 × 30% × 25% = $18,687) could be imposed (in
addition to interest penalties based on the ‘shortfall interest charge’ and ‘general interest
charge’ under TAA Sch 1 Subdiv 280-B and s 8AAB). The application of such a penalty
would depend on whether the taxpayer had exercised the care that a ‘reasonable ordinary
person’ would be likely to have exercised in the circumstances of the taxpayer to fulfil the
taxpayer’s tax obligations (see Miscellaneous Taxation Ruling MT 2008/1).
Consequently, it is necessary to determine whether the taxpayer would have foreseen the
probability of a shortfall amount arising from such a claim. The taxpayer’s knowledge of the
law and level of expertise are relevant in determining whether reasonable care has been
exercised.
If the tax shortfall occurs and the amount is greater than $10,000 or 1% of the taxpayer’s
income tax payable for the year then the taxpayer must have a ‘reasonably arguable position’
to support their actions. Failure to have a reasonably arguable position would result in a
penalty of 25% of the shortfall amount (see Miscellaneous Taxation Ruling MT 2008/2).
351
In this respect, a matter is reasonably arguable if, having regard to the relevant authorities,
that what is argued for is about as likely to be correct as incorrect, or is more likely to be
correct than incorrect (TAA Sch 1 s 284-15).
Where there is uncertainty in interpreting the law, the taxpayer must make reasonable
enquiries to resolve the issue. This would include gaining advice either from the ATO or a
professional tax adviser.

[¶30-266] Solution 266
Advice on disallowed claims
(1) Taxation assessor’s interpretation
•
Travel
Travelling expenses are deductible under ITAA97 s 25-100. A specific deduction is allowed
under s 25-100 for travel made between unrelated workplaces. This does not apply if one of
the workplaces is where the taxpayer resides. In this case, the travel was between work and
home. Travel of this type is private in nature and is not allowable (ITAA97 s 8-1(2)(b)). As
Susan was not on call 24 hours a day, the decision in FC of T v Collings 76 ATC 4254 would
not apply. (See FC of T v Payne 2001 ATC 4027.)
From a tax planning perspective it is preferable that the employer pays for the taxi travel as it
would be an exempt benefit under FBTAA s 58Z.
•
Decline in value
If Susan is to be entitled to a decline in value deduction, the computer must have been used to
produce assessable income. ITAA97 s 40-25 is not restricted to assets used to produce
business income and case law allows depreciation on assets used to produce salary income
(FC of T v Faichney 72 ATC 4245). (See FC of T v Payne 99 ATC 4391.)
If the computer is used in relation to work-related activities, then, to the extent to which the
computer is used for this purpose, a decline in value deduction should have been allowed.
•
Loss on sale of shares
If the shares were the only post-CGT asset disposed of during the year, the loss would be a
net capital loss. The net capital loss is not deductible but is carried forward and offset against
any future net capital gain (ITAA97 s 102-10(2)).
352
If in the same year there was a disposal of another post-CGT asset for a capital gain, then the
capital loss on disposal of the mining shares would be offset against the capital gain to
determine the net capital gain or net capital loss for the year (ITAA97 s 102-5; 102-10).
(2) Disputing the ATO decision

If Susan is dissatisfied with the assessment she may, within the later of
•
two years after service of the notice of original assessment, or
•
60 days after the service of the notice of the amended assessment,
•
lodge with the Commissioner a written objection stating fully and in detail the grounds of the
objection (TAA s 14ZU to 14ZW).
This objection must be signed by Susan or her authorised agent (TAA Sch 1 s 388-75).
The two-year period is increased to four years for individual resident taxpayers with complex
tax affairs. However, Susan would come within the provisions relating to taxpayers with no
complex affairs as contained in s 170(1) of the ITAA36.
(3) Time of payment

If the tax is unpaid by the due date, additional penalty tax is attracted based on the shortfall
interest charge and the general interest charge (TAA Subdiv 280-B and s 8AAA to 8AAH).
The Commissioner may in special circumstances remit the additional tax in whole or part (s
8AAG). The lodgement of an objection does not postpone or defer liability to pay the tax due
(TAA s 14ZZR), although TAA Sch 1 s 255-10 and 255-15 give the Commissioner power to
grant an extension of time to pay the tax or to permit payment by instalments.
In the light of the provisions mentioned above, Susan should arrange for the tax to be paid by
20 December 2019 rather than delay payment until her return to Australia.
[¶30-267] Solution 267

Powers to amend an assessment
ITAA36 s 170 sets out the Commissioner’s powers to amend assessments.
(1)
If the taxpayer made a full disclosure of all material facts when requesting a private tax
ruling, the Commissioner would be bound by the ruling. TAA s 357-60 provides that there
will be limited circumstances where the Commissioner of Taxation will be able to withdraw
an otherwise binding ruling.
(2)
353
The term ‘avoidance of tax’ in ITAA36 s 170(1) is interpreted widely to mean the taxpayer
has paid less tax than he or she should have paid.
In this case, tax avoidance is clearly present; but has there been ‘fraud or evasion’? Neither
term is defined in the Act. However, case law suggests that evasion occurs where there is an
intentional omission of income, while fraud involves both design and purpose to deceive.
Fraud occurs where a person makes a false statement or representation either knowing that it
is false or without a genuine belief in its truth.
Further information is required to determine whether the omission of an item of income from
a taxpayer’s return is evasion or fraud. If it involves either evasion or fraud then the
Commissioner can amend the assessment at any time (s 170(1)). If there is no evasion or
fraud, only avoidance of tax, then the Commissioner can amend the assessment within four
years from when the Commissioner gives notice of the assessment to the taxpayer (s 170(1)),
or within two years for an individual resident taxpayer with no complex affairs. Where the
taxpayer has entered into a scheme with a sole or dominant purpose of avoiding tax, the
period is four years.
(3)
The taxpayer may apply to the Commissioner in writing any time within two years, if the
taxpayer is one without complex affairs, or four years from the date upon which the tax
became due and payable and request the Commissioner to amend the assessment (s 170(5)).
Note that under s 170(5) the Commissioner’s power to amend the assessment is discretionary,
not mandatory. To preserve the taxpayer’s mandatory right he or she must lodge a signed
written objection within four years of service of the notice of assessment (TAA s 14ZU;
14ZW) (two years for individual resident taxpayers who qualify under s 170(1) as taxpayers
with no complex affairs).
[¶30-268] Solution 268

Objections to assessments; appeals
(a)
Under TAA s 14ZU a taxpayer may object to an assessment or amended assessment. The
objection must be in the approved form (TAA Sch 1 s 388-50) and be lodged with the
Commissioner within the period contained in TAA s 14ZW. It is also important that the
objection states in full detail the grounds relied on by the taxpayer. Section 14ZW provides
that the time limit for lodging an objection is generally two years after receipt of notice of the
original assessment or four years for taxpayers with complex affairs. In the case of an
amended assessment the time limit is two years or four years (for taxpayers with complex
affairs) from the date of service of the original assessment, or 60 days after service of the
amended assessment.
Therefore, if Design Architects Ltd is a taxpayer with complex affairs it would effectively
have the maximum time to object to the amended assessment, ie up to 3 December 2022.
354
Pursuant to s 14ZY the Commissioner must consider the objection and notify the taxpayer of
the outcome in writing. Section 14ZZ states that where the taxpayer is dissatisfied with the
decision they may apply to the Administrative Appeals Tribunal (AAT) for review. If the
amount of tax involved is less than $5,000 the taxpayer may appeal to the Small Taxation
Claims Tribunal. Alternatively, the taxpayer may apply to the Federal Court against the
decision. The objection must be made within 60 days after the service of notice of the
disallowance of the objection (s 14ZZN).
Where a further objection is made by the taxpayer against the Commissioner’s decision s
14ZZK and 14ZZP state that the taxpayer is limited, unless the court or tribunal allows
otherwise, to the grounds stated in the objection appeal. Furthermore, the burden of proving
that the assessment is excessive is placed on the taxpayer.
(b)
If the Commissioner’s objection decision is a reviewable objection decision, then Design
Architects Ltd can elect to take the matter to the AAT or Federal Court.
However, in deciding whether to appeal to the AAT or the Federal Court the following
factors should be considered.
Amount at issue and its importance

If there is a small amount at issue then it may be preferable to appeal to the AAT to avoid the
higher costs associated with an appeal to the Federal Court. However, even though the
amount at issue may be small an appeal to the Federal Court might be more appropriate
because of the legal issues to be decided. An example of this occurred in Payne v FC of T
2002 ATC 2025, and concerned whether rewards tickets issued under a frequent flyer
program constituted assessable income. In Payne’s case the matter went to court because of
the important legal issue relating to the taxpayer but also because of the large number of other
taxpayers who were affected by the decision.
Privacy
Appeals to the AAT are heard in private. However, all court hearings in relation to the appeal
are heard in public. This may be important where a taxpayer requires privacy.
Costs
The AAT is less formal and not bound by rules of evidence. Consequently a taxpayer may
represent themselves without legal counsel. However, if the taxpayer appeals to the court
then a barrister must be employed to present the taxpayer’s case. This can be very expensive.
Other costs to be considered are appeal application fees ($920 for companies appealing to the
AAT) compared to Federal Court fees for filing, setting down and hearing the matter. Federal
Court fees are considerably more expensive than AAT appeal application fees.
355
For an unlisted company, the filing fee (filing of a notice of appeal commencing an appeal
from a decision of the Administrative Appeals Tribunal) is $10,095 (as of 1 July 2018), the
setting down fee is $6,760 (Setting down for hearing a proceeding (including an application,
appeal, cross-claim or cross-appeal) or an issue in question in a proceeding) (as of 1 July
2018) and the daily hearing fee starts at $2,700 (as of 1 July 2018). The taxpayer will also
incur costs for their own legal representation on the issue.
Further consideration should be given to the possibility that the taxpayer may be unsuccessful
in their court appeal. The taxpayer is then likely to bear the opposing party’s costs of the
court proceedings as well as their own.
Rights of appeal
The taxpayer may only appeal to the Federal Court from a decision of the AAT on a question
of law. Where this occurs, the Federal Court may address the issue and make an order as it
wishes and affirm the decision, set it aside, or even refer the issue back to the AAT.
Where the Federal Court makes a decision which is unfavourable to the taxpayer that
taxpayer may appeal to the Full Federal Court where a question of law is involved. If this is
unsuccessful the taxpayer may then appeal, by special leave, to the High Court. The taxpayer
should be aware of all the direct court costs and the costs that may arise where the decision is
unfavourable.
Time
Where a matter is referred to the Federal Court the time taken for the matter to be decided
and judgment handed down may be in excess of two years. In comparison, the time taken to
receive a decision on an appeal to the AAT is much shorter.
[¶30-269] Solution 269

Objection and appeal
(1)
Under TAA s 14ZU and 14ZW, if Shah is a taxpayer with complex tax affairs (see ITAA36 s
170(1)), Shah has four years after service of the notice of assessment in which to lodge with
the Commissioner a written objection stating fully and in detail the grounds on which he
relies. Otherwise the time period is reduced to two years where Shah’s affairs are not of a
complex nature. As Shah is not self-employed and is not carrying on a business, the relevant
objection period is two years after the service of notice of assessment. Service of the notice of
assessment is deemed to be the time it would have arrived in the ordinary course of mail. The
two- or four-year period is computed exclusive of the day of service of the notice of
assessment (Acts Interpretation Act 1914, s 36(1)).
In Shah’s situation, the notice of assessment was dated 1 October 2019 and posted on 2
October 2019. If it is deemed delivered on 5 October, the first day of the two-year period is 6
356
October 2019, and the objection must be lodged by midnight on 5 October 2021. Where this
date is a Saturday, Sunday or public holiday, the objection must be lodged by the next
business day.
Claims disallowed
Home office—interest
As Shah is not self-employed and he is not carrying on a business from home, the
expenditure would not be deductible under ITAA97 s 8-1(1). Although, as an employee, he
may be required to complete work at home, it is likely the home office is maintained as a
matter of convenience rather than as a necessity. (See Handley v FC of T 81 ATC 4165; FC
of T v Forsyth 81 ATC 4157.) According to Taxation Ruling TR 93/30, the home office must
be a ‘place of business’ to be allowed both running and occupancy expenses. In Shah’s case
the home office is not a place of business, and only a portion of the running expenses are
eligible.
In these circumstances, his claim for a proportion of mortgage interest applicable to the home
office is unlikely to succeed.
Home office—contents insurance

If the equipment in the office is used by Shah to earn assessable income, normally a claim
will be allowable for depreciation, particularly if there is a requirement for him to use this
equipment in completing work for his employer after hours.
More details would be required as to whether the employee or employer owns the equipment
and who pays the insurance. If Shah owns the equipment and uses it for work-related
purposes, insurance of the equipment should be deductible under s 8-1(1).
Medical expenses
Medical expenses are not an allowable deduction.
Shah might be eligible for the means tested medical expense tax offset, which is available for
the cost incurred in obtaining disability aids, attendant care or aged care between 2015/16 and
2018/19. The percentage of net medical expenses that can be claimed would be determined
by Shah’s adjusted taxable income and family status. However, the net medical expenses tax
offset is being phased out and will be totally removed by 1 July 2019.
(2)
With respect to the 2017/18 year of income, Shah should include the omission as part of an
objection against his notice of assessment (TAA s 14ZU), and lodge it within the relevant
time limits under TAA s 14Z. Before making his written application, Shah should ensure that
the conditions for substantiation of his claim are satisfied.
(3)
357
Shah may appeal from the Administrative Appeals Tribunal (AAT) to the Federal Court only
on a ‘question of law’, not on a ‘question of fact’ (Administrative Appeals Tribunal Act 1975,
s 44(1)).
The matters discussed in this question are unlikely to raise any question of law, merely
questions of fact (ie what actually happened). Consequently, Shah would not have a right of
appeal to the Federal Court from an AAT decision.
It should be noted that where the amount of tax involved is less than $5,000, the matter would
be referred to the Small Taxation Claims Tribunal.
[¶30-270] Solution 270

Access by Commissioner
(1)
While the Commissioner’s power under TAA53 s 353-10 to require the provision of
information seems fairly broad, the power must be executed in a bona fide manner relating to
the assessment of a specific taxpayer (FC of T v Smorgon 77 ATC 4522; Perron Investments
Pty Ltd v DFC of T 89 ATC 4310; FC of T v Coombes (No 2) 99 ATC 4634).
In Perron Investments it was held that:
•
s 353-10 operates independently of TAA53 s 353-15
•
documents which are sought under s 353-10(1)(b) must relate to the assessment of a named
taxpayer
•
s 353-10(1) only relates to documents in existence, and
•
legal privilege may only be claimed by the taxpayer.
It would seem that, insofar as the documents sought relate to the determination of Expo’s
assessable income and are not likely to be protected by legal privilege, the Commissioner’s
claim would be a valid one.
Legal professional privilege can only be claimed for communications which have been
created for the dominant purpose of obtaining legal advice or in preparation of litigation
(Grant v Downs (1976) 135 CLR 674; Esso Australia Resources v FC of T 2000 ATC 4042;
FC of T v Pratt Holdings Pty Ltd 2005 ATC 4903).
A difficulty may arise from the fact that the documents sought are located offshore. However,
ITAA36 s 264A provides that an Offshore Information Notice may be served on a taxpayer
requiring the taxpayer to produce documents or information that are outside Australia and
that relate to the assessment of the taxpayer.
(2)
358
If Expo does not provide the information requested in the Offshore Information Notice, s
264A(10)(a)(i) provides that the information is not admissible in proceedings disputing the
taxpayer’s assessment. Consequently, failure to comply with the request for information may
mean that the Commissioner could issue an amended assessment (under ITAA36 s 170)
based on the information available to him and Expo would be unable to use the required
information to defend the assessment or amended assessment.
[¶30-271] Solution 271

Access by Commissioner
(1)
TAA53 s 353-15(1) provides that the Commissioner or any officer authorised by him shall at
all times have full and free access to all buildings, places, books, documents and other papers
for any of the purposes of the Act and, for that purpose, may make extracts from or copies of
any such books, documents or papers (see comments in Solution 261).
One of the main defences of Brobham & Co would be to claim legal professional privilege in
relation to the documents sought. On the basis of the decision in Grant v Downs (1976) 135
CLR 674 and Baker v Campbell 83 ATC 4606, legal professional privilege may be claimed
only where the sole purpose of the communication between the taxpayer and the legal adviser
is the provision of legal advice or for use in pending or anticipated litigation. However, in
Esso Australia Resources Ltd v FC of T 2000 ATC 4042, the sole purpose test has been
replaced by a dominant purpose test.
Since the documents in question were not provided by a legal adviser, but rather by an
accountant, it seems access to such documents could not be denied on the basis of legal
professional privilege. However, if some of the documents sought do not appear to relate to
the determination of the taxpayer’s income, access would not be justified. Therefore,
Brobham & Co may be able to argue that access to the advice relating to the three new road
construction projects and the restructuring of the corporate organisation is not within the
Commissioner’s powers under TAA53 s 353-15(1). In a recent case, FC of T v Pratt
Holdings Pty Ltd 2005 ATC 4903, it was held that legal privilege did not apply to documents
that had been prepared by an accountant and which were to be used as part of advice to the
lawyers of the taxpayer. The situation arose from circumstances where an accounting firm
was asked to prepare a valuation of assets to determine the amount of losses in the group. As
the accounting firm was only preparing a valuation report as part of advice to be given by the
taxpayer’s lawyer, the Commissioner argued that legal privilege did not apply. However, the
Full Federal Court held that legal privilege did apply because the documents were produced
as part of advice given to the taxpayer in order to determine what action should be taken with
their legal advisers on anticipated litigation.
The Commissioner of Taxation has released the ‘Access and Information Gathering Manual’
which outlines the Commissioner’s views and practice relating to access to information. The
manual states that:
359
tax officers will seek access to all source documents which record a transaction or
arrangement undertaken by a taxpayer, and
•
access to non-source documents and restricted source documents will only be claimed with
approval by the Deputy Commissioner where the source documents do not provide enough
information on a transaction.
Non-source documents include working papers on the audit file. Restricted source documents
include letters of advice which relate to transactions or arrangements, or other documents.
Based on these guidelines, the advice on the new road projects and the reorganisation would
come under the restricted source category and special circumstances would need to be present
to justify the Commissioner gaining access to the documents.
Another aspect of TAA53 s 353-15 which must be considered is that the occupier of a
building entered into by the Commissioner or his officers must provide all reasonable
facilities and assistance for the purpose of the section. This means that assistance with finding
the documents sought by the Commissioner must be provided. This may pose a dilemma for
the taxpayer or his agent—should the information be provided immediately, or should the tax
officers be given full and free access to search for the required documents, enabling the
officers to look at all the files held by the taxpayer or agent?
(2)
An administrative penalty may be imposed where an occupier of a building fails to provide
reasonable assistance to the tax officers seeking access under TAA53 s 353-15 (TAA Sch 1 s
288-35).
[¶30-272] Solution 272

Assessment; objection; freedom of
information; substantiation
Your letter to Ambrose should cover the following:
(1)
Is the assessment valid?
Has Ambrose furnished a return?
The main requirements relating to the lodgement of returns are contained in:
•
ITAA36 s 161 to 161AA, and
•
TAA Sch 1 s 388-85.
360
ITAA36 s 161 requires every person, if required, to furnish a return signed either by that
person (s 161(1)) or a duly authorised person (s 161(2)). Further, TAA Sch 1 s 388-50 states
that a return shall not be deemed to have been duly furnished to the Commissioner unless and
until the proper form, signed as required by the Act, has been received by an authorised
taxation official. The form must contain a declaration that any information in the document is
true and correct (s 388-60). Where such a document is lodged by the taxpayer’s agent, an
authorisation by the taxpayer allowing the agent to lodge the return and stating that the
information is correct, must be signed by the taxpayer (s 388-65).
As Ambrose has not signed the information, the information is not on the proper form and is
without the required declaration verifying the information, can the Commissioner validly
assess the taxpayer on the information provided, particularly as it is the general practice of
the ATO to reject incomplete returns?
Clearly Ambrose has not furnished a return within the meaning of the Act. However, the
Commissioner can use ITAA36 s 166 to make an assessment. Section 166 provides that the
Commissioner can make an assessment either from the return and other information in his
possession, or from one or more of these sources. Under s 166 the Commissioner can rely
entirely on other information to make an assessment. So it would appear that the assessment
is valid.
(2)
If the notice of assessment is valid, Ambrose has two years after service of the notice of
assessment to lodge a written objection with the Commissioner (TAA s 14ZW) if he is a
taxpayer with no complex affairs (ITAA36 s 170(1)). As the notice of assessment includes
the penalty tax, Ambrose can object both against the disallowance of the deductions and
against the penalty tax in one notice of objection, as both are treated as one assessment (TAA
s 14ZR).
(3)
Ambrose’s best approach to acquiring a copy of the information obtained by the ATO is to
use the Freedom of Information Act 1982. This Act gives members of the public rights of
access to official non-exempt documents of the Government of the Commonwealth and of its
agencies.
The request for access must be in writing and preferably made on the form for a request
under the Freedom of Information Act 1982 available at any ATO. This request should result
in Ambrose receiving a copy of the information incorrectly lodged at the ATO but only after
the ATO notations have been masked (see Murtagh v FC of T 84 ATC 4516). However, in
Walker v FC of T 95 ATC 2001, it was held that a group of taxpayers was able, under FOI, to
gain access to ATO file notes relating to various tax officers’ considerations of the
application of ITAA97 to the taxpayers’ situation.
In the latter case, the AAT concluded that as the Act and its interpretation are matters of
public interest, it cannot be contrary to public interest to disclose the views of officers of the
ATO on the application of the law to facts leading to an assessment.
Under income tax legislation there is no express provision which obliges the Commissioner
to supply information to the taxpayer until the objection procedures have commenced.
361
While it is customary for the Commissioner to issue an adjustment sheet detailing
adjustments made to a taxpayer’s return, he is not obliged to do so. As Ambrose has not
lodged a return, he might not have received an adjustment sheet.
It is only when an appeal reaches the courts that the Commissioner can be required to give
particulars. When a case appears before the AAT, the Commissioner is obliged to supply a
detailed statement of his decision on the objection and relevant documents. To enable the
issues to be defined, there is generally a preliminary hearing and an exchange of documents
between the taxpayer and the Commissioner.
The power to order discovery arises by virtue of the inherent jurisdiction of the Court. The
power does not assist the taxpayer at earlier stages in his or her objection.
On several occasions the Commissioner has claimed Crown privilege—a common law right
that it is not in the public’s interest to disclose the information. Where the Commissioner
claims Crown privilege, the Court has an inherent power and duty to inspect the documents to
decide whether privilege should be granted. In making this decision a court often has to
consider two conflicting aspects of public interest: first, public interest that harm shall not be
done to the nation or the public service by disclosure of certain documents; secondly, public
interest that the administration of justice shall not be frustrated by the withholding of
documents.
It is unlikely the Commissioner would seek to claim Crown privilege in Ambrose’s situation.
The matter would probably be recognised as an error in the delivery of postage material and
the ATO would provide Ambrose with the information he is seeking under the Freedom of
Information Act 1982.
(4)
Under the substantiation rules in ITAA97, Ambrose is required to supply ‘written evidence’
to support his claimed deductions (ITAA97 s 900-1 to 900-65).
‘Written evidence’ means a receipt, invoice or similar document giving full details of the date
of the expense, the amount, the nature of the goods or services and the name of the supplier
(ITAA97 s 900-115).
Where an item of expenditure is $10 or less and the aggregate of such items is $200 or less a
diary record of the expenditure is adequate (ITAA97 s 900-125).
In some circumstances, the Commissioner may accept that it would be unreasonable to expect
written evidence. In these cases, the taxpayer is required to keep a record of such expenses,
such as a diary (ITAA97 s 900-195).
If Ambrose incurred the expenses he should have receipts for the library acquisitions or diary
records. He could obtain a receipt or evidence of payment from Amnesty International, or
may be able to support his claim by an entry in his cheque book butt. However, it should be
noted that the substantiation rules do not apply to gifts.
The new kitchen cupboards are clearly not a repair, and Ambrose’s statement ‘try to claim as
a repair’ could be taken as evidence of an attempt at tax avoidance. Presumably his tax agent
362
would have advised him that this expenditure was not deductible and the item would not have
been included when preparing the tax return for his signature.
If Ambrose’s work-related laundry expenses do not exceed $150, and his work-related
expenses including laundry do not exceed $300, then no written evidence is required
(ITAA97 s 900-40).
363

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Reimbursement of medical expenses

Damages for personal injury

Consequently, her taxable income for the year would be:

A superannuation benefit is defined in s 307-5(1) to include a payment made from a

The tax treatment of a superannuation benefit depends on:

Therefore, the tax free component is:

365 days/13,514 days × $ 300,000 = $8102

Therefore, the taxable component = $291,898 − $40,000 = $251,898

Section 301-20 provides that the taxable component is taxed as follows:

This is calculated as:

This amount is tax free.

Taxation of the approved early retirement

$10,399 + (38 × $5,200) = $207,999

Consequently, the amount of $100,000 received by Foreman as a redundancy payment is tax

Therefore, the tax on his Australian income is determined as:

Total income = $75,000

(1) Assessable pursuant to ITAA97 s 6-5 $49,300

As there are no deductions, assessable income equals taxable income.

Australian tax payable is as follows:

An ‘employee’ also includes a director, an office holder and an associate of an employee.

Consequently, the assessable discount would be:

The cost of the shares for CGT purposes will be:

The capital gain will be calculated as follows:

It is necessary to look at factors such as:

The determination of whether such an activity is a business or a hobby is a question of fact

Furthermore, s 20-25(3) provides that where a taxpayer disposes of a right to receive an

A is the share of the annuity received by the taxpayer

On this basis the deductible amount is:

Some of the issues which require consideration here are:

A determination of a taxpayer’s residence is a question of fact based on the objective

Contrast Jack’s circumstances with the facts in FC of T v Applegate 79 ATC 4307. In

On the basis of FC of T v Jenkins 82 ATC 4098, FC of T v Applegate 79 ATC 4307 and

As a non-resident Morris is only assessable on Australian-source income (ITAA97 s 6-5(3)

Accrual period Opening balance Accrual amount

The credit card discount would be an allowable deduction.

(a) Superannuation Payment

2,159 days/14,973 days × $350,000= $50,467

This leaves a taxable component of $350,000 − $80,467 = $269,533

(b) Employment Termination Payment

Therefore, the tax free component is calculated as:

2,159 days/14,973 days × $20,000 = $2,883

Consequently, amounts received from members as subscriptions or payments to a club (or

The taxpayer will be assessed on the $1,800.

Therefore, to determine whether the compensation received by BPH is of an income or

‘In my opinion, damages received as compensation for non-performance of a business

Taxation Ruling IT 2650 outlines the factors to be considered in determining whether a

Some of these factors are:

(2) Early retirement scheme

(4) Other benefits

The $1,000 would be unlikely to be income unless paid in anticipation of services to be

Therefore the assessable amount would be $1,500.

According to the indexation method, the calculations are as follows:

1 April 1987 acquired 2,000 shares in RSC at $4.25

Indexed cost base = 1.493* × cost of shares

Indexed cost: $4.25 × 1,000 × 1.493 = $6,345

2 December 2018 sale proceeds: 1,000 shares at $8 per share = $8,000