Cpa Program Australia Taxation 2nd Editi

CPA PROGRAM
AUSTRALIA
TAXATION
2ND EDITION
CPA PROGRAM
AUSTRALIA
TAXATION
2ND EDITION
Published by Deakin University, Geelong, Victoria 3217, on behalf of CPA Australia Ltd, ABN 64 008 392 452
Previously published as Introductory Taxation by BPP Learning Media Ltd

First edition published January 2019
Second edition published June 2019
© 2010–2019 CPA Australia Ltd (ABN 64 008 392 452). All rights reserved. This material is owned or
licensed by CPA Australia and is protected under Australian and international law. Except for personal
and educational use in the CPA Program, this material may not be reproduced or used in any other manner
whatsoever without the express written permission of CPA Australia. All reproduction requests should be
made in writing and addressed to: Legal, CPA Australia, Level 20, 28 Freshwater Place, Southbank, VIC 3006,
or legal@cpaaustralia.com.au.
Edited and designed by DeakinCo.

Printed by Blue Star Print Group
ISBN 978 0 6482918 4 8
Authors
Suzannah Andrews Consultant
Dr Ken Devos Associate Professor, Faculty of Business and Law,
Swinburne University of Technology
Rami Hanegbi Senior Lecturer, Faculty of Business and Law, Deakin University
Stephen Marsden Lecturer, School of Accountancy, Queensland University of Technology, Brisbane
Wes Obst Consultant
Denis Vinen Associate Professor, Faculty of Business and Law,
Swinburne University of Technology
CPA Australia acknowledges the contribution of Tony Greco, Robert Gregory, Dianne Harvey, Dean
Matchett, Roger Timms and Robin Woellner to previous editions of this Study guide.
Advisory panel
Suzannah Andrews Consultant
Dr Ken Devos Senior Lecturer, Monash University
Dean Matchett Matchett Partners Pty Ltd
Gavan Ord Business Investment Policy Manager, CPA Australia
Joanna Roach Bristol-Myers Squibb Australia
CPA Program team

Yvette Absalom Alex Lawrence Seng Thiam Teh
David Baird Caroline Lewin Paul Shantapriyan
Jessica Burdett Elise Literski Alisa Stephens
Nicola Drury Julie McArthur Tiffany Tan
Jeannette Dyet Ram Nagarajan Helen Willoughby
Kristy Grady Venkat Narayanan
Geraldine Howley Shari Serjeant
Learning designer
Deborah Evans DeakinCo.
Acknowledgments
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(APESB), at March 2019. To ensure you are aware of the latest information provided by APESB, please visit http://www.apesb.org.au or
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This publication contains copyright material from the Australian Taxation Office (ATO). © Australian Taxation Office for the Commonwealth
of Australia.
Quotations from the following source are reproduced under a Creative Commons Attribution 3.0 Australia licence: Tax Practitioners Board
(TPB).
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These materials have been designed and prepared for the purpose of individual study and should not be used as a substitute for
professional advice. The materials are not, and are not intended to be, professional advice. The materials may be updated and amended
from time to time. Care has been taken in compiling these materials, but they may not reflect the most recent developments and have
been compiled to give a general overview only. CPA Australia Ltd and Deakin University and the author(s) of the material expressly
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Any opinions expressed in the study materials for this subject are those of the author(s) and not necessarily those of their affiliated
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As the supplier of third-party Study guide materials to the publisher, CPA Australia is responsible for the use of any materials for which
the intellectual property is owned or controlled by a third party.
AUSTRALIA TAXATION
Contents
Subject outline 1
Module 1: Legal, ethical and regulatory fundamentals 23
Module 2: Principles of assessable income 67
Module 3: Principles of general and specific deductions 107
Module 4: Capital allowances 143
Module 5: CGT fundamentals 175
Module 6: Taxation of individuals 231
Module 7: Taxation of SBEs and partnerships 301
Module 8: Taxation of trusts, companies and

superannuation funds 341
Module 9: FBT fundamentals 397
Module 10: GST fundamentals 433
Module 11: Administration of the tax system 465

AUSTRALIA TAXATION
Subject outline
OUTLINE
2 | AUSTRALIA TAXATION
Contents
Before you begin 3
Australia Taxation 3
Study guide
My Online Learning
Study plan
Australia Taxation Study map 6
Detailed study session planning
Your exam information 20
About the authors 20
OUTLINE
SUBJECT OUTLINE | 3
Before you begin

The purpose of this subject outline is to:
• provide important information to assist you in your studies
• define the aims, content and structure of the subject
• outline the learning materials and resources provided to support learning
• provide information about the exam and its structure.
The CPA Program is designed around five overarching learning objectives to produce future
CPAs who will:
• Be technically skilled and solution driven
• Be strategic leaders and business partners in a global environment
• Be aware of the social impacts of accounting
• Be adaptable to change
• Be able to communicate and collaborate effectively.
For information on dates, fees, rules and regulations, and additional learning support, please refer
to the CPA Australia website: cpaaustralia.com.au/cpaprogram.
Australia Taxation
Australia Taxation is designed to provide you with an awareness of the key provisions of the
relevant taxation legislation and enable you to apply the relevant legislative concepts to
determine taxation consequences. It is important to consider the taxation impact on individuals,
partnerships, companies, trusts and superannuation funds.
On completion of this subject, you should be able to:

• understand the key administrative components of the Australian taxation system and
the basic principles of Australian income tax, fringe benefit tax and goods and services
taxation legislation
• analyse, discuss and resolve issues relating to the determination of assessable income and
allowable deductions
• explain taxation law that relates to the taxation of individuals, companies, partnerships,
trusts and superannuation funds
• analyse events and apply relevant legislation to determine tax liability.
The Australia Taxation subject reflects legislation in place to 30 March 2019. Exam questions will
be based upon the 2018–19 tax year.
Study guide
The Study guide is your primary examinable resource and contains all the knowledge you
need to learn and apply to pass the exam. The Australia Taxation Study guide is divided into
11 modules, and includes a number of features to help support your learning. These include:
• Objectives—to describe what you are expected to know and be able to do after completing
the module, as well as identify what you’ll be assessed on in the exam.
• Examples—to demonstrate how concepts are applied to real-world scenarios.
• Questions (and suggested answers)—to provide you with an opportunity to assess your
understanding of the key learning points. These questions are an integral part of your study
and should be fully utilised to support your learning of the module content.
• Teaching materials—this section of your Study guide will inform you of any additional
resources to be referred to in conjunction with the module.
OUTLINE
My Online Learning
My Online Learning is CPA Australia’s online learning platform, which provides you with access
to a variety of resources to help you with your study. We suggest you view the video ‘Insights for
a great semester of study’ on My Online Learning, which will provide you with some insights on
how to plan your semester. It will also take you on a guided tour of My Online Learning to show
you how (and when) to access the range of resources available.
You will find a wide range of subject-level and module-level resources on My Online Learning.
Subject-level resources are those that apply to the entire subject. These resources can be used
at any time but are most useful when you’ve completed all the modules for the entire subject—
whereas module-level resources should be used while you work through a particular module in
the Study guide.
Some of the resources you may find on My Online Learning include:

• A PDF version of the complete Study guide, as well as a PDF version of each individual module.
• Knowledge checks—these enable you to check your learning for each module and across the
entire subject. You can access these Knowledge checks from any device and retake the test
multiple times.
• Ask the Expert forum—this allows you to post a technical question about the subject content
and have it answered by a subject expert.
• Interactive resources—to help you understand the concepts covered in an engaging manner.
• Exam information—to help you prepare and plan for your exam.
• Study group—to allow you to search for a study group in your area or connect with local
candidates and form your own study group.
You should refer to the Study map located on My Online Learning to see what module resources
you can access and in what order you should use them.
You can access My Online Learning from the CPA Australia website: cpaaustralia.com.au/
myonlinelearning.
Help desk
For help when accessing My Online Learning, either:
• email memberservice@cpaaustralia.com.au, or
• telephone 1300 73 73 73 (Australia) or +61 3 9606 9677 (international) between 8.30 am and
5.00 pm (AEST) Monday to Friday during the semester.
OUTLINE
SUBJECT OUTLINE | 5
Study plan
Total hours of study for this subject will vary depending on your prior knowledge and experience
of the course content. Your individual learning pace and style and your work commitments
will need to be taken into consideration. You will need to work systematically through the
Study guide and attempt all the in-text questions and online Knowledge checks. The workload
for this subject is the equivalent of that for a one-semester postgraduate unit. An estimated
15 hours of study per week through the semester is recommended, but additional time may be
required for revision.
The ‘Weighting’ column in the following table provides an indication of the emphasis placed on
each module in the exam, while the ‘Recommended proportion of study time’ column is a guide
for you to allocate your study time for each module.
With our flexible study options, you can complete the CPA Program in your own time with access
to national support if you need it. Please refer to the CPA Australia website: cpaaustralia.com.au/
cpaprogram_support.
Table 1: Module weightings and study time
Recommended
proportion Recommended
of study time Weighting study
Module (%) (%) schedule
1. Legal, ethical and regulatory fundamentals 6 6 Week 1
2. Principles of assessable income 10 10 Weeks 1, 2
3. Principles of general and specific deductions 8 8 Weeks 2, 3
4. Capital allowances 7 7 Week 3
5. CGT fundamentals 15 15 Weeks 4, 5
6. Taxation of individuals 15 15 Weeks 5, 6
7. Taxation of SBEs and partnerships 6 6 Week 7
8. Taxation of trusts, companies and 9 9 Weeks 7, 8

superannuation funds
9. FBT fundamentals 7 7 Week 8
10. GST fundamentals 8 8 Week 9
11. Administration of the tax system 9 9 Weeks 9, 10
100 100
You can see an overview of all the learning resources for this subject in the Study map on the
next page.
The Study map is then followed by a detailed Study planner, which will help you allocate your
study time per module/week.
OUTLINE
Australia Taxation Study map

BEFORE YOU BEGIN
Study guide—Subject outline
• Study and exam information

• Study companion and exam
•
mark allocations
Topic finder
BYB
MODULE 1
• Insights for a great semester
of study Study guide
• Frequently asked questions

• General My Online Learning M1 Knowledge checks
administration queries Week 1

Ask the Expert forum
Study time proportion: 6%

MODULE 2
Study guide M2
Weeks 1, 2
Knowledge checks MODULE 3
Ask the Expert forum Study guide
Study time proportion: 10% Knowledge checks

M3
Weeks 2, 3 Ask the Expert forum
MODULE 4
Study guide
Knowledge checks
M4
Week 3
Ask the Expert forum
MODULE 5
Study guide
Knowledge checks
M5
Weeks 4, 5 Ask the Expert forum
MODULE 6
Study guide
Knowledge checks
M6
Ask the Expert forum Weeks 5, 6
MODULE 7
Study guide
Knowledge checks
M7
Week 7 Ask the Expert forum
MODULE 8
Study guide
Knowledge checks
M8
Ask the Expert forum Weeks 7, 8
MODULE 9
Study guide
Knowledge checks
M9
Week 8 Ask the Expert forum
MODULE 10
Study guide
Knowledge checks
M10 MODULE 11
Ask the Expert forum Week 9
Study guide
Knowledge checks
M11 Ask the Expert forum
Weeks 9, 10 Study time proportion: 9%
EXAM PREPARATION
Key:
What to expect in your exam
• Study companion and exam

EP Ask the Expert
forum
Learning task
Study guide
Revision
mark allocations Business simulation
Supplementary
• Topic finder
Case study document
Knowledge checks Video
OUTLINE
SUBJECT OUTLINE | 7
Detailed study session planning

Recommended
study time Done
Before you begin
— Study guide—Subject outline 15 mins
— Video: Insights for a great semester of study 6 mins
— Study and exam information 5 mins
— Study companion and exam mark allocations 30 mins
— Topic finder —
— Ask the Expert forum: Frequently asked questions and —

General My Online Learning administration queries
Total 1 hr
Notes:
OUTLINE
Recommended
study time Done
Study
session Module 1—Week 1
1 Study guide—Tax law environment 1.5 hrs
2 Study guide—Ethical principles and behaviour and 3.5 hrs

Identifying ethical dilemmas
3 Study guide—Tax practitioner obligations, Tax Practitioners 3.5 hrs

Board Code of Professional Conduct, and Tax planning,
avoidance and evasion
— Knowledge checks 30 mins
— Ask the Expert forum: Module 1—Legal, ethical and —

regulatory fundamentals
Total 9 hrs
Notes:
OUTLINE
SUBJECT OUTLINE | 9
Recommended
study time Done
Study
session Module 2—Weeks 1 and 2
1 Study guide—Defining and determining income 2 hrs

and Determining source of income
2 Study guide—Tax implications of residency and 3 hrs

non-residency
3 Study guide—Derivation and Determining derivation 3 hrs

for tax purposes
4 Study guide—International taxation core concepts 3 hrs
5 Study guide—Trading stock core concepts 2 hrs
— Ask the Expert forum: Module 2—Principles of —

assessable income
Total 13.5 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—General deductions 3 hrs
2 Study guide—Specific deductions 3.5 hrs
3 Study guide—Limitations of deductibility 3.5 hrs
4 Study guide—Substantiation requirements for individuals 2 hrs
— Ask the Expert forum: Module 3—Principles of general —

and specific deductions
Total 12.5 hrs
Notes:
OUTLINE
SUBJECT OUTLINE | 11
Recommended
study time Done
Study
1 Study guide—Small business entities and Capital allowances 3 hrs

core concepts
2 Study guide—Capital allowances for non-small business 4 hrs

entities and Capital allowance rules for small business entities
3 Study guide—Defining capital works and Calculating capital 3 hrs

works deductions
— Ask the Expert forum: Module 4—Capital allowances —
Total 10.5 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—CGT core concepts 3 hrs
2 Study guide—CGT events 3.5 hrs
3 Study guide—CGT assets 1 hr
4 Study guide—Determining gain/loss from CGT event 4 hrs
5 Study guide—Determining exception or exemption 2.5 hrs
6 Study guide—Rollover provisions and other reliefs 3 hrs
7 Study guide—Calculating net capital gain/loss 3.5 hrs
— Ask the Expert forum: Module 5—CGT fundamentals —
Total 21 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—Individual taxation core concepts and 3.5 hrs

Defining types of assessable income
2 Study guide—Employment termination payments 3 hrs
3 Study guide—Personal services income 2.5 hrs
4 Study guide—Employee share schemes 1 hr
5 Study guide—Capital gains tax relief for individuals 1 hr
6 Study guide—Taxing superannuation for individuals 3 hrs
7 Study guide—Calculating allowable deductions 2 hrs
8 Study guide—Applying tax offsets 4 hrs
9 Study guide—Calculating tax payable 3 hrs
— Ask the Expert forum: Module 6—Taxation of individuals —
Total 23.5 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—Small business entity concessions 2 hrs

core concepts
2 Study guide—Calculating the small business income 1 hr

tax offset
3 Study guide—Small business restructure rollover 1 hr
4 Study guide—Partnership taxation core concepts and 1 hr

Determining the net partnership income/loss
5 Study guide—Calculating a partner’s share of tax payable 2.5 hrs
6 Study guide—Alteration of partner’s interest 1.5 hrs
— Ask the Expert forum: Module 7—Taxation of SBEs —

and partnerships
Total 9.5 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—Trust taxation core concepts 1.5 hrs
2 Study guide—About Division 6 2.5 hrs
3 Study guide—Determining net income of a trust, 3.5 hrs

and Discrepancies and capital gains
4 Study guide—About trust distributions, Family trusts, 1 hr

and Administration and reporting for trusts
5 Study guide—Company tax core concepts 2 hrs
6 Study guide—Calculating taxable income 2.5 hrs
7 Study guide—Dividend imputation system 3 hrs
8 Study guide—Superannuation fund taxation 1.5 hrs
— Ask the Expert forum: Module 8—Taxation of trusts, —

companies and superannuation funds
Total 18 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—Fringe benefits tax core concepts and 2.5 hrs

Calculating fringe benefits tax
2 Study guide—Specific fringe benefits 3 hrs
3 Study guide—Exempt fringe benefits and employees, 2.5 hrs

Salary packaging, Administration, and Reportable
fringe benefits
— Ask the Expert forum: Module 9—FBT fundamentals —
Total 8.5 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—GST core concepts 1 hr
2 Study guide—Determining supply 4 hrs
3 Study guide—Input tax credits 1.5 hrs
4 Study guide—Calculating GST 2.5 hrs
5 Study guide—Administration 1.5 hrs
— Ask the Expert forum: Module 10—GST fundamentals —
Total 11 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
1 Study guide—Income tax self-assessment, Lodging of tax 3 hrs

returns and assessments, and Tax audits
2 Study guide—Objections, reviews and appeals 2.5 hrs
3 Study guide—Tax reporting and payment obligations 1.5 hrs
4 Study guide—ATO guidance documents and rulings 2 hrs
5 Study guide—Penalties and interest charges 2.5 hrs
6 Study guide—Identifying Part IVA and Promoter 3 hrs

penalty regime
— Ask the Expert forum: Module 11—Administration of the —

tax system
Total 15 hrs
Notes:
OUTLINE
Recommended
study time Done
Study
session Exam preparation—Week 11
1 Revise Modules 1, 2 and 3 3 hrs
2 Revise Modules 4 and 5 3 hrs
3 Revise Modules 6, 7 and 8 3.5 hrs
4 Revise Modules 9, 10 and 11 3 hrs
— Video: What to expect in your exam 7 mins
— Study companion and exam mark allocations 15 mins
— Topic finder —
Total 13 hrs
Notes:
OUTLINE
Your exam information

The Australia Taxation exam is three hours and 15 minutes in duration and comprises multiple-
choice and extended-response questions. Multiple-choice questions include knowledge,
application and problem-solving questions that are designed to assess understanding
of Australia Taxation principles. Extended-response questions focus on the application of
concepts and theories from the subject study materials to solve a given problem.
The Study guide is your central examinable resource. Where advised, relevant sections of
the CPA Australia Members’ Handbook and legislation are also examinable.
This is an open-book exam, so you may bring any reference material into the exam that you
believe to be relevant and that may assist you in undertaking the exam. This may include,
for example, the Study guide, additional materials from My Online Learning, readings and
prepared notes.
You will have access to an on-screen calculator within the computer-based exam environment.
If you are sitting a paper-based exam, we recommend that you bring your own calculator.
Please ensure that the calculator is compliant with CPA Australia’s guidelines. The calculator
must be a silent electronic calculating device the primary purpose of which is calculation.
Calculators with text-storing abilities are not permitted in the exam.
As this exam forms part of a professional qualification, the required level of performance is high.
You are required to achieve a passing scaled score of 540 in all CPA Program exams. Further
information about scaled scores and exam results is available at: cpaaustralia.com.au/cpaprogram.
About the authors

Suzannah Andrews BEng Imperial College London, CA
Suzannah has many years of experience in Australian tax as an
adviser, trainer and educational consultant. She spent a number
of years in the Big-4 accountancy firms, working as an adviser in
the corporate tax field. She has experience working with both
large multinationals and middle-market clients.
In recent years, Suzannah has focused on tax training and

education. She was a key member of the Tax Technical
Knowledge Centre at PricewaterhouseCoopers, responsible
for development of educational materials, face-to-face training
of staff and partners, and knowledge management.
Suzannah worked with CPA Australia for more than seven years
as Technical Consultant for the Australia Taxation – Advanced
subject of the CPA Program (then called Advanced Taxation)
and is the Chief Examiner for the subject.
OUTLINE
Dr Ken Devos BBus, GradDipTax, MTax, PhD, CPA

Ken is an associate professor in the Faculty of Business and
Law at Swinburne University in Melbourne. Ken lectures in
undergraduate and graduate tax courses and has published a
number of articles in both national and international taxation
journals. Ken conducted tax training courses and educational
services for accounting firms, the ATO and CPA Australia. Ken is
a joint author of the Australian Taxation Study Manual (Oxford
University Press) and Australian Small Business Taxation 2018
(LexisNexis). His doctoral thesis, Factors Influencing Individual
Taxpayer Compliance Behaviour, was published by Springer
in 2014.
Rami Hanegbi LLB (Hons) Monash, BEcon (Accounting)

Monash, LLM , PhD
Rami is a senior lecturer at Deakin Law School (Melbourne).
He lectures in both undergraduate and postgraduate subjects
in the areas of taxation and superannuation law, and was
involved in developing one of the first undergraduate
superannuation law courses in Australia for law students.
He is a co-author of Principles of Taxation Law (Sadiq et al.
2019, Thomson Reuters).
Rami has researched extensively in the areas of tax and

superannuation law, and has previously been invited by
government bodies to give input on proposed policy.
Stephen Marsden BBus (Acc) QUT, MBus (Acc) QUT, CPA,

FCTA, MAICD
Stephen is a full-time lecturer employed in the QUT Business
School in Brisbane, where he is responsible for lecturing and
tutoring a wide range of undergraduate and postgraduate
financial accounting and taxation law subjects.
Over the past 27 years, Stephen has presented numerous

professional development seminars and workshops for
CPA Australia in the areas of income tax, fringe benefits tax,
goods and services tax and financial accounting.
Wes Obst DipAgSc Longerenong, BBus Vic. I.C., GradDipTax

CQU, CPA
Wes has extensive experience in taxation law as a lecturer
in the university sector in accounting and law degrees at the
undergraduate and postgraduate levels. He is a joint author of
the annual publication Principles of Taxation Law (Sadiq et al.
2019, Thomson Reuters); and Financial Management for
Agribusiness (Obst et al. 2009, Thomson).
OUTLINE
Denis Vinen BEc, DipEd, MBA, DBA, CA, FCPA

Denis is currently Deputy Chair of the Accounting, Economics
and Finance Department and Program Director of the Master
of Accounting suite of programs in the Faculty of Business and
Law at Swinburne University in Melbourne. Denis lectures in
postgraduate tax courses and is a registered tax agent with
experience in providing taxation, financial and investment
advice. Denis has been a frequent visitor to Vietnam since
1995, specialising in the teaching of taxation and finance,
conducting short courses for Vietnamese companies and
developing finance and accounting training manuals for the
banking sector in Vietnam.
AUSTRALIA TAXATION
Module 1
LEGAL, ETHICAL AND REGULATORY
FUNDAMENTALS
24 | LEGAL, ETHICAL AND REGULATORY FUNDAMENTALS
Contents
MODULE 1
Preview 25
Introduction
Objectives
Teaching materials
Tax law environment 28
Introduction
Overview of the Australian legal system
Power to raise taxes in Australia
Progress of taxation Bills through parliament
How the courts interpret taxation law
Taxation and administrative law
Accessing the law
Ethical principles and behaviour 37
What are ethics?
Ethical principles
APES 110 Code of Ethics for Professional Accountants
APES 220 Taxation Services
Tax Practitioners Board Code of Professional Conduct
Identifying ethical dilemmas 43
Applying the conceptual framework
Facing ethical conflicts
Resolving ethical dilemmas
Steps for making a good decision
Ethical dilemma checklist
Tax practitioner obligations 47
What is the Tax Practitioners Board?
Tax agent
Business activity statement agent
Tax (financial) adviser
Tax Practitioners Board Code of Professional Conduct 54
Principles of the Tax Practitioners Board Code of Professional Conduct
Code of operations for tax (financial) advisers
Tax planning, avoidance and evasion 59
Distinguishing between terms
Promoter penalty regime
Summary and review 61
Suggested answers 63
References 65
STUDY GUIDE | 25
Module 1:
MODULE 1
Legal, ethical and
regulatory fundamentals
Study guide
Preview
Introduction
The power to raise taxes is defined in the Australian Constitution. Generally, the federal
government has the power to raise taxes, including income tax and goods and services tax (GST).
Taxation law is administrated by the Australian Taxation Office (ATO), and decisions regarding
disputes are made by the ATO, or through the court system.
All tax practitioners are subject to professional standards. These various codes operate along
similar rules and present professional obligations and steps on how to make a good ethical
decision in a professional context.
The Tax Practitioners Board (TPB) is responsible for the registration and regulation of tax agents,
business activity statement (BAS) agents and tax (financial) advisers across Australia, and each
type of registration is subject to the TPB’s Code of Professional Conduct.
The module content is summarised in Figures 1.1, 1.2 and 1.3.

Figure 1.1: Module summary—taxation law

MODULE 1
Taxation law
Federal law Australian Constitution Tax planning,

avoidance and
evasion
ITAA36 Australian Promoter penalty

ITAA97 Taxation Office (ATO) regime
Administrative
Court system Appeals Tribunal
(AAT)
Federal Court High Court
Source: CPA Australia 2019.
Figure 1.2: Module summary—ethical behaviour
Making good
Codes of ethics Ethical behaviour
decisions
APES 110 TPB Code of Determine Steps for making

Professional Conduct ethical conflicts a decision
APES 220 Applying the Ethical tensions

conceptual framework between values

STUDY GUIDE | 27
Figure 1.3: Module summary—Tax Practitioners Board
MODULE 1
Tax Practitioners Board (TPB)
Types of Code of Link to

tax practitioner Professional Conduct Corporations Act
Tax agent Tax (financial)

adviser
BAS agent
Objectives
After completing this module, you should be able to:
• develop an understanding of the administration of the Australian tax system and
its regulatory environment;
• identify the potential ethical dilemma in a tax advisory context;
• describe various tax practitioners’ obligations based on the tax practitioners’ regime,
including the Code of Professional Conduct; and
• explain the difference between tax planning, tax avoidance and tax evasion.
Teaching materials
• Legislation and codes:
– Income Tax Assessment Act 1936 (Cwlth) (ITAA36)
– Taxation Administration Act 1953 (Cwlth) (TAA)
– APES 110 Code of Ethics for Professional Accountants
– APES 220 Taxation Services
– Tax Practitioners Board (TPB) Code of Professional Conduct
• Glossary:
– Following is a link to a glossary of common tax and superannuation terms. You may want
to consult the glossary when you come across an unfamiliar term: https://www.ato.gov.au/
Definitions/
– For languages other than English, you can go to: https://www.ato.gov.au/general/
other-languages/in-detail/information-in-other-languages/glossary-of-common-tax-and-
superannuation-terms/
• CPA Australia skills list: cpaaustralia.com.au/cpa-program/cpa-program-candidates/your-

experience/skills-list (note that the employability skills are not examinable)
Tax law environment

MODULE 1
Introduction
It is essential to have a good knowledge of the legal obligations and rights of taxpayers in
respect of the imposition and collection of taxes under Australian law.
Understanding the source of taxation law in Australia (made by the federal government—
see the following section), and any major legal principles, is very important. These legal
principles will also be used by the AAT and/or the federal court system when resolving disputes
or questions of law in the area of taxation.
Overview of the Australian legal system

Australia operates under a federal system of government. Power is shared between the federal
government and the various state governments under the division of powers. Of primary
importance is the Australian Constitution, which outlines the division of powers between the
federal and the state governments. The Australian Constitution gives the federal government
the power to make laws regarding the collection of income tax. The next section, ‘Power to raise
taxes in Australia’, explains the power to raise taxes in more detail.
The doctrine of the separation of powers is also important because it ensures that no one
arm of government holds all the power. Power is shared between the three separate arms of
government: the legislature, the judiciary and the executive. Under the separation of powers,
the legislature (parliament) makes the law by passing legislation. The judiciary (the courts) applies
the law to individual cases.
The executive, made up of government departments and executive authorities (of which the ATO
is one), is responsible for implementing the laws passed by the legislature.
There are federal statutes enacted by the parliament of Australia that apply to the whole of
Australia, and laws enacted by the self-governing parliaments of the Australian states and
territories. Federal statutes and subordinate legislation govern Australian taxation law, and the
federal court system applies and interprets this statute law.
Australian Constitution
The federal government has the power to make laws under the Australian Constitution.
The chief items included in the Australian Constitution are summarised as follows:
• the structure and operation of federal parliament
• the powers held by the federal government to create law
• the existence of the six Australian colonies at federation in 1901 and their recognition as
states; it also recognises the state constitutions and state laws as at 1901, and that they will
remain in place unless changed by later state or federal legislation
• the division of powers, which states how the federal and state parliaments share powers to
create law under the federal system, and the regulation of the power-sharing relationship
• the role of the executive arm of government, including the creation of federal executive
authorities, such as the ATO, and their powers
• the existence of representative democracy and an independent federal judiciary
• the creation and powers of the High Court of Australia
• the rules for amending the Constitution: it can only be amended if the change has the
support of both houses of federal parliament and then passes a referendum where it has
been agreed to by a majority of people in a majority of states.
The Australian Constitution can be easily accessed online, for example at: https://www.aph.gov.
au/About_Parliament/Senate/Powers_practice_n_procedures/Constitution.aspx.
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Power to raise taxes in Australia

As seen in the ‘Overview of the Australian legal system’ section, it is the Australian Constitution
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that contains the power of the federal government to raise taxes. The relevant sections of the
constitution are presented and discussed in this section.
Section 51(ii)
Section 51(ii) of the Constitution is a general power to make laws in respect of taxation. This is a
concurrent power because the states or territories may also make laws with respect to taxation,
except for those powers reserved exclusively for the Commonwealth (e.g. imposition of duties
and customs and excise under s. 90). Where a state or territory law conflicts with a law enacted
by the Commonwealth, the Commonwealth will prevail.
Although both the state and federal governments can in theory impose income taxes, for many
decades the arrangement has been that only the federal government does so.
Further, the federal government has coupled taxation with the power to enact grants to the
states or territories under s. 96 of the Constitution (revenue power). This means the federal
government collects the tax, and then makes grants to the state and territory governments
of funds from income tax and GST, to deliver services such as health and education.
Section 114
Section 114 of the Australian Constitution says of state powers:
A State shall not, without the consent of the Parliament of the Commonwealth, raise or
maintain any naval or military force, or impose any tax on property of any kind belonging to
the Commonwealth, nor shall the Commonwealth impose any tax on property of any kind
belonging to a State.
The states or territories also (through their residual powers) raise taxes in their jurisdiction,
such as stamp duty, land tax and payroll tax. They also provide for municipal authorities (e.g. city
councils) to impose rates and levies for local services provided (e.g. a garbage collection service).
These local councils could be regarded as a third level of government, with their own very limited
power to raise taxes.
Section 53
A taxation Bill imposes a tax and, under s. 53 of the Constitution, these particular Bills cannot
originate in, or be amended by, the Senate. They must originate in the House of Representatives.
However, the Senate may ask the House of Representatives to amend these Bills. This progress
of taxation Bills through parliament is discussed in more detail later in the module.
Sections 54 and 55
Under s. 54 of the Constitution, laws that appropriate revenues or monies for the ordinary,
annual services of the government can only deal with that appropriation.
Under s. 55 of the Constitution, laws imposing tax can only deal with the actual imposition of
taxation. Because of this, a form of assessment Act deals with assessment and collection of tax
while a ratings Act imposes that tax and determines the rate.
Assessment Acts
There are two chief assessment Acts that govern the assessment and collection of income tax in
Australia: ITAA36 and ITAA97.
Progress of taxation Bills through parliament

A Bill is a proposed piece of legislation in draft form. It must go through a formal procedure for it
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to become enacted as law.
Step 1: Preparation of Bill

Proposals for tax legislation are considered by the prime minister and cabinet, who initiate most
proposed laws for debate in parliament. The Treasurer is the minister responsible for arranging
the preparation of Bills relating to raising revenue. The Office of Parliamentary Counsel drafts the
Bill in accordance with instructions from Treasury.
Step 2: First reading

The Bill is introduced to the House of Representatives with a first reading, where the long title is
read out. Copies of the Bill and any explanatory memoranda are given to members of parliament
and made publicly available. The Treasurer will then move that the Bill be read a second time.
Step 3: Second reading

The second reading speech explains the purpose and principles of the Bill. The second reading
debate gives an opportunity for the opposition and other non-government members to speak
before voting on whether to agree to the Bill in principle. The Bill is then examined in detail,
with the opportunity for members to suggest amendments.
Step 4: Third reading

The third reading is the final stage. If the Bill is likely to pass the House of Representatives,
then this is a mere formality. The second reading speech, any explanatory memoranda and
a record of any debate may provide assistance to the courts in determining the meaning or
intention of the Act (Acts Interpretation Act 1901 (Cwlth), s. 15AB).
Step 5: Three readings in Senate

The Bill is then presented to the Senate, where it again has three readings. However, the Senate
has no power to amend the Bill, although it may request that the House of Representatives make
an amendment. If agreement cannot be reached with the House of Representatives, the Bill is
laid aside.
Step 6: Royal assent

If the Bill passes both houses, it is then presented to the Governor-General for royal assent,
at which time it becomes an Act of parliament.
Step 7: Commencement
An Act may specify the date of commencement, but if not, the default commencement is the
28th day after receiving assent.
Figure 1.4 illustrates the passage of Bills through parliament.

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Figure 1.4: Passage of taxation Bills through parliament
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Draft bill
House of
Representatives
Federation Bill presented

Chamber
(Second debating Or
Chamber) First reading
Second reading
(in principle debate)
Second reading Possible reference to
(in principle debate)
House of
Consideration
Representatives
in detail
Consideration in detail Standing
(amendments may
(amendments may Committee
be made)
be made)
Third reading
(amendments must be
agreed to by both Houses)
Senate
Similar process to Senate committee
the House of may consider bill
Representatives
Governor-General
Assent
Law
Source: Parliament of Australia 2018, ‘Infosheet 7: Making laws’, accessed April 2019, https://www.aph.
gov.au/about_parliament/house_of_representatives/powers_practice_and_procedure/00_-_infosheets/
infosheet_7_-_making_laws.
Retrospective taxation law

It is not uncommon for taxation law to have retrospective operation. If a law doesn’t commence
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from the date of the announcement, but from a stated date in the Act, which applies before
the law receives assent, then it is said to apply retrospectively.
The Federal Budget is a good example of retrospective operation. The Federal Budget is
delivered on a specific date in May every year, and will make announcements that may be
‘effective from the date of the Budget’ but that have not yet been enacted in law.
The prospect of a taxpayer being subject to laws that were not in force at the time of a particular
transaction can be challenging. A common retrospective situation is ‘legislation by public
announcement’, whereby the federal government publishes a statement of intention to change
a tax law with an effective date of that notice. Such a situation can result in uncertainty about
potential legislative change, for which there is little guidance and that may not ever be passed
by parliament when it is eventually drafted as a Bill.
How to amend taxation law

Governments may invite public discussion on taxation policy through bodies such as the Board
of Taxation.
This provides opportunities for stakeholders, including professional associations such as

CPA Australia, to make submissions about policy. In later stages, Treasury—which is responsible
for tax policy for the federal government—may invite public submissions in response to draft
legislation dealing with issues that are complex and may have unintended consequences.
This process means the potential impact of proposed legislation can be considered long
before the legislation is enacted.
How the courts interpret taxation law

Legislation is now the primary source of new law in Australia, but it does not automatically
override common law (though it will in circumstances where it shows a clear intention to do
so). In Australia, most tax case law involves issues of interpreting the relevant statutes, so that
affected groups, including tax advisers and tax officials, can apply the law efficiently and correctly.
Practically, this is the model by which Australia operates where most law is now made by
parliament through legislation, or the executive through subordinate legislation. This is the
case in relation to the creation and interpretation of taxation law.
Statutory interpretation
Judges are faced with the task of applying legislation to the particular case heard before them.
To apply the legislation, they must first interpret and understand it. Problems occur when the
judge has difficulty interpreting the statute.
There are a number of situations that might lead to a need for statutory interpretation:
• Ambiguity might be caused by an error in drafting, or words may have a dual meaning.
• Uncertainty may arise where the words of a statute are intended to apply to a range of
factual situations and the courts must decide whether the case before them falls into
any of these situations.
• There may be unforeseeable developments.
• The legislation may use a broad term.
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The courts can be reluctant to make significant changes to the interpretation of legislation
since this encroaches on the responsibility of parliament, which is better able to investigate new
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laws and their potential effect on the community. This is a particular consideration in relation
to taxation law.
Federal court system

The High Court of Australia has the sole judicial authority to interpret the provisions of the
Australian Constitution, including the operation of the various powers of the federal government
to create law.
It is the ultimate court of appeal, meaning that its judgment is final and conclusive. Appeal to the
High Court from lower courts is by special leave. The granting of special leave depends on the
seriousness of the issue being considered, and whether it has national significance. Special leave
is not commonly granted. Appeals concerning taxation would stem from decisions at the Federal
Court. The Federal Court is created under a parliamentary power and can only hear matters
dictated by parliament.
Questions of law concerning taxation usually originate before a single judge of the Federal Court.
They may also arise on appeal from a federal tribunal such as the AAT. There is also a right of
appeal to the Full Federal Court where a majority decision will prevail. Where the case is heard
before a single judge of the High Court, there may under certain circumstances be an appeal
to the full bench of the High Court.
Figure 1.5 illustrates the Australian federal court system.
Figure 1.5: Australian federal court system
High Court of Australia
Appeal by special leave
Full Court of Federal Court Full bench

majority decision
Federal Court
Appeals Direct appeal Non-judicial

from AAT of certain administration
on questions Commonwealth
of law only administrative
decisions

As will be referred to later, in the section ‘Reading a taxation law case’, a court’s reason for its
decision is known as the ‘ratio decidendi’ of the case (commonly referred to as ‘ratio’). The principle
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of the ‘doctrine of precedent’ means that courts are bound by the ratio of courts higher in the
court hierarchy (illustrated in Figure 1.5). For instance, if the High Court previously decided that a
taxpayer in a certain situation was allowed a certain deduction under the legislation, and a case
with very similar relevant facts (involving a different taxpayer) comes before the Full Federal Court,
the latter court is obliged to arrive at a similar decision. Although courts are not bound by the ratio
of earlier decisions of courts that are not higher in the court hierarchy, they are still persuaded by
such decisions (the degree of persuasiveness is stronger where a previous decision has been made
by a court of the same level as compared to a decision by a lower-level court).
Sometimes courts might make statements in their decision that are not essential to the decision
but are made in passing. These statements are known as ‘obiter dictum’. An example of this
would be a taxpayer claiming a deduction, the court stating the expense is deductible and
stating why (ratio), but then commenting that the expense would not be deductible had the facts
been different in certain ways (obiter). Statements that constitute obiter are persuasive rather
than binding on later court decisions.
Example 1.1: Interpreting legislation

An example of where it was necessary for the courts to interpret legislation can be seen in FC of T v.
Applegate [1979] ATC 4307.
A resident of Australia is defined in s. 6(1) of ITAA36 as including a person whose domicile is Australia
unless they have a ‘permanent place of abode’ in another country. This means that individuals who
retain their Australian domicile will remain tax residents while staying overseas unless they can satisfy
the Commissioner that they have a permanent place of abode in that other country for the tax year
in question.
The Full Federal Court in FC of T v. Applegate [1979] ATC 4307 was required to decide the meaning
of the word ‘permanent’ in this context. A literal interpretation using the dictionary would mean a
taxpayer would have to abandon Australia forever. This would produce an absurd outcome because the
individual would lose their Australian domicile and the ‘domicile test’ in s. 6(1) would not be necessary
in the first place. The court looked to the purpose of the legislation and held that ‘permanent’ does
not mean everlasting in this context, but requires an enduring association with the place of abode
that is more than temporary for the year in question.
Taxation and administrative law

The ATO is responsible for collecting revenue for the federal government and is part of the
federal Treasurer’s portfolio.
The ATO administers legislation for taxes, superannuation and excise under supervision
of the Commissioner of Taxation (the Commissioner), who in turn is appointed by the
Governor-General.
The Commissioner is granted general powers of administration under s. 8 of ITAA36 and may
delegate authority to tax officers (e.g. for the purpose of conducting audits and investigations—
see Module 11 under ‘Tax audits’).
A particularly relevant area for tax agents and advisers concerns disputes of the assessment
process—this is discussed in more detail in Module 11 under ‘Objections, reviews and appeals’.
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Taxation decisions (known as 'objection decisions') are reviewable or appealable or both under
Part IVC of the TAA. The taxpayer can seek a review or appeal (as appropriate) by either applying
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to the AAT or appealing to the Federal Court.
The Commissioner has quasi-judicial powers such as the ability to impose administrative
penalties. Guidance on the Commissioner’s views as set out in ATO-issued tax rulings may be
regarded as de facto law making where taxpayers choose not to object or litigate but rather
arrange their affairs in accordance with this view. Tax rulings are discussed further in Module 11
under ‘Australian Taxation Office guidance documents and rulings’.
Similarly, the AAT has quasi-judicial powers by hearing disputes that become binding on those
parties, although it is not a court and is not bound by its own precedent. However, the AAT
is a tribunal so it has no powers of judicial review. The taxpayer has a right to appeal to the
Federal Court on a question of law.
This is discussed in more detail in Module 11 under ‘Objections, reviews and appeals’.
Commonwealth Ombudsman
The Commonwealth Ombudsman is appointed by the governor-general as an independent
person with wide powers to investigate complaints about certain government departments
and agencies (including the ATO). A report may be made concerning the relevant agency if an
informal view or recommendation is not acted on. However, the ombudsman is usually a last
resort because they cannot overturn or remake a taxation review or decision; they can merely
make a written decision about a complaint about the agency. As far as tax matters are concerned,
the ombudsman will only deal with matters that involve public officials alleging wrongdoings in
the public sector (such as corruption and abuse of power). For most administrative tax matters,
the relevant body to contact is the Inspector-General of Taxation.
The Commonwealth Ombudsman can be accessed at: www.ombudsman.gov.au.
Inspector-General of Taxation
The Inspector-General of Taxation (IGT) is a statutory body, formed under the Inspector-General
of Taxation Act 2003 (Cwlth). It is independent from both the ATO and the TPB. Its roles are:
• To investigate complaints about the administrative actions of the ATO and TPB. Such
administrative complaints involve matters concerning the fairness and reasonableness of the
ATO or TPB in their dealings with people (which would include their policies and procedures).
Examples of administrative complaints include complaints about the timeliness of responses
from either of these bodies, the conduct of the officers of these bodies, or whether the ATO
has considered all the relevant information in an audit. Administrative complaints do not
include ones concerning a disagreement about the presence of a tax liability or the amount
of tax payable.
• To improve the administration of the tax system for all taxpayers by carrying out broad
reviews, leading to recommendations made to the ATO, TPB and the government. This is
at times linked to the first role, in that the IGT, using an analysis of complaints data,
can undertake a review on an issue relating to tax administration, which can contribute
to improvements in the tax system.
The Inspector-General of Taxation can be accessed at: https://igt.gov.au.

Accessing the law

In Australia, all federal and state legislation, subordinate legislation in the form of regulations,
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and all reserved judgments are available freely and publicly through a variety of law databases,
both online and in physical libraries.
The most comprehensive Australian database is the Australasian Legal Information Institute
(AustLII), a comprehensive and free online legal database, accessed at: http://www.austlii.edu.
au/. AustLII is published by the law faculties of two major Australian universities and is the
primary source of both Australian law and links to the world’s legal resources. All Australian
taxation legislation is available on the AustLII database. All taxation decisions of the AAT and the
Federal Court are also available on the AustLII database. Simply enter this front page and search
for any Australian federal government or state government piece of legislation or case or browse
through the various listed databases.
ATO website
The ATO website is a very important and authoritative source for correct information on taxation
law in Australia.
Access the ATO website at: www.ato.gov.au. The search function is excellent, and the best way to
find information is to search the area or term you are looking for, and then consider the results
to link through to the relevant fact pages and information sheets.
The ATO Legal Database is published by the ATO and available at: http://www.ato.gov.
au/law/. This database provides access to much of the material the ATO uses when making
decisions. This includes tax legislation and related material, public rulings, tax-related case law,
ATO interpretative decisions and taxpayer alerts. To use the database, select from the links to
documents, or use the search function.
Reading a taxation law case

Each case heard by a judge contains a judgment and a decision. These are delivered orally by
the judge in a closed or open court. All judgments follow the same format. This is the same for
all civil law cases, including taxation cases heard in the AAT or the Federal Court.
We can use the example of a well-known AAT decision, Robyn Frances Murtagh and
Commissioner of Taxation [1984] AATA 249, to demonstrate how to read an AAT judgment:
• case citation—the case has a title and citation in the form of Robyn Frances Murtagh and
Commissioner of Taxation [1984] AATA 249. This denotes the claimant (Robyn Frances
Murtagh) versus the defendant (Commissioner of Taxation), the year the decision was made
(1984), the tribunal hearing the case (Administrative Appeals Tribunal of Australia), and the
page where it appears (249)
• court—states whether this is the first time the case has been heard (original jurisdiction)
or if it is an appeal, and if so, from which court or tribunal (e.g. from the AAT in a Federal
Court judgment)
• catchwords and the precedents used to inform the decision

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• actual judgment (the order and the decision)—the actual judgment appears about halfway
into the report. The judgment contains two important elements, which we have already
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referred to in the section ‘Federal court system’:
– ratio decidendi—this is Latin for ‘the reason for the decision’, and it is the ratio decidendi
that may create a precedent for the future. This key element of the judgment can
sometimes be difficult to determine when reading a decision. Helpful tips are to separate
the important facts from the unimportant ones, determining what precedents were
applied in the decision, cross-checking against the points made in the catchwords and
precedent listing, and reading the judgment with later decisions that cite that judgment
in mind
– obiter dictum—this is Latin for ‘sayings by the way’. These are additional observations on
the case itself that, although made by the judge, are not directly relevant to the judge’s
decision. They therefore carry less weight than the ratio decidendi and are not binding
as precedents.
Ethical principles and behaviour

What are ethics?
Ethics and morals are concerned with right and wrong and how conduct should be judged to
be good or bad. It is about how we should live our lives and, in particular, how we should behave
towards other people. It is therefore relevant to all forms of human activity.
Morals differ from ethics in the sense that they derive from a person’s individual beliefs and are
often linked to religious views.
They are not derived from professional ethics, which are the views and rules of the professional
organisation that an individual is a member of.
Therefore, it is perfectly possible for an individual to find an action to be justified ethically

(in terms of professional ethics) but be immoral (to their personal views).
Where an individual’s morals clash with their professional ethics, they can protest or resign—
but this will have consequences for them professionally and therefore is the hardest choice that a
professional may face. The law will provide the individual some protection if they make an ethical
protest. Where an individual follows their professional ethics, they may not be taking (to them)
the correct course of action, but they will be afforded the protection of their profession.
When developing professional ethical standards, such as the ones studied in this module,
professional bodies attempt to develop strong fundamental ethical behaviour in their members.
By doing this it is hoped that members will practise ethical decision-making and therefore have
a strong sense of what is ethically right and wrong.
➤ Question 1.1
Consider the following situations. Do you think the person is acting morally and in accordance
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with professional ethics?

(a) A registered tax agent uses legitimate tax planning to allow a high-income earning business
owner to only pay as much tax as a salary earner on a much lower income.
(b) A registered tax agent prepares the accounts and tax returns of a client. Unknown to the
client, the tax agent’s sister runs a competing business, but the tax agent feels that due to
their own honesty, they can keep the client’s affairs confidential.
(c) An airline pilot decides to risk an emergency landing in severe bad weather for a passenger
who is gravely ill and will die if not treated very soon.
Check your work against the suggested answer at the end of the module.
Ethical principles
All codes and standards in this module—APES 110, APES 220 and the TPB Code of Professional
Conduct—provide very similar principles (in the case of APES 110 and APES 220) or are based
around the same principles (in the TPB Code of Professional Conduct—ethical guidelines)
that give the fundamental principles all members should follow in their professional lives.
These principles are regarded as fundamental because they form the bedrock of professional
judgments, decisions, reasoning and practice.
All members who subscribe to these standards must not only know the fundamental principles,
but also apply them in their everyday work. APES 110 and APES 220 are framework- or
ethics-based.
There are serious consequences for failing to follow them. Whenever a complaint is made
against a party to the Accounting Professional and Ethical Standards Board (APESB) standards,
failure to follow the contents of the fundamental principles will be taken into account when a
decision is made as to whether a prima facie case exists of professional misconduct. The codes
reflect the standards all bodies expect from their members.
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APES 110 Code of Ethics for Professional Accountants

The APESB publishes APES 110. APES 110 is based on the international code issued by the
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International Ethics Standards Board for Accountants (IESBA), which is commonly used by
accounting bodies internationally. (An updated version of APES 110 was released in November
2018, which is operative from 1 January 2020, but may be adopted earlier.)
APESB is formed by the main accounting bodies in Australia. Established in 2006, the board is
made up of three members—CPA Australia, Chartered Accountants Australia & New Zealand
(CA ANZ) and the Institute of Public Accountants (IPA). All members of these organisations
are bound by the standards published by the APESB.
Fundamental ethical principles of APES 110

First, the member as a professional accountant should be guided by the one overarching
principle of APES 110—to act in the public interest (para. 100.1 A1). It states:
A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in
the public interest. A Member’s responsibility is not exclusively to satisfy the needs of an individual
client or employing organisation. Therefore, the Code contains requirements and application
material to enable Members to meet their responsibility to act in the public interest (APES 110,
para. 100.1 A1).
The member should follow the five fundamental principles of APES 110 at all times.
Under para. 110.1 A1 of APES 110:

There are five fundamental principles of ethics for Members:
a. Integrity—to be straightforward and honest in all professional and business relationships.
b. Objectivity—not to compromise professional or business judgements because of bias,
conflict of interest or undue influence of others.
c. Professional competence and due care—to:
(i) Attain and maintain professional knowledge and skill at the level required to ensure that
a client or employing organisation receives competent Professional Activities, based on
current technical and professional standards and relevant legislation; and
(ii) Act diligently and in accordance with applicable technical and professional standards.
d. Confidentiality—to respect the confidentiality of information acquired as a result of
professional and business relationships.
e. Professional behaviour—to comply with relevant laws and regulations and avoid any
conduct that the Member knows or should know might discredit the profession (APES 110,
para. 110.1 A1).
Example 1.2: Examples of acting unethically

The following list links each of the fundamental principles to an example of a situation where someone
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would be acting unethically.

• integrity—handing over work to a colleague that you know contains errors
• objectivity—allowing personal feelings about something to cloud your judgment
• professional competence and due care—taking on work you are not qualified to do
• confidentiality—leaving sensitive or confidential information where anyone can look at it
• professional behaviour—cheating in professional exams.
A professional has a responsibility to make ethical decisions based on honesty, integrity, objectivity and
confidentiality. As part of this, they need to manage their emotions in order to maintain professionalism,
so should not allow personal feelings to interfere with professional judgments. They must also be
aware of situations where they should request assistance if there is work they are not qualified to do
and should always check that information gathered for analysis is accurate and comprehensive.
Consider how each of the listed examples of acting unethically would affect the employability of that
person—it would certainly harm their career prospects.
Fundamental threats
As well as identifying fundamental principles, APES 110’s ethical guidelines identify five
types of threat to those principles. These threats are self-interest threats, self-review threats,
advocacy threats, familiarity threats and intimidation threats. The fundamental threats are
described in Table 1.1.
Table 1.1: Fundamental threats
Type of threat Description of threat
Self-interest The threat that a financial or other interest will inappropriately influence a Member’s
judgment or behaviour
Self-review The threat that a Member will not appropriately evaluate the results of a previous
judgment made, or an activity performed by the Member, or by another individual
within the Member’s Firm or employing organisation, on which the Member will rely
when forming a judgment as part of providing a current activity
Advocacy The threat that a Member will promote a client’s or employing organisation’s
position to the point that the Member’s objectivity is compromised
Familiarity The threat that due to a long or close relationship with a client, or employing
organisation, a Member will be too sympathetic to their interests or too accepting
of their work
Intimidation The threat that a Member will be deterred from acting objectively because of
actual or perceived pressures, including attempts to exercise undue influence over
the Member
Source: Based on APES 110 Code of Ethics for Professional Accountants, para. 120.6 A3,
accessed April 2019, https://www.apesb.org.au/uploads/home/02112018000152_APES_110_
Restructured_Code_Nov_2018.pdf.
The ethical guidelines take an ‘identify, evaluate and address threats’ approach to dealing with
ethical issues. They state that where a threat is identified, the member should assess whether
or not it is significant and then take action to remove or mitigate it. Further advice for dealing
with ethical issues is covered in the sections ‘Tax practitioner obligations’ and ‘Identifying
ethical dilemmas’.
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NOCLAR standard
The NOCLAR standard, incorporated as a new section of APES 110 in 2017, provides guidance
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on responding to non-compliance with laws and regulations (NOCLAR), which a professional
accountant may encounter in their professional activities. An example of where NOCLAR may
potentially apply is in the area of tax evasion.
Under NOCLAR, accountants are now enabled to set aside the APES 110 fundamental standard of
confidentiality when it is in the public interest to report non-compliance with laws and regulations,
and where the conditions for reporting NOCLAR are met. First, the non-compliance must have
a direct and material effect on the financial statements of the client or employer. Second, if the
non-compliance is not qualitative, then the non-compliance must be fundamental to the business
and its operations. There needs to be credible evidence of serious negative consequences to
employees, creditors, investors or the general public in financial or non-financial terms.
When these conditions are met, the standard not only enables, but places a responsibility upon,
all professional accountants to disclose NOCLAR to public authorities. The NOCLAR standard
came into effect in Australia on 1 January 2018.
APES 220 Taxation Services

The APESB has issued professional standard APES 220 (current version revised in July 2018).
Revisions to APES 220 have been recommended to incorporate the NOCLAR standard just
discussed. At the time of writing, APES 220 has not been updated to incorporate NOCLAR.
Paragraph 1.1 of APES 220 states:

The objectives of APES 220 Taxation Services are to specify a Member’s professional and ethical
obligations in respect of:
• fundamental responsibilities when the Member performs a Taxation Service for a Client
or Employer;
• preparation and lodgement of returns to Revenue Authorities [such as the ATO];
• association with tax schemes and arrangements;
• the use of estimates;
• false and misleading information;
• professional Engagement matters;
• Client Monies;
• professional fees; and
• documentation (APES 220, para. 1.1).
One of the topics covered in the standard is false and misleading information. Paragraphs 7.1
and 7.2 of APES 220 require members to refuse to provide taxation services if they are provided
with false or misleading information, or to make (or omit to make) a statement that is false or
misleading. Under para. 7.3, ‘Where a Member forms the view that a Taxation Service is based or
false or misleading information or the omission of material information, the Member shall discuss
the matter with the Client or Employer and advise them of the consequences if no action is
taken’. It is currently recommended that APES 220 be updated to reflect the NOCLAR standard,
and it is likely this will change the reporting of false and misleading information when it meets
the NOCLAR conditions.
All members must follow the mandatory requirements of APES 220 when providing taxation
services.
The six fundamental responsibilities of APES 220 that members must follow when providing
taxation services mirror the fundamental principles that must be followed in APES 110.
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The APES 220 fundamental responsibilities are:

• public interest (the overarching principle in APES 110)
• integrity and professional behaviour
• objectivity
• independence obligations
• confidentiality
• professional competence and due care (APES 220, s. 3).
➤ Question 1.2
Access the latest version of APES 220 Taxation Services at: http://www.apesb.org.au/uploads/
home/09072018131941_APES_220_July_2018.pdf, or by searching for it using your search engine.
Make sure you have found the most up-to-date edition (July 2018).
Answer the following questions:
(a) What is the chief requirement for a member when preparing and lodging a tax return to the
ATO on behalf of a client?
(b) What is the obligation of the member if they find the information provided by the client is
false and misleading?
Tax Practitioners Board Code of Professional Conduct

The TPB Code of Professional Conduct is issued by a regulatory authority, and all tax
practitioners in Australia must comply with it if they wish to maintain their registration with
the TPB. The TPB code is found in the Tax Agent Services Act 2009 (Cwlth) (TASA).
The TPB Code of Professional Conduct covers the three types of tax practitioner—tax agents,
BAS agents and tax (financial) advisers. However, the fundamental principles of the TPB code are
the same across all three registration types. It is the application of the principles that differs.
STUDY GUIDE | 43
The 14 fundamental principles of the TPB code are based on similar concepts found in APES 110
and APES 220. The 14 principles are set out under the five categories of:
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• Honesty and integrity
• Independence
• Confidentiality
• Competence
• Other responsibilities (TPB n.d.).
Principle 4 of the TPB Code of Professional Conduct (under 'Independence') states that the
practitioner must act lawfully in the best interests of their client. This requirement equates
to the Corporations Act 2001 (Cwlth) requirement of Australian financial services (AFS)
representatives (financial advisers) to act in the best interests of their client.
The TPB Code of Professional Conduct is discussed in more detail in the later section
‘Tax Practitioners Board Code of Professional Conduct’.
Identifying ethical dilemmas

Applying the conceptual framework
APES 110 provides a conceptual ethical framework to guide decision-making for tax advisers
needing to make an ethical decision.
The conceptual framework requires Members to use their professional judgement in order to:
• identify any threats to compliance with the fundamental principles
• evaluate the significance of the identified threats
• apply safeguards to eliminate threats or reduce them to an acceptable level (CPA Australia
2014, p. 8).
Figure 1.6 demonstrates the application of the conceptual framework published in the
APES 110 standard.
Figure 1.6: The conceptual framework

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Are there any circumstances or relationships

No
that create any threats to compliance with the
fundamental principles?
Proceed/continue with the

Yes professional service,
engagement or with the
employing organisation
Yes
Are these threats at an acceptable level?†
No
Are there available safeguards that would Yes Apply safeguards so that threats
eliminate threats or reduce threats to an are eliminated or reduced to an
acceptable level? acceptable level
No
Decline or discontinue the professional service

or resign from the engagement or the
employing organisation
†
‘Acceptable level’ in the Code is defined by using the third party test. It means a level at which a
reasonable and informed third party would be likely to conclude—weighing all the specific facts and
circumstances available to the Member at that time—that compliance with the fundamental principles
is not compromised.
Source: CPA Australia 2014, An Overview of APES 110 Code of Ethics for Professional Accountants, p. 7,
accessed March 2019, cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/
ethics/an-overview-of-apes-110-code-of-ethics.pdf?la=en.
Facing ethical conflicts

The previous section ‘Ethical principles and behaviour’ discussed the need for taxation
professionals, including tax advisers, to be ethical, and the consequences of being unethical.
The conceptual framework presented in Figure 1.6 shows tax advisers the steps to follow to
make a good ethical decision.
It is therefore important that they can spot an ethical problem and be able to deal with it
effectively and appropriately.
Many taxation services dilemmas challenge both personal integrity and business skills and
therefore a strong ethical understanding is important. We now consider potential situations
where tax advisers have to make ethical decisions, and how they should resolve them.
Ethical conflicts and conflicts of interest

Ethical conflicts are situations where two ethical values or requirements seem to be incompatible.
They can also arise where two conflicting demands or obligations are placed on an individual
tax adviser.
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A conflict of interest arises where a conflict creates a threat to the objectivity of the adviser.
This might be due to the member undertaking a professional activity for two parties where their
MODULE 1
interests are in conflict, or in the alternative, where the member’s interests are in conflict with a
party (APES 110, para. 210.2). While working, information or other matters may arise that mean
the adviser cannot continue to work for one party without harming another. Conflicts of interest
are not wrong in themselves, but they will become a problem if a professional continues with
a course of action while being aware of and not declaring them.
Situations where ethical conflicts may arise

Ethical conflicts occur as a result of tensions between four sets of values.
• Societal values—the law, such as taxation evasion and the grey area that is tax avoidance
(see the later section ‘Tax planning, avoidance and evasion’).
• Personal values—values and principles held by the individual.
• Corporate values—the values and principles of the organisation where the individual works,
often laid down in ethical codes.
• Professional values—the values and principles of the professional body that the individual
is a member of, often laid down in standards as discussed previously.
Where society believes that businesses are not conducting themselves correctly, laws may be
introduced to ensure a minimum level of behaviour is followed. Examples of this are laws
created to deal with tax evasion, fraud and tax avoidance.
Ethical conflicts involve unclear choices of what is right and wrong. In fact, the choice could be
what is the least wrong course of action to take. In such circumstances, there is little an individual
can do but to seek advice and trust their own instincts to make the correct choice.
Remember that laws do not necessarily help an individual to resolve an ethical issue—indeed
many members of society feel torn when their personal ethics lead them to feel following a
particular law is immoral.
Where a professional duty conflicts with statute, the advice of all the relevant professional
standards is clear—the law overrides every time.
Resolving ethical dilemmas

Tax advisers will encounter situations throughout their professional life that present them with
an ethical dilemma or conflict of interest.
Ethical conflicts may arise from:

• members asked to act contrary to taxation laws or technical and/or professional standards
• divided loyalties between colleagues and the taxation law and/or professional standards
• tax advisers having to do work beyond the degree of expertise or experience they possess
• personal relationships with other employees or clients
• gifts and hospitality being offered.
Take a look at the scenario in Question 1.3.

➤ Question 1.3
Lucy is a junior accountant in her second year of full-time employment. During Lucy’s lunch break,
MODULE 1
her company’s human resources manager has asked Lucy for some help. The human resources
manager has recently inherited a considerable portfolio of investment properties, shares and cash.
She would like Lucy to advise her on potential income tax and capital gains tax (CGT) liabilities.
What are the key ethical issues here?
Steps for making a good decision

We have seen there are many situations that could cause ethical conflicts, ranging from the
trivial to the very serious (such as taxation fraud).
Generally, individuals should consider:

• transparency—do I feel comfortable with others knowing about my decision? Is my
decision defensible?
• effect—have I considered all parties who may be affected by the decision? Have all factors
been taken into account, such as mitigating circumstances?
• fairness—would a reasonable third party, such as a taxation authority, view the decision
as fair?
➤ Question 1.4
Which of the following would not be a suitable question to ask yourself when resolving an ethical
dilemma in your role as a tax adviser? Explain your choice.
A Does my solution benefit my career?
B Have I thought about all the possible consequences of my solution?
C Would my colleagues and/or my clients think my solution is reasonable?
D Could I defend my solution under public scrutiny, including to the relevant taxation authorities?
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Ethical dilemma checklist

The following steps suggest an approach for conflict resolution:
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• Step 1: Gather and record relevant facts.
• Step 2: Assess the ethical issues involved.
• Step 3: Decide if the issue is legal in nature.
• Step 4: Identify any fundamental principles that may be affected.
• Step 5: Identify any affected parties.
• Step 6: Consider possible courses of action.
• Step 7: If necessary, seek professional or legal advice.
• Step 8: Refuse to be associated with the conflict.
Always document all meetings, conversations and actions in relation to a particular ethical
problem as you may be required at a later date to show how you dealt with the matter.
Paragraph 110.2 A2 of APES 110 states that a member faced with such a conflict might consider
consulting certain people, but that ‘such consultation does not relieve the Member from the
responsibility to exercise professional judgement to resolve the conflict or, if necessary, and unless
prohibited by law or regulation, disassociate from the matter creating the conflict’.
Tax practitioner obligations

What is the Tax Practitioners Board?
The TPB is responsible for the registration and regulation of tax agents, BAS agents and tax
(financial) advisers across Australia. These three types of registered entities are collectively
referred to as 'tax practitioners'.
The TPB is responsible for ensuring compliance with the legislation that governs tax practitioner
registration, TASA. The TPB is also responsible for compliance with the TPB Code of Professional
Conduct. The TPB Code of Professional Conduct is discussed in the section ‘Tax Practitioners
Board Code of Professional Conduct’.
The TPB has the following responsibilities:

• administering a system to register tax practitioners, ensuring they have the necessary
competence and personal attributes
• providing guidelines and information on relevant matters
• investigating conduct that may breach the TASA, including non-compliance with the Code,
and breaches of the civil penalty provisions
• imposing administrative sanctions for non-compliance with the Code
• applying to the Federal Court in relation to contraventions of the civil penalty provisions in the
TASA (TPB 2019).
Tax agent
Any individual (or partnership) who provides tax agent services for a fee or other reward must be
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registered with the TPB.
Under the TAA, taxpayers using a registered tax agent may not be liable to some administrative
penalties imposed by the ATO.
Tax agent services relate to:

• ascertaining (that is, working out) or advising about liabilities, obligations or entitlements of
entities (that is your clients) under a taxation law
• representing entities in their dealings with the Commissioner of Taxation (Commissioner)
in relation to a taxation law
• where it is reasonable to expect the entity will rely on the service to satisfy liabilities or
obligations, or to claim entitlements, under a taxation law (TPB 2018d).
Table 1.2 provides a non-exhaustive list of the types of services that may or may not constitute
a tax agent service under the TASA, if provided for a fee or reward.
Table 1.2: Examples of tax agent services
Tax agent Not a tax

Service service agent service
Preparing returns, notices, statements, applications or other X

documents about your client’s liabilities, obligations or entitlements
under a taxation law.
Lodging returns, notices, statements, applications or other documents X

about your client’s liabilities, obligations or entitlements under a
taxation law.
Assisting clients with tax concessions for expenditure incurred on X

research and development activities where the service involves the
application of taxation laws.
Preparing depreciation schedules on the deductibility of capital X

expenditure.
Preparing or lodging objections on behalf of a taxpayer under Part IVC X

of the Taxation Administration Act 1953 (TAA) against an assessment,
determination, notice or decision under a taxation law.
Giving clients advice about a taxation law that they can reasonably be X
expected to rely on to satisfy their taxation obligations.
Dealing with the Commissioner on behalf of clients. X
Applying to the Commissioner or the Administrative Appeals Tribunal X

(AAT) for a review of, or instituting an appeal against, a decision on
an objection under Part IVC of the TAA.
Reconciling BAS provision data entry to ascertain the figures to be X

included on a client’s activity statement.
Filling in an activity statement on behalf of a client or instructing them X

which figures to include.
Ascertaining the withholding obligations for employees of your clients, X

including preparing payment summaries.
Installing computer accounting software and determining default X

goods and services tax (GST) and other codes tailored to clients.
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Tax agent Not a tax

Service service agent service
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Installing computer accounting software without determining default X
GST and other codes tailored to clients.
Coding transactions, particularly in circumstances where it requires the X

interpretation or application of a taxation law.
Coding tax invoices and transferring data onto a computer program X

for clients under the instruction and supervision of a registered tax or
BAS agent.
Contracting the services of a specialist to provide advice about an X

area of taxation law that you have no expertise and cannot review
for accuracy.
Services provided by an auditor of a self-managed superannuation X

fund under the Superannuation Industry (Supervision) Act 1993.
Providing general taxation advice to clients that does not involve X

the application or interpretation of a taxation law to the client’s
personal circumstances.
General training (such as a classroom) in relation to the use of X

computerised accounting software not related to particular
fact situations.
Preparing bank reconciliations. X
Entering data. X
Source: TPB 2018, ‘Tax agent services’, accessed March 2019,

https://www.tpb.gov.au/tax-agent-services.
Business activity statement agent

With the introduction of the self-assessment regime, Pay-As-You-Go (PAYG) and GST, compliance
tasks (e.g. lodging activity statements such as the BAS) have significantly increased. The ‘registered
BAS agent’ category was introduced with a scope that is limited to the preparation and lodgment
of BAS activity statements, which may allow suitably qualified entities (e.g. bookkeepers) to perform
these tasks.
Any individual (or partnership) who provides BAS agent services for a fee or other reward must
be registered with the TPB.
BAS services include any service that relates to:

• ascertaining liabilities, obligations or entitlements of an entity that arise, or could arise,
under a BAS provision
• advising an entity about liabilities, obligations or entitlements of an entity or another entity
that arise, or could arise, under a BAS provision
• representing an entity in their dealings with the Commissioner of Taxation, and
is provided in circumstances where the entity can reasonably be expected to rely on the service
for either or both of the following purposes:
• to satisfy liabilities or obligations that arise, or could arise, under a BAS provision, or
• claim entitlements that arise, or could arise, under a BAS provision.
A BAS service also includes a service that the Tax Practitioners Board has declared, by way of a
legislative instrument to be a BAS service (TPB 2018f; see also TASA, s. 90-10).
A BAS provision includes:

• GST law
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• wine equalisation tax law

• luxury car tax law
• fuel tax law
• fringe benefits tax law (relating to collection and recovery only)
• pay as you go (PAYG) withholding
• PAYG instalments (TPB 2018f; see also ITAA97, s. 995-1(1)).
Table 1.3 includes a non-exhaustive list of the types of services that may and may not constitute
a BAS service under the TASA.
Table 1.3: Examples of BAS agent services
Not a BAS
Service BAS service service
Applying to the Registrar for an ABN on behalf of a client. X
Installing computer accounting software without determining default X

GST and other codes tailored to the client.
Coding transactions, tax invoices and transferring data onto a X

computer program for clients through processes that require the
interpretation or application of a BAS provision.
Coding transactions, tax invoices and transferring data onto a X

computer program for clients through processes that do not require
the interpretation or application of a BAS provision.
Confirming figures to be included on a client’s activity statement. X
Completing activity statements on behalf of an entity or instructing X

the entity which figures to include.
General training in relation to the use of computerised accounting X

software not related to client’s particular circumstances.
Preparing bank reconciliations. X
Entering data without involvement in or calculation of figures to be X

included on a client’s activity statement.
Confirming the withholding tax obligations for the employees of X

a client.
Services declared to be a BAS service by way of a legislative X

instrument issued by the TPB.
Preparation and provision of a payment summary that may include X

reportable fringe benefits amounts and the reportable employer
superannuation contributions.
Registering or providing advice on registration for GST or X

PAYG withholding.
Services under the Superannuation Guarantee (Administration) X

Act 1992 to the extent that they relate to a payroll function or
payments to contractors.
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Not a BAS
Service BAS service service
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Determining and reporting the superannuation guarantee shortfall X
and associated administrative fees.
Dealing with superannuation payments made through a clearing X

house.
Completing and lodging the taxable payments annual report to the X

ATO on behalf of a client.
Sending a TFN declaration to the Commissioner on behalf of a client. X
Source: TPB 2018, ‘BAS services’, accessed November 2018, www.tpb.gov.au/bas-services.
Tax (financial) adviser

All AFS licensees and their representatives (we will refer to them as a ‘financial adviser’ to
differentiate terms) that provide tax (financial) advice services for a fee or other reward must
be registered with the TPB.
If a financial adviser is advising their clients on the taxation consequences of the financial advice
they provide, they are deemed to be providing a tax (financial) advice service, and must be
registered with the TPB as a tax (financial) adviser.
What is the Australian financial services licensing regime?

The AFS licensing regime for financial planners and advisers is governed through the
Corporations Act and compliance is through the Australian Securities and Investments
Commission (ASIC).
Under the AFS licensing regime, all entities or individuals providing a defined financial service
to a retail client—for example, providing advice on investing surplus monies into a managed
investment fund to an individual or couple—must be registered as either an AFS licensee or
as an authorised representative of an AFS licensee. An authorised representative can be an
individual, a body corporate, a partnership, a group of body corporates or individuals who are
trustees of a trust, or an employee or director or an AFS licensee or related body corporate.
Section 761A of the Corporations Act states that an ‘authorised representative of a financial
services licensee means a person authorised in accordance with section 916A or 916B to
provide a financial service or financial services on behalf of the licensee’.
Section 766A(1) of the Corporations Act defines a financial service as follows:

For the purposes of this Chapter, subject to paragraph (2)(b), a person provides a financial
service if they:
(a) provide financial product advice (see section 766B); or
(b) deal in a financial product (see section 766C); or
(c) make a market for a financial product (see section 766D); or
(d) operate a registered scheme; or
(e) provide a custodial or depository service (see section 766E); or
(f) engage in conduct of a kind prescribed by regulations made for the purposes of this paragraph.
TPB provides the following definition:

A tax (financial) advice service consists of five key elements:
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1. a tax agent service (excluding representations to the Commissioner of Taxation)

2. provided by an Australian financial services (AFS) licensee or representative of an AFS licensee
3. provided in the course of advice usually given by an AFS licensee or representative
4. relates to ascertaining or advising on liabilities, obligations or entitlements that arise, or could
arise, under a taxation law
5. reasonably expected to be relied upon by the client for tax purposes (TPB 2018e).
Table 1.4 includes a non-exhaustive list of the types of services commonly provided by a financial
adviser and whether they constitute a tax (financial) advice service.
Table 1.4: Examples of tax (financial) advice services
Tax (financial) Tax agent

Service advice service service
Any service specified by the TPB by legislative instrument to be Yes Yes

a tax (financial) advice service.
Personal advice (as defined in the Corporations Act 2001), including Yes Yes
scaled advice and intra-fund advice, which involves the application or
interpretation of the taxation laws to a client’s personal circumstances
and it is reasonable for the client to expect to rely on the advice for
tax purposes.
Any advice (other than a financial product advice as defined in the Yes Yes
Corporations Act 2001) that is provided in the course of giving
advice of a kind usually given by a financial services licensee
or a representative of a financial services licensee that involves
application or interpretation of the taxation laws to the client’s
personal circumstances, and it is reasonable for the client to
expect to rely on the advice for tax purposes.
Factual tax information that does not involve the application No No

or interpretation of the taxation laws to the client’s personal
circumstances. Such information could be included in, but is not
limited to:
• regulated disclosures such as product disclosure statements
and financial services guides
• other products such as general marketing and promotional
materials.
Client tax-related factual information. Such information includes, No No

but is not limited to:
• payment summaries
• other documents such as annual summary of interest paid
and account statements.
General advice (as defined in the Corporations Act 2001). No No
Any service that does not take into account an entity’s relevant No No
circumstances so that it is not reasonable for the entity to expect to
rely on it for tax purposes. This includes simple online calculators as
defined in the Australian Securities and Investments Commission’s
Class Order (CO 05/1122).
Factual information provided by call centres and front line staff and No No
specialists that would not be expected to be relied upon for tax
related purposes.
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Tax (financial) Tax agent

Service advice service service
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Preparing a return or a statement in the nature of a return (to provide No Yes
this service would require registration as a tax agent).
Preparing an objection under Part IVC of the Taxation Administration No Yes

Act 1953 against an assessment, determination, notice or decision
under a taxation law.
A service specified not to be a tax agent service in Regulation 13 No No

of the Tax Agent Services Regulations 2009.
Dealing with the Commissioner of Taxation on behalf of a client. No Yes

This may include, for example, applying for a private binding ruling
on behalf of a client.
Source: TPB 2018, ‘Tax (financial) advice services’, accessed March 2019,
https://www.tpb.gov.au/tax-financial-advice-services.
Registering as a tax agent

The requirements for registration as a tax agent are as follows:
• have a primary qualification in one of certain stated fields, or in the alternative, be a voting
member of a recognised tax agent association. Note that in some cases, extensive work
experience will mean that this requirement is unnecessary
• have undertaken board-approved course/s in certain areas (this will depend on the
qualifications and work experience of the applicants). If the first requirement was fulfilled due
to having voting membership of a recognised tax agent association, then this requirement
is unnecessary
• have sufficient work experience (the amount required is dependent on the primary
qualifications of the applicant).
Tax agents are also required to meet continuing professional education requirements (TPB 2018b).
Registering as a BAS agent

The requirements for registration as a BAS agent are as follows:
• primary qualifications in bookkeeping or accounting
• have undertaken a board-approved GST/BAS course
• have sufficient relevant work experience (less hours of work experience are required where
the person is a voting member of a recognised BAS or tax agent association).
BAS agents are also required to meet continuing professional education requirements (TPB 2018c).
Registering as a tax (financial) adviser

The requirements for registration as a tax (financial) adviser are as follows:
• be, or have been within the preceding 90 days, an Australian financial services (AFS) licensee
or a representative of an AFS licensee.
• meet certain qualifications and experience requirements (TPB 2018c).
Tax (financial) advisers are also required to meet continuing professional education requirements.
Tax Practitioners Board Code

of Professional Conduct
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Principles of the Tax Practitioners Board Code

of Professional Conduct
The TPB Code of Professional Conduct sets out 14 principles under five specialist categories.
These principles are essentially the same for all tax practitioners—tax agents, BAS agents and tax
(financial) advisers.
The TPB code principles are set out under five separate categories and are based on the law in
s. 30-10 of TASA:
Honesty and integrity
(1) You must act honestly and with integrity.
(2) You must comply with the taxation laws in the conduct of your personal affairs.
(3) If:
(a) you receive money or other property from or on behalf of a client; and
(b) you hold the money or other property on trust;
you must account to your client for the money or other property.
Independence
(4) You must act lawfully in the best interests of your client.
(5) You must have in place adequate arrangements for the management of conflicts of interest
that may arise in relation to the activities that you undertake in the capacity of a registered
tax agent or BAS agent.
Confidentiality
(6) Unless you have a legal duty to do so, you must not disclose any information relating to
a client’s affairs to a third party without your client’s permission.
Competence
(7) You must ensure that a tax agent service that you provide, or that is provided on your behalf,
is provided competently.
(8) You must maintain knowledge and skills relevant to the tax agent services that you provide.
(9) You must take reasonable care in ascertaining a client’s state of affairs, to the extent that
ascertaining the state of those affairs is relevant to a statement you are making or a thing you
are doing on behalf of the client.
(10) You must take reasonable care to ensure that taxation laws are applied correctly to the
circumstances in relation to which you are providing advice to a client.
Other responsibilities
(11) You must not knowingly obstruct the proper administration of the taxation laws.
(12) You must advise your client of the client’s rights and obligations under the taxation laws
that are materially related to the tax agent services you provide.
(13) You must maintain the professional indemnity insurance that the Board requires you
to maintain.
(14) You must respond to requests and directions from the Board in a timely, responsible and
reasonable manner (TASA, s. 30-10).
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Code of operations for tax (financial) advisers

Tax (financial) advisers are required to comply with the above obligations contained in
MODULE 1
s. 30-10 of TASA. This is a requirement of their registration, and if it were not for the rules
around recognising other obligations, the requirements would be onerous, as tax (financial)
advisers are already subject to the provisions of another licensing regime.
A lot of the fundamental principles of the TPB Code of Professional Conduct ‘are similar to
the obligations of AFS licensees and their representatives under the Corporations Act 2001’
(TPB 2018a).
Because of this, ‘it is recognised that tax (financial) advisers who already comply with their
obligations under the Corporations Act 2001 and other relevant Australian Securities and
Investments Commission (ASIC) requirements will generally also comply with most Code
obligations’ (TPB 2018a).
Table 1.5 ‘provides a brief summary comparison of the Code and relevant obligations under
the Corporations Act 2001. This table does not aim to comprehensively cover all the relevant
obligations under the Corporations Act 2001’ (TPB 2018a).
Table 1.5: Code of Professional Conduct and Corporations Act requirements
Code of Professional Conduct principles Corporations Act 2001
1. You must act honestly and with integrity. Sections 912A, 913B, 915C, 991A, 1041E, 1041G
and 1041H
Obligations are similar. In particular, the following is noted:
• Licensees have a general obligation to ensure that the
financial services covered by their licence are provided
efficiently, honestly and fairly.
• In the course of carrying on a financial services
business, a person must not engage in dishonest
conduct (according to the standards of ordinary
people) in relation to a financial service.
• A licensee must not engage in conduct that is, in all
the circumstances, unconscionable. Further, there are
also obligations in relation to false or misleading
statements or conduct under Part 7.10 of the
Corporations Act.
• ASIC may suspend or cancel an AFS licence if no
longer satisfied that the licensee or the licensee’s
representatives are of good fame or character.
2. You must comply with the taxation laws No similar obligation exists in the Corporations Act.
in the conduct of your personal affairs.
However, under ITAA97, it is a legal obligation for all
taxpayers to comply with taxation laws for both their
personal and business tax affairs.
3. If you receive money or other property Sections 981B and 981H

from or on behalf of a client, and you The following is noted:
hold the money or other property on • The licensee must ensure that money paid into a
trust, you must account to your client client’s account satisfies certain requirements.
for the money or other property. • Money paid to the licensee by their client (or their
representative) is taken to be held in trust by the
For further information, refer to: licensee for the benefit of the client.
https://www.tpb.gov.au/holding-money- • Money held by the licensee on behalf of the client for
or-other-property-trust-information- the purchase or sale of a financial product or insurance
sheet-tpbi-152012. must be deposited into an account with an approved
foreign bank or a cash management trust on the day
it is received, or the next business day.

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4. You must act in the best interests Sections 961A, 961B, 961G, 961J and 961H
of your client. The person providing personal advice to retail clients is
required to:
• act in the best interests of the client in relation to
the advice
• give priority to the interests of the client in the event
of a conflict of interest
• ensure the advice is appropriate
• warn clients if the advice is based on incomplete or
inaccurate information.
Note: Section 961B outlines steps a provider can follow for

the purpose of satisfying the best interests duty.
See also Regulatory Guide RG 175 Licensing: Financial

Product Advisers—Conduct And Disclosure—in particular
Part E—which gives guidance on ‘acting in the client’s best
interests and related obligations’.
5. You must have in place adequate Sections 912A and 961J

arrangements to manage conflicts of • Licensees must have in place adequate arrangements
interest that may arise in relation to for the management of conflicts of interest that may
the activities that you undertake in the arise (either wholly or partially) in relation to activities
capacity of a registered tax practitioner. undertaken by the licensee or a representative in the
provision of financial services.
For further information, refer to: • If there are competing interests between the advice
https://www.tpb.gov.au/code- provider and the client, the provider must give priority
professional-conduct-managing- to the client’s interests when giving advice.
conflicts-interest-tpb-information-sheet-
tpbi-192014. See also Regulatory Guide RG 181 Licensing: Managing
Conflicts of Interest.
6. Unless you have a legal duty to do so, No similar obligation exists in the Corporations Act.
you must not disclose any information
relating to a client’s affairs to a third However, it is noted that Australian Privacy Principle 6.1
party without your client’s permission. in the Privacy Act 1988 (Cwlth) requires you to not
use personal information about an individual that was
For further information, refer to: collected for a particular purpose (primary purpose) or for
https://www.tpb.gov.au/tpbi- another purpose (secondary purpose) unless the individual
322017-code-professional-conduct- has consented to the use or disclosure of the information.
confidentiality-client-information-tax-
financial-advisers.
7. You must ensure that a tax agent service Sections 912A and 961B
you provide or that is provided on your • A licensee must maintain the competence to provide
behalf is provided competently. financial services and ensure that its representatives
are adequately trained and are competent to provide
financial services.
• The person providing the advice must assess whether
they have the expertise required to provide advice on
the client’s identified subject matter. If the provider
does not have the expertise, they must decline to
provide the advice.
See also Regulatory Guide RG 104 Licensing: Meeting

the General Obligations and Regulatory Guide RG 105
Licensing: Organisational Competence.
STUDY GUIDE | 57
MODULE 1
8. You must maintain knowledge and skills Sections 912A and 961B
relevant to the tax agent services that • A licensee must maintain the competence to provide
you provide. financial services and ensure that its representatives
are adequately trained and are competent to provide
For further information, refer to: those financial services.
https://www.tpb.gov.au/explanatory- • If the person providing the advice does not have
paper-tpb-ep-062014-continuing- the expertise required to provide advice on the
professional-education-policy- client’s particular subject matter, they must decline
requirements-registered-tax. to provide the advice.
9. You must take reasonable care in Sections 961B and 961H

ascertaining a client’s state of affairs, • The person providing the advice must make reasonable
to the extent that ascertaining the state enquiries to obtain complete and accurate information
of those affairs is relevant to a statement relating to the client’s relevant circumstances.
you are making or a thing you are doing • If it is reasonably apparent that the information on
on behalf of the client. which the advice is based is incomplete or inaccurate,
the person providing the advice must warn the
For further information, refer to: client that:
https://www.tpb.gov.au/reasonable- – the advice is, or may be, based on incomplete
care-ascertain-clients-state-affairs-tpb- or inaccurate information relating to the client’s
information-sheet-tpbi-172013. relevant personal circumstances, and
– that the client should consider the
appropriateness of the advice before acting on it.
• If the person providing the advice does not have the
expertise required to provide advice on the client’s
particular subject matter, they must decline to provide
the advice.
10. You must take reasonable care to ensure Sections 912A, 961B and 961G
that taxation laws are applied correctly • A licensee must comply with financial services
to the circumstances in relation to which laws and take reasonable steps to ensure that its
you are providing advice to a client. representatives comply with financial services laws.
• The person providing personal advice to a retail client
For further information refer to: is required to act in the best interests of the client in
https://www.tpb.gov.au/reasonable- relation to the advice. The resulting advice must also
care-ensure-taxation-laws-are-applied- be appropriate to the client.
correctly-information-sheet-tpbi-182013.
11. You must not knowingly obstruct Sections 912A and 1310
the proper administration of the A person must not, without lawful excuse, obstruct or
taxation laws. hinder ASIC, or any other person, in the performance
or exercise of a function or power under the
Corporations Act.
There is also a general requirement that licensees must

comply with financial services laws and that AFS licensees
take reasonable steps to ensure that their representatives
comply with financial services laws.

MODULE 1
12. You must advise your client of the Sections 912A, 961B and 961H
client’s rights and obligations under No similar obligations exist in the Corporations Act.
the taxation laws that are materially However, the following is noted:
related to the tax agent services • The person providing the advice must make
you provide. reasonable enquiries to obtain complete and
accurate information relating to the client’s relevant
circumstances.
• If it is reasonably apparent that the information on
which the advice is based is incomplete or inaccurate,
the person providing the advice must warn the
client that:
– the advice is, or may be, based on incomplete
or inaccurate information relating to the client’s
relevant personal circumstances, and
– the client should consider the appropriateness
of the advice before acting on it.
• There is a general requirement that licensees must
comply with financial services laws and that AFS
licensees take reasonable steps to ensure that their
representatives comply with financial services laws.
13. You must maintain the professional Section 912B

indemnity insurance that the Board Licensees must have arrangements for compensating
requires you to maintain. retail clients for losses or damage they suffer as a result
of a breach by the licensee or its representatives of their
For further information, refer to: obligations in Chapter 7 of the Corporations Act.
https://www.tpb.gov.au/explanatory-
paper-tpbep-052014-professional- See also Regulatory Guide RG 126 Compensation and
indemnity-insurance-requirements-tax- Insurance Arrangements for AFS Licensees.
financial-advisers.
14. You must respond to requests and Section 912C

directions from the Board in a timely, While there is no requirement to respond to the TPB,
responsible and reasonable manner. there is an obligation for licensees to respond to ASIC.
In particular, licensees must respond to requests

for information from ASIC within a reasonable time
and as directed.
Source: Adapted from TPB 2018, ‘Code comparison with the Corporations Act 2001’,
accessed March 2019, https://www.tpb.gov.au/code-comparison-corporations-act-2001.
Act in the best interests of the client

Principle 4 of the TPB Code of Professional Conduct is to ‘act lawfully in the best interests of your
client’. This directly corresponds to one of the core tenets of the AFS licensing regime, which is
the duty to act in the best interests of the client.
One of the main duties of an AFS licensee representative under the Corporations Act is the
duty—enshrined in law—to act in the best interests of the client, to give priority to the interests
of the client in relation to any conflict of interest, and to ensure that the advice given to the client
is appropriate.
STUDY GUIDE | 59
Tax planning, avoidance and evasion
MODULE 1
Distinguishing between terms
The Australian taxation legislation imposes the tax liabilities and compliance requirements that
create a threshold for legal behaviour. Deliberate non-compliance to reduce the incidence of
tax is described as either tax fraud or tax evasion.
The concept of what is or is not acceptable tax planning behaviour rarely aligns with the law.
The law is subjective and may vary over time with community attitudes. Advisers who create
legal tax planning strategies are working within the taxation law to legally and ethically minimise
taxation paid by their clients. Advisers also act within their remit to legally minimise taxation for
their client using the rules allowed for in the taxation system. This is tax planning, and it operates
within the law. This is acceptable behaviour.
But the lines blur quickly between good tax planning and unacceptable tax avoidance. It can
be difficult to distinguish between tax planning and tax avoidance because determining the
intention or spirit of the law is a subjective judgment.
Tax planning is defined as organising a taxpayer’s affairs to minimise the incidence of tax using
legal means and in a way that is not ‘artificial or contrived’. The taxpayer’s financial affairs are
optimised in such a way that a reduction in tax payable is merely incidental to, or a consequence
of, genuine investment decisions.
Example 1.3: Allowable tax planning

An example of allowable tax planning is bringing forward a capital loss on disposal of a CGT asset
that the taxpayer had already intended to sell, so as to offset it against a capital gain of the taxpayer
in that same tax year (as the CGT provisions allow a capital loss to be set off against a capital gain
in the year in determining assessable income). The purpose of the legislation is to provide relief for
realised capital gains. A tax adviser has a duty to ensure their client accesses these CGT provisions
as required for under the law.
Tax laws sometimes provide different outcomes for the same economic activity conducted
in different ways, which encourages the development of aggressive schemes to exploit what
may be unintended legal features. This has been described as tax avoidance and is based
on exploiting tax laws in a manner that is not necessarily illegal (though the anti-avoidance
provisions in the legislation often make tax avoidance illegal).
Example 1.4: Tax avoidance

An example where tax planning crosses over into tax avoidance would be where the taxpayer has a
capital gain and an unrealised capital loss on another asset that they wish to keep, whereby a sale
and immediate repurchase would realise that capital loss and reduce assessable income for the year.
This was never the intention of the legislation, since the immediate repurchase means that the taxpayer
has enjoyed a reduction in assessable income while still holding the other asset. There has been no
economic loss to the taxpayer and the sale and repurchase does not make commercial sense except
for the tax benefit obtained.
Tax evasion has been described as a ‘blameworthy act or omission’ generally requiring intent
and knowledge that it will affect the person’s tax position (Denver Chemical Manufacturing Co v.
FC of T [1949] HCA 25). An example would be deliberate non-disclosure of assessable income.
Figure 1.7 shows how the line can be blurred between tax planning and tax avoidance.
MODULE 1
Figure 1.7: The line between tax planning and tax avoidance
Tax evasion
Behaviour outside the law
(Deliberate non-compliance)
Legal compliance boundary
Tax avoidance
(Use of means that, but for
the anti-avoidance provisions, Unacceptable behaviour
legally reduce tax in a manner
unintended by the legislation)
Indistinct behaviour boundary
Tax planning
(Use of legal means in a way Acceptable behaviour
intended by legislation)
The section ‘Identifying Part IVA’ in Module 11 examines how legislation regulates tax avoidance
chiefly through Part IVA of ITAA36.

The promoter penalty regime is in place in order to deter the promotion of tax avoidance and
tax evasion schemes.
The introduction of the tax (financial) adviser registration regime in 2014 was one method
of regulating the provision of taxation advice by financial advisers, who may well be potential
promoters of tax avoidance or evasion schemes. It should be noted that they may also not be
the promoters of such schemes.
Under the promoter penalty regime, a tax (financial) adviser, any other tax practitioner or any
other individual who is considered a promoter must prove that they are not a promoter of such
a scheme.
The operation of the promoter penalty scheme, relevant penalties, and any exclusions or
exceptions are discussed in the section ‘Promoter penalty regime’ in Module 11.
STUDY GUIDE | 61
Summary and review
MODULE 1
This module gave an overview of many of the important fundamentals of the Australian tax
system and principles that apply to those working in the Australian tax field. It started off by
describing the legal framework that the Australian tax system operates in. This included an
overview of the relevant parts of the Australian Constitution, as well as a description of the
legislative process of creating tax laws, and the judicial process for interpreting them. This part
also included an introduction to accessing tax laws online, and how to read tax cases.
This was then followed by a discussion regarding the ethical environment that is relevant to those
involved in the tax industry. This included an overview of the more important principles in the
ethics codes of the accounting bodies, as well as the ethics code of the TPB. These principles
were then expanded upon in discussing where ethical conflicts and conflicts of interest
potentially arise, as well as how to deal with such conflicts.
The module then discussed the roles and responsibilities of the TPB and provided a description
of the services offered by those registered by the TPB (tax agents, BAS agents and tax (financial)
advisers). This was followed by further discussion of the relevant code of conduct, which those
registered by the TPB need to abide by.
The module finished with a description of the concepts of tax planning, avoidance and evasion.
These concepts are very important for tax professionals, because while it is important for such
professionals to act in their clients’ best interests, they must also ensure that there is compliance
with the relevant laws and obligations.
MODULE 1
SUGGESTED ANSWERS | 63
Suggested answers
MODULE 1
Suggested answers
Question 1.1
There is never any single answer to moral questions, as different people have varying opinions on
what is ‘right’ and ‘wrong’.
(a) Whether this is moral very much depends on the perspective of the individual regarding the
role of taxation and government, and the relative tax burden different members of society
should bear. From a professional ethics point of view, minimising tax in a legal manner is
perfectly professionally ethical.
(b) Although the tax agent here might feel that they are doing nothing wrong and acting in a
moral manner, there is a potential professional ethics issue here given the potential conflict
of interest. The agent owes a duty to the client to avoid such conflicts and should find a way
to either disclose the conflict to the client and get the client to consent to its presence, or not
undertake the work for that client.
(c) The pilot may be risking the lives of everyone on board the aircraft to save the life of just one.
You could consider this unethical, but the pilot may have many years of experience in dealing
with bad weather, so they consider the risk to be low. Pilots will have their own guidelines for
dealing with these situations. Ignoring them may constitute unethical behaviour.
Return to Question 1.1 to continue reading.
Question 1.2
(a) Section 4.1 of APES 220 states that:
A Member shall prepare and/or lodge returns and other relevant documents required to be
lodged with a Revenue Authority in accordance with the information provided by a Client or
Employer, their instructions and the relevant Taxation Law (APES 220, s. 4.1).
(b) Section 7.1 of APES 220 says that in this situation:

A Member shall not provide a Taxation Service to a Client or Employer if the Member finds
that information on which the Taxation Service is to be based contains false or misleading
information or omits material information and the Client or Employer is not prepared to
appropriately amend it (APES 220, s. 7.1).

Question 1.3
MODULE 1
The issues here are professional competence and due care. Lucy is in her first two years of
working as an accountant, so it is unlikely she would have sufficient competence to calculate the
tax liabilities.
Question 1.4
The correct answer is Option A because the best solution to an ethical dilemma should be taken
whether or not it improves your career.

REFERENCES | 65
References
MODULE 1
References
CPA Australia 2014, An Overview of APES 110 Code of Ethics for Professional Accountants,
accessed March 2019, cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-
resources/ethics/an-overview-of-apes-110-code-of-ethics.pdf?la=en.
TPB n.d., ‘The Code of Professional Conduct’, accessed April 2019, https://www.tpb.gov.au/code-
obligations.
TPB 2018a, ‘Code comparison with the Corporations Act 2001’, accessed March 2019, https://
www.tpb.gov.au/code-comparison-corporations-act-2001.
TPB 2018b, ‘Qualifications and experience for tax agents’, accessed March 2019, https://www.
tpb.gov.au/qualifications-and-experience-tax-agents.
TPB 2018c, ‘Qualifications and experience for tax (financial) advisers’, accessed March 2019,
https://www.tpb.gov.au/qualifications-and-experience-tax-financial-advisers.
TPB 2018d, ‘Tax agent services’, accessed March 2019, https://www.tpb.gov.au/tax-agent-

services.
TPB 2018e, ‘Tax (financial) advice services’, accessed March 2019, https://www.tpb.gov.au/tax-
financial-advice-services.
TPB 2018f, ‘Terms explained’, accessed March 2019, https://www.tpb.gov.au/terms-explained.
TPB 2019, ‘About the Tax Practitioners Board’, accessed March 2019, https://www.tpb.gov.au/
about-tpb.
MODULE 1
AUSTRALIA TAXATION
Module 2
PRINCIPLES OF ASSESSABLE INCOME
68 | PRINCIPLES OF ASSESSABLE INCOME
Contents
Preview 69
Introduction
Objectives
Teaching materials
Defining and determining income 71
What is income?
MODULE 2
Types of income
Compensation
Fixed income investments
Determining source of income 77
Source is a matter of fact
Core source principles
Tax implications of residency and non-residency 77
Why is residency important?
Test of residency for individuals
Test of residency for companies
Test of residency for trusts
Test of residency for superannuation funds
Derivation 82
Why is derivation important?
Derivation: When and why?
Determining derivation for tax purposes 85
Existence of a business
Commencement of a business
Determining income from a business
International taxation core concepts 88
Treatment of foreign income, deductions and offsets
Double taxation agreements and allocation of taxing rights
Withholding tax regime
Transfer pricing regime
Conversion of foreign currency rules
Trading stock core concepts 95
Overview
Accounting for trading stock
Valuation of trading stock
Disposal of trading stock
Trading stock concessions for small business entities
References 105
STUDY GUIDE | 69
Module 2:
Principles of
assessable income
MODULE 2
Study guide
Preview
Introduction
Income tax is levied on taxable income. Taxable income equals assessable income (ordinary
income + statutory income) minus all general and specific deductions. There are four types
of income examined in this module: ordinary income, statutory income, exempt income and
non-assessable, non-exempt (NANE) income.
There are four elements of income. These are the type of income derived, the source of that
income, the derivation of that income and the residency status of the taxpayer. Each element
contains several tests and rules pertaining to whether or not that income is included as
assessable income for the purposes of the income tax equation.
This module also briefly introduces international taxation core concepts and the trading
stock rules.
The module content is summarised in Figure 2.1.

Figure 2.1: Module summary—assessable income

Foreign
Residency
exchange Ordinary
test
(FX) rules
Statutory
International Types of
Residence
taxation income Exempt
MODULE 2
Non-assessable
non-exempt
Assessable
Source Compensation
income
Existence Accounting for
Taxable
Commencement Derivation Trading stock Valuation of
income
Income versus Disposal

capital
Objectives
• differentiate between ordinary income, statutory income, exempt income and non-assessable
non-exempt income in a given situation;
• identify the tax implications relating to income source and residence;
• determine the circumstances in which income has been derived for tax purposes;
• identify the tax treatments of non-complex international transactions; and
• apply the tax trading stock rules to determine the value of trading stock.
Teaching materials
– Corporations Act 2001 (Cwlth)
– International Tax Agreements Act 1953 (Cwlth)
– Superannuation Act 1990 (Cwlth)
• Glossary:
Definitions/
– For languages other than English, you can go to: https://www.ato.gov.au/general/
other-languages/in-detail/information-in-other-languages/glossary-of-common-tax-and-
superannuation-terms/
STUDY GUIDE | 71
Defining and determining income

Four core elements must be determined for income tax to be payable—the type of income,
the source of the income, how that income is derived, and whether that taxpayer is a resident
or non-resident of Australia.
MODULE 2
What is income?
The first step in determining assessable income for taxation purposes is to determine what
constitutes income. Broadly, there are two types of income—active income and passive income.
Active income is income received for services performed. Examples are wages, salaries,
commissions and income from a business where clearly defined services are provided.
Passive income is income received on a regular basis by an individual or entity with little or no
effort on their behalf. Examples are interest, dividends, rent, fixed income investment monies
and superannuation income streams.
In relation to Australian taxation law, there is no absolute definition of ‘income’ in either ITAA36
or ITAA97, and the courts have also been reluctant to provide a comprehensive judicial definition
of the term. However, a principle from the courts is that for something to be income, it must
‘come in’ to the taxpayer and be received as money or in a form that is convertible into money
(Tennant v. Smith [1982] AC 150). It is important for tax purposes to determine what actually
constitutes income. For discussion purposes, the concept of income is often divided into the
following four categories:
• income from personal exertion
• income from business
• income from profit-making schemes
• income from property.
Types of income
Income tax is paid on taxable income. Taxable income is assessable income, less allowable
deductions. It is important to examine the various types of income defined under the common
law and income tax legislation in order to determine what is assessable income.
There are four types of income defined in ITAA36 and ITAA97:

• taxable income
• assessable income
• exempt income
• NANE income.
Taxable income
The tax base on which tax is imposed is termed ‘taxable income’. It is the amount on which tax
rates are applied. Taxable income is defined as follows:
Taxable income = Assessable income minus all general and specific deductions
(ITAA97, s. 4-15)
Deductions are discussed in Module 3.

Assessable income
Assessable income consists of ordinary income and statutory income (ITAA97, s. 6-1).
A taxpayer must pay tax on assessable income. Assessable income does not include ordinary
or statutory income that is exempt income or NANE income (discussed later in this section).
If an amount is neither ordinary income nor statutory income, then it is not deemed assessable
income. This means that you do not have to pay tax on it.
MODULE 2
What is ordinary income?

Section 6-5(1) of ITAA97 defines ‘ordinary income’ as income according to ordinary concepts.
However, income tax legislation provides no specific guidelines on what is meant as ‘income
according to ordinary concepts’. There is a large amount of case law in this area. At common law,
ordinary income is seen as a flow derived from its source, and is measured in terms of money at
arbitrary intervals.
Ordinary income consists of the following three income receipts:

• personal services (exertion) income (PSI; i.e. income receipts from salary and wages)
• income from carrying on a business
• passive income such as interest, rent or dividends.
Capital gains are not ordinary income. They are a capital receipt and are taxed under the capital
gains tax (CGT) provisions found in the income tax legislation. CGT is covered in Module 5.
It is essential to determine whether a receipt is income or capital. The traditional view is

found in the United States decision, Eisner v. MacComber [1919] 252 US 189, which states
that ‘the fundamental relation of capital to income has been much discussed by economists,
the former [capital] being likened to the tree on the land, the latter to the fruit or the crop
[income]’. Taking that view, rent on the property is the fruit on the tree (income) while profit
made on the sale of the property itself is the tree (capital).
Common law has established traits that assist in determining whether an income receipt is
ordinary income. The main ones are:
• There must be a gain realised by the recipient; there must be benefit to the recipient
of the income.
• Income ‘comes in’ to the recipient in a beneficial manner.
• Income is in monetary form or is capable of being converted into money.
• Income when received has the character of income in the hands of the recipient.
• Income is often received in a regular or periodic manner.
• Income does not include windfall gains.
• Compensation for the loss of income is income in nature.
• A gain of a capital nature is not ordinary income.
• Although a receipt is derived from illegal/immoral activities, it is still characterised
as ordinary income.
• A person cannot derive income by dealing with themselves.
STUDY GUIDE | 73
What is statutory income?

Assessable income also consists of statutory income. These are amounts that do not fit the
definition of ordinary income but are specifically listed in either ITAA97 or ITAA36 as assessable
income. Items defined as statutory income under Division 15 of ITAA97 include:
• allowances—s. 15-2, which provides for the inclusion in a taxpayer’s assessable income of
all allowances, gratuities, compensations, benefits, bonuses and premiums provided to
the taxpayer that relate directly or indirectly to the taxpayer’s employment or to services
MODULE 2
rendered by the taxpayer. Section 15-2 has limited operation because it does not apply to a
benefit that is a fringe benefit under the legislation and it does not apply to any amount that
is assessable as ordinary income under s. 6-5
• return to work payments (s. 15-3)
• profit-making undertaking or plan (s. 15-15)
• royalties not included as ordinary income (s. 15-20)
• reimbursed car expenses (s. 15-70).
Doctrine of constructive receipt

The doctrine of constructive receipt applies to ordinary and statutory income. This doctrine
establishes that income is derived by the taxpayer as soon as it is applied or dealt with in any
way on the taxpayer’s behalf.
Statutory non-cash rules

The common law principle that income must be received as money or is convertible into money
must be considered in the context of the statutory rules in s. 21A of ITAA36. The effect of the
rules is as follows:
• In determining the income derived by a taxpayer, a ‘non-cash business benefit’ that is not
convertible into cash will be treated as if it were convertible into cash (ITAA36, s. 21A(1)).
• The value of the benefit is reduced to the extent that the recipient of the benefit would
otherwise have been entitled to a deduction (the otherwise deductible rule) for its cost
if the recipient had paid for it (ITAA36, s. 21A(3)).
• The value of the benefit is reduced where the cost is a non-deductible entertainment
expense to the provider (ITAA36, s. 21A(4)).
• Where the total assessable value of the non-cash business benefits does not exceed $300,
the income is exempt (ITAA36, s. 23(2)).
Example 2.1: Statutory non-cash rules

Sue is a computer retailer who receives a prize (voucher) from one of her suppliers for having the highest
turnover. The prize entitles Sue, and nobody else who may hold the voucher, to stay in Sydney for a
week. The normal cost for the voucher would have been $1500. Sue has received a benefit in respect
of carrying on a business; however, it is not ordinary income due to the non-convertible non-cash
nature (FC of T v. Cooke and Sherden [1980] ATC 4140). The arm’s-length value of $1500 is statutory
income under s. 21A(1) of ITAA36.
In relation to the above facts, what if Sue used the voucher solely for attending a computer conference
that happened to be in Sydney that week? Sue has received a non-cash business benefit that would
have been tax deductible to her if she had purchased the voucher in order to attend the computer
conference as a business-related trip. Therefore, no amount is included as statutory income under
the ‘otherwise deductible’ exception (ITAA36, s. 21A(3)).
Exempt income
An amount of ordinary or statutory income is deemed exempt income if it is made exempt from
income tax under ITAA97, ITAA36 or any other federal government legislation. Division 11 of
ITAA97 contains a list of exempt income.
There are two classes of exempt income:

• first class (s. 11-5 of ITAA97):
MODULE 2
– ordinary and statutory income of certain entities, irrespective of the nature of their
income (e.g. registered charitable bodies, religious institutions, scientific institutions,
public education institutions, employee and employer associations and trade
unions, public hospitals, animal racing, sports, musical and art societies, and clubs
and government bodies) (ITAA97, s. 11-5)
• second class (s. 11-15 of ITAA97):
– specified types of ordinary and statutory income, such as pooled development fund
dividends, non-cash business benefits that do not exceed $300, certain social security
type payments such as family tax benefits, allowances received by members of the
defence force and scholarships paid to full-time students (ITAA97, s. 11-15).
Where an amount of income is declared exempt:

• It is not assessable and it is therefore tax free.
• Exempt income will reduce the deduction allowable for a tax loss.
• A loss or outgoing incurred in deriving the exempt income is not an allowable deduction
(see Module 3 on general and specific deductions for more information).
• The disposal of an asset used to produce exempt income does not incur a capital gain/loss.
This is relevant to the taxation of capital receipts through CGT (Module 5).
Non-assessable, non-exempt income

Section 6-23 of ITAA97 states that ‘an amount of ordinary income is non-assessable non-exempt
income if a provision of this Act or of another Commonwealth law states that it is not assessable
income and is not exempt income’.
There are many types of legislated NANE income. Examples of NANE income include income
derived during one tax year that needs to be repaid in a later tax year, demerger dividends,
and goods and services tax (GST) payable on a taxable supply.
Compensation
For the purposes of taxation, common law establishes that a compensation receipt takes the
character of the item that it replaces (e.g. if the compensation replaces some of a wage, then it
will take the form of ordinary assessable income).
To determine the treatment of compensation in this way, it is important to assess:

• if the income is deemed capital or income in nature (which is determined by the facts of each
case). In some cases, compensation is paid that is partly income in nature, and partly capital
in nature (e.g. compensation paid for the loss or damage of capital assets via insurance).
If the compensation for each component can be clearly identified, then it can be split into
an income component and a capital component for taxation purposes. Where the amount
cannot be clearly split into income and capital, then the entire amount is treated as capital
• if the compensation is assessable as ordinary income or statutory income.
STUDY GUIDE | 75
Amounts received for entering into restrictive covenants

Amounts received by a person in consideration of restrictions on their future income-earning
capacity or for entering into restrictive covenants whereby the recipient undertakes not to use a
specified asset or trade with another party are also generally of a capital nature as demonstrated
in Dickenson v. FC of T (1958) 11 ATD 415 and FC of T v. Woite (1982) 82 ATC 4578. They are
therefore only assessable to the extent that the CGT provisions apply.
MODULE 2
Example 2.2: Compensation received for a restrictive covenant
Jill runs a successful design business in the Brisbane CBD. Jill signed a contract restricting her right to
set up a similar business in the Melbourne CBD and received compensation of $96 000. The $96 000
received by Jill is not assessable as ordinary income as the receipt is a capital receipt.
Amounts received for loss of income

Payments received under a personal disability insurance policy by an individual due to injury
from an accident were held by the court to be of an income nature (FC of T v. DP Smith [1981]
81 ATC 4114).
Example 2.3: Compensation for loss of income

John is a builder who suffered a back injury in a workplace accident on 1 July 2018. John was unable
to work for a year and received $82 500 as workers compensation for his loss of income. In this case
the $82 500 is assessable to John under s. 6-5 as ordinary income, as is takes the place of a revenue
receipt because the amount received is a ‘substitution for income’.
Generally, a compensation receipt takes on the same character as the item that it replaces (see C of T
v. Meeks (1915) 19 CLR 568). Consequently, workers compensation payments for loss of wages are
fully assessable as ordinary income under s. 6-5 of ITAA97.
Amounts received for cancellation of contracts and agency agreements

Payments received in respect of the cancellation of a contract that is integral to the way
that a taxpayer conducts their business operations, or from the cancellation of an exclusive
agency agreement, were held to be of a capital nature (Van den Berghs v. Clark [1935] AC 431;
Californian Oil Products Ltd v. FC of T [1934] 52 CLR 28).
Table 2.1 examines the common forms of compensation to determine if they are generally
considered as income or capital in nature.
Table 2.1: Forms of compensation
Compensation for: Income or capital? Authority
Loss of profits and Income Sections 15–30 and

trading stock 70–115 of ITAA97
Loss of contract Ordinary business contract (income) Heavy Minerals Pty

Ltd v. FC of T [1966]
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Contract of capital nature representing 115 CLR 512

important part of business structure (capital)
Business entered into special arrangement to

perform the contract (i.e. plant and equipment)
(capital)
Severe restriction of business operations that

relate to profit-making structure (capital)
Where the contract is for a long period of

time (capital)
Loss of agency Affected the business’s underlying structure— Californian Oil Products
the business is terminated (capital) v. FC of T [1934]
52 CLR 28
Did not affect the business’s underlying
structure and deemed to be of a revenue Kelsall Parsons & Co. Ltd
account—the business will survive (income) v. IRC [1938] 21 TC 608,
and IRC v. Flemming
& Co. (Machinery) Ltd
[1951] 33 TC 57
Entering a restrictive Capital—deprivation of the right to work or Dickenson v. FC of T

covenant conduct business is of a capital nature [1958] 98 CLR 460
Part 3-1 of ITAA97
Income replacement Income—amounts received for lost salary or Maher v. FC of T [2005]

wages under income protection, sickness/ ATC 2083
accident insurance, workers compensation
Fixed income investments

Income received from investment funds and trusts—for example a managed investment fund,
a share club or an investment trust—is included as assessable income to the taxpayer in the year
the income is earned. Investment income includes income or credits from a:
• cash management trust
• money market trust
• mortgage trust
• unit trust
• managed fund, such as a property trust, share trust, equity trust, growth trust,
imputation trust or balanced trust.
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Determining source of income

Source is a matter of fact
Determining the source of the income—where it comes from—is the next important step in
determining the tax liability of a taxpayer.
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Under s. 6-5 (and s. 6-10) of ITAA97, a taxpayer who is an Australian resident is liable for taxation
on the ordinary (and statutory) income derived by them from all sources whether in or out of
Australia. The key here is the source for the resident—the fact that the income can be derived
both in and out of Australia.
This is different for foreign residents. Under s. 6-5 (and s. 6-10) of ITAA97, a foreign resident is
generally only liable to tax on ordinary (and statutory) income that has an Australian source.
Core source principles

Some other important principles around source of income are as follows:
• The source of wages and salaries is usually where the services or duties are performed.
• To determine the source of business income, many factors are considered. These include the
place the contract was made, where the contract is performed and where payment is made.
• Interest usually has a source where the obligation to pay the interest arises.
• Dividends have a source that is based on where the company paying the dividends earned
the profits from which they were paid.
• Royalties that are assessable as ordinary income under s. 6-5 of ITAA97 are usually deemed
to have a source in the country where the royalty arose.
Tax implications of residency and non-residency

Residency is very important as it relates back to the source of assessable income.
We already know from the previous section, ‘Determining source of income’, that the assessable
income of an Australian resident includes the ordinary and statutory income derived from all
sources. This generally means that resident individuals and entities are liable to Australian
taxation on both Australian and foreign-sourced income.
A foreign resident is generally only liable to tax on ordinary (and statutory income) that has an
Australian source.
Test of residency for individuals

An Australian resident individual is defined in s. 6(1) of ITAA36 as follows:
A resident of Australia means a person who resides in Australia, and includes a person (other than
a company):
1. whose domicile is in Australia, unless the Commissioner is satisfied that the person’s permanent
place of abode is outside Australia;
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2. who has actually been in Australia continuously or intermittently, during more than one-half of
the tax year of income, unless the Commissioner is satisfied that the person’s usual place of
abode is outside Australia and that they do not intend to take up residence in Australia; or
3. who is a member of a Commonwealth Government superannuation scheme or the spouse,
or a child under 16, of such a person (ITAA36, s. 6(1)).
There are effectively four tests applied to determine if an individual is a resident for taxation
purposes. These are presented in Table 2.2.
Table 2.2: Residency tests
Considerations Source
Primary test
Resides in Australia A question of fact and degree, and it is

necessary to consider all the relevant
circumstances.
A person continues to reside where they have Levene v. IRC [1928]

a settled or usual abode. AC 217
A person may be resident in more than Lloyd v. Sulley [1884]

one place. 2 TC 37
A person is a resident in Australia when their Taxation Ruling TR 98/17

behaviour over a considerable time has a
‘degree of continuity, routine or habit’ that is
consistent with residing here.
Do not confuse tax residency with immigration Taxation Ruling TR 98/17

residency—six months sufficient for tax
residency—see 183-day rule later in the table.
Additional statutory tests
Domicile test An individual’s domicile of origin at common Taxation Ruling IT 2650

law is generally determined at birth by the
location of the father’s domicile.
However, an individual can change their domicile Iyengar v. FC of T [2011]

if they intend to make a home indefinitely in ATC ¶10-222
another country (domicile of choice)—for
example, if they take out Australian citizenship.
Although a person can be a ‘resident’ of more

than one country at any given point, they can
only have one domicile at a time.
A person who has an Australian domicile FC of T v. Applegate

is deemed to be a resident unless the [1979] ATC 4307
Commissioner is satisfied that their permanent
place of abode is outside Australia. Permanent is FC of T v. Jenkins [1982]
not forever—it can be temporary or transitory. ATC 4098
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Considerations Source
183-day test If a person has been in Australia for at least

183 days during a particular tax year, there is a
presumption that the person is a tax resident
for that year.
However, if a taxpayer spends more than 183 Gunawan v. FC of T
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days outside Australia, that does not necessarily [2012] ATC ¶10-234
mean they are not a resident in Australia.
It is not necessary for the 183 days to be Taxation Ruling IT 2681

consecutive—separate visits within the year
will be added.
Only contravened if the person can prove that

their usual place of abode is outside Australia
and they do not intend to take up residence
in Australia.
Commonwealth An individual is a resident of Australia if they are: Superannuation Act 1990

superannuation fund test (a) a contributing member of a superannuation (Cwlth)
scheme for Commonwealth government
officers established under the Baker v. FC of T [2012]
Superannuation Act 1990 ATC ¶10-240
(b) an eligible employee for the purposes
of the Act
(c) a spouse, or a child under 16 years of age
of a person covered by (a) or (b) above.
Test of residency for companies

If the taxpayer is a company, then the basic test of residence is formulated in s. 6(1) of ITAA36,
as seen from the previous definition of a ‘resident’. There are two tests for taxation purposes that
establish if the company is a tax resident of Australia:
1. it is incorporated in Australia, or
2. although not incorporated in Australia, it carries on business in Australia and has either:
– its central management and control in Australia, or
– its voting power controlled by shareholders who are residents of Australia (ITAA36, s. 6(1)).
With regard to voting power, the courts have examined the issue of residency of the controlling
shareholders. Based on the decision in Patcorp Investment Pty Ltd v. FC of T [1976] ATC 4225,
the courts held that a shareholder is a person who is listed on the company’s register, or who is
entitled to be registered. The courts, therefore, have not looked through an ownership chain to
determine the ultimate owner of the shares. Because of this, the ownership test has been largely
avoided by the use of nominee companies.
A company’s central management and control is located where its operations are controlled
and directed (Koitaki Para Rubber Estates Ltd v. FC of T [1941] 2 AITR 167). This is based on the
decision in De Beers Consolidated Mines Ltd v. Howe [1906] AC 455, where it was observed:
We ought … to proceed as nearly as we can upon the analogy of an individual. A company cannot
eat or sleep, but it can keep house and do business. We ought, therefore, to see where it really
keeps house and does business … I regard that as the true rule … The real business is carried on
where the central management and control actually abides (p. 438).
In Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v.
Commissioner of Taxation [2016] HCA 45 (Bywater), the court concluded that a company not
incorporated in Australia and without its major operational activities in Australia will be carrying
on business in Australia if its central management and control is in Australia.
The Bywater case also confirmed that a company will not necessarily have its central
management and control where its board meets, if it is apparent that the decisions are in
fact made by someone else.
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Following the Bywater case, the Australian Taxation Office (ATO) released final Taxation Ruling
TR 2018/5, which indicates that any entity that has its central management and control located in
Australia and carries on business (anywhere in the world) is an Australian tax resident, subject to
any applicable double tax agreement (discussed later in the module).
Practical Compliance Guideline PCG 2018/9, which is to be read in conjunction with TR 2018/5,
notes that most companies should have little difficulty identifying where central management
and control are located as this will normally be where the directors make their decisions.
The ATO’s previous interpretation in Taxation Ruling TR 2004/15, issued in October 2004, was that
a foreign incorporated company that has its major operational activities (such as major trading,
manufacturing or mining activities) outside Australia would not be a resident of Australia
because it was not considered to be carrying on business in Australia, even though its central
management and control may be in Australia.
TR 2018/5 addresses four key matters related to residency:

• Does the company carry on business in Australia? If a company carries on business and has
its central management and control in Australia, it will carry on business in Australia within the
meaning of the central management and control (CM&C) test of residency. It is not necessary
for any part of the actual trading or investment operations of the business of the company to
take place in Australia because the central management and control of a business is factually
part of carrying on that business.
• What does central management and control mean? CM&C refers to the control and
direction of a company’s operations in making high-level decisions that set the company’s
general policies, and determine the direction of its operations and the type of transactions
it will enter. This is different from the day-to-day conduct and management of its activities
and operations.
• Who exercises central management and control? This is a question of fact, and in reality,
it is the company’s directors who exercise a company’s CM&C. However, a person who has
the legal power or authority to control and direct a company, but does not use it, does not
exercise CM&C. For example, in Bywater, the court disregarded the role of those directors
who were formally appointed, but did not play any real role in the affairs of the company.
• Where is central management and control exercised? A company will be controlled and
directed where those making its high-level decisions do so as a matter of fact and substance,
not where the decisions are merely recorded and formalised. Thus, the CM&C of a company
is not necessarily exercised where the trading or investment activities of the company are
carried on or the place where those who control and direct a company live. What matters
is where directors or other persons actually perform the activities to control and direct
the company.
Test of residency for trusts

The beneficiaries of a trust are taxed on their share of the net income received from a trust
dependent on whether the beneficiary is deemed a resident or a non-resident for taxation
purposes:
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• A resident beneficiary is assessable on their share of the net income of the trust on both
Australian-sourced and foreign-sourced income.
• A non-resident beneficiary for part of the year is assessable on their share of the net income
of the trust based on all Australian-sourced income plus any foreign sources. Foreign-sourced
income is apportioned for the period of residency in the tax year.
• A non-resident beneficiary for the whole year is assessable on their share of the net income
of the trust derived from Australian sources.
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Where a trustee is taxed on foreign income to which no beneficiary is presently entitled,
the non-resident beneficiary can claim a refund for the tax paid when the income is distributed.
Module 8 examines the taxation of trusts in more detail.
Test of residency for superannuation funds

Self-managed superannuation funds (SMSFs) are governed by the ATO. SMSFs must meet the
following residency tests defined in Table 2.3.
Table 2.3: SMSF residency test
Residency test Explanation
Establishment The fund was established in Australia, or at least one of its assets is
located in Australia.
The fund was ‘established in Australia’ if the initial contribution to

establish the fund was paid and accepted in Australia.
Central management and control The central management and control of the fund is ordinarily
in Australia.
This means the SMSF’s strategic decisions are regularly made,

and high-level duties and activities are performed, in Australia.
It includes formulating the investment strategy of the fund, reviewing
the performance of the fund’s investments, formulating a strategy for
the prudential management of any reserves, and determining how
assets are to be used for member benefits.
In general, your fund will still meet this requirement even if its
central management and control is temporarily outside Australia
for up to two years. If central management and control of the fund
is permanently outside Australia for any period, it will not meet
this requirement.
Active member test The fund either has no active members or it has active members who
are Australian residents and who hold at least 50 per cent of:
• the total market value of the fund’s assets attributable
to superannuation interests, or
• the sum of the amounts that would be payable to active
members if they decided to leave the fund.
A member is an ‘active member’ if they are a contributor to the fund

or contributions to the fund have been made on their behalf.
Source: Adapted from ATO 2018, ‘Check your fund is an Australian super fund’, accessed December
2018, www.ato.gov.au/super/self-managed-super-funds/setting-up/check-your-fund-is-an-australian-
super-fund/#fundresidencyconditions; ATO 2019, ‘ATO-held super’, accessed March 2019, https://www.
ato.gov.au/individuals/super/growing-your-super/keeping-track-of-your-super/ato-held-super/.
Derivation
Why is derivation important?
Common law has established that income is a ‘flow derived from a source’. Sections 6-5(2) and
6-5(3) of ITAA97 establish that, for assessable income to be included in a particular year, then that
amount of income must be derived by the taxpayer in that year. This makes the derivation of the
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flow of income very important when considering what assessable income needs to be included
in the income tax year.
In the common law definition of derivation in taxation law, ‘derived’ means ‘obtained’, ‘got’ or
‘acquired’ and that all income is ‘derived from something or by someone’ (Clarke v. FC of T [1927]
CLR 246).
There are two accepted methods for accounting for derivation of income—it can be derived on a
cash or an accruals basis:
• Cash—revenue is accounted for when cash or its equivalent is received. For example, Travis,
an employee, receives a salary in Year 2 for work he completed for his employer in Year 1.
Assuming the cash basis applies, Travis has derived his salary in Year 2 (when he received it)
even though it related to work he performed in Year 1.
• Accruals—revenue is accounted and matched to expenses as it is earned (rather than when
the payment is received). For example, JB WiFi carries on a business selling computers.
In Year 1, JB WiFi sold a computer to a customer on a payment plan that allowed the
customer to pay for the computer in Year 3. Assuming the accruals basis applies, JB WiFi has
derived the income from the sale of the computer in Year 1 (when the income was earned)
even though it does not receive payment from the customer until Year 3.
High Court decision: Basis a matter of fact

In Executor Trustee and Agency Co. of South Australia v. C of T (SA) [1938] 63 CLR 108, the High
Court of Australia has established that the decision over what accounting method a taxpayer
should choose is a matter of fact. The issue is to be resolved through determining which method
truly reflects the real income position of the taxpayer. Additionally, there is no superiority of the
cash over the accruals methods.
Taxation Ruling TR 98/1 provides examples

Taxation Ruling TR 98/1 provides guidelines to taxpayers on which method provides the correct
basis to determine income.
It states that where income is derived by an employee, it is likely that a cash basis of income
recognition is appropriate. Where income is derived in a non-business activity in providing
knowledge or skill, a cash basis is appropriate.
Where a business activity is carried on that involves the sale of trading stock, the use of
circulating capital or the use of staff and equipment to produce income, the ruling states that
an accrual basis of income recognition is more appropriate. This means that for most businesses,
an accruals basis of income derivation will be required. Because of this, an adjustment to cash
receipts is necessary for a taxpayer to correctly determine their assessable income.
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Derivation: When and why?

Table 2.4 details the preferred accounting method (cash or accruals) for different sources of income.
Table 2.4: Accounting method (cash versus accruals)
Source of income Accounting method Comments
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Wages/salary Cash Income not derived until received
Income from property Cash Income not derived until paid or

received
Income from property—royalties Accruals Only if it constitutes business income

and interest (e.g. banks and money lenders)
Business income—trading Accruals Taxation Ruling TR 98/1

stock, circulating capital,
staff/equipment—used to
produce income
Amounts received in advance Cash In some cases, income may not be

derived until the goods and services
have actually been supplied, even if
cash has been paid. In Arthur Murray
Pty Ltd v. FC of T [1965] 114 CLR 314,
the possibility of refunds being required
(despite a contract negating a return of
fees) on dancing lessons that had been
paid for—but not yet held—meant that
the income was taken to be derived
when the service or good was supplied.
Instalment sales Cash—sale price earned J. Rowe & Son v. FC of T [1971] ATC 4001
when goods sold/debt
created
Long-term construction contracts Basic approach or the Taxation Ruling IT 2450

estimated profits method
Basic approach includes all up-front,
advance progress, progress and final
payments as assessable income in
year received and claims deductions
for losses and outgoings as they
are incurred
Estimated profits method spreads

the ultimate profit or loss on a long-
term project over the years it takes to
complete the contract
Redirection of income Doctrine of constructive Income is taken to have been derived by

receipt—common law a taxpayer if it is applied or dealt with in
any way on the person’s behalf

➤ Question 2.1
On 18 December 2018, Rosemary Miller, who was born in Canada, arrived in Australia with an
unrestricted work permit to take up a job with Marketing Expertise Pty Ltd for a period of six years.
As an incentive to join the firm, Rosemary was paid $5000 and provided with a stopover in
Singapore where she met some friends. The cost of the stopover was $1500.
For the year ended 30 June 2019, Rosemary received $70 000 by way of salary. As part of the
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firm’s bonus plan, Rosemary also received $4000. However, while she was informed of the bonus
on 30 June 2019, it was not paid to her until 5 July 2019.
Upon her departure from Canada, Rosemary rented out her house in Vancouver at AUD 2400
per month. On 6 July 2019, Rosemary received a notice from her agent that rent received on
her behalf up to 30 June 2019 was $15 600 (of which $2600 related to the month of July 2019).
A statement of account from Rosemary’s Vancouver bank indicated interest deposited in her
Vancouver bank account for the year ended 30 June 2019 was $1800, of which $400 related to
the period from 18 December 2018.
Determine the assessability of these income amounts.
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Determining derivation for tax purposes

Ordinary income includes income derived from carrying on a business.
Therefore, it is essential to establish whether a business exists. In s. 995-1 of ITAA97, the definition
of a ‘business’ includes ‘any profession, trade, employment vocation or calling, but does not
include occupation as an employee’.
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Existence of a business
The actual existence of a business is a question of both fact and degree and determined
by common law, through guidance in Taxation Determinations, and via the rulings of the
Commissioner of Taxation.
Whether a business exists is very much dependent upon the circumstances of each case and
an assessment of the importance of those factors. Relevant factors to determine the existence
of a business are:
• degree of system and organisation used—where the activity is conducted on a systematic
and organised basis, it is more likely to be considered a business. This is especially so where
the activities have a commercial basis
• scale of activities—the size and scale of the activities are important. Are the activities of
such a scale that whatever is produced is in excess of that which would be required by
the taxpayer for personal use? The smaller the business, the more likely it is to be hobby
(not a business)
• repetitive transactions—a business activity is associated with regular and repetitive
transactions. This is not always the case; sometimes isolated transactions can be regarded
as a business (see Table 2.5)
• profit factor—a business operation is usually carried on in order to make a profit.
• type of activity—where the goods are unsuitable for personal or domestic use this will be
more indicative of a business
• time—although not decisive, the more time the taxpayer spends on the activity, the more
likely it is to be of a business nature.
Before the decision in Spriggs v. FC of T; Riddell v. FC of T [2009] HCA 22, professional sports
personnel who were employed to play team sports were considered to be employees and not
carrying on a business. Following this decision, it is now possible for professionals who play team
sports to be conducting a business for taxation purposes.
Commencement of a business
As with the existence of a business, the commencement of a business is also a question of
fact. For a business to commence operation, it is necessary that there is a sign of commercial
production or activity being undertaken.
The timing—or commencement—of the business is important to determine whether assessable

income is derived and the point of time when allowable deductions may be claimed, as illustrated
in the following cases.
Example 2.4: Commencement of a business

Southern Estates Pty Ltd v. FC of T [1966] 117 CLR 481. A partnership bought land, cleared it and
sowed pasture in order to run sheep on it. It was decided it had not commenced business. There was
no clear sign of commercial production and the activities were regarded as preliminary to the actual
commencement of business as a primary producer.
Thomas v. FC of T [1972] ATC 4094. Although the taxpayer’s farming activities were on a small scale
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(planting 30 avocado pear trees and 75 macadamia nut trees), the taxpayer was not merely involved in
a recreation or hobby or preparing the land for use; the taxpayer was in fact now carrying on a business
of primary production as the trees that produced the income had been planted.
Softwood Pulp and Paper Ltd v. FC of T [1976] ATC 4439. A company incurred expenditure on a feasibility
study to determine whether a paper mill project should be undertaken. It was held the expenditure
was of a capital nature as the company had not commenced business.
Determining income from a business

It is essential to be able to determine the difference between an income and a capital receipt
when deriving business income for taxation purposes.
Table 2.5 demonstrates how various sources of income from a business are brought to account
as income under the general income provisions (ITAA97, s. 6-5), statutory income provisions and
common law.
Table 2.5: How income from business is brought to account
Exception to
general principle
Type of income General principle Authority (where applicable)
Ordinary income Assessable income— Californian Copper

‘what is done is not Syndicate v. Harris
merely a realisation or [1904] 5 TC 159
change of investment,
but an act done in what
is truly the carrying on,
or carrying out of a
business’
Isolated transaction Assessable income— FC of T v. Myer

amount received from Emporium Ltd [1987]
an isolated commercial 87 ATC 4363
transaction that is
not entered into in
the ordinary course
of carrying on the
taxpayer’s business
is assessable income
where the taxpayer
entered into the
transaction with the
purpose of making a
relevant profit or gain
from the transaction
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Exception to
general principle
Isolated transaction Assessable income— ITAA36, s. 120CA—

any gain from the supports Myer case
transfer of a right
to receive income
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without transferring the
underlying property is
assessable income
Not necessary that

the purpose of
profit-making be the
dominant purpose—
sufficient that the
profit-making purpose
is significant
Realisation of Non-assessable Scottish Australian The sale of investments

investments income—gain made on Mining v. FC of T may be deemed to be
the mere realisation of [1950] 81 CLR 18 assessable as ordinary
an investment does not income; although a
give rise to business capital asset was sold,
income, but may be it was sold to meet
subject to tax under income requirements
the CGT provisions
Punjab Co-operative
Bank Lt, Amritser v.
IT Come Lahore [1940]
AC 1055
RAC Insurance Pty

Ltd v. FC of T [1990]
95 ALR 515
Non-cash business Assessable income— ITAA36, s. 21A Not assessable—where,

benefits—statutory a non-cash benefit if the recipient had
income accruing as a result of incurred the cost of
business is assessable the benefit, they would
although it is not in have been able to claim
monetary form a deduction
Recipient of the benefit Not assessable—

to include as assessable a non-deductible
income the arm’s- entertainment expense
length value (basically, where the cost of
the market value) of the benefit is not
the benefit deductible to the
person who provides it
Limits or restrictions on
convertibility into cash Exempt—where the
are disregarded value of the non-cash
business benefits
received is less
than $300
Exception to
general principle
Other statutory income Assessable ITAA97, s. 15-2

income—value to
the taxpayer of all
allowances, gratuities,
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compensations,
benefits, bonuses and
premiums received
Bounties or subsidies ITAA97, s. 15-10

received that are
not ordinary income
under s. 6-5
Profit arising from the ITAA97, s. 15-15

carrying on or carrying
out of a profit-making
undertaking or plan;
for example, the profit
arising from the sale
of property that is
acquired for resale at
a profit is assessable
Amount received by ITAA97, s. 15-20

way of a royalty that is
of a capital nature
Work-in-progress ITAA97, s. 15-50

amounts received
International taxation core concepts

Treatment of foreign income, deductions and offsets
The chief rules determining the taxation liability of non-residents are that:
• non-residents are liable to Australian tax on all ordinary and statutory income that has its
source in Australia, and
• non-residents are exempt from Australian tax on foreign-sourced ordinary or statutory income.
Assessable income derived by non-residents is taxed on the same basis as assessable income
derived by residents. There are some exceptions to this rule, which are outside the scope of
this module.
The same income tax exemptions (e.g. the small business exemptions) and exclusions from
income apply to non-residents, and the same business deductions and incentives can be applied
against gross income. The only instance when exemptions, exclusions or deductions do not
apply to non-residents is if ITAA97 specifically excludes non-residents, or specifically makes the
item applicable to residents only.
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Non-resident individuals are subject to different tax rates to resident individuals, and do not have
access to the tax-free threshold (discussed in Module 6). Non-resident individuals are generally
exempt from the Medicare levy. Non-resident individuals cannot claim personal tax offsets.
Non-residents can also be liable for FBT.
Non-resident companies are taxed at the same rate as resident companies, but are treated
differently in areas such as consolidation and dividend imputation. Withholding rules for
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dividends are discussed later in this section, and the dividend imputation rules for resident
companies are discussed further in Module 8.
Non-residents and capital gains tax

One main exception to the general rules just explained is in the calculation of income for
CGT purposes. A foreign resident’s CGT liability is based on whether the CGT asset is taxable
Australian property. Under s. 855-15 of ITAA97, taxable Australian property is an asset that is:
• taxable Australian real property
• an indirect interest in Australian real property
• a business asset of a permanent establishment in Australia
• an option or right to acquire any of the CGT assets in items 1, 2 or 3, or
• a CGT asset deemed to be Australian taxable property where a taxpayer, on ceasing to
be an Australian resident, makes an election as such under s. 104-165.
There is a withholding tax applied to the sale of taxable Australian property to increase the
amount of CGT recovered from foreign residents. This is outlined later in the withholding tax
discussion in the section ‘Foreign resident capital gains withholding’.
The 50 per cent CGT discount is not available to foreign and temporary resident individuals
(including the beneficiaries of trusts and partners in a partnership) for assets acquired after
8 May 2012. The 50 per cent discount will be apportioned where a CGT event occurred after
8 May 2012 and the non-resident had acquired the asset before that date, or they held a period
of Australian residency after that date. CGT events that occurred before 8 May 2012 are not
affected (ATO 2018b).
On 9 May 2017, the government announced that Australia’s foreign resident CGT regime will
be extended to deny foreign and temporary tax residents access to the CGT main residence
exemption. This change applies from the date of announcement. Properties held prior to this
date will be grandfathered (exempted from the new rules) until 30 June 2019. This means that
while the new CGT rule will apply to all future cases from 9 May 2017, the old rule of main
residence exemption will continue to apply to some existing situations until 30 June 2019,
even though the law has been changed.
In the 2017–18 Federal Budget, the government announced that non-residents will no longer
have access to the CGT main residence exemption from 9 May 2017 (subject to certain
exemptions for disposals occurring before 30 June 2019). Legislation has not yet been
introduced and this proposed change is not examinable.
Double taxation agreements and allocation of taxing rights

Australia has double taxation agreements (DTAs) in place with most of its major trading
partner countries.
A DTA is an agreement between two countries governing the way in which income derived
by residents of those countries is taxed. The aim of DTAs is to relieve taxpayers from double
taxation and to mitigate tax evasion.
The chief piece of legislation in this area is the International Tax Agreements Act 1953 (Cwlth).
The tax provisions in the DTAs prevail if there are conflicting provisions in ITAA36 or ITAA97.
The International Tax Agreements Act previously contained the actual DTAs with each country,
but they are now accessed through the Australian Treaty Series online database available
through AustLII at: www.austlii.edu.au/au/other/dfat/treaties/.
Each DTA is unique to the two countries involved as are the respective articles in the tax
agreements, and they must be individually consulted when considering the implications of dual
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residency and double taxation. The allocation of taxation rights and the operation of the DTAs
generally follow these two broad principles:
• First, the DTAs state that the allocation of taxing rights, namely where the liability for
taxation arises for the resident, over certain classes of income, are reserved entirely to the
country of residence of the person deriving the income.
• Second, all other income is able to be taxed (sometimes only to a limited extent) by the
country where the income has its source. If the country of residence of the taxpayer also
taxes that income—meaning double taxation arises—then the resident country is required
to grant a credit against its tax for the tax imposed by the source country.
However, income may also be taxed solely in the country of residence where:
• the duration of the recipient’s visit in the country of source does not exceed a specified
limit (more than 183 days), and
• the salary is paid by a non-resident of the source country.
Example 2.5: How a DTA operates

As an example, the Australia/Singapore DTA adopts the above approach as stipulated in Articles 11
and 12.
To highlight how the DTA operates, assume that Caine, a resident of Australia and employed as a
logistics manager by an Australian company, is sent to Singapore on a specific project for nine months.
While in Singapore, Caine also does some part-time lecturing at the Singapore Management University.
As Caine’s stay in Singapore is greater than 183 days, then the exemption from taxation in Singapore
under Article 12 of the Australia/Singapore DTA will not apply. Rather, as provided in Article 11,
Caine’s income earned from both his activities as a logistics manager and a lecturer will be assessable
in Singapore. As Caine is a resident of Australia, the same income will also be assessable in Australia.
Caine will therefore receive a foreign income tax offset in Australia for the tax paid in Singapore
(ITAA97, Division 770; Article 18 of the Australia/Singapore DTA).
Under certain DTAs, visiting academics and teachers are often exempt from tax on their remuneration in
the source country provided their visit does not exceed two years. However, there is no such exemption
in the Australia/Singapore DTA.
Withholding tax regime

Dividends, interest and royalties paid to non-residents are liable to withholding tax at a flat rate.
Withholding tax operates so that an amount representing the total tax payable is withheld from
the payment by the payer (before being paid to the non-resident) and this amount is remitted
directly to the ATO. The withholding taxes applied to dividends, interest and royalties are the
final taxation liability for each of these payments. The amounts subject to withholding tax are
NANE income of non-residents under s. 128D of ITAA36.
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Dividends
Dividend withholding tax is paid by a resident company on dividends paid to non-residents at a
flat rate of 30 per cent. For dividends paid to residents of countries where Australia has a DTA,
the withholding amount is generally 15 per cent. The withholding rate may change depending on
the specific DTA, and the DTA should be checked in each instance.
Note that withholding tax does not apply to the franked part of the dividend. Franking is
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discussed in Module 8.
Interest
Interest withholding tax is paid on interest that is:
• derived by a non-resident, and
• paid by a resident, except where the interest is wholly incurred by the resident as an expense
of carrying on a business overseas at or through a permanent establishment, such as a
branch, or
• paid by a non-resident and the interest is wholly or partly incurred by the non-resident in
carrying on a business in Australia at or through a permanent establishment in Australia
(ITAA36, s. 128B(2)).
Withholding tax must be paid not only when the interest is paid, but also when it is payable and
is dealt with in some other manner at the direction of the non-resident, such as reinvestment
of funds.
Interest withholding tax is imposed at a flat rate of 10 per cent, which is generally the same
amount in most DTAs. However, this rate may change depending on the specific DTA, and the
DTA should be checked in each instance.
Royalties
Any royalties (as per the broad definition in ITAA36, s. 6(1)) derived by a non-resident are subject
to withholding tax, unless a specific exemption applies. The tax applies where the royalties are
paid by:
• a resident, except where they are outgoings wholly incurred by the payer in carrying on a
business outside Australia at or through a permanent establishment, such as a branch, or
• a non-resident and are outgoings wholly or partly incurred by the payer in carrying on a
business in Australia at or through a permanent establishment in Australia (CCH 2012).
The rate of royalty withholding tax is a flat rate of 30 per cent.
Where the royalties paid flow to a resident of a country where Australia has an extensive DTA
in place, then the rate is generally limited to 10 per cent of the gross amount of the royalties
(CCH 2012). The withholding rate may change depending on the specific DTA, and the DTA
should be checked in each instance.
This lower rate applies unless these royalties are effectively connected to a branch in Australia.
In this instance, the royalties are treated as business profits and are taxed accordingly. If the
country of residence of the receiver of the royalties also taxes that income, then that country
will give credit against the tax paid for the Australian tax.
Foreign resident capital gains withholding

Where a foreign resident disposes of certain taxable Australian property, then they are required
to pay a foreign resident capital gains withholding (FRCGW) amount.
For all new contracts entered into from 1 July 2017, the following rate and threshold applies:
• real property disposals where the contract price is $750 000 and above
• rate of FRCGW 12.5 per cent on the disposal amount.
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The ATO (2018a) states that ‘for contracts that are entered into from 1 July 2016 and before 1 July
2017, even if they are not due to settle until after 1 July 2017, the FRCGW tax rate is 10% and
applies to real property disposals where the contract price is $2 million and above’.
Transfer pricing regime

The Australian transfer pricing tax regime is in place to ensure that an Australian entity does
not pay less tax in Australia because it has entered into non-arm’s-length cross-border dealings
with another entity.
Transfer pricing generally occurs for tax purposes where an Australian resident entity enters into
a cross-border transaction (e.g. the supply or acquisition of goods and services) with an overseas
entity, which is part of the same multinational group, for profit-shifting purposes.
Apart from applying the transfer pricing rules to particular transactions, the Australian tax transfer
pricing regime now also considers whether the division of profits between an Australian entity
and another entity that is part of the same multinational group needs to be adjusted because the
entities have not been acting on an arm’s-length basis.
The key concept underpinning the transfer pricing regime is the application of the arm’s-length
principle. Under the arm’s-length principle, the conditions that apply to a related party cross-
border transaction should approximate those that would be expected to operate between
an Australian entity and an overseas entity dealing wholly independently with each other in
comparable circumstances (the arm’s-length conditions).
Where the actual conditions differ from the arm’s-length conditions, a transfer pricing adjustment
may be required, so that the Australian entity’s tax position reflects the arm’s-length value of the
goods or services supplied or acquired.
Such an outcome is generally aligned with the transfer pricing adjustments that may be required
under the associated enterprises articles of the various DTAs that Australia has entered into with
most of its major trading partners.
Conversion of foreign currency rules

There are rules for the conversion of foreign currency into Australian currency. They are found
in Subdivisions 960C–960D of ITAA97. The main principle to apply for foreign currency is that
it needs to be translated into Australian currency to calculate income, deductions and offsets.
This rule applies to all transactions that affect a taxpayer’s tax liability and are not limited to
just income and deductions.
Amounts that need to be translated into Australian currency are:

• ordinary income
• expenses
• obligations and liabilities
• a receipt or payment
• an amount of consideration or a value.
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An overview of the main foreign currency translation rules for particular events is presented in
Table 2.6.
Table 2.6: Translation rules into Australian currency
Item Translation rules
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Ordinary income The exchange rate to be used is the rate prevailing at the time of
derivation; however, where derivation occurs after the time of receipt,
it is the rate at the time of receipt.
Statutory income (excluding The applicable exchange rate is the rate at the time the amount
capital gains) must be returned as income or at the time of receipt, whichever
occurs first.
Deductions (excluding capital The exchange rate to be used is the rate at the time the amount
allowance rules) becomes deductible or at the time at which payment occurs,
whichever is the earlier.
Cost of a depreciating asset If an obligation to pay for the asset is not satisfied before the
taxpayer holds the asset, the cost of the asset is to be translated into
Australian currency at the exchange rate when the taxpayer began
to hold the asset.
Otherwise, the exchange rate to be used is the exchange rate when

the obligation is satisfied.
Trading stock Where an item of trading stock at the end of the year is valued at
cost, the exchange rate to be used is the rate prevailing when the
item became on hand.
However, if it is valued at market selling value or replacement value,

the exchange rate to be used is based on the rate applicable at the
end of the year.
CGT Where there is a transaction or event that involves an amount of

money or the market value of other property, to which the CGT
provisions apply, the exchange rate applicable is the one at the time
of the transaction or event.
Non-specified receipts Where any receipt or payment is not covered by the specific rules
and payments contained in s. 960-50(6), the exchange rate to be used is the rate at
the time of receipt or payment.
Functional currency rules

The translation rules in Table 2.6 and found in s. 960-50 of ITAA97 concerning foreign-sourced
income do not apply where the functional currency rules apply.
There are rules for the conversion of foreign currency into Australian currency. These are found
in Subdivisions 960C–960D of ITAA97. The main translation rule is that foreign currency needs to
be translated into Australian currency in order to calculate Australian taxation liability in terms
of income, deductions and offsets.
These foreign translation rules as such do not apply in the case of functional currency. This is
where the eligible tax entity, for example a company, keeps its accounts solely or predominantly
in a foreign currency—the functional currency. When this occurs, only the net income of the
entity must be translated into Australian currency. This is opposed to each individual transaction
(the standard translation rules).
The functional currency rules apply to an Australian resident company that is required to prepare
financial reports under s. 292 of the Corporations Act 2001 (Cwlth), namely:
• a permanent establishment
• a controlled foreign company
• an offshore banking unit
• a transferor trust.
The functional currency rules apply when the taxpayer makes a written election to apply them.
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The functional currency rules continue until the taxpayer seeks withdrawal or at the end of the
year in which the taxpayer is no longer required to prepare a financial report under s. 292 of
the Corporations Act.
Foreign exchange rules

Gains and losses caused by movements in exchange rates, which are either on an income
or capital account, are assessable or deductible under Division 775 of ITAA97 unless there is
a specific exemption.
Formula to learn
The basic rule is contained in s. 775-15 of ITAA97. It states that assessable income for the year includes
a foreign exchange (FX) realisation gain as a result of a foreign exchange realisation event (FRE) that
happens during the year.
However, an exception to the above approach applies to short-term foreign currency realisation gains
and losses where the gain or loss is closely linked to a capital asset (ss. 775-70 to 775-80).)
There are five main FREs relating to the treatment of gains and losses on FX transactions:
• FRE 1—CGT event A1 occurs when an entity disposes of a foreign currency or the right to
it. The amount of the gain or loss is that which is attributable to exchange rate fluctuations
(s. 775-40).
• FRE 2—event occurs when the right to receive foreign currency ends. The amount of the gain
or loss is that which is attributable to exchange rate fluctuations (s. 775-45).
• FRE 3—event occurs when an entity ceases to have an obligation to receive foreign currency
(s. 775 50).
• FRE 4—event occurs when an entity ceases to have an obligation to pay foreign currency.
A gain occurs when the amount originally recognised for tax purposes is greater than the
amount paid to extinguish the liability due to exchange rate fluctuations. If reversed, a loss
occurs (s. 775-55).
• FRE 5—event occurs when an entity ceases to have a right to pay foreign currency (s. 775-60).
Example 2.6: Foreign exchange events

On 1 April 2018 (when AUD 1 = USD 0.78), Taj, a doctor, purchased medical products for his surgery
from an overseas supplier for USD 10 000. Taj therefore assumed an obligation to pay foreign currency
and is entitled to a deduction of AUD 12 821 (USD 10 000 / 0.78). This amount is deductible to Taj in
the 2017–18 tax year under s. 8-1.
On 15 March 2019 (when AUD 1 = USD 0.70), Taj pays his supplier USD 10 000. As a consequence,
FRE 4 happens because Taj ceases to have an obligation to pay the foreign currency. The AUD amount
Taj pays in respect of the event is AUD 14 286 (USD 10 000 / 0.70) and this exceeds the amount on
assuming the obligation (AUD 12 821). Taj has made an FX realisation loss of AUD 1465, which he can
deduct in the 2018–19 tax year.
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➤ Question 2.2
On 1 April 2018 (when AUD 1 = USD 0.78), Fred, a distributor of slippers, entered into a contract
to supply slippers to a customer in the United States for USD 10 000. As a result of entering into
a contract, Fred has a right to receive foreign currency.
(a) Calculate the amount that must be included in Fred’s assessable income for the 2017–18
income year in respect of the supply, assuming that Fred derives the income on the date
of contract.
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(b) The US customer paid Fred for the slippers on 15 March 2019 (when AUD 1 = USD 0.70).
At this time Fred ceases to have the right to receive the foreign currency because the debt
has now been satisfied. What FRE occurs?
(c) What amount does Fred receive because of this event?
(d) Does Fred make an FX realisation gain or loss?
Trading stock core concepts

Overview
A taxpayer derives ordinary income from the sale of trading stock under s. 6-5 of ITAA97 and
is allowed a deduction under s. 8-1 of ITAA97 for the cost of purchasing trading stock. It is
therefore necessary to understand the trading stock provisions in Division 70 of ITAA97.
Trading stock is defined in s. 70-10 of ITAA97 to include anything produced, manufactured or

acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course
of business. It also specifically includes livestock. Some examples are as follows:
• The purchase of a mine is capital; the mineral when extracted is trading stock.
• The taxpayer is a share dealer; where shares are purchased for resale they may be included
as trading stock.
• Land is trading stock when held by a land dealer.
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Section 70-1 of ITAA97 provides a good overview of the trading stock rules:
This Division deals with amounts you can deduct, and amounts included in your assessable income,
because of these situations:
• you acquire an item of trading stock;
• you carry on a business and hold trading stock at the start or the end of the income tax year;
• you dispose of an item of trading stock outside the ordinary course of business, or it ceases to
be trading stock in certain other circumstances (ITAA97, s. 70-1).
Section 70-5 of ITAA97 states that ‘the purpose of income tax accounting for trading stock is to
produce an overall result that (apart from concessions) properly reflects your activities with your
trading stock during the income year’.
In this respect, there are three key features of tax accounting for trading stock. They are:
1. You [i.e. the taxpayer] bring your gross outgoings and earnings to account, not your net profits
and losses on disposals of trading stock.
2. Those outgoings and earnings are on revenue account, not capital account. As a result:
a. the gross outgoings are usually deductible as general deductions under section 8-1 (when
the trading stock becomes trading stock on hand); and
b. the gross earnings are usually assessable as ordinary income under section 6-5 (when the
trading stock stops being trading stock on hand).
3. You must bring to account any difference between the value of your trading stock on hand at
the start and at the end of the income year. This is done in such a way that, in effect:
a. you account for the value of your trading stock as assessable income; and
b. you carry that value over as a corresponding deduction for the next income year (ITAA97,
s. 70-5).
Section 70-15 provides that a deduction is available under s. 8-1 on the purchase of trading stock.
If the item becomes part of your trading stock on hand before or during the tax year in which you
incur the outgoing, then it is deductible in that year. Otherwise, the amount is deductible in the
first tax year during which the item becomes part of your trading stock on hand or for which an
amount is included in your assessable income in connection with the disposal of the item.
A deduction is only available on the purchase of trading stock when it has been acquired and is
on hand. Goods invoiced but not in the physical possession of the taxpayer (because they are
in transit) are regarded as stock on hand if the owner has power of disposition (All States Frozen
Foods Pty Ltd v. FC of T [1990] 90 ATC 4175).
Accounting for trading stock

Section 70-35(1) of ITAA97 states that where a taxpayer carries on business, all trading stock on
hand at the start of the income year and all trading stock on hand at the end of that year are
taken into account in calculating the taxpayer’s taxable income.
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Specifically, according to s. 70-35, changes in trading stock on hand affect taxable income
as follows:
• Where the value of closing stock exceeds the value of opening stock, the amount of the
excess is assessable.
• Where the value of opening stock exceeds the value of closing stock, the amount of the
excess is deductible.
In determining the value of trading stock at the start of the year, s. 70-40 states that ‘the value
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of an item of trading stock on hand at the start of an income year is the same amount at which it
was taken into account under this Division … at the end of the last income year’. Where the item
was not taken into account at the end of the last year, the value is taken to be nil. The result of
these provisions is that the value of closing stock at the end of the year is the value of opening
stock at the beginning of the following year.
Valuation of trading stock

There are only three permissible methods for valuing trading stock. The taxpayer must elect
to value each item of trading stock on hand at the end of a year at its:
• cost
• market selling value, or
• replacement value.
The taxpayer is able to adopt a different basis of valuation for each class of stock, or even each
item of stock within a class. The only rule is the value of closing stock adopted at the end of one
tax year automatically becomes its opening value at the beginning of the following year (s. 70-40).
These three methods are exhaustive and no other method of valuation is permissible except for
‘obsolete stock’ (see the next section for the definition of ‘obsolete stock’).
Because of the wording ‘each item’ in s. 70-45(1) of ITAA97, the taxpayer may adopt a different
basis of valuation for each class of stock, or even each item of stock within a class, and the
valuation basis may be switched between the different methods from year to year.
Trading stock definitions

The following definitions are important for valuing trading stock.
• cost price—the cost of the stock to the taxpayer, including all charges in getting it to its
existing condition and bringing it to the place where it is ‘on hand’. This is referred to as
‘full absorption costing’. First in, first out (FIFO), average cost, retail inventory method and
standard cost are the only methods accepted by the Commissioner to estimate cost price
• replacement value—the price at which trading stock can be replaced by the taxpayer
buying a comparable item in the market on the last day of the accounting period
• market selling value—the value from a sale or sales in the ordinary course of the
taxpayer’s business
• assets that become trading stock—at the time the assets become trading stock, the
taxpayer is treated as if just before the item became trading stock, the taxpayer sold it to
someone else at arm’s length and then immediately bought it back for the same amount
• obsolete stock—s. 70-50 of ITAA97 provides that, due to obsolescence or other special
circumstances, a valuation for trading stock below the values contained in s. 70-45 is
warranted, and the taxpayer can elect to write down the stock to a lower value, as long
as the value is reasonable.
Example 2.7: Valuation of trading stock

KDeckkie Solar Systems operates a solar system and electrical business. For the year ending 30 June
2019, the details relating to its opening trading stock and closing trading stock under the three
alternative methods of valuation were:
Quantity on Total opening Replacement Market selling

Item hand 30.06.19 value ($) Cost price ($) cost ($) price ($)
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A 1500 6500 10 15 20
B 300 3000 20 15 18
C 600 1000 8 6 5
Invoices indicate that $800 000 has been incurred in purchasing trading stock this year. There are a
further 250 units of Item A, which are still with the freight company as they have not been delivered
to KDeckkie Solar Systems. An invoice for these items shows that KDeckkie Solar Systems had paid
$12 per item on 28 June 2019 and had received a bill of lading for shipment of the stock.
Assuming KDeckkie Solar Systems wishes to minimise its assessable income, it will value closing stock
using the lowest values it can use. It can use different values for different items of stock.
Closing stock valued using s. 70–45 methods would be:
Item Quantity Price used ($) Total value ($)
A 1500 10 15 000
A 250 12 3000
B 300 15 4500
C 600 5 3000
Total 25 500
The impact on KDeckkie Solar Systems income would be:

$
Closing stock = 25 500
Opening stock = $6500 + $3000 + $1000 = 10 500
Stock adjustment income (s. 70–35) 15 000
The impact on KDeckkie Solar Systems would be a deduction for purchases of:
Purchases (s. 8–1) $800 000
Disposal of trading stock

There are five methods for disposing of trading stock. The treatment for each method is
summarised in Table 2.7.
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Table 2.7: Disposal of trading stock
Method of disposal Treatment
In the ordinary course of trading Opening and closing stock are brought to account using ordinary
accounting procedures (gross sales less cost of sales).
Not in the ordinary course Assessable on the market value of the stock on the date of disposal.
of trading The purchaser is deemed to acquire the goods at that value.
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Notional disposal of trading stock Treated as having been disposed of outside the ordinary course of
business if it stops being trading stock on hand of an entity and,
immediately afterwards, the transferor is not the item’s sole owner,
but an entity that owned the item immediately beforehand still has
interest in the item (ITAA97, s. 70-100).
Cease to hold item as trading Just before it stopped being trading stock, treated as if it was sold
stock, but still own it to someone else for its cost, and the taxpayer immediately buys
it back for the same amount (ITAA97, s. 70-110).
Trading stock lost or destroyed When a taxpayer receives compensation for lost trading stock,
the assessable income is the amount that is received by way of
insurance or indemnity for the loss. The receipt that replaces an
amount has the same treatment as what it replaces, so treated as
ordinary income (ITAA97, s. 70-115).
Death of an owner
Upon the death of the taxpayer, their assessable income up to the time of death includes the
market value at that time of the trading stock of the business. The person on whom the trading
stock devolves is deemed to have acquired it at its market value.
Trading stock concessions for small business entities

A trading stock concession applies to taxpayers who qualify as a small business entity
(SBE). A business is classed as such if it:
• carries on a business, and
• satisfies the $10 million aggregated turnover test.
Requirements for an SBE are discussed in more detail in the first section of Module 4,
‘Small business entities’.
The trading concession operates so that where the difference (a reasonable estimate)
between the value of the opening and closing stock is $5000 or less, the taxpayer can choose
not to value each item at year end and choose not to account for changes in value. Instead,
the value of trading stock on hand at the end of the year is deemed to be the same as the value
of trading stock at the start of the year.
Instead of conducting a stocktake, the taxpayer can provide an estimate. The taxpayer is required
to record how they estimated the value of the stock, but they do not have to notify the ATO of
how they have chosen to apply the estimate.
This $5000 threshold applies to both increases and decreases in the value of the trading stock.
If the difference is more than $5000, then the SBE will need to ‘use the general trading stock rules
and conduct a stocktake and account for changes in the value of trading stock at the end of the
income year’ (ATO 2018c), as described in the previous sections.
Example 2.8: Trading stock concessions for small

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business entities
Kirsten operates a clothing shop and has elected to use the SBE trading stock concessions. At the
start of the 2018–19 tax year, the value of Kirsten’s trading stock is $25 000. Using her reliable inventory
system, Kirsten estimates that the value of trading stock at the end of the tax year is $28 000. As the
difference between the opening and closing trading stock values is less than $5000 ($3000), Kirsten may
choose not to account for trading stock. Therefore, the closing value of trading stock will be $25 000
(the same as the opening value) and not $28 000. As a result, the increase in value of trading stock
($3000) is not included in assessable income as it would have been if the SBE option had not been used.
An SBE taxpayer with a change of $5000 or less in the value of trading stock may still choose to account
for changes in the value of trading stock. Where an SBE taxpayer makes this choice, the general trading
stock rules in Division 70 apply. Therefore, the taxpayer must make an adjustment to assessable income
or deductions for the change in value of trading stock in accordance with s. 70-35. This choice is likely
to be made in situations where the taxpayer wishes to increase assessable income to absorb tax losses
or to obtain a deduction where the value of trading stock has declined.
Assume that Kirsten does in fact elect to account for trading stock. In this case, the provisions of
Division 70 would apply. Kirsten would include the difference in value of opening and closing stock
($3000) in assessable income, and the value of closing stock would be $28 000.
➤ Question 2.3
Yasmin is a full-time graphic designer and works as an employee for Creative Design Pty Ltd.
She receives an annual full-time salary of $90 000 (exclusive of superannuation) for services
performed. Yasmin worked in her full-time job from 1 July 2018 until 1 October 2018. Yasmin
took two months’ paid annual leave from 2 October 2018, and then resigned from the company,
effective from 2 December 2018. Yasmin had used all her annual leave so was paid no entitlements
upon leaving the company.
Yasmin went to Europe on 3 October 2018 on a working holiday. After travelling for two months,
Yasmin returned to Australia on 15 December 2018 due to the unexpected death of her mother.
Yasmin subsequently decided to stay in Australia and returned to work for her old graphic design
company on 1 February 2019, receiving her previous salary of $90 000 per annum.
Yasmin has owned a property since 2016, which she purchased off the plan and immediately
rented out. Yasmin has never lived in the property herself, but it was continuously rented from
July 2016 up until the end of February 2019. On 30 March 2019, Yasmin exchanged contracts
on the sale of the property.
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(a) What type of income has Yasmin received in the 2018–19 tax year?
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(b) While travelling in Europe from 3 October to 15 December 2018, what is the source of the
income received by Yasmin?
(c) Is Yasmin a resident or non-resident taxpayer for all or part of the 2018–19 tax year?
(d) In January 2019, Yasmin started selling framed graphic art prints at two local markets near
her house. Yasmin creates the graphic art prints herself and gets them framed by a local
supplier. On 22 January 2019 (when AUD 1 = VND 16 550), Yasmin entered into a contract
to purchase picture frames from Vietnam for her business for 30 000 000 Vietnamese Dong
(VND). On 22 June 2019, Yasmin pays her supplier for the frames (when AUD 1 = VND 17 860).
Calculate the FX loss or gain that Yasmin has realised.
Summary and review

This module introduced the key concepts of assessable income, starting with defining and
determining income. Tax is levied on the ‘taxable income’ of a taxpayer derived during
the income year where ‘taxable income’ is calculated as assessable income less allowable
deductions. Assessable income of a taxpayer comprises both ordinary income and statutory
income except when these components are ‘exempt’ income or otherwise excluded from
MODULE 2
assessable income.
Ordinary income is referred to in the legislation as ‘income according to ordinary concepts’

and although it is not defined in the legislation, the courts have identified various factors that
indicate whether an amount is income according to ordinary concepts. A frequent characteristic
of income receipts is regularity, even if the receipts are not directly related to employment or
services rendered. We also saw how tax law draws an important distinction between ‘income’
and ‘capital’ gains, whereby income gains are assessable under s. 6-5 of ITAA97 and capital gains
are only assessable if caught under specific statutory income provisions.
The module then discussed the concepts of residence, source and derivation, which underpin the
Australian income tax system. The assessable income of a resident of Australia includes ordinary
and statutory income derived directly or indirectly from all sources in and out of Australia;
whereas the assessable income of a non-resident includes only the ordinary and statutory income
that has an Australian source. The legislation covers four circumstances in which an individual
is a resident of Australia and three circumstances in which a company is treated as a resident of
Australia for tax purposes. There are two accepted methods in accounting for the derivation
of income: it can be derived on a ‘cash’ or on an ‘accruals’ basis.
As ordinary income also includes income derived from carrying on a business, the module then
examined the criteria for determining when a business exists. The actual existence of a business
is a question of fact and degree and determined by decisions from the courts, through guidance
in Taxation Determinations, and via rulings from the ATO.
The core concepts of international tax were then explored in relation to the tax obligations of
non-residents. There is an emphasis on DTAs, foreign currency translation and exchange rules
and the withholding tax and transfer pricing regimes. The aim of DTAs is to relieve taxpayers
from double taxation and mitigate tax evasion, and the transfer pricing system is there to ensure
Australian entities do not pay less tax in Australia by entering into non-arm’s-length cross-border
dealings with another entity.
Finally, the module covered the core taxation concepts related to trading stock given that a
taxpayer derives ordinary income from transactions in selling trading stock. Accounting for and
valuation (using cost, replacement value or market selling value) of opening and closing trading
stock were examined as were the tax treatment when disposing of trading stock and the tax
concessions available for SBEs.
Suggested answers
Suggested answers
MODULE 2
Question 2.1
The assessability of the amounts received by Rosemary depends on her residency status at the
time each amount is derived. Non-residents are only assessable on income that has an Australian
source. Given Rosemary was born in Canada, this would usually indicate her domicile and her
residence status is Canadian. However, as her usual place of abode is Australia, this may indicate
residency of another country.
An issue that arises under the ‘resides test’ is the period of residence of a taxpayer who migrates
to Australia during the year of income. Taxpayers will generally be treated as residents of
Australia only for the period after migration. The fact that Rosemary intends to stay in Australia,
based on a work contract for six years, would probably indicate her usual place of abode and
therefore her residency status has now changed to that of Australian from 18 December 2018.
The amount of $5000 received by Rosemary to join the firm would be assessable income
as a receipt in anticipation for future work and would be assessable income under s. 6-5 as
ordinary income.
The $1500 cost of the stopover would be assessable income to Rosemary under s. 15-2 as a
non-monetary benefit. However, it could also be subject to FBT if it is seen as a provision of a
benefit to a future employee. FBT is covered in Module 9.
The $70 000 salary received by Rosemary would be assessable income under s. 6-5 as ordinary
income.
The $4000 bonus would normally also be assessable under s. 6-5 as ordinary income. However,
as it was not paid until 5 July 2019, it would not be derived for the year ending 30 June 2019.
It would be included as assessable income for the year ending 30 June 2020.
If Rosemary was a non-resident of Australia, the rent from her Canadian property would not
be assessable due to its foreign source. However, if Rosemary is a resident, the $15 600 rent
received would be assessable. The rent received relating to July would also be assessable,
even though it was received in advance. It was received and derived in the year ended 30 June
2019. Although the rent was received by her agent, amounts dealt with for Rosemary’s benefit
are a constructive derivation under s. 6-5(4).
Similarly, if Rosemary was a non-resident, the interest deposited in her Canadian bank account
would not be assessable income. However, as indicated earlier, it is likely Rosemary would
be regarded as a resident from the time she arrived in Australia. As a result, only the interest
received of $400 (deposited in the account) since 18 December 2018 would be regarded
as assessable income and derived when credited as a constructive receipt under s. 6-5(4).
The balance of interest received of $1400 would be regarded as foreign income received by
a non-resident and hence not assessable as income.
MODULE 2
Question 2.2
(a) The amount that must be included in Fred’s assessable income for the 2017–18 income year
in respect of the supply, assuming that Fred derives the income on the date of contract,
is AUD 12 821 (USD 10 000 / 0.78). This amount is included in Fred’s assessable income
under s. 6-5 for the 2017–18 tax year.
(b) FRE 2 therefore happens on 15 March 2019.
(c) The AUD amount that Fred receives in respect of the event is AUD 14 286 (USD 10 000 / 0.70).
(d) As this amount is greater than the amount originally recognised for tax purposes (AUD 12 821),
Fred makes an FX realisation gain of AUD 1465, which he must include in his assessable
income for the 2018–19 tax year.
Question 2.3
(a) Yasmin has received a salary, rent from her investment property and proceeds from the
sale of her investment property. A salary is classified as active, ordinary income, and rent is
passive, ordinary income, with both assessable under s. 6-5 of ITAA97. The proceeds from the
sale of the property is not ordinary income but is a capital receipt and qualifies as statutory
income subject to CGT provisions in Part 3-1 of ITAA97 (discussed in Module 5).
(b) The source of her annual leave income (she is still employed by Creative Design until
2 December) is Australian. The source of her rental income against her investment property
is also Australian (Nathan v. FC of T [1918] 25 CLR 183).
(c) Residency is ultimately a question of fact and degree. Yasmin would be deemed to be an
Australian resident taxpayer for the entire 2018–19 tax year based on the facts presented.
Her resignation from Creative Design is not effective until 2 December 2018. Due to her
being called back early from Europe on 15 December, she never commenced residency or
work in Europe. Her absence from Australia from 2 October to 15 December inclusive is well
under the 183-day rule. She returned to Australia from that date and recommenced work
in February 2019. Importantly, Yasmin’s intention was always to return to Australia upon the
expiration of her working holiday visa and hence she would still be considered a resident for
tax purposes. Where Yasmin continues to reside or has a settled and usual place of abode
would suggest that her domicile was in Australia (Levene v. IRC [1928] AC 217). Yasmin
resided in Australia for the entire year other than the two months when she was travelling in
Europe. Yasmin’s permanent place of abode was Australia. See IT 2650.
(d) When Yasmin pays her supplier on 22 June 2019, FRE 4 occurs as she no longer has an
obligation to pay the foreign currency. On 22 January 2019, Yasmin was contracted to
pay AUD 1813 for the frames (AUD 1 = VND 16 550). On 22 June 2019, when she paid the
supplier, the AUD price was $1680, which is less than the amount on assuming the obligation.
This results in Yasmin making an FX gain of $133. Such a gain will be assessable income under
s. 775-15 of ITAA97.

REFERENCES | 105
References
References
MODULE 2
ATO 2018a, ‘Capital gains withholding: Impacts on foreign and Australian residents’, accessed
March 2019, https://www.ato.gov.au/general/capital-gains-tax/in-detail/calculating-a-capital-gain-
or-loss/capital-gains-withholding--impacts-on-foreign-and-australian-residents/.
ATO 2018b, ‘CGT discount for foreign resident individuals’, accessed March 2019, https://www.
ato.gov.au/General/Capital-gains-tax/International-issues/CGT-discount-for-foreign-resident-
individuals/.
ATO 2018c, ‘Simplified trading stock rules’, accessed March 2019, https://www.ato.gov.au/
business/income-and-deductions-for-business/in-detail/simplified-trading-stock-rules/.
CCH 2012, Australian Master Tax Guide 2012, CCH, Australia.

MODULE 2
AUSTRALIA TAXATION
Module 3
PRINCIPLES OF GENERAL AND
SPECIFIC DEDUCTIONS
108 | PRINCIPLES OF GENERAL AND SPECIFIC DEDUCTIONS
Contents
Preview 109
Introduction
Deductions versus offsets
Objectives
Teaching materials
General deductions 111
Determining general deductions
General principles underlying s. 8-1
Apportionment
Specific exclusions from s. 8-1
Specific deductions 117
Overview
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Repairs
Bad debts
Tax losses of current and previous years
Borrowing expenses and negative gearing
Other specifically deductible expenses
Limitations of deductibility 125
Entertainment expenses
Occupational clothing
Payments to related entities
Prepaid expenditure
Non-commercial loss rules
Thin capitalisation
Substantiation requirements for individuals 131
Types of expenses needing substantiation
Retention of documents
Penalty tax
References 141
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Module 3:
Principles of general and
specific deductions
MODULE 3
Study guide
Preview
Introduction
Module 2 explained that taxable income is assessable income minus all general and specific
deductions. This module examines these deductions in detail.
There are two positive limbs (which allow deductions) and four negative limbs (which deny
deductions) used to determine whether a general deduction can be applied under s. 8-1 of
the Income Tax Assessment Act 1997 (Cwlth) (ITAA97). In addition to the general deduction
rules, there are also specific deductions stated in the taxation law and they include deductions
for non-capital repairs, tax losses and bad debts. The rules for borrowing expenses and
negative gearing for investment properties are also discussed, as are limitations applied to
the application of both general and specific deductions. In conclusion, the module presents the
documents taxpayers need to retain in order to prove certain employment-related deductions.
These substantiation requirements apply to work expenses, business car expenses and business
travel expenses.

Tax deductions are different to tax offsets. A deduction is an amount subtracted from assessable
income when determining the amount of taxable income on which tax is paid. A tax offset is
subtracted from the actual tax payable that is calculated on the taxable income. Tax offsets are
discussed in more detail in Module 6.

Figure 3.1: Module summary—deductions
Deductions
General deductions Statutory deductions Substantiation Limitations
Two positive limbs Repairs Work Entertainment
Four negative limbs Bad debts Car Occupational clothing

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Apportionment Specifically deductible Business travel Related entities
Tax losses Prepaid expenditure
Borrowing expenses Non-commercial loss
Negative gearing
Objectives
• determine whether a loss or outgoing is tax deductible in a given situation;
• calculate the allowable deduction for tax purposes; and
• determine the substantiation requirements for a particular deduction.
Teaching materials
– A New Tax System (Goods and Services Tax) Act 1999 (Cwlth) (GST Act)
– Higher Education Support Act 2003 (Cwlth)
• Glossary:
Definitions/
– For languages other than English: https://www.ato.gov.au/general/other-languages/
in-detail/information-in-other-languages/glossary-of-common-tax-and-superannuation-
terms/
STUDY GUIDE | 111
General deductions
Determining general deductions
Under s. 4-10 of ITAA97, income tax is payable on taxable income that is calculated by deducting
‘general’ and ‘specific’ deductions for the income year, from assessable income for that year
(s. 4-15 of ITAA97). A deduction cannot be allowed under both general and specific provisions,
and s. 8-10 of ITAA97 prevents this double deduction by requiring a deduction to be made under
the most appropriate section or provision.
The most common deductions are general deductions. These fall within the general deduction
provision, s. 8-1 of ITAA97. The provision contains two positive and four negative limbs.
MODULE 3
Two positive limbs
Section 8-1 of ITAA97 allows the taxpayer to deduct from their assessable income any ‘loss or
outgoing to the extent’ that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing
your assessable income (ITAA97, s. 8-1).
The key principles underlying s. 8-1, including explanation of terms, will be outlined shortly.
Four negative limbs

A loss or outgoing is not deductible under the general provision where it is:
1. of capital, or of a capital nature
2. of a private or domestic nature
3. incurred in relation to gaining or producing either exempt income or non-assessable,
non-exempt (NANE) income, or
4. prevented from being a deduction via a provision of ITAA97 (ITAA97, s. 8-1).
Figure 3.2 presents a workflow to use when figuring out whether an amount will be deductible
under s. 8-1 of ITAA97.
Figure 3.2: Deductibility workflow
QUESTION: Is the amount deductible under s. 8-1?
It was incurred in gaining/producing assessable income
OR
in carrying on a business for the purpose of gaining/producing assessable income

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AND IT IS NOT
Capital, or of a capital nature OR
Private or domestic nature OR
Incurred in relation to gaining/producing exempt income or non-assessable non-exempt income OR
prevented from making deduction under specific provision of ITAA97.
YES it is a general deduction NO it is not a general deduction
General principles underlying s. 8-1

There are general principles established by taxation rulings and case law that are used when
interpreting whether s. 8-1 of ITAA97 applies and an amount is deductible.
Losses and outgoings

Losses (e.g. losses through theft) do not directly produce assessable income as they are outside
the control of the taxpayer. However, they are still deductible if they are associated with earning
assessable income or carrying on a business that produces income. Outgoings are deliberate
expenses and will also be deductible if they meet the requirements of s. 8-1 of ITAA97.
Incurred
To be deductible, expenses must be incurred. This will be the case either where there has been
an actual payment or an existing liability to pay, that is, the taxpayer is legally committed to
the expenditure even though it has not been paid (RACV Insurance Pty Ltd v. FC of T [1974]
ATC 4169; Coles Myer Finance Ltd v. FC of T [1993] ATC 4214). For example, where goods have
been ordered and delivered but the payment is not due until the next tax year, the outgoing
will still be incurred in the current year as the taxpayer is legally required to pay (incurred) even
though they have not actually paid during the current tax year. In this case, the deduction will
be in the current tax year, not when the payment is made at a later date.
Use of the term ‘incurred’ also means that accounting provisions such as provisions for long
service leave and doubtful debts will not be deductible as they are not incurred. At the time
of making the provision there is no loss or outgoing; this only arises, for example, when the
employee actually takes the long service leave or the debt becomes bad.
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The term ‘necessarily incurred’ is used in s. 8-1(1)(b) of ITAA97, but the courts have held that this
does not require that the outgoing is necessary, only that it is appropriate or adapted to carrying
on the business. (For more detail on the meaning of ‘business’, see Module 2.) For example, if a
business engages in legal action against a competitor for stealing industrial secrets and loses the
case, it could be argued that this expense was not necessary, but it will still be incurred as it is
appropriate or adapted to carrying on a business.
Connected with assessable income or carrying on a business

There must always be a connection (nexus) between the loss or outgoing and the assessable
income or carrying on of a business to earn assessable income. Another way of looking at
this is to ask whether the loss or outgoing was incurred ‘in the course of’ earning assessable
income or carrying on the business. For example, there is no actual income-earning activity
MODULE 3
resulting from an employee’s cost of travelling to work and therefore there is no connection with
assessable income and this expense is not deductible. However, if the employee incurs travel
costs necessary to perform their job (e.g. travel from work to visit a client), then this travel cost is
in the course of earning assessable income and is deductible.
A taxpayer is not required to show that the loss or outgoing has to produce assessable income
in the same year as the expense. It is sufficient if the expenditure will produce future income,
will reduce future expenditure or was incurred in deriving income of a previous tax year (Steele v.
Deputy Commissioner of Taxation [1999] ATC 4242; Finn v. FC of T [1961] 106 CLR 60). Even if the
business has ceased (e.g. the mine has closed but the company still exists), an expense can still
be deductible if it is connected with past income such as employee compensation payments to
employees who worked in the mine before it closed.
Capital expenses
Capital expenses can be seen as a once-off cost such as the cost of building a new factory or
costs that have an enduring benefit. For example, the cost of establishing a patent will benefit
the business for a number of years. Both these approaches (once-off and enduring benefit)
are indications that an expense is capital in nature but they are not the only considerations.
The decision in Sun Newspapers Ltd & Associated Newspapers Ltd v. FC of T [1938] 61 CLR
337 is the one that is most commonly used to determine whether or not an expense is capital.
In this case the court asked the question as to whether the expenses were towards operating
the business or whether it altered the business structure (changed the ability to earn income).
For example, expenditure incurred in defending or preserving capital assets (e.g. legal costs
relating to a dispute over ownership of property) is capital in nature as it affects the structure
of the business, while expenditure in the continual competitive battle for business to obtain sales
(e.g. ongoing advertising) does not alter the structure of the entity and therefore is not capital.
The distinction is between expenses that are incurred to operate the business (not capital)
and expenses that change the way the business is structured or operated (capital).
Private and domestic expenses

Private expenses are those incurred by individual taxpayers that are related to their normal
personal activities and are not in the course of earning income. Expenses that are essentially
private in nature will include childcare, travel to and from work, cost associated with your private
home (e.g. interest, rent and repairs), normal meals and everyday clothing. To show that an
expense is not private, you would have to show that it is incurred in the course of earning income.
For example, it is not possible to argue that childcare is deductible on the basis that you could
not work without it, because the decision to put a child into childcare is a private decision and
does not directly contribute to earning assessable income. On the other hand, if an employer
provided employees with free childcare, the expense for the employer is not private as it is
incurred to benefit employees, make a happier workplace and towards increasing productivity.
Therefore, the employer’s expense is in the course of carrying on the business, is not private and
would be deductible under s. 8-1 of ITAA97.
Apportionment
Section 8-1 of ITAA97 uses the phrase ‘to the extent that’, which requires that where an expense
is not used wholly for a deductible purpose, it must be apportioned into deductible and non-
deductible amounts.
The High Court decided in Ronpibon Tin v. FC of T [1949] 78 CLR 47 that apportionment is to be
determined on the amount the taxpayer actually spent, not on ‘how much a taxpayer ought to
MODULE 3
spend in obtaining his income’.
For example, if the taxpayer paid for a business advertising campaign that was ineffective,
the expense is still deductible even though the expense may be seen as being unsuccessful.
On the other hand, the taxpayer may wish to claim travel expenses for a trip involving both
private and business purposes, where only the business portion is deductible. For example,
in Cunliffe v. FC of T [1983] ATC 4380, an expense claim by a restaurateur of $46 493 for the
costs of a 16-month overseas gastronomic tour was reduced to $15 730, as part of the trip was
private in nature.
Where the expense resulted in a tax loss (the expense was greater than the assessable income),
the expense may be partly non-deductible if there is a purpose other than producing assessable
income. For example, if a taxpayer borrows money at 10 per cent interest and on-lends it to
their daughter at 1 per cent, then the interest paid on the loan by the taxpayer is partly private
(9 per cent) and the private portion will be non-deducible (Ure v. FC of T [1981] ATC 4100).
Specific exclusions from s. 8-1

The fourth negative limb of s. 8-1(2) of the general deductions provisions states that a loss
or outgoing is not deductible under the general provision where it is prevented from being
a deduction via a provision of the Act. Table 3.1 summarises some of the more common
specific exclusions.
Table 3.1: Specific exclusions from s. 8-1
Section Deduction excluded
Section 26-5 of ITAA97 Penalties imposed for breach of the law, except a penalty under
Subdivision 162-D of the GST Act.
Section 26-10 of ITAA97 The provision for accrued long service leave, annual leave, sick and other
leave. However, the actual payment of the leave or a payment from one
employer to another employer in respect of accrued leave entitlements
of transferred employees is deductible.
Section 26-19 of ITAA97 Losses or outgoings incurred in gaining or producing a rebatable benefit
(i.e. income support payments such as Austudy, and Youth and Newstart
Allowance).
Section 26-20 of ITAA97 Payments made to reduce student debts owed to the Commonwealth under
the Higher Education Support Act 2003 (Cwlth) including Higher Education
Contribution Scheme (HECS)/Higher Education Loan Program (HELP)
payments, unless the payment is made by an employer who is subject to
fringe benefits tax (FBT, covered in Module 9) in respect of the payment.
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Section 26-22 of ITAA97 Contributions and gifts made to political parties and individuals who are
candidates for, or members of, parliament and local government bodies.
Section 26-26 of ITAA97 Non-share distributions or returns accrued on non-share equity interests.
Section 26-30 of ITAA97 Travelling expenses in respect of a relative accompanying an employee

or self-employed person on a business trip, unless there is a genuine and
substantial business purpose for the relative’s presence or the expenditure
incurred is subject to FBT.
Section 26-31 of ITAA97 Effective from 1 July 2017, s. 26-31 denies a deduction for travel in relation to
the earning of assessable income from residential rent. For example, this will
deny a deduction for the cost of travel to collect residential rents.
MODULE 3
Section 26-40 of ITAA97 Expenditure incurred in maintaining a child under the age of 16 years or
a spouse.
Section 26-45 of ITAA97 Membership fees paid to a recreational club, whether paid by the member
or another person, unless the expenditure is incurred in providing a
fringe benefit.
Section 26-50 of ITAA97 The cost of a leisure facility, unless the expenditure is incurred in providing
a fringe benefit or the facility is used for the gaining of income or for the
recreation of employees (for this section, the term ‘employee’ does not
include members or directors of a company).
Section 26-52/53 of ITAA97 Bribes made to foreign and Australian public officials.
Section 26-54 of ITAA97 Expenditure related to illegal activities, such as drug dealing or people
smuggling, in respect of which the taxpayer has been convicted of an
indictable offence (an offence punishable by imprisonment for at least
one year).
Section 26-74 of ITAA97 Excess superannuation concessional contributions charge.
Section 26-75 of ITAA97 Excess superannuation non-concessional contributions tax.
Section 27-5 of ITAA97 The GST component, to the extent that the taxpayer is entitled to an input
tax credit or decreasing adjustment.
Section 32-5 of ITAA97 Entertainment expenses, unless incurred in providing a fringe benefit or
excepted by Subdivision 32-B. The denial of a deduction also extends to
property used in providing the entertainment (s. 32-15).
Section 34-10 of ITAA97 Expenditure incurred by an employee on a non-compulsory uniform,

unless the non-compulsory uniform is entered on the Register of
Approved Occupational Clothing. This provision does not stop an
employee from deducting expenditure on ‘occupational specific clothing’
or ‘protective clothing’.
Section 40-45 of ITAA97 Capital allowance deductions on eligible work-related items provided as an
FBT-exempt benefit from their employer (e.g. an employee provided with
a laptop computer that is mainly used for employment-related purposes
cannot claim depreciation deductions). Capital allowance provisions are
discussed in Module 4.
Division 250 of ITAA97 Certain capital allowance deductions where the taxpayer has financed the
acquisition of the property by a non-recourse borrowing and then leased the
property to a non-resident, a tax-exempt body or back to a previous owner.
Section 51AF of ITAA36 Private usage proportion of car expenses incurred by employees or their
relatives in respect of a car provided by an employer for the exclusive use
of the employee or their relative.
Section 51AGA of ITAA36 Unless excluded by regulation, car parking expenses incurred by an
employee in parking for more than four hours between 7 am and 7 pm
at or near the employee’s primary place of employment on a day where
the car was used to travel from home to work.
Section 51AH of ITAA36 Reimbursement of an expense incurred by an employee where the

reimbursement constitutes a taxable fringe benefit.
Section 51AJ of ITAA36 An employee contribution to a fringe benefit to the extent that the
contribution represents payment for the private element of the benefit.
Section 51AK of ITAA36 Non-cash business benefits to induce business taxpayers to purchase
property (e.g. the supplier provides a $200 watch with the purchase of a
$10 000 computer. The purchaser will be taken to have incurred expenditure
of $200 on the watch and denied this sum as a deduction under s. 8-1(1).
The value for depreciation of the computer will be $9800, because the watch
is not a business asset).
Section 82A of ITAA36 The first $250 of certain self-education expenses, whether deductible or not
MODULE 3
(e.g. if the taxpayer incurred $200 on non-deductible childcare so they could

attend university, this $200 can be used against the $250 limit reducing it to
$50 of deductible expenses that would be excluded from deduction).
Source: Based on Income Tax Assessment Act 1936 (Cwlth), Federal Register of
Legislation, accessed March 2019, https://www.legislation.gov.au/Details/C2019C00106;
Income Tax Assessment Act 1997 (Cwlth), Federal Register of Legislation, accessed March 2019,
https://www.legislation.gov.au/Details/C2019C00113.
Taxation Ruling TR 98/9 states that where self-education is directly relevant to the activities by
which a taxpayer currently derives assessable income, or is likely to lead to an increase in income
from those activities, the self-education expenses associated with the study are deductible.
In FC of T v. Hatchett [1971] ATC 4184, expenditure to obtain a teacher’s higher certificate
was allowed, but university fees to obtain a degree were not as they were not connected with
earning assessable income. Equally, in Finn v. FC of T [1961] 106 CLR 60, an architect (employed
by the Western Australian government), who expended money in travelling to gain experience
in ‘hot weather architecture’ to improve his promotion prospects, gained a deduction on the
grounds of relevance of expenditure to the production of future assessable income.
A deduction will generally be denied where the study is designed to enable a taxpayer to obtain
employment or to open up a new income-earning activity. In addition, where a taxpayer seeks
to claim a deduction for self-education expenses under s. 8-1, the deduction available may
be restricted by the operation of s. 82A of ITAA36, as seen in Table 3.1. However, HECS/HELP
payments (student contributions for higher education) are not a self-education cost and therefore
cannot be used to reduce the $250 exclusion (ITAA36, s. 82A(2)).
➤ Question 3.1
Leslie Smith starts working at an accounting practice. She discovers she must complete an
undergraduate degree in accounting in order to gain a promotion in her employment. Leslie enrols
as a part-time student in an accounting degree program at a local university because of this
information. She incurs the following expenses.
$
Student union fees 120
Books (used over the length of the course) 250
Photocopying 68
Travelling expenses by train from work to university 310
Higher Education Assistance/HECS/HELP 2500
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What deductions, if any, is Leslie entitled to?
MODULE 3
Specific deductions
Overview
The income tax legislation also provides specific deductions separate to the general deductions
found in s. 8-1, and these are discussed in the last two sections of this module. The main specific
deductions covered are repairs, bad debts, specifically deductible expenses, tax losses of
previous years and capital allowances.
This section examines the first four specific deductions, and capital allowances are covered
in Module 4.
Repairs
The expenditure for repairs (non-capital expenditure) to premises (or part premises) or to a
depreciating asset, held or used by the taxpayer solely for the purpose of producing assessable
income, is deductible in the year that the expenditure is incurred. Where the property is used
only partly for the purpose of producing assessable income, the deduction for repairs is
allowable only to the extent considered reasonable in the circumstances (ITAA97, s. 25-10(1)).
Section 25-10 of ITAA97 does not provide a definition of ‘repair’. Repair has been defined by
case law as the restoration of part of some income-producing property or structure by ‘renewal
of decayed or worn out parts’ (Taxation Ruling TR 97/23), but it is not a total reconstruction of the
entirety (see TR 97/23; Lurcott v. Wakely and Wheeler [1911] 1 KB 905).
The definition of repair means that if a taxpayer elects to replace an asset (instead of repairing
it), then the whole cost of the replacement is considered capital expenditure, even if it was less
expensive to replace the asset than to have it repaired.
For example, if the front brick wall of a building is cracked, caused by the shifting of the
foundations, and a bricklayer is engaged to re-lay and re-mortar the section of the wall that is
cracked, the cost would be claimable as a repair. However, if the wall is replaced by a concrete
wall reinforced with steel rods, then there has not been a repair but a replacement of the entirety
(W Thomas & Co. Pty Ltd v. FC of T [1965] 115 CLR 58; Lindsay v. FC of T [1961] 106 CLR 377).
To determine if the repairs are tax deductible, the decision tree in Figure 3.3 can be used.
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Figure 3.3: Decision tree
Is it a repair?
YES NO—improvement
Are the repairs associated If an improvement then

with the purchase and capital expenditure and
sale of asset? NO deduction
NO YES
Is it a repair of assets used solely or partly Then generally no deduction unless

for income-producing purposes? it meets the requirements of TR 97/23
SOLELY PARTLY
Then fully deductible in the Then deduction as per a percentage of the asset used for
year expenditure is incurred income, or as considered reasonable in the circumstances
Repair versus improvement

While a repair restores an item to its former condition or level of efficiency, an improvement
makes the item functionally better than it was previously.
Examples of repairs that are generally deductible are maintaining plumbing, mending leaks,
repairing machinery and painting. On the other hand, an improvement (not deductible) would
be landscaping, installing insulation or replacing cupboards as part of a refurbishment.
Where the work that was carried out has added to, altered or changed the asset or part of it
compared with its earlier condition or function, it is likely that the repair will be deemed an
improvement, alteration, addition or renovation. These are all treated as capital expenditure.
This raises the question of whether the use of a new or different material in restoring the asset
constitutes an improvement.
If a more up-to-date material is equivalent to the original and there is no obvious physical
advantage in using the new material as against the former type, then it should be deemed
a repair.
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AAT decisions suggest that work does not cease to be a repair because different materials are
used. It is the restoration of efficiency in function rather than the exact repetition of form that is
significant (Case V167 88 ATC 1107 and Taxation Ruling TR 97/23). If the taxpayer employs not
only a different material but one that is of a different physical construction and that gives a better
result with diminished future maintenance costs, then it is generally viewed as an improvement
(FC of T v. Western Suburbs Cinema Ltd [1952] 86 CLR 102).
The cost of repairs to remedy a defect in an asset that was in need of repair at the time of
acquisition is also a capital expense and not deductible as a repair (The Law Shipping Company
Ltd v. Inland Revenue Commissioners [1924] 12 TC 621). These repairs are known as ‘initial
repairs’ and are treated as part of the cost of the depreciating asset (see Module 4) because
the repair is needed to bring the asset to a functional state. An initial repair can also be seen as
an improvement to the asset as it is being improved from its condition at the time of purchase.
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On this basis, an initial repair will still be capital and not deductible as a repair even if the
purchaser was not aware of the need for the repair at the time of purchase (Taxation Ruling
TR 97/23 para. 61).
Bad debts
As discussed in Module 2, taxable income of a taxpayer can be assessed on a cash or accruals
basis. If amounts have been included in assessable income under the accruals basis, but are
not actually received and later written off as bad debts, the taxpayer has effectively paid tax
on income that has not been (and is not expected to be) obtained.
Under s. 25-35 of ITAA97, if the debt is not paid the taxpayer is entitled to a deduction for
the resulting bad debt that has already been taxed as assessable income. A deduction for
the bad debt is only allowable in the tax year that the debt is written off as bad. Therefore,
raising an accounting provision for doubtful debts will not be deductible under s. 25-35
or any other provision.
If a bad debt claimed as a deduction is recouped in a subsequent tax year, then the recouped
amount would be assessable income.
The four conditions that must all be met for a debt to qualify as a bad debt are:
• There must be an existing debt.
• The debt must be bad (a reasonable business would consider it unlikely to be paid and not
merely doubtful).
• The debt must have been written off as bad during the tax year in which the deduction
is claimed.
• The debt must have been included in the taxpayer’s assessable income for the tax year or
earlier tax year, or the debt must be in respect of money lent in the ordinary course of a
money lending business. In this latter case, the bad debt is deductible whether or not the
amount written off had been included in assessable income.
Tax losses of current and previous years

A tax loss is incurred when allowable deductions (other than unrecouped tax losses brought
forward from an earlier tax year) exceed total assessable income and net exempt income of that
year. For an Australian resident, ‘net exempt income’ is the sum by which the taxpayer’s total
exempt income derived from all sources exceeds the sum of the losses and outgoings (not being
of a capital nature) incurred in deriving that exempt income and any foreign taxes payable on
that exempt income (see s. 36-20(1) of ITAA97).
Deducting tax losses for non-corporate tax entities

The rules for the deduction of tax losses for entities other than corporate tax entities are found
in s. 36-15 of ITAA97 and introduced here.
Under s. 36-15 of ITAA97, a domestic tax loss can be carried forward and deducted in arriving at
the taxpayer’s taxable income of future income years. Any domestic losses incurred from 1989–90
onwards can be carried forward indefinitely until they are fully absorbed.
Section 36-15 provides that a tax loss shall be deductible in a later tax year in accordance with
the following provisions:
• where for the later tax year, the taxpayer has not derived exempt income and the total
assessable income exceeds the total deductions, the earlier year tax loss is deducted from
that excess (s. 36-15(2))
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• where for the later tax year, the taxpayer has derived net exempt income, the deduction for
the earlier year tax loss shall be made first from the taxpayer’s net exempt income and then
from that part of the taxpayer’s assessable income that exceeds deductions (s. 36-15(3))
• where for the later tax year, the taxpayer has net exempt income, but deductions exceed
total assessable income, then that excess is subtracted from net exempt income and the
earlier year tax loss is then deducted from any net exempt income that remains (s. 36 15(4))
• where there are two or more tax losses, the losses are taken into account in the order in which
they were incurred (s. 36-15(5)).
➤ Question 3.2
Sally has $30 000 of assessable income, $3000 net exempt income and deductions totalling
$38 000. What is the tax loss?
Deductions are not restricted to tax losses incurred in carrying on a business—any defined
‘tax loss’ is eligible for a deduction. For example, if a taxpayer’s assessable income consisted
solely of rental income, interest and dividends, and the taxpayer’s deductions exceed total
assessable income, the taxpayer would be entitled to a deduction of the resultant ‘tax loss’ in
assessments of subsequent years, subject to the requirement that the loss must be first set off
against any net exempt income. Losses from business activities for individuals are subject to the
non-commercial loss rules under Division 35 of ITAA97 (see later in this module).
Tax losses incurred prior to a taxpayer becoming bankrupt are denied as a deduction and cannot
be carried forward. If the taxpayer repays the debt, they can then deduct so much of the repaid
debt that does not exceed the amount of the loss. The treatment of losses for trusts is discussed
in Module 8. The treatment of tax losses for corporate entities is discussed in the next section.
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Deducting tax losses for corporate entities

Section 165-10 of ITAA97 provides that to claim a deduction for a tax/capital loss, corporate
tax entities, chiefly companies, must satisfy either the continuity of ownership test (COT) or
the same business test (SBT). Similar provisions apply for the treatment of bad debts, but this
section will focus on the treatment of losses.
Continuity of ownership test

Satisfaction of the COT under s. 165-12 of ITAA97 requires the same persons to have owned the
same shares that, when taken together, carry more than 50 per cent of all voting, dividend and
capital distribution rights at all times during the ownership test period. This test applies where all
shares are beneficially owned by individuals, and it applies to all tax losses, net capital losses and
bad debt deductions after 21 September 1999.
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The ownership test period for tax losses and net capital losses is defined as the period from the
start of the loss year to the end of the tax year in which the loss is claimed.
Section 165-12(6) also allows for an alternative test to apply where a company is beneficially
owned by individuals through interposed companies at any time during the ownership test
period. The alternative test is satisfied where it is the case or it is reasonable to assume, after
tracing through interposed entities, that there are persons (none of them companies or trustees)
who between them at all times during the ownership test period:
• are able to control more than 50 per cent of the voting power of the company
• would receive more than 50 per cent of any dividend paid
• would receive more than 50 per cent of any distribution of capital.
(See ss. 165-150(2), 165-155(2) and 165-160(2) of ITAA97.)
Section 165-165(1) has a same-share test, requiring that a person’s share in a company is only
counted for the COT if the same person holds exactly the same shares throughout the relevant
period. However, share splits and consolidations are counted provided the same person
beneficially owns them throughout the ownership test period.
For the purposes of the COT, if the beneficial owner of shares dies, ownership is deemed to
survive as long as the shares are held by the trustee of the estate or by a beneficiary (s. 165-205).
A company is able to deduct part of a prior year’s tax loss where the COT is satisfied in relation
to only part of the year (s. 165-20).
Same business test

Where a company fails the COT, unrecouped tax losses may still be deductible where the
company carries on the same business at all times in the year of recoupment as it carried on
immediately before the change in beneficial ownership of shares that disqualified the company
from satisfying the COT (s. 165-13). This is the SBT.
To satisfy the SBT, the company must not have derived any assessable income from a business
or transaction of a kind that it did not engage in prior to the change in ownership of shares
(s. 165-210(2)) and must not commence a business or initiate a transaction in order to meet the
SBT (s. 165-210(3)).
Business continuity test

There is currently legislation before the federal parliament that supplements the SBT with a
more flexible similar business test. Collectively, both tests will be referred to as the business
continuity test.
The new similar business test will allow corporate tax entities greater access to past year losses
when companies enter into new transactions or business activities. It is expected the new test will
apply for losses made in an income year starting on or after 1 July 2015. As of 30 December 2018,
this was not yet law. Losses cannot be accessed under the new test until the law is passed.
Rules on how tax losses are deducted

Corporate tax entities are generally able to choose the amount of prior year tax loss they wish to
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deduct in a later tax year (ITAA97, s. 36-17). Rules restricting the extent to which prior year losses
can be deducted apply in certain circumstances:
• An entity cannot choose to deduct any prior year losses where there is an amount of excess
franking offsets (i.e. unused franking credits) (s. 36-17(5)(a)).
• An entity cannot deduct a loss that will result in an excess franking offset (s. 36-17(5)(b)).
These restrictions are designed to prevent companies from refreshing prior year tax losses into
current year tax losses, thereby making tests such as the COT easier to satisfy.
Borrowing expenses and negative gearing

Borrowing expenses
Section 25-25 of ITAA97 allows for a deduction for expenditure incurred in borrowing money
where the money is used by the taxpayer for the purpose of producing assessable income.
Expenses eligible for a deduction under s. 25-25 are deducted over five years or over the length
of the loan if it is less than five years. Ure v. FC of T [1981] ATC 4100 established that the words
‘expenditure incurred in borrowing money’ in the former s. 67 of ITAA36 refers ‘to the cost of
borrowing as distinct from the cost of the money’. For example, expenditure on legal expenses,
valuation fees, survey fees and stamp duty are costs of borrowing under s. 25-25 of ITAA97.
Interest payable represents a cost of money and is deductible under the general deduction
provisions found in s. 8-1 of ITAA97.
Interest on borrowings to purchase a property that earns rental income for the taxpayer will
be deductible under the general deduction rules.
Example 3.1: Determining borrowing expenses

A borrower (not a small business entity (SBE)) incurred the following expenditure in connection with
obtaining a 10-year loan of $200 000 at a rate of 7.5 per cent from 31 March 2019. The loan was for
several purposes and secured against the borrower’s own home.
$
Legal fees 1 600
Procuration fees 400
Valuation of security (taxpayer’s home) 80
The loan proceeds were applied as follows: $

• repayment of taxpayer’s home loan 40 000
• expansion of factory 100 000
• financing working capital needs of taxpayer’s business 60 000
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What deductions could the taxpayer claim in their return for the year ended 30 June 2019?
The costs of raising the funds are not deductible under s. 8-1 as they are capital in nature, but may
be deducted pro-rata over five years under s. 25-25 to the extent those funds are applied to earn
assessable income.
Legal fees $1600, procuration fees $400 and valuation fee $80 each qualify as a deductible borrowing
expense under s. 25-25; however, only $160 000 of the $200 000 borrowed is used to produce assessable
income. The remaining $40 000 is used for private purposes (to repay the taxpayer’s home loan).
As the loan has not been repaid, s. 25-25(5) requires the deduction to be spread over the period of
the loan or five years, whichever is the shorter.
The maximum amount for the first year is the expense divided by the number of days in the five-year
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period and then multiplied by the remaining days in the first year. The maximum amount that can be
claimed for the 2018–19 tax year would therefore be $104.80, determined as follows:
• Step 1: Remaining expenditure $2080 ($1600 + $400 + $80)
• Step 2: Remaining loan period 1827† days
• Step 3: Expenditure per day in loan period $1.1385 ($2080 / 1827 days)
• Step 4: Maximum amount in current period $104.74 ($1.1385 × 92 days)
†
Includes two extra days due to two leap years over the five-year period.
The actual deduction received will be the maximum amount apportioned by the use of the funds.
In this case, the amount used to earn assessable income is $160 000 out of the $200 000 raised.
The deduction is therefore:
$104.74 × $160 000

= $83.79
$200 000
As only $160 000 (80%) of the funds borrowed was used for income-producing purposes, the deduction
for interest for the 2018–19 tax year is limited to $3025.
$160 000 × 0.075 × 92 / 365 days = $3025
Negative and positive gearing

Negative gearing relates to the situation where the allowable deductions associated with an
investment exceed the assessable income from that investment. In this situation, the excess of
deductions over assessable income can be used as a deduction against other assessable income
received by that taxpayer.
For example, take the case of a salaried individual taxpayer who receives rental income from
an investment property that incurs interest expenses. If the deductible expenses (including the
interest on the loan borrowed to finance the property) exceeds the income earned from the
property, then the property is ‘negatively geared’. This means those excess expenses can be
used by the taxpayer to offset not only the rental income, but their other income—in this case,
their salaried income. This will result in reducing overall tax payable.
Example 3.2 shows how negative gearing works in practice to reduce tax payable. It also
compares a negatively geared property to a positively geared property.
Positive gearing is when the income received from the investment is higher than the interest
charged and other expenses.
Example 3.2: Comparing negatively and positively

geared properties
Rod and Karen are brother and sister and both earn around $70 000 per year. They are both thinking
about buying an investment property worth [$600 000]. Interest on an investment loan will be 6 per cent
pa, payable on an interest-only basis. Additional property expenses are estimated at $5000 a year.
Rental income is expected to be $500 a week.
Rod will need to borrow the $400 000 needed to buy his investment apartment as he has no savings.
Interest on the loan is $2000 a month, which is tax deductible. [Rod is negatively geared as his deduction
exceeds the rental income.]
Karen has some money saved so she only needs to borrow $100 000 for a similar apartment. Karen’s
interest payment is $500 a month, which is also tax deductible. [Karen is positively geared as her
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deductions are less than the rental income she will receive.]
Rod and Karen’s

income before
buying an Rod’s negatively Karen’s positively
investment geared investment geared investment
property property property
($) ($) ($)
Salary 70 000 70 000 70 000
Plus rental income — 26 000 26 000
Less interest — –24 000 –6 000
Less property expenses — –5 000 –5 000
Taxable income 70 000 67 000 85 000
Tax [see Table 6.13 of [–15 697] [–14 662] [–20 872]
Module 6] + Medicare levy
Net income [54 303] [52 338] [64 128]
Assumptions:
…
• [Example] does not take into account inflation, increases in rental income or changes to interest
rates or income tax rates over time.
• Capital growth is not taken into account as it does not affect income calculations. The same capital
gain would be applicable under either scenario.
• [Example does not take into account that both Rod and Karen used savings to invest in property.
These savings may have been earning assessable income before being used to purchase their
investment properties.]
Karen is positively geared so her income is considerably higher than Rod’s. If Karen had left her money
in a savings account earning 5 per cent interest [$300 000 × 5% = $15 000], her after tax income would
be the same, however a savings account has no potential for capital gain.
Rod actually has less money in his pocket as most of his rental income is being paid to the bank in
interest, so he has to cover some of his investment expenses from employment income. He will be
hoping a future capital gain will recoup his short-term income losses.
Source: ASIC MoneySmart, ‘Negative and positive gearing’, accessed November 2018,
https://www.moneysmart.gov.au/investing/invest-smarter/negative-and-positive-gearing. Rates based
on Income Tax Rates Act 1986 (Cwlth), Schedule 7, Federal Register of Legislation, accessed April 2019,
https://www.legislation.gov.au/Details/C2018C00364.
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Other specifically deductible expenses

Certain expenses are expressly listed as specifically deductible under statute, even though under
s. 8-1 of ITAA97 they would be assessed as being of a capital, private or domestic nature. If they
are expressly stated, they are able to be used to reduce assessable income. These are:
• the expense of managing the taxpayer’s income tax affairs (ITAA97, s. 25-5)
• preparation of leases used in earning assessable income (ITAA97, s. 25-20)
• expenses in connection with the discharge of a mortgage given as security for a loan
repayment, which is solely for the purpose of producing assessable income. Where the
mortgage was used partly to earn assessable income, a part deduction is available (ITAA97,
s. 25-30)
• transport expenses incurred for travel between workplaces where assessable income is
earned in both workplaces and one of the places is not the taxpayer’s main residence
(ITAA97, s. 25-100)
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• capital expenditure to terminate a lease or a licence if incurred in the course of carrying on/
cessation of a business (ITAA97, s. 25-110)
• employer contributions to a complying superannuation fund on behalf of employees (ITAA97,
s. 290 60)
• employee contributions to a complying superannuation fund where the employee notifies the
superannuation fund that it is deductible (ITAA97, ss. 290-150, 290-170)
• payments for membership of a trade, business or professional association (up to $42 for each
association) (ITAA97, s. 25-55)
• charitable donations to nominated funds or institutions (min. of $2) (ITAA97, Subdivision 30-A).
Limitations of deductibility
Entertainment expenses
Entertainment expenses are generally not deductible, unless they are incurred in providing
a fringe benefit or removed from the exclusion (ITAA97, ss. 32-30–32-50). Fringe benefits are
covered in Module 9.
The definition of entertainment is broad and is defined in s. 32-10 as entertainment in the form
of food, drink or recreational activities and any related accommodation or travel. Recreational
activities include activities in vehicles, vessels or aircraft; for example, an employer taking their
employees out for lunch on their private yacht is not a deductible expense.
Other examples of entertainment expenses that are not deductible include tickets to sporting
events, business lunches and staff social functions. The disallowance of entertainment-related
deductions also relates to travel or accommodation to attend any of these events, or incidental
‘entertainment allowances’. Any property used to provide entertainment, such as the rental
of a space for a Christmas party, is also not deductible.
There are some limited exceptions, which means deductions are allowed for the following:
• meals that are provided in an in-house dining facility, meals provided in a dining facility,
and in an in-house recreational facility
• taxpayers in the business of entertainment—where the taxpayer’s business consists of
providing entertainment to paying customers, such as running a winery, then the cost of
providing that entertainment in the ordinary course of business can be deducted
• promotion/advertising expenses
• overtime meals—if the employee is entitled to overtime meals under an industrial instrument
• food, drink, accommodation and travel at seminars of over four hours in duration
• charitable entertainment—the exception applies to the cost of entertainment provided to
members of the public who are sick, disabled or otherwise disadvantaged (e.g. if a company
sponsors a concert for an aged care facility).
Example 3.3: Deducting entertainment expenses

Venturing Tech Pty Ltd, a company that packages and re-sells software, incurred the following expenses
during the year ended 30 June 2019:
• drinks provided at a public launch for the repackaging of its products $4000
• meals and drinks for selected clients at a public hotel $3000
• food and drinks provided to the company directors in an in-house dining room $6000
The cost ($4000) of promoting and advertising a product to the public is deductible as it would be
deductible under s. 8-1 and it is excepted from the denial of a deduction for entertainment by s. 32-45.
However, the meal and drinks ($3000) provided to selected clients would not be deductible as they
are excluded by s. 32-5.
The cost ($6000) of food and drink provided on working days in an in-house facility to company
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directors (classed as employees) is excepted from the denial of a deduction for entertainment by
s. 32-30, Item 1.1. As a result, it will be deductible provided the expense is deductible under s. 8-1.
Occupational clothing
Expenditure on clothing and maintenance of that clothing is generally treated as private and is
therefore not deductible. There are three exemptions to this rule, where the cost of clothing may
be deductible:
• clothing is ‘necessary and peculiar’ to the taxpayer’s occupation, such as a uniform
• clothing is conventional, but because of the occupation of the taxpayer, extra expense is
incurred. Examples where a deduction would be allowed is clothing a professional actor buys
to perform a role, or specialist clothing for an undercover police officer. Examples that were
found to not be deductible are sport clothes worn by sports teachers, swimming costumes
worn by swimming coaches, and conventional clothing worn by members of an orchestra
• non-compulsory uniforms with a registered design (s. 34-10, see earlier in this module).
Payments to related entities

An individual taxpayer may make a payment to a related entity. Section 26-35(2) of ITAA97
defines a related entity as a relative of the taxpayer, or a partner in a partnership structure,
for example, a person who pays their spouse (but not as an employee) to work in the taxpayer’s
business. A common example is a tradesperson who employs a spouse to do the bookkeeping
and administration of the trade business.
First, the taxpayer must be able to claim a deduction for the payment made to their spouse
under another provision of ITAA36 or ITAA97, normally the general deduction provision under
s. 8-1(1). The amount of the payment must then be considered as reasonable. The Commissioner
of Taxation (Commissioner) has the power to reduce the deduction to a reasonable amount
where it is considered that the taxpayer has made an excessive payment to the related entity.
Prepaid expenditure
A deduction may be claimed for prepaid expenditure, and treatment differs depending on a
number of factors—status of the taxpayer, the nature of the expense, and whether the taxpayer
is an SBE that is eligible for small business tax concessions—see the section ‘Concessional
treatment: 12-month rule’. The prepayment rules mainly apply to prepayments that would be
deductible under s. 8-1 of ITAA97 or deductible under the research and development (R&D)
concession provision (s. 355-110 of ITAA97).
A prepaid expense is defined as expenditure incurred under an agreement for something that
will be done (wholly or partly) in a later income year.
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The prepaid expenditure rules change the timing of the deductions for specific prepaid expenses
that would normally be deductible in full in the year they are incurred.
Standard prepayment rule

The standard rule for a taxpayer who incurs a prepaid expense means that there is no immediate
deduction. The expenditure must be apportioned over each tax year during which the services
are provided. This is known as the eligible service period (ESP). The ESP cannot exceed 10 years.
There are concessional rules in place for SBEs and individuals incurring non-business expenditure.
These are covered in the next section, ‘Concessional treatment: 12-month rule’.
Example 3.4: Application of prepayment rules
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Reuben runs a barber and coffee window from leased premises. On 1 November 2018, Reuben made
a lease payment of $6000 to cover the period 1 November 2018 to 31 December 2019. The ESP for
this expenditure runs from 1 November 2018 and ends on 31 December 2019, a period of 426 days,
but only 242 days (1 November 2018–30 June 2019) of this are within the current tax year.
Reuben’s income year ends on 30 June every year. As the ‘thing to be done’ under the agreement
(access to the leased premises) is not wholly done within the expenditure year, the prepayment rules
will apply and the deduction will be $3408 ($6000 × (242 / 426)). The balance of the $2952 will be
deductible in the 2019–20 tax year.
Concessional treatment: 12-month rule

SBEs that are eligible for small business tax concessions, and individuals incurring non-business
expenditure can claim an immediate deduction for prepayments where:
• the payment is incurred for an ESP not exceeding 12 months
• the 12-month period ends no later than the last day of the tax year following the year in
which the payment (individual) or expenditure (SBE) was incurred.
Where the ESP does not meet these requirements, then the deduction for the prepaid
expenditure is claimed proportionately over each tax year during which the services are to
be provided, to a maximum period of 10 years (ITAA36, s. 82KZM).
A small business taxpayer that does not elect to enter the SBE tax system will have any
prepayments apportioned over the ESP to a maximum period of 10 years as per the standard
prepayment rules (ITAA36, s. 82KZMD).
Note that SBEs are introduced in Module 4.
Exclusions to the prepayment rules

The prepayment rules only apply to deductions that would be otherwise allowable under the
general deduction provisions found in s. 8-1(1) of ITAA97 and under very limited R&D deduction
provisions. There are some exclusions:
• amounts of less than $1000 (excluding GST input credits)
• amounts required by the court or federal, state or territory government legislation
• payments of salary or wages (under a contract for service)
• amounts incurred by a general insurance company in relation to the issuing of policies
or the payment of reinsurance premiums (ATO 2018).
Special rules also apply to prepayments made under a tax shelter arrangement.
➤ Question 3.3
Cushio Pty Ltd is a small manufacturer of bespoke cushions and furnishings. Cushio was required
to prepay two years’ rent at a cost of $25 000 per annum. The lease commenced on 1 May 2019.
How much, if any, can Cushio claim as a deduction in respect of prepaid rent for the year ended
30 June 2019?
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A taxpayer can only claim losses from a genuine business activity. A taxpayer cannot claim a loss
for a business that is a hobby or a lifestyle choice.
Even if the activity has business-like characteristics, if it is unlikely to ever make a profit and does
not have a ‘significant commercial purpose or character’, a taxpayer will be unable to offset
losses made against other income. In this case, the loss can be carried forward to be used as a
deduction when the business makes a profit.
This rule applies to losses from an Australian or foreign source.
To determine if the activity is deemed either a business loss that can be offset against other
income, or a non-commercial loss that can be deferred until the activity begins making a profit,
there is a three-step process to be applied, which is shown in Table 3.2.
Table 3.2: Three-step process to determine the deductibility of non-commercial losses
Step Details
Step 1: Look at assessable If the loss-making business is in primary production or the professional arts
income and other income (excepted activity) and the assessable income from other sources is less than
$40 000, then losses can be offset against other income.
If the above applies, then the process stops here.
If the loss-making business is in something else, then the income test must
first be satisfied.
Under the income test, if the adjusted taxable income (sum of taxable
income, reportable fringe benefits, reportable superannuation contributions
and net investment losses) is:
• less than $250 000, go to step 2
• $250 000 or more, go to step 3.
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Step Details
Step 2: Check four tests Losses can be offset in the current year if any of the four tests are met:
• assessable income test—the business has assessable income of at least
$20 000 or a reasonable estimate for the year would be at least $20 000
in the case of the business operating for only part of the year
• profits test—the business has a profit for tax purposes in three out of the
past five years (including the current year)
• real property test—the value of real property or of an interest in real
property used by the taxpayer in the business on a continuing basis was
at least $500 000
• other assets test—the value of assets (excluding real property, cars,
motor cycles and similar vehicles) used on a continuing basis in carrying
on the business was at least $100 000.
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If none of the four tests are passed, then move to step 3.
Step 3: Commissioner’s Check if you should apply for a Commissioner’s discretion. Application of the
discretion Commissioner’s discretion is generally only for exceptional circumstances.
For example, situations where events outside the taxpayer’s control have
affected the results such as drought, flood and other natural disasters.
Source: Based on ATO 2018, ‘Non-commercial losses’, accessed April 2019,

www.ato.gov.au/business/non-commercial-losses/.
Example 3.5: Non-commercial losses

Peter Bell is an employee accountant earning $100 000 per annum. He has reportable superannuation
contributions of $10 000, no reportable fringe benefits and total net investment losses of $7000.
Peter also operates a business selling pottery, which commenced on the first day of the current tax
year. No assets of significant value are used in the business and he operates from his private home.
During the current tax year, Peter derives $12 000 in business income, but his business deductions
amount to $16 000 ($4000 loss).
In step 1, Peter’s business is not an excepted activity and his adjusted taxable income of $117 000
($100 000 + $10 000 + $7000) is less than $250 000. In step 2, none of the four tests are satisfied as his
assessable income is less than $20 000, he has no previous years where the business earned taxable
income and there are no significant assets used in the business. Assuming the Commissioner does
not exercise discretion, Peter cannot offset the $4000 loss from his business against his salary in this
tax year. The business loss is carried forward to be offset against future net business income or salary
income in a later year when at least one of the conditions in s. 35-10(1) is met.
Thin capitalisation
Thin capitalisation is defined as where the assets of an Australian multinational entity are
predominantly financed by debt with only a relatively low amount of equity. Debt to equity
(share capital) funding is often expressed as a ratio. For example, a debt–equity ratio may be 2:1,
which means for every $4 of debt, the entity is funded by $2 of equity. This is known as ‘gearing’.
An entity that is regarded as highly geared is financed predominantly by debt as opposed
to equity.
The thin capitalisation rules limit the amount of debt used to fund Australian operations/
investments by capping the amount of an entity’s debt deduction (such as interest) that can be
claimed against assessable income, where the entity’s debt–equity ratio exceeds certain limits.
The debt to equity limits applied do vary, but they are approximately a ratio of 0.75:0.25 debt
to equity.
A debt deduction is an expense an entity incurs in connection with a debt interest, such as an
interest payment or a loan fee that the entity would otherwise be entitled to claim a deduction for.
…
Examples of debt interests include loans, bills of exchange, or a promissory note. Generally, interest
free debt does not count as part of an entity’s debt (ATO 2016).
The thin capitalisation rules apply to both Australian-owned and foreign-controlled Australian
resident entities that are part of an international group. Australia’s thin capitalisation provisions
are set out in Division 820 of ITAA97.
Category of entity
The thin capitalisation provisions can be complex to apply because there are eight different
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categories of entities.
Each entity has its own prescribed formula or method statement on how the provisions will apply
to cap the amount of debt deductions available. The eight entities are:
• non-ADI general outward investor
• non-ADI financial outward investor
• non-ADI general inward investment vehicle
• non-ADI financial inward investment vehicle
• non-ADI general inward investor
• non-ADI financial inward investor
• ADI outward investing entity
• ADI inward investing entity.
(Note that ADI means authorised deposit-taking institution, such as a bank, and a non-ADI
is any other entity).
Applying the thin capitalisation rules

To apply the thin capitalisation provisions, the Australian resident entity must apply the
four following steps:
1. Identify any exemptions available (refer to the remainder of this section).
2. Determine which category of entity is affected (refer to the previous section ‘Category
of entity’).
3. Apply the specific thin capitalisation test for that particular type of entity.
4. Disallow any debt deductions to the extent the entity exceeds its maximum allowable debt
(discussed in the following section ‘Disallowing excess debt deductions’).
The first step is to apply any exemptions. The thin capitalisation provisions will not apply in a tax
year where one of the following conditions is satisfied:
• The entity did not incur any debt deductions during the tax year (ITAA97, s. 820-40).
• The entity’s debt deductions do not exceed $2 million in a particular tax year (s. 820 35).
• The Australian resident entity is not foreign controlled and does not have any offshore
investments as its operations are wholly based in Australia.
• The entity is an outward investor (i.e. an Australian resident investor with offshore interests)
that is not also foreign controlled and the entity meets the asset threshold test (s. 820-37).
The asset threshold test requires that the total average value of Australian assets held by an
entity and its associates (as defined under s. 318 of ITAA36) represents 90 per cent or more
of the total average assets of the entity and all its associates.
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Disallowing excess debt deductions

Under the various formulas provided for each of the eight categories of entities, any debt
deductions must be disallowed to the extent to which the adjusted average debt exceeds the
maximum allowable debt. Such excess amounts cannot be included in the cost base of an asset
(see s. 110-54 of ITAA97) and any interest payment disallowed will continue to be subject to
interest withholding tax (see Module 2).
Substantiation requirements for individuals

Types of expenses needing substantiation
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Substantiation means that the individual taxpayer must retain specified documentary evidence
to substantiate the deduction being made. Some small expenses are excluded from these
requirements:
• individual expenses of $10 or less and the total of these expenses does not exceed $200
• laundry expenses up to $150 or the total expenses subject to substantiation are less than $300
• work expenses plus laundry expenses are less than $300.
There are three types of expenses claimed as deductions that must have substantiation under
Division 900 of ITAA97. These are:
• work expenses, including a meal allowance and travel allowance
• car expenses
• business travel expenses.
To claim a deduction for work expenses, car expenses and business travel, an individual must
retain specified documentary evidence to substantiate the deduction.
Note: In 2015-16, Australians claimed $23 billion in work-related deductions, and as a result
the ATO is concerned with over-claiming and has issued statements that it will focus more on
compliance with the substantiation rules.
Work expenses
Section 900-30 defines a work expense as a loss or outgoing incurred in producing your salary,
wage or certain PAYG withholding payments (i.e. payments for work or services, retirement
payments, benefits and compensation payments—see s. 900-12 of ITAA97).
Work expenses include tools of trade, protective clothing, trade journals and other deductions
under s. 8-1(1). Claims for repairs (s. 25-10), borrowing expenses (ss. 25-25 and 25-30), election
expenses (s. 25-60), subscriptions to trade, business or professional associations (s. 25-55),
and the decline in value of a depreciating asset (s. 40-25) also require substantiation.
Work expenses do not include a loss or outgoing to do with a motor vehicle (including a four-
wheel drive vehicle), unless the loss or outgoing is in respect of travel outside Australia or is a taxi
fare (s. 900-30(6)). Car expenses and travel expenses are the subject of separate substantiation
requirements, and these are discussed in the next two sections.
To substantiate a work expense claim, the taxpayer must provide ‘written evidence’
(Subdivision 900-E). If a taxpayer is required to obtain written evidence to support a claim for
a deduction, the taxpayer must use one of the following methods:
• evidence from the supplier
• evidence recorded by the taxpayer for:
– small expenses, or
– expenses unable to be substantiated in the normal way, or
• evidence on a payment summary.
Car expenses
More detailed substantiation requirements apply in relation to claiming business-related car
expenses. The methods available to the taxpayer and the substantiation rules vary according to
the number of kilometres travelled for income-producing purposes.
1. Business kilometres travelled equal to or less than 5000 km

If the taxpayer is claiming equal or less than 5000 km in the tax year, they have two options
available to them: cents per kilometre method or the logbook.
Cents per kilometre

Substantiation of car expenses is not required. The taxpayer needs to make a ‘reasonable
estimate’ of business usage.
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The taxpayer’s deduction is calculated by applying a prescribed rate (68c per kilometre in the
2018–19 year) to an estimate of the number of business kilometres travelled (s. 28-25).
Logbook
The taxpayer must substantiate the claim by maintaining a logbook and odometer records
for the period the car was held during the tax year. Based on this method, the deduction is a
proportion of actual car expenses based upon the ‘business use percentage’. The taxpayer
must also substantiate the actual car expenses.
Business use percentage is defined as the number of business kilometres that the car has
travelled divided by total kilometres travelled in that period.
2. Business kilometres travelled more than 5000 km

If the taxpayer has travelled more than 5000 km in the income-producing year, then they have
the same methods of substantiation available to them:
– cents per kilometre—the same as for kilometres travelled equal to or less than 5000 km,
but deduction limited to a maximum of 5000 km
– logbook—as for kilometres travelled equal to or less than 5000 km.
Business travel expenses

Business travel expenses are travel expenses incurred in producing assessable income other
than salary or wages. Business travel expenses do not include a loss or outgoing to do with a
motor vehicle, unless in respect to travel outside Australia or a taxi fare.
To substantiate a business travel expense, the taxpayer must have written evidence as required
by Subdivision 900-E of ITAA97 (discussed earlier in the section ‘Work expenses’) or odometer
records to support a claim for fuel or oil (s. 900-80(2)).
Substantiation with written evidence is not required for employees claiming deduction against
overtime meal allowances paid under an industrial award or a domestic or overseas travel
allowance, whether or not paid under an industrial award.
Written evidence
Written evidence from the supplier generally means a receipt, invoice or similar document giving full
details of the name of the supplier, the amount of the expense, the nature of the goods or services,
the day the expense was incurred and the date of the document. There are two exceptions:
1. If the document does not show the date on which the expense was incurred, the taxpayer can
use independent evidence such as a bank statement or credit card statement to show when
the expense was paid.
2. If the document does not specify the nature of the goods or services, the taxpayer may write
in the missing details (s. 900-115(3)).
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Evidence recorded by the taxpayer

If an expense is $10 or less and the total of all such small expenses is $200 or less, the taxpayer
need not have documents from the supplier to substantiate the claim, but can maintain their own
record of the expenses in a note book, provided the record maintained by the taxpayer contains
the same details that are required for written evidence from the supplier (name of supplier,
amount, date and goods or services purchased).
Retention of documents
A deduction is not allowable, and is deemed never to have been allowable for an expense,
if the taxpayer fails to retain:
• written evidence of the expense or the relevant odometer records if the expense is a car
expense in respect of fuel or oil
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• logbook and odometer records (where applicable), and
• a travel diary (where applicable).
The retention period for all substantiation records is normally five years. This period is extended
if the expense is in dispute.
Penalty tax
A penalty tax will be applied if the taxpayer makes a false declaration on their income tax return
that they have substantiation records—and they do not. Penalty tax will also be applied if a
taxpayer does not sign the declaration on their return, as then a claim cannot be substantiated.
Under s. 284-90(1) Item 3, Schedule 1 of TAA, penalty tax is applied on any tax shortfall that
results from the taxpayer’s failure to have substantiation. The penalty imposed is 25 per cent of
the tax shortfall. A further 20 per cent penalty may result where the taxpayer has been penalised
in an earlier year.
➤ Question 3.4
Fumi is employed as a lawyer in a medium-sized law firm in Wollongong, Australia.
She uses her own car for work as she is required to undertake extensive travel to regional towns.
Fumi is paid a car allowance of $2000 by her employer in the 2018–19 income tax year. Fumi
keeps a logbook for the entire year and receipts for any costs incurred. Fumi’s logbook shows
that the car travelled 16 000 km during the year, of which 4725 km were in the course of her
employment. The total costs of running the car for the year were $5000.
Fumi is completing a Masters of International Law at a university in Sydney, approximately
100 km away from her work and home. She catches the train to university and does not use her
private car. This course will improve her changes of promotion with her current employer and
her employer also gives her some time off to sit exams.
Fumi purchased a new investment property on 1 September 2018 and rented it out from 1 October
2018. Fumi borrowed $240 000 over 10 years on 1 September 2018 and incurred borrowing
costs of $2500. Interest paid on the loan during the 2018–19 income tax year was $16 000.
Fumi used the loan funds as follows:
• Repayment of home loan (main residence): $180 000
• Purchase of investment property to earn rental income: $60 000
Fumi incurred the following expenses during the 2018–19 income tax year:
$
Internet cost at home (40% personal use and 60% study related) 660
Train fares from work to university two nights a week 180
Train fares from university to home after classes two nights per week 180
Clothing (normal suits) for work 2 400
Annual membership of The Law Society of New South Wales 209
Entertaining clients at business lunches 2 000
FEE-HELP (Higher Education Loan Program) debt paid during the year 3 600
Fumi’s costs for her new investment property are:

$
New carpets throughout—September 2018 4 000
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Extension of new bathroom and bedroom—September 2018 15 500

Leaking roof and subsequent repairs—January 2019 660
Replacing faulty electrical sockets—March 2019 990
(a) Determine what amounts are allowable deductions to Fumi for the 2018–19 income tax year
(not including her car expenses).
$
STUDY GUIDE | 135
Notes and other calculations:
MODULE 3
(b) Determine Fumi’s deductible car expenses. Has Fumi kept adequate records to substantiate
her claim? Of the two methods she could use to calculate her expenses, which one will
she choose?
(c) Calculate the total amount of allowable deductions Fumi can claim.
Summary and review

This module discussed the principles of deductions. A taxpayer may be entitled to a deduction
as either a general deduction or a specific deduction. Section 8-1of ITAA97 enables a deduction
under one of the two positive limbs, provided none of the four negative limbs apply (which
exclude capital and private expenses, expenses relating to earning exempt income and expenses
specifically excluded). A specific deduction may be available (ITAA97, s. 8-5) if a specific provision
provides for the deduction. Specific deductions include deductions for repairs, tax losses,
bad debts and borrowing expenses.
If an expense is only partly for a taxable purpose, the taxpayer is only entitled to a deduction for
the proportion of the expense connected with earning assessable income. Where deductible
MODULE 3
expenses from an investment exceed the assessable income (negative gearing), this excess of
deductible expenses can be used as a deduction against other assessable income such as wages
and salaries.
The module then went on to explain the specific provisions that limit both general and specific
deductions. These exclusions include expenses for entertainment and clothing, payments to
related entities, non-commercial losses, prepayments and thin capitalisation interest expenses.
Lastly, the module outlined the documents taxpayers need to retain in order to prove certain
employment-related deductions. These substantiation requirements apply to work expenses,
business car expenses and business travel expenses. Penalties may apply if these records are
not retained.
Suggested answers
Suggested answers
MODULE 3
Question 3.1
The undergraduate degree in accounting would be a ‘prescribed course of education’ for the
purposes of s. 82A of ITAA36. All the mentioned expenses, except the HECS/HELP payments,
would be ‘expenses of self-education’ (s. 82A(2)). Consequently, the first $250 of expenses of
self-education may be denied a deduction under s. 82A(1).
The self-education expenses in calculating the first $250 denied as a deduction do not have to
be deductible, or could be deductible under specific provisions other than s. 8-1. For example,
if Leslie had childcare costs in fulfilling her course requirements, then this expense can be used
to reduce the $250 exclusion even though it is not deductible (Taxation Ruling TR 98/9 and
s. 82A(2)).
The textbooks are capital costs ($250) as they have a life of more than one year and as a
depreciating asset will be eligible for deduction under Division 40 of ITAA97. As the cost of the
textbooks is not deductible under s. 8-1(2)(a) of ITAA97 (capital exclusion), this cost can be used
to reduce the s. 28A of ITAA36 non-deductible amount of $250, reducing the exclusion to zero
($250 – $250).
Leslie may therefore claim all her s. 8-1 expenses, totalling $748 (i.e. $120 + $68 + $310 + $250).
The union fees and photocopying are clearly connected with the degree and the travel costs
from work to university is not a private journey and is also deductible. The capital allowance
deductions for her textbooks is $250 as it is a non-business asset costing under $300, which is
allowed in full in the year expended (ITAA97, s. 40-80(2); see the Module 4 section ‘Non-business
depreciating asset of $300 or less’).

Question 3.2
$ $
Deductions 38 000
Assessable income 30 000
Net exempt income 3 000 33 000
Tax loss 5 000
Question 3.3
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Deductible expenses are subject to the prepayment rules in Part III, Division 3 Subdivision H of
ITAA36. Prepayment rules vary depending on the nature of the taxpayer. If Cushio is an eligible
SBE and the prepayment relates to a period of no longer than 12 months, ending in the next tax
year, then the amount is fully deductible. In this case the ESP extends beyond 12 months and
therefore this expenditure must be apportioned over the period to which the expenditure relates.
ESP of expenditure 731 days

Current year 61 days
Deductible amount for the 2018–19 tax year. 61 / 731 × $50 000 = $4172
Question 3.4
(a) Fumi’s allowable deductions for 2018–19 (not including her car expenses) are as follows:
Self-education† $
Internet cost at home—study related (60% × $660) 396
Train fares from work to university two nights per week 180
Total 876
Less reduction $250 – $180 70 ‡
Self-education deduction 806
†
Self-education costs are deductible under s. 8-1 of ITAA97 if there is a connection between the
education and the earning of assessable income. The fact that this self-education could lead to a
promotion within her current employment and is supported by her employer shows that these costs
are connected to earning assessable income. The travel from work to university is not a private
expense as it is incurred in the course of undertaking the degree.
‡
For self-education expenses, s. 82A of ITAA36 denies a deduction for the first $250. However,
non-deductible self-education expenses can be used to reduce the $250 exclusion. In this case,
the travel costs of $180 from university to home are a private expense and not deductible under
s. 8-1 and therefore can be used to reduce the non-deductible amount from $250 to $70.
Annual membership of The Law Society of New South Wales 209
Deductions relating to investment property

Leaking roof and subsequent repairs—January 2019 660
Replacing faulty electrical sockets—March 2019 990
Total repairs 1650
Note that the new carpet is associated with the purchase and the new bathroom and
bedroom is capital, so they are not deductible s. 8-1(2) (see Module 4 for capital allowances).
The other amounts would be considered repairs (ITAA97, s. 25-10) as they are not capital nor
are they associated with the purchase of the property (assuming the roof was not leaking
and that the electrical sockets were working at the time of purchase—that is, they are not
initial repairs associated with the purchase of the property (W Thomas & Co Pty Ltd v. FC of T
[1965] 115 CLR)).
All borrowing costs are deductible pro-rata over five years to the extent that they earn
assessable income (ITAA97, s. 25-25). In this case, $60 000 is used for the investment property,
so 25 per cent ($60 000 / $240 000) of borrowing costs can be deducted. To calculate this:
Total borrowing costs ($2500 / 1826 days × 303 days) $414.84
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The loan is only being used 25 per cent for income-producing purposes.
Borrowing costs deduction ($414.84 × 25%) $103.71
Interest deductible ($16 000 × 25%) $4000
Total deductible for investment property ($1650 + $103.71 + $4000) $5753.71
(b) Deductible car expenses

In relation to the car expenses, Fumi holds sufficient records to substantiate her claim.
The business percentage of use is 4725 / 16 000 = 29.5%. Therefore, the deductible amount
under the logbook method (actual costs) would be $5000 × 29.5% = $1475 (ITAA97, s. 28-90).
Alternatively, Fumi could claim 4725 km × 68 c/km = $3213 cents per kilometre method
(ITAA97, s. 28 25). The cents per kilometre method gives the higher deduction.
Car expenses deduction $3213
(c) Total allowable deductions

Total allowable deductions are the sum of the totals in part (a) + (b):
Total deduction, ignoring cents ($806 + $209 + $5753 + $3213) $9981

MODULE 3
REFERENCES | 141
References
References
MODULE 3
ATO 2016, ‘Thin capitalisation’, accessed November 2018, https://www.ato.gov.au/business/thin-
capitalisation/.
ATO 2018, ‘General information about prepaid expenses’, accessed March 2019, https://www.
ato.gov.au/individuals/tax-return/2017/in-detail/publications/deductions-for-prepaid-expenses-
2017/?page=2#general_information_about_prepaid_expenses.
MODULE 3
AUSTRALIA TAXATION
Module 4
CAPITAL ALLOWANCES
144 | CAPITAL ALLOWANCES
Contents
Preview 145
Introduction
Objectives
Teaching materials
Small business entities 147
What is a small business entity?
Carrying on a business
Aggregated turnover test
Capital allowances core concepts 149
Introducing the capital allowance regime
Determining the capital allowance amount
Capital allowances for certain second-hand assets
Capital allowances for non-small business entities 151
Overview
Non-business depreciating asset of $300 or less
Low-value asset pool
Computer software
General rules and determining effective life
MODULE 4
Balancing adjustment
Blackhole expenditure
Project pool expenditure
Capital allowance rules for small business entities 161
Temporary instant asset write-off
Small business asset pool
Blackhole expenditure and start-up expenditure
Defining capital works 164
Types of capital works
Calculating capital works deductions 164
Rate of deduction
Rules when applying deduction
Type of construction and date of commencement
References 173
STUDY GUIDE | 145
Module 4:
Capital allowances
Study guide
MODULE 4
Preview
Introduction
Module 4 introduces the capital allowance regime (commonly referred to as 'tax depreciation')
for taxpayers. Under Division 40 of ITAA97, taxpayers are able to claim a deduction for the
decline in value of depreciating assets—used for a taxable purpose—over the lifetime of the
asset. The treatment of depreciating assets varies depending on the type of asset and on
whether the taxpayer is a small business entity (SBE) or a non-small business entity.
An SBE is defined as an entity that must carry on a business and satisfy the $10 million aggregated
turnover test (this drops to $5 million for the small business income tax offset and $2 million for
access to the capital gains tax (CGT) SBE concessions). An SBE operated as a company can also
benefit from a lower company tax rate of 27.5 per cent (see Module 8).
If the taxpayer is not an SBE, then they can apply a certain set of capital allowance rules, including
allocating the asset to a low-value pool. Otherwise the non-SBE taxpayer determines the effective
life of the asset using either the diminishing value or prime cost method (known in accounting
terms as ‘straight-line’ depreciation).
However, the rules are different for those who qualify as an SBE and choose to use the simplified
capital allowance rules. Chiefly, SBEs can access the instant asset write-off for the business portion
of most individual assets that cost less than $20 000 (until 30 June 2019). For assets over this
amount, they can be depreciated in a special small business asset pool.
Module 4 also examines the capital works deduction for certain structural improvements, which is
applied at either 2.5 per cent or 4 per cent. This rate is based on the type of capital works,
the date construction began and how the capital works are used.

Figure 4.1: Module summary—small business entity
SBE
SBE CGT SBE
Business definition $10 million Business definition $2 million
Figure 4.2: Module summary—capital allowances

MODULE 4
1. <$300
2. Low-value
Four rules >$300 – <$1000
3. In-house software
Non-SBEs and project pool
Blackhole expenditure 4. General rules
Capital allowances
Meet SBE test 1. Instant asset
SBEs write-off <$20 000
2. Small business
Three rules asset pool
Core concepts
3. Start-up capital
expenditure
Division 40 Eligibility Methods
Prime cost Diminishing value
Figure 4.3: Module summary—capital works
Types of
Capital works Apportionment
construction
Date of
2.5% or 4%
commencement

STUDY GUIDE | 147
Objectives
• evaluate the tax implications of the tax depreciation rules available to non-small business
entities;
• evaluate the tax implications of the tax depreciation rules available to small business
entities; and
• calculate the allowable deduction in a particular income tax year for qualifying expenditure
on capital works.
Teaching materials
• Legislation:
• Glossary:
MODULE 4
Definitions/
terms/
• CPA Australia skills list: https://www.cpaaustralia.com.au/cpa-program/cpa-program-

candidates/your-experience/skills-list
Small business entities

What is a small business entity?
There are two types of SBEs for taxation purposes, effective from 1 July 2016 (see Figure 4.1).
The first type is classed as an SBE if it:

1. carries on a business, and
2. satisfies the $10 million aggregated turnover test (increased from $2 million per annum
from 1 July 2016).
This first definition applies to the calculation of the capital allowances discussed in the
‘Capital allowance rules for SBEs’ section. It also applies to the calculation of fringe benefits
tax (FBT) for SBEs, which is covered in Module 9.
For the purposes of determining if a business is eligible for the small business income tax offset,
the aggregated turnover test is limited to $5 million.
The second type of SBE for the purposes of taxation is a ‘CGT small business entity’, where the
aggregated turnover test is limited to $2 million.
The taxation of SBEs generally is the subject of Module 7.

Carrying on a business
It is essential to determine if an entity is ‘carrying on a business’ as this impacts whether the
earnings of the business are to be included in assessable income, and whether deductions can
be applied to these earnings (see Module 2 for further discussion of ‘carrying on a business’).
Section 995-1 of ITAA97 defines a ‘business’ as including any ‘profession, trade, vocation or
calling’. In the majority of cases, it is very clear whether or not a business is being carried out.
It is not always certain though, especially when the activity carried out is insignificant compared
with other income-earning activities of an individual.
Example 4.1: Determining if a taxpayer is carrying on

a business
Sally works full-time as an accountant for a major accounting partnership. She is also a passionate
cake decorator, and makes and sells wedding and celebration cakes in her home in her spare time.
In the last income year, Sally’s cake decorating business has increased four-fold, and she generated
$30 000 additional income from the venture, $18 000 of which is profit. Sally has spent all her spare
MODULE 4
hours after work and every weekend making and selling cakes, and has been actively promoting her
services via social media and at wedding fairs. She is so overwhelmed, she is looking at hiring an
assistant to help her on the weekends.
To determine whether or not Sally is ‘carrying on a business’, the most important factors are:
• The degree of system and organisation used. Where the activity is conducted on a systematic
and organised basis, it is more likely to be considered a business. This is especially so where the
activities have a commercial basis.
• Scale of activities. The size and scale of the activities are important. Are the activities of such a
scale that whatever is produced is in excess of that which would be required by the taxpayer for
personal use? The smaller the business, the more likely it is to be hobby (not a business).
• Repetitive transactions. A business activity is associated with regular and repetitive transactions.
This is not always the case; sometimes isolated transactions can be regarded as a business.
• Profit factor. A business operation is usually carried on in order to make a profit.
• Type of activity. Where the goods are unsuitable for personal or domestic use, this will be more
indicative of a business.
• Time. Although not decisive, the more time the taxpayer spends on the activity, the more likely
it is to be of a business nature.
So, is Sally carrying on a business? Weighing up all the factors, the growing size, her profitability, the
large amount of sustained effort, advertising her cake services and taking on an employee, it is likely
that Sally is carrying on a business.
To meet the SBE test, it must be determined that the entity is ‘carrying on a business’. In addition,
an SBE will be taken to be carrying on a business in the year the business is wound up, provided
the taxpayer is an SBE in the year the business is wound up (ITAA97, s. 328-110(5)).
Aggregated turnover test

The second condition to qualify as an SBE is that the business must meet the aggregated
turnover test of less than $10 million. There are three ways to meet this:
• Aggregated turnover for the previous income year was less than $10 million.
• Aggregated turnover for the current income year is likely to be less than $10 million,
as calculated on the first day of the income year or the first day the entity commenced
carrying on a business (if later). This applies except if, for the prior two years, the aggregated
turnover was $10 million or more for both years.
• Aggregated turnover for the current income year was less than $10 million as calculated at
the end of the income year.
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Aggregated turnover is the sum of the annual turnover of the income year, the annual turnover
of any entity connected with the main entity during the income year, and the annual turnover
of an affiliate (ITAA97, s. 328-115).
Capital allowances core concepts

Introducing the capital allowance regime
In Module 3 we covered the general and specific deduction rules. Under the general deduction
rules found in s. 8-1(2)(a), a taxpayer is denied an immediate deduction for any outgoing of
capital or of a capital nature.
A deduction for any loss in value of a capital asset due to wear and tear while it is being used
in the process of producing assessable income is also disallowed under the general deduction
provisions because the loss has not been incurred.
To overcome this problem, Division 40 of ITAA97 allows taxpayers to claim a deduction for this
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decline in value of depreciating assets—used for a taxable purpose—over the lifetime of the
asset. These are the rules for depreciating assets under the uniform capital allowance system.
Division 40 also allows for rules that provide deductions for certain other capital expenditure.
The Division 40 rules apply to all taxpayers. SBEs can choose to access simplified capital allowance
arrangements. These are discussed later in the section ‘Capital allowance rules for SBEs’.
The capital allowance rules covered in Division 40 relate to:

• plant and equipment
• software
• cars
• certain intellectual property
• depreciating assets in mining and quarrying
• depreciating assets used for primary production
• carbon sink forest expenditure
• blackhole expenditure.
The term blackhole expenditure refers to the capital expenditure incurred by a business that
is not generally deductible, depreciable or included in the cost base of a CGT asset.
Determining the capital allowance amount

Division 40 of ITAA97 permits a deduction for a capital allowance (commonly referred to as
'depreciation') on depreciating assets that a taxpayer constructs, starts to hold under a contract
or starts to hold in some other way.
The taxpayer may deduct an amount equal to the decline in value of a depreciating asset that
the taxpayer holds and uses, or has installed ready for use, for a taxable purpose during a year.
The decline in value is calculated through spreading the cost of the asset over its effective life
and using either the prime cost or the diminishing value method (these methods are discussed
further in the section ‘Capital allowances for non-small business entities’). The effective life
of the asset is either assessed by the taxpayer or based on the Commissioner of Taxation
(Commissioner) estimates. There may be a need for balancing adjustments if a balancing
adjustment event occurs on disposal or at the end of the life of the asset (also discussed in the
section on ‘Capital allowances for non-small business entities’). Rollover relief may be available
for some disposals (see the section ‘Balancing adjustment’), and CGT consequences also need
to be determined (Module 5).
There are special rules for cars (defined in s. 995-1 of ITAA97). In Module 3 it was explained
that the deduction for car expenses may be determined on the basis of cents per kilometre.
However, if the cost of the car is not claimed using cents per kilometre, and is claimed as a
capital allowance under Division 40 of ITAA97, then the capital allowance is limited to what is
known as the ‘car limit’ (ITAA97, s. 40-230). For 2018–19, the car limit is $57 581, which means
that regardless of the actual cost of the car, the maximum cost for capital allowance calculation
purposes cannot exceed this amount.
Three questions for eligibility

There are three core questions used to determine whether a taxpayer is entitled to a deduction
for a capital allowance, and then to determine the amount of deduction available.
1. What is a depreciating asset?

A depreciating asset is one 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)). Put simply, it is an asset that
declines in value over time.
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A business asset is one that is capable of being put to use in the taxpayer’s business. Land
and trading stock are specifically excluded from being depreciating assets. Intangible assets
(such as licenses and permits) are not depreciating assets unless they are listed in s. 40 30(2).
Examples of depreciating assets are tangible assets with an effective life such as motor
vehicles, computers, tools and furniture.
2. Which taxpayer holds the depreciating asset?

The economic owner of a depreciating asset holds the asset. The depreciating asset’s
‘economic owner’ is the entity that can access the asset’s economic benefits while stopping
other entities from doing the same. The economic owner is often, but not always, the legal
owner of the asset. There can be several economic owners of one asset, and in this case the
asset is treated as jointly held.
3. When does the depreciating asset start to decline in value?

The depreciating asset’s ‘start time’ is at the earlier of the following:
– when the taxpayer first uses the asset, or
– when the taxpayer has the asset installed ready for use for any purpose.
Example 4.2: Depreciating asset

Hanan acquires a laptop on 1 March 2019 and starts to use it for wholly private purposes.
On 15 June 2019, she commences using the laptop equally for business and private purposes. The ‘start
time’ for the computer is 1 March 2019, the day the computer was first used.
Hanan will need to work out the decline in value of her computer from 1 March 2019, but she will only
be able to claim a deduction for 50 per cent of the decline in value of her computer from 15 June 2019.
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Capital allowances for certain second-hand assets

From 1 July 2017, certain second-hand depreciating assets that are part of income-earning
residential rental properties will not be entitled to a deduction for depreciation (ITAA97, s. 40-27).
This applies to the second-hand assets purchased with residential rental property that was
acquired, or the contract to purchase was signed, after 7.30 pm on 9 May 2017. This exclusion
also applies if the depreciating assets were used for a private purpose during 2016–17 (e.g. the
property was the taxpayer’s private home) and the property became a residential rental property
after 1 July 2017. These restrictions do not apply to property acquired before this date or for new
depreciating assets installed in existing residential rental property. They also do not affect capital
works deductions claimed under Division 43 of ITAA97 (see later in this module).
Depreciating assets affected by s. 40-27 will include items that are not part of the building
structure (not fixtures) of the property, such as freestanding items of furniture, curtains, carpets,
freestanding cookers, dishwashers, hot water systems and spa pumps.
Capital allowances for non-small business entities
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Overview
Capital allowances are the amounts that can be claimed as a deduction over a depreciating
asset’s effective life. The following capital allowance rules apply to all entities that are not
classified as SBEs. SBEs are eligible for simplified capital allowance rules, as discussed in the
later section ‘Capital allowance rules for SBEs’.
Basically, a deduction for the decline in value of a depreciating asset is grouped into four categories.
1. non-business depreciating asset costing $300 or less
2. asset allocated to a low-value asset pool
3. asset allocated to a software development pool
4. asset not included in categories 1 to 3—apply the general rules and determine the effective
life of the asset (select the diminishing value or prime cost method).
Figure 4.4 provides an overview of the capital allowance rules, which are then discussed in more
detail in the rest of the section.
Note that Figure 4.4 excludes entities engaged in primary production, exploration, prospecting
or that incur carbon sink forest or blackhole expenditure.
Figure 4.4: Depreciation flowchart
Was the asset a non-business YES Immediate deduction if

asset costing $300 or less?1 conditions in s. 40-80 are met
NO Rate
Was the asset allocated to YES Year 1..............18.75%DV

Depreciate in low-value pool Subsequent years
a low-value pool?2
..........................37.5%DV
NO
Year 1.........................Nil
Was expenditure incurred Year 2...................30%PC
YES Deduct in a software
in developing Year 3...................30%PC
development pool
computer software?3 Year 4...................30%PC
Year 5...................10%PC
NO
Determine ‘effective life’

of depreciating asset.4
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Selected depreciation method
Diminishing value Prime cost
Apply formula: Apply formula:
Days held 100%

Asset’s cost × ×
365 Asset’s effective life
If you start to hold asset on or after 10 May 20065

Days held 200%
Base value × ×
3656 Asset’s effective life (s. 40-72)
Note:
1
The immediate deduction for a depreciating asset costing $300 or less is restricted to a non-business
asset. If the asset is part of a set of assets, the total cost of the set must not exceed $300 (s. 40-80(2)).
2
A low-value pool can be created for assets that cost less than $1000 or have declined in value under
the diminishing value method to below $1000 (s. 40-425).
3
A taxpayer can irrevocably elect to create a software development pool for expenditure incurred in
developing computer software that is used solely for a taxable purpose (s. 40-450).
4
A taxpayer can either self-assess an asset’s effective life or use the Commissioner’s effective life
determination unless an exception applies (s. 40-95).
5
Note that the diminishing value formula was different for assets held before 10 May 2006.
6
For both the prime cost and the diminishing value methods, the denominator is always 365, even in
leap years.
Source: Adapted from Shaw, G. 2001, ‘The depreciation saga’, Taxpayer, no. 10 (5 November),
p. 156. Reproduced with permission of Tax & Super Australia. Disclaimer: Any updates made to the
table are made by CPA Australia and Taxpayers Australia Ltd. are not responsible for any errors or
omissions nor for the results of any actions taken on the basis of the information.
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Non-business depreciating asset of $300 or less

A non-business depreciating asset costing $300 or less is eligible for an immediate 100 per cent
deduction. The asset must cost $300 or less, and the asset must be used by taxpayers
predominantly in deriving non-business assessable income such as rental income derived as
an individual, employed property investor holding just one property. This expenditure cannot
then be allocated to a low-value asset pool.
These assets cannot be part of a set with a total value in excess of $300 in a tax year. Further,
the taxpayer cannot acquire one or more assets identical or substantially the same in a tax year
where the aggregate cost is more than $300.
Low-value asset pool

Taxpayers can choose to claim the decline in the value of the depreciating asset via the low-value
asset pool. This is for a low-cost asset that cost less than $1000 (after deducting GST) or a
low-value asset (ITAA97, s. 40-425). A low-value asset is one for which capital allowances have
already been claimed over one or more years, which results in an undeducted cost of less than
$1000. A low-value asset can only be added to the pool if capital allowances have previously
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been calculated via the diminishing value method.
All assets in the low-value asset pool are depreciated at an annual diminishing value rate of
37.5 per cent. If an asset is allocated to the pool at some point during the income year, then the
deduction is half (50%) of the pool rate, which is 18.75 per cent in that first year. The rate is then
37.5 per cent in Year 2 and onwards.
If a taxpayer chooses to create a low-value pool and allocate a low-cost asset to it, then all other
low-cost assets acquired in the current or future income years must be allocated in that pool.
They can be added to the pool on an individual basis. Once an asset is allocated to the low-cost
asset pool, then it must stay in that pool for the duration of its life.
If the asset is used partly for business use, and partly for personal use, then the business-use
component is allocated to the low-cost asset pool.
Example 4.3: Low-value pool

The closing balance of the low-value pool of Main Ltd for the year ended 30 June 2018 was $4500.
During the 2018-19 tax year, Main Ltd:
• acquired a depreciating asset for $950. Its taxable use percentage is 85 per cent
• allocated to its low-value pool a low-value asset that had been depreciated under the diminishing
value method to $980 as at 30 June 2018. Its taxable use percentage is 100 per cent.
The decline in value of the depreciating assets in the low-value pool for the 2018–19 tax year is
determined as follows:
Asset Calculation Amount
New low-cost asset allocated to the pool 18.75% × ($950 × 85%) $151.41
for the 2018–19 tax year
37.5% write-off of closing balance from 37.5% × ($4500 + $980) $2055.00

2017–18 ($4500 plus $980 for the low-value
asset added at the start of the tax year)
Total decline in value $2206.41
Closing value of low-value pool $4500 + $980 + ($950 × 85%) – $2206.41 $4081.09
Computer software
If a taxpayer incurs expenditure on developing, or having another entity develop computer
software that is intended to be used solely for a taxable purpose, that taxpayer may choose to
allocate such expenditure to a software development pool or treat it as in-house software.
If expenditure on software development is not solely for a taxable purpose, it cannot be

allocated to a software development pool, and must be capitalised and treated as in-house
software. Off-the-shelf software cannot be included in a software development pool, but would
be treated as in-house software.
Non-capital software costs can be deducted under s. 8-1 of ITAA97 provided they satisfy the
requirements of s. 8-1. These costs would include the cost of making minor changes, correcting
faults and the cost of updating software to function correctly on different devices.
In-house software
In-house software is defined in s. 995.1 of ITAA97 and covers:
• software that you acquire or develop (or have another entity develop) that is mainly for your
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use in performing the functions for which it was developed

• software that is not deductible outside Division 40 of ITAA97 or the simplified capital
allowance rules for small business entities.
According to the ATO (2018a), expenditure on in-house software may be deducted in the
following ways:
• The decline in value of acquired in-house software, such as off-the-shelf software, cannot be
allocated to a software development pool. Instead, it is worked out using an effective life
of five years using the prime cost method. In-house software installed ready for use before
1 July 2015 had an effective life of four years.
• Expenditure incurred in developing (or having developed) in-house software may be (or may
need to be) allocated to a software development pool (see the next section of this module).
• If expenditure incurred in developing (or having another entity develop) in-house software
is not allocated to a software development pool, it can be capitalised into the cost of a
resulting unit of in-house software and its decline in value can then be worked out using an
effective life of five years from the time the software is first used or installed ready for use.
• If in-house software costs $300 or less, then an immediate deduction may be available
(see the earlier section in this module).
• The termination value of in-house software still being held, but that the taxpayer has stopped
using and expects never to use again or decides never to use, is zero. An immediate
deduction for the cost of the software is available at that time (ATO 2018a).
Allocating to the software development pool

Once a taxpayer chooses to create a software development pool, the choice is irrevocable
(ITAA97, s. 40-450). Any expenditure incurred in developing software must be allocated to
the pool. It must also be written off in the pool if the project is terminated or abandoned.
Any consideration for disposal of pooled software is included in assessable income unless
rollover relief applies.
Expenditure allocated to a software development pool declines in value at the following rate
using the prime cost method (see the section ‘Prime cost formula’ later in this section for a
description of the prime cost method).
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First year Nil

Second year 30%
Third year 30%
Fourth year 30%
Fifth year 10%
Due to the staggered rate of deduction, there will be a separate pool for each year, with a
maximum of four pools at any one time (ITAA97, s. 40-450(4)).
General rules and determining effective life

For assets that are not dealt with as a non-business asset of $300 or less, a low-value asset or
in-house software allocated to a software development pool, the general method of depreciation
is used. This is also applicable to some other specific assets listed in the legislation.
There are two methods used to work out the decline in value of a depreciating asset: the prime
cost (PC) method or the diminishing value (DV) method. A taxpayer can generally choose to
use either method for each depreciating asset held. Once the taxpayer has chosen a method for
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a particular asset, they cannot change to another method for that same asset. Diminishing value
gives higher deductions in the early years but these reduce over time. The prime cost method
spreads the deduction evenly over the life of the asset and therefore gives smaller deductions in
the early years but higher deductions in later years. Many taxpayers select the diminishing value
method as it gives the deductions earlier, but if the taxpayer is in a tax loss situation, they may
prefer the prime cost method to move the capital allowance deduction into later years when
there is taxable income.
This is where your problem-solving and decision-making skills can be used to determine the best
advice for the taxpayer. Use these skills not only in Australian tax, but also in developing your
career plans.
Diminishing value formula

If the taxpayer starts to hold the depreciating asset before 10 May 2006, the decline in value is
calculated under s. 40-70 of ITAA97 using the following diminishing value formula.
Days held 150%

Base value × ×
If the taxpayer starts to hold the depreciating asset on or after 10 May 2006, the diminishing
value formula under s. 40-72 of ITAA97 is:
Days held 200%

Base value × ×
To start to hold the depreciating asset on or after 10 May 2006, the taxpayer must have started:
• construction of the asset on or after 10 May 2006, or
• to hold the asset in some other way on or after 10 May 2006.
Prime cost formula

The general formula for the prime cost method under s. 40-75(1) of ITAA97 is:
Days held 100%

Asset’s cost × ×
However, an adjusted prime cost formula must be used in later tax years under s. 40-75(2) of ITAA97
if any of the following circumstances occur in a subsequent tax year:
• The asset’s effective life is recalculated.
• A second element cost is incurred in a year after the tax year in which the start time occurred.
• There is an application of the commercial debt forgiveness provisions that reduces the asset’s
opening adjustable value.
• Certain GST adjustments are made under Subdivision 27-B of ITAA97.
• There is a change in the asset’s opening adjustable value due to short-term foreign exchange
(FX) realisation gains and losses.
In these circumstances, the prime cost formula is adjusted under s. 40-75(3) from the year in
which the change arose:
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Opening adjustable value

for the change year plus Days held 100%
× ×
any second element of 365 Asset‘s remaining
cost for that year effective life
Definitions
Let’s take a look at the key terms presented in the formulas.
Effective life is the estimated period a depreciating asset can be used by any entity for a taxable
purpose, or for the purpose of producing exempt income or non-assessable, non-exempt
(NANE) income, or for conducting research and development activities.
To determine effective life, assume the asset will be subject to wear and tear at a rate that is
reasonable for the taxpayer’s expected usage and will be maintained in reasonably good order
and condition. Effective life is expressed in years and can include fractions of a year, such as
6 2/3 years.
A taxpayer may choose to recalculate the effective life of a depreciating asset if its current
effective life is no longer accurate due to a change in circumstances as to the use of the asset
such as change in technology, redundancy or changes in the environment where the asset
is used.
Base value is the asset’s ‘cost’ for the year in which the start time occurs. Base value is only
relevant where the diminishing value formula is selected. In later years, it will be the asset’s
opening adjustable value (after reductions for decline in value in prior years) plus any second
element cost made in a subsequent year.
Days held is the number of days that a taxpayer has held the depreciating asset for any purpose.
The ‘days held’ for an item that is purchased during the tax year includes the day purchased plus
the remainder of days the asset is installed for any purpose. Days held for an asset that ceases
to be used for any purpose during the tax year includes the last day. If the tax year is a leap year,
the total number of days held in the year is 366, even though the denominator in the formula for
calculating depreciation under both the diminishing balance and prime cost methods is fixed
at 365.
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Cost of a depreciating asset is the sum of two elements less any entitlement to input credits
for GST. The first element of cost is either an amount specified in the table in s. 40-180(2) of
ITAA97 or, if no amount is specified, what it costs the taxpayer to start holding the depreciating
asset, which is generally the amount paid (see Example 4.4). The second element of cost is the
additional cost to bring the asset to its present condition and location after the taxpayer starts
to hold the asset.
Example 4.4: Cost for depreciating asset

Nick Lim, a painter, buys a panel van from Alex Pham. The conditions of exchange for ownership of the
panel van provide that Nick will:
• pay Alex $2000 in cash
• paint Alex’s house (market value of this service is $3000)
• undertake maintenance work for Alex for the next three years (market value $1000 per year).
The cost of the panel van is $8000 ($2000 + $3000 + ($1000 × 3 years)), which is below the car limit of
$57 581 (see earlier in the module) and therefore the full $8000 will be the cost of the panel van for
depreciation purposes.
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Adjustable value signifies the cost of the asset that has yet to decline in value at a particular time.
Where an asset has yet to be used or is installed ready for use for any purpose, the adjustable
value is the asset’s cost (s. 40-85(1)(a)). For a time in the tax year where the taxpayer uses the asset
or has it installed ready for use, the adjustable value is the asset’s cost less its decline in value up
to that time (s. 40-85(1)(b)).
For a time in a later tax year, the adjustable value is the asset’s opening adjustable value for that
year, plus any amount included in the second element of its cost for that year, less the asset’s
decline in value for that year up to that time (s. 40-85(1)(c)).
Example 4.5: Comparing diminishing value and prime

cost methods
Tony Dalton acquires a depreciating asset on 29 July 2018 and immediately uses it for a taxable purpose.
The number of days Tony holds the asset in the 2018–19 non-leap year is 337. The denominator remains
365 as given in the legislated formula. Assume the depreciating asset cost Tony $10 000 (excluding
GST), and has an effective life of 10 years.
From this information, the decline in value of the asset for the 2018–19 tax year using the diminishing
value method would be:
$10 000 × (337 / 365) × (200% / 10) = $1846.57
The prime cost method of depreciation would result in a tax deduction of:
$10 000 × (337 / 365) × (100% / 10) = $923.29
Assuming Tony does not sell the asset and continues to use it wholly for income-producing purposes
the deductions in the next year (2019–20) will be:
Diminishing value method:
($10 000 – $1846.57) × (365 / 365) × (200% / 10) = $1630.68
Prime cost method:
$10 000 × (365 / 365) × (100% / 10) = $1000

Balancing adjustment
A balancing adjustment event arises where an entity:
• stops holding a depreciating asset (e.g. due to disposal, loss or theft, conversion to trading
stock or death)
• stops using a depreciating asset or having it installed for any purpose and expects never
to use it again (e.g. business cessation)
• has not used a depreciating asset and decides never to use it, or
• changes its interest or holding of a depreciating partnership asset (ITAA97, s. 40-295).
When a balancing adjustment event occurs, the asset’s adjustable value at the time of the event
is compared to its termination value. If the termination value is greater than the adjustable
value, the taxpayer includes the excess in their assessable income. If the termination value is
less than the adjustable value, then the taxpayer can deduct the difference.
‘Termination value’ is defined as the amount the taxpayer received, or is taken to have received,
as a result of the balancing adjustment event. It is reduced by the GST payable if the event is a
taxable supply and is adjusted for any increasing or decreasing GST adjustment (see Module 10
on GST). Termination value of the depreciating asset is set by s. 40-300(2) of ITAA97 in some
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specified circumstances; for example, it is zero for in-house software never to be used again.
Example 4.6: Determining assessable balancing adjustment

amount (no goods and services tax)
Bobbie purchased a machine that she held for two years and used wholly for a taxable purpose.
She then sold it for $2600. Its adjustable value at the time was $2200.
As the termination value of $2600 is greater than the adjustable value of the machine at the time of
its sale, the difference of $400 is included in Bobbie’s assessable income as an assessable balancing
adjustment amount.
Source: Adapted from ATO 2017, ‘What happens if you no longer hold or use a depreciating asset?’,
accessed March 2019, https://www.ato.gov.au/forms/guide-to-depreciating-assets-2016/?page=12.
Reduction for non-taxable use

Where a depreciating asset has not been used solely for a taxable purpose, the balancing
adjustment is reduced by the amount that is attributable to the non-taxable portion using the
following formula (s. 40-290):
Formula to learn
Reduction formula:
Sum of reductions for a non-taxable purpose

× Balance adjustment amount
Decline in value of depreciating asset since start time
Events in a low-value pool

Special rules apply where a balancing adjustment event happens to a depreciating asset that has
been allocated to a low-value pool. When this occurs, the pool’s closing balance for that year is
reduced (but not below zero) by the taxable use percentage of the asset’s termination value.
If the termination value of a pooled asset exceeds the pool closing balance, the excess is
included in the taxpayer’s assessable income.
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Relief for involuntary disposals

Where a depreciating asset ceases to be held by a taxpayer because it is:
• lost or destroyed
• compulsorily acquired by an Australian government agency
• disposed of to a private acquirer under a statutory power of compulsory acquisition, other than
compulsory acquisition of minority interest under the Corporations Act 2001 (Cwlth)
• disposed of to an entity (other than a foreign government agency) under threat of
compulsory acquisition
• fixed to land that is compulsorily subject to a mining lease and disposed of to the lessee
(other than a foreign government agency), or
• fixed to land that is disposed of to an entity that would have been the lessee (other than
a foreign government agency) in circumstances where a mining lease would have been
compulsorily granted if the land had not been disposed of and the lease would have
significantly affected the taxpayer’s use of the land,
then the taxpayer can choose either to include a balancing adjustment in assessable income or
apply some or all of the balancing adjustment amount as a reduction in the cost of a replacement
asset (s. 40-365).
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If the taxpayer chooses to apply the balancing adjustment amount against the cost of a
replacement asset, the taxpayer must incur expenditure on the replacement asset, or must start
to hold it:
• no earlier than one year before the involuntary disposal occurred, and
• no later than one year after the end of the tax year in which the involuntary disposal occurred
(s. 40-365(3))
In addition, the taxpayer must have used the replacement asset, or have it installed ready for
use, wholly for a taxable purpose by the end of the tax year in which the taxpayer incurred
the expenditure on the asset, or started to hold it, and be able to deduct an amount for it
(s. 40-365(4)).
The replacement asset does not have to fulfil the same function as the original asset.
The amount covered by the choice is applied in reduction of:

• the cost of the replacement asset—where the replacement asset’s start time occurs in the
current year, or
• the sum of the replacement asset’s opening adjustable value for a later year and any amount
included in the second element of its cost for that year—where the replacement asset’s start
time occurs in an earlier year (s. 40-365(5)).
Other than for an involuntary disposal, there is no other provision to offset the balancing
adjustment against a replacement asset under the general provisions in Division 40 of ITAA97.
Rollover relief
Where a depreciating asset is transferred between certain related entities and CGT rollover relief
is available, then no balancing adjustment amount arises immediately. The balancing adjustment
is effectively deferred until the next balancing adjustment event occurs.
Blackhole expenditure
Prior to 1 July 2001, some business capital expenditure was neither deductible, depreciable,
nor included in the cost base of a CGT asset. These expenses fell into a so-called ‘blackhole’
and could not be deducted anywhere under ITAA36 or ITAA97, and became known as
‘blackhole expenditure’.
From 1 July 2001, Division 40 gives a deduction for business-related costs that used to fall into
this blackhole.
The deduction for blackhole expenditure must be made in proportions equally over five years at
the rate of 20 per cent for the year in which the business capital expenditure is incurred, and a
rate of 20 per cent in each of the following four tax years. No balancing adjustment applies.
Business-related expenditure under s. 40-880 of ITAA97 must be incurred by the taxpayer:

• in relation to the taxpayer’s business, or
• in relation to a business that used to be carried on, or
• in relation to a business proposed to be carried on, or
• to liquidate or deregister a company of which the taxpayer was a member, wind up a
partnership of which the taxpayer was a partner, or wind up a trust of which the taxpayer
was a beneficiary, that carried on a business.
An example of blackhole expenditure is the costs incurred for the establishment or winding up
of a business.
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Project pool expenditure

Project pool expenditure is expenditure that relates to a project, but does not form part of the
cost of a depreciating asset. It can be written off over the life of the project, and this is achieved
through allocating project amounts to a project pool.
Project amount is defined under s. 40-840 of ITAA97 to be expenditure that:

• does not form part of the cost of a depreciating asset
• is not deductible under another provision of the income tax law, and
• is directly connected with the business or project.
The project amount includes:

• site preparation
• feasibility studies
• environmental assessments
• obtaining rights to intellectual property
• upgrading community infrastructure.
To meet the project expenditure requirements, the project must have a finite (limited) life.
Project pool expenditure does not generally apply to SBEs, and there are no simplified provisions.
Determining the project amount

Where the project amount is incurred before 10 May 2006, the formula to use is:
Pool value × 150% / DV project pool life
Where the project amount is incurred on or after 10 May 2006, then the formula to use is:
Pool value × 200% / DV project pool life

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What is pool value?

Year 1 of allocation to the pool—the sum of the project amounts allocated to the pool for
that year.
Year 2 and subsequent—closing pool value for the previous tax year (project costs allocated less
amounts claimed), plus any project amounts allocated in the current year.
Pool value must be reduced by the amount of any applicable GST input credit.
DV project pool life

This is the effective life of the project, or if that life has been recalculated, the most recently
recalculated project life.
➤ Question 4.1
Prior to commencing the construction of an office building, Sunrise Building Ltd undertook an
environmental assessment in August 2018 that cost $60 000. Construction was completed on
13 June 2019, and the company commenced leasing floor space from that date. The building
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is expected to produce rental income for the next 30 years (its project life). Sunrise Building
can commence deducting the $60 000 environmental assessment cost in the 2018–19 tax year.
What is the deduction for project pool expenditure in the 2018–19 tax year?
Capital allowance rules for small business entities

Being classified as an SBE allows certain concessions to the general capital allowances rules,
providing a simplified method of determining the deductions. SBEs are those entities that are
determined to be carrying on a business and that meet a predetermined annual aggregated
turnover test. The turnover test for the determination of depreciating assets under the capital
allowance regime is $10 million per annum.
(Note that this was increased from $2 million per annum from 1 July 2016.)
SBEs who choose to apply the small business capital allowance rules must use these rules to
calculate the deductions for all depreciating assets (except those specifically excluded). The entire
set of rules must be applied, not just individual elements. For example, only applying the instant
asset write-off, but not the small business pool capital allowance amounts, is not allowed (see the
next sections, ‘Temporary instant asset write-off’ and ‘Small business asset pool’).
SBEs can only claim a deduction for the portion of the asset that is used for business or other
taxable purposes.
Temporary instant asset write-off

Effective from 12 May 2015, an SBE can claim an immediate deduction of 100 per cent of the
business-use portion of depreciating assets that cost less than $20 000. This concession is not
available if the asset cost $20 000 or more, even if the business-use proportion is less than
$20 000. This limit applies to each individual asset, which can be new or second-hand assets.
The rule is currently in place until 30 June 2019, and to be eligible the depreciating asset must
be purchased and used, or installed ready for use, by 30 June 2019. Unless this concession is
extended, the instant write-off will return to $1000 from 1 July 2019.
Note: For qualifying assets acquired from 29 January 2019, the immediate write-off limit for an
SBE will be increased to $25 000 and will continue through to 30 June 2020.
This is an area where you can demonstrate professional self-awareness by keeping up to date
with changes to tax law.
Small business asset pool

Any assets that cost $20 000 or more can be placed in a small business asset pool. When placed
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in the small business asset pool, the taxpayer can claim a:

• 15 per cent deduction in the first year (regardless of when the asset was purchased or
acquired during the year), and a
• 30 per cent diminishing value deduction each year after the first year.
If the balance of the small business asset pool at the end of the income year (2018–19) is less than
$20 000 (before applying any other depreciation deduction), then it can be written off under the
temporary instant write-off concessions. This will return to $1000 from 1 July 2019 if the $20 000
concession is not extended (see previous note).
When a balancing adjustment event (see ‘Balancing adjustment’) occurs to an asset previously
added to the pool, then the business-use proportion of the asset’s termination value is deducted
from the pool before the depreciation of the pool is calculated and subtracted.
If an SBE chooses to stop using the small business capital allowance rules, then the general
capital allowance rules for non-SBEs will apply. However, any assets that are currently in the small
business pool will continue to be depreciated in that pool.
Example 4.7: Small business entity asset write-off and general

pool deductions
Paul O’Leary, an eligible SBE taxpayer, purchased a commercial refrigerator for $18 000 (exclusive of
GST) on 2 September 2018. Paul estimates that the refrigerator will be used 70 per cent for business
purposes over its four-year effective life. Paul can claim $12 600 ($18 000 × 0.7) as an immediate
deduction for the 2018–19 tax year as the items cost less than $20 000.
However, if the commercial refrigerator had cost $21 000 (exclusive of GST), Paul would have to include
it in his general small business pool, as the total cost of the refrigerator exceeds $20 000 even though
the 70 per cent business-use estimate would have brought the tax-deductible amount to $14 700
($21 000 × 0.7), which is below $20 000. In this case, the deduction for 2018–19 for the refrigerator
added to the pool will be $2205 ($14 700 × 15% for the year added to the pool).
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Blackhole expenditure and start-up expenditure

SBEs and taxpayers not yet carrying on a business are allowed to claim specific deductions
immediately when starting up a small business. This provision is active from the 2015–16
income year.
This relates to certain start-up capital expenditure that would be otherwise deducted over five
years under s. 40-880 of ITAA97 (the blackhole provisions previously discussed).
For the deduction to apply, it must relate to capital expenditure for a proposed business.
The expense needs to be incurred through the obtaining of professional advice or services
about the structure or operation of the proposed business. It can also be a tax, charge or fee
paid to an Australian government agency relating to the establishing or ongoing structure
of the business.
The taxpayer must also meet the requirements of an SBE for the relevant income tax year. If they
do not meet the requirements of an SBE, then the taxpayer must be neither:
• carrying on a business, nor
• connected to or affiliated with a non-SBE that is carrying on a business.
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Example 4.8: Determining if a start-up expense can be
immediately deducted
Ziggy DDD Pty Ltd is an SBE. It is in the process of setting up a dance supplies company. Ziggy DDD
is uncertain as to the best way to set up its ownership structure. The directors of Ziggy DDD obtain
advice from a lawyer and from a consultant in order to assist them in determining the best structure.
As the start-up expenditure rules apply to the costs of obtaining this advice, it can be fully deducted
in the income year in which it is incurred.
Source: Adapted from ATO 2018, ‘Certain start-up expenses immediately deductible’, accessed March
2019, https://www.ato.gov.au/forms/guide-to-depreciating-assets-2018/?page=19.
➤ Question 4.2
Writing Now is an SBE sole trader. The sole trader generates revenues of $200 000 per year and
calls upon a bank of five freelance writers on a project-by-project basis. In the current tax year,
Writing Now decides to purchase a new car for $30 000, a new set of office furniture for $9000,
a new printer for $700, a new laptop for $1300 and a second-hand bookcase for business reference
materials for $4000. The printer and the laptop are both determined to have 100 per cent business
use, the furniture and the bookcase are both determined to have 80 per cent business use and
the car is used 50 per cent for business.
Which of these assets can be deducted under the instant asset write-off rules, and how much
can be written off for each applicable asset?
Defining capital works

Types of capital works
Capital works relate to the buildings and structural improvements that are used in producing
assessable income, or in carrying on research and development activities.
Division 43 of ITAA97 allows the taxpayer a deduction for capital works that are used to produce
assessable income. These provisions provide a deduction for ‘construction expenditure’ on
‘capital works’ used to produce assessable income or carry on research and development
activities. Assets deducted under Division 43 are excluded from deduction under the Division 40
general capital allowances provisions previously discussed. These terms are defined as follows.
Capital works refers to buildings, structural improvements and environmental improvement

earthworks, and any extensions, alterations and improvements to them. This also applies to
rental properties.
Construction expenditure is the capital expenditure incurred in the construction of capital

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works. It includes actual construction cost and other costs such as architect fees, engineering
fees, permit costs associated with obtaining approval for the construction and the cost of
foundation excavations.
Structural improvements are not specifically defined in the legislation. Examples include sealed
roads, sealed driveways, sealed car parks, bridges, pipelines, fences, and concrete or rock dams.
Example 4.9: Capital works deduction

Shaun owns a rental property that produces assessable income. He would be able to claim a capital
works deduction for recent extensions relating to a new outdoor entertaining area and garage. As part
of these extensions, the driveway was sealed and new retaining walls were built into the backyard.
These structural improvements would also be eligible for the capital works deduction.
Calculating capital works deductions

Rate of deduction
To calculate the rate of the capital works deduction, three elements are needed:
• type of capital works
• extent to which it is used for income-producing purposes/research and development
activities, and
• date the construction commenced.
Rules when applying deduction

There are rules applying to calculating the capital works deduction. They are as follows:
• The deduction can be claimed for 25 years (at 4% per year) or 40 years (at 2.5% per year)
from the date construction was completed.
• Generally, it is the owner of the building who is entitled to claim the deduction, but this can
be transferred to an eligible lessee or quasi-ownership rights holder.
• Construction commencement date requires a physical start, usually the pouring of foundations.
• Deduction is apportioned between income-producing and non-income producing purposes,
as well as the different income-producing purposes.
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• The deduction commences on the day the building is first used for income-producing
purposes after construction is completed.
• If the actual construction costs cannot be determined, then an estimate from a quantity
surveyor or other independent qualified person can be used.
• The capital works expenses incurred reduce the cost base of the property for CGT purposes.
If the taxpayer claims the capital works deduction, then that will need to be considered when
determining a capital gain or loss. See Module 5 for more detail.
Type of construction and date of commencement

The rates of capital works deduction are either 2.5 per cent or 4 per cent. This depends on the
type of capital works, the date construction began and how the capital works are used.
Table 4.1 lists various types of construction along with the date at which work must have
commenced for the taxpayer to be eligible to claim a capital works deduction. For each type
of construction, it also shows the rate of deduction and the period over which the deduction
can be claimed (ATO 2018b).
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Note: Section 43-150 defines ‘industrial activities’ as including manufacturing operations,
metal refining and extraction from ore, petroleum refining, timber milling and a range of
processes used for fresh produce such as milk and meat.
Table 4.1: Capital works deductions for buildings and structural improvements
Construction
Types of construction commenced after Deduction rate applicable years
Building intended to be used on 21/8/1979 22/8/1979 – 21/8/1984—2.5%

completion to provide short-term
accommodation to travellers in: 22/8/1984 – 15/9/1987—4%
• apartment buildings in which you
own or lease at least 10 apartments 16/9/1987 – 26/2/1992—2.5% (where
• units or flats the construction related to certain pre
• hotels 16/9/1987 contracts, the rate is 4%)
• motels
• guest houses with at least 27/2/1992 onwards—4%
10 bedrooms.
Building intended to be used on 19/7/1982 20/7/1982 – 21/8/1984—2.5%

completion for non-residential purposes
such as a shop or office. 22/8/1984 – 15/9/1987—4%
16/9/87 onwards—2.5%
Building intended to be used wholly or 26/2/1992 27/2/1992 onwards—4%

mainly for industrial activities.
Any building intended to be used on 17/7/1985 18/7/1985 – 15/9/1987—4%

completion for residential purposes or
to produce income. 16/9/1987 – onwards—2.5% (where
the construction related to certain
pre-16/9/1987 contracts, the rate is 4%)
Structural improvements intended to 26/2/1992 27/2/1992 onwards—2.5%

be used on completion for residential
purposes or to produce income.
Construction
Types of construction commenced after Deduction rate applicable years
Environment protection earthworks 18/8/1992 18/8/1992 onwards—2.5%

intended to be used on completion
for residential purposes or to
produce income.
Any capital works used to produce 30/6/1997 The capital works must actually be
income, even if they were not intended used in a deductible way in the income
to be used for that purpose. year in which the deduction is claimed
(see onwards rates details earlier in the
For pre-1 July 1997 works only, the capital table for each type of construction).
works must have been intended for
use for specified purposes at the time
of completion.
Note: 2.5 per cent means that deductions can be claimed over 40 years and 4 per cent means they are
claimed over 25 years.
Source: ATO 2018, ‘The type of construction and the date construction commenced’, accessed January
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2019, https://www.ato.gov.au/general/property/in-detail/rental-properties/rental-properties---claiming-
capital-works-deductions/?page=3.
Example 4.10: Capital works deductions and changing use

A taxpayer commences construction of a 30-unit motel on 15 January 2017. Construction is completed
on 30 June 2018 and qualifying expenditure is $1 million. From 1 July 2018 until 31 January 2019,
the whole of the motel is available to travellers. However, from 1 February 2019, the taxpayer leases
10 units for six months to a company as accommodation for its employees.
The whole motel was therefore used in the prescribed 4 per cent manner (Table 4.1) from 1 July 2018
until 31 January 2019 because all 30 units were wholly used for short-term traveller accommodation.
However, only 20 of the 30 units were used as short-term accommodation in the prescribed 4 per cent
manner from 1 February 2019 to 30 June 2019 because the remaining 10 units were used for other
income-producing purposes (i.e. rental accommodation) deductible at a 2.5 per cent rate for that
period (Table 4.1).
The total allowable deduction for the 2018–19 tax year is (deductions only start when construction is
completed and it is used for income-producing purposes):
01.07.18–31.01.19: $1 000 000 × 0.04 × 215 / 365 days $23 561.64

01.02.19–30.06.19: $1 000 000 × 0.04 × 150 / 365 days × 20 / 30 units $10 958.90
01.02.19–30.02.19: $1 000 000 × 0.025 × 150 / 365 days × 10 / 30 units $3 424.66
The formula in s. 43-210 of ITAA97 requires the use of 365 days as the denominator even in a leap
year, although the days used will be based on a 366-day year in a leap year.
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➤ Question 4.3
On 1 October 2018, Matthew purchased a rental property for $425 000 and immediately rented
it out. Matthew received a report from a quantity surveyor stating that:
• construction of the property commenced in February 2005
• the property was a residential townhouse
• construction was completed in November 2005
• the townhouse was built by a developer
• the estimated cost of constructing the townhouse was $200 000.
Calculate Matthew’s capital works deduction claim in the 2018–19 tax year.
Source: Adapted from ATO 2018, Rental Properties: Claiming Capital Works Deductions,
accessed March 2019, https://www.ato.gov.au/misc/downloads/pdf/qc21620.pdf.
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➤ Question 4.4
DimSim Pty Ltd purchased a large retail and restaurant building on 1 April 2019. DimSim
immediately occupied the building to commence trading as a new Asian fusion restaurant and
bar. The building was originally built in 2002 at a cost of $325 000. Construction commenced on
1 May 2002 and was completed on 12 November 2002.
DimSim Pty Ltd is classified as an SBE and is eligible for the special allowance rules that apply.
DimSim made the following purchases on 1 April 2019 to commence business:
• Coffee machine $6 000
• Industrial oven $25 000
• Stainless steel benches $8 000
Determine the following capital allowances DimSim can claim in the 2018–19 income tax year.
(a) Calculate the capital works deduction DimSim can claim on their restaurant premises.
(b) Determine how the purchases of capital equipment will be deductible.
Assume that DimSim Pty Ltd has been operating for five years (with other restaurants in other
locations) and has elected to not be classified as an SBE for the 2018–19 income tax year.
DimSim purchases specialist refrigerator units across its businesses for a value of $65 000 on
5 March 2019. DimSim determines that the effective life of the equipment is 9.5 years and chooses
to use the diminishing value method to calculate the capital allowance.
DimSim purchases $2000 worth of low-value assets in 2018–19 and allocates them to its low-
value asset pool. The closing balance of the low-value asset pool on 30 June 2018 was $18 000.
(c) Calculate the depreciation claimable for the specialist refrigerator units using the diminishing
value method.
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(d) Calculate the capital allowance attributable to the low-value asset pool for the 2018–19
income tax year.
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Summary and review

This module introduced the capital allowance regime (commonly referred to as ‘tax depreciation’)
for taxpayers. The capital allowance rules under Division 40 of ITAA97 allow taxpayers to claim
a deduction for the decline in value of depreciating assets. This deduction is based on the
percentage business usage of the asset and is spread over its effective life. Either the prime
cost or diminishing value methods can be used to calculate the deduction.
The treatment of depreciating assets varies depending on the type of asset and whether the
taxpayer is an SBE or not, so the module then discussed the rules for capital allowances for both
non-SBEs and SBEs. An SBE is defined as an entity that carries on a business and satisfies the
$10 million aggregated turnover test. Under the capital allowance provisions, an SBE can benefit
from an immediate write-off of depreciating assets costing less than $20 000. Assets costing
$20 000 or more are added to a general asset pool and the pool value is written off at a fixed
rate. Non-SBE taxpayers can allocate low-value assets to a low-value pool or claim a deduction
for each separate asset based on their effective life using either the prime cost or diminishing
value methods.
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Specific assets such as software, some intangibles, cars and project pool expenses are dealt
with separately. In addition, s. 40-880 allows capital expenses (blackhole expenses) that are not
eligible for deduction under the capital allowance provisions to be written off over five years,
or immediately if they are start-up costs of a small business.
When the depreciating asset is sold or no longer used (balancing adjustment event), a balancing
adjustment is required to adjust for the previous estimated decline in value. If the termination
value is greater than the adjustable value, the excess is generally assessable, and if it is less then
this amount is generally deductible.
The final sections of the module explained how capital works deductions are calculated.
Capital works used to earn assessable income are not deductible under the general capital
allowance provisions, but a deduction may be available under Division 43 of ITAA97. The rates
of capital works deduction are either 2.5 per cent or 4 per cent depending on the type of capital
work, the date construction began and what the capital works are used for.
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Suggested answers
Suggested answers
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Question 4.1
The deduction in the 2018–19 tax year is as follows:
$60 000 × 200% / 30 = $4000
Question 4.2
The solution is all of them except the car. The car cost more than $20 000, and even though
the business use was $15 000 ($30 000 × 50%), it is still not eligible for the instant write-off.
The remaining depreciating assets each come under the $20 000 limit as each asset is considered
separately (i.e. it is not cumulative). The full amounts are deductible for the laptop ($1300)
and the printer ($700), while the 80 per cent business-use component is deductible for the
furniture and the bookcase. Therefore, $7200 for the office furniture is deductible, and $3200
for the bookcase.
As the car is not eligible for the immediate write-off, the business-use proportion can be added
to the SBE asset pool and depreciated at 15 per cent for the current year. As part of the total
pool, in future years the car will be depreciated at a diminishing value rate of 30 per cent.

Question 4.3
Matthew claims a capital works deduction for the rental property based on the estimate of the
construction costs from the quantity surveyor. However, he only claims a deduction for that
part of the year his property was available for rent (1 October to 30 June 2019). The rate of
deduction he claims was 2.5 per cent as construction of his residential property started after
15 September 1987.
His annual capital works deduction was calculated as follows:
$200 000 × 2.5% = $5000
As the property was only used for income-producing purposes for 273 days in the 2019 tax year,
the deduction is calculated as follows:
$5000 × 273 / 365 = $3739
Source: Adapted from ATO 2018, Rental Properties: Claiming Capital Works Deductions,
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accessed March 2019, https://www.ato.gov.au/misc/downloads/pdf/qc21620.pdf.
Question 4.4
(a) A deduction for capital works expenditure is subject to Division 43 of ITAA97. The rate of the
deduction depends on the type of capital works, the extent it was used for income-producing
purposes and the date construction commenced. The allowance rate for a restaurant
(used for non-residential purposes such as a shop) built in 2002 is 2.5 per cent (Table 4.1).
The building was held for 91 days (1 April 2019–30 June 2019). Therefore, the capital works
deduction is $2025.68 ($325 000 construction expenditure × 2.5% × (91 / 365)).
(b) DimSim is an SBE so the special capital allowance rules apply. The oven is over $20 000
and therefore not eligible for the immediate write-off and will be added to the asset pool
and a 15 per cent deduction can be claimed in 2018–19 ($25 000 × 15% = $3750) (ITAA97,
s. 328-190(2)). The two other amounts will be immediately deductible as they are under
$20 000 and subject to the instant asset write-off rules (ITAA97, s. 328-180). Therefore,
the total deductible amount is $17 750 ($3750 + $6000 + $8000).
(c) Cost is $65 000. Days to depreciate are from 5 March to the end of the tax year, which is
118 days. Depreciation = $65 000 × (118 / 365) × (200% / 9.5) = $4423.94 (ITAA97, s. 40-72(1)).
(d) The depreciating assets were allocated to a low-value pool. The depreciation on the
new low-value assets is $2000 × 18.75% × 100% business use (year 1) = $375 (ITAA97,
s. 40-440(1), Step 3 only). The opening balance depreciation is $18 000 × 37.5% = $6750.
Total depreciation is $7125.

REFERENCES | 173
References
References
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ATO 2018a, ‘In-house software’, accessed March 2019, https://www.ato.gov.au/forms/guide-to-
depreciating-assets-2018/?page=14.
ATO 2018b, ‘The type of construction and the date construction commenced’, accessed January
2019, https://www.ato.gov.au/general/property/in-detail/rental-properties/rental-properties---
claiming-capital-works-deductions/?page=3.
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AUSTRALIA TAXATION
Module 5
CGT FUNDAMENTALS
176 | CGT FUNDAMENTALS
Contents
Preview 177
Introduction
Objectives
Teaching materials
CGT core concepts 179
What is capital gains tax?
CGT interaction with other taxes
Six-step process for determining CGT
CGT equation
Administration and reporting
CGT events 184
Overview of CGT events
Defined CGT events
Determining the CGT event
Specific CGT events
CGT assets 196
What is a CGT asset?
Collectables
Personal use assets
Determining gain/loss from CGT event 198
How to calculate the gain/loss
Capital proceeds
Cost base
Indexed cost base
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Reduced cost base

Determining exception or exemption 206
Pre-CGT assets
Specific CGT exemptions
Main residence exemption
Amount of main residence exemption available
Foreign residents and the main residence exemption
Rollover provisions and other reliefs 211
How rollovers and reliefs operate
Disposal of assets to, or creation of assets in, a wholly owned company
Replacement asset rollover events
Small business restructure rollover
Demerger relief
Same asset rollover events
CGT consequences of death
Calculating net capital gain/loss 216
Determining net capital loss
Determining net capital gain
Applying the CGT discount
CGT small business concessions
References 229
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Module 5:
CGT fundamentals
Study guide
MODULE 5
Preview
Introduction
Capital gains tax (CGT) is levied on capital gains arising from CGT events happening (generally)
to CGT assets. Note, a capital gain can arise in many circumstances and does not always involve
a CGT asset. Capital gains are included as part of assessable income and subject to the income
tax provisions.
The calculation of a capital gain or capital loss follows a standard six-step process, which is
presented in Figure 5.1, as well as in the section ‘CGT core concepts’ in this module. It is
important that all candidates have a working knowledge of the six-step process for calculating
a capital gain and a capital loss.
The final step in the process is to calculate the total capital gain or loss to the taxpayer. As part
of this step, any relevant discounts and any relevant small business concessions are applied.

Figure 5.1: Module summary—CGT definitions and process
CGT definitions Six-step process for CGT
Capital loss 1. Determine CGT event
Capital gain 2. Identify CGT asset
CGT asset 3. Calculate capital gain/loss
CGT event 4. Determine exceptions/exemptions
Other legislation 5. Consider rollover provisions
6. Calculate total gain/loss

– Apply CGT discounts
– Apply small business concessions
MODULE 5
Objectives
• determine which CGT event(s) apply/applies in a given situation;
• analyse the tax implications of different types of CGT assets;
• determine when a gain is exempt from CGT;
• calculate the capital gain or capital loss that arises from a CGT event;
• apply the potential reliefs from CGT liability to a given situation; and
• calculate an entity’s net capital gain or capital loss.
Teaching materials
• Legislation:
– Family Law Act 1975 (Cwlth)
– Treasury Laws Amendment (Tax Integrity and Other Measures) Act 2018 (Cwlth)
• Glossary:
Definitions/
terms/
STUDY GUIDE | 179
CGT core concepts

What is capital gains tax?
Capital gains tax (CGT) is levied on capital gains arising from CGT events happening (generally)
to CGT assets.
A capital gain or loss arises when a CGT event occurs, generally in relation to a CGT asset
(e.g. the disposal of a CGT asset). Sometimes a capital gain or loss can be triggered in other
circumstances, including when a managed fund or trust makes a distribution to a taxpayer.
A capital gain or loss may also occur when certain gifts are received by taxpayers. CGT events are
covered in the next section, ‘CGT events’. The section ‘Determining gain/loss from CGT event’
later in this module examines how to determine the capital gain or loss for each CGT event.
It is important to understand that CGT is not a separate tax, but that it is a part of an individual’s
income tax. Taxation is levied on the net capital gain at the taxpayer’s marginal tax rate.
CGT was introduced into Australia on 20 September 1985, and normally only applies to CGT
assets acquired by the taxpayer from that date. If an asset is acquired before 20 September
1985, it is generally exempt from CGT. Note that income that comes from the disposal of a
pre-20 September 1985 asset may still be liable for taxation under the ordinary income provisions
(s. 6-5) or under s. 15-15 of ITAA97.
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Capital gains are included as part of assessable income and subject to the income tax provisions.
What is a capital gain/loss?

A capital gain or loss is generally calculated as the difference between the cost to acquire the
asset and the proceeds received as a result of the CGT event.
For many of the CGT events, if the proceeds received from the CGT event are higher than the
cost base (discussed in the section ‘Cost base’ later in this module), then a capital gain is made.
Likewise, for many CGT events, if the proceeds received from the CGT event are less than the
reduced cost base of the asset (discussed in the section 'Reduced cost base' later in this module),
then a capital loss is incurred. A capital loss can be applied against capital gains for the same
income year, and carried forward into future income years to offset against future capital gains.
A capital loss cannot be deducted from the taxpayer’s income.
There is no limit on how long the loss can be carried forward (subject to certain rules applying to
companies), and the losses are applied in the order they were incurred.
What is a CGT event?

CGT events are the different types of transactions or events that might result in a capital gain
or capital loss.
Many CGT events involve a CGT asset (see the following section) and some relate to capital
receipts. There are a wide range of CGT events, and these are discussed in the section
‘CGT events’ in this module.

The definition of a CGT asset is discussed in more detail later in the section ‘CGT assets’. Included
in the definition of a CGT asset is any kind of property, including items such as shares in a publicly
listed company, or an investment property used to generate rental income. Also included are
legal/equitable rights other than property (s. 108-5).
There is no CGT paid on the disposal of an individual’s main residence—the main residence
exemption is discussed in the later section ‘Determining exception or exemption’. In fact,
most personal assets are exempt from CGT, which includes the main residence, car and personal
use assets. Personal use assets and collectables are discussed in more detail in the section
‘CGT assets’.
Depreciating assets used solely for taxable purposes—for example, fittings in a rental property
or business equipment—are also exempt from CGT.
When does a capital gain/loss occur?

Each CGT event sets out its own rules for when each event occurs and a capital gain or loss
arises. For example, in CGT event A1, a capital gain or loss occurs when the contract for disposal
of the asset is entered into—not the settlement date. When applying event A1, if a contract is
signed to sell an investment property in June 2019, and settles in September 2019, then any gain
or loss is reported in the 2018–19 tax year.
MODULE 5
What about residency?

For Australian residents, CGT applies to any assets held anywhere in the world. This is irrespective
of whether the Australian residents are individuals, partnerships, trusts, superannuation funds
or companies.
For foreign residents (non-Australian residents for taxation purposes), a capital gain or loss is
incurred if a CGT event happens to an asset that is taxable Australian property.
CGT interaction with other taxes

Other (non-CGT) tax provisions take precedence over CGT. For example, if a disposal of a CGT
asset is subject to another form of taxation under Australian tax legislation, then any capital gain
on that asset is reduced accordingly.
Where the disposal of the asset occurs in the ordinary course of a business, then the gross
proceeds from that transaction will be assessed as ordinary income under s. 6-5, and no capital
gain will arise.
Figure 5.2 shows how this operates.

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Figure 5.2: CGT interaction with other taxation legislation
No No CGT. Consider
Has a CGT event
whether any other tax
occurred?
legislation applies.
Yes
Does any tax legislation Yes Income is subject to tax

apart from CGT and under that legislation
s. 15-15 apply? (e.g. s. 6-5).
No
Is a pre-CGT asset
(acquired before Yes Is there a profit-making Yes Profit may be taxed
20 September 1985) undertaking or plan? under s. 15-15.
involved?
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No
CGT may apply to

any gain, subject to
exemptions, exclusions
and rollover relief.
Six-step process for determining CGT

To determine a taxpayer’s net capital gain, a universal six-step process is followed, as shown
in Table 5.1.
Table 5.1: Six-step process for determining CGT
Step Description Module section reference
Step 1 A CGT event must occur for a capital gain ‘CGT events’
Determine CGT event or loss to arise.
Step 2 The CGT event often (but not always) ‘CGT assets’
Identify a CGT asset involves a CGT asset.
The underlying asset or assets must be

determined to calculate any capital gain
or loss.
Step 3 This must be considered separately for each ‘Determining gain/loss

Calculate the capital gain CGT event. from CGT event’
or loss
Step 4 Applying an exception or an exemption ‘Determining exception

Determine exceptions or may prevent a capital gain occurring. or exemption’
exemptions
Step 5 Applying a rollover will defer a capital ‘Rollover provisions and

Apply applicable rollover gain until a subsequent CGT event occurs. other reliefs’
provisions Sometimes the taxpayer must choose the
rollover. In other instances, the rollover
applies automatically.
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Step 6 Step 6 brings together all the capital ‘Calculating net capital
Calculate net capital gains for the year and the capital losses gain/loss'
gains/loss for the current and previous tax years.
CGT discounts and the small business
concessions are applied—if applicable—
to further reduce net capital gain.
Figure 5.3 applies the six-step process as a decision tool.

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Figure 5.3: CGT six-step process
Step 1: No
Did a CGT event
happen in the tax year?
Yes
Step 2:
Identify the CGT asset
(if relevant)
Step 3:
Calculate the capital
gain/loss
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Step 4: Yes
Do any exceptions
or exemptions apply?
No
Yes Step 5:
CGT liability
Do rollover
is deferred
provisions apply?
No
Step 6:
Determine net capital
gain/loss
Net loss
Net gain
Carried forward for

Included in No capital
offset against future-
assessable income gain or loss
year net capital gains

CGT equation
Formula to learn
Calculating the final net capital gain or loss can be a complex process. The equation is:
Net Capital Capital CGT CGT small

= – – –
capital gain gains losses discount business concessions
The calculation of net capital gain or loss is Step 6 in the CCT six-step process and is covered in the later
section ‘Calculating net capital gain/loss’.
Administration and reporting

We know now that net capital gains are included in assessable income (ITAA97, s. 102-5) and
tax is paid at marginal tax rates. Therefore, taxpayers are required to keep proper records of all
CGT assets acquired after 19 September 1985. Taxpayers can choose to maintain records or keep
an asset register.
Records
Where a taxpayer elects to maintain records, the taxpayer must keep details, in English, of the:
• date the asset was acquired and its cost, including any incidental costs
• date the CGT event occurred and any costs related to the CGT event
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• capital proceeds received or deemed to be received (s. 121-20).
Records must be kept for five years after the last relevant CGT event in relation to the asset.
This applies to all records, unless the Commissioner of Taxation advises otherwise or the
company has been dissolved (s. 121-25). Records do not have to be kept for events where the
capital gain or loss is disregarded, except upon a rollover (s. 121-30).
Asset register
Taxpayers can keep a CGT assets register with a separate entry for each asset. The entries in
the register must be in English. All entries in an assets register must be certified by a tax agent.
The original records pertaining to the asset listed in the register must be kept for five years.
This five-year period is from when the entry of the asset in the register was certified, not the
date of the CGT event.
CGT events
Overview of CGT events
A capital gain or loss can only potentially arise if a defined CGT event occurs. This is found
in s. 100-20(1), and the defined CGT events are listed in Division 104 of ITAA97. They are also
presented in the next section.
Defined CGT events

The CGT events are set out in Division 104 of ITAA97, and summarised in Table 5.2. Note that
events relating to tax consolidation (L1–L8) are not included in the table and are not examinable.
The table shows that there a large number of CGT events, but some of these occur only rarely.
Candidates are not required to have an in-depth knowledge of all events.
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The chief CGT events, which are examined in more detail in the later section ‘Specific CGT
events’, are:
• CGT event A1—Disposal of a CGT asset
• CCT event C1—Loss or destruction of a CGT asset
• CGT event C2—Cancellation, surrender and similar endings
• CGT event D1—Creating contractual or other rights
• CGT event F1—Granting, renewing or extending a lease
• CGT event H1—Forfeiture of a deposit.
Table 5.2 outlines the main defined CGT events.
Table 5.2: CGT events
Event number
(section) Description Timing of event Example
A1 Disposal of a CGT asset. When the taxpayer enters Sale of shares by

(s. 104-10) into the disposal contract. an investor.
If no contract, when
ownership transfers.
B1 Use and enjoyment before When use of CGT asset Hire purchase
(s. 104-15) title passes. passes to another entity. arrangements.
End of a CGT asset (C1–C3):
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C1 Loss or destruction of When the taxpayer Factory destroyed by fire.
(s. 104-20) a CGT asset. receives compensation
or, if none, when loss is
discovered or destruction
occurred.
C2 Cancellation, surrender When taxpayer enters Cancellation of legal rights

(s. 104-25) and similar endings. into contract to end an arising from a contract.
intangible asset. If no
contract, when asset ends.
C3 End of option to acquire When option ends. Gain/loss made by

(s. 104-30) shares, etc. company when option to
acquire its shares expires
without being exercised.
Bringing into existence a CGT asset (D1–D4):
D1 Creating contractual When taxpayer enters into Non-compete clause in a

(s. 104-35) or other rights. contract or right is created. business sale contract.
D2 Granting an option. When option is granted. Option to purchase land

(s. 104-40) within a specified period
granted.
D3 Granting a right to income When taxpayer enters Taxpayer holds a mining

(s. 104-45) from mining. into contract or right is entitlement, and grants
granted. a right to income from
operations permitted
under the entitlement.
D4 Entering into a When covenant is Landowner enters into

(s. 104-47) conservation covenant. entered into. covenant with government
to conserve their property
for environmental
purposes.
Event number
Events relating to trusts (E1–E9):
E1 Creating a trust over a When trust is created. Assets are transferred to

(s. 104-55) CGT asset. a new family trust.
E2 Transferring a CGT asset When asset is transferred. Assets are transferred to

(s. 104-60) to a trust. an existing family trust.
E3 Converting a trust to a When trust is converted. Non-unit trust is converted

(s. 104-65) unit trust. to a unit trust.
E4 Capital payment for When trustee makes Amounts distributed

(s. 104-70) trust interest. payment. from a unit trust that are
non-assessable due to
the small business 50%
concession.
E5 Beneficiary becoming When beneficiary becomes In specie distribution

(s. 104-75) entitled to a trust asset. absolutely entitled. of trust assets to a
beneficiary.
E6 Disposal to beneficiary to Time of the disposal. Property transfers on the

(s. 104-80) end income right. winding-up of a trust.
E7 Disposal to beneficiary to Time of the disposal. Property disposals on the

(s. 104-85) end capital interest. winding-up of a trust.
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E8 Disposal by beneficiary When disposal contract Sale of trust interests

(s. 104-90) of capital interest. is entered into or, if none, originally acquired for nil
when beneficiary ceases to consideration.
own CGT asset.
E9 Creating a trust over future When taxpayer makes Assignment of prospective

(s. 104-105) property. agreement. interest in partnership to a
discretionary trust.
E10 Annual cost base reduction When the reduction The annual reduction
(s. 104-107A) of interest in attribution happens. in cost base due to tax
managed investment trust deferred distributions
(AMIT). exceeds the cost base of
the asset.
Events relating to leases (F1–F5):
F1 Granting, renewing or When lease agreement is Lessor grants a lease and,

(s. 104-110) extending a lease. entered into or, if none, if it is a long-term lease,
at start of lease. For lease does not choose to apply
renewal/extension, at start event F2.
of renewal/extension.
F2 Granting, renewing or When lessor grants the Lessor grants lease over
(s. 104-115) extending a long-term lease or at start of renewal land and lease is for at
lease. or extension. least 50 years.
F3 Lessor pays lessee to get When lease term is varied Payment made by lessor to
(s. 104-120) lease changed. or waived. shorten duration of lease.
F4 Lessee receives payment When lease term is varied Payment received by

(s. 104-125) for changing lease. or waived. lessee for agreeing to
shorten duration of lease.
F5 Lessor receives payment When lease term is varied Payment received by lessor
(s. 104-130) for changing lease. or waived. for agreeing to shorten
duration of lease.
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Event number
Events relating to shares (G1 and G3):
G1 Capital payment for When company pays Liquidator’s interim

(s. 104-135) shares. non-assessable amount. distribution made more
than 18 months before
company ceases to exist.
G3 Liquidator or administrator When declaration is made. Liquidator makes

(s. 104-145) declares shares or financial declaration before
instruments worthless. final winding-up of a
company where no further
shareholder distributions
expected.
Special capital receipts (H1 and H2):
H1 Forfeiture of a deposit. When deposit is forfeited. Deposit paid to taxpayer is

(s. 104-150) forfeited when purchaser
pulls out of contract for
sale of land.
H2 Receipt for event relating When act, transaction or Payment to the owner of
(s. 104-155) to a CGT asset (residual event occurs. land who plans to build a
event—designed to ensure building on the land as an
tax is paid where no other inducement to commence
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CGT event applies). building early, but with no
legal obligation to do so
(s. 104-155(1)).
Australian residency ends (I1 and I2):
I1 Individual or company When individual or Taxpayer owning certain

(s. 104-160) stops being an Australian company stops being assets leaves Australia
resident. Australian resident. to become permanent
resident of the UK.
I2 Trust stops being resident When trust ceases to be Trustee and central
(s. 104-170) trust. resident trust for CGT management and control
purposes. of a trust move overseas.
CGT events relating to rollovers (J1, J2, J4–J6):
J1 Company stops being When the company is Rollover of Australian

(s. 104-175) member of wholly owned no longer fully owned by asset from a non-resident
group after rollover. the group. group company to a
resident group company,
(Note: Since the tax followed by break-up
consolidation regime was of corporate group.
introduced, this event
occurs only rarely.)
J2 Change in relation to When the change Replacement asset

(s. 104-185) replacement asset or happens. acquired by taxpayer
improved asset after under small business
small business rollover. rollover becomes
trading stock.
J4 Trusts fails to cease to exist When failure occurs. Trust continues to exist
(s. 104-195) after its assets are rolled six months after its assets
over into a company. have been rolled over
into a company under
Subdivision 124-N.
Event number
J5 Failure to acquire At end of replacement Taxpayer claims small

(s. 104-197) replacement asset asset period (generally two business rollover relief
or undertake capital years after the rollover). on disposal of an asset,
expenditure in respect but does not purchase
of existing active asset a replacement asset
after small business within two years after
replacement asset rollover. the disposal.
J6 Cost of replacement asset At end of replacement Taxpayer claims small

(s. 104-198) or capital expenditure asset period (generally two business rollover relief on
in respect of existing years after the rollover). disposal of an asset, but
active asset not sufficient purchases a replacement
to cover capital gain asset costing less than the
disregarded under small gain that was disregarded
business rollover. under the rollover.
Other CGT events (K1–K12):
K1 International transfer When the unit starts to Taxpayer starts to hold an

(s. 104-205) of emissions unit be held as a registered international emissions
(CGT implications of emissions unit. unit as a registered
carbon pricing). emissions unit.
K2 Bankrupt pays amount in When payment is made. Bankrupt taxpayer

(s. 104-210) relation to debt. can claim part of pre-
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bankruptcy capital loss

if taxpayer repays some
of related debt.
K3 Asset passes to tax- Just before death. Asset is transferred to a

(s. 104-215) advantaged entity foreign resident beneficiary
after death. on death of taxpayer.
K4 CGT asset becomes When asset becomes Land previously held as an

(s. 104-220) trading stock of taxpayer. trading stock. investment is subdivided by
the taxpayer in preparation
for development and sale,
and becomes trading stock.
K5 Companies and trusts When CGT events A1, C2 Taxpayer sells shares in
(s. 104-225) holding collectable assets or E8 happen to shares in a company that owns
that have fallen in value. the company or interests artwork that has decreased
in the trust that owns in value.
the collectable.
K6 Sale of pre-CGT shares When another CGT event Taxpayer sells pre-CGT
(s. 104-230) or trust interest, where involving the shares or shares in private company.
market value of post-CGT interest occurs. Eighty per cent of the
assets held by company/ value of the company
trust represents at least relates to post-CGT assets.
75% of net value of the
company/trust.
K7 Balancing adjustment When balancing Disposal of a truck partly

(s. 104-235) event occurs for adjustment event occurs. used for private purposes.
depreciating asset used
wholly or partly for
private purposes.
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Event number
K8 Direct value shifts affecting When decrease in Existing shares in a

(s. 104-250) equity or loan interests in value of equity or loan family business held by
a company or trust. interest occurs. a husband and wife are
devalued when new shares
are issued to the son.
K9 Entitlement to receive When the entitlement Capital gains on sale of

(s. 104-255) certain amounts in arises. eligible venture capital
respect of venture investments.
capital investments.
K10 Foreign exchange gains. When the foreign currency Foreign exchange gain
(s. 104-260) amount is paid to the on the sale of a CGT
taxpayer. asset for foreign currency
consideration, paid within
12 months of the sale.
K11 Foreign exchange losses. When the foreign currency Foreign exchange loss
(s. 104-265) amount is paid to the on the sale of a CGT
taxpayer. asset for foreign currency
consideration, paid within
12 months of the sale
(see Module 2).
K12 Foreign hybrid loss Just before the end of the Capital loss made by
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(s. 104-270) exposure adjustment. tax year. partners in foreign
hybrids (e.g. UK limited
partnerships).
Source: Based on Income Tax Assessment Act 1997 (Cwlth), Division 104-5, Federal Register
of Legislation, accessed March 2019, https://www.legislation.gov.au/Details/C2019C00113.
Determining the CGT event

The first step is to determine which CGT event is the correct one to apply to the taxpayer’s
situation.
It is very important that the most appropriate CGT event is selected. This is because each CGT
event has its own rules for determining the timing of that event (as summarised in Table 5.2),
and a capital gain or loss is calculated differently for different CGT events. Exemptions and
relevant concessions only apply to certain CGT events.
Section 102-25 outlines how to determine the appropriate CGT event, which is shown in Figure 5.4.
Figure 5.4: Order of application of CGT events (s. 102-25)
No CGT cannot apply. Consider

Has a CGT event
whether the transaction is subject
occurred?
to tax under other legislation
Yes
Does any CGT event Yes Apply only the most specific CGT
apart from D1 and H2 event, unless an exception applies
apply? (see below)
No
Does CGT event D1 Yes

(creating contractual or Apply CGT event D1
other rights) apply?
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No
Does CGT event H2

(receipt for event Yes
Apply CGT event H2
relating to a CGT asset)
apply?
Specific CGT events

This section examines the chief CGT events most likely to occur in a given tax year. To recap,
these are:
• CGT event A1—Disposal of a CGT asset
• CCT event C1—Loss or destruction of a CGT asset
• CGT event C2—Cancellation, surrender and similar endings
• CGT event D1—Creating contractual or other rights
• CGT event F1—Granting a lease
• CGT event H1—Forfeiture of a deposit.
For many of the CGT events, the determination of the capital gain or loss generally involves
a comparison of capital proceeds upon the CGT event occurring with the cost base or the
reduced cost base of the asset. These terms are discussed in more detail in the later section
‘Determining gain/loss from CGT event’.
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Event A1: Disposal of a CGT asset

Disposal of a CGT asset is the most common CGT event. It occurs where there is a disposal or
part disposal of a CGT asset (s. 104-10). This disposal occurs only where there is a change in the
beneficial ownership of the asset. There would not be a change of ownership where an asset is
destroyed (CGT event C1 would apply) or where there is a change in trustee without any change
to the beneficial ownership of trust assets (taxation of trusts is covered in Module 8).
Timing
CGT event A1 occurs at the date the disposal contract is entered into, or if there is no contract,
when the change of ownership occurs.
Calculation of capital gain or loss

A capital gain is made if the capital proceeds from the disposal are more than the cost base
of the asset. Conversely, a capital loss arises if those capital proceeds are less than the asset’s
reduced cost base.
Exceptions
A capital gain or loss is disregarded if the asset was acquired before 20 September 1985
(i.e. for pre-CGT assets).
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Example 5.1: Determining the CGT event—Lucy Yee
On 20 June 2019, Lucy Yee entered into a contract to sell land that she had acquired on 1 April 1995.
The contract is settled on 1 October 2019. Lucy made a capital gain of $650 000 from the sale. What CCT
event has occurred, and what is the timing of the event?
The gain is made in the 2018–19 tax year, as the time of the CGT event A1 is when the contract is
made, not when settlement takes place.
If the contract falls through, then CGT event A1 does not occur because there is no change in
beneficial ownership of the land. Assuming Lucy had lodged her income tax return for the 2018–19
tax year, and included the capital gain, if the contract subsequently fell through, she would request
an amendment to the 2018–19 income tax assessment to exclude the capital gain.
Event C1: Loss or destruction of a CGT asset

Where a CGT asset that is owned by the taxpayer is lost or destroyed, CGT event C1 occurs
(s. 104-20).
Timing
The time of the event is when the taxpayer first receives compensation (such as a payment from
an insurance policy) for the loss or destruction or, if no compensation is received, when the loss is
discovered or the destruction occurred.
Capital gain or loss

The taxpayer makes a capital gain if the capital proceeds from the loss or destruction—meaning
any compensation received—are more than the asset’s cost base, and a capital loss if those
proceeds are less than the asset’s reduced cost base.
Exception
A capital gain or loss is disregarded if the asset that was lost or destroyed was acquired before
20 September 1985.
Example 5.2: Determining the CGT event—Tony Paton

On 1 February 2018, Tony Paton’s dairy farming business is destroyed by fire. Tony receives $1.2 million
in compensation from his insurance company on 1 October 2018. What CGT event has occurred?
As Tony received compensation, CGT event C1 would have occurred on 1 October 2018 (2018–19 tax
year) and not on 1 February 2018 (2017–18 tax year) when the fire occurred.
Event C2: Cancellation, surrender and similar endings

CGT event C2 only applies to intangible assets. An intangible asset has no physical form and
includes contractual rights, options, leases or shares in a company.
CGT event C2 occurs if ownership of an intangible asset ends, due to any of the following reasons:
• it is redeemed or cancelled
• it is released, discharged or satisfied
• it expires
• it is abandoned, surrendered or forfeited
• it is exercised (for options)
• it is converted (for convertible interests) (s. 104-25).
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Timing
The event occurs when the taxpayer enters into the contract that results in the ending of the
asset, or—if there is no contract—when the asset actually ends, for example the expiration date.

A capital gain arises if the capital proceeds on the ending of the asset are more than the asset’s
cost base. A capital loss arises if those proceeds are less than the asset’s reduced cost base.
Exceptions
There are some exceptions to CGT event C2, and these are detailed in s. 104-25(5) of ITAA97.
The most common one is that it does not apply to pre-CGT assets.
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➤ Question 5.1
Coffee Roasters and Bikes & Beans Cafe entered into a contract on 31 July 2018. The contract
specified that Coffee Roasters was the sole provider of roasted coffee beans and all associated
coffee-making hardware and support services to Bikes & Beans Cafe for the following five years.
Coffee Roasters paid $20 000 for the right to provide the beans, hardware and support. As a
result of a dispute, the contract was dissolved on 15 June 2019 and Coffee Roasters received
$30 000 for giving up its right to be sole provider of coffee beans, hardware and support.
What CGT event was triggered, and what was the capital gain amount?
Event D1: Creating contractual or other rights

Events A1 and C1–C2 all relate to CGT assets being disposed of, or ceasing to exist.
In comparison, events D1–D4 all relate to when a new asset is created. So the question is,
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why does the creation of an asset result in CGT? While an asset is indeed created, the transactions
may also involve the disposal of legal rights, often in return for a cash sum.
The four CGT events that apply to situations where a new asset is created are:
• the creation of contractual or other rights—CGT event D1 (s. 104-35)
• the granting of an option—CGT event D2 (s. 104-40)
• the granting of a right to income from mining—CGT event D3 (s. 104-45)
• entering into a conservation covenant—CGT event D4 (s. 104-47).
The most common events in this group are D1 and D2. We will look in detail at CGT event D1.
CGT event D1 has wide application because it occurs whenever a taxpayer creates a contractual
right or other legal or equitable right in another entity. One common example of CGT event D1
is a restrictive covenant in a business disposal contract. Under the covenant, the vendor of the
business agrees, in return for a cash amount, not to establish a similar business within a given
timeframe and locality. In such an instance, a right has been created in favour of the purchaser.
Timing
The event occurs when the contract is entered into or, if no contract exists, then when the right
is created.

A capital gain occurs if the capital proceeds from the creation of the rights are greater than any
incidental costs incurred in creating the rights. A capital loss occurs if the capital proceeds are
less than the incidental costs.
Exceptions
It is important to remember that CGT event D1 does not apply where another CGT event,
other than H2, occurs. If a taxpayer were to enter into a contract to sell an asset such as land or
shares, then CGT event A1 would occur when the contract to dispose of the asset is entered into,
and CGT event D1 is disregarded even though there are contractual rights associated with the
contract of sale.
Alternatively, if a contract involves different sums received for different purposes, then it is
possible for CGT event D1 to be triggered together with other CGT events.
Example 5.3: Determining the CGT event—David Wong

David Wong sells a shop for $800 000 and also promises not to compete with the new buyer for three
years for $200 000. What CGT event or events are triggered?
The sale of the shop will trigger CGT event A1 and the restraint of trade (not to compete) provision
will trigger CGT event D1.
There are other specific exclusions for CGT event D1. These are:
• the right is created ‘by borrowing money or obtaining credit from another entity’
• the right requires the taxpayer to do something that gives rise to another CGT event for
the taxpayer
• ‘a company issues or allots equity interests or non-equity shares in the company’
• ‘the trustee of a unit trust issues units in the trust’
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• ‘a company grants an option to acquire equity interests, non-equity interests or debentures

in the company’
• ‘the trustee of a unit trust grants an option to acquire units or debentures in the trust’
(s. 104-35(5)).
Event F1: Granting a lease

A lease is a CGT asset as it involves legal rights over property. CGT events F1–F5 specifically
address transactions in relation to leases. We will look specifically at CGT event F1, the most
common of these events.
Two different taxpayers can be caught by these events:

1. the lessor—the taxpayer who grants the lease, usually the owner of the property
2. the lessee—the taxpayer who is given the right to use the property, in return for rental
payments and (sometimes) a lease premium. The premium is the amount paid for obtaining
the lease.
Where a lessor grants, renews or extends a lease, CGT event F1 occurs (s. 104-110) and can result
in a capital gain or loss for the lessor.
Timing
Where a lease is granted, CGT event F1 occurs when the lease contract is entered into or, if there
is no contract, at the start of the lease.
Where an existing lease is renewed or extended, CGT event F1 occurs at the start of the renewal
or extension.
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The lessor will make a capital gain if the capital proceeds (any lease premium paid by the lessee)
are greater than the cost to the lessor of granting, renewing or extending the lease.
A capital loss arises where the capital proceeds are less than such costs. A lease premium is
typically paid at the beginning of the lease and does not include rent payable under the lease.
Exceptions
The lessor can choose to apply CGT event F2 (instead of event F1) to certain long-term leases
(50 years or more). Note that the capital gain or loss is calculated differently under CGT event F2,
so consideration should be given as to which provides the taxpayer with the best result.
➤ Question 5.2
On 15 May 2019, Solving Solutions Ltd granted a lease of office premises to BooksareUs Pty Ltd in
return for a lease premium payment of $15 000. The legal expenses incurred by Solving Solutions
to prepare the lease agreement were $1500.
What is the capital gain derived and under which CGT event?
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Event H1: Forfeiture of a deposit

CGT event H1 occurs where a deposit is forfeited because a prospective sale or other transaction
does not proceed (s. 104-150).
Timing
The time of the event is when the deposit is forfeited.

A capital gain arises where the deposit is more than the expenditure incurred in connection
with the prospective sale or other transaction. A capital loss occurs if the deposit is less than
that expenditure.
Example 5.4: Determining the CGT event—Beau Morris

On 22 October 2018, Beau Morris received a deposit of $60 000 for the prospective sale of his investment
property, a beach house, for $620 000. The sale was to take place on 1 December 2018. The purchaser
did not proceed with the sale and the deposit was forfeited on 5 November 2018. Beau decided not
to offer his beach house for sale to anyone else.
CGT event H1 would occur at this time and Beau would make a capital gain of $60 000 on 5 November
2018 (reduced by any costs incurred in entering into the contract).
Note that if Beau did continue to offer his beach house for sale, the forfeited deposit could be included
in CGT event A1 (and H1 would not apply) when the house was subsequently sold (see Taxation Ruling
TR 1999/19).
CGT assets
As introduced in the first section, ‘CGT core concepts’, a CGT event generally occurs to a defined
‘CGT asset’. That CGT asset must have been acquired on or after 20 September 1985.
A CGT asset is defined in s. 108-5(1). It includes any kind of property and extends to include legal
or equitable rights that are not property. Examples of a CGT asset include:
• land and buildings (treated together, or as separate assets—this may vary)
• shares in a company
• units in a unit trust
• rights and options
• leases
• goodwill
• licences
• convertible notes
• contractual rights
• foreign currency
• any major capital improvement made to certain land or a pre-CGT asset
• collectables
• personal use assets (ITAA97, s. 108-5(1)).
Special CGT rules apply to CGT assets that are defined as collectables or personal use assets.
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Collectables
A collectable is:
(a) artwork, jewellery, an antique, or a coin or medallion; or
(b) a rare folio, manuscript or book; or
(c) a postage stamp or first day cover;
that is used or kept mainly for your (or your associate’s) personal use or enjoyment (ITAA97,
s. 108.10(2)).
An interest in, a debt arising from, or an option or right to acquire a collectable will also be a
collectable (s. 108-10(3)).
CGT treatment
Any capital gain or loss is disregarded if the first element of the collectable’s cost base (or first
element of its ‘cost’ if it is a depreciating asset) on acquisition was $500 or less (s. 118-10(1)).
The first element of cost base is what the person paid for the asset or its market value if the
person was given the asset or acquired it through a non-arm’s length transaction. This $500
threshold excludes any goods and services tax (GST) input tax credit. A set of collectables is
taken to be a single collectable, so having the seller sell a set as individual separate assets that
were each acquired for no more than $500 would not stop the total acquisition being treated
as a collectable acquired for more than $500 (s. 108-15).
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Example 5.5: CGT treatment of sets of collectables

An antique set of 20 pieces of cutlery consisting of knives, forks and spoons (usually sold as a set)
purchased at $2000 would be considered as a full set for CGT purposes. Thus, any gain or loss on the
sale of individual pieces of cutlery would need to be determined, even if the taxpayer claimed that as
there were 20 pieces, the apportioned cost of individual pieces of that cutlery were $100 each, and so
acquired at no more than $500 each.
Any capital losses from collectables can only be offset against capital gains on other collectables
in either the current year or in a future year (s. 108-10). A capital gain from a collectable can
qualify as a ‘discount’ capital gain if all the eligibility conditions to apply the 50 per cent CGT
discount are met. Concessions are calculated in Step 6 of the CGT process and discussed in the
last section of this module, ‘Calculating net capital gain/loss’.
Personal use assets

A personal use asset (Subdivision 108-C) is defined as a non-collectable asset, other than land
or buildings, used or kept mainly for personal use or enjoyment of the taxpayer or an associate
(s. 108-20(2) and (3)). A debt arising from, or an option or right to acquire, a personal use asset
will also be a personal use asset.
Examples
Examples of personal use assets include boats, caravans, televisions and sporting equipment.
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An option or right to acquire a personal use asset, a debt arising from a CGT event in which
a personal use asset was the subject of the event, and debt arising other than from gaining
assessable income or carrying on a business will also be a personal use asset (s. 108-20(2)).
For example, the debt arising on a personal, interest-free loan between a parent and their
child is a personal use asset as it did not arise from gaining income or carrying on a business.
CGT treatment
Any capital gain is disregarded where the first element of the personal use asset’s cost base
(or first element of its ‘cost’ if it is a depreciating asset) on acquisition was $10 000 or less
(s. 118-10(3)). The $10 000 threshold excludes any GST input tax credit.
Where personal use assets are a set and would ordinarily be disposed of as such, the set of
personal use assets will be taken to be a single asset for the purposes of the $10 000 threshold.
Any capital loss arising from a personal use asset is disregarded for CGT purposes regardless of
the asset’s cost base (s. 108-20(1)). Such losses are not available to offset capital gains on any type
of CGT asset.
Example 5.6: Personal use assets

On 30 August 2018, Sophie McCullough disposed of the following assets, all of which were acquired
after 19 September 1985.
Asset Cost base Capital gain/(loss)
Shares $7800 $3270
Painting $1750 ($1250)
Motor boat $8000 $2500
As a result of CGT event A1, Sophie will incur a capital gain of $3270 in respect of the shares. The capital
loss of $1250 from disposal of the painting, which is a collectable, cannot be offset against the capital
gain from the shares. It can only be offset against a gain from a collectable, and shares are not
collectables. The motor boat is a personal use asset. As the first element of its cost on acquisition did
not exceed $10 000, the capital gain on the disposal of the boat is disregarded.
Determining gain/loss from CGT event

How to calculate the gain/loss
Having established that a CGT event has occurred and identified the relevant asset(s), Step 3 is
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to calculate the capital gain or capital loss that arises from each CGT event.
Each CGT event outlines how to calculate the capital gain or capital loss for that CGT event.
There are rules that apply to many events, being that the taxpayer must:
• determine the capital proceeds arising from the CGT event
• determine the cost base of the CGT asset
• subtract the cost base from the capital proceeds.
Where the capital proceeds exceed the cost base, a capital gain arises.
If the capital proceeds are less than the cost base, then the reduced cost base must be
ascertained. If the reduced cost base exceeds the capital proceeds, there is a capital loss.
If the capital proceeds are less than the cost base but more than the reduced cost base, there is
neither a capital gain nor a capital loss.
Figure 5.5 is a flowchart demonstrating how to determine the capital gain and loss.
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Figure 5.5: Flowchart of determining capital gain/loss for many of the CGT events
Capital gain
Are proceeds greater Yes Consider whether indexation or CGT
than cost base? discount is available to reduce
tax payable (refer to later notes).
No
Capital loss
Are proceeds less than Yes Consider whether loss is available to
reduced cost base? offset other capital gains made in
current or future tax year.
No
NO GAIN, NO LOSS
Now let’s turn to the definitions and operation of capital proceeds, cost base and reduced
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cost base.
Capital proceeds
The capital proceeds arising from a defined CGT event is the sum of:
• any money the taxpayer has received or is entitled to receive PLUS
• the market value of any property the taxpayer received or is entitled to receive in respect
of the CGT event occurring.
Determining capital proceeds: The general rule

Capital proceeds will be taken into account at the time of the CGT event, irrespective of whether
they were actually received at that time.
Example 5.7: Capital proceeds

Megan sells a CGT asset for $90 000 with payments to be made in three equal annual instalments of
$30 000 each. Megan’s capital proceeds in the year of the CGT event will be $90 000, even though
she may only receive $30 000 at the time of the event.
Capital proceeds do not include the GST (if any) on a supply. Module 10 examines GST.
Where the capital proceeds are in a foreign currency, it is necessary to determine the Australian
equivalent at the time of the CGT event (s. 960-50) (refer to Module 2 for the foreign currency
translation rules).
Modifications to the determination of capital proceeds

There are six modifications to the general rule in the calculation of capital proceeds. Note that
not all capital proceeds modifications apply to all CGT events (s. 116-25).
These modifications are explained in Table 5.3.
Table 5.3: Capital proceeds—modifications to the general rule
Modification Description
1. Market value substitution Capital proceeds are deemed to be equal to the market value of the
rule (s. 116-30)† underlying CGT asset where:
• no proceeds are received (e.g. a gift), or
• some or all of the proceeds cannot be valued, or
• actual proceeds differ from the market value of the asset, and the
parties to the transaction did not deal with each other on an arm’s-
length basis (i.e. parties are not acting independently, or one party
exercises influence or control over the other), or
• actual proceeds differ from the market value and the CGT event is
event C2 (cancellation, surrender and similar endings).
2. Apportionment rule Capital proceeds are apportioned if:

(s. 116-40) • a payment relates to more than one CGT event, or
• only part of the proceeds relates to the CGT event.
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3. Non-receipt rule Capital proceeds are reduced by any amount not received after
(s. 116-45) reasonable steps have been taken to recover the amount. The non-
receipt must not be attributable to anything that the taxpayer or
taxpayer’s associate has done or omitted to do.
4. Repaid rule (s. 116-50) Capital proceeds are reduced by any non-deductible amount a taxpayer
has to repay.
5. Assumption of liability Capital proceeds are increased if another entity acquired the CGT asset
rule (s. 116-55) from the taxpayer subject to a liability by way of security over the asset.
The increase is equal to the amount of the liability the other entity
assumes.
6. Misappropriation rule Capital proceeds are reduced if an employee or an agent of the taxpayer
(s. 116-60) misappropriates (whether by theft, embezzlement, larceny or otherwise)
all or part of those proceeds.
However, if the taxpayer later receives an amount as recoupment for all

or part of the misappropriated proceeds, capital proceeds are increased
accordingly.
†
The market value substitution rule does not apply to:
– CGT event D1 (creating contractual rights) where no capital proceeds are received
– the expiry of a CGT asset or the cancellation of a statutory licence (both CGT event C2) where no
capital proceeds are received
– CGT event C2 when the event occurs in respect of shares or units in ‘widely held’ companies or
unit trusts (at least 300 shareholders/unitholders) and some capital proceeds are received.
Source: Based on Income Tax Assessment Act 1997 (Cwlth), Division 116, Federal Register of
Legislation, accessed March 2019, https://www.legislation.gov.au/Details/C2019C00113.
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Example 5.8: Market value substitution rule

Soren gives some land, worth $300 000, to his son as a gift.
To determine the capital proceeds, in calculating any capital gain or loss under CGT event A1, Soren is
deemed to receive capital proceeds of $300 000 (market value substitution rule). The capital proceeds
would also be $300 000 if Soren sold the land worth $300 000 to his son for $100 000, as this would be
regarded as a non-arm’s length transaction.
Example 5.9: Assumption of liability rule

Greg sells land in return for $360 000 in cash and the buyer becoming responsible for a $160 000
liability under Greg’s mortgage.
The capital proceeds of $360 000 are increased by $160 000 to $520 000 (assumption of liability rule).
Cost base
The cost base generally includes all non-deductible expenditure incurred in acquiring,
maintaining, improving and disposing of a CGT asset.
Where a CGT event occurs in relation to a CGT asset, the asset’s cost base must generally be
calculated in order to determine the capital gain. The gain is generally the difference between
capital proceeds and cost base.
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As with capital proceeds, the cost base is modified in certain circumstances, often by substituting
market value for any amounts actually paid for an asset.
For assets acquired before 21 September 1999, the cost base may also be increased by
indexation. This is discussed in the section ‘Indexed cost base’.
Where a capital loss has arisen from a CGT event, the amount of that loss is calculated by
reference to the reduced cost base, which can be different to the cost base. This is discussed
in the section ‘Reduced cost base’.
Five elements of determining cost base

Section 110-25 states that an asset’s cost base consists of five elements. These elements are
shown in Table 5.4.
Table 5.4: Five elements of cost base
Element Examples
1. The money paid, or required A taxpayer pays $1000 for a painting at an art auction. The first
to be paid, in acquiring element of the painting’s cost base is $1000.
the asset plus the market
value of any property given, A taxpayer purchases land for $600 000. The vendor agrees that the
or required to be given. purchase price can be paid in three monthly instalments of $200
000. The first element of the land’s cost base is $600 000, even if all
instalments have not yet been paid.
2. Incidental costs incurred The incidental costs can only include (s. 110-35):
where no tax deduction has • remuneration for the services of a surveyor, valuer, auctioneer,
been or will be allowed for accountant, broker, agent, consultant or legal adviser
these costs. • transfer costs
• stamp duty
• advertising and marketing costs
• valuation and apportionment costs
• search fees
• conveyancing kit costs
• borrowing expenses, such as loan application and mortgage
discharge fees
• costs incurred by a head company of a consolidated group to a
person outside the group that reasonably relates to a CGT asset
transferred between members of the group
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• termination or similar fees as a direct result of the ownership

of an asset ending.
3. The costs of owning the These costs include:

CGT asset, but only where • interest on money borrowed to acquire the asset
the asset was acquired • costs of maintaining, repairing and insuring it
after 20 August 1991 and • rates or land tax
where no tax deduction has • interest on money borrowed to refinance the money borrowed
been or will be allowed for to acquire the asset
these costs. • interest on money borrowed to finance capital expenditure to
increase the asset’s value.
4. Capital expenditure incurred: Initial (non-deductible) repair expenditure incurred on a CGT asset
• for the purpose or after its acquisition would be included in the fourth element of
expected effect of the cost base of the asset (see Taxation Determination TD 98/19;
increasing or preserving see Module 3).
the asset’s value (does
not apply to capital
expenditure incurred in
relation to goodwill), or
• that relates to installing
or moving the asset.
5. Capital expenditure incurred Compensation payment made to a potential purchaser of a CGT

to establish, preserve or asset when the sale contract is terminated would be included in the
defend title to the asset or fifth element of the cost base of the asset.
a right over the asset.
Note:
• Any expenditure relating to illegal activities, entertainment, penalties and bribes to a public official
is specifically excluded from the cost base of a CGT asset (s. 110-38).
• All elements of the cost base are reduced by the amount of any GST input tax credit (s. 103-30).
(GST input tax credits are covered in Module 10.)
• For CGT assets acquired after 13 May 1997, the cost base is reduced to the extent that an amount
in respect of the asset’s cost is deductible (e.g. a capital works deduction for a building) or a
non-assessable recoupment of costs is received in respect of the asset (s. 110-45).
Source: Based on Income Tax Assessment Act 1997 (Cwlth), Subdivision 110-A, Federal Register of
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Additional cost base considerations

Any expenditure relating to illegal activities, entertainment, penalties and bribes to a public
official are excluded from the cost base of a CGT asset. All elements of the cost base are reduced
by the amount of any GST input tax credit. For CGT assets acquired after 13 May 1997, the cost
base is reduced to the extent that an amount in respect of the asset’s cost is deductible (e.g. a
capital works deduction for a building) or a non-assessable recoupment of costs is received in
respect of the asset (s. 110-45).
➤ Question 5.3
Adam Zwar purchases a block of land with the intention of erecting two townhouses on it.
The following costs were incurred by Adam in acquiring the land (net of any GST input tax credits).
$
Purchase price 250 000
Legal fees 3 500
Stamp duty 10 660
Valuation fees 1 500
Calculate the cost base.
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Gifting and the market value substitution rule

The most common modification to the cost base is the replacement of the actual price paid
with the market value of the asset at the time of acquisition. This is known as the 'market value
substitution rule' (this was also discussed in earlier section ‘Capital proceeds’).
The market value substitution rule applies for cost base when, at the time of acquisition of
the asset:
• there is no expenditure incurred by the taxpayer, which is generally when they are in the
receipt of a gift
• some or all of the expenditure incurred is unable to valued, and
• the asset was acquired in a transaction where the parties were not dealing at arm’s length
in connection with the acquisition (s. 112-20(1)).
Section 112-20(2) provides that the market value substitution rule will not apply despite the
parties not dealing at arm’s length, where the acquisition of the asset resulted from another entity
doing something that did not constitute a CGT event, and what was paid to acquire the asset
was not more than its market value at the time of acquisition.
Example 5.10: Gifting and the market value substitution rule

Lucy Liu received a gift from her parents of 3000 shares in Angels Ltd. At the time, the market value of
each share was $10. Because Lucy did not incur any expenditure in acquiring the asset, Lucy would be
deemed to have acquired the shares at their market value of $10 per share on the date of acquisition.
The first element of the cost base of Lucy’s shares is therefore $10 × 3000 = $30 000.
Lucy’s parents would be deemed to have disposed of the shares at their market value at the time of
the gift (see the earlier section ‘Modifications to the determination of capital proceeds’). Their capital
proceeds would be $10 × 3000 = $30 000.
Indexed cost base

Indexing of the cost base occurs for CGT assets acquired prior to 11.45 am on 21 September
1999. The three conditions that must be met for indexing to be applied are as follows:
• the asset was acquired at or before 11.45 am on 21 September 1999, and
• had been acquired at least 12 months before a CGT event occurred in relation to the
asset, and
• the taxpayer elects to use the indexation method.
Increasing the cost base by indexation (s.110-36) has the result of decreasing any capital gain
from the CGT event.
Although indexation is available for all taxpayers, its importance is now severely limited as
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indexation was frozen from the quarter ended 30 September 1999 and is not available for assets
acquired after 21 September 1999. Further, expenditure on CGT assets acquired before this
date can only be indexed to September 1999. Indexation is never available when calculating a
capital loss.
Calculation of indexed cost base
Formula to learn
To calculate the indexed cost base, these steps should be followed:
Elements 1 (money paid plus market value), 2 (incidental costs), 4 (capital expenditure for asset’s value)
and 5 (capital expenditure to establish title or right over asset) of the cost base
INDEXED
by the consumer price index,
PLUS
the unindexed third element (costs of ownership)
Any expenditure incurred on a CGT asset after 11.45 am on 21 September 1999 cannot be indexed.
So, in order to index expenditure, it must be multiplied by the indexation factor, calculated as follows:
The index number for the quarter of the year in which the CGT event occurred to the asset
(frozen at the quarter ended 30 September 1999 if CGT event occurred after that date)
The index number for the quarter in which the amount was paid
(or the expenditure incurred)
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The indexation factor is calculated to three decimal places, rounding up if the fourth decimal
place is five or more (s. 960-275(5)).
In practical terms, if indexation is available, then unless the CGT event occurred prior to the
September 1999 quarter, the numerator for the indexed cost base formula will be 68.7 (the figure
for the September 1999 quarter—see Table 5.5) as indexation is frozen from the September 1999
quarter onwards.
Consumer price index (CPI) numbers are published for all quarters up to the current date and are
used for other tax and superannuation purposes. Note that Table 5.5 stops at September 1999,
when indexation was frozen for CGT cost-base purposes.
Table 5.5: CPI numbers
Year 31 March 30 June 30 September 31 December
1999 67.8 68.1 68.7 —
1998 67.0 67.4 67.5 67.8
1997 67.1 66.9 66.6 66.8
1996 66.2 66.7 66.9 67.0
1995 63.8 64.7 65.5 66.0
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1994 61.5 61.9 62.3 62.8
1993 60.6 60.8 61.1 61.2
1992 59.9 59.7 59.8 60.1
1991 58.9 59.0 59.3 59.9
1990 56.2 57.1 57.5 59.0
1989 51.7 53.0 54.2 55.2
1988 48.4 49.3 50.2 51.2
1987 45.3 46.0 46.8 47.6
1986 41.4 42.1 43.2 44.4
1985 37.9 38.8 39.7 40.5
Source: ATO 2018, ‘Consumer price index (CPI) rates’, accessed November 2018,
https://www.ato.gov.au/rates/consumer-price-index.
For CGT events that occur from 21 September 1999, some taxpayers can choose to apply the
CGT discount instead of using an indexed cost base. The CGT discount is discussed in the last
section ‘Calculating net capital gain/loss’.
Reduced cost base

We know that a capital gain is determined by reference to an asset’s cost base or indexed cost
base. However, a capital loss is determined with reference to an asset’s reduced cost base.
All elements of the cost base discussed previously (except for the third element—costs of
ownership of the CGT asset incurred after 20 August 1991) form part of the reduced cost base.
When determining the reduced cost base, the taxpayer excludes the following elements (s. 110-55):
• any amount allowed or allowable as a deduction
• any decline in value of a CGT asset (i.e. depreciation deduction)
• any recouped costs not included in assessable income
• certain costs that give rise to a tax offset rather than a deduction
• if the CGT asset is shares in a company, certain distributions from amounts derived by
the company before you acquired the shares
• any expenditure on illegal activities, entertainment, contributions to political parties,
water infrastructure improvement payments, penalties and bribes of public officials
• any GST input tax credits after 19 February 2004 (s. 103-30).
Items included in the reduced cost base are never indexed.
Any amount that is assessable because of a balancing adjustment, or would be assessable if

the taxpayer had not elected to take balancing adjustment relief, is included in the reduced cost
base. Balancing adjustments are discussed in Module 4.
Example 5.11: Determining reduced cost base

Deirdre Green acquired an investment property in November 2005 for $400 000. The incidental costs
of acquisition and disposal were $60 000. Deirdre had claimed a capital works deduction of $24 000
on the construction cost of the dwelling (capital works deductions are available under Division 43—
see Module 4). On 10 May 2019, Deirdre sold the property for $420 000.
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As there is a capital loss here, it is calculated as the reduced cost base minus the capital proceeds.
The reduced cost base is calculated as follows:

$
Cost of property (first element) 400 000
Plus: Incidental costs (second element) 60 000
Less: Capital works deduction (as this is a
deduction, it is subtracted from the
reduced cost base) (24 000)
Total reduced cost base 436 000
To calculate the capital loss:

Less: Capital proceeds (sales price) (420 000)
Capital loss 16 000
Determining exception or exemption

Pre-CGT assets
The chief exemption to CGT is of course pre-CGT assets. These are assets acquired before
20 September 1985. There is one exception to this exemption—CGT event K6. CGT event K6
may result in a capital gain if certain CGT events occur to pre-CGT shares in a company,
or pre-CGT interests in a trust.
The date of acquisition of the CGT asset is therefore very important. Refer back to Table 5.2,
which lists the timing of each CGT event.
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Specific CGT exemptions

Division 118 exempts various capital gains and losses from CGT. As explained by the Australian
Taxation Office (ATO) (2018), capital gains and capital losses that do not fall under the CGT
regime include:
• a car (i.e. a motor vehicle designed to carry a load of less than one tonne and fewer than nine
passengers) or motorcycle or similar vehicle
• a decoration awarded for valour or brave conduct, unless the taxpayer paid money or gave
any other property for it
• collectables acquired for $500 or less (refer back to the section ‘Collectables’ under
‘CGT assets’)
• a capital gain from a personal use asset acquired for $10 000 or less (refer back to the
section ‘Personal use assets’ under ‘CGT assets’)
• any capital loss from a personal use asset (refer back to the section ‘Personal use assets’
under ‘CGT assets’)
• CGT assets used solely to produce exempt income or some amounts of non-assessable,
non-exempt (NANE) income (i.e. tax-free income)
• a CGT asset classified as trading stock at the time of a CGT event
• compensation or damages received for any wrong, injury or illness suffered by the taxpayer
or their family
• a capital gain or loss made from a CGT event happening to a depreciating asset (not CGT
event K7 however)
• winnings or losses from gambling, a game or a competition with prizes
• a reimbursement or payment of your expenses (but not for the loss, destruction or transfer
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of an asset) under a scheme established by an Australian government agency, a local
government body or foreign government agency
• amounts indicated under an Act or legislative instrument (e.g. regulations or local
government by-laws)
• a right or entitlement to a tax offset, deduction or a similar benefit under an Australian law,
under the law of a foreign country or part of a foreign country
• some types of testamentary gifts
• the ending of rights that directly relate to the breakdown of a marriage or relationship,
including cash received as part of the marriage or relationship breakdown settlement
• in certain circumstances, a general insurance policy, a life insurance policy or an annuity
instrument
• ceasing to hold an eligible vessel to the extent it is used to produce certain exempt income
(ATO 2018).
Main residence exemption

An important and commonly used exemption is the main residence exemption (Subdivision 118-B).
The main residence exemption means that there is no capital gain or capital loss made from a
CGT event that relates to a dwelling that is the taxpayer’s main residence.
The main residence rule can change depending on how the taxpayer came to own the dwelling
and how they subsequently treated it—for example, if it was later rented out. There are also
different rules relating to foreign investment and the main residence.
Definition of dwelling
A dwelling is defined under the legislation as a unit of residential accommodation and includes
a building, caravan, houseboat or other mobile home. It also includes the land under the unit
of accommodation (s 118-115).
The land that is adjacent to a dwelling will be eligible for the main residence exemption where
the land was used for private and domestic purposes. The maximum area of such land eligible
for the exemption is two hectares (s. 118-120). However, where a taxpayer’s land exceeds two
hectares, the taxpayer can select which two hectares the main residence exemption applies to
(Taxation Determination TD 1999/67).
Definition of main residence

There is no definition of main residence in the taxation legislation. Instead, the ordinary
meaning applies and this involves a question of fact. The following are taken into account:
• the length of time the taxpayer has lived in the dwelling
• the place of residence of the taxpayer’s family
• whether the taxpayer’s personal belongings have been moved into the dwelling
• the address to which the taxpayer’s mail is delivered
• the taxpayer’s address on the electoral roll
• the connection of services such as telephone, gas and electricity
• the taxpayer’s intention in occupying the dwelling.
Amount of main residence exemption available

Subdivision 118-B (ss. 118-100–118-210) states that the main residence exemption will not
apply where:
• the residence was only a main residence for part of the ownership period, or
• the residence was used for the purpose of producing assessable income.
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More than one residence

If a taxpayer owns more than one residence that qualifies as a main residence, they must choose
which one is the main residence for CGT purposes. This choice occurs in the income year where
the CGT event occurs in relation to the dwelling in question.
Where a taxpayer has a main residence and acquires another dwelling that is to become the
new main residence, then both dwellings are treated as the taxpayer’s main residence for
the shorter of:
• six months ending when the ownership interest in the existing main residence ends, or
• the period between the acquisition of the new ownership interest and end of the old
ownership interest (ITAA97, s. 118-140(1)).
This change of main residence exemption only applies where the existing main residence was
used as a main residence for a continuous period of at least three months in the preceding
12 months, ending when the taxpayer’s ownership interest in it ends and it was not used for
income-producing purposes during that 12-month period (s. 118-140(2)).
Absence from main residence

A taxpayer who initially occupies a dwelling as a main residence, and then is absent from the
dwelling, can choose to continue to treat the dwelling as the main residence if they meet
the following criteria (s. 118-145):
• for a maximum of six years if the dwelling, which is the main residence, is used to produce
assessable income during the absence. A taxpayer is able to claim a maximum period
of six years every time the dwelling becomes, and then ceases to be, the individual’s
main residence
• for an indefinite period if the dwelling is not used for income-producing purposes during
the period of absence.
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This absence rule will only apply if another dwelling is not being claimed as a main residence at
the same time.
Different main residences

If a spouse has a different main residence, then a choice has to be made by the couple about
which dwelling will be the main residence. Where the spouses nominate a different dwelling as
their main residence and each has a 50 per cent interest in each, then each dwelling is deemed
to be a main residence at 50 per cent.
However, where a spouse has an interest in a property of more than 50 per cent, then the
dwelling is taken to be the main residence for only half of the period. If the ownership interest
is 50 per cent or less, then the dwelling is deemed to be the spouse’s main residence for that
period (s. 118-170).
➤ Question 5.4
When Shaun and Jane married, they bought and moved into a town house. They each own
50 per cent of the town house. They also own a beach house but Jane’s share is 70 per cent.
From 1 July 2018, Shaun mainly lives in the town house and Jane mainly lives in the beach house.
For the period 1 July 2018 to 30 June 2019, Shaun nominates the town house as his main residence
and Jane nominates the beach house as her main residence.
On 30 June 2019, Shaun and Jane dispose of both dwellings.
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Apply the CGT and any main residence exemption to this event for the period 1 July 2018 to
30 June 2019.
Source: Adapted from Income Tax Assessment Act 1997 (Cwlth), s. 118-170, Federal Register of
Partial exemption
Where the dwelling was the main residence for only part of the ownership period, then an
individual will only get a partial exemption (s. 118-185).
Formula to learn
The capital gain, or loss, is calculated by using the following formula.
Non-main residence days

Capital gain or capital loss amount ×
Days in your ownership period
However, a different rule will apply in partial exemption situations where (s. 118-192):
• the property was initially subject to the main residence exemption, and
• on or after 7.30 pm on 20 August 1996, it was subsequently used for income-
producing purposes.
Where these conditions are fulfilled, s. 118-192 rather than s. 118-185 will apply. The effect
of s. 118-192 is that the first element of the cost base will be reset to the market value of the
residence at the time it was first used for income-producing purposes. Further, any other relevant
expenditures from that point will be taken into account in the asset’s cost base, meaning that
the property will be treated ‘as if’ it was acquired at the point that it started being used as an
income-producing asset.
Where a taxpayer initially uses a house as their main residence, then rents it out (on or after
20 August 1996), and then subsequently moves back into it (without being able to utilise the
absence provision in s.118-145), both of the above sections will apply. In such a situation,
s. 118-192 will apply for when it is first used for rental purposes, meaning that the first element
of its cost base will the market value at that time. Then, when calculating the capital gain for
the rest of the ownership period, it will be subject to the pro-rata rule under s. 118-185 for this
remaining period.
Example 5.12: Capital gain where partial use as a

main residence
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If the taxpayer initially lived in the house they purchased in 2011 for two years, and then afterwards
(starting 2013) it was used for rental purposes for three years, and then (starting in 2016) the owner
moved back into it for another three years before selling the house (in 2019), the first element of the
cost base would be its market value when it was first used for rental purposes in 2013 (s. 118-192).
Further, the capital gain would then be subject to a 50 per cent main residence exemption (because
after it was initially used for rental purposes, it was then used as a main residence for half of that time
between 2013 and 2019).
Foreign residents and the main residence exemption

During the 2017–18 Federal Budget (on 9 May 2017), the government announced that Australia’s
foreign resident CGT regime will be extended to deny foreign tax residents access to the CGT main
residence exemption for eligible transactions. These proposed changes are in the Treasury Laws
Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018. At the time
of writing, this Bill was before the Senate.
Under this Bill, taxpayers who are foreign residents at the time of a CGT event cannot benefit from
either the full or partial main residence provisions regarding their period of ownership. For instance,
a taxpayer who was initially an Australian resident and lived in their main residence for many years,
and then subsequently became a foreign resident and then later sold their house, would be unable
to utilise the main residence exemption (full or partial) upon the sale of their house. However, if the
foreign resident inherited a house, and the deceased was an Australian resident who used their
house as their main residence, then the foreign resident, upon selling the house, would be potentially
entitled to a partial exemption relating to the period for which the deceased owned the house. It is
proposed that this change is to apply from the date of the announcement of 9 May 2017. However,
certain transitional arrangements mean that these new provisions will not apply where the foreign
resident acquired their interest prior to 9 May 2017 and the CGT event (usually a sale) occurred up
to the end of 30 June 2019.
The Bill also modifies some of the rules regarding when a foreign resident who owns Australian real
estate through interposed entities is potentially subject to CGT.
These proposed changes are non-examinable.

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Foreign resident capital gains withholding regime

There is a 12.5 per cent withholding obligation for foreign residents who dispose of the following:
• taxable Australian real property with a market value of $750 000 or above
• an indirect Australian real property interest
• an option or right to acquire such property or interest.
Under this rule, when the vendor (owner) of these Australian assets is a foreign resident, then the
purchaser of the property is required to pay 12.5 per cent of the purchase price direct to the ATO.
The vendor can then claim a credit for the foreign resident capital gains withholding payment that
the purchaser has made by lodging a tax return for the relevant year (see Module 2).
Rollover provisions and other reliefs

How rollovers and reliefs operate
Rollovers exist that allow the taxpayer to reduce, defer or disregard their capital gain or loss.
Applying a rollover allows the taxpayer to defer or disregard—or roll over—a capital gain or a
capital loss until a further (or later) CGT event occurs. There are many types of rollovers under
the taxation legislation; the chief ones are:
• rollover for the disposal of assets to, or creation of assets in, a company (Division 122)
• replacement assets rollovers (Division 124)
• small business restructure rollovers (Division 328-G)
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• demerger relief (Division 125)
• same asset rollovers (Division 126).
Disposal of assets to, or creation of assets in, a wholly

owned company
This rollover event allows taxpayers to incorporate their businesses into a company without
incurring a CGT liability. The rollover will apply where there is a change in the entity legally
owning the assets; however, there is no change in the underlying beneficial ownership of the
actual assets (ITAA97, Subdivision 122-A, s. 122-15).
It applies to individuals, trustees or all partners in a partnership. The CGT assets must be
transferred to a wholly owned company, and the consideration is in the form of non-redeemable
shares. The shares must be of substantially the same market value as the net assets transferred
for the rollover to be applied.
The assets transferred to the wholly owned company also retain their previous tax attributes,
meaning that the cost base, the reduced cost base and the pre-CGT status remain the same.
Example 5.13: Transferring over to Designing Now

Michael runs a business as a graphic designer. After speaking with his accountant, he decides that the
business should be incorporated. Michael sets up a new company, Designing Now Pty Ltd, of which
he is the sole shareholder, and transfers his business assets to Designing Now.
CGT event A1 would occur on transfer of any CGT assets to the company. However, if Michael
chooses a rollover under Subdivision 122-A, any capital gains or losses are disregarded. Michael will
be deemed to have acquired the shares in Designing Now for an amount equal to the total cost base
of the business assets. Further, to the extent that the assets were acquired before 20 September 1985,
Michael’s shares will also be deemed to be pre-CGT assets.
Designing Now will be deemed to have acquired the business assets at the same time as Michael,
so to the extent that Michael originally acquired the assets before 20 September 1985, the company
will continue to treat the assets as pre-CGT assets. Designing Now will take on Michael’s cost base/
reduced cost base for the assets he acquired post-CGT.
Replacement asset rollover events

Replacement asset rollovers involve the ownership of one CGT asset ending and the
acquisition of a new (replacement) CGT asset. When a replacement asset rollover event
occurs, the following happens:
• Any capital gain or loss made from the original asset is disregarded.
• The new (replacement) asset takes on the cost base of the original asset.
• If the original asset was acquired before 20 September 1985 (pre-CGT), the new
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(replacement) asset is also deemed to be a pre-CGT asset (ITAA97, Subdivision 124-A).
The various replacement asset rollovers available in the legislation are detailed in Table 5.6.
Table 5.6: Replacement asset rollovers
Division/Subdivision Type of rollover
Subdivision 124-B Involuntary disposal of a CGT asset owned by the taxpayer due to:
• compulsory acquisition (or threat of impending compulsory
acquisition) by an Australian government agency or certain
other entities
• whole or partial loss or destruction of the asset
• land becoming compulsorily acquired subject to a mining lease, or
• a lease granted by an Australian government agency expiring and
not being renewed
where the taxpayer receives compensation in the form of a replacement
asset or money to purchase a replacement asset (or a combination
of both).
Subdivisions 124-E and 124-F Exchange of shares, units, rights or options.
Division 615
Subdivision 124-I Conversion of a body to an incorporated company.
Subdivision 124-M Scrip-for-scrip exchange, where a share in a company or an interest in a

trust is replaced by a share or an interest in another entity and the other
entity obtains at least 80 per cent of the voting rights in the original
company or trust (e.g. company takeover situations). Various conditions
apply in obtaining such relief.
Subdivision 124-N Disposal of assets by a fixed trust to a company under a trust restructure.
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Example 5.14: Replacement asset rollover event

Limor Chan purchased land in June 1985. On 1 March 2019, the government compulsorily acquired
the land, and gave Limor some different land in return. There is no capital gain or loss on the
disposal of the original land, as it is a pre-CGT asset. However, if Limor elects to apply rollover under
Subdivision 124-B, the new land would also qualify as a pre-CGT asset, even though it was acquired
on 1 March 2019.

The small business restructure rollover allows small businesses to transfer active assets
(discussed later in this module, and generally applies to assets used in the course of a business,
or intangible assets inherently connected with the business) from one entity (the transferor)
to one or more other entities (transferees) without incurring an income tax liability (including,
but not limited to, CGT liability). It applies to transfers on or after 1 July 2016.
Small businesses who meet the standard small business entity (SBE) rules (including an aggregated
turnover of less than $10 million) can access this concession. The rollover applies to the transfer
of active assets that are CGT assets, trading stock, revenue assets or depreciating assets.
The rollover is available when the following conditions are met:

• the entity is an applicable SBE or related entity
• the rollover is part of a genuine restructure (not an artificial or tax-driven scheme)
• the rollover must not result in a change to the ultimate economic ownership of the
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transferred assets (see s. 328-430).
Note that:
Non-fixed (discretionary) trusts may be able to meet the requirements for ultimate economic
ownership, for example, where there is no practical change in which individuals economically
benefit from the assets before and after the transfer.
Family trusts may meet an alternative ultimate economic ownership test where:
• the trustee has made a family trust election [see Module 8], and
• every individual who had ultimate economic ownership of the transferred asset before the
transfer, and every individual who has ultimate economic ownership after the transfer, must be
members of the family group relating to the family trust (ATO 2017).
Example 5.15: Small business restructure

Janey runs a small marketing and public relations agency business as a sole trader.
She now wishes to run the business through a unit trust. Janey sets up the Whistles Media Trust with
herself as sole unit holder, and transfers the active assets of the business to the trust. This would not
result in a change in ultimate economic ownership of those assets.
Source: Adapted from ATO 2017, ‘Small business restructure rollover’, accessed March 2019,
https://www.ato.gov.au/General/Capital-gains-tax/Small-business-CGT-concessions/Small-business-
restructure-rollover/.
Example 5.16: Ultimate economic ownership changes

Janey, Michelle and David operate the small marketing and public relations agency business as
equal partners. They want to transfer their interests in the assets of the partnership to a company.
Michelle and David are a couple.
Janey, Michelle and David establish a company, whereby 300 identical shares are issued:
• 100 shares are issued to Janey
• 150 shares are issued to Michelle
• 50 shares are issued to David.
David receives fewer shares because he has other income and Michelle and David, as a couple, want to
lower their overall income tax bill.
While this does not change the individuals who have the ultimate economic ownership of the asset,
there is a change in the proportionate share of that ultimate economic ownership. Accordingly, Janey,
Michelle and David cannot use the small business restructure rollover.
However, if the shares were distributed equally between the partners, the ultimate economic ownership
of the assets would be unchanged, and Janey, Michelle and David could use the rollover, subject to
satisfying the other conditions.
Source: Adapted from ATO 2017, ‘Small business restructure rollover’, accessed March 2019,
https://www.ato.gov.au/General/Capital-gains-tax/Small-business-CGT-concessions/Small-business-
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Demerger relief
Rollover relief is available where the original interests in a company or trust demerge and the
taxpayer receives new or replacement interests in the demerged entity. A demerger generally
involves the splitting of a corporate group into two or more groups or entities, with ultimate
ownership remaining the same.
The aim of this rollover is to ensure that businesses can restructure without triggering costly
capital gains.
Where demerger relief applies, any capital gain or loss for the ultimate shareholders and for
members of the corporate group can be disregarded (ITAA97, Division 125).
Example 5.17: Demerger relief

Peter owns shares (his original interests) in Company A, a public company. Company B is a wholly
owned subsidiary of Company A. Company A announces a demerger utilising a proportionate capital
reduction and the disposal of all its shares in Company B to its 320 000 shareholders. Following the
demerger, all of the shareholders in Company A, including Peter, will own all of the shares in Company
B (their new interests).
Same asset rollover events

A same asset rollover event means an asset can be transferred from one taxpayer to another—
and no CGT arises (Division 126).
The applicable CGT is later paid by the transferee (i.e. the person to whom the transfer is made,
or who received the transferred asset) when a later CGT event occurs to the asset.
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When a same asset rollover event occurs, the following happens:

• Any capital gain or loss the transferor makes is disregarded.
• The transferee acquires the transferor’s cost base in the asset at the time of the transfer.
• Where the asset is a pre-CGT asset (transferor acquired the asset before 20 September 1985),
the asset retains its pre-CGT status in the hands of the transferee.
• Where the asset is a collectable or personal use asset of the transferor, it retains this status
in the hands of the transferee.
The type of same asset rollovers found in the legislation is presented in Table 5.7, and Table 5.8
outlines the effect of these rollovers.
Table 5.7: Type of same asset rollovers
Subdivision Type of rollover
126-A CGT assets transferred to a spouse or former spouse as a result of a binding legal
agreement following a marriage or relationship breakdown.
126-B CGT assets transferred between companies in the same wholly owned group,
involving at least one foreign resident company.
126-C Changes to a trust deed of a complying approved deposit fund, complying

superannuation fund or a fund that accepts workers entitlement contributions.
126-D Transfer of assets from a small superannuation fund with fewer than five members
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to another complying superannuation fund on marriage breakdown.
126-G CGT assets transferred between certain fixed trusts under a trust restructure.
Example 5.18: Same asset rollover event 126-A

Meg’s ex-husband Francesco owns land (purchased in 1997) with a cost base of $75 000. As a result of
a court order under the Family Law Act 1975 (Cwlth), Francesco is required to transfer the land to Meg.
Rollover relief automatically applies to ensure that Francesco does not crystallise a capital gain or loss
on the transfer. Meg’s cost base in the land is $75 000 (the same as Francesco’s cost base).
Table 5.8: Effect of rollovers
No rollover Rollover applied
Capital gain or loss arises on transfer/disposal Capital gain or loss on transfer/disposal of original
of original assets under CGT event A1. assets is disregarded.
Assets (either same assets or replacement assets) Assets (either same assets or replacement assets)
acquire new cost base and acquisition date. maintain the cost base and acquisition date of the
original assets.
Assets lose any pre-CGT status. Assets (both existing and replacement assets)
maintain any pre-CGT status.
CGT consequences of death

Generally, when a person dies, any capital gain or loss from a CGT event involving a CGT asset
that the deceased owned at the time of death is disregarded (s. 128-10).
There are three exceptions to this general rule. It is where the CGT asset passes to:
• a tax-advantaged beneficiary who is a tax-exempt entity
• the trustee of a complying superannuation entity, or
• a foreign resident, and the asset is not ‘taxable Australian property’.
In these three cases, the trustee of the deceased’s estate must include any capital gain in the tax
return of the deceased (see s. 104-215 and earlier discussions of CGT event K3).
Where the deceased’s CGT asset(s) devolves to a legal personal representative, or passes to a
beneficiary in the deceased’s estate, then either of these parties is taken to have acquired the
asset on the day of the deceased’s death. In this case, any capital gain or capital loss the legal
representative makes if the asset passes to a beneficiary in the deceased’s estate is disregarded
(s. 128-15).
Where a CGT asset is transferred to a legal personal representative or beneficiary, there are
modifications to the cost base and reduced cost base as a result of the death. These are:
Where the deceased died after 19 September 1985 and:
• the asset was acquired by the deceased before 20 September 1985, it is taken to be acquired
by the trustee or beneficiary on the date of death at its market value
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• the asset was acquired by the deceased on or after 20 September 1985, it is taken to be
acquired by the trustee or beneficiary on the date of death at the deceased’s cost base or
reduced cost base (unless it was the main residence of the deceased just before the time
of death)
• the asset was a dwelling that was the main residence of the deceased just before death
and not being used to earn assessable income at that time, it is taken to be acquired by the
trustee or beneficiary on the date of death at its market value.
Different rules apply where the asset was trading stock of the deceased (ITAA97, s. 128-15(4)
Item 2).
Moreover, a beneficiary can include in the cost base (or reduced cost base) of any CGT asset,
any expenditure incurred by the legal representative that would have been able to be included in
the asset’s cost base at the time the asset passes to the beneficiary (s. 128-15(5)).
As a result of these provisions, it is important that any beneficiary keeps appropriate records,
especially concerning:
• the market value of assets acquired by the deceased before 20 September 1985 or the
deceased's main residence, and
• the cost base and reduced cost base of assets acquired by the deceased on or after
20 September 1985.
Calculating net capital gain/loss

Formula to learn
As introduced in the first section, ‘CGT core concepts’, a taxpayer’s net capital gain for a tax year is
calculated as follows:
Net Capital Capital CGT CGT small

= – – –
capital gain gains losses discount business concessions
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The earlier section ‘Determining gain/loss from CGT event’ covered the calculation of each
individual capital gain or loss.
This section examines the determination of net capital gain, which can be reduced by capital
losses, the CGT discount and CGT small business concessions.
Determining net capital loss

A net capital loss arises in a tax year:
• if a taxpayer incurred a capital loss in the year and did not make a capital gain that could be
offset against that loss, or where
• a capital gain arose during the year, and the sum of the capital losses realised during the year
exceeded the capital gain made during the year (s. 102-10).
We already know that net capital losses are able to be carried forward and offset against any
capital gains arising in future years. Net capital losses cannot be used to reduce any other
assessable income of the taxpayer.
Determining net capital gain

Capital gains arising in a tax year can be reduced by:
• capital losses arising in the current tax year, and
• any unused net capital losses and collectable losses brought forward from previous tax years.
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Note that for companies, using prior year capital losses to reduce current year’s gains depends
upon the continuity of ownership or the same business test being satisfied (see Module 3).
Example 5.19: Realising capital gains and losses

During the year ending 30 June 2019, Frederick Ho disposed of some shares. Electing to use the
indexation method for his capital gains, he realises the following capital gains and losses:
$
ABC Ltd Gain 5 000
DEF Group Ltd Loss (2 500)
Hello Ltd Gain 500
IJK Ltd Gain 1 750
Lolly Ltd Loss (450)
The sum of the capital gains of $7250 would be reduced by the sum of the capital losses ($2950) to
produce a net capital gain of $4300. However, if the loss from Lolly Ltd had been $4950 (rather than
$450), a net capital loss of $200 would have arisen that could be carried forward to the 2019–20 tax
year to be offset against any subsequent capital gain.
Where the taxpayer has more than one capital gain (such as two capital gains due to selling two
properties), as well as a capital loss (current or carried forward), the taxpayer can decide in which order
to apply the capital loss against the capital gains.
Note that where there are capital losses from both the current year as well as carried-forward ones
from previous years, the current year capital losses are to be applied first (s. 102-5). Also, where there
are carried-forward capital losses from multiple previous years, they are applied in the order in which
they are made (s. 102-15).
➤ Question 5.5
In the 2018–19 tax year, James (who does not own any collectables) made capital gains of $20 000
and capital losses of $12 000. James also had net capital losses carried forward from previous
years, as follows:
Year Net capital loss
2017–18 $6000
2016–17 $4000
How will James reduce his capital gain for 2018–19 to zero?
$
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Applying the CGT discount

After applying capital losses, the next step is to apply the CGT discount. It is important that the
CGT discount percentage is only applied after the gain is reduced by any capital losses.
The CGT discount applies to individuals, trusts, complying superannuation funds and life
insurance companies. Companies (apart from certain life insurance companies) are not able to
claim the CGT discount.
Formula to learn
The CGT discount percentage for individuals and trusts is 50 per cent.
The CGT discount percentage for complying superannuation funds and life insurance companies is
33.33 per cent.
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To qualify for the CGT discount, the following four conditions must be satisfied (Subdivision 115-A).
1. The underlying CGT event creating the gain must occur after 11.45 am on 21 September 1999.
2. Indexation must not have been applied in calculating the capital gain.
3. The CGT event must relate to a CGT asset that has been owned by the taxpayer for at least
12 months. (This is the 12-month rule—see the next section.)
4. The taxpayer must generally be an Australian resident.
Note that for assets acquired after 8 May 2012, the CGT discount of 50 per cent is generally
not available to foreign and temporary resident individuals (including beneficiaries of trusts and
partners in a partnership).
The 12-month rule

To qualify for the CGT discount, a CGT asset must have been acquired by the taxpayer making
the capital gain at least 12 months before the CGT event.
The 12-month period excludes both the day of acquisition and the day of the CGT event.
Therefore, a period of 365 days (or 366 in a leap year) must elapse between the day of acquisition
and the happening of the CGT event to satisfy the 12-month rule (Taxation Determination TD
2002/10). For example, if the asset was acquired on 30 June 2018, the discount would not apply
if the CGT event occurred before 1 July 2019.
Example 5.20: 12-month rule
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In May 2018, John Norris (an Australian resident) acquired 1000 ordinary shares in a listed public
company for $10 per share. He sells these shares in April 2019 for $16 per share.
At the date of sale, John has owned the shares for less than 12 months and therefore he is unable to
choose the CGT discount. John must therefore include a capital gain of $6000 ($6 per share for 1000
shares) in calculating his net capital gain for the 2018–19 tax year.
Certain CGT events, such as those that create a new asset, cannot qualify for the CGT discount
because the asset will not have been acquired at least 12 months before the CGT event. The CGT
events for which the CGT discount cannot apply are CGT events D1, D2, D3, E9, F1, F2, F5, H2, J2,
J5, J6 and K10.
Under the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No 2)
Bill 2018, taxpayers who invest in certain types of affordable housing will also be eligible to an
additional 10 per cent discount on their capital gain on such dwellings. Under this proposed law,
the taxpayer, to be eligible, must have used their investment property to provide affordable housing
for at least three years. A dwelling will be regarded as providing affordable housing where it is
managed by an eligible community housing provider, and that provider has given the owner a housing
certificate (in its approved form). Further, only amounts subject to the general CGT discount can be
eligible for this further 10 per cent discount. At the time of writing, this Bill was before the Senate.
These proposed changes are non-examinable.
CGT small business concessions

Four specific CGT concessions may be available to qualifying SBEs, which may allow them to
disregard or defer part or all of a capital gain from an active asset used in a small business.
The basic conditions as set out in s. 152-10 of ITAA97 must be met before any of the four
concessions can be considered as follows:
(a) a CGT event happens in relation to a CGT asset of yours in an income year
Note: This condition does not apply in the case of CGT event D1: see section 152-12.
(b) the event would (apart from this Division) have resulted in the gain;
(c) at least one of the following applies:
(i) you are a CGT small business entity for the income year;
(ii) you satisfy the maximum net asset value test (see section 152-15);
(iii) you are a partner in a partnership that is a CGT small business entity for the income
year and the CGT asset is an interest in an asset of the partnership;
(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT
asset in the income year;
(d) the CGT asset satisfies the active asset test (ITAA97, s. 152-10).
(Note that for gains from CGT event D1, an alternative test in s. 152-12 is used.)
Condition (a) is that a defined CGT event happens in relation to a CGT asset in the income year
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(except for CGT event D1). Under condition (b), the CGT event in condition (a) results in a capital
gain. Under condition (c), the entity must be a CGT SBE for the income year with an aggregated
turnover of less than $2 million, or they must meet the maximum net asset value test under
s. 152-15 of ITAA97. Under this maximum net asset value test, the entity (including related entities
or affiliates) must have net assets of no more than $6 million (excluding personal use assets such
as a home, to the extent that it has not been used to produce income).
Condition (d) is that the CGT asset satisfies the active asset test. A CGT asset satisfies the active
asset test under s. 152- 35 if:
• the taxpayer has owned the asset for 15 years or less and the asset was an active asset of
theirs for a total of at least half of the relevant period, or
• the taxpayer has owned the asset for more than 15 years and the asset was an active asset
of theirs for a total of at least 7.5 years during the relevant period.
The ‘relevant period’ commences at the time of acquiring the asset, and ceases upon the time
of the CGT event. However, if the business ceased within 12 months of the CGT event, then the
relevant period will end at that time instead.
Note that for gains from CGT event D1, rather than the active asset test being satisfied,
the taxpayer must show that the CGT event D1 was inherently connected with an active asset
of theirs (s. 152-12). For instance, if the taxpayer sells a restaurant that was an active asset,
and has entered into a restrictive covenant to not compete with this restaurant for three years,
then the covenant will trigger CGT event D1, and will fulfil this alternative test as it was inherently
connected with an active asset of theirs.
A CGT asset is an active asset if the taxpayer owns it, and:

• they use it or hold it ready for use in the course of carrying on a business (whether alone
or in partnership)
• it is an intangible asset (e.g. goodwill) inherently connected with a business they carry on
(whether alone or in partnership) (s. 152-40).
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Certain CGT assets cannot be active assets, even if they are used or held ready for use in the
course of carrying on a business—for example, assets whose main use is to derive rent (unless the
asset was rented to an affiliate or connected entity for use in their business). Generally, a rental
property will not be an active asset.
Shares in a resident company or interests in a resident trust are active assets if the market value
of the company or trust's active assets, cash and financial interests that are connected with the
running of the business is 80 per cent or more of the market value of all the company's or trust's
assets. Note that where the capital gain has arisen from a sale (or other CGT event) of shares in a
company or units in a trust, then there are other conditions that also need to be fulfilled for CGT
small business concession eligibility. They are:
• That the individual making the sale has to be a CGT concession stakeholder in the company
or trust just before the CGT event occurs (s. 152-10(2)(d)). This means that either they, or their
spouse, must be a significant individual of the company or trust sold (s. 152-60) (if it is their
spouse who is the significant individual, then the taxpayer themselves must also directly/
indirectly have some interest in the entity before it is sold). A significant individual is one
that has a direct or indirect interest in the company or trust of at least 20 per cent (s. 152-55).
Note that there are alternative rules where there is an interposed entity between the
individual and the company/trust that is sold, and the interposed entity is the one that has
actually made the sale (e.g. Bill owns X Ltd, which owns Y Ltd, and X Ltd sells Y Ltd), but these
are beyond the scope of this course.
• Another condition is that the company or trust being sold must be a CGT SBE by having an
aggregated turnover of less than $2 million, or pass the maximum net asset value test by
having net assets of no more than $6 million (s. 152-10(2)(c)). In other words, it is not sufficient
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that the taxpayer making the sale fulfils one of the requirements in condition (c) above;
the entity sold must also pass one of these two tests as well. Note that the way the maximum
net asset value test is calculated for such purposes is slightly modified as compared to how
it is usually calculated, but such modifications are beyond the scope of this course.
• Also, unless the taxpayer making the sale of the shares or units, in fulfilling condition (c)
above, is relying on satisfying the maximum net asset value test, then they must also show
that they themselves have been carrying on a business just before the CGT event. This means
that if a taxpayer is not themselves carrying on a business, but sells an interest in a company/
trust that does, then in fulfilling condition (c) above, they must rely on the maximum net asset
value test (s. 152-10(2)(b)); see Treasury Laws Amendment (Tax Integrity and Other Measures)
Act 2018, Schedule 2).
Four types of CGT small business concessions

The four concessions available are:
• 15-year exemption—if the business has continuously owned an active asset for at least
15 years and the taxpayer is aged 55 or over and is retiring or permanently incapacitated,
then there will not be an assessable capital gain upon sale of the asset.
• 50 per cent active asset reduction—reduction of the capital gain on an active asset by
50 per cent. This is in addition to the 50 per cent CGT discount if applicable.
• Retirement exemption—capital gains from the sale of active assets are exempt up to a
lifetime limit of $500 000. If the taxpayer is under 55, the exempt amount must be paid into
a complying superannuation fund or a retirement savings account.
• Rollover—upon sale of an active asset, all or part of the capital gain can be subject to a
rollover where the taxpayer makes an election to do so. However, if such an election is
made, then by the end of two years after the CGT event, the amount subject to the rollover
must have been used for the acquisition of a replacement active asset, and/or for incurring
expenditure on making capital improvements to an existing active asset. If this is not the
case, then in effect the rollover will be reversed and the taxpayer will be subject to a CGT
liability (refer CGT events J5 and J6 in Table 5.2, earlier).
These four CGT small business concessions are separate to the small business restructure
rollover discussed in the earlier section ‘Small business restructure rollover’. Eligible taxpayers
can apply as many of the concessions available to them until the capital gain is reduced to nil.
There are rules about the order in which you apply the concessions, any current year or prior
year capital losses, and the application of the 50 per cent CGT discount. Specifically, the 15-year
exemption, if applicable, will mean that the other concessions are irrelevant as no CGT will be
payable. If it is not applicable, then the 50 per cent active asset reduction is generally applied.
After that, the remainder of the gain will be potentially subject to the retirement exemption and/
or the rollover to the extent that the taxpayer elects to use one or both of them (each of these
two concessions can be used if the abovementioned conditions for each of them are fulfilled).
Note that examples of these concessions are given in Module 7.
➤ Question 5.6
Mohamad is a resident Australian taxpayer, and works as a consultant cardiologist in the public
hospital system. He receives an annual salary package of $290 000. Mohamad has no partner and
two children, aged 12 and 14. He has a main residence, as well as four investment properties,
and a large share portfolio.
Mohamad purchased a residence (called Property A) on 1 June 2011 and lived it in it for four
years before moving to a new area. He then rented Property A for four years and sold it on 1 June
2019 for $850 000. He purchased and moved into a new residence on 1 June 2015 (Property B),
at which time Property A was worth $700 000.
The costs incurred for Property A were as follows:
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Purchase price $600 000

Valuation fees at time of purchase $4 500
Selling costs $18 000
Capital improvements undertaken in 2018 $70 000
Mohamad has previously claimed $12 000 in capital works deductions on the improvements for
the period it was a rental property.
Mohamad purchased a parcel of shares for his investment portfolio in May 1995 for $15 000.
He sold these shares in November 2018 for $35 000.
(a) What is the maximum period for which Mohammad can claim the main residence exemption
on Property A, sold on 1 June 2019?
(b) Mohamad has chosen to make Property B his main residence for the purposes of the main
residence exemption. Calculate the capital gain amount to be included in Mohamad’s income
tax return.
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(c) Calculate the indexed cost base of the share package sold in November 2018 for $35 000.
(d) Using the facts in part (c), calculate the net capital gain amount to be included in Mohamad’s
income tax return.
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Summary and review

This module introduced and reviewed the laws regarding the CGT provisions in the income tax
legislation. It started off by discussing the core CGT concepts, including an overview of what
are capital gains, capital losses and CGT events. It then went on to discuss CGT events in more
detail, including an overview of many of these events, as well as the more important CGT events.
Many of the CGT events involve a CGT asset of the taxpayer, and so the next part of this module
went on to explain what is considered a CGT asset. This included an examination of collectables
and personal use assets, which are subsets of CGT assets, and are subject to specific rules.
The module then followed this with a discussion on how to calculate the capital gain or loss
resulting from a CGT event being triggered. Many of the CGT events utilise the concepts of
capital proceeds, cost base and reduced cost base in determining the capital gain or loss,
and so these concepts were explained in some detail.
This was then followed by a discussion on when capital gains and losses are disregarded for
CGT purposes. This included a discussion of the highly important main residence exemption,
and rollovers, which also allow CGT relief in certain situations.
Lastly, the module described how to calculate the net capital gain/loss of the taxpayer. This is
an important step, as the net capital gain is the amount included in the taxpayer’s assessable
income. This part of the module comprised an explanation of the general 50 per cent discount,
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as well as the small business CGT exemptions.

Suggested answers
Suggested answers
Question 5.1
CGT event C2 occurred on 15 June 2019 when Coffee Roasters surrendered its contractual right.
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A capital gain arises if the capital proceeds received are more than the right’s cost base. If there
were no legal costs associated with the termination, Coffee Roasters would have made a capital
gain of $10 000 on the disposal of its contractual right.
Question 5.2
As a result of the lease, Solving Solutions Ltd will derive a capital gain of $13 500 for the 2018–19
tax year under CGT event F1.
Question 5.3
The purchase price of $250 000 is the first element in the cost base and the incidental costs that
relate to the acquisition ($15 660) are the second element. As a result, the cost base relating to
the acquisition of the land would be $265 660.

Question 5.4
CGT on sale of town house:
• Shaun can disregard any gain on disposal of his share of the town house, as it was his main
residence since purchase.
• Jane will be subject to CGT on her share of the gain on the town house that relates to the
period 1 July 2018 to 30 June 2019.
CGT on sale of beach house:

• As Jane owns more than 50 per cent of the beach house, it can only be taken to be her main
residence for half the period she lived in it (six months). Consequently, Jane will be subject to
CGT on her share of the gain on the beach house, with a reduction to take into account the
six-month period when it is deemed to be her main residence.
• Shaun will be taxed in full on the gain on his share of the beach house as it has never been
his main residence.
Question 5.5
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James’s net capital gain for 2018–19 is reduced to zero as follows:
$
2018–19 capital gains 20 000
2018–19 capital losses (12 000)
2016–17 net capital losses (4 000)
2017–18 net capital losses (4 000)
Net capital gain Nil
By applying the carried-forward net capital losses in the order in which they are made, $2000 of
the $6000 loss from 2017–18 remains to be carried forward to a future tax year, but the capital loss
of $4000 from 2016–17 is completely extinguished.

Question 5.6
(a) The maximum period Mohamad can claim is the four years when he was resident plus four
years of the six years’ absence from main residence criterion. That is a total of eight years.
If Mohamad chooses to claim the main residence on Property A, then he cannot claim it on
the new house (Property B) for the same period (Subdivision 118-B).
(b) Amount received is $850 000 (s. 116-20) less cost base. This is a situation where s. 118-192
applies, as the house was originally his main residence, and was then utilised for income-
producing purposes after 20 August 1996. As a result, the first element of the cost base is
the dwelling’s market value at the time it started earning income ($700 000). Other relevant
expenditures incurred as of this time are also taken into account, including the capital
improvements of $70 000 and the selling costs of $18 000. This is reduced by the capital
works deduction of $12 000, meaning that for the purposes of s. 118-192, the total cost base
is $776 000. This means that the capital gain would be $74 000.
(c) The indexed cost base is (s. 960-275):
The index number for the quarter of the year in

which the CGT event occurred to the asset
(frozen at the quarter ended 30 September 1999 if CGT event occurred after that date)
The index number for the quarter in which the amount was paid
(or the expenditure incurred)
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which equals 68.7 divided by 64.7 (June 1995) equals 1.062 (rounded to three decimal places).
Therefore the indexed cost base is $15 000 (original purchase price) multiplied by 1.062
(June 1995 quarter used), which equals $15 930.
(d) Using the indexed cost base, the capital gain on the shares would be $19 070 ($35 000 –
$15 930).
Added to the capital gain on the house of $74 000 (which could be discounted by
50 per cent) gives a net capital gain, after discounting, of $56 070.
However, using the 50 per cent CGT discount rule for the shares (rather than indexation),
the capital gain on them would be $20 000 ($35 000 capital proceeds – $15 000 cost base).
This would be added to the capital gain on the house of $74 000, totalling $94 000,
which could be multiplied by 50 per cent, which equals $47 000 net capital gain.
Note that you cannot use the indexed cost base and the 50 per cent reduction rule on
the same capital gain.

MODULE 5
REFERENCES | 229
References
References
ATO 2017, ‘Small business restructure rollover’, accessed March 2019, https://www.ato.gov.au/
General/Capital-gains-tax/Small-business-CGT-concessions/Small-business-restructure-rollover/.
MODULE 5
ATO 2018, ‘CGT assets and exemptions’, accessed 22 November 2018, https://www.ato.gov.au/
general/capital-gains-tax/cgt-assets-and-exemptions/.
MODULE 5
AUSTRALIA TAXATION
Module 6
TAXATION OF INDIVIDUALS
232 | TAXATION OF INDIVIDUALS
Contents
Preview 233
Introduction
Objectives
Teaching materials
Individual taxation core concepts 235
Steps for calculating individual taxation
The tax equation
Defining types of assessable income 236
Employee-related income
Remuneration for overseas services
Income derived from the sharing economy
Income derived from dividends
Income derived from interest
Income derived from property
Income derived from trust investments
Income derived from trusts
Income derived from royalties
Tax treatment of minors
Employment termination payments, personal services income
and employee share schemes 243
Employment termination payments
Personal services income
Employee share schemes
Capital gains tax relief for individuals 259
Capital gains tax main residence exemption
Capital gains tax and marriage breakdown
Individuals, capital gains tax and the small business concessions
Taxing superannuation for individuals 261
Introducing superannuation contributions
Concessional contributions
MODULE 6
Non-concessional contributions
Division 293 tax
Superannuation benefits
Non-superannuation annuities
Calculating allowable deductions 269
Employee versus contractor test for deductions
Employment-related expenditure
Negative gearing
Income protection/replacement
Tax-deductible superannuation contributions
Applying tax offsets 271
Adjusted taxable income
Rebate income
Offsets summary table
Calculating tax payable 286
Tax rates
Tax-free threshold
Medicare levy
References 299
STUDY GUIDE | 233
Module 6:
Taxation of individuals
Study guide
Preview
Introduction
Individual taxation is calculated through a seemingly simple taxation equation. We already know
that taxable income equals assessable income minus allowable deductions. There are special
MODULE 6
rules for individual assessable income and certain allowable deductions, which are discussed in
this module.
Gross tax is payable on the amount of taxable income. From this amount it is necessary to apply
the correct marginal tax rate in order to determine gross tax payable. From this, the taxpayer
needs to subtract any non-refundable tax offsets, refundable tax offsets and any tax already paid.
Added to this amount is the Medicare levy and Medicare levy surcharge as well as any Higher
Education Loan Program (HELP) assessment debt, if applicable (not discussed in this module).

Figure 6.1: Module summary—steps for calculating individual tax
Medicare levy
and Medicare levy Steps for calculating
surcharge individual tax
Calculating tax
Tax rates Tax equation
payable
Types of
Tax-free threshold
assessable income
Unearned
Foreign- Sharing Trust
Ordinary minor Dividends Property Interest Royalties
source economy income
income
Other assessable income
Contributions
ETPs CGT relief for

PSI Superannuation Benefits
individuals
ESSs
Capital exclusion
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CGT marriage CGT small business

Main residence
breakdown rollover concessions
Allowable deductions Tax offsets
DICTO
Zone rebate
Employer versus contractor Employee deductions
Medical expenses
Super contribution
Low income
Integration Control Decision
test test tool LMITO
SAPTO
Beneficiary
Foreign income
Franking credit
Private health insurance

STUDY GUIDE | 235
Objectives
• analyse the income tax implications of various types of income received by individuals;
• apply common CGT reliefs available to individuals;
• identify the income tax implications of an individual making superannuation contributions
and withdrawals;
• calculate the allowable deductions available to individuals in a given situation;
• apply the tax offsets (rebates and credits) that an individual is entitled to in a given
situation; and
• calculate the tax payable or tax refund for individuals.
Teaching materials
• Legislation:
– Family Law Act 1975 (Cwlth)
– Income Tax Rates Act 1986 (Cwlth)
– Treasury Laws Amendment (Personal Income Tax Plan) Act 2018 (Cwlth)
• Glossary:
Definitions/
terms/
MODULE 6
Individual taxation core concepts
Steps for calculating individual taxation
In the Australian taxation system, marginal rates of taxation are applied to an individual’s
taxable income.
• Step 1: The first step is to determine assessable income. The first section, ‘Defining types of
assessable income’, examines the types of assessable income that are included at this stage.
• Step 2: Determine other types of special case assessable income that may have to be
included at this point. This includes any employment termination payments (ETPs), personal
services income (PSI) and income derived from employee share schemes (ESSs). It may also
include any income from capital gains, after the application of applicable capital gains tax
(CGT) reliefs. These items are covered in the sections ‘Employment termination payments,
personal services income and employee share schemes’ and ‘Capital gains tax relief
for individuals’.
• Step 3: Deduct allowable deductions from assessable income—see the sections ‘Taxing
superannuation for individuals’ (for relevant superannuation deductions) and ‘Calculating
allowable deductions’ (for all other deductions).
• Step 4: Apply the correct marginal tax rate (see the final section, ‘Calculating tax payable’,
for this year’s marginal rates) to determine gross tax payable. From this, is subtracted any
non-refundable tax offsets, and then added to this is the Medicare levy and Medicare levy
surcharge (see the final section, ‘Calculating tax payable’), as well as any HELP assessment
debt (not discussed in this module), if any.
• Step 5: Any tax already paid by, or amounts credited to, the taxpayer are then deducted from
the resulting sum. Any refundable tax offsets are then also deducted. This then determines
the total amount of tax payable or tax refund due.
The tax equation

The tax equation is presented in Figure 6.2.
Figure 6.2: The individual tax equation
Assessable income
minus
Deductions
From tax rates Gross tax payable

Taxable income
determine
minus
Non-refundable tax offsets†
add
Medicare levy†
HELP assessment debt‡
minus
Refundable tax offsets
(private health insurance,
and franking)
minus
Tax paid (if any)§
Tax refund
or
Tax payable
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†
For individuals, apart from the private health insurance tax offset and the franking offset, the sum
of the other tax offsets cannot exceed the amount of tax payable (see Divisions 63 and 67 of ITAA97,
and s. 160AD of ITAA36), so they are not refundable. Non-refundable tax offsets cannot be carried
forward to offset tax payable in a future year, and any excess credit cannot be used to reduce the
Medicare levy, Medicare levy surcharge or HELP assessment debt.
‡
The term ‘HELP assessment debt’ includes assessment debt under the former Higher Education
Contribution Scheme (HECS).
§
Includes tax instalments, tax withheld under the Pay-As-You-Go (PAYG) system and tax file number
(TFN) amounts deducted.
Defining types of assessable income

Employee-related income
Employee-related ordinary income can include a salary, wage, gratuity, commission or allowance
paid to the individual in relation to their employee-related activities.
If an employer provides an employee with a defined fringe benefit as part of their employment,
then tax is not levied on the employee in respect of that fringe benefit. The fringe benefit will be
subject to fringe benefits tax (FBT), payable by the employer. FBT is the subject of Module 9.
STUDY GUIDE | 237
Remuneration for overseas services

Where an Australian resident individual receives remuneration for services performed overseas,
which is subject to tax in the overseas country, then the remuneration may be exempt from tax
in Australia. This is when there is a period of continuous foreign service of 91 days or more and
certain conditions are satisfied. To be exempt from Australian tax, the foreign service must be
directly attributable to:
• aid or charitable work as an employee of a recognised non-government organisation
• work as a government aid worker, or
• work as a government employee deployed as a member of a disciplined force (ITAA36,
ss. 23AG, 23AF).
Income derived from the sharing economy

The key terms used in this section are defined as follows.
Crowdfunding is the practice of using the internet and/or social media to find supporters and
raise funds for a project or venture (ATO 2018c).
The sharing economy allows people to connect with others to complete various transactions,
including sharing resources or assets, providing services or crowdfunding. These transactions
generally occur online or through smart devices (ATO 2017b).
Examples include renting out a room in a house or a whole house on Airbnb, or providing ride
sourcing services for a fare, such as through Uber or GoCatch.
Income sourced through the sharing economy

Although the sharing economy business model differs from that of a traditional service provider,
the Australian Taxation Office (ATO) has published guidance that it will apply the tax law as it
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currently stands. Those individuals providing services through the sharing economy have the
same tax obligations as traditional service providers.
Basically, service providers using the sharing economy will have their payments for services
treated as assessable income. This is unless there are reasonable grounds to consider the activity
of providing the services as a hobby or recreational pursuit (so the factors to be considered in
determining whether a business exists, discussed in Module 2, must be applied). The same rule
applies for the goods and services tax (GST), so if the individual is carrying on a business and
the annual turnover meets the $75 000 threshold, they must register for GST. GST is covered
in Module 10. The rules for applying the main residence exemption and CGT are particularly
important in relation to Airbnb services, and are also applied in the same manner. See the section
‘Capital gains tax relief for individuals’ for more information.
Watch this video from the ATO at the following link for a simple description of how tax applies to the
sharing economy: https://www.ato.gov.au/general/the-sharing-economy-and-tax/.
Income derived from dividends

Where a resident individual receives a dividend from a resident Australian company, that dividend
may be franked, partly franked or unfranked.
A franked dividend is effectively one that has been paid out of profits on which the company
has paid tax. The tax paid by the company is imputed to the shareholder by means of a franking
credit that is attached to the dividend received by the shareholder.
For franked dividends, the individual shareholder includes in assessable income the amount
of the dividend received plus the franking credit and claims a tax offset for the tax already paid
by the company.
An unfranked dividend is effectively one that has been paid from profits that have not been
taxed to the company.
For unfranked dividends, the individual shareholder includes the dividend received in assessable
income and there is no tax offset.
For partly franked dividends, the franked portion is treated as a franked dividend and the
unfranked portion is treated as an unfranked dividend.
Franking of dividends is discussed in detail in Module 8.
Where a resident individual receives a dividend from a non-resident company, the individual
is assessed upon the amount of dividend received plus any foreign tax paid on the dividend,
such as withholding tax. The taxpayer then receives a credit for the foreign tax paid equal
to the lower of the foreign tax paid, or for the Australian tax payable on that dividend.
Tax treatment for non-residents

The tax treatment of dividends is different for non-residents.
Non-residents are assessed for tax on dividends that are paid out of profits derived from sources
within Australia.
Dividends are subject to tax in Australia via the withholding system (discussed in Module 2)
and so the foreign resident does not include the dividend income in their Australian assessable
MODULE 6
income. Further, to the extent that the dividend is franked, withholding tax is not levied, so the
dividend income is free from Australian tax in the hands of the non-resident (because it has
effectively already been taxed in the company).
However, an unfranked dividend, or an unfranked portion of a dividend, is subject to withholding

tax at the rate of 30 per cent or generally 15 per cent if Australia has a tax treaty with the non-
resident’s country. No further tax is then payable in Australia on the dividend.
Income derived from interest

Australian residents are required to include interest income as assessable income. Interest income
consists of:
• interest earned from financial institution accounts and term deposits
• interest earned from any other source including penalty interest received on an investment
• interest earned from children’s savings accounts if you opened or operated an account for
a child and the funds in the account belonged to you, or you spent or used the funds in
the account
• interest … paid or credited to you [by the ATO]
• life insurance bonuses (you may be entitled to a tax offset equal to 30% of any bonus amounts
included in your income)
• interest from foreign sources (you may be entitled to a tax offset for any tax paid on this
income) (ATO 2018b).
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Interest received by non-residents from Australian sources is subject to the withholding tax
system (discussed in Module 2) and is therefore not included in the non-resident’s Australian
assessable income.
Income derived from property

The chief source of income derived from real property is rental income. Taxpayers are subject
to taxation on rent and rent-related payments and the full amount must be included on the tax
return. Rent-related payments are:
• letting/booking fees
• insurance payment paid to the taxpayer as compensation for lost rent
• a reimbursement or recoupment for deductible expenditure, such as an amount from a
tenant to cover the cost of repairing damage to the rental property (where the whole amount
received from the tenant would be included in income and a deduction claimed for the cost
of the repairs)
• rent received from renting out a room or a whole house or unit on a short-term basis,
through a website or app, via the sharing economy.
If goods or services are received by the taxpayer instead of monetary rent, then the taxpayer
must work out the monetary value and include that as assessable income.
If the taxpayer owns an investment property jointly or in-common with another person, or
has an interest in a rental property business, then the individual taxpayer’s share of the rent is
assessable. This is in contrast to a residential tenancy bond, which is not generally ‘income’ and
consequently refunds cannot be claimed as a deduction. However, where part of the bond is
kept for repairs or maintenance, then this amount is returned as income and a deduction can be
claimed when the expenditure is incurred. Similarly, where the bond is kept due to unpaid rent,
then it will be regarded as income.
MODULE 6
The use of negative gearing in respect of rental properties as an offset against other income is
discussed in more detail in Module 3.
CGT upon the sale of the property where rent was derived is discussed in Module 5.
Income derived from trust investments

Income received from trust investment products is included as assessable income. Income and
credits from the following must be included:
• cash management trust
• money market trust
• mortgage trust
• unit trust
• managed fund, such as a property trust, share trust, equity trust, growth trust, imputation trust
or balanced trust (ATO 2015).
Also included are income and credits from managed investment trusts—a form of fixed interest
unit trust. Resident taxpayers are required to withhold the final tax amount from managed
investment trust (MIT) payments made to foreign residents.
Income derived from trusts

A trust is not a separate taxable entity, but the trustee is required to lodge a tax return for the
trust. Trust beneficiaries are required to declare the amount of the trust’s income to which they
are entitled in their individual tax return. They are required to pay tax on it, even if they did not
receive the actual income.
One exception is that you do not need to declare a trust distribution if family trust distribution
tax has already been paid. This is discussed in more detail in Module 8, which deals with
trust income.
Income derived from royalties

Royalties are payments made by one person for the use of rights owned by another person.
Royalty payments can be either periodic, irregular or one-off payments and are generally only
assessable when actually received.
Examples include the right to use a copyright or patent, the supply of scientific, technical,
industrial or commercial knowledge or information, or film and video tape royalties. See Taxation
Ruling IT 2660.
Royalties received by non-residents from Australian sources are subject to the withholding tax
system (discussed in Module 2) and are therefore not included in the non-resident’s Australian
assessable income.
Royalties received by a resident taxpayer are generally included as ordinary income and
assessable under s. 6-5 of ITAA97. Where a receipt is not assessable as ordinary income it will
be assessable under s. 15-20. Alternatively, where the royalty is not assessable as income under
these other provisions, it could be subject to CGT.
MODULE 6
Tax treatment of minors

The aim of Division 6AA (ss. 102AA–102AJ) of ITAA36 is to limit the tax advantages of diverting
income to children. It does this by imposing a higher rate of tax on certain unearned income
of children under 18 years of age at 30 June of the relevant tax year.
A minor is subject to the higher rate of tax unless they are an excepted person under the law,
and then standard marginal tax rates will apply.
The same individual taxation rates as an adult apply to a minor who is an excepted person.
An excepted person is someone under 18 who has finished full-time study and is working
full-time, has disabilities or is entitled to a double orphan pension. Adult marginal rates also
apply to minors receiving excepted assessable income, namely income derived from business
or employment, Centrelink payments and income from a deceased person’s estate (ITAA36,
s. 102AE(2)). The ‘eligible assessable income of a year of income of a person is so much of the
assessable income of the person of the year of income as is not excepted assessable income’
(ITAA36, s. 102AE(1)).
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Minor taxation rates

The minor taxation rates apply to eligible taxable income received by minors under the age
of 18 years old. Eligible taxable income is defined in s. 102AD of ITAA36 as follows:
The eligible taxable income of a year of income of a person who is a prescribed person in relation
to the year of income is the amount (if any) remaining after deducting from the eligible assessable
income of the person of the year of income:
(a) any deductions allowable to the person in relation to the year of income that relate exclusively
to that eligible assessable income;
(b) so much of any other deductions (other than apportionable deductions) allowable to the person
in relation to the year of income as, in the opinion of the Commissioner, may appropriately be
related to that eligible assessable income; and
(c) the amount that bears to the apportionable deductions allowable to the person in relation to
the year of income the same proportion as the amount that, but for this paragraph, would be
the eligible taxable income of the person of the year of income bears to the sum of:
(i) the taxable income of the person of the year of income; and
(ii) the apportionable deductions allowable to the person in relation to the year of income
(ITAA36, s. 102AD).
Table 6.1 summarises the taxation rates applicable on eligible taxable income for resident minors.
Table 6.1: Taxation rates on eligible taxable income
Income Tax rates for 2018–19 income year
$0 – $416 Nil
$417 – $1307 Nil plus 66% of the excess over $416
MODULE 6
Over $1307 45% of the total amount of income that is not excepted income
Source: ATO 2018, ‘Higher tax rates’, accessed March 2019, https://www.ato.gov.au/individuals/
investing/in-detail/children-and-under-18s/your-income-if-you-are-under-18-years-old/?page=3#Higher_
tax_rates.
Income to which Division 6AA of ITAA36 does not apply (i.e. excepted assessable income) is
taxed at ordinary rates so that the $18 200 tax-free threshold applies.
Minors with only eligible taxable income cannot access the low-income rebate (see the section
‘Applying tax offsets’). Minors with income from working can, however, apply the low-income
rebate to their wages, which effectively increases their tax-free income.
Figure 6.3 demonstrates how the taxation of children is applied.

Figure 6.3: Taxation of children (if the minor is a resident)—tax rates for 2018–19
Exclusively related (Assuming the minor

Eligible Eligible
allowable deductions, has no other income.)
assessable taxable
less appropriately related = If eligible income
income, income,
and apportionable below $417, tax-free.
s. 102AE(1). s. 102AD.
deductions, s. 102AD. Shade-in provisions†
apply between $417
and $1307, with tax
Prescribed persons,
at a rate of at least
s. 102AC(1). Under 18
66c on each $ over
and not in a full-time
$416. Over $1307 the
occupation, or not
whole is taxed at
incapacitated for work.
45 per cent.
Excepted Taxed at ordinary

assessable rates, with first
income, $18 200 zero rated.
s. 102AE(2).
Excepted
persons,
s. 102AC(2).
†
The tax on eligible taxable income between $417 and $1307 is the greater of (i) 66 per cent of the excess
over $416, and (ii) the difference between the tax on the whole of the taxable income and the tax on
taxable income other than the eligible taxable income.
Source: Based on Income Tax Assessment Act 1936 (Cwlth), Federal Register of Legislation,
accessed March 2019, https://www.legislation.gov.au/Details/C2019C00106.
MODULE 6
Example 6.1: Applying minor taxation rates

Jill, a minor, has a taxable income of $9000 for 2018–19 of which $400 is eligible taxable income.
To calculate Jill’s tax payable, note that as the eligible taxable income does not exceed $416, the whole
of the taxable income is taxed at ordinary resident rates in the normal way. Applying 2018–19 rates,
the tax payable by Jill is therefore nil. (She is not liable for the Medicare levy as her taxable income
does not exceed the threshold.)
➤ Question 6.1
Eli is 17 and a minor for taxation purposes. He has a taxable income of $13 000 in the 2018–19
income tax year, which includes $826 of eligible income.
What is Eli’s tax payable for 2018–19?
STUDY GUIDE | 243
Employment termination payments, personal

services income and employee share schemes
Employment termination payments
Lump sum payments that relate to the termination of a person’s employment are statutory
income. Payments that are made by the employer on termination of an employee’s employment
fall into three main categories:
• ETPs
• genuine redundancy payments and early retirement scheme payments
• unused annual leave and long service leave payments.
To receive concessional tax treatment as an ETP, a payment must generally be received no later
than 12 months after the termination. An ETP does not include any of the following payments
that are either tax free or taxed under their own taxing rules (s. 82-135):
• a superannuation benefit (i.e. a lump sum or income stream from a superannuation fund)
• a payment of a pension or annuity
• unused annual and long service leave payments
• the tax-free part of a genuine redundancy payment or early retirement scheme payment
• certain foreign termination payments
• an advance or loan on terms and conditions that would apply if the parties were dealing
at arm’s length
• a payment that is a deemed dividend
• a capital payment in respect of personal injury so far as the payment is reasonable having
regard to the nature of the personal injury and its likely effect on the person’s capacity to
derive income from personal exertion
• a payment made by a company or trust as described in s. 152-310(2)
• a capital payment in respect of a legally enforceable contract in restraint of trade, so far
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as the payment is reasonable having regard to the nature and extent of the restraint
• an amount received in commutation of a pension and wholly applied to pay a
surcharge liability
• an amount included in assessable income under the ESS rules.
An ETP is defined as a lump sum payment received by a person (s. 82-130(1)(a)):

• in consequence of the termination of that person’s employment (life benefit termination
payment), or
• after another person’s death, in consequence of the termination of the other person’s
employment (death benefit termination payment).
ETPs must generally be taken as cash. The exception to this rule is if the payment is a ‘transitional
termination payment’, which the employee directs should be paid into a superannuation fund.
There are two types of ETP, each with their own taxing rules:
• life benefit termination payment
• death benefit termination payment.
We will now look at these two types of ETP in more detail.

Life benefit termination payment

The life benefit termination payment may be made up of two components: the tax-free component
and the taxable component.
1. Tax-free component
The tax-free component of a life benefit termination payment is not assessable income and
not exempt income (s. 82-10). The tax-free component is that amount of the payment that
consists of either or both of the invalidity segment and the pre-July 1983 segment.
An invalidity segment is that part of the ETP that satisfies the following conditions
(s. 82-150(1)):
– The payment is made to a person because they stop being gainfully employed
(this could include either employees or self-employed persons) as a result of ill health
(whether physical or mental).
– The gainful employment stops before the person’s ‘last retirement day’ (generally when
a person reaches 65 years of age).
– Two legally qualified medical practitioners certify that because of ill health, it is unlikely
that the person can ever be gainfully employed in a capacity for which they are
reasonably qualified because of education, experience or training.
The invalidity segment is calculated using the following formula to ensure that it is made up
only of the part of the ETP that compensates the person for the years of gainful employment
that are lost because of ill health:
Formula to learn
The amount of ETPs is calculated using the formula in s. 82-150(2):
Days to retirement
Amount of employment termination payment ×
Employment days + Days to retirement
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Where:
• days to retirement is the number of days from the day on which the person’s employment was
terminated to the last retirement day
• employment days is the number of days of employment to which the payment relates.
The pre-July 1983 segment is that part of the ETP that is attributable to employment before
1 July 1983. An ETP cannot have a pre-July 1983 segment unless the employee was working
for the employer before 1 July 1983.
Formula to learn
The amount of the pre-July 1983 segment is calculated using the method found in s. 82-155(2):
Step 1. Subtract the invalidity segment (if any) from the ETP
Step 2. Multiply the amount in Step 1 by the fraction:
Number of days of employment to which the payment relates that occurred pre-1 July 1983
The total number of days of employment to which the payment relates
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2. Taxable component
The taxable component of a life benefit termination payment is the amount of the payment
remaining after deducting the tax-free component. 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.
The tax rate depends on the age of the employee and the amount received:
– Tax does not exceed 15 per cent on the amount up to the ETP cap amount ($205 000
in 2018–19) if the taxpayer has reached preservation age (see Table 6.2) on the last day
of the tax year.
– Tax does not exceed 30 per cent up to the ETP cap amount if the taxpayer is below
preservation age.
– In all cases, tax is payable at the top marginal rate of 45 per cent on amounts in excess
of the ETP cap amount.
The Medicare levy is also added where appropriate. Table 6.2 lists the preservation age.
Table 6.2: Preservation age
Taxpayer’s date of birth Preservation age
Before 01.07.60 55
01.07.60 to 30.06.61 56
01.07.61 to 30.06.62 57
01.07.62 to 30.06.63 58
01.07.63 to 30.06.64 59
After 30.06.64 60
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Source: Adapted from ATO 2018, ‘Withdrawing and using your super’, accessed March 2019,
https://www.ato.gov.au/Individuals/Super/Withdrawing-and-using-your-super/.
Whole-of-income cap threshold of $180 000

From the 2012–13 year of income, a whole-of-income cap amount ($180 000 non-indexed) applies
in conjunction with the indexed ETP cap amount for ETPs that are not classified as excluded
payments (discussed later). For these termination payments, the applicable cap that is used to
determine entitlement to the ETP tax offset is the lesser of:
• the ETP cap amount (as indexed, $205 000 for the 2018–19 tax year), or
• the amount worked out under the whole-of-income cap of $180 000 (non-indexed).
Consequently, only the part of the life benefit termination payment that takes a person’s annual
taxable income (including the ETP) up to $180 000 is eligible to be taxed at a maximum of
15 per cent or 30 per cent, depending on the taxpayer’s age (s. 82-10).
The whole-of-income cap is calculated by subtracting from $180 000 the person’s taxable income
(which may comprise, for example, salary and wage income or other income) for the income
year in which the ETP is made. Taxable income in this case excludes the ETP in question and any
other ETPs received later in the income year (s. 82-10(4)–(5)). Also, tax losses are not taken into
account in working out the whole-of-income cap.
Consequently, the amount of the ETP when added to the individual’s other taxable income that
is equal to or below the whole-of-income cap of $180 000 continues to be eligible for the ETP tax
offset, while any amount of the ETP that takes the individual’s total taxable income over $180 000
is taxed at 45 per cent.
The whole-of-income cap of $180 000 does not apply to any life benefit termination payment that
qualifies as an excluded payment, such as a genuine redundancy, an early retirement scheme
or an invalidity segment (s. 82-10(6)). This includes a genuine redundancy payment received
by a taxpayer over the age of 65, even though they are not entitled to the specific genuine
redundancy tax concessions.
Table 6.3 outlines the treatment of life benefit termination payments.
Table 6.3: Taxation of life benefit termination payments—2018–19
Payment amount Below preservation age Preservation age or older
$0 to cap amount †
Maximum of 30% tax Maximum of 15% tax
Above cap amount 45% 45%
†
The ‘cap amount’ refers to the lower of the ‘whole-of-income’ cap and the $205 000 ETP cap amount
(explained above).
Note also that the $205 000 ETP cap amount is reduced for each life benefit termination payment
already received by an employee in the same tax year or received for the same termination either in
that or an earlier year (ITAA97, s. 82-10(4)).

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Example 6.2: Applying employment termination payment

taxation
On 1 July 2019, Paul Metts received an ETP of $150 000, having retired from his employment at age
69 after working for his employer for 45 years. His employment service period is 16 436 days, of which
3287 days relate to service prior to 1 July 1983. The amount of tax payable on the ETP is calculated
as follows.
The tax-free component only comprises the pre-July 1983 segment as there is no invalidity segment.
Number of pre-July days

Therefore, the pre-July 1983 segment = × $150 000
Total number of days of employment
= (3287 / 16 436) × $150 000
= $29 998
The taxable component = $150 000 – $29 998

= $120 002
As Paul has reached preservation age, he pays tax at 15 per cent on the first $120 002, namely $18 000
(excluding Medicare levy). Note that as Paul’s taxable income only comprises the $150 000 ETP, he is
below the $180 000 whole-of-income cap, which therefore does not apply.
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Example 6.3: Whole-of-income cap does not apply

A taxpayer, aged 62 years, received a genuine redundancy payment (excluded payment) of $210 000
and had no other income in the 2018–19 tax year. In these circumstances the redundancy payment
would only be subject to the $205 000 ETP cap. Consequently, the first $205 000 would be concessionally
taxed at 15 per cent, with the balance of $5000 taxed at marginal rates.
Death benefit termination payment

A death benefit termination payment is an ETP received by a person after another person’s death
in consequence of the termination of the other person’s employment (s. 82-130(1)(a)(ii)).
The death benefit termination payment is also made up of a tax-free component and a taxable
component, and must generally be received no later than 12 months after termination. As with
the life benefit termination payment, the tax-free components of the payment are the invalidity
and the pre-July 1983 components discussed previously that are non-assessable, non-exempt
(NANE) income.
The taxable component is included in assessable income (except the amount up to the ETP
cap amount, which is NANE income where the death benefit is paid to a dependant). The tax
treatment will depend on whether the payment is made to a dependant or non-dependant or the
trustee of the deceased person’s estate (see ss. 82-65–82-75 and Table 6.4). Dependants include
the deceased’s spouse (or former spouse), child aged below 18 and any other person with whom
the deceased person had an ‘interdependency relationship’ (s. 302-195).
Table 6.4: Taxation of death benefit termination payments—2018–19
Payment amount Payment to dependant Payment to non-dependant
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$0–$205 000 (cap) Tax-free (NANE income) Maximum of 30% tax
Above $205 000 45% 45%
The Medicare levy is added where appropriate and the $205 000 ETP cap amount is reduced by
the amount of death benefit termination payment already received in consequence of the same
termination. The ETP cap amount is indexed for later years.
The death benefit termination payment to the trustee of a trust estate is taxed in the hands of the
trustee in the same way as if paid directly to the dependant or non-dependant who is intended
to benefit.
Genuine redundancy payments and early retirement scheme payments

A genuine redundancy payment is a payment made in consequence of the dismissal of an
employee because their position is genuinely redundant (s. 83-175(1)) (see Weeks v. FC of T
[2013] FCAFC 2).
An early retirement scheme payment is a payment made to an employee whose employment

is terminated under a scheme approved by the Commissioner of Taxation for the reorganisation
of an employer’s operations (s. 83-180).
Genuine redundancy and early retirement scheme payments consist of a tax-free amount that
is NANE income and an assessable amount that may be taxed as an ETP.
The tax-free amount is calculated by reference to a formula in s. 83-170(3).
Formula to learn
Base amount + (Service amount × Years of service)
Where:
• base amount for 2018–19 is $10 399 and the service amount is $5200 (indexed annually)
• years of service is the number of whole years of employment to which the payment relates.
Example 6.4: Applying genuine redundancy payments

On 30 June 2019, after 18 years and nine months’ service with her employer, Kate Smith had her
employment terminated when the section of the company in which she worked was closed down.
She was paid $110 000 as a genuine redundancy payment.
The tax-free amount is calculated as $10 399 + ($5200 × 18) = $103 999.
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The amount in excess of the tax-free threshold ($110 000 – $103 999 = $6001) is assessable as an ETP
if the conditions in s. 82-130 are satisfied.
Unused annual leave and long service payments

Payments made to employees on termination of employment for unused annual leave and/
or unused long service leave are not ETPs and are subject to Subdivisions 83-A and 83-B of
ITAA97. An unused annual leave payment is included in full in a taxpayer’s assessable income
in the year it is received and, subject to certain exceptions, is taxed at marginal rates (s. 83-10(2)).
The exceptions are where:
• the payment was made in respect of employment before 18 August 1993
• the payment is made in connection with a genuine redundancy payment, early retirement
scheme payment or the invalidity segment of an ETP or superannuation benefit (s. 83-15).
Where an exception applies, a tax offset ensures that the maximum rate of tax that can apply
is 30 per cent (plus Medicare levy).
The amount of any payment made for annual leave that occurred before 18 August 1993 is
calculated using the following formula:
Number of days in accrual period that occurred before 18 August 1993

Payment ×
Number of days in the accrual period
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Payments for unused annual leave made on the death of an employee to either the beneficiaries
or the trustee of the deceased estate are exempt from tax.
An unused long service leave payment of a taxpayer will be included in assessable income if it
has been accrued since 15 August 1978. Only 5 per cent of the amount of any long service leave
payment accumulated before 16 August 1978 will be included as income.
An offset ensures that the maximum rate of tax applied to unused long service leave payments is
30 per cent (plus Medicare levy) in the following circumstances (s. 83-85):
• the payment is made in respect of employment between 16 August 1978 and 17 August
1993, or
• the payment is a genuine redundancy or early retirement scheme payment or is the invalidity
segment of an ETP or superannuation benefit.
The calculation of the unused long service leave for the pre-18 August 1993 period or the post-
17 August 1993 period is performed using the following formula (s. 83-95(2)):
Unused long service leave days in the relevant period

Amount of payment ×
Total unused long service leave days
‘Unused long service leave days in the relevant period’ means the number of unused days of long
service leave in the pre-18 August 1993 period or the post-17 August 1993 period (as applicable)
worked out under s. 83-100.
Table 6.5 summarises the taxation of payments in lieu of unused annual leave and unused long
service leave.
Table 6.5: Taxation of payments in lieu of unused annual leave and unused long
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service leave
Maximum rate of tax

Type of leave Actual date Amount assessable (excluding Medicare levy)
Long service leave Accrued to 15.08.78 5% Marginal rate
16.08.78 to 17.08.93 100% 30%
18.08.93 onwards† 100% Marginal rate
Annual leave Accrued to 17.08.93 100% 30%
18.08.93 onwards† 100% Marginal rate
†
If, in respect of a genuine redundancy payment, early retirement scheme payment or invalidity segment
of an ETP or superannuation benefit, tax is capped at 30 per cent.

Example 6.5: Application of a long service leave payment

Helen Smith started work in 1986 with Exo Ltd and therefore has no pre-16 August 1978 eligible
service. She retired on 30 April 2019 and received a payout of $15 600 for her unused long service
leave. Assume that the:
• total number of days of unused long service leave is 80
• number of days long service leave unused prior to 18 August 1993 is 19
• number of days long service leave unused after 17 August 1993 is 61.
The tax payable by Helen in respect of the $15 600 unused long service leave is determined as follows:
Step 1: Calculate the pre-16 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 following formula:
Unused long service leave days in the relevant period

Amount of payment ×
Total unused long service leave days
61 days (unused long service leave post-17 August 1993)

$15 600 × = $11 895
80 days (total number of unused long service leave days)
Of the $15 600 received for long service leave, $11 895 will be included as assessable income
and taxed at Helen’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 determined as follows:
Post-15 August 1978 component less post-17 August 1993 component

= $15 600 – $11 895
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= $3705
Of the $15 600 received for long service leave, $3705 will also be included in Helen’s
assessable income. However, Helen will receive a rebate to ensure that the amount of $3705
will only be taxed at a maximum rate of 30 per cent (plus Medicare levy).

Income is treated as PSI if it is a reward for personal efforts or skills, or if the income is derived by
an entity, for the personal efforts or skills of an individual (s. 84-5).
The treatment of PSI is governed by Divisions 84, 85 and 86 of ITAA97 and applies to personal
services entities (PSEs).
A PSE is defined as ‘a company, partnership or trust whose ordinary income or statutory income
includes the personal services income of one or more individuals’ (s. 86-15(2)).
Determining personal services income: Step 1—is income personal services income?
PSI is income gained mainly as a reward for the personal efforts or skills of an individual. Income
that is gained by an entity (a company, trust or partnership) for the personal efforts or skills of
an individual will be PSI (see s. 84-5(1) and examples in that subsection).
The rules for determining if income is PSI are summarised in Figure 6.4.
STUDY GUIDE | 251
Figure 6.4: Rules determining if income is personal services income
Is there a payment to you or a

PSE for your personal services? No
(Division 84 and s. 86-15) The rules for PSI do not
apply. However, current
Yes taxation arrangements
(including the application
of the Part IVA
Are you or the PSE conducting anti-avoidance provisions)
a personal services business Yes continue to apply.
(PSB)? (Division 87)
Individual No Personal services entity
The payment is your PSI Is the payment The payment is your PSI
and your assessable No received by Yes to be included in your
income includes this PSI. a PSE? assessable income.
(Division 84) (Division 86-15) (Division 84 and s. 86-15)
Your PSI can be reduced by

certain deductions that the PSE
is entitled to including salary
promptly paid to you
(s. 86-20 and Subdivision 86-B).
Your deductions that Subdivision 86-B limits
relate to your PSI these deductions to those
are detailed in available to an individual
Division 85. under Division 85.
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Any PSI remaining
is included in
your assessable income.
(s. 86-15)
The PSE is required to

withhold on your PSI
remaining in the PSE.
(Division 13 in TAA)
Source: Adapted from Explanatory Memorandum, New Business Tax System (Alienation of Personal
Services Income) Bill 2000, Federal Register of Legislation, accessed March 2019, https://www.legislation.
gov.au/Details/C2004B00697/Explanatory%20Memorandum/Text.
Income is not PSI if it is mainly:

• for the supply or sale of goods
• for granting a right to use property, or
• generated by an income-producing asset (ATO 2017a).
For example, a taxpayer who sells goods or who delivers products using a truck that they own
is not deriving PSI because their income is mainly from the sale of goods or from the use of the
truck, rather than as a reward for personal efforts and skills.
The income derived by a sportsperson from their personal skill is PSI, as is the income derived
by a consultant. The fact that income is paid under a contract does not stop it being for an
individual’s personal efforts or skill (see Fowler v. FC of T (2008) ATC 2476, Taxation Ruling
TR 2001/7).
Determining PSI: Step 2—is the taxpayer conducting a personal services business?
The PSI rules do not apply to PSI that is income from conducting a PSB. An individual or PSE
conducts a PSB if:
• the individual or PSE has a PSB determination from the Commissioner of Taxation in force, or
• the individual or PSE satisfies the results test, or
• less than 80 per cent of the PSI is derived from a single source and the individual or PSE
satisfies one of the other three PSB tests.
There are four PSB tests.
Where an individual or a PSE does not have a PSB determination in force, it must satisfy at least
one of four tests to self-assess that it is conducting a PSB. These four tests are:
1. The results test (see s. 87-18)—if an individual or PSE satisfies the results test, they will be
conducting a PSB, even if 80 per cent or more of the PSI is from one source (see Re Prasad
Business Centres Pty Ltd v. FC of T (2015) ATC 10-396).
2. The unrelated clients test (see s. 87-20)—income derived from two or more entities not
related to each other (see Yalos Engineering Pty Ltd v. FC of T (2010) ATC 10-139).
3. The employment test (see s. 87-25)—employs one or more entities to perform at least
20 per cent (by market value) of the principal work on their behalf.
4. The business premises test (see s. 87-30)—maintains and uses an exclusively used business
premises to gain or produce PSI (see Dixon Consulting Pty Ltd v. FC of T (2007) ATC 2550).
To satisfy the results test, the individual must meet the following three conditions in relation to
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at least 75 per cent of the PSI during the year:

• the individual’s PSI is for producing a result
• the individual is required to supply the plant and equipment or tools of trade (if any) needed
to perform the work that produces the result
• the individual is liable for the cost of rectifying any defects in the work performed (s. 87-18(1)).
Where physical rectification is not possible, an individual or PSE must be liable for damages
in relation to the defect (see Taxation Ruling TR 2001/8).
For each of these conditions, the industry, custom and practice will be considered and taken into
account. When determining whether the results test has been satisfied, the Commissioner of
Taxation will also consider contractual statements between parties to ensure that they convey the
real contractual position.
Apart from the results test, the other three tests cannot be used to determine that an individual
or PSE is conducting a PSB if 80 per cent or more of the PSI is from one source. For the purpose
of the 80 per cent source test, one entity and/or its associates are regarded as the one source.
Where more than 80 per cent of the PSI for an individual is received from one source, the individual
or PSE cannot be conducting a PSB unless they satisfy the results test or obtain a determination
from the Commissioner of Taxation that they are conducting a PSB.
There is a method statement for calculating the taxation implications of PSI found in s. 86-20(2)
of ITAA97. Example 6.6 draws upon this method statement.
Figure 6.5 explains the operation of the PSI rules.

STUDY GUIDE | 253
Figure 6.5: Operation of the personal services income rules
Does an individual or a PSE have income that is mainly a reward for personal efforts or skills of an
individual (an individual’s PSI) and not mainly a reward from the use of assets, the sale of goods,
or a business structure? (Division 84)
Yes
Does the individual or PSE satisfy the No

‘results test’?
No
Is 80 per cent or more
of the individual’s PSI from Part 2-42 of ITAA97
one source? does not apply.
(Division 87)
Yes
No
Has the Commissioner of Taxation made

a PSB determination relating to the
individual’s PSI? You will need to meet one Does the individual or the PSE meet
of the following tests: Yes at least one of the following three
• the results test PSB tests:
• the employment test • the unrelated clients test
• the business premises test, or • the employment test, or
• the unusual circumstances test. • the business premises test?
Yes Yes
The individual or the PSE is conducting a PSB.
Divisions 85 and 86 do not apply. However, No
No Part IVA of ITAA36 may still apply if
income splitting occurs.
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The individual or the PSE is not The individual or the PSE is not
conducting a PSB. conducting a PSB.
Division(s) 85 and/or 86 applies. Division(s) 85 and/or 86 applies.
Source: Based on Taxation Ruling TR 2001/7, ATO Legal Database, p. 6, accessed March 2019,
https://www.ato.gov.au/law/view/document?DocID=TXR/TR20017/NAT/ATO/00001; Taxation Ruling
TR 2001/8, ATO Legal Database, p. 4, accessed March 2019, https://www.ato.gov.au/law/view/
document?DocID=TXR/TR20018/NAT/ATO/00001.
Application of the personal services income rules

If an individual or PSE fails to obtain a PSB determination or fails to satisfy any of the four PSB
tests, they are not conducting a PSB for that year. This means that, as an individual, deductions
against PSI are limited.
For a PSE, it means that any PSI will be attributed to and included in the assessable income of
the individual who provided the service, unless within 14 days after the end of the PAYG payment
period, the PSI is paid to that individual as a salary or wage.
The amount of PSI of a PSE assessable to the individual who performs the services may be
reduced by any:
• PSI deductions—are broadly limited to amounts that an employee-like individual could
deduct and include the expenses of one car used exclusively for business purposes and one
car with some private usage and superannuation for the individual who provides the services
(s. 86-75).
• Entity maintenance deductions—such as bank and government charges, statutory fees and
tax-related expenses, but only where these expenses have not first been offset against any
non-PSI income derived by the PSE. (See also TR 2003/10 regarding PSI deductions.)
If the result is a net PSI loss, the individual, rather than the PSE, is entitled to deduct the net PSI
loss from other income. If the individual’s current income cannot absorb the loss, then it is able
to be carried forward and deducted against future income.
Any net non-PSI of the PSE is retained and taxed in the entity.
Calculating how much personal services income to include in the individual’s

assessable income
The amount of PSI included in assessable income under s. 86-15 may be reduced (not below
zero) by certain deductions to which a PSE is entitled. Figure 6.6 outlines the method statement
under s. 86-20(2) that is used to work out whether and by how much the amount can be reduced.
Figure 6.6: Calculating personal services income
Step 1—Determine the amount of any PSI deductions to which the PSE is entitled.
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Step 2—Determine the amount of any entity maintenance deductions to which the PSE is entitled.
Step 3—Determine the PSE’s other assessable income, disregarding any PSI.
Step 4—Subtract the other income (Step 3) from the entity maintenance deductions (Step 2).
Is the amount under Step 4 greater than zero?
Yes No
Step 5—The PSI is reduced by the total amount Step 6—The PSI is reduced by the amount
of Step 1 + Step 4. Step 6 does not apply. under Step 1 only. Step 5 does not apply.
Consequently, either Step 5 or Step 6 will apply depending on the result in Step 4. After the
income attributable to the individual under s. 86-20 has been calculated, the income for the PSE
can be determined.
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Example 6.6: Taxation implications of personal services income

method statement
The following example illustrates the method statement in s. 86-20(2).
Helen Orange is a computer consultant who provides her consulting services through her private
company, Comsolv Pty Ltd. The company has contracted with A Pty Ltd for Helen to provide consulting
services for software development and network design maintenance. The income gained by Comsolv
for personal services is PSI and will be attributed to Helen and included in her assessable income.
The income and deductions of Comsolv consist of:
$
PSI 100 000
Other income 2 500
Entity maintenance deductions 4 000
Other income deductions 500
PSI deductions 30 000
To determine the amount by which the PSI should be reduced, the steps in the s. 86-20(2) method
statement should be followed:
$
Step 1 Determine any PSI deductions 30 000
Step 2 Determine any entity maintenance deductions to which PSE is entitled 4 000
Step 3 Determine any other assessable income 2 500
Step 4 Entity maintenance deductions less other income (Step 2 – Step 3) 1 500
Step 5 PSI is reduced by the sum of Step 1 and Step 4 ($30 000 + $1500) 31 500
Step 6 PSI is reduced by the deductions in Step 1 under this step. Step 6 does
not apply as the amount under Step 4 is greater than zero
The amount of assessable income attributed to Helen is $100 000 – $31 500 = $68 500. This amount
is included in Helen’s assessable income to be taxed at her marginal income tax rates.
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The balance of the other income of the entity, which is now zero, is reduced by the other income
deductions still available:
$0 – $500 = ($500)
The personal services entity has an overall loss of $500. This loss is retained in the PSE to be offset
against any future income that the entity earns.
Alternatively, if the PSI deduction had been $130 000 rather than $30 000, then Helen’s net PSI loss
would have been $100 000 – ($130 000 + $4000 – $2500) = $31 500 loss. The net loss of Comsolv would
remain at $500.
Division 85 outlines the deductions that an individual can and cannot claim against PSI where
they are not conducting a PSB. With some exceptions, the deductions against PSI are essentially
limited to the deductions that are available to an employee (see s. 85-10(1)).
➤ Question 6.2
Jack Kendall is an academic who provides consulting services through his private company JJ Ltd.
The company has contracted with B Ltd for Jack to provide consulting services. The income gained
from JJ, which does not constitute a PSB, will be attributable to Jack and will be included in his
assessable income.
The income and deductions of JJ for the 2018–19 tax year consisted of:
$
PSI 100 000
Other income 4 000
Entity maintenance deductions 3 000
Other income deductions 500
PSI deductions 55 000
Determine the amount attributable to Jack under the PSI regime for the 2018–19 tax year.
MODULE 6
Employee share schemes

One way a company can remunerate its employees is to allow them to acquire shares or provide
them with the rights to acquire shares in the company at a discount.
Division 83A of ITAA97 covers the tax treatment of ESSs. It contains rules for the up-front and
deferred taxation of discounts on shares and rights provided under ESSs.
Up-front taxation
Up-front taxation is the default position. This means that normally, any discount to the market
value of interests in shares or rights provided under an ESS is taxed up front on acquisition.
The discount must be included in an employee’s assessable income for that tax year (s. 83A-25).
There is a $1000 tax exemption for taxpayers participating in an ESS who pay tax up front, if the
sum of their taxable income, reportable fringe benefits, reportable superannuation contributions
and total net investment losses is less than $180 000 and the employee and the scheme meet
certain conditions (see s. 83A-35). These conditions are:
• The ESS interests offered under the scheme relate to ordinary shares only.
• The employee must be employed by the company providing the ESS or by one of
its subsidiaries.
• The scheme must be offered to at least 75 per cent of the permanent employees with
three or more years of service who are Australian residents.
• 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.
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• The employee must not receive more than 10 per cent ownership of the company, or control
more than 10 per cent of the voting rights in the company, as a result of participating in
the scheme.
Example 6.7: Determining tax liability under employee

share scheme
Mack Patton is employed by Dairy Cheese Company Ltd, and acquires shares in Dairy Cheese at a
$1500 discount to their market value under an ESS. The discount is not eligible for deferral. It is treated
under the up-front taxation rules. Mack’s taxable income, adjusted by reportable fringe benefits,
reportable superannuation contributions and total net investment loss, is $80 000.
If the ESS meets the other conditions (see earlier), Mack will receive the tax exemption, and will
reduce the amount of the discount included in his assessable income by $1000. He will still include
the remaining $500 in his assessable income.
Deferred taxation
Deferred taxation is possible, but is not as commonly used as up-front taxation. Deferred taxation
would apply to ESS interests where:
• The ESS interest relates to ordinary shares and is subject to a real risk of forfeiture. This results
in a real risk of forfeited shares. Deferred taxation operates to mitigate this risk.
• The relevant ESS interest is acquired under a salary sacrifice arrangement, and the employee
must receive no more than $5000 worth of shares under such arrangements in a tax year
(certain other conditions must also be met).
• The ESS restricts the employee from immediately disposing of a right (s. 83A-105).
The general requirements for deferred taxation are the same as for up-front taxation. However,
start-up companies have particular concessions that apply to them, which will be discussed in the
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next section.
An interest would be at real risk of forfeiture if a reasonable person would consider that there is
a real risk that the employee would lose the interest, or never receive it, or through the market
value of the interest falling to nil.
When tax on an ESS discount is deferred, it is deferred until the ESS deferred taxing point occurs.
When is the deferred taxing point?

For shares it is the earliest of when (s. 83A-115):
• there is no real risk that the employee will lose the share under the conditions of the scheme,
other than by disposing of it, and there are no restrictions preventing disposal, or
• the employee ceases the employment in respect of which they acquired the share, or
• fifteen years have elapsed since the employee acquired the share.
For rights, under s. 83A-120(4):

The first possible taxing point is the earliest time when:
(a) you have not exercised the right; and
(b) there is no real risk that, under the conditions of the employee share scheme, you will forfeit
or lose the ESS interest (other than by disposing of it, exercising the right or letting the right
lapse); and
(c) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately
disposing of the ESS interest—the scheme no longer so restricts you (ITAA97, s. 83A-120).
At the deferred taxing point, s. 83A-110 includes an amount in the employee’s assessable income
equal to the current market value of the ESS interest less its cost base.
The 30-day rule

If the ESS interests are disposed of within 30 days after the day that would be the ESS deferred
taxing point, the ESS deferred taxing point is instead the date of disposal. This is the 30-day rule
(ss. 83A-115(3), 83A-120(3)).
Example 6.8: Risk of forfeiture

Suzy Weeks enters into an ESS arrangement with her employer, AAA. She will receive 1000 AAA shares
in three years if she is still employed by AAA at that time.
Furthermore, AAA will grant her shares if she ceases employment before three years for an unexpected
reason, such as sickness or invalidity under a ‘good leaver clause’.
In this situation, there is a real risk of forfeiture as Suzy’s shares are at risk and she will defer tax
for three years. However, if employees at AAA routinely received their shares, regardless of their
reason for leaving, the ATO may consider that the scheme has contrived a ‘real risk’ and is not
eligible for deferral of tax.
Figure 6.7: Operation of the employee share scheme rules
Conditions:
1. Employee share scheme
2. Employee of the group
Employee receives 3. Ordinary shares
shares or options 4. At least 75% of employees can
under employee participate in the scheme
share scheme 5. Does not result in employee
Concessionally owning more than 10% of shares
All others 6. Does not result in employee
taxed schemes
owning more than 10% of
voting rights
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Further conditions: Schemes eligible for Schemes eligible for Further condition:
1. No risk of forfeiture a tax exemption a tax deferral Genuine risk of forfeiture
2. Restriction on disposal
(minimum of 3 years or
at time of ceasing
employment if sooner)
3. Non-discriminatory access
to shares (or rights) and
the provision of finance
Acquisition taxing point
Employee is taxed on Employee is taxed on discount

discount when shares when shares or rights are
or rights are acquired acquired less a tax exemption
for the first $1000 of discount
$1000 tax exemption only

applies if income is less than
$180 000
Later taxing point
Any subsequent capital Any subsequent capital At cessation time Cessation time:
gains/losses are covered gains/losses are covered by discount and capital Earliest of: (shares and rights)
by CGT (access to CGT CGT (access to CGT discount) gains are taxed as ● 15 years
discount) income (no CGT ● Ceasing employment
discount) ● Employee can pass legal
title or could, but for a
waiting period
(extra point for rights)
● Rights can be exercised
Source: Based on The Treasury 2009, Reform of the Taxation of Employee Share Schemes,
Consultation Paper, Australian Government, Canberra, p. 49.
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Start-up companies and employee share schemes

There is a concession in place for employees of eligible small start-up companies when acquiring
shares (or rights) in their employer (or in a holding company of their employer) on or after 1 July
2015. Under this concession, the employee is provided with an income tax exemption for the
discount received on the eligible shares (or rights).
For shares, the discount is not subject to income tax. The share, once it is acquired, is then
subject to CGT with a cost base reset at market value. For rights, the discount is not subject to
up-front taxation, and it is then subject to CGT with a cost base equal to the employee’s cost of
acquiring the right.
To access this concessional treatment, the following conditions must be met:

• There can be no equity interests listed on a stock or securities exchange in the company in
which the ESS interests are.
• The ESS interest must be in a company incorporated for less than 10 years at the end of the
most recent income year before the ESS interest was acquired.
• The ESS interest must be in a company that had an aggregated turnover of no more than
$50 million in the most recent income year before the ESS interest was acquired.
• The employing company (which may or may not be the company issuing the ESS interest)
must be an Australian resident taxpayer.
• For a share, the EES interest must be acquired at no more than 15 per cent discount to the
market value of the share.
• For a right, the right must have an exercise price that is greater than or equal to the market
value of an ordinary share in the issuing company when the right is acquired.
Where the start-up concession applies, all other ESS taxation rules do not apply, including no
access to either the $1000 up-front concession or the deferred taxation concession (ss. 83A-35(2)
(c), 83A-105(1)(ab)).
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Capital gains tax relief for individuals
Capital gains tax main residence exemption
CGT was explored in detail in Module 5.
In this section we will examine the main elements of CGT that impact individual taxation,
starting with the main residence exemption: there is no capital gain or capital loss made from
a CGT event that relates to a dwelling that is the taxpayer’s main residence.
The Module 5 sections ‘Main residence exemption’ and ‘Amount of main residence exemption
available’ looked at how the main residence exemption operates for resident individuals in
more detail, particularly in relation to the rules about when the main residence exemption will
not apply.
Does the main residence exemption apply in the sharing economy?

Basically, the main residence exemption does not apply where:
• the residence was only a main residence for part of the ownership period, or
• the residence was used for the purpose of producing assessable income.
It is necessary to consider how a main residence is treated for CGT where it is used in the sharing
economy, such as when it is rented out as a whole house, or a room in a house on sites such
as Airbnb.
The current view is that when a main residence is used in such a manner, it is likely that part
of the CGT exemption will be lost. If the main residence is used for the purpose of producing
assessable income during the ownership period, the taxpayer will lose a proportion of the
exemption based on the proportion of the property made available for rent and the length
of time it was rented.
However, the full CGT main residence exemption may still be available if the taxpayer moves
out of the main residence to live in another home for a period of time.
If the property is used for income-producing purposes in this period of absence, the maximum
period the dwelling can be treated as the taxpayer’s main residence is six years (under the
absence from main residence rules in s. 118-145—refer to the ‘Absence from main residence’
section in Module 5). If they are simply leaving their property to stay with friends or family while
renting out their house via Airbnb, or a room in that house, then the property is still considered
their main residence.
Capital gains tax and marriage breakdown

Marriage breakdown and same asset rollover
A CGT same asset rollover event under Subdivision 126-A will occur when CGT assets are
transferred to a spouse or former spouse as a result of a binding legal agreement following a
marriage or relationship breakdown.
Marriage breakdown and the main residence exemption rule

Where a post-CGT acquired ownership interest in a dwelling is transferred to a former spouse as
a result of a CGT marriage breakdown rollover under Subdivision 126-A, the CGT main residence
exemption rules are applied.
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They will consider the way both the transferor and transferee spouses used the dwelling during
their combined period of ownership when determining the transferee spouse’s eligibility for the
main residence exemption on a future disposal of the property (s. 126-5). This is discussed further
in the ‘Amount of main residence exemption available’ section in Module 5.
Example 6.9: Same asset rollover and relationship breakdown

Reece (the transferor spouse) was the sole owner of a dwelling that he used as rental property for two
years, then he used it as a main residence for three years. After living in the house for three years,
he transferred it to his former spouse, Eliza (the transferee spouse), because of a marriage breakdown
that satisfied the rollover conditions of Subdivision 126-A. Eliza used the dwelling only as a rental
property for a further six years before selling it. She never lived in the house.
Eliza will only be eligible for a 27 per cent main residence exemption as the dwelling was only used as a
main residence for three years of the 11-year collective period that Reece and Eliza owned the dwelling.
Example 6.10: Crystallising gain/loss on transfer

Lucy’s ex-husband Chris owns land (purchased in 1997) with a cost base of $75 000. As a result of a
court order under the Family Law Act 1975 (Cwlth), Chris is required to transfer the land to Lucy.
Rollover relief automatically applies to ensure that Chris does not crystallise a capital gain or loss on
the transfer. Lucy’s cost base in the land is $75 000 (the same as Chris’s cost base).
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Individuals, capital gains tax and the small business concessions

There are four small business concessions available to SBEs, which include small business owners
and sole traders (individuals) who met the requirements of a CGT SBE. These concessions are
summarised in Table 6.6 and explored in more detail in the section ‘Refresher on capital gains
tax concessions for small business entities’ in Module 7. These concessions are important to
consider when an individual is carrying on a small business and makes a capital gain in relation
to an active asset.
Table 6.6: Capital gains tax small business concessions
Rule Description
15-year exemption If the business has continuously owned an active asset for at least 15 years and
the taxpayer is aged 55 or over, and is retiring or permanently incapacitated,
then there will not be an assessable capital gain upon sale of the asset.
50% active asset reduction Reduction of the capital gain on an active asset by 50%. This is in addition to
the 50% CGT discount if applicable.
Retirement exemption Capital gains from the sale of active assets are exempt up to a lifetime limit of
$500 000. If the taxpayer is under 55, the exempt amount must be paid into a
complying superannuation fund or a retirement savings account.
Rollover exemption Upon sale of an active asset, all or part of the capital gain can be subject to
a rollover where the taxpayer makes an election to do so. However, if such
an election is made, then by the end of two years after the CGT event,
the amount subject to the rollover must have been used for the acquisition of
a replacement active asset, and/or for incurring expenditure on making capital
improvements to an existing active asset. If this is not the case, then in effect
the rollover will be reversed and the taxpayer will be subject to a CGT liability.
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Taxing superannuation for individuals

Introducing superannuation contributions
Superannuation contributions can be paid either by employers on behalf of employees, or directly
by the employee or self-employed person into their superannuation account.
Employer contributions
Under Australian law, all employers are legally required to make compulsory Superannuation
Guarantee (SG) contributions on behalf of their employees. For 2018–19, the rate is 9.5 per cent
of the employee’s wage or salary (ordinary times earnings). Ordinary time earnings are defined
as what the employee earns for ordinary hours of work, including over-award payments,
commissions, allowances, bonuses and paid leave.
Concessional contributions
Concessional contributions are those where the contributor claims a deduction for the
superannuation contribution. These include SG contributions and deductible contributions
made by an individual into their own superannuation account.
SG contributions made through salary sacrifice arrangements are also counted as employer
contributions.
Although previously only self-employed persons could make tax-deductible contributions to their
own superannuation accounts, now nearly all taxpayers have the ability to do so (whether they
are self-employed, employees or have other sources of income).
All concessional contributions made to all of the individual’s superannuation funds are added
together and counted towards the concessional contributions cap.
Superannuation contributions caps are upper limits on the amount of money an individual
can contribute (concessional or non-concessional) to their superannuation fund in each tax year.
Currently concessional contributions in the superannuation fund are taxed at a concessional
rate of 15 per cent. Superannuation caps are able to be exceeded, but any excess amount is
subject to higher tax rates. The amount of additional tax applied will vary depending on the
age of the taxpayer, the financial year the excess contributions relate to, and whether they are
concessional or non-concessional.
Table 6.7 outlines the concessional contributions caps and the treatment of any excess
contributions.
Table 6.7: Concessional contributions caps

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Your age at Your concessional Treatment of excess

Income year Date this date contribution cap concessional contributions
Included as taxable income,

2018–19 30 June 2018–19 taxed at marginal tax rate
All ages $25 000
2017–18 30 June 2017–18 plus an excess concessional
contributions charge
Source: Based on ATO 2019, ‘Contribution caps’, accessed March 2019, https://www.ato.gov.au/Super/
Self-managed-super-funds/Contributions-and-rollovers/Contribution-caps/#Concessional_contributions.
As Table 6.7 shows, the concessional contributions cap was reduced to $25 000 per year effective
from 1 July 2017.
Unused concessional cap carry forward

In order to address the reduction of both the concessional and non-concessional contributions
caps (see the section ‘Non-concessional contributions’), those individuals with superannuation
balances of $500 000 or less will be eligible to ‘catch up’ their contributions by rolling over
any unused contributions caps for up to five years. This concession applies from 1 July 2018.
The first year an individual is entitled to use carry-forward unused amounts is the 2019–20
financial year. Unused amounts are available for a maximum of five years, and after this period
will expire. Example 6.11 shows how the unused concessional caps are carried forward.
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Example 6.11: Carry-forward concessional contributions

During 2018–19 to 2021–22, Sam has minimal superannuation contributions as he is working part-time
while completing studies. His superannuation balance is continuing to grow with earnings and a small
amount of superannuation contributions, but in 2020–21 his account balance reduced due to negative
returns in that year. Sam has unused cap amounts for each of the 2018–19 to 2021–22 financial years.
Carry-forward concessional contributions
2018–19 2019–20 2020–21 2021–22
General contributions cap $25 000 $25 000 $25 000 $25 000
Total unused available cap accrued $0 $22 000 $44 000 $69 000
Maximum cap available $25 000 $47 000 $25 000 $94 000
Superannuation balance 30 June prior year $480 000 $490 000 $505 000 $490 000
Concessional contributions $3 000 $3 000 nil nil
Unused concessional cap amount accrued $22 000 $22 000 $25 000 $25 000
in the relevant financial year
Note: This table assumes no indexing of general cap.
Sam would be entitled to use the unused concessional cap amounts in 2019–20 and 2021–22, as his total
superannuation balance at the end of 30 June in the year immediately preceding was less than $500 000.
Sam would not be able to use his unused concessional cap contributions in 2020–21, as his total
superannuation balance at the end of 30 June of the previous year was $505 000.
In 2021–22, Sam returns to work. For that year he has a maximum concessional cap amount available
of $94 000 ($69 000 plus $25 000) for 2021–22 and is eligible to contribute this amount as this total
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superannuation balance at the end of 30 June 2021 was now less than $500 000.
Source: ATO 2019, ‘Concessional contributions cap’, accessed March 2019,

https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=3.
Excess concessional contributions charge

The excess concessional contributions (ECC) charge is applied to the additional income tax
liability that arises from making excess concessional contributions (above the cap). The ECC
charge is payable for the year a person makes excess concessional contributions.
ECC are basically taxed at the taxpayer’s marginal tax rate (s. 291-15(a)), and a non-refundable
tax offset is received equal to 15 per cent of the excess contributions (s. 291-15(b)).
Low-income superannuation tax offset

Low-income earners have their 15 per cent contributions tax paid on SG contributions effectively
rebated to them through the low-income superannuation tax offset (LISTO). This refund is paid
directly to the superannuation fund by the government. This is available for those earning income
of up to $37 000. The rebate is capped at $500.
Non-concessional contributions
Non-concessional contributions are those paid from after-tax monies—so after the tax has
already been paid at some point on the money being invested. They are contributions made by
or on behalf of a member that are undeducted and are excluded from the assessable income
of the fund.
The non-concessional cap for an income year is a multiple of the concessional contributions cap
(four times $25 000; see Table 6.8).
Concessional contributions in excess of the concessional contributions cap for the year are also
included in non-concessional contributions. Note that both the ECC charge (discussed earlier)
and the excess non-concessional contributions tax are not tax deductible.
Table 6.8: Non-concessional contributions cap
Financial year Non-concessional cap Tax on amounts over cap
2018–19 $100 000 47%
Source: ATO 2019, ‘Excess concessional contribution charge’, accessed March 2019,
For those members with a total accumulated superannuation balance of over $1.6 million,
the cap is reduced to nil. This has been applied from 1 July 2017.
Bring-forward arrangement
Individuals who were under age 65 at any time during the tax year may be able to make non-
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concessional contributions of up to three times the annual non-concessional contributions cap

in a single year. When the individual makes contributions greater than the annual cap, then they
will automatically gain access to future year caps. This is known as the ‘bring-forward’ option.
From 1 July 2017, the bring-forward amount and period is dependent on the total superannuation
balance on the day before the financial year.
Capital gains tax cap amount

The non-concessional CGT cap allows individuals (who are eligible to make non-concessional
contributions so have a superannuation balance under $1.6 million) to make non-concessional
superannuation contributions, up to the lifetime CGT cap amount. The CGT cap amount applies
to capital gains subject to the CGT small business concessions, where the retirement exemption
or 15-year exemption applies, and the gain is contributed to superannuation.
The CGT cap applies to all excluded CGT contributions, and is a lifetime cap. For 2018–19,
the CGT cap is $1 480 000.
Division 293 tax

There is also additional tax paid by individual taxpayers (known as the Division 293 tax)
whose overall income for surcharge purposes plus their concessionally taxed superannuation
contributions exceed a threshold in any income year. This threshold is $250 000 (2018–19 income
year), and for those individuals earning over $250 000, their concessional superannuation
contributions are levied an additional 15 per cent tax, so they effectively pay 30 per cent tax
on these contributions.
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Superannuation benefits
Superannuation benefits are paid in a retirement income stream (see s. 307-70) or as a lump sum
(see s. 307-65). Most retirement benefits are now paid as retirement income streams, also known
as ‘account-based pensions’, which have no set time limit and are paid on a regular basis to the
retiree, or annuities, which generally have a fixed time period. Annuities are discussed in the
next section, ‘Non-superannuation annuities’.
The taxation status of the payment of retirement income streams is constantly evolving as
governments are constantly searching for the best way to ensure that individuals are incentivised
to contribute to their own retirement, and to then use their retirement savings for their
own retirement.
In the past, the taxation of retirement income streams and lump sums has been very complex,
involving calculations of items such as taxable amounts, and non-taxable amounts for all
individuals.
For all individuals’ superannuation benefits accessed on or after the age of 60, benefits paid from
a taxed superannuation fund (which nearly all superannuation funds are) are received tax free.
Components of a superannuation benefit

There are two possible components of a superannuation benefit (s. 307-120):
• the tax-free component
• the taxable component.
Taxable component
The taxable component of a benefit is made up of employer contributions (e.g. SG contributions),
salary sacrificed contributions, and personal contributions where a tax deduction was claimed.
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It will typically also include the earnings that the fund has made by investing the superannuation
balance.
Tax-free component
The tax-free component is made up of the contributions segment and the crystallised segment.
‘The contributions segment generally includes all contributions made after 30 June 2007 that
have not been, and will not be, included in the superannuation fund’s assessable income’
(ATO 2018a). Most often, this means member contributions where a tax deduction has not
been claimed by the member (non-concessional contributions).
The crystallised segment is comprised of the pre-July 2007 contributions as follows:

• concessional component
• the post-June 1994 invalidity component
• undeducted contributions
• CGT exempt component
• pre-July 1983 component (ATO 2018a).
Tax status of benefits for those aged 60 and over

As stated previously, benefits paid from a taxed fund are now tax free to those aged at least
60 who meet a condition of release. The tax-free status applies whether the benefit is taken as
a lump sum or as an ongoing income stream. Nearly all Australian superannuation funds are a
taxed fund, meaning the superannuation benefits are paid from a taxed source. An untaxed fund
is where taxation has not been paid by the scheme, and relates only to benefits from some older
public sector schemes now closed to new members.
Tax status of benefits for those aged between preservation age and 59
Individuals can access their superannuation when they reach preservation age and retire, or if
they commence a transition to retirement income stream. Preservation rules, and preservation
ages, are presented in the section ‘Life benefit termination payment’.
For those who have reached preservation age but are under age 60, no tax is payable on the
tax-free component of the lump sum payment. There is no tax on the taxable component of lump
sums received below the low rate cap of $205 000 for the 2018–19 year. The $205 000 low rate cap
is a lifetime cap. Amounts above the low rate cap are taxed at 15 per cent plus Medicare levy.
The treatment is different for income streams. The tax-free component of the income stream
benefits is not taxed. Income sourced from the taxable component is taxed at the marginal tax
rates. There is a tax offset applied equal to 15 per cent of the taxable portion of the payment.
Note these rules apply to benefits received from a taxed source.
Example 6.12: Superannuation proportioning rule and

tax offset
During the 2018–19 tax year, Jared Boustead, aged 59 (and having reached his preservation age),
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received an income stream benefit from his complying superannuation fund made up of a $10 000
tax-free component and a $40 000 taxable component. The $40 000 would be included in Jared’s
assessable income and taxed at marginal rates, but then Jared would also be entitled to a tax offset
of 15 per cent of the $40 000 taxable component (i.e. Jared’s tax liability would be reduced by $6000).
Benefits paid to persons aged under preservation age

In very limited and specific circumstances, benefits can be paid out to people aged under their
preservation age. This usually occurs in exceptional circumstances such as permanent incapacity.
Rates vary depending upon the reason for accessing the benefits. In some cases they can be
received tax free. See: https://www.ato.gov.au/rates/schedule-11---tax-table-for-employment-
termination-payments/?page=6.
If superannuation is being accessed because of severe financial hardship, then the tax-free
component is still tax free. The taxable component of the income payment is still added to your
taxable income and taxed at the individual’s marginal rates unless if paid as a lump sum, in which
case the tax rate is capped at 20 per cent.
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Benefits paid through a transition to retirement income stream

A transition to retirement income stream allows an individual to access some of their retirement
benefits while still working, thereby combining some employment income with some retirement
income stream benefit. This may allow the individual to reduce work and still maintain their living
standards, or salary sacrifice income into their superannuation account at a higher rate.
A transition to retirement stream can only be commenced if the individual has reached their
preservation age (discussed earlier).
An individual cannot withdraw more than 10 per cent of the balance of their account each
financial year and lump sum withdrawals are prohibited. The taxation status for the receipt of
benefits is the same as for other income streams, dependent on the age of access.
Non-superannuation annuities
Non-superannuation annuities and pensions are taxed under s. 27H of ITAA36.
A (non-superannuation) annuity is defined as an annuity, or a pension paid from a foreign

superannuation fund, or a pension paid from a superannuation scheme that is not an Australian
or foreign superannuation fund (ITAA36, s. 27H(4)).
An annuity is a regular, periodic payment of money for a fixed period or until the death of
the annuitant.
An annuity amount needs to be distinguished from a series of payments that represent a

repayment of the purchase price upon the disposal of an asset, which are instalments of capital.
Recovery of capital exclusion

Recovery of capital exclusion: Because the amounts of certain annuities are included in a
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taxpayer’s assessable income under s. 27H, a formula is used to exclude the capital portion of
the annuity payments. This formula is the recovery of capital exclusion.
To avoid taxing the amount of a taxpayer’s own capital that is included in the annuity payment,
there is a deduction for the proportion of each annuity payment that represents a return of
that part of the capital investment for which the annuitant has not previously obtained a tax
deduction. This is referred to as the undeducted purchase price (UPP).
Where an annuity is derived by a taxpayer, the allowance for the UPP will not cease upon the
taxpayer’s death. For example, where the taxpayer dies and the annuity is payable to the
taxpayer’s spouse, the spouse will also be able to claim a deduction in respect of the UPP.
Formula to learn
Excluded from the annuitant’s assessable income each year is the deductible amount determined from
this formula from s. 27H(2) of ITAA36:
A × (B – C )
D
Where:
‘A’ represents the proportion of the annuity to which the taxpayer is entitled in the tax year. Where the
taxpayer receives the entire annuity, this component will be one.
‘B’ represents the UPP, which is so much of the purchase price paid on or after 1 July 1983 that has not
been allowed as a deduction. The ‘purchase price’ is the sum of payments made to purchase the pension
or annuity, and so much as the Commissioner of Taxation considers reasonable of the payments made
to obtain pension/annuity benefits.
‘C’ represents the residual capital value, which is any capital amount payable on termination of the
annuity or pension.
‘D’ represents the relevant number under s. 27H(4), which will be one of the following depending on
the circumstances:
• the number of years for which the annuity is stated to be payable (e.g. 10 years)
• the life expectancy in years of the person for whose lifetime the annuity is to be paid (calculated in
accordance with the Australian life tables), or
• in any other case the number that the Commissioner of Taxation considers appropriate, having
regard to the total number of years during which the annuity may reasonably be expected to be
payable. Where the annuity is payable to dependants of the annuitant, the Commissioner of Taxation
will generally use the period of whoever has the longer life expectancy.
MODULE 6
Example 6.13: Recovery of capital exclusion

On 1 June 2019, Darryl, aged 60, purchased an annuity of $19 200 per annum to be paid to him for
his life, then on his death to his wife Cassie for her life, and on Cassie’s death a lump sum of $25 000
(capital amount) is to be paid to their child Billy.
The UPP that Darryl paid for the annuity is $45 000. On the date when the annuity first becomes payable,
Darryl’s life expectancy is seven years and Cassie’s is 10 years.
The deductible amount is calculated under s. 27H(2) as:
A × (B – C )
D
1 × ($45 000 − $25 000)

10
= $2000
Therefore, the amount to be included in Darryl’s assessable income each year under s. 27H(1) is $17 200
(Annuity $19 200 – Deductible amount $2000).
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Calculating allowable deductions

Employee versus contractor test for deductions
The first five sections have so far examined an individual’s assessable income. The next step
is to consider the deductions available to an individual.
The principles of general and specific deductions and substantiation have already been
discussed in Module 3. There will be references back to Module 3 throughout sections of
this module.
The first section of Module 3, ‘General deductions’, examines the general deduction provisions
under the first limb of s. 8-1 of ITAA97. Because most individuals are employees, and are not
carrying on a business, satisfying the first positive limb of s. 8-1 is the main test for deductions.
Under the first positive limb of s. 8-1, the expenditure must be incurred in gaining or producing
the taxpayer’s assessable income. The loss or outgoing must also not be of a capital, private or
domestic nature
Firstly, if the individual is deemed to be an employee (not a contractor), then only the first limb
of s. 8-1 can apply.
This is different to a contractor carrying on a business, who can also use the second positive limb
of s. 8-1 to claim a deduction. The second limb is the ability to deduct any ‘loss or outgoing to
the extent’ that ‘it is necessarily incurred in carrying on of a business for the purpose of gaining or
producing the taxpayer’s assessable income’.
Therefore, it is necessary to establish whether the individual is an employee or a contractor.
MODULE 6
For an employer–employee relationship to exist, there generally must be a master–servant
relationship between the payer and the payee.
Two tests for determining a master–servant relationship are the control test and the integration
test. There are other tests, but the control test and integration test are the two most important
ones.
The control test

An employer–employee relationship generally exists where one person contracts to perform work
for another and the performance of that work is substantially subject to the control and direction
of the person for whom the contract is being performed.
The presence of a right to control how, where, when and who is to carry out particular work points
strongly (and usually conclusively) to employee status.
The integration test

An employer–employee relationship generally exists where an individual is part and parcel of the
principal’s business organisation, or an individual’s activities are restricted to providing service to
one principal, or if the benefits arising from the work flow to the principal.
Other factors
While the control test is generally a key factor, it is necessary to examine the totality of the
relationship between the parties. In the High Court decision in Stevens v. Brodribb Sawmilling
Co. Pty Ltd [1986] HCA 1, Mason J said:
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.
ATO employee/contractor decision tool

The ATO has published an employee/contractor decision tool, which individuals can use to
establish if they are an employee or a contractor for the purposes of taxation and superannuation.
Go to the calculator at the following link and use it to establish if you are an employee or contractor
in your current position: https://www.ato.gov.au/Calculators-and-tools/Host/?anchor=ECDTSGET&
anchor=ECDTSGET/questions/ECDT#ECDTSGET/questions/ECDT. Then think of the circumstances
of close family and friends, and test their status.
Employment-related expenditure
Module 3 looks at employment-related expenditure in detail. The main provisions are
summarised in Table 6.9.
Table 6.9: Summary of chief employment-related expenditure deductions

MODULE 6
Deduction Yes/No Exemptions
Entertainment Generally NO However, where an entertainment

expense is incurred in providing a fringe
benefit, it is deductible. Other limited
exceptions also apply.
Occupational clothing Generally NO Deduction is available—if uniform

or protective.
Clothing is generally
treated as private and Deduction is available—if the
not deductible expenditure was excessive because the
clothing was peculiar to the occupation
(e.g. see FC of T v. Edwards (1994)
ATC 4255). Exemption only allowed
in limited circumstances.
Car expenses YES—if used for Extensive substantiation requirements

employment purposes must be met.
See the section ‘Types of expenses

needing substantiation’ in Module 3.
Self-education expenditure YES—but the first $250 The first $250 is disallowed, but can
is disallowed be soaked up by non-deductible self-
education expenditure.

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Negative gearing
Negative gearing relates to the application of allowable deductions associated with an investment
property owned by the individual taxpayer. Negative gearing is discussed in Module 3.
If the deductions related to an investment property owned by an individual exceed the

assessable income derived in respect of that investment property in any particular income year
(e.g. excess loan interest), then this excess is able to be used to reduce the tax payable on
other assessable income received by that taxpayer.
Income protection/replacement
Individuals are able to claim the cost of the premiums they pay directly to an insurance company
for income protection insurance as a deduction. Income protection insurance protects a person’s
ability to generate income, and pays a replacement income if they are injured and unfit to work.
For the policy payment to be deductible it must be paid directly by the employee. It is not
deductible where the insurance premiums are deducted from the superannuation contributions
paid by the employer.
Basically, insurance can be capital or revenue in nature. Income protection premiums are
deductible against assessable income because they are revenue in nature.
If an income insurance or replacement policy provides a benefit that is income and capital in
nature, then only the premium attributable to the income benefit is deductible.
Individuals cannot claim a deduction for a premium or any part of a premium for a policy that
compensates for items like a physical injury. Deductions cannot be claimed on life insurance
premiums, trauma insurance premiums or critical care insurance premiums.
MODULE 6
Tax-deductible superannuation contributions
Tax-deductible superannuation contributions are available under s. 290-150 of ITAA97 to most
individuals (including both employees and the self-employed) who wish to make a direct
contribution up to the contributions cap (maximum of $25 000 in the 2018–19 year). However,
the individual must give the trustee of the superannuation fund a notice of intention to
claim deductions.
Applying tax offsets

The main difference between a taxable deduction and a personal tax offset or rebate is when it
is applied in the process of calculating assessable income and determining tax payable.
A deduction is an amount subtracted from assessable income when determining the amount
of taxable income on which tax is paid.
A tax offset is subtracted from the actual tax payable that is calculated on the taxable income.
The tax offset directly reduces the amount of tax payable on taxable income. Many of the
tax offsets are intended to provide relief from the amount of tax payable for people whose
situation—low income, large expenses, age or family situation—may make full payment of the
tax assessable difficult. It is possible for a tax offset to reduce tax payable to zero, but they
cannot generally be used on their own to gain a tax refund.
Example 6.14: Deductions versus offsets

Deirdre has 2018–19 assessable income of $33 000 and deductions of $400. Her taxable income is
$32 600 and her gross tax is $2736. She is eligible for the full rate of low-income tax offset (LITO)
(see Table 6.10) of $445 as well as the low- and middle-income tax offset (LMITO) of $200 (see Table 6.10).
Her net tax is therefore $2736 – ($445 + $200) = $2091.
Adjusted taxable income

There is an income test for any dependent tax offset, for example the dependent (invalid and
carer) tax offset (DICTO) and the zone/overseas service rebate. This income test is known as
adjusted taxable income (ATI). The ATI for offsets is not the same as taxable income and for
2018–19, the ATI limit is $100 000.
The ATI for tax offset and rebate purposes is the sum total of the following amounts:
• taxable income
• reportable employer superannuation contributions
• deductible personal superannuation contributions
• total net investment loss from financial investments (e.g. shares) and rental properties
• adjusted fringe benefits (i.e. reportable fringe benefits amount adjusted down for FBT paid
by the employer)
• income from certain tax-free pensions and benefits from Department of Human Services
or Department of Veterans’ Affairs
• income from foreign employment that is exempt in Australia
minus the annual amount of any child support paid by the taxpayer.
Rebate income
MODULE 6
The rebate income test is used to determine eligibility for the senior Australians and pensioners
tax offset (SAPTO). It is similar to the previous tests for adjustable taxable income and comprises
the following amounts:
• taxable income (assessable income minus deductions)
• adjusted fringe benefits amount (total reportable fringe benefits amounts × 1/(1 – FBT rate))
• total net investment loss (includes net financial investment loss and net rental property loss)
• reportable superannuation contributions (includes both reportable employer superannuation
contributions and deductible personal superannuation contributions).
The ATO has published an income test calculator for the ATI, the rebate income, and the income
for surcharge purposes (which determines eligibility for the Medicare levy surcharge and the
private health insurance rebate).
Go to the calculator at the following link and complete each test on the income test calculator using
your own (and/or other) situations: https://www.ato.gov.au/calculators-and-tools/income-tests-
calculator/.
Offsets summary table

Offsets can be a large and confusing area of taxation law—they are relatively simply to apply,
but there are many types of offsets, and their rates and application rules change regularly.
The chief rebates for the 2018–19 financial year are presented in Table 6.10.
Table 6.10: Tax offsets available to Australian taxpayers 2018–19
2018–19 rates
Note: Some current year rates
were not available at the time of
publishing. This is indicated in
Name of offset/rebate Description Eligibility Income test the table.
Family situation rebates
Dependent (invalid and carer) tax Available to taxpayers who are Taxpayer eligible if: Yes—ATI $2717 for 2018–19 year.
offset—DICTO maintaining certain defined 1. they contribute to
types of dependants who maintenance of eligible Upper limit for the taxpayer is Indexed annually.
genuinely cannot work due to dependant $100 000—this means when the
invalidity or carer obligations. 2. eligible dependant receives taxpayer’s ATI (and spouse’s ATI) Reduces by $1 for every $4
an eligible pension or exceeds $100 000, the DICTO is for which the dependant’s ATI
payment not available. exceeds $282.
3. taxpayer does not receive a
disqualifying payment So, for 2018–19, DICTO cuts
4. they do not exceed the out when the dependant’s ATI
relevant ATI. exceeds $11 150.
Eligible dependants are:

• spouse, parents and
spouse’s parents, children,
brothers, sisters, spouse’s
brothers and sisters over
16 years old.
Dependant and taxpayer must
be residents.
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| TAXATION OF INDIVIDUALS
2018–19 rates
Zone rebate Available to individuals classified The individuals must live in For each of the zones, the The zone rebate is calculated as
as residents of specified remote one of two zones, Zone A and rebate consists of a basic the SUM of:
There are also specialist overseas areas of Australia. Zone B. amount plus a percentage of 1. A fixed amount (higher in
service rebates that operate the ‘relevant rebate amount’. Zone A than for Zone B, and
under similar rules as the zone From 1 July 2015, the zone The areas covered by Zone A higher again for the special
rebate. rebate specifically excludes and Zone B and the special The ‘relevant rebate amount’ zone A and B).
fly-in, fly-out and drive-in, areas are provided by the ATO is the sum of the DICTO and 2. A percentage (either 50%
drive-out workers where their and are accessible here: notional offsets covering or 20%) of the sum of
normal residence is not within a https://www.ato.gov.au/ children, students and sole the DICTO (see income
zone. FIFO workers who spend calculators-and-tools/australian- parents. thresholds provided for the
more than 183 days in a zone, zone-list/. DICTO), and any notional
but whose normal residence tax offset, such as a sole
is not in that zone, will instead To be eligible for the zone dependant ($2717), sole
be taken to be resident of the rebate, the taxpayer must meet parent of a non-student
area that incorporates their the residency test: child under 21 notional
normal residence. • The taxpayer resides in tax offset of ($1607), or a
the zone (not necessarily student (which is notional
continuously) for more than tax offset of $376 cutting
half of the tax year (at least out when the dependant’s
183 days). ATI exceeds $1786).
• In counting the 183 days,
non-continuous stays are Note that 1) the fixed amount,
added together. A day and 2) the relevant percentages
includes a fraction of a day. have remained the same since
• The zone rebate is in the 1993–94 income year.
addition to other rebates.
See Table 6.11 for the fixed
amounts and percentages
applied.
2018–19 rates
Medical expenses rebate Available to taxpayers whose Depends on whether the Based on ATI. For single taxpayers with an
net medical expenses in the tax taxpayer is single or has a family. ATI of $90 000 or less or a
year exceed a certain threshold. Indexed annually in accordance family with a combined ATI
No upper limit on the amount a with CPI. of $180 000 or less (if there is
Only applies to the amount of taxpayer may claim. one dependent child, with the
‘net medical expenses’ incurred threshold increasing by $1500
by the taxpayer in the relevant Net medical expenses must for each subsequent child after
income year. be paid by the taxpayer the first), the medical expenses
for themselves and any rebate is calculated as follows:
Importantly, this rebate is being dependants.
phased out and will be obsolete Medical expenses rebate =
by the end of the 2018–19 Net expenses are eligible [(Eligible medical expenses –
income tax year. medical expenses minus refunds Medical refunds) – $2377] × 20%
received by the National (2018–19 rates).
In 2018–19, the rebate is only Disability Insurance Scheme
available to defined medical (NDIS) and private health For single taxpayers with an
expenses that relate to insurers. ATI above $90 000 or a family
disability aids, attendant care with a combined ATI above
or aged care. $180 000 (if there is more than
one dependent child, with the
threshold increasing by $1500
for each subsequent child after
the first), the medical expenses
rebate is calculated as follows:
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Medical expenses rebate –
[(Eligible medical expenses –
Medical refunds) – $5609] × 10%
(2018–19 rates).
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2018–19 rates
Rebates that limit the effective tax rate for a class of receipt
Superannuation contribution An offset is available to an For 2018–19 income years Based on: the sum of the Offset available is 18% of
offset for spousal contributions individual taxpayer who made and later: The sum of the spouse’s assessable income, the contribution made to
a contribution to a complying spouse’s assessable income, total reportable fringe benefits the spouse’s superannuation
fund or a retirement savings total reportable fringe benefits amounts and reportable account, up to a maximum
account (RSA) on behalf of their amounts and reportable employer superannuation offset of $540, which is payable
spouse (married or de facto) employer superannuation contributions (less than $40 000). if eligibility conditions are met.
who is earning a low income contributions was less than
or not working. $40 000 and the contributions Spouse must not have exceeded The offset reduces gradually
made were not deductible to their non-concessional to nil when the sum of spouse
the taxpayer. contributions cap, or have a assessable income, total
superannuation balance that reportable fringe benefits
exceeds the transfer balance amounts and reportable
cap of $1.6 million. employer superannuation
contributions is between
$37 000 and $40 000.
Rebate for assessable life A rebate of tax is allowable on The rebate applies to the No income test. The rebate is currently 30%.
assurance bonuses amounts rendered assessable following policies: issued
by s. 26AH of ITAA36 (bonuses by a taxable life assurance
received under a short-term company or friendly society,
life policy). or various state government
insurance offices.
2018–19 rates
Rebates that limit the effective tax rate for a class of receipt
Income arrears rebate Individual taxpayers who receive Amount of the eligible lump See eligibility conditions. When eligibility conditions are
certain income in a lump sum sum that has accrued before the met the formula is:
payment that contains income year of receipt must be more
accrued in an earlier year(s) than 10% of the taxable income Tax on arrears minus notional
are entitled to the income in the year of receipt (after tax on arrears.
arrears rebate. deducting the income in arrears,
net capital gains, abnormal Tax on arrears: Amount of
Aim of the rebate is to limit income, ETPs and termination tax (excluding Medicare levy)
the tax payable on the arrears payments in lieu of annual leave payable in the year of receipt,
component of the lump sum to or long service leave). which is attributable to the
the amount of tax that would amount of the eligible lump sum
have been payable had the that accrued in earlier years.
income been received in the
year it was accrued. Notional tax on arrears:
Amount representing the tax
that would have been payable
on the lump sum that accrued
before the year of receipt, if that
amount had been taxed in the
year it was accrued.
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2018–19 rates
Rebates that increase tax threshold of recipients
LITO Taxpayer individuals are entitled Resident taxpayers. Full rebate applies to incomes Maximum rebate is $445.
to a rebate if they earn under a under $37 000.
certain income threshold. Minors with unearned income Rebate reduced by 1.5 cents
not eligible. Rebate applies on a ($0.015 per $1.00) for every
proportional scale between dollar over $37 001 and phases
Not automatically indexed. $37 001 and $66 667. out entirely by $66 667.
Not refundable. From 2022/23, the new LITO Example: Sam’s taxable income
will apply as follows (Treasury for 2018–19 is $43 500. As
Laws Amendment (Personal his taxable income exceeds
Income Tax Plan) Act 2018 $37 000, Sam can claim a LITO
(Cwlth), Schedules 1 and 2): as follows:
Taxable income Maximum LITO $445

< $37 000: $645 rebate Less reduction in rebate
($43 500 – $37 000) × 0.015 $98
$37 000 – $41 000: $645 less Rebate allowed $347
6.5% of excess over $37 000
$41 000 – $66 667: $385 less

1.5% of the excess over $41 000.
2018–19 rates
LMITO Taxpayer individuals are entitled Resident taxpayers (and certain New tax offset introduced for Taxable income
to a rebate if they earn under a trustees). the 2018–19, 2019–20, 2020–21 < $37 000: $200 rebate
certain income threshold. and 2021–22 income years. $37 000 – $48 000: $200 +
Not automatically indexed. 3 cents for each $ > $37 000
The rebate cuts out where $48 000 – $90 000: $530 rebate
Not refundable. taxable incomes exceed $90 000 – $125 333: $530 less
$125 333. 1.5 cents for each $ > $90 000.
Entitlement to the LMITO is in
addition to the existing LITO. The effect of LITO and the
LMITO is that a resident
For 2022–23 and later years, taxpayer’s tax-free threshold is
both the LITO and LMITO will effectively increased to $21 595.
be replaced with a new low-
income tax offset (Treasury Laws Example: Sam’s taxable income
Amendment (Personal Income for 2018–19 is $43 500. As his
Tax Plan) Act, Schedules 1 taxable income exceeds $37 000
and 2). but is less than $48 000, his
LMITO, which is in addition to
his LITO, is calculated as follows:
=$200 + ($43 500 – $37 000)
× 0.03
= $200 + $195
= $395 LMITO
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2018–19 rates
SAPTO SAPTO is available to low- The taxpayer must have, for at Based on rebate income. Will receive a full, partial or nil
income aged persons least one day in the year, been offset amount.
(recipients of the Age Pension eligible for Veterans’ Affairs Rebate income must be under
and self-funded retirees). pension and have reached certain cut-off thresholds. Maximum offset for SAPTO
Veterans’ Affairs pensioner age For the 2018–19 income year, (single) is $2230.
Possible to use SAPTO to (60), or have been eligible for the rates are:
reduce tax liability to zero, the Age Pension and reached Maximum offset for SAPTO
and not have to lodge a pension age (65.56 years) for Rebate is reduced by 12.5c for (couple—each) is $1602.
tax return. the 2018–19 tax year. every dollar over the minimum
threshold and shades out Maximum offset for SAPTO
Spouses are tested on entirely at the maximum. (couple—each separated by
combined rebate income, but illness) is $2040.
the amount of rebate is based These thresholds differ based
on the individual. on single, couple and couple
separated by illness.
Shade-out taxable income
Single: $32 279 – $50 119
Couple (each): $28 974 – $41 790

each
Couple (separated by illness):

$31 279 – $47 599 each.
2018–19 rates
Beneficiary rebate Taxpayers whose assessable Possible to use beneficiary Different formulas based Formula:
income includes certain rebate to reduce tax liability to on whether the rebatable Where the rebatable benefit
government benefits are eligible zero, and not have to lodge a benefit amount is higher or amount is $37 000 or less then
for this rebate. These payments tax return. lower than $37 000 (which is the formula is:
include Newstart Allowance the upper threshold for the
and specified Commonwealth If an individual is eligible for lowest marginal tax rate). [A – $6000] × 0.15.
education and training SAPTO and the beneficiary
payments, such as Austudy rebate, they can only claim the Where the rebatable benefit
and ABSTUDY, and special higher rebate. If the rebates are amount is more than $37 000,
assistance paid to farmers. the same, only one rebate is then the formula is:
allowed.
[A – $6000] × 0.15 + [A –
$37 000] × 0.15
A: The amount of rebatable

benefit received by the taxpayer
during the year rounded to the
nearest dollar.
The effect of these formulas is

that the amount of rebate is the
same for benefits up to $37 000,
but increases to 30% for that
portion of the benefit above
$37 000.
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2018–19 rates
Rebates to prevent double tax
Foreign income tax offset The resident taxpayer is entitled When a resident taxpayer Based on the foreign source The amount of the offset is the
to a tax offset for the foreign tax receives foreign source income income received. lesser of the foreign tax paid
paid on foreign source income. on which foreign tax has been or the amount of Australian
paid, the taxpayer is assessed tax payable in respect of the
Non-refundable—cannot be on the gross amount of the foreign income.
carried forward to subsequent foreign income, that is, the
years and non-transferable. amount received plus the If the amount of foreign tax
foreign tax withheld. paid is equal to or less than
$1000, the taxpayer can claim
the amount of the tax paid as a
tax offset without having to work
out the Australian tax payable in
respect of the foreign income.
Any offset remaining after being

applied against a taxpayer’s
basic income tax liability can
be applied first against the
Medicare levy, then against any
Medicare levy surcharge liability.
2018–19 rates
Rebates to prevent double tax
Franking credit tax offset Resident shareholder is entitled Where a resident individual Refundable offset. Tax offset amount equal to the
to a tax offset equal to the shareholder receives a franked amount of franking credit.
amount of the franking credit on distribution, the individual
the distribution. shareholder is assessed
not only on the amount of
Module 8 looks at franking the distribution received,
credits and the imputation but also on the amount of
system in more detail. franking credit attached to
the franked distribution.
Rebates to encourage government policy
Private health insurance offset Certain taxpayers can claim a Two conditions: Based on income for Medicare Private health insurance offset is
tax offset for the cost of private 1. Insurance premium is paid levy surcharge purposes. This is means tested.
health insurance premiums. for a complying health the sum of:
Alternatively, they can apply insurance policy. • taxable income Based on a three-tiered level.
for reduced health insurance 2. Premium must generally be • reportable fringe benefits
premiums. paid in the same year as the • net investment losses, and See Table 6.12 for the tiers and
offset is claimed. Level of • reportable superannuation insurance rebate entitlement.
Most people claim the offset offset available depends on contributions,
through directly reduced health taxpayer age and income. less certain superannuation
insurance premiums. benefits that are eligible for
Offset is available to individual a tax offset under s. 301-20(2)

taxpayers. of ITAA97.
Adjusted on 1 April every year.
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Refundable offset.
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Table 6.11 summarises the zone allowances.
Table 6.11: Zone allowances for the 2018–19 tax year
Zone Allowance
Ordinary zone A $338 + 50% of the ‘relevant rebate amount’
Special zone A $1173 + 50% of the ‘relevant rebate amount’
Ordinary zone B $57 + 20% of the ‘relevant rebate amount’
Special zone B $1173 + 50% of the ‘relevant rebate amount’
Table 6.12 outlines the private health insurance rebate thresholds.
Table 6.12: Private health insurance rebate entitlement by income threshold 2018–19
Income thresholds†
Status Base tier Tier 1 Tier 2 Tier 3
Single $90 000 or less $90 001 – 105 000 $105 001 – 140 000 $140 001 or more
Family‡ $180 000 or less $180 001 – 210 000 $210 001 – 280 000 $280 001 or more
Rebate for premiums paid 1 April 2019 – 31 March 2020
Age Base tier Tier 1 Tier 2 Tier 3
Under 65 years 25.059% 16.706% 8.352% 0%

MODULE 6
65–69 years 29.236% 20.883% 12.529% 0%
70 years or over 33.413% 25.059% 16.706% 0%
†
The income thresholds were set on 1 July 2015 and will remain at the 2014–15 levels until the year
2020–21.
‡
The family income threshold is increased by $1500 for each Medicare levy surcharge dependent
child after the first child.
Source: Adapted from ATO 2018, ‘Income thresholds and rates for the private health insurance
rebate’, accessed November 2018, https://www.ato.gov.au/individuals/medicare-levy/private-health-
insurance-rebate/income-thresholds-and-rates-for-the-private-health-insurance-rebate/; Commonwealth
of Australia 2019, ‘PHI 08/19 - Private Health Insurance - Rebate Adjustment Factor Effective 1 April
2019’, accessed April 2019, http://www.health.gov.au/internet/main/publishing.nsf/Content/health-
phicircular2019-08.
Example 6.15: Applying the dependent (invalid and carer)

tax offset
During the 2018–19 tax year, Jack’s spouse, Samantha, received dividend income and a disability
pension, giving her an ATI of $5600. Jack’s ATI for the 2018–19 tax year comprised $95 000 in salary.
Jack and Samantha lived together for the whole year and are not eligible for Family Tax Benefit Part B.
Jack is entitled to a DICTO of $1387, calculated as follows:
$
Maximum DICTO available 2018–19 2 717
Less reduction for Samantha’s ATI (¼ × ($5600 – $282)) 1 330
Rebate allowable 1 387
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Example 6.16: Applying the zone rebate

Archibald and his family have resided for the whole of the 2018–19 tax year in ordinary zone A. Archibald
supports a wife, aged 41, and two children, one aged three and the other aged six. The six-year-old
attends school. Archibald’s wife had an ATI of $3262 for the year.
Archibald’s zone rebate is calculated as follows:

$
Notional dependent spouse rebate ($2717 – (¼ × ($3262 – $282)) (ignore cents) 1 972
Notional dependant rebate—one student 376
Notional child rebate—first child, not being a student 376
Relevant rebate amount 2 724
Ordinary zone A rebate is $338 + 50% of $2724 = $1700.
➤ Question 6.3
Paul and Celeste Hui are aged 68 and 66 years respectively. They live together and both receive
an Age Pension. Paul has a rebate income of $33 000 and Celeste has a rebate income of $36 500.
Both qualify for the SAPTO.
Calculate the level of SAPTO for both Paul and Celeste in the 2018–19 income tax year.
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➤ Question 6.4
John and Maryanne, aged 49 and 50 respectively, have one dependent child and paid $5100
for private health insurance premiums for the period 1 July 2018 to 30 March 2019. They have
not claimed reduced premiums from their health insurer. John’s income for surcharge purposes
is $85 000 and Maryanne’s income for surcharge purposes is $109 000. Hence, their combined
income for surcharge purposes is $194 000.
What is their private health insurance tax offset amount? Use the currently published rebate
percentages (based on the 2018–19 income tax year) to calculate the answer.
Calculating tax payable

This final section presents the last two steps of calculating tax payable.
After deriving assessable income and then allowable deductions, the taxpayer has their
taxable income.
From that, they need to apply the correct marginal tax rate, which is presented in the following
section, to determine gross tax payable.
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From this, non-refundable tax offsets (most offsets—see the ‘Applying tax offsets’ section) are
applied and then the Medicare levy and Medicare levy surcharge as well as any HELP assessment
debt (not discussed in this module) are added. Medicare levy and Medicare levy surcharge are
presented in the sections ‘Tax-free threshold’ and ‘Medicare levy’. Then the remaining refundable
offsets (the franking credit offset and the private health insurance offset) are applied.
The last step is to deduct any tax already paid by, or amounts credited to, the taxpayer from the
resulting sum to determine the total amount of tax payable or tax refund due.
Tax rates
All individuals are taxed on a sliding scale depending on their taxable income.
The rates for Australian residents for 2018–19 are in Table 6.13.
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Table 6.13: Resident tax rates 2018–19
Taxable income Tax on this income
0 – $18 200 Nil
$18 201 – $37 000 19c for each $1 over $18 200
$37 001 – $90 000 $3572 plus 32.5c for each $1 over $37 000
$90 001 – $180 000 $20 797 plus 37c for each $1 over $90 000
$180 001 and over $54 097 plus 45c for each $1 over $180 000
Source: Based on Income Tax Rates Act 1986 (Cwlth), Schedule 7, Federal Register of Legislation,
accessed April 2019, https://www.legislation.gov.au/Details/C2018C00364.
These rates do not include the Medicare levy of 2 per cent, which will be discussed shortly.
The foreign resident tax rates are outlined in Table 6.14.
Table 6.14: Foreign resident tax rates 2018–19
These rates apply to individuals who are foreign residents for tax purposes.
Taxable income Tax on this income
0 – $90 000 32.5c for each $1
$90 001 – $180 000 $29 250 plus 37c for each $1 over $90 000
$180 001 and over $62 550 plus 45c for each $1 over $180 000
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Foreign residents are not required to pay the Medicare levy.
Tax-free threshold
All Australian adult resident taxpayers have a tax-free threshold, and as of the 2018–19 tax year,
it is $18 200.
Some taxpayers, such as recipients of Australian Government pensions, qualify for tax offsets
that effectively raise this tax-free threshold. Tax offsets were covered in the section ‘Applying
tax offsets’.
Taxpayers who cease being or become residents during the year have the threshold pro-rated
over the year according to a set formula. The threshold is calculated according to the number
of months the individual taxpayer was a resident, including the month they became a resident
and/or ceased to be a resident.
Formula to learn
The tax-free threshold is calculated as (Income Tax Rates Act 1986 (Cwlth) s. 20):
 $4736 × Number of months in the year the individual is a resident 

$13 464 +  
 12 months 
Applying this formula, an individual who is resident for only part of the year has a tax-free threshold of
at least $13 464, with an additional amount of tax-free threshold according to the number of months the
individual is a resident.
Example 6.17: Applying the tax-free threshold formula

Laila arrived in Australia on 4 January 2019 to take up permanent residence. She commenced work
on 1 February 2019 and worked until 30 June 2019.
The reduced tax-free threshold is calculated as:
$4736 × 6 months
= $13 464 +
12 months
= $13 464 + $2368
= $15 832
Medicare levy
The Medicare levy raises funds to partly finance Australia’s universal health care system,
Medicare. The Medicare levy is an additional 2 per cent of taxable income.
There are three main rules around the Medicare levy:

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• reduction for low-income earners

• Medicare levy exemption
• additional Medicare levy surcharge for high-income earners without applicable private health
insurance.
Reduction for individual low-income earners

Medicare levy is reduced for income under a certain threshold, and can result in a situation where
no Medicare levy is payable.
The Medicare levy is not payable on taxable income that is equal to or less than $21 980 (2017–18
tax year—the most recent tax year available at the time of publication). This is increased to
$34 758 for seniors and pensioners entitled to the SAPTO.
A partial Medicare levy is payable on taxable income that is between $21 980 and $27 475
($34 758 and $43 447 for seniors and pensioners entitled to the SAPTO).
Medicare levy figures for the 2018–19 tax year as indicated in the 2019 Federal Budget for singles
are $22 398 and for seniors and pensioners $35 418. However, note these changes have not
been made law at the time of writing.
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Reduction based on family taxable income

The reductions discussed previously are based on individual taxable income. The Medicare levy
can still be reduced based on family taxable income.
Resident taxpayers with an income above $27 475 ($43 447 for seniors and pensioners entitled
to the SAPTO in 2017–18) may still qualify for a reduction if:
• they have a spouse (married or de facto), or
• they have a spouse who died during the year, and they did not have another spouse before
the end of the year, or
• they are entitled to an invalid and invalid carer tax offset in respect of a child, or
• they had sole care of one or more dependent children, and
• they meet the family taxable income thresholds.
Note that sole care means that you alone had full responsibility for the upbringing, welfare and
maintenance of a child or student.
Medicare levy rate based on family taxable income

In 2017–18, the Medicare levy was reduced if family taxable income is equal to or less than
$46 361 plus $4257 for each dependent child.
Calculating family taxable income
Formula to learn
Family taxable income = Individual taxable income + Spouse taxable income
(including spouse who died in tax year)
Sole parent family taxable income = Individual taxable income
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Medicare levy exemption
Taxpayers are exempt from the Medicare levy if they:
• meet certain medical requirements, for example in receipt of a sickness allowance from
Centrelink, were a ‘blind pensioner’, or entitled to free health under defence force
arrangements or a Veterans’ Affairs Gold Card
• are a foreign resident
• are not entitled to Medicare benefits.
Medicare levy surcharge

The Medicare levy surcharge is applied to taxpayers with an income above a set level and who
do not have an appropriate level of private hospital insurance. The amount of Medicare levy
surcharge is only calculated against income for surcharge purposes. This is the sum of the
taxpayer’s taxable income (including the net amount on which family trust distribution tax has
been paid), reportable fringe benefits, reportable superannuation contributions and total net
investment losses less the amount of any superannuation benefit for which they are eligible for
a tax offset under s. 301-20(2) of ITAA97.
The base income threshold for application of the surcharge is $90 000 for singles and $180 000
for families.
The surcharge is not payable if the family income exceeds the threshold, but the individual’s
income for surcharge purposes was below $21 980 or less in the 2017–18 year.
Having determined whether a taxpayer is liable for the Medicare levy surcharge, the actual
surcharge is then imposed on the taxpayer’s taxable income and reportable fringe benefits only.
It is a three-tier system that is presented in Table 6.15.
Table 6.15: Medicare levy surcharge income thresholds for 2014–15 to 2020–21
Base tier Tier 1 Tier 2 Tier 3
Single threshold $90 000 or less $90 001–105 000 $105 001–140 000 $140 001 or more
Family threshold† $180 000 or less $180 001–210 000 $210 001–280 000 $280 001 or more
Medicare levy surcharge 0% 1% 1.25% 1.5%
†
The family income threshold is increased by $1500 for each Medicare levy surcharge dependent child
after the first child.
Source: Adapted from ATO 2018, ‘Income thresholds and rates for the Medicare levy surcharge’,
accessed March 2019, https://www.ato.gov.au/Individuals/Medicare-levy/Medicare-levy-surcharge/
Income-thresholds-and-rates-for-the-Medicare-levy-surcharge/.
➤ Question 6.5
Jericho is 38 years old, single, and does not have any private patient hospital cover through a
private insurance company. His taxable income for the 2018–19 income tax year is $90 000 and
in addition he had reportable fringe benefits of $20 000.
What is the amount of his Medicare levy surcharge?
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Example 6.18: Calculating tax payable

During the 2018–19 tax year, Jane Miller, an employee of Training Teachers Now Pty Ltd, had the
following assessable income and allowable deductions.
$ $
Salary (includes $11 000 PAYG tax withheld) 47 000
Allowances
Telephone 1 000
Entertainment 4 000 5 000
Company car—fully maintained 15 000
Jane incurred the following expenses:

Mobile telephone—business use 1 200
Entertainment of business clients 3 500
Determination of Jane Miller’s tax liability for year ended 30 June 2019
Assessable income
Salary 47 000
Allowances 5 000
52 000
Less: Allowable deduction
Business use of telephone 1 200
Taxable income 50 800
Tax payable (2018–19 tax rates) 8 057

Less: Low-income rebate† 238
Less: LMITO‡ 530
7 289
Add: Medicare levy (2% of $50 800) 1 016

8 305
Less: PAYG withholding tax 11 000
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Tax refund 2 695
†
Calculation of low-income rebate
Maximum low-income rebate 445
Less: Reduction ($50 800 – $37 000) × 0.015 207
Low-income rebate 238
‡
Taxable income between $48 001 and $90 000
Jane Miller would not be assessed on the fully maintained company car as FBT would be payable by
her employer, Training Teachers Now, on the car fringe benefit. No tax deduction is allowable for the
entertainment of business clients (see Division 32).
➤ Question 6.6
Christina is an individual resident taxpayer for the 2018–19 full income tax year. She is aged 46,
is single and has no dependants.
Christina holds private hospital health insurance that meets the requirements of the private health
insurance tax offset. Her annual premium for the 2018–19 income tax year was $2200, which has
not been reduced to take into account any offset available.
Christina has the following transactions:
Income from wages $87 000
Rental income received $15 000
Interest received $1 400
Expenses
Substantiated car expenses having travelled 1200 km for work (calculate using the cents per km
method, 68c per km in 2018–19, applied to an estimate of the number of business kilometres
travelled)
Entertainment of clients $4 000
Landlord fees, rates, interest on rental property $17 000
Other
Reportable fringe benefits amount $10 000
Determine Christina’s tax payable for the 2018–19 income tax year by answering the following
questions:
(a) Calculate Christina’s taxable income.
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(b) Calculate the minimum amount of compulsory SG to be paid by Christina’s employer.
(c) Determine the total amount of Christina’s tax payable.

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(d) Calculate Christina’s income for Medicare levy surcharge purposes.
(e) Determine Christina’s amount of private health insurance tax offset.
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Summary and review

Module 6 focused on the taxation of individuals and in particular the concept of the tax equation.
In determining the tax payable by an individual, it is required firstly to ascertain their taxable
income, which is their assessable income less their entitlement to particular deductions, if any.
Depending upon the level of taxable income, tax will be applied, and from this will be deducted
any entitlement to any non-refundable tax offsets. To this figure is added the Medicare levy
and Medicare levy surcharge (if applicable) less any refundable tax offsets and tax already paid.
The end result is the net tax payable/refundable.
The module began with defining particular types of assessable income. These include income
from foreign sources, dividends, interest, property, trusts and royalties. The inclusion of income
from the sharing economy was covered, as was the particular tax treatment of minors.
The module then discussed three particular income regimes. First was the tax treatment of
termination payments, including ETPs (including both life and death benefit termination
payments), genuine redundancy payments and early retirement schemes. The rules relating
to the taxation of unused annual leave and long service leave payments were also illustrated.
Second was the discussion of the PSI, in particular the rules for determining whether income is
PSI and whether a taxpayer is conducting a PSB. The operation of the PSI rules was illustrated
along with the application of the method statement. Third was the discussion of the ESS
provisions, including both up-front and deferred taxation. A brief reference was also made
to the application of ESS to start-up companies.
A brief overview of the CGT provisions as they apply to individuals was provided, including the
operation of the main residence exemption, marriage breakdown rollover relief and the small
business concessions.
The taxation of individual superannuation was illustrated, including the taxation of superannuation
MODULE 6
contributions, the operation of the LISTO, as well as the taxation of superannuation benefits and
non-superannuation annuities.
A very brief reference was made to individual allowable deductions and various employment-
related expenditure, negative gearing and income protection.
A major section of the module then examined the most common tax offsets and rebates
available to individuals, including family situation rebates, rebates that limit the effective tax
rate of a class of receipt, rebates that increase the tax threshold of recipients, rebates that
prevent double taxation and rebates that encourage government policy.
Finally, in calculating the tax payable for an individual, the tax rates for both residents and
foreign residents were indicated along with the application of the tax-free threshold formula.
Application of the Medicare levy, Medicare levy exemption and Medicare levy surcharge were
also discussed and illustrated.
Suggested answers
Suggested answers
Question 6.1
Eli’s eligible assessable income is between $417 and $1307, so the first $416 is tax free. Then the
amount $826 – $416 = $410 is taxed at 66c in the dollar = $270 tax payable. The rest of the
$12 174 is excepted assessable income, so taxed at ordinary resident rates in the normal way.
As that amount is under the tax-free threshold of $18 200, there is no further tax applied and he
is not liable for the Medicare levy.
MODULE 6
Question 6.2
To determine the amount by which the PSI should be reduced, the steps in the s. 86-20(2)
(ITAA97) method statement should be followed:
$
Step 1 PSI deductions 55 000
Step 2 Entity maintenance deductions 3000
Step 3 Other income 4000
Step 4 Entity maintenance deductions less other income (Step 2 – Step 3) (1000)
Step 5 Step 5 does not apply as the amount under Step 4 is less than zero
Step 6 As the amount in Step 4 is less than zero, the PSI income is reduced by
the amount in Step 1 ($55 000)
The amount of assessable income attributed to Jack is $100 000 – $55 000 = $45 000. This amount
is included in Jack’s assessable income to be taxed at his marginal income tax rate.
The balance of the other income of the entity is reduced by the other income deductions still
available: $1000 – $500 = $500.
The personal services entity has an assessable income of $500. This amount is retained in the PSE.

Question 6.3
Paul $
Maximum offset 1602.00
Less: Reduction as rebate income is above shade-out threshold of $28 974

for 2018–19 income tax year for couple
($33 000 – $28 974) × 0.125
SAPTO 1098.75
Celeste $
Maximum offset 1602.00
Less: Reduction as rebate income is above shade-out threshold for couple
($36 500 – $28 974) × 0.125
SAPTO 661.25
Question 6.4
As John and Maryanne fall within the Tier 1 category and they are aged under 65, they are
entitled to a tax offset of 16.943 per cent of their insurance premiums. Their private health
insurance tax offset for 2018–19 is ($5100 × 16.943%) or $864.09.

MODULE 6
Question 6.5
Jericho’s total income for Medicare levy surcharge purposes is $110 000, which makes him a
Tier 2 income earner for calculating the Medicare levy surcharge.
Jericho’s actual Medicare levy surcharge liability is calculated as:
($90 000 taxable income + $20 000 reportable fringe benefits) × 1.25% = $1375

Question 6.6
(a) Assessable income is $87 000 + $15 000 + $1400 = $103 400 (ITAA97, s. 6-5). Allowable
deductions (s. 8-1) are $17 000 against the rental income and ($1200 × 0.68) = $816 car
expenses (s. 28-25). Entertainment is not deductible (s. 32-5).
Christina’s taxable income for the year is therefore assessable income less allowable
deductions = $103 400 – $17 000 – $816 = $85 584.
(b) The SG amount in the 2018–19 income tax year is 9.5 per cent of Christina’s wage or salary
(ordinary time earnings). For Christina this is 9.5 per cent of a base of $87 000, which is $8265
(ITAA97, s. 291-25).
(c) Tax payable is calculated on Christine’s taxable income of $85 584. Tax payable on this
for the tax year is $19 361.80. Medicare levy is $1711.68. Medicare levy surcharge does
not apply as Christine has private health insurance. Tax payable is $21 073.48 less LMITO
of $530 = net tax payable $20 543.48.
(d) To calculate Christina’s taxable income for Medicare levy surcharge purposes, it is necessary
to add back the rental losses and add in the fringe benefits amount. This is $85 584 + $2000 +
$10 000 = $97 584.
(e) Christina’s income for the private health insurance tax offset purposes is $97 584 ($85 584 +
$2000 rental losses + $10 000 reportable fringe benefits), and this is the Tier 1 scale for an
individual taxpayer under 65 years. The rebate on premiums for Christina is 16.943 per cent
(for rebate up to 31 March 2019). The total rebate is $2200 × 16.943% = $372.75.
MODULE 6
MODULE 6
REFERENCES | 299
References
References
ATO 2015, ‘Managed investment trusts’, accessed March 2019, https://www.ato.gov.au/

individuals/investing/managed-investment-trusts/.
ATO 2017, ‘Income that is not PSI’, accessed March 2019, https://www.ato.gov.au/Business/
Personal-services-income/Working-out-if-the-PSI-rules-apply/Step-1--Have-you-received-PSI-/
Income-that-is-not-PSI/.
ATO 2017b, ‘The sharing economy and tax’, accessed April 2019, https://www.ato.gov.au/
General/The-sharing-economy-and-tax/.
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ATO 2018a, ‘Calculating components of a super benefit’, accessed March 2019, https://www.
ato.gov.au/Super/APRA-regulated-funds/Paying-benefits/Calculating-components-of-a-super-
benefit/.
ATO 2018b, ‘Investment income’, accessed March 2019, https://www.ato.gov.au/Individuals/

Income-and-deductions/Income-you-must-declare/Investment-income/.
ATO 2018c, ‘Crowdfunding’, accessed March 2019, https://www.ato.gov.au/Business/Income-

and-deductions-for-business/In-detail/Crowdfunding/.
MODULE 6
AUSTRALIA TAXATION
Module 7
TAXATION OF SBES AND PARTNERSHIPS
302 | TAXATION OF SBES AND PARTNERSHIPS
Contents
Preview 303
Introduction
Objectives
Teaching materials
Small business entity concessions core concepts 305
Refresher on the definitions of small business entity
Company tax rates for small business entities
Refresher on trading stock rules for small business entities
Refresher on capital allowance rules for small business entities
Refresher on capital gains tax concessions for small business entities
Calculating the small business income tax offset 310
What is the small business income tax offset?
Calculating net small business income for the small business income tax offset
Eligible income and deductions
Small business restructure rollover 313
What is the small business restructure rollover?
Who can access the rollover?
Eligible assets
When is the rollover available?
Taxation implications of the rollover
Partnership taxation core concepts 316
What is a partnership?
Tax status of a partnership
Partnership income tax return
Overview of partnership losses
Determining the net partnership income/loss 318
Determining net partnership income or loss
Tax administration
Calculating a partner’s share of tax payable 319
Partnership elections
Impact of salaries paid to a partnership
Impact of interest paid to partners
Alteration of partner’s interest 327
Real and effective control of partnership income
Alteration of partner’s entitlement to profit
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General work in progress rule

General capital gains tax rule
Dissolution or reconstitution of a partnership
References 339
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Module 7:
Taxation of SBEs
and partnerships
Study guide
Preview
Introduction
Module 7 looks at the taxation consequences of two entities—small business entities (SBEs)
and partnerships. What constitutes an SBE has already been defined in this course, and is
presented again in this module. SBEs have concessional taxation treatment across a range of
areas, including special trading stock rules, simplified depreciation rules, small business capital
MODULE 7
gains tax (CGT) concessions, a start-up expenditure deduction, a CGT small business rollover
exemption and a small business tax offset.
Partnerships are required to lodge a partnership tax return, and the partnership derives ‘net
income’ to the extent that the difference between the partnership’s assessable income exceeds
its allowable deductions. The most important element about determining partnership income
is that each individual partner is liable for individual taxation on their share of partnership
income. Each partner is taxed in their individual capacity on their share of the net income
of the partnership, whether it is distributed to the partner or not.

Figure 7.1: Module summary—taxation of small business entities and partnerships
Taxation of SBEs
SBE tests
27.5% tax rate
Trading stock rules
Simplified depreciation
Start-up expenditure
CGT small business

concessions
Small business income

tax offset
Small business restructures
Taxation of partnerships
Determining partnership Determining partner’s Alteration of

Core concepts
income or loss share of tax partner’s interest
Partnership income Non-commercial

Tax status Salary Interest payable
tax return loss
Objectives
MODULE 7

• evaluate the tax implications for eligible small business entities (SBEs) based on the
available tax concessions;
• determine the net partnership income or partnership loss;
• calculate a partner’s share of the net partnership income or partnership loss; and
• evaluate the tax implications from an alteration of a partner’s interest in a partnership.
Teaching materials
• Legislation:
• Glossary:
Definitions/
terms/
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Small business entity concessions core concepts

Refresher on the definitions of small business entity
In the first section of Module 4, we defined a small business entity (SBE) for taxation purposes.
This section identified the various eligibility measures and the various thresholds available to
determine the different types of SBE entities for different types of taxation laws.
Table 7.1 summarises the different types of SBEs, the different threshold amounts, and the type
of taxation law that applies to each amount.
Table 7.1: Refresher on small business entity definitions
Carrying on Aggregated Taxation area and

Title a business turnover test study guide reference
Small business entity The entity must be $10 million aggregated Depreciation (capital
‘carrying on a business’ turnover test. allowances regime)—
(ITAA97, s. 328-110(1)). The threshold is Module 4.
An entity will also be $2 million for tax years
taken to be carrying on a before 1 July 2016. Fringe benefits tax
business if it winds up a Aggregated turnover (FBT)—Module 9.
business that it formerly is the sum of the annual
carried on, and it was turnover of the income Goods and services
an SBE for the income year, the annual turnover tax (GST) simplified
year in which it stopped of any entity connected registration and
carrying on the business with the main entity reporting—Module 10.
(ITAA97, s. 328-110(5)). during the income year,
and the annual turnover Company tax rate of
of an affiliate (ITAA97, 27.5% for base rate
s. 328-115). entities.
Small business entity Must carry on a business $5 million aggregated Eligibility for small
(for the purposes of the turnover test. business income tax
small business income offset—see the section
tax offset) ‘Calculating net small
MODULE 7
business income for
the offset’.
CGT small business Must carry on a business $2 million aggregated Capital gains tax (CGT)
entity turnover test. concessional treatment
as outlined in ITAA97,
Division 152—Module 5.
Definitions
Section 995-1 of ITAA97 defines a business as including ‘any profession, trade, vocation or
calling’. In the majority of cases, it’s very clear whether or not a business is being carried out.
It’s not always certain though, especially when the activity is carried out as ancillary or as a
side activity to the individual’s main income.
The criteria for meeting the business entity test are presented in Module 4, in the section
‘Carrying on a business’.
Aggregated turnover is the sum of the annual turnover of the income year, the annual turnover
of any entity connected with the main entity during the income year, and the annual turnover of
an affiliate (ITAA97, s. 328-115).
Company tax rates for small business entities

Companies that are base rate entities apply a 27.5 per cent company tax rate. A base rate entity
is a company that both:
• has an aggregated turnover less than $50 million for the 2018–19 income year, and
• has no more than 80 per cent base rate entity passive income. This income includes dividend
income and franking credits on such dividends, interest income, royalties and rental income,
net capital gains and distributions from partnerships and trusts, to the extent it is referable to
an amount that is otherwise passive income (Treasury Laws Amendment (Enterprise Tax Plan
Base Rate Entities) Act 2018 (Cwlth), s. 23AA).
SBEs would generally qualify as base rate entities, and so would apply the reduced 27.5 per cent
tax rate.
All other companies—that do not meet the rules for a base rate entity—are taxed at the
30 per cent company tax rate.
Refresher on trading stock rules for small business entities

Table 7.2 presents an overview of the trading stock rules as applied to SBEs. Refer back to the
section ‘Trading stock concessions for small business entities’ in Module 2 for more information.
Table 7.2: Small business entity trading stock rules
Rule Description Application
Trading stock Where the difference Under these rules the taxpayer does not have to:
concession between the value of • conduct a stocktake at the end of the
opening stock and the income year
estimated value of closing • account for any changes in the value of the
MODULE 7
stock is $5000 or less. trading stock. In other words, the value of the
opening stock may be kept as the value of
the closing stock
The taxpayer is required to record how they

estimated the value of the closing stock,
but does not have to notify the Australian Taxation
Office (ATO) of how they have chosen to apply
the estimate.
Refresher on capital allowance rules for small business entities

Table 7.3 presents an overview of the simplified depreciation rules that can be used by SBEs.
Refer back to the section ‘Capital allowance rules for small business entities’ in Module 4.
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Table 7.3: Small business entity capital allowance rules
Rule Description Application

Access Annual aggregated turnover Must use these rules to calculate the deductions
of less than $10 million for all depreciating assets.
for tax years 1 July 2016
onwards, or less than Entire set of rules (presented in the next section)
$2 million for previous must be applied, not just individual elements.
tax years.
Claim a deduction for the portion of the asset that
is used for business or other taxable purposes.
Instant asset Instant write-off for the The deduction is claimed in the year that the asset
write-off business portion of most is purchased and used, or installed ready for use.
assets that cost less
than $20 000.
In place until 30 June 2019.
Small business Assets costing $20 000 or If the SBE stops using the small business
asset pool more are allocated to a depreciation rules, the general depreciation rules
small business asset pool. will apply. In that case, any assets that are currently
Then apply: in the small business pool will continue to be
• 15% diminishing value depreciated in that pool.
deduction in the first
year (regardless of when If the balance of the pool, prior to calculating the
the asset was purchased pool deduction for the year, falls below $20 000,
or acquired during that amount may be claimed as a deduction in
the year) that year.
• 30% diminishing value
deduction each year There are no simplified provisions for project pool
after the first year. expenditure for SBEs.
Deduction for start- Deduction for capital Applicable expenditure:

up expenditure expenditure for a proposed • obtaining of professional advice or services
business. about the structure or operation of the
proposed business
• tax, charge or fee paid to an Australian
MODULE 7
government agency.
Refresher on capital gains tax concessions for small business

entities
As discussed in Module 5, there are four CGT small business concessions for certain SBEs.
These are separate to the small business restructure rollover discussed in detail in the section
‘Small business restructures’ later in this module.
There are four specific concessions available that allow qualifying SBEs to disregard or defer
part or all of a capital gain from an active asset used in a small business. The first requirement
is that the asset must be an active asset to meet the concessions.
A CGT asset is an active asset if the taxpayer owns it, and:

• the taxpayer, their affiliate or an entity connected to them uses it, or holds it ready for use,
in the course of carrying on a business (whether alone or in partnership)
• it is an intangible asset (e.g. goodwill) inherently connected with a business they carry on
(whether alone or in partnership).
Shares in a resident company and interests in a resident trust may be active assets in certain
circumstances. Note that where the capital gain has arisen from a sale (or other CGT event) of
shares in a company or units in a trust, there are additional conditions that need to be fulfilled
for CGT small business concession eligibility.
Certain CGT assets cannot be active assets, even if they are used or held ready for use in
the course of carrying on a business—for example, assets whose main use is to derive rent.
Please see Module 5 under ‘CGT small business concessions’.
A CGT asset must also satisfy the active asset test under ITAA97, s. 152-35(1). The active asset
test is met if:
(a) you have owned the asset for 15 years or less and the asset was an active asset of yours for
a total of at least half of the period specified in subsection (2); or
(b) you have owned the asset for more than 15 years and the asset was an active asset of yours for
a total of at least 7½ years during the period specified in subsection (2) (ITAA97, s. 152-35(1)).
The entity must be a CGT small business entity for the income year with an aggregated turnover
of less than $2 million, or it must meet the maximum net asset value test under s. 152-15 of
ITAA97. Under this test, the entity (including related entities or affiliates) must have net assets
of no more than $6 million (excluding personal use assets such as a home, to the extent that it
hasn’t been used to produce income).
The small business concessions are summarised in Table 7.4. Additional examples showing the
application of the CGT concessions are provided after this table.
Table 7.4: CGT small business entity concessions

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Rule Description
15-year exemption If the business has continuously owned an active asset for 15 years
and the taxpayer is aged 55 or over, and is retiring or permanently
incapacitated, then there will not be an assessable capital gain upon
sale of the asset.
50% active asset reduction Reduction of the capital gain on an active asset by 50%. This is in
addition to the 50% CGT discount if applicable.
Retirement exemption Capital gains from the sale of active assets are exempt up to a lifetime
limit of $500 000. If the taxpayer is under 55, the exempt amount
must be paid into a complying superannuation fund or a retirement
savings account.
Rollover exemption All or part of the capital gain can be subject to a rollover where the
taxpayer makes an election to do so. However, if such an election is
made, then by the end of two years after the CGT event, the amount
subject to the rollover must have been used for the acquisition of a
replacement active asset, and/or for incurring expenditure on making
capital improvements to an existing active asset. If this is not the case
then, in effect, the rollover will be reversed and the taxpayer will be
subject to a CGT liability.

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Example 7.1: Fifteen-year exemption

Megan and Mary are partners in a partnership that conducts a coffee wholesale business on commercial
land they purchased in 1990 and have owned continuously since that time. The net value of their CGT
assets for the purpose of the maximum net asset value test is less than $6 million.
Megan and Mary are both over 60 years old and wish to retire. As they have no children, they decide
to sell the major asset of the wholesale commercial business, the land. They sell the land for a total
capital gain of $870 000.
Both Megan and Mary qualify for the small business 15-year exemption in relation to the capital gain.
Consequently, the capital gain is not included in their assessable income.
Example 7.2: Fifty per cent active asset reduction

Tony Ryan operated a car-washing business for 10 years as a sole trader. On 2 May 2019 Tony sold
the business for $950 000 and made a capital gain of $300 000. Tony had prior-year capital losses
totalling $40 000.
Assuming all the conditions for the concession are met, Tony’s capital gain for the 2018–19 tax year
is calculated as follows:
$
Capital gain 300 000
Less: Prior years losses 40 000
260 000
Less: 50% general CGT discount 130 000
130 000
Less: 50% small business reduction 65 000
Assessable capital gain 65 000
This capital gain may be further reduced by the small business retirement exemption or small business
rollover, or a combination of both (if applicable).
Example 7.3: Retirement exemption

Suppose, using Example 7.2, that Tony Ryan was aged 60 when he sold the car-washing business and
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Tony used those proceeds to fund his retirement. Tony had not previously used any of his lifetime
CGT retirement limit.
In this situation, Tony would also be eligible for small business retirement relief if he so elects in writing,
as the resulting net capital gain of $65 000 (after applying the 50% CGT discount and the 50% small
business CGT reduction) is less than the CGT retirement limit of $500 000.
As Tony is aged 60, he can disregard the $65 000 gain and is not required to contribute that amount
to a complying superannuation fund or retirement savings account. Thereafter, Tony’s CGT lifetime
retirement limit will be reduced to $435 000 ($500 000 – $65 000).
Example 7.4: Rollover exemption

Anne McDonough sold the premises from which she had operated her small business—a bookshop—
since 2001 for a capital gain of $450 000. As Anne satisfies the basic conditions for the CGT small
business concessions, and has elected to use the rollover exemption, this capital gain is reduced by
the 50 per cent general CGT discount to $225 000 and then by the 50 per cent small business reduction
to $112 500, which is then subject to the rollover. If Anne acquires a replacement asset within the
replacement asset period, she can disregard the $112 500 capital gain. If at the end of the two-year
replacement period, Anne has only spent $72 500 on a replacement active asset, CGT event J6 will
occur and Anne will incur a capital gain of $40 000 (the difference between the original capital gain
rolled over and the amount of expenditure incurred on the replacement asset).
Calculating the small business income tax offset

What is the small business income tax offset?
The small business income tax offset reduces the tax paid by an eligible sole trader and a SBE
by up to a maximum of $1000 each year. This offset is also known as the unincorporated small
business tax discount. It is not available to incorporated entities, namely companies. It is found in
Subdivision 328-F of ITAA97.
The offset, which is worked out on the proportion of tax payable on business income, is 8 per cent
for the 2018–19 income year.
The offset will increase to:

• 13 per cent in 2020–21
• 16 per cent in 2021–22.
To be eligible for the offset, the taxpayer must be carrying on a small business as a sole trader,
or have a share of net small business income from a partnership or trust. The small business must
have an aggregated turnover of less $5 million for the 2018–19 income year (ATO 2018c).
The formula for calculating the small business tax offset is contained in s. 328-360(1) of ITAA97
and is reproduced below:
 Your total net small business income 

8% ×  × Your basic income tax liability for the year 
 Your taxable income for the income year 
Calculating net small business income for the small business

income tax offset
Net small business income for the purposes of the small business income tax offset is all of the
assessable income from eligible business activities minus deductions. It is not calculated on
gross income.
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The offset is applied to the net small business income earned as a small trader, or the individual’s
share of net small business income from a partnership or trust. If the net small business income
is a loss, it is treated as zero for the purposes of the application of the small business income
tax offset. In that case, there is no offset available.
If the taxpayer generated eligible business income from more than one sole trader or
partnerships during the income year, then they must combine all of the assessable business
income from all their sole trader businesses, minus the deductions from that income,
to determine eligibility.
If carrying on more than one business, and any of these made a loss, the non-commercial
losses rules must first be applied. Net small business income is only reduced by losses deductible
in the current year. To work out net small business income, start with the net business income
or loss. Increase this amount by any deferred non-commercial losses not deductible in the
current year.
The non-commercial loss rules are discussed generally in the ‘Non-commercial loss rules’ section
in Module 3.
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Eligible income and deductions

The following can be included in net small business income for the purposes of the offset:
• any farm management deposits claimed as a deduction
• any repayments of farm management deposits included as income
• any net foreign business income that relates to sole trading business
• other income or deductions such as interest or dividends derived in the course of conducting
your business (ATO 2018a).
The following types of income cannot be included in net small business income for the purposes
of the offset:
• net capital gains made from carrying on your business
• personal services income (unless you were a personal services business)
• salary and wages received
• allowances and director’s fees
• government allowances and pensions
• interest and dividends unless it’s related to a business activity
• interest earned on a farm management deposit (ATO 2018a).
Furthermore, the following deductions cannot be included in net small business income for
the purposes of the offset:
• tax-related expenses such as accounting fees
• gifts, donations or contributions
• personal superannuation contributions
• current year business losses which are not deductible this year under the non-commercial
loss rules
• tax losses from prior years (unless they are deferred non-commercial losses [as discussed
in Module 3]) (ATO 2018a).
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Example 7.5: Calculating the small business tax offset
For the year ended 30 June 2019, Lucy derived $65 000 in assessable income from eligible business
activities in her work as a freelance public relations consultant. She operates as a sole trader and does
not have any other sources of income. She has $18 000 deductions (all allowable for calculating net
small business income).
Lucy’s eligible income for calculating the tax offset is $47 000 ($65 000 – $18 000). Tax payable on
$47 000 for the 2018–19 tax year is $6822 (excluding the 2% Medicare levy). The Medicare levy is not
included in computing the offset.
The rate of the small business tax offset for the 2018–19 tax year is 8 per cent. The amount of Lucy’s
small business tax offset is calculated as follows:
 $47 000 
8% ×  × $6822  =
$546
 $47 000 
Note that Lucy would also be eligible for the low- and middle-income tax offset (LMITO; discussed in
Module 6). However, this does not impact the calculation of the small business tax offset, which is
based on the tax liability before offsets.
➤ Question 7.1
Lucian runs a small accounting practice as a sole trader, Ballarat Accounting, and has operated in
the same premises for eight years. He has generated assessable business income of $250 000 this
year and employs a part-time bookkeeper who is paid a salary of $25 000. His eligible allowable
deductions (excluding the above-mentioned salary) totalled $130 000.
Lucian has no partner or children, and holds private hospital insurance. He is not liable for
Medicare Levy Surcharge.
During the 2018–19 income year, Lucian received unfranked dividends of $20 000 from ASX
publicly listed companies in respect of investments that he owns in his own name.
Ballarat Accounting’s annual aggregated turnover in the last financial year was $220 000.
(a) Determine if Lucian is eligible to be an SBE and a CGT small business entity.
(b) Calculate the amount of small business income tax offset Lucian will receive.
Lucian and his bookkeeper, Charlie, have a promising business opportunity to provide remote
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bookkeeping services to farmers utilising Cloud accounting software. Charlie and Lucian decide
to set up a partnership to pursue this idea. They have signed a partnership agreement and
commenced business as the Bookkeeping on the Move Partnership on 1 October 2018.
Charlie has a 60 per cent share of the partnership, while Lucian has a 40 per cent share.
The partnership agreement splits profits and losses in accordance with the above percentages.
The Bookkeeping on the Move Partnership generated $30 000 gross income over the 2018–19
income tax year. The partnership agreement states the following:
– Charlie will receive a partnership salary of $14 000 per annum.
– The partnership has $8000 in allowable deductions.
– The management of the business shall be the sole responsibility of Charlie.
– After payment of salaries, all profits and losses are to be shared between Charlie and
Lucian in the ratio of Charlie 60 per cent and Lucian 40 per cent.
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(c) Calculate the net partnership income of the Bookkeeping on the Move Partnership.
(d) Determine how the net partnership income of the Bookkeeping on the Move Partnership
should be distributed to the partners.
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What is the small business restructure rollover?
The small business restructure rollover allows small businesses to transfer active assets from one
entity (the transferor) to one or more other entities (transferees) without incurring an income tax
(including, but not limited to, CGT) liability.
The small business restructure rollover applies to transfers on or after 1 July 2016. The operation
of the rollover is contained in ITAA97, Subdivision 328-G. The following is a summary of
the small business restructure rollover. It is discussed in more detail in Module 5 under the
‘Rollover provisions and other reliefs’ section.
Who can access the rollover?

The rollover will apply if each entity that is party to the transfer event is (in the income year
where the transfer occurs):
• a small business entity [meeting all the SBE requirements]
• an entity that has an affiliate that is a small business entity
• an entity that is connected with a small business entity
• a partner in a partnership that is a small business entity.
This means that an entity not carrying on a business, but holding assets for a small business entity,
may be able to apply the rollover. For example, where one entity owns a property in which another
connected entity is carrying on a business (ATO 2017).
Eligible assets
This rollover applies to active assets that are CGT assets, depreciating assets, trading stock or revenue
assets transferred between entities as part of a genuine restructure of an ongoing business.
Active assets are assets used, or held ready for use, in the course of carrying on a business.
The rollover is not available for any other business assets. Assets such as loans to shareholders
of a company are not active assets of the business carried on by the creditor, and as such are not
eligible (ATO 2017).
When is the rollover available?

The rollover is available when the following conditions are met:
• the entity is an applicable SBE or related entity
• the rollover is part of a genuine restructure (not an artificial or tax-driven scheme)
• the rollover must not result in a change to the ultimate economic ownership of the
transferred assets.
Determining a genuine restructure

Determining whether a restructure is ‘genuine’ is a matter of fact—that is, it depends on all
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the facts surrounding the individual restructure.
The legislation includes a safe harbour rule to provide an alternative way of satisfying the
requirement that a restructure is genuine, which provides greater protection for small business
that a genuine restructure will be considered as such.
No change to ultimate economic ownership

The restructure must not result in a change to the ultimate economic ownership of the
transferred assets.
The ultimate economic owners of an asset are the individuals who, directly or indirectly, own an
asset. Where there is more than one individual with ultimate economic ownership … each
individual’s share of ultimate economic ownership must be maintained (ATO 2017).
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Note that:
Non-fixed (discretionary) trusts may be able to meet the requirements for ultimate economic
ownership—for example, where there is no practical change in which individuals economically
benefit from the assets before and after the transfer.
Family trusts may meet an alternative ultimate economic ownership test where:
• the trustee has made a family trust election [see Module 8], and
• every individual who had ultimate economic ownership of the transferred asset before the
transfer, and every individual who has ultimate economic ownership after the transfer, must be
members of the family group relating to the family trust (ATO 2017).
Trusts are discussed in more detail in Module 8.
Taxation implications of the rollover

There are several taxation implications from applying the small business restructure rollover.
First, the ‘assets transferred under the rollover will not result in an income tax liability arising for
either party at the time of the transfer’ (ATO 2017). Second, if the transferor is established:
to have received an amount for the transferred asset equal to the transferor’s cost of the asset for
income tax purposes … the transferee will be taken to have acquired the asset at the time of the
transfer for an amount that equals the transferor’s cost just before transfer (ATO 2017).
Specific taxation implications are presented in Table 7.5.
Table 7.5: Taxation implications of the same asset rollover
Tax Description
CGT Pre-CGT assets will retain their pre-CGT status after the transfer.
To be eligible to claim the CGT discount for any subsequent sale of the
asset, the taxpayer will need to wait at least 12 months before a CGT event
happens to that asset.
For the purposes of determining eligibility for the 15 year CGT exemption,
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the transferee is taken as having acquired the asset when the transferor
acquired it (ATO 2017).
Trading stock The rollover cost of an asset that is trading stock is either the:
• cost of the item for the transferor at the time of the transfer, or
• value of the item for the transferor at the start of the income year, if the
transferor held the item as trading stock at that time (ATO 2017).
Depreciating assets The rollover prevents the transferor from having to make a balancing
adjustment when assets are transferred. This allows the transferee to deduct
the decline in value of the depreciating asset using the same method and
effective life as the transferor was using (ATO 2017).
Revenue assets If the asset is a revenue asset, the rollover cost is the amount that
would result in the transferor not making a profit or loss on the transfer.
The transferee will inherit the same cost attributes as the transferor just
before transfer (ATO 2017).
Tax Description
Shares or interests in This rollover does not require that market value consideration, or any
a company/trust consideration, be given in exchange for the transferred assets.
Where membership interests are issued as consideration for the transfer,
the cost base or reduced cost base of those new membership interests
should be worked out based on the following formula:
(Sum of rollover costs and adjustable values of the rollover assets minus
liabilities the transferee assumes for the assets) divided by number of
new membership interests
An integrity rule is included to ensure that a capital loss on any direct or
indirect membership interest in the transferor or transferee that is made
subsequent to the rollover will be disregarded (ATO 2017).
Stamp duty/GST Must be considered before restructuring.
Anti-avoidance rule Even though a restructure may satisfy the rollover requirements, this does
not prevent the general anti-avoidance rule from applying to a scheme
involving the application of the rollover (ATO 2017).
Module 11 examines the general anti-avoidance rules.
Source: Based on ATO 2017, ‘Small business restructure rollover’, accessed December 2018,
https://www.ato.gov.au/general/capital-gains-tax/small-business-cgt-concessions/small-business-
Partnership taxation core concepts

What is a partnership?
There will be a partnership for tax purposes where it falls under either (or both) limbs of the
definition of ‘partnership’ in the tax legislation (ITAA97, s. 995-1).
The first limb covers a situation where there is a partnership in general law. A partnership in
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general law exists where there is a relationship that subsists between persons carrying on a
business in common with a view of profit (Partnership Act 1892 (NSW), s. (1)1). All states and
territories in Australia have a Partnership Act that contains a virtually identical definition to
the one contained in the NSW Partnership Act.
A partnership begins when the partners agree to conduct their business activity together.
This can be before the business actually begins to trade, such as when premises are leased
and a bank account opened. There must be at least two partners.
In most cases, there is no doubt about the existence of a partnership. The partners declare their
intention by such steps as signing a written partnership agreement and adopting a business
name. These outward and visible signs of the existence of a partnership are not essential,
however—a partnership can exist without them. No formal agreement is required to set up a
partnership, and the fact that two people carry on business together may be enough to show
that a partnership does exist—there may be a partnership in law even if the parties do not legally
recognise themselves as partners.
The second limb of the tax definition of partnership applies where persons receive income jointly.
For instance, where two people own a rental property together, this would be unlikely to fall
under the first limb of the definition of a partnership because they are not carrying on a business,
but would fall under the second, because they are earning income (rental income) jointly.
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A partnership is not a separate legal entity. Hence, it does not have a taxable income and it
cannot pay income tax in its own right. However, a partnership is considered a taxpayer for the
purposes of the tax legislation because it derives income.
The partnership itself must register an Australian Business Number (ABN) and for GST with the
ATO if the turnover of the partnership is at least $75 000 per annum (see Module 10). It is also
required to lodge a partnership tax return with the ATO. However, a partnership does not pay
income tax in its own right—any tax from income from the partnership is paid by the individual
partners in their own returns.
Tax status of a partnership

A partnership is a common form of tax structure. Partnerships allow for legitimate income
splitting under the taxation acts, and also allow individuals to pool capital, know-how and skill.
However, as stated in the previous section, the partnership itself is not taxed on the net income
of the partnership.
A partnership is instead merely a flow-through vehicle where each partner shares in the net
income of the partnership in proportion to the interest that the partner holds in the partnership.
The partner then includes their share of the net income from the partnership in the calculation of
their individual assessable income. The individual partners are therefore liable to pay tax on their
share of income derived from the partnership structure, and declare their share in their individual
tax returns.
Partnership income tax return

As previously mentioned, a partnership is required to lodge a partnership income tax return.
In the partnership tax return, the partnership includes its assessable income and deducts
its allowable deductions. The partnership will derive net income to the extent that the
partnership’s assessable income exceeds its allowable deductions. The term ‘net income’ of the
partnership is used instead of ‘taxable income’ as a partnership is not a separate legal entity
and does not pay tax. Hence, it does not have a taxable income.
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Once the net income of the partnership has been ascertained, this tax profit is distributed to
each partner (in the case of a partnership at general law) in accordance with their profit sharing
ratio as per the partnership agreement. This is the case, regardless of whether there has been
a cash distribution of the profit or not (see Rowe v. FC of T 71 ATC 4157).
Each partner consequently includes their share of the partnership distribution in their respective
income tax returns and pays tax on this partnership distribution at their respective marginal tax
rates (ITAA36, s. 92(1)).
Overview of partnership losses

If the partnership derives a loss, unlike a trust or company, the loss is distributed in that tax year
to each of the partners in accordance with their respective interests in the partnership. In other
words, unlike a company or trust, partnership losses are not quarantined within the partnership.
A partner is entitled to a share of any partnership loss according to that partner’s proportional
interest in the partnership. Each partner will be entitled to offset their share of partnership loss
against any other assessable income derived in the partner’s individual tax return.
Determining the net partnership income/loss

Determining net partnership income or loss
Two key terms in this section, ‘net income’ and ‘partnership loss’, are defined as follows.
Net income is defined as assessable income of the partnership less all allowable deductions,
except:
1. tax losses of earlier years under Division 36 of ITAA97, which should have been claimed
in the tax returns of the individual partners in the year that the net partnership loss was
incurred, and
2. deductions for partners’ personal superannuation contributions under s. 290-150 of ITAA97,
which are generally deductible to the individual partners if they meet certain criteria
(s. 90 of ITAA36).
A partnership loss occurs where allowable deductions except 1 and 2 in the definition of net
income exceed the assessable income of the partnership (s. 90 of ITAA36).
The net income or loss of the partnership is calculated as if the partnership was a resident
taxpayer. Both Australian and foreign source income and deductions are assessed when
calculating the net partnership income.
Partner is a resident
Where a partner is a resident, the partner includes their share of net partnership income as
assessable income in their tax return. The partner derives their share of any exempt partnership
income and any non-assessable, non-exempt partnership (NANE) income. The partner is entitled
to their share of any partnership loss.
Where net partnership income includes franked dividends or foreign source income on which
foreign tax has been paid, the resulting franking credit (see Module 8) and foreign income
tax offsets (see Module 6) flow to the resident partners based on their share of these classes
of income.
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Partner is a non-resident for whole year

Special rules apply to non-resident partners. If a partner is a non-resident for the whole year,
that partner is only assessed on their share of the net partnership income attributable
to Australian sources, and is entitled to a deduction for their share of partnership losses
attributable to Australian sources.
Partner is a non-resident for part-year

If a partner is a non-resident for only part of the year, that partner will be assessed on their
share of partnership net income attributable to Australian sources, plus net income attributable
to foreign sources during the period of Australian residency. The same rules apply to a partner’s
share of losses, exempt income and NANE income.
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Example 7.6: Share of partnership income

Michael, Mica and Morris are partners in a small partnership operating a contract catering service.
Each of the three partners receives an equal share of any distributions. During the 2018–19 tax year,
the partnership received a franked dividend of $1200. The dividend statement showed $400 franking
credits attached.
The partnership met all the conditions to be eligible to claim the franking credit. As a result of receiving
the dividend, the partnership includes $1600 in the net partnership income that is shared by the
partners (i.e. $1200 + $400).
Each partner is assessed on their $533 share of the partnership income (being $1600 × 1/3), and is entitled
to a tax offset of $133 representing their proportionate share of the franking credit (being $400 × 1/3).
Tax administration
We now know that a partnership does not pay tax itself, but it is still required to calculate a net
income or loss as if it were a taxpayer in its own right.
The partnership is not required to make Pay-As-You-Go (PAYG) income instalments for the
partnership, as the payment of taxation is the responsibility of each individual partner based on
their share of partnership income. As such, it is the individual partners that pay PAYG instalments
based on the profit distribution and their other sources of income.
In order for the individual partners to be in a position to be able to pay PAYG on their own
individual quarterly activity statements, the partnership will need to calculate its income or loss
position at the end of each reporting period, and report this to the partners accordingly.
It is the individual partner’s obligation to pay tax on their share of the partnership income.
Calculating a partner’s share of tax payable

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The non-commercial loss rules in Division 35 of ITAA97 apply to partnerships in a modified form.
These rules are discussed in further detail in the ‘Non-commercial loss rules’ section in Module 3,
which you should refer back to.
How do the non-commercial loss rules apply to partnerships?
These rules determine whether a partner is eligible to offset a loss from a business activity
in the partnership against other assessable income. When calculating whether the business
activity passes any of the four tests in Division 35, assets that are owned by partners who are not
individuals need to be excluded. Similarly, any assessable business activity income that goes
to partners who are not individuals must be excluded. Note that a person may be involved in a
business activity both as an individual and as a member of a partnership. In determining whether
the person is eligible to offset a loss, both partnership and individual income and assets need
to be taken into consideration.
Rules concerning partnership losses where adjusted taxable income is less

than $250 000
As provided for in s. 35-10(2E), if the partnership’s adjusted taxable income is less than $250 000,
the taxpayer should also check if they pass any of the following four tests. If yes, then the
business losses derived by the partnership can be offset against individual taxation income.
If the taxpayer’s adjusted taxable income is more than $250 000, then they must defer the loss
to a future income year, or apply for the Commissioner of Taxation’s (Commissioner’s) discretion
in limited circumstances.
These tests are summarised in Table 7.6.
Table 7.6: Non-commercial loss rules
Tax Description
Assessable income Business has assessable income of at least $20 000 per annum.
Profits Business had a profit for tax purposes in three out of the past five years
(including the current year).
Real property Value of real property or of an interest in real property used in the business
on a continuing basis was at least $500 000.
Other assets Value of assets (excluding real property, cars, motorcycles and similar vehicles)
used on a continuing basis in carrying on the business was at least $100 000.
Source: Based on ATO 2018, ‘Four tests’, accessed December 2018,

https://www.ato.gov.au/business/non-commercial-losses/four-tests/.
Example 7.7: The assessable income test

Jarli is in business in partnership with Ross and a company. The partnership earned $22 000 assessable
income last year from the business activity.
Of that income, $4000 went to the company and $9000 to each individual in the partnership. Therefore
the partnership income would not be sufficient to allow Jarli to pass the income test ($22 000 − $4000
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= $18 000).
However, Jarli has an interest in the business activity outside the partnership. He received $3500 in
assessable income from this non-partnership interest, so that the total assessable income he can
count for the purposes of this test is $21 500 ($3500 + $9000 + $9000). Jarli’s adjusted taxable income
is below the $250 000 threshold; therefore, he is able to deduct the loss.
Ross cannot take into account the non-partnership assessable income earned by Jarli for the purpose
of this test. Ross does not satisfy the assessable income test.
Source: Adapted from ATO 2018, ‘Partnerships’, accessed December 2018,

https://www.ato.gov.au/business/non-commercial-losses/partnerships/.
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Example 7.8: The profits test

Neha and Raj operate a business activity as a partnership. This year, Neha and Raj both have adjusted
taxable income of less than $250 000. They each receive $5000 in income from the partnership and
have received the same amount for the past four years.
Raj does not have any tax deductions for his part in the business, so he has made a profit every year—
therefore, he has no loss to offset.
Neha took out a loan to finance her investment in the partnership and is paying $8000 a year in interest.
Therefore, she has made a net loss of $3000 every year for the past four years, but as she does not
pass the profits test she cannot offset her losses.

Example 7.9: Real property test

John, Bill and George are equal partners in a real estate business. The business has five offices.
The partnership owns four of the offices, which have a property value of $450 000. Bill and George
have no property interests in the business except as partners, so neither Bill nor George pass the real
property test as the property value is less than $500 000.
However, John has adjusted taxable income of less than $250 000 and owns the fifth office in his own
right. It is valued at $70 000. Adding the value of his property to the value of the property assets held in
partnership allows him to pass the real property test and claim a loss ($450 000 + $70 000 = $520 000).

Example 7.10: The other assets test

Marika and Bill both have adjusted taxable income of less than $250 000. They are in partnership with
Steelco Pty Ltd. They are equal partners in a manufacturing enterprise that has plant, equipment and
trading stock valued at $210 000.
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Steelco owns $70 000 of these assets and as Steelco is a company, this amount must be ignored for
the purposes of the other assets test.
However, as the balance is still above $100 000 ($210 000 − $70 000 = $140 000) both Marika and Bill
are entitled to deduct losses.

➤ Question 7.2
Garry and Joanne are partners in a business. The partnership commenced operations in March
2015 and has made profits in each of the past four income years.
The partnership carries on business in both Australia and Sweden. The net income of the
partnership for the year ended 30 June 2019 has been calculated as $80 000. The Australian-
sourced net income of the partnership came to $60 000. The Swedish-sourced income was $20 000.
According to the partnership agreement, Garry is entitled to 60 per cent of the partnership
profits and Joanne 40 per cent.
(a) Assuming that Garry and Joanne are both residents for Australian tax purposes, what is each
partner’s share of the net income of the partnership for the year ended 30 June 2019?
(b) Assume the same facts as above. However, this time assume that Garry is a resident and
Joanne is a non-resident for Australian tax purposes. What is each partner’s share of the net
income of the partnership for the year ended 30 June 2019?
$
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(c) Do the non-commercial loss provisions have any application to the partnership?
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Partnership elections
Elections affecting the calculation of partnership income, such as valuation of trading stock
and method of depreciation, are required to be made by the partnership and not by the
partners individually.
The most important point is that an election made by the partnership applies to all partners.
Impact of salaries paid to a partnership

As previously mentioned, a partnership is not a separate legal entity. Partners cannot enter into
a contract of employment with the partnership.
The tax consequence of this status is that a partner’s salary is not deductible under the general
income provisions of s. 8-1, but rather the salary is distributed out of the net partnership income.
Broadly, the partnership salary does not change the size of the net income of the partnership.
However, a partner taking a salary does change how this net income is distributed between the
partners. It changes how much of the profit goes into each of the partner’s assessable income.
The salary is distributed to the relevant partner(s) and any residual amount of net income is
then split among the partners. The split of the residual distribution between partners is made
according to the profit-sharing ratio stated in the partnership agreement.
For example, if the partnership agreement says income will be distributed equally between three
partners, then that is how the income split will be made.
Partnership salary agreement

An agreement by the partners to pay a partnership salary to a partner is a contractual
agreement. This agreement is between the partners to vary the interests of the partners in
the partnership (and thus the partnership net income) between the partners.
For the agreement to be effective for tax purposes in a tax year, the agreement must be entered
into before the end of the applicable tax year.
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As the partnership salary is not a deduction, the payment of salary to a partner cannot result
in or contribute to a partnership loss for tax purposes. Furthermore, where the current year’s
partnership profits are not sufficient to cover a partner’s salary (taken as drawings in advance of
profits), the excess salary over the partner’s share of net partnership income is not assessable
income to the partner in that tax year.
The excess is assessable to the partner in a future tax year when sufficient profits are available
and the partner’s interest is also deducted (see the section ‘Alteration of partner’s interest’
for more on the impact of interest).
The following three examples show the application of a partner salary. They are taken
from Taxation Ruling (TR) 2005/7. The latest version of this taxation ruling was issued on
5 November 2014.
Example 7.11: Implications of partnership salary agreements 1

Anna and Robert formed a partnership under which it was agreed that they would share the profits
and losses of the partnership equally. The partnership agreement allowed the partners to draw a salary
if the partners so agreed. It was agreed at the beginning of the income year that Anna would draw
a salary of $20 000, for managing the business, and that the balance of profits and losses would be
shared equally. The net profit after paying Anna’s salary was $35 000.
Determination of the net income is as follows:

$
Partnership profit (after deducting salary) 35 000
Plus:
Anna’s salary 20 000
Net income 55 000
The net income is then distributed, in accordance with the partnership agreement, being 50 per cent
each, as follows:
Anna: $
Salary 20 000
Plus interest in balance of net income:
50% of (55 000 – 20 000) 17 500
Distribution 37 500
Robert: $
Interest in balance of net income:
50% of (55 000 – 20 000) 17 500
Distribution 17 500
Total distribution 55 000
Source: Adapted from Taxation Ruling TR 2005/7, ATO Legal Database, accessed December 2018,
http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR20057/NAT/ATO/00001.

Christine and Julia formed a partnership under which it was agreed that they would share the profits
and losses of the partnership equally. The partnership agreement provided that in addition to this,
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Christine would be entitled to draw $20 000 a year for managing the business. The tax year’s net
(accounting) loss, after paying Christine’s salary, was $10 000.
Determination of the net income is as follows:

$
Partnership net loss (after deducting salaries) (10 000)
Plus:
Christine’s salary 20 000
Net income 10 000
The net income is then distributed, in accordance with the partnership agreement, being 50 per cent
each, as follows:
Christine: $
Salary: 10 000
Interest in partnership net income:
50% of ($10 000 – 10 000) 0
Distribution 10 000
Julia: $
Interest in partnership net income:
50% of ($10 000 – 10 000) 0
Distribution 0
Total distribution 10 000
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The $20 000 was taken by Christine as drawings in advance of profits. Christine’s drawings do not
affect her liability to tax, other than to determine her individual interest in the net income and loss of
the partnership under s. 92 of ITAA36.
The $10 000 drawn in excess of available profits will be met from profits in future years and be assessable
to Christine under subsection 92(1) of ITAA36 in that future year when sufficient profits are available.
If the partnership is wound up before this time, the $10 000 excess is repayable by her and thus not
assessable under subsection 92(1) of ITAA36 or s. 6-5 of ITAA97.
http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR20057/NAT/ATO/00001.

Christine and Julia formed a partnership under which it was agreed that they would share the profits
and losses of the partnership equally. The partnership agreement provided, however, that Christine
would be entitled to draw $20 000 a year for managing the business. The agreement regarding the
sharing of profits or loss is to be construed as an agreement to share equally in profits remaining after
the salary is taken into account, if any, and equally in losses. The 2018–19 year’s net (accounting) loss,
after paying Christine’s salary, was $30 000.
Determination of the net loss, for the purpose of completing the Statement of Distribution on the
Partnership return, is as follows:
$
Partnership net loss (after deducting salaries) (30 000)
Plus:
Christine’s salary 20 000
Net loss (10 000)
The net loss is then distributed, in accordance with the partnership agreement, being 50 per cent
each, as follows:
Christine: $
Interest in partnership net loss 50% of $(10 000) (5 000)
Distribution (5 000)
Julia: $
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Interest in partnership net loss 50% of $(10 000) (5 000)
Distribution (5 000)
Total distribution (10 000)
The $20 000 ‘partnership salary’ cannot create or increase a partnership loss. The salary was taken
by Christine as drawings in advance of profits. Christine’s drawings do not affect her liability to tax,
other than to determine her individual interest in the net income or loss of the partnership under
s. 92 of ITAA36.
The $20 000 drawn in excess of available profits will be met from profits in future years and be assessable
to Christine under subsection 92(1) of ITAA36 in that future year when sufficient profits are available.
If the partnership is wound up before this time, the $20 000 excess is repayable by her and thus not
assessable under subsection 92(1) of ITAA36 or s. 6-5 of ITAA97.
https://www.ato.gov.au/law/view/document?docid=TXR/TR20057/NAT/ATO/00001.
Impact of interest paid to partners

Interest paid on monies advanced (lent) to the business by a partner is tax deductible to the
partnership if the partnership uses the funds for the purpose of producing income. The reason is
that the partner lends that money to the partnership not in their capacity as a partner, but in the
capacity of a lender.
However, the interest on a partner’s capital account or on a credit balance in a partner’s current
account (in other words, interest paid on a partner’s equity) is not deductible to the partnership.
The interest is merely an agreed means of distributing a partnership profit or loss, similar to
a partner’s salary. Interest debited to a partner’s current account is not regarded as income of
the partnership.
Where a partnership borrows money from a bank to repay in part, loans to the partnership
from partners (i.e. partner’s funds in their capital account), the interest paid will be deductible
to the partnership under s. 8-1 of ITAA97 provided the borrowed monies are used for working
capital purposes, which will subsequently allow the partnership to produce assessable income
(see FC of T v. Roberts; FC of T v. Smith [1992] 92 ATC 4380).
The Full Federal Court said that a deduction for interest on such financing would be limited to
the capital of the partnership. This includes:
• capital contributed by the partners
• retained profits.
Partners drawings are not taken into account in determining the net income of the partnership.
They are neither assessable to the individual partners nor deductible to the partnership for
taxation purposes.
The taxation consequences of interest, partner salaries and drawings on both the partnership
structure and individual partner are summarised in Table 7.7.
Table 7.7: Summary of taxation consequences of partner interest,

salaries and drawings
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Tax consequences
Transaction Partnership Partner
Interest on partner’s capital Non-deductible—merely Allocation of profits (s. 92)

account or credit balance on allocation of profits
current account
Interest on loan provided to Deductible Assessable interest

partnership by partner for income
producing purposes
Interest on loan provided to Deductible for a general law N/A

the partnership by bank to partnership (FC of T v. Roberts;
repay partners’ funds previously FC of T v. Smith [1992] ATC 4380)
used to generate partnership
assessable income
Salary paid to partners Non-deductible—merely Allocation of profits (s. 92)

allocation of profits
Drawings Ignored for tax purposes Ignored for tax purposes
Note: Partners are not entitled to a deduction under s. 8-1 for interest on borrowings to pay personal
income tax. This is a personal expense and is not incurred in deriving assessable income.

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➤ Question 7.3
Susan and Jack formed a partnership in which it was agreed to share profits and losses equally.
As Susan would be more active in attending to the partnership business, it was agreed that she
be paid an annual salary of $30 000.
The accountant has just finalised the partnership results for the 2018–19 tax year and has advised
the partners that the partnership derived a net loss of $20 000 after paying Susan’s salary.
(a) For the purposes of completing the partnership tax return, what is the partnership net income
or loss?
(b) How is the partnership net income or loss as calculated in Part (a) to be distributed to each
partner for tax purposes based on the partnership agreement?
Check your work against the suggested answer at the end of the module. MODULE 7
Alteration of partner’s interest

Real and effective control of partnership income
Family partnerships could enter into income splitting arrangements through the inclusion of
children or adults as partners when they do not have the real and effective control and disposal
of their share of the partnership income.
To minimise this opportunity for loss of revenue, s. 94 of ITAA36 imposes special rates of tax
on certain partners who receive a share of uncontrolled partnership income.
Where a person under the age of 18 years is allegedly a partner in a partnership, the minor’s
interest in the partnership income will be potentially subject to the provisions of Division 6AA,
as s. 94 is inapplicable to minors. Division 6AA was discussed in Module 6 (‘Tax treatment
of minors’).
Division 6AA basically allows the Commissioner to determine what is a reasonable return for the
time and effort put into the partnership by the minor together with a reasonable return on any
capital invested by the minor. Those amounts considered to be reasonable (‘excepted assessable
income’) will be taxed at normal rates, whereas any excess amounts referred to as ‘eligible
taxable income’ will be assessed at special rates (generally 45% plus 2% Medicare levy).
Alteration of partner’s entitlement to profit

Assignment of a partner’s interest in a partnership
A partner may assign their share, or part of their share, in a partnership with the consequence
that the net income of the partnership attributed to the assigned share is derived beneficially
by the assignee. These arrangements are referred to as an Everett assignment.
This principle was established by a full High Court decision in FC of T v. Everett 80 ATC 4076
(Everett’s case).
In Everett’s case, the taxpayer, a partner in a firm of solicitors, assigned by deed and for valuable
consideration six-thirteenths of his share in the partnership to his wife. Under the terms of
the assignment, Everett’s wife was not entitled to become a member of the partnership or to
interfere in the business. The High Court held that a partner’s interest in a partnership is a chose
in action (essentially a bundle of personal rights over property) that may be assigned in whole or
part. The assigning partner stands in the relationship of a trustee to the assignee who receives
the income as net income of a trust estate.
As a beneficiary, Everett’s wife was assessable on the trust income and Everett was not liable for
any tax on that income.
Taxation treatment of an Everett assignment: Capital gains tax provisions

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Where a partner has entered into an Everett assignment, the ATO will treat the assignment as a
disposal of a CGT asset (the partner’s interest, or part interest, in the partnership).
CGT provisions will apply to any disposal of a partner’s share of partnership assets acquired after
19 September 1985. The cost base of the partnership interest will be the amount of consideration
given by the partner to acquire the partnership interest (s. 110-25(2)), and as the assignment is
usually not an arm’s-length transaction, the consideration received on disposal of the assigned
partnership interest by the assignor would be deemed to be the market value of the interest
(s. 116-30). The market value of the interest is to be determined by discounting the expected
net cash flow accruing to the assigned interest by an appropriate rate.
Note: The ATO has suspended the application of the Everett assignment guidelines and web
material as of 14 December 2017. This means that those looking to enter into new Everett
assignment arrangements from 14 December 2017 can no longer rely on the ATO guidelines
and must contact the ATO individually. Those who have entered into assignments before
14 December 2017, which comply with the guidelines and do not demonstrate any high-risk
factors, can continue. Those arrangements demonstrating high-risk factors may be subject
to review. High-risk factors include the use of related party financing and self-managed
superannuation funds (SMSFs).
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During 2018, the ATO began consulting with stakeholders with a view to publishing draft
guidance on this issue. However, as at the date of writing, no such guidance has been issued
on this matter.
Treatment of expenses on assignment of a share in a partnership

Where a partner assigns their share of an interest in a partnership, any expenses incurred by the
assignor partner in connection with the partnership may have to be apportioned in accordance
with the interest assigned.
For example, if a partner assigns half their interest in a partnership, a deduction is only allowable
to the assignor partner for the share of the partnership interest not assigned.
Expenditure incurred by the assignor partner that is unrelated to the partner’s proportionate
interest in the partnership, such as subscriptions, travel expenses and depreciation of
professional library, remains fully deductible to the assignor partner.
Treatment of partnership loss

Where there is a partnership loss, the share of a partnership loss attributable to the assigned
interest is deductible to the assignor in the capacity of trustee for the trust estate of the
assigned interest.
This means that the loss will be carried forward in the trust estate and applied against trust
income in future years, and no deduction is allowed to the assignee in the year in which the
partnership loss is incurred (see Income Taxation Ruling (IT) 2608).
Alteration of profit/loss entitlements

Attempts by partners towards the end of the tax year to adjust the ratios in which they share
profits or losses for the year are ineffectual (established in Board of Review Case P73, 82 ATC 346
and Case Q53, 83 ATC 285). Two other case examples are described in Example 7.14.
Example 7.14: Alteration of profit/loss entitlements
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In the Board of Review Case W79 89 ATC 705, the Tribunal held that a decision to pay a salary to
one of the partners after the end of the tax year was an attempt to redistribute partnership income.
To make a decision to pay a salary after the close of the tax year was too late to alter what had derived.
In FC of T v. Nandan 96 ATC 4095 the Federal Court held that a dissolution agreement entered into
on the last day of the tax year to give one partner a fixed sum of $15 000 out of the final annual profit,
with the other partner receiving the remainder, displaced the original partnership agreement, which had
provided for both partners to receive 50 per cent of the profits.
General work in progress rule

Where a partnership returns income on an accruals basis, the value of work in progress is not
included in the net income of the partnership unless it creates a recoverable debt for which
the partnership is entitled to payment.
However, where, on the retirement or death of a partner, a payment for unbilled work in progress
is made to the retiring partner or to the trustee of the deceased’s estate as a reflection of the
partner’s future expected profit, that payment is assessable income to the retiring partner or to
the trustee of the deceased partner’s estate.
General capital gains tax rule

It is the individual partners who make a capital gain or capital loss from a CGT event, not the
partnership itself. For CGT purposes, each partner owns a proportion of each CGT asset.
Each partner calculates a capital gain or capital loss on their share of each asset (ATO 2018b).
Each partner claims their share of a credit for foreign resident capital gains withholding amounts.
Dissolution or reconstitution of a partnership

At common law, the dissolution or reconstitution of a partnership occurs when there is a
change in the membership of the partnership.
This change may occur because of the death or retirement of a partner or the admission
of a new member, notwithstanding any clause in the partnership agreement.
A partnership is dissolved through:

• agreement of the partners
• the death or bankruptcy of a partner
• a court on application of a partner.
It should be noted that old partnerships, although dissolved, may continue to subsist for
purposes such as the collection of book debts.
A partnership is reconstituted where:

• a partner dies and the remaining partners agree to continue the partnership
• a partner retires and the remaining partners continue the partnership, or
• a new partner is admitted to the partnership.
If there is a change in the composition of a partnership (a partner retires, dies, or a new partner
is admitted) then the old partnership is dissolved and a new partnership is formed.
This means that, when a partnership is dissolved and then reconstituted, the partnership is
required to lodge a partnership tax return for both the old and new partnerships. This will show
the net partnership income or partnership loss to the date of dissolution (the old partnership)
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and from the date of reconstitution to the end of the tax year (the new partnership). The new
partnership may also need to apply for a tax file number (TFN).
Reconstituted continuing entity

A partnership can allow for multiple and successive partnership changes to be made via
the partnership agreement, thereby ensuring they do not need to meet the administrative
requirements mentioned previously. Where the partnership is a reconstituted continuing entity,
it only needs to lodge one income tax return covering the whole year using its existing TFN.
It does not need to have a new TFN or ABN.
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The ATO:
will treat a changed partnership as a reconstituted continuing entity if the original partnership
agreement incorporated a provision for a change in membership or shares and the following
factors apply:
• the partnership is a general law partnership
• at least one of the partners is common to the partnership before and after reconstitution
• there is no period where there is only one ‘partner’ …
• the partnership agreement includes an express or implied continuity clause or, in the absence
of a written partnership agreement, the conduct of the partners is consistent with continuity
• there is no break in the continuity of the enterprise or firm (ATO 2019).
Taxation consequences: Calculation

The taxation consequences of a partnership dissolution or reconstitution affect four main areas:
• trading stock
• depreciation (capital allowances)
• CGT
• GST.
The taxation consequences of the dissolution/reconstitution of a partnership are summarised

in Table 7.8.
Table 7.8: Tax consequences of dissolution/reconstitution
Trading stock Disposal taken into account at the partnership level in determining partnership
(s. 70-100 of ITAA97) profit and loss—partners receive their proportionate share.
Note: Election to treat trading stock at its tax value is possible if at least
25 per cent of the partner’s interest in the old partnership continues into the
new partnership.
Depreciation Balancing adjustments are considered at the partnership level to determine the
(s. 40-340 and 40-345 net income of the partnership.
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of ITAA97)
Note: Balancing adjustment will not be required if both the transferor(s) and
transferee(s) make a written joint election for rollover relief.
Capital gains Partnership entity is ignored and a fractional interest approach is taken.
(ss. 108-5(2)(c) and Each partner has a fractional interest in each and every partnership asset.
106-5 of ITAA97)
Capital gains/losses are excluded from partnership calculations—these are
taken into account at individual partner level.
GST (GST Ruling Dissolution

(GSTR) 2003/13) • Part of carrying on the partnership’s enterprise.
• In-kind distribution deemed to be a supply in the course of an enterprise.
Reconstitution
• Reconstituted partnership retains its GST registration despite a change in
its membership.
• Change in membership does not give rise to any supplies or acquisitions
from one partnership to another partnership.

Example 7.15: Admission of new partner to the partnership

Lucas and Eddie are equal partners in a business. The partnership acquired business premises to
run its business on 16 March 2012 for $240 000. The current market value of the property is $360 000.
Lucas and Eddie are considering admitting a third and equal partner, Melanie, into the partnership.
Melanie will contribute $120 000 for admission into the partnership.
What are the CGT consequences to Lucas and Eddie of admitting Melanie into the partnership?
The CGT consequences for Lucas and Eddie, respectively, on disposing of their one-third individual
interest are as follows.
Capital proceeds received for giving up one-third $

interest in CGT asset of partnership
(in this case capital proceeds equals half of the $120 000
contributed by Melanie for the one-third interests
disposed of by Lucas and Eddie) 60 000 each
Less: Individual cost base

Lucas and Eddie are deemed to have disposed
of one-third of their interest in the
partnership business premises (1/3 × $240 000 / 2) 40 000 each
Capital gain ($60 000 − $40 000) 20 000 each

CGT 50% discount (as held for more than 12 months) (10 000) each
Net capital gain 10 000 each
➤ Question 7.4
On 1 July 2018 Pablo Alonso commenced business as an electrician in partnership with his wife,
Kate, and son Noah, aged 17. Noah still attends high school and works with his father on weekends
and the school holidays. The partnership agreement provides the following:
• Noah shall work in the business on weekends and on school holidays and be paid a salary
that is considered reasonable for the hours that he works.
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• Pablo will receive a salary of $25 000 per annum.

• The management of the business shall be the sole responsibility of Pablo.
• After payment of salaries, all profits and losses are to be shared equally between the three
partners.
For the year ended 30 June 2019, the partnership had net income of $45 000 after paying Pablo
a salary of $25 000 and Noah a salary of $6000 (which was considered reasonable).
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Calculate the net income of the partnership.

$ $
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Summary and review

This module has covered the core concepts of an SBE, including revisiting the definition
of an SBE and the core income tax concessions that apply to SBEs. These include the capital
allowances provisions, trading stock and CGT small business concessions.
An SBE must carry on business and meet the aggregated turnover test. The aggregated turnover
test is different for different areas of taxation—mainly the test is $10 million aggregated turnover
to meet the definition of an SBE. For the purposes of SBEs using the small business CGT
concessions, the aggregated turnover is $2 million.
The company tax rate of 27.5 per cent applies to base rate entities. For the year ended 30 June
2019, this tax rate applies to those entities with an aggregated turnover of less than $50 million
that have no more than 80 per cent base rate entity passive income (BREPI).
The small business income tax offset was also discussed, which reduces the tax paid by
an eligible sole trader and an eligible SBE. The small business tax offset is calculated on a
proportional rate up to a maximum of $1000 at 8 per cent for the 2018–19 income year. Net small
business income for the purposes of the income is all of the assessable income from eligible
business activities minus deductions.
The module then turned its attention to the taxation of partnerships. A partnership is not a
separate legal entity. Hence, it does not have a taxable income and does not pay income tax
in its own right. Instead, a partnership is required to include in its tax return all of its assessable
income less allowable deductions. The resultant figure is referred to as the ‘net income of the
partnership’. This amount is distributed to the partners in accordance with the profit sharing
arrangements in the partnership agreement.
This partnership distribution is included in each partner’s respective income tax return and tax
is paid by each partner based on their marginal tax rate. Where a partnership derives a loss,
unlike a trust and company, this loss is distributed to the partners and claimed as a deduction
to offset against their other income. In other words, a partnership loss is not carried forward
in the partnership.
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A partner’s salary is not deductible to the partnership but, instead, is regarded as part of the
profit distribution. However, interest paid by the partnership on an advance (or loan) made by
a partner to the partnership is considered an allowable deduction provided the funds were
used to produce assessable income.
A minor’s interest in the partnership income will be potentially subject to the provisions of
Division 6AA of ITAA36.
The module concluded with a brief discussion of Everett assignments and the CGT, trading stock,
depreciation and GST consequences regarding the dissolution or reconstitution of a partnership.
Suggested answers
Suggested answers
Question 7.1
(a) To be treated as a SBE, Ballarat Accounting is required to carry on business and have an
aggregated turnover of less than $10 million in the 2018–19 income tax year. To access the
CGT concessions, its aggregated turnover must be less than $2 million (or the net asset
value test must be satisfied). Ballarat Accounting has an annual turnover of $250 000 for
the 2018–19 income year, so this is well below the $10 million threshold.
(b) Lucian’s eligible income for the purposes of calculating the small business tax offset is
$95 000 (i.e. $250 000 – $25 000 – $130 000).
The unfranked dividends received of $20 000 do not come into the calculation of net small
business income, but do form part of Lucian’s overall taxable income for the year ended
30 June 2019 of $115 000 (being the denominator in the small business tax offset formula
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shown below).
Tax payable on Lucian’s taxable income of $115 000 for the 2018–19 tax year is $30 047
(excluding the 2% Medicare levy). The Medicare levy is not included in computing the offset.
The rate of the small business tax offset for the 2018–19 tax year is 8 per cent. The amount
of Lucian’s small business tax offset is calculated as follows:
 $95 000 
8% ×  × $30 047  =
$1986 (rounded)
 $115 000 
The amount of Lucian’s small business tax offset is $1986. However, the maximum small
business tax offset that is able to be claimed is $1000. Hence, Lucian will receive $1000
(s. 328-360).
(c) See the following calculation of net income:

$
Gross income 30 000
Minus partnership salary (14 000)
Minus allowable deductions (8 000)
Net income 8 000
Add back non-deductible salaries:
Salary—Charlie 14 000
Section 90 of ITAA36 Net partnership income 22 000
(d) See calculation of how the net partnership income is assessable and distributed as follows.
The net partnership income would be assessable as follows:
Charlie $
Salary (as agreed) 14 000
Partners share of residual ($22 000 – $14 000) × 0.6 4 800
Sub-total (Charlie) 18 800
Lucian
Share of residual ($22 000 – $14 000) × 0.4 3 200
Net partnership income 22 000
Charlie will declare $18 800 (which is his share of the partnership income) in his personal
income tax return and add it to his other income.
Lucian’s share of the income of the partnership is $3200. Lucian will declare this amount in
his personal income return and add it to his other income.
Question 7.2
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(a) Assuming that Garry and Joanne are both residents for Australian tax purposes, their share
of the net income of the partnership for the year ended 30 June 2019 in accordance with
s. 92(1)(a) of ITAA36 is as follows:
$
Garry—resident ($80 000 × 60%) 48 000
Joanne—resident ($80 000 × 40%) 32 000
Net income of the partnership 80 000
Hence, Garry will include an amount of $48 000 in his 2019 income tax return, while Joanne
will include an amount of $32 000.
(b) The share of the net income of the partnership for the year ended 30 June 2019 in
accordance with ss. 92(1)(a) and 92(1)(b) is as follows:
$
Garry—resident ($80 000 × 60%) 48 000
Joanne—resident ($60 000 Australian-sourced income × 40%) 24 000
Net income of the partnership 72 000
Garry will include an amount of $48 000 in his 2019 income tax return, while Joanne will
only include an amount of $24 000. This is her share of the Australian-sourced income
(i.e. $60 000).
(c) Despite the fact that the net income of the partnership is less than $250 000, the non-
commercial loss provisions do not apply due to the fact that partnership has derived a net
income. The non-commercial loss provisions contained in Division 35 of ITAA97 only apply
where the partnership has derived a loss for taxation purposes.
Question 7.3
(a) Partnership net income
$
Partnership net loss after deducting Susan’s salary (20 000)
Add salary paid to Susan 30 000
Net income of partnership 10 000
(b) Net income of $10 000 as calculated in Part (a) is distributed as follows:
Susan $
Salary 20 000
Interest in partnership net income
50% of ($10 000 less $10 000) Nil
10 000
MODULE 7
Jack
Salary Nil
Interest in partnership net income
50% of ($10 000 less $10 000) Nil
Nil
Total distribution of partnership 10 000
The $30 000 salary taken by Susan represents a distribution of partnership profits in advance.
As the partnership’s net income was only $10 000, which has all been allocated to Susan due
to her salary entitlement, the excess of $10 000 over available profits will be assessable to
her in a future year when sufficient profits are available. The $30 000 salary does not affect
her liability to tax other than to determine her individual interest in the net income and loss
of the partnership.

Question 7.4
The net partnership of Pablo, Kate and Noah Alonso is as follows:
$ $
Net income after paying salaries 45 000
Add back non-deductible salaries:

Salary—Pablo 25 000
Salary—Noah 6 000 31 000
The net partnership income would be assessable as follows:
Noah†
Salary 6 000
Share of residual ($76 000 – $31 000) / 3 15 000 21 000
Kate
Share of residual ($76 000 – $31 000) / 3 15 000
Pablo
Salary 25 000
Share of residual ($76 000 – $31 000) / 3 15 000 40 000
†
As Noah is a prescribed person (i.e. a minor), his partnership distribution and salary will be subject to
the principles contained in Division 6AA of ITAA36. The salary (provided it is considered reasonable)
will be regarded as excepted assessable income and be subject to the normal rates of income tax
applicable to resident Australian taxpayers.
On the other hand, Noah’s share of the distribution of partnership income is likely to be regarded as
eligible taxable income and taxed at the special rates of tax contained in Division 6AA.

MODULE 7
REFERENCES | 339
References
References
ATO 2017, ‘Small business restructure rollover’, accessed March 2019, https://www.ato.gov.au/
General/Capital-gains-tax/Small-business-CGT-concessions/Small-business-restructure-rollover/.
ATO 2018a, ‘Claiming the offset’, accessed December 2018, https://www.ato.gov.au/

business/income-and-deductions-for-business/in-detail/small-business-income-tax-
offset/?anchor=Claimingtheoffset.
ATO 2018b, ‘Guide to capital gains tax’, accessed December 2018, https://www.ato.gov.au/
forms/guide-to-capital-gains-tax-2018/.
ATO 2018c, ‘Small business income tax offset’, accessed December 2018, https://www.ato.gov.
au/business/income-and-deductions-for-business/in-detail/small-business-income-tax-offset/.
ATO 2019, ‘Partnership tax return instructions 2015’, accessed April 2019, https://www.ato.gov.au/
MODULE 7
forms/partnership-tax-return-instructions-2015/?page=13.
MODULE 7
AUSTRALIA TAXATION
Module 8
TAXATION OF TRUSTS, COMPANIES AND
SUPERANNUATION FUNDS
342 | TAXATION OF TRUSTS, COMPANIES AND SUPERANNUATION FUNDS
Contents
Preview 343
Introduction
Objectives
Teaching materials
Trust taxation core concepts 346
Overview of trusts
Rules governing taxation of trust income
About Division 6 348
Introducing Division 6
Determining taxation of trust income
Overview of deceased estates
Determining net income of a trust 353
Workflow for determining net income
Seven-step process for determining net income and how it is assessed
Discrepancies and capital gains 357
Discrepancies in income and net income
Capital gain included in trust income
About trust distributions 360
Overview of streaming
Trust loss provisions
Family trusts 361
Administration and reporting for trusts 365
Tax file number withholding rules
Trustee reporting requirements
Company taxation core concepts 366
General company concepts
Company for taxation purposes
Public or private companies
Residency status of company
Calculating taxable income 369
Company tax rate
Calculating a company’s taxable income
Gross-up and franking credit tax offset
Tax administration
Dividend imputation system 375
Introducing the dividend imputation system
Franking credit qualified person requirements
Maximum franking credit
The benchmark rule
Anti-streaming rules
Franking account
MODULE 8
Superannuation fund taxation 382

Entry: Contributions
Earnings
Exit: Retirement phase
References 395
STUDY GUIDE | 343
Module 8:
Taxation of trusts,
companies and
superannuation funds
Study guide
Preview
Introduction
Module 8 examines the taxation of trusts. How trusts are taxed is governed by the provisions in
Division 6 of ITAA36. At what instances these provisions potentially tax the trustee and/or the
beneficiaries of a trust will vary, depending on the individual facts. However, the provisions will
not tax the ‘trust’ itself, as unlike a company, a trust (as opposed to its trustee and beneficiaries)
is not regarded as an entity that is subject to tax. There are additional provisions in the legislation
that grant certain concessions to family trusts that make a valid family trust election.
MODULE 8
Companies (defined as such for taxation purposes) are treated as a separate taxation entity and
must lodge a company tax return. The current company tax rates are 27.5 per cent (for base rate
entities) and 30 per cent (for all other companies). Corporate tax entities that receive a franked
distribution directly are required to include the franking credit attached to the distribution in their
assessable income. The module also provides an overview of the dividend imputation system
that applies when dividends are paid by a resident company to a resident individual shareholder.
Superannuation is taxed at three points: on entry into the fund (via contributions made by the
member), on earnings (taxed at 15% while in the fund), and upon exit from the fund, which is
the retirement phase.

Figure 8.1: Module summary—taxation of trusts
Trustee and Determining net

Concessions
beneficiary income of the trust
Division and Distributable Proportionate

Taxation of trusts
provisions income approach
Family trust
Administration Trust distributions
election
Family tax TFN Trustee Trust loss

FTDT Streaming
concessions withholding reporting provisions
Figure 8.2: Module summary—company taxation
General company Dividend

Company taxation
concepts imputation
Frankable
Company Calculating taxable distributions
separate income
taxation entity Benchmark rule
Tax rate
Anti-streaming
integrity
Company tax Steps for
return calculation
Franking account
Franking credit
tax offset
MODULE 8

STUDY GUIDE | 345
Figure 8.3: Module summary—superannuation fund taxation
Superannuation fund taxation
Entry Earnings Exit
Taxed at 15% in
Contributions Retirement phase
accumulation phase
Concessional Non-concessional Mostly tax-free
Objectives
• apply the taxation laws to calculate the net income or loss of a trust;
• determine the tax implications on distribution of the net income of a trust;
• calculate the taxable income and tax payable by a resident company;
• apply the principles of the imputation regime including the franking of distributions to
a given situation; and
• determine the tax implications of contributions received by a superannuation fund and the
fund earnings.
Teaching materials
• Legislation:
– Income Tax Rates Act 1986 (Cwlth)
• Glossary: MODULE 8
Definitions/
terms/

candidates/your-experience/skills-list (note that the employability skills are not examinable)
Trust taxation core concepts

Overview of trusts
The CCH Macquarie Dictionary of Law defines a trust as:
An arrangement, developed and enforceable in equity, for the holding and management of
property by one party (the trustee) for the benefit of another (the beneficiary) or for some specific
purpose (CCH 1996).
A commonly referred-to international definition is that of Underhill, who states:

A trust is an equitable obligation, binding a person (who is called a trustee) to deal with property
over which he has control (which is called trust property), for the benefit of persons (who are called
the beneficiaries or cestuis que trust) of whom he may himself be one, and any of whom may
enforce the obligation (Hayton 1979, p. 1).
Categories of trust
There are two categories of trust—express and non-express.
The types of express trust are:

• trusts created between living persons referred to as inter-vivos trusts (including fixed trusts,
discretionary trusts and unit trusts)
• trusts created by the Will of any person (referred to as testamentary trusts).
Non-express trusts are those that come into existence without an expressed intention to create
a trust. Types of non-express trust are implied, resulting and constructive trusts.
Fixed and discretionary trusts

Fixed trusts are those where the beneficiaries have a fixed right to a predetermined proportion
of the income/capital of the trust. On the other hand, discretionary trusts (also called non-
fixed trusts) exist where the trustee can decide what portion of the income/capital each of the
beneficiaries is entitled to in any given year.
Note that some trusts are hybrid, in that some of the interest of the trust property and its income
is fixed, and some of it is subject to the discretion of the trustee.
Parties to a trust
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The important parties to a trust are summarised in Table 8.1.

STUDY GUIDE | 347
Table 8.1: Parties to a trust
Settlor The person who makes the original property settlement to establish the trust fund.
The settlor can be a godparent, uncle, aunt or a close family friend who would have
reason for establishing a trust fund or an independent third party.
Settled fund The nominal sum bestowed by the settlor to establish the trust.
Beneficiary The person (including a company) who may benefit from the distribution of trust
income and/or property.
The beneficiary has equitable ownership over the trust property.
There are no restrictions on who can be a beneficiary; they can be a company, a minor,
or a person with a legal disability (explained in the section ‘Beneficiary “presently
entitled” but under a legal disability’)—in fact, a trust is often established with the
protection of assets for dependants as its chief purpose.
A beneficiary under a fixed trust has a proprietary right to a fixed proportion of trust
income and/or capital.
A beneficiary under a discretionary trust does not have a right to trust income, only a
right to be considered by the trustee as a potential recipient of trust income.
Trustee Person or company who manages the trust estate as legal owner of the trust property.
As the trustee is personally liable for all contracts entered into with third parties (with a
right to be indemnified out of the trust assets when acting within the powers of the
trust deed), it is common to use a limited liability company or a company limited by
guarantee as trustee.
The trustee is responsible for managing the trust’s tax affairs, including registering the
trust in the tax system, lodging trust tax returns and paying some tax liabilities.
Trust deed Written document (memorandum) that governs the operations of the trust.
Guardian Person from whom consent must be gained before a change can be made to the trust
deed. Not all trusts will have a guardian.
Appointor Person who has the power to appoint and remove the trustee.
Rules governing taxation of trust income MODULE 8

The taxation of the income of an Australian resident trust is found in the rules contained in
Division 6, Part III of ITAA36. These are known generally as the Division 6 rules.
There are two parties to the trust that play a role in the taxation of trusts—the trustee and
the beneficiary.
The trustee is responsible for managing the trust’s tax affairs, including registering the trust in the
tax system, lodging trust tax returns and paying some tax liabilities.
Beneficiaries (except [those under a legal disability, such as] minors and non-residents) include their
share of the trust’s net income as income in their own tax returns. There are special rules for some
types of trust including family trusts, deceased estates and super funds (ATO 2019b).
These are examined in this module.

About Division 6
Introducing Division 6
As stated in the ‘Rules governing taxation of trust income’ section, nearly all of the key provisions
on the taxation of trust income can be found in Division 6 of ITAA36 (comprising ss. 95AAA–102).
Division 6 of ITAA36 establishes the basis for calculating the net income of the trust. This is
effectively the trust’s taxable income.
It is important to distinguish the income of the trust estate, which is the income for trust
purposes, and the net income of the trust estate, which is the trust’s income for tax purposes.
Although these two amounts will sometimes be the same, they will at other times be different
(this is explained in more detail later in this module).
Where a beneficiary is presently entitled to a ‘share’ of the income of a trust estate, the liability
to tax will be assessed as follows:
• that ‘share’ will be applied to the net (taxable) income of the trust estate, with the resultant
tax liability being assessed to the beneficiary (s. 97) (for instance, if they are entitled to 50% of
the income of the trust estate, they will be assessable on 50% of the net income of the trust)
• if the beneficiary is under a legal disability, the liability will be assessed to the trustee of the
trust estate (s. 98) at the tax rate of the beneficiary. Similarly to s. 97, such a liability under
s. 98 will be based on calculating the percentage entitlement of the beneficiary to the income
of the trust estate, and then that percentage being applied to the net income of the trust.
To the extent that no beneficiary is presently entitled to the income of the trust estate,
the trustee will be assessed under s. 99 and s. 99A.
The following important concepts are discussed in the next three subsections:
• beneficiary ‘presently entitled’
• beneficiary ‘presently entitled’ but under a legal disability
• no beneficiary ‘presently entitled’.
Beneficiary ‘presently entitled’

A beneficiary who is ‘presently entitled’ and not under a legal disability is required to pay the
tax on that share of the net income of the trust to which the beneficiary is presently entitled.
So what does presently entitled actually mean? The present entitlement in s. 97 is not defined.
The concept of ‘entitlement’ refers to a beneficiary’s vested and indefeasible interest in
MODULE 8
trust income.
To establish a present entitlement, common law has established that the trustee must, under the
terms of the trust, be legally required to pay the trust income to the beneficiary, or deal with
the trust income on the beneficiary’s behalf.
STUDY GUIDE | 349
Beneficiary ‘presently entitled’ but under a legal disability

A beneficiary who is ‘presently entitled’ to any of the income of a trust estate, but is under a
legal disability, will have their share of net income assessed to tax to the trustee.
It is the trustee who will be liable to pay tax on it, as if it were the income of an individual
taxpayer not subject to any deductions.
The term legal disability is not defined in the income tax legislation. The High Court of Australia
has concluded that a beneficiary would be considered to be under a legal disability if he or she
could not give a valid discharge for a payment made to him or her (Taylor v. FC of T 70 ATC 4026).
Examples of beneficiaries with a legal disability are:

• undischarged bankrupt
• mentally incapacitated adult
• individual under 18 years of age.
No beneficiary ‘presently entitled’

Where there is net income of a trust, to which no beneficiary is presently entitled, then the trustee
will be assessed and liable to pay tax on that share of net income under either s. 99 or s. 99A.
Most trustees are assessed under s. 99A. Accordingly, all undistributed trust income is taxed at
the top marginal rate of tax (presently 45% plus the 2% Medicare levy).
If the trustee is assessed under s. 99 of ITAA36, the trustee is assessed and liable to pay tax as
if the income were that of an individual and taxed at ordinary marginal taxation rates (plus the
Medicare levy).
Section 99 applies only where the Commissioner of Taxation (Commissioner) considers it

unreasonable to apply s. 99A and therefore the higher marginal tax rate. This occurs in a limited
range of circumstances, most commonly deceased estates, bankruptcy and insolvent estates,
and estates created to meet certain losses or contingencies, including loss of parental support,
mental or physical injuries, compensation and relief awards.
Non-resident beneficiaries
Different rates and rules apply for non-resident beneficiaries based on whether they are presently
entitled to share in the income, and their status as a resident or non-resident for part or all of
the income year.
MODULE 8
Determining taxation of trust income

Figure 8.4 summarises the taxation of trust income for residents, non-residents for part of the
year, and non-residents for the full year. All section references are in Division 6 of ITAA36.
Figure 8.4: Taxation of trust income
Net trust income

s. 95
Calculated as if trustee were a resident

taxpayer, so includes net income from
both Australian and foreign sources.
Beneficiaries
1. Residency
Non-resident for Non-resident for

Resident
part of year whole of year
Assessable on
Assessable on share of the Assessable on share
share of the net
net income attributable to: of the net income
income regardless
• Australian sources, attributable to
of its source.
plus Australian sources.
• foreign sources by
apportional adjustment
for period of residency.
2. Status
Beneficiary presently No beneficiary

Beneficiary presently entitled
entitled to trust income is presently entitled
to trust income but under a
and not under any to trust income.
legal disability.
legal disability.† s. 99 or s. 99A
s. 98
s. 97 ITAA36
Trustee liable and assessed for taxation‡

Beneficiary includes
share of net trust
income in own
tax return.
†
Franked distributions and capital gains can be ‘streamed’ to particular beneficiaries. Streaming is
discussed in the ‘About trust distributions’ section. These streaming provisions are not discussed in
this figure.
‡
Trustees are liable to be assessed and pay tax in respect of income distributed to certain non-residents
(ss. 98(1)–(4)) and, for this purpose, are required to retain a sufficient amount of the distribution to
MODULE 8
a non-resident beneficiary to pay the tax on the income and ensure it is remitted to the Australian
Taxation Office (ATO).
STUDY GUIDE | 351
Example 8.1: Applying trust provisions to trust income

The Jones Family Trust is a discretionary trust that has three beneficiaries, Tim (aged 15), Sonia (aged 18)
and Neil (aged 21). Neil is also the trustee of this trust. The trust’s main asset is an investment property.
During the 2018–19 tax year, the income from the property was $25 000, and the allowable deductions
(such as repairs) totalled $5000. The income of the trust estate was $20 000, as was the net income of
the trust. Neil declared that Tim was entitled to $10 000 of the trust income, and Sonia was entitled
to $5000 of the trust income, with the rest being undistributed. As a result:
• As Tim is under a legal disability (being under 18), the trustee Neil is assessable for tax on Tim’s
share of the net income of the trust. As Tim is entitled to 50 per cent of the income of the trust
estate, the tax liability of Neil is calculated based on 50 per cent of the net income of the trust,
being $10 000.
• Sonia was not under a legal disability, and so would be assessable under s. 97. As she is entitled
to 25 per cent of the income of the trust estate, she is assessable on 25 per cent of the net income
of the trust, being $5000.
• The $5000 of undistributed net income of the trust is assessable in the hands of Neil the trustee.
Most likely s. 99A rather than s. 99 would apply, meaning it would be taxed at the top tax rate.
Overview of deceased estates

For taxation purposes, the administration of a deceased estate covers three distinct stages:
• income to date of death and amounts received after but relating to the period prior to death
• income from date of death to completion of administration of the estate
• after administration is complete.
Income to date of death and amounts received thereafter relating to the pre-
death period
The trustee of a deceased estate is obliged to lodge a tax return on behalf of the deceased
for income derived by the deceased up to and including the date of death.
The trustee must also lodge a trust return in which will be included those amounts received by
the trustee that would have been assessable income of the deceased had they been received
while the deceased was alive (s. 101A of ITAA36). The legislation states that no beneficiary is to
be presently entitled to this income (s. 101A(1)). This means that in the year of death, the trustee
of the deceased’s estate must lodge two tax returns:
• form I individual tax return for the deceased recording income relating up to the date
of death
• form T trust return to record the income received and relating to after the date of death.
Importantly, s. 101A(2) specifically excludes payments that are made in respect of annual leave
and long service leave. This will mean that such payments made by the deceased’s ex-employer MODULE 8
after the death of the deceased will not be subject to tax.
Income from date of death to completion of administration of the estate

An executor or administrator of a deceased estate cannot be legally compelled to pay any of the
special or general bequests or legacies to any beneficiaries until the administration is complete.
This period of administration requires the calling in or collecting of all property, obtaining full
details of all liabilities, and paying or making provision for all creditors’ claims.
At that point when all liabilities have been met, executorial or administrative duties are at an end
and the trustee’s sole task is to finalise the distribution of the remaining assets. Only at that point
are the beneficiaries able to demand payment of the amounts due to them, to which they then
become presently entitled.
During the administration period, the executor or administrator must lodge income tax returns
and pay tax on the net income of the estate. If it is clear during administration that a portion of
the net income of the estate will not be required to settle debts, the executor or administrator
may pay that income to, or apply it on behalf of, a beneficiary before the completion of
administration. In this case, the beneficiary will be deemed to be presently entitled to that
amount and taxed at their individual marginal taxation rates. The executor or administrator will
therefore not be taxed on that amount even though the estate has not been fully administered.
After administration is complete

At the end of the administration period, the trustee can transfer assets to the beneficiaries
nominated in the Will, in which case Division 6 of ITAA36 ceases to operate. However, if the
trustee continues to hold the assets, any income to which no beneficiary is presently entitled
will be taxed under s. 99 or s. 99A (see the earlier section on this). Income to which beneficiaries
are presently entitled but that has not been distributed will be assessed in the normal manner
under s. 97 or s. 98 (see earlier sections covering this).
Example 8.2: Income of a deceased estate

Dave Chan died on 2 September 2018. His Will appointed a close friend, Aimee Philips, as the executor
of his estate. The Will provided that the estate was to be distributed equally between his two children,
Harry, aged 40, and Ted, aged 38. Aimee completed the administration of the estate on 1 July 2019.
The trustee received the following amounts:
Received between 2 September 2018 and 30 June 2019
$
MODULE 8
Salary 3000
Holiday pay 1200
Long service leave 5800
Accrued after the date of death

Interest 400
Rent 4390
STUDY GUIDE | 353
The income would be assessed as follows:
Salary—under s. 101A the $3000 is assessed to the trustee as income to which no beneficiary is presently
entitled. As the income is from a deceased estate, the Commissioner would be expected to assess
the income under s. 99 and not s. 99A.
Holiday pay and long service leave—these amounts are not assessable in the return to date of death
or to the estate (s. 101A(2)).
Interest and rent accrued after death, but before completion of administration of the estate, is income
to which no beneficiary is presently entitled and will be aggregated with the salary and, it would be
reasonable to expect, assessed to the trustee under s. 99.
The trustee will therefore be assessed on a total of $7790 (i.e. $3000 + 400 + 4390) under s. 99.
If the trustee derived any further income, such as from interest or rent, after 30 June 2019 that income
is available for distribution to the beneficiaries. If the trustee derived, say, $8000 of such income,
and distributed $4000 to each beneficiary, then both Harry and Ted would be assessed on $4000 of
trust income under s. 97 because the period of administration is complete, and both beneficiaries
are presently entitled and not under a legal disability.
Testamentary trusts
A testamentary trust is a trust established under a Will. A testamentary trust is separate to the
trust that is created when a deceased estate comes into existence. There are a number of strong
advantages to using a testamentary trust rather than direct transfer of assets to beneficiaries.
The chief ones are:
• Distributions from a testamentary trust to a minor beneficiary are subject to ordinary marginal
tax rates (including the tax-free threshold of $18 200) as the income will be ‘excepted trust
income’ rather than potentially taxed at Division 6AA rates.
• Income and capital gains can be distributed to beneficiaries in a tax-efficient manner using
a discretionary testamentary trust.
• The trustee of a testamentary trust can elect to be taxed on a capital gain that would
otherwise be assessed to a beneficiary who cannot benefit from the capital gain.
Determining net income of a trust

Workflow for determining net income
Figure 8.5 is a presentation of the tax implications and tax rates upon distributions of trust
MODULE 8
income. It examines the situation for a resident trust estate. It uses the tax rates for the 2018–19
tax year, and assumes a resident trust estate and a resident natural person beneficiary.
MODULE 8
354
| TAXATION OF TRUSTS, COMPANIES AND SUPERANNUATION FUNDS
Figure 8.5: Taxation of trust income for a resident trust estate
Tax rates for 2018–19 tax year—assuming a resident trust estate and a resident natural person beneficiary.
Beneficiary includes Section 97 Taxed at ordinary rates.

share of net trust Beneficiary presently
income in own entitled and not under
individual return. legal disability. Tax at the following rates (assuming no
Eligible taxable other income)
income (s. 102AD). Up to $416 Nil
$417–1307 On excess over $416, at least 66%
Beneficiary is a ‘prescribed $1307+ Whole income taxed at 45%
person’ (s. 102AC),

i.e. under 18 and not
Section 98 in full-time employment.
Beneficiary is presently
entitled but under Excepted trust
Taxed as the first part of the
legal disability. income (s. 102AG(2)).
beneficiary’s income at ordinary
Beneficiary is an ‘excepted tax rates.

person’ (s. 102AC(2)).
Where the deceased died within
the 3 years preceding the end Taxed at ordinary rates.
of the relevant income year.
Trustee liable to be Section 99 DECEASED
assessed on share No beneficiary ESTATES
of net income of presently entitled. Where the deceased died not Taxed at the following rates
trust estate. less than three years before the Up to $416 Nil
end of the relevant income year. $417–670 50% on excess over $416
$671–37 000 19% of entire income
INTER-VIVOS Where Commissioner $37 001–90 000 $7030 plus 32.5% of the excess
TRUSTS exercised discretion over $37 000
(s. 99A(2)). $90 001–180 000 $24 255 plus 37% of the excess
over $90 000
$180 001 and over $57 555 plus 45% of the excess
INTER-VIVOS over $180 000
Section 99A TRUSTS
No beneficiary
presently entitled. TRUSTS ESTATES
Share of trust net income
of deceased persons
used for tax avoidance. taxed at 45%
Notes: Add Medicare levy where applicable.

STUDY GUIDE | 355
Seven-step process for determining net income and how

it is assessed
Determining the net (taxable) income of the trust estate and the income tax implications
of distribution to beneficiaries can also be considered in a stepped process.
Table 8.2 details the seven-step process for determining net income of the trust and how it
is assessed.
Table 8.2: Determining net income of the trust and how it is assessed
Step Description Commentary
Step 1 Calculate the ‘income of the Nominal income (such as a franking credit) is generally not
trust estate’ as defined in included, irrespective of whether it is defined as income
the trust deed of the trust estate in the trust deed.
Step 2 Calculate the ‘net income’ of the All income of the trust, regardless of its source, is included
trust (in accordance with s. 95 in the calculation.
of ITAA36)
Net income = Total assessable income of the trust –
Allowable deductions
Step 3 Determine any streaming of Capital gains and franked distributions can be streamed
franked dividends and/or capital to particular beneficiaries in certain circumstances.
gains during the year
This is covered briefly in the ‘About trust distributions’
section.
Step 4 Calculate each beneficiary’s This will determine:

‘share’ of the income of the • the amount of trust income to which each beneficiary
trust estate and then apply will be presently entitled
that ‘share’ to the net income • the amount of taxable income attributable to each
beneficiary.
The share will be a fraction or proportion—the

proportionate approach.
Step 5 Determine residency for Refer to Figure 8.5 regarding residency.

each beneficiary
If a beneficiary is a non-resident of Australia, then tax is
only payable on the share of Australian source income
allocated to the non-resident beneficiary.
Where a beneficiary is an Australian resident for part of MODULE 8

a year, then tax is payable on the beneficiary’s share
of Australian source income plus the share of any foreign
source income attributable to the beneficiary’s period
of residency in Australia.
Step 6 Determine the tax implications Has the trust made a capital gain? (See the ‘Capital gain
of each allocation of net included in trust income’ section.)
income based on the type
of income received Has the trust derived any exempt or non-assessable,
non-exempt (NANE) income? Each beneficiary’s
distribution will retain the same tax-free status—
see Example 8.3.
Has the trust received any dividends in the tax year?

(See the next section.)
Step Description Commentary
Step 7 Calculate the entitlement to the 1. Beneficiary presently entitled and not under a
net income of each beneficiary legal disability.
Will be assessable on their share of the net income

of the trust under s. 97.
2. Beneficiary presently entitled but under a legal

disability.
Under s. 98, tax paid by the trustee on share of

net income of each beneficiary as if the income
were that of an individual and were not subject to
any deduction.
3. No beneficiary is presently entitled. Trustee liable

under s. 99A.
Taxed at 45% plus 2% Medicare levy, though in some

situations s. 99 will apply and tax will be levied at marginal
tax rates.
Example 8.3: Steps 6 and 7—determining exempt income

Ben and Jen are the only beneficiaries of the BJ Trust, and are presently entitled to trust income in
equal proportions. Ben and Jen are not under any legal disability.
The deed of the BJ Trust provides that losses are to be recouped from future trust income.
Trust income/(loss):
$
2017–18 tax year Loss (10 000)
2018–19 tax year Assessable income 100 000
Allowable deduction (105 000)
Net exempt income 20 000
Trust losses of the 2017–18 year must be recouped from income of the 2018–19 tax year, in accordance
with the trust deed.
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Tax law requires losses to be deducted from net exempt income and therefore the losses of $10 000
(2017–18) and $5000 (2018–19) will reduce net exempt income to $5000.
Ben and Jen will each receive an amount of $2500 by way of distribution, with the amounts retaining
their character as exempt income in the hands of the beneficiaries.
Treatment of dividends received by the trust (Step 6)

It is generally necessary that shares be held ‘at risk’ for at least 45 days (or 90 days for preference
shares) in order to obtain the benefit of franking credit offsets (see holding period rule in the
‘Franking credit qualified person requirements’ section). A beneficiary of a non-fixed trust cannot
satisfy this requirement as no beneficiary holds any interest in the assets of the trust (in this case
the shares giving rise to the dividends).
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In these circumstances, a beneficiary will only be entitled to franking credit offsets if:
• the trust lodges a family trust election (as discussed in the section ‘Family trusts’) and the
trustee has held the shares ‘at risk’ for at least 45 days, or
• the beneficiary satisfies the small shareholder exemption requirements (franking credit
offsets of less than $5000 from all sources for the year), or
• the shares were acquired by the discretionary trust prior to 31 December 1997.
Where a beneficiary receives a distribution that includes a franking credit but is denied access
to the offset, the beneficiary is entitled to a deduction equal to the lesser of the beneficiary’s:
(i) share of the trust net income, and
(ii) the share of the franking credit attributable to the dividend (ITAA97, s. 207-150(3)).
Note that where a trust is in a tax loss position, it is not possible to distribute franked dividends
to beneficiaries, and any franking credits are lost.
➤ Question 8.1
The net income of the Vincent Trust for the year ended 30 June 2019 comprises:
Dividends:
$
Australian public company 4200
Franking credits 1800
UK public company 1700
UK withholding tax (15%) 300
Net income (s. 95) 8000
The trustee resolves to distribute the income equally between the beneficiaries Clare and Kathy
Vincent, who are presently entitled and under no legal disability. The beneficiaries received no
other dividend income for the year.
What will each beneficiary include in their personal tax return?
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Discrepancies and capital gains

Discrepancies in income and net income
We have seen in the ‘Determining net income of a trust’ section that trust income is calculated
in accordance with the definition of ‘income’ in the deed. As discussed, some items, such as
franking credits, cannot be ‘trust income’ irrespective of the terms of the trust deed.
Trust income (as distinguished from the net income of the trust) is often referred to as
distributable income. It is calculated via the definition of income that is contained in the trust
deed (if it is mentioned in the trust deed).
Where the deed contains no definition of distributable income, then the income is calculated
according to the concept of ordinary income.
Basically, the amount of distributable income from the trust may differ from the net income of the
trust calculated in the previous section ‘Determining net income of a trust’. This will give rise to
discrepancies between distributable income and the net income of the trust. They occur when:
• items of assessable income such as capital gains are treated as capital under trust law,
the requirements of the trust deed or a discretion available to the trustee
• expenses according to trust law or the trust deed are either non-deductible for income tax
purposes or deductible to a lesser extent
• taxation law provides for special incentives that do not form part of trust income for trust
law purposes
• a different basis is used for valuing trading stock or depreciating assets for trust accounting
purposes than the basis used for income tax purposes.
Where the taxable ‘net income’ (as defined in s. 95 of ITAA36) exceeds the trust (distributable)
income, the application of the ‘proportionate approach’ may result in a beneficiary becoming
liable to tax on an amount that is more than the beneficiary’s actual entitlement.
For the proportionate approach, calculate each beneficiary’s ‘share’ of the income of the trust
estate and then apply that ‘share’ to the net income, via a fraction or percentage.
As a reminder, the proportionate approach is Step 4 of the process of determining net income
of the trust presented in the earlier section ‘Seven-step process for determining net income and
how it is assessed’.
➤ Question 8.2
Assume that the Farnsworth Trust for the 2018–19 tax year has the following income amount:
Trust income $
Business profits 1000
Capital gain 400
Franked dividend 700†
Trust income 2100
†
Franking credit of $300 excluded (discussed earlier).
Taxable income $
Business profits 1000
Capital gain (after 50% discount) 200
Franked dividend 700
Franking credit 300
2200
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The trustee resolves that the trust income will be distributed to:
Linda 50%
Donna 50%
None of the beneficiaries received any other dividends for the tax year. Applying the proportionate
approach, what is each beneficiary’s entitlement to the trust income and to the net income of
the trust?
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Capital gain included in trust income

Where a capital gain is included in net income of a trust, and the proportionate approach is
applied, then presently entitled beneficiaries will be assessed on the capital gain (even if that
gain is not actually distributed to them).
Issues with the proportionate approach

Application of the proportionate approach can cause significant difficulties where the difference
between income for trust law purposes and net income of the trust for tax purposes relates to a
capital gain.
If there are separate income and capital beneficiaries, applying the proportionate approach
can produce an inequitable result. This is because the income beneficiary can be assessed as
having an extra capital gain in proportion to their interest in the trust income, but without being
able to benefit from the gain.
Treatment of a discounted capital gain

Some trusts can benefit from a 50 per cent capital gains tax (CGT) discount. Each beneficiary
will need to be advised as to what proportion of that capital gain, if any, is attributable to a
discounted capital gain.
The beneficiary must gross up that part of their share of the net income that is attributable to a
discounted capital gain by applying a gross-up factor of 100 per cent (multiply the capital gain by
two). The grossed-up amount is treated as the beneficiary’s capital gain.
A non-corporate beneficiary then applies any capital losses against this grossed-up capital gain
before applying the CGT discount that is appropriate for that beneficiary.
A corporate beneficiary is not entitled to the CGT discount. Likewise, no CGT discount is allowed
for a trustee assessed under s. 98(3) or s. 99A.
The beneficiary shows the amount attributable to the capital gain separately in their tax return
from other assessable income from the net trust distribution.
A capital gain in a trust can also be reduced by the small business 50 per cent reduction
concession (see the Module 7 section ‘Refresher on capital gains tax concessions for small
business entities’), and not reduced by the general 50 per cent CGT discount.
In these circumstances, that part of a beneficiary’s share of the net trust income attributable to MODULE 8
the discounted capital gain must again be grossed up by multiplying the capital gain by two.
This grossed-up amount is treated as the beneficiary’s capital gain for the purpose of applying
any of the beneficiary’s capital losses before the beneficiary applies any CGT discount.
If both the 50 per cent CGT discount and the small business 50 per cent reduction reduced the
trust’s capital gain, then the beneficiary multiplies the capital gain by four. The beneficiary must
apply its capital losses to the grossed-up capital gain before applying the appropriate CGT
discount percentage and/or small business 50 per cent reduction.
Example 8.4: Including capital gain in trust income

During the 2018–19 tax year, a trust derived $60 000 net income from trading activities and, in addition,
as a result of CGT event A1 occurring on 1 December 2018, made a discountable capital gain of
$3000. If the trustee elects to choose the 50 per cent CGT discount option, the trustee will include a
net capital gain of $1500 as part of net trust income.
The net trust income of the trust for taxation purposes is $61 500 ($60 000 + $1500). If the trustee
distributed this income to one beneficiary who was presently entitled to trust income and has no capital
losses, then that beneficiary will gross up the discounted capital gain component of $1500 to $3000.
If the beneficiary was an individual who is eligible for the 50 per cent CGT discount, then that beneficiary
would include in their assessable income the net trust distribution of $60 000 from trading activities
and a net capital gain of $1500 (50% of the grossed-up capital gain of $3000).
About trust distributions

Overview of streaming
Trust income retains the same character when it is distributed to a beneficiary as it had when
received by the trustee. For example, if the trustee receives a fully franked dividend, a distribution
of that income to a beneficiary will generally result in the beneficiary having to gross up the
dividend income and being entitled to a franking credit tax offset.
Before 2010, it had been accepted that trustees could ‘stream’ (direct) different types of
income to different beneficiaries as long as the trust deed permitted it, and the trust accounts
were maintained so that separate classes of trust income could be identified in the accounts.
This provided trustees with tax planning opportunities—for example, franked dividends could be
specifically distributed to those beneficiaries who could best use the attached franking credits.
Similarly, capital gains could be distributed to beneficiaries who had available capital losses.
The High Court decision in FC of T v. Bamford [2010] HCA 10 gave rise to uncertainty regarding
whether the streaming of trust income was permissible. As a result, new legislation was
introduced confirming the availability of streaming for tax purposes, but only for capital gains
and for franked distributions.
Now, it is confirmed in Division 6 that trustees can stream capital gains or franked distributions
to beneficiaries. They need to have the power to do this under the trust deed. This power can
be either express or implied:
• An express power to stream may arise where the trust deed empowers the trustee to
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separately account for distinct classes of income or capital, and where beneficiaries’
entitlements may then relate to those classes.
• A streaming power may be implied if the trust deed empowers the trustee to distribute
income or capital at their absolute discretion and there is nothing further in the trust deed,
or trust law in the relevant jurisdiction that limits that power (ATO 2016c).
Streaming of franked distributions

A beneficiary may be made specifically entitled to a franked distribution. This means they will be
taxed on the franked distribution. This is how franked distributions are streamed to particular
beneficiaries for tax purposes.
If no beneficiary is specifically entitled to a franked distribution, it is taxed proportionately to all

beneficiaries based on their entitlement to the trust income (with some modifications)—that is,
in much the same way as other net income of the trust (ATO 2019a).
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Streaming of capital gains

A trust’s capital gain can be streamed to beneficiaries for tax purposes (even if they do not have
a present entitlement to trust income) by making them specifically entitled to the gain.
A beneficiary who has a capital gain streamed to them is treated as having an extra capital gain
that they will then take into account in working out their own net capital gain for the income year
(ATO 2016b).
The ATO describes the concept of specific entitlement as follows:

A beneficiary who is specifically entitled to a capital gain or franked distribution received by a trust
is generally assessed for tax on the gain or distribution. They also get the benefit of any franking
credits attached to a franked distribution (subject to integrity rules).
A trustee of a resident trust can choose to be specifically entitled to a capital gain of their trust
– making the choice in the trust tax return – in which case the trustee is taken to be specifically
entitled to all of the capital gain. This choice can only be made if no part of the capital gain is
paid or applied for the benefit of a beneficiary.
A trustee can’t choose to be specifically entitled to a franked distribution in the same manner
(ATO 2016a).
Trust loss provisions

A tax loss of a trust can be carried forward and used to reduce the trust’s net income in a
later year.
The tests that a trust will be subject to in determining whether it can recoup previous losses
will depend on whether the trust is a fixed or a non-fixed trust.
Trust loss provisions don’t generally apply to trusts that have validly elected to be a family trust,
except for the income injection test, which applies in certain circumstances.
The trust loss provisions don’t apply to capital losses (ATO 2018b).
Family trusts
A trust is a family trust at any time a family trust election is in force. The election must nominate
a particular individual (the ‘test individual’) who will be used to determine the ‘family group’.
A family trust election can be made at any time. It can specify an earlier income year from when
the election is to commence, provided that from the beginning of the specified income year until MODULE 8
30 June of the income year immediately preceding that in which the election is made:
• the trust passes the family trust control test (generally this will be fulfilled when the test
individual and/or a member of the test individual’s family have control of the trust, or in the
alternative, a test individual and/or a member of their family, together with a professional/
legal adviser to that family, have control of the trust), and
• any conferrals of present entitlement to income or capital during the period, or actual
distributions of such amounts, have been made to the specified individual or members
of their family group (ATO 2017).
The test individual

A family trust election must specify a person as the individual whose family group is to be taken
into account in relation to the election (referred to as the specified individual, primary individual
or test individual throughout Schedule 2F of ITAA36).
The specified individual has no additional rights or responsibilities and does not even need to be
directly associated with the trust. Only one individual can be specified in a family trust election
(ATO 2017).
Family group
For family trust election purposes, a ‘family group’ includes (s. 272-90):
• defined family members of the test individual specified in the family trust election
• certain former family members of the test individual
• certain family owned or controlled companies, partnerships and trusts
• certain others, such as charities, that are exempt from income tax.
Figure 8.6 provides a visual representation of a family group for family trust election purposes.
Figure 8.6: Members of the test individual’s family group
Grandparents† Grandparents†
Parents† Parents†
Test individual
Siblings† Test individual Siblings†
spouse
Children—includes
Nieces and Nieces and
adopted, step and
nephews† nephews†
ex-nuptial children†
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Lineal
descendants†
†
The family group includes all spouses of these family members.
Source: Adapted from ATO 2017, ‘Family trusts: Concessions’, accessed March 2019,
https://www.ato.gov.au/general/trusts/in-detail/family-trusts---concessions/?page=1.
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Tax concessions for family trusts

When a trust becomes a family trust (by making a family trust election) they are able to access five
main tax concessions. More details on these measures are discussed in the rest of this module,
but their impacts from a family trust perspective are presented in Table 8.3.
Table 8.3: Family trust tax concessions
Operation of concession
Tax concession area Description for family trust
Trust loss measures A non-fixed trust has a carried By becoming a family trust, the trust
forward tax loss, or certain debt is subject to concessional treatment
deductions, but the trust could not and only one of the trust loss tests—
satisfy the required trust loss tests to the income injection test—applies,
recoup the loss. and only in a modified way.
Company loss tracing The company loss provisions allow a The tracing concession applies so
concession company that has a non-fixed trust that where the relevant interests in a
as a shareholder to benefit from company are held by the trustee of
a tracing concession where that a family trust, a single notional entity
non-fixed trust is a family trust. that is a person will be taken to own
the interests. This makes it easier to
fulfil the continuity of ownership test
(COT; discussed in Module 3), as the
trust’s interest in the company will be
regarded as a single interest, and so
there will be no need to trace past
the family trust.
Holding period rules The holding period rules allow Broadly, unless the trustee of a
regulating access to the trustee and beneficiaries of a non-fixed trust has elected for it
franking credits family trust that receives a franked to be a family trust, a beneficiary
dividend or franked non-share of the trust who does not have a
dividend to benefit from a franking vested and indefeasible interest in
credit concession. so much of the capital of the trust
as is comprised by the shares giving
rise to the dividends will not be a
‘qualified person’ for the purposes of
the holding period rule (unless their
total franking credits amount to less
than $5000 for the year). Someone
who is not a ‘qualified person’ is
denied the benefit of the franking
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credits attached to dividends paid
on shares, or interests in shares,
acquired by trusts (other than widely
held public share-trading trusts).
Trustee beneficiary Generally, these rules require the Trusts that have made a family
reporting rules trustee of a closely held trust to trust election or an interposed
advise the ATO of certain details. entity election (among others) are
excluded from having to comply
These are details about each trustee with the trustee beneficiary
beneficiary that is presently entitled reporting rules.
to a share of a tax preferred amount
of the trust, or has included in its
assessable income a share of the net
income of the trust comprising an
‘untaxed part’.
Operation of concession
Tax concession area Description for family trust
Access the small business Small business entities can There are requirements that
restructure rollover restructure their business including must be met in order to access
(discussed in the ‘Small by moving assets into, or out of, the rollover. One of these is that
business restructure a trust, company, partnership or a there is no material change in the
rollover’ section in combination, without adverse CGT ultimate economic ownership of
Module 7) consequences. an asset. Special rules apply in this
context to discretionary trusts that
have made family trust elections,
which make it possible to show
that individuals within the family
group are the ultimate economic
owners of the trust (and so can fulfil
this requirement of the rollover).
Fulfilling this requirement would
typically not be possible without a
family trust election.
Source: Based on ATO 2017, ‘Family trusts: Concessions’, accessed March 2019,
Family trust distribution tax

There is a penalty when the trustee of a family trust makes a distribution of income or capital
to someone outside of a specified individual or member of the individual’s family group.
The rate of family trust distribution tax is the top marginal rate of individual tax of 45 per
cent plus the 2 per cent Medicare levy—being a total of 47 per cent in the 2018–19 income
year. Family trust distribution tax is paid on the amount (income) or value (capital) of any
non-complying distributions.
Seeking expert advice

Family trust structuring is a complex area, and expert advice from a specialist in this area should
always be sought.
This is an area where a professional’s willingness to check that information gathered is correct,
and to request assistance where necessary, is vital.
MODULE 8
Example 8.5: Family trust elections and family trust

distribution tax
The trustee of Trust A (which has a family trust election in force) distributes $70 000 to the trustee of
Trust B in the 2016–17 income year. Trust B is not a member of Trust A’s family group, nor has Trust B
made a family trust election. Consequently, the trustee of Trust A becomes liable to pay family trust
distribution tax on the $70 000 distribution to Trust B. In the 2018–19 income year, the trustee of Trust B
makes a family trust election specifying that the trust be treated as a family trust at all times from the
beginning of the 2016–17 income year. The family trust election specifies the same individual named
in the family trust election of Trust A, resulting in Trust B becoming part of the specified individual’s
family group.
As Trust B has a family trust election in force from 1 July 2016, it is treated as having been a member of
the family group in relation to the $70 000 distribution made by the trustee of Trust A in the 2016–17
income year. Therefore, there is no family trust distribution tax liability for the trustee of Trust A.
Source: Adapted from ATO 2017, ‘Family trusts: Concessions’, accessed March 2019,
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Administration and reporting for trusts

Tax file number withholding rules
The tax file number (TFN) withholding rules apply to ‘closely held trusts’.
A closely held trust is defined in s. 102UC(1) of ITAA36 to include:

• a trust where up to 20 individuals in aggregate have entitlement to 75 per cent or greater
share in the income or capital of the trust
• a discretionary trust.
A family trust is included in this definition for the purposes of the application of the TFN
withholding rules.
There are a number of exclusions from the definition:

• a complying superannuation fund, a complying approved deposit fund (ADF) or a pooled
superannuation trust (PST)
• trustees of deceased estates (for the first five years after the individual’s death)
• a fixed trust that is a unit trust with only exempt beneficiaries
• a unit trust with units listed on the ASX.
All beneficiaries are required to provide their TFN to the trustee before any trust distribution is
made. If the trustee does not have the beneficiary TFN then the trustee may withhold taxation
at the top marginal rate of 45 per cent plus the 2 per cent Medicare levy.
Beneficiaries are able to claim a credit in their tax return for amounts withheld by the trustee.
Some distributions are excluded from the requirement to withhold tax if a TFN is not supplied.
These are:
• distributions below $120 for the whole tax year (where the distribution relates to part of
the tax year, use 120 multiplied by the number of days to which the payment applies,
divided by 365)
• distributions in respect of income of the trust that was subject to the TFN withholding rules
in an earlier tax year (amounts that a beneficiary was presently entitled to but that the trustee
did not distribute)
• distributions in respect of income of the trust that the beneficiary was presently entitled
to and related to a tax year before the TFN withholding rules applied
• non-residents for tax purposes
• distributions to a beneficiary under a legal disability—for example, a minor.
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Trustee reporting requirements

Trustees must provide to the Commissioner a TFN report in the approved form within one month
after the end of the quarter to which it relates (i.e. the quarter in which the TFN was provided by
the beneficiary) or within such further time as the Commissioner allows.
The TFN report must include the beneficiary’s:

• TFN
• full name
• date of birth (individuals only)
• postal address
• business or residential address
• entity type
• Australian Business Number (ABN) (non-individual beneficiaries only) (ATO 2016a).
Trustees are required to register for PAYG withholding for closely held trust purposes where
required, and to lodge an annual TFN withholding report detailing all payments together with
amounts withheld (if any).
Trustees are also required to lodge an annual trustee payment report detailing all distributions
made to each beneficiary during the tax year, even where the beneficiary has quoted a TFN
(this report is lodged by completing in full the details in the statement of distribution in the trust’s
tax return), and issue a payment summary to a beneficiary showing amounts withheld within
14 days of the due date of the lodgment of the annual TFN withholding report.
Penalties will be imposed for failing to meet the withholding and reporting requirements.
Company taxation core concepts

General company concepts
Under the Corporations Act 2001 (Cwlth), a company is an entity so registered under the law.
This is distinct to a company for taxation purposes, which is discussed in the next section,
‘Company for taxation purposes’.
The key feature of a company is that it has a separate legal personality, or existence,
distinct from its members and directors.
A person possesses legal rights and is subject to legal obligations. In law, the term person
is used to denote two categories of legal person:
1. An individual human being is a natural person. A sole trader is a natural person, and there
is legally no distinction between the individual and the business entity in a sole tradership.
2. The law also recognises artificial persons in the form of companies.
Separate legal personality is a common law principle that grants a company a legal identity,
separate from the members who comprise it. It follows that the property of a company belongs
to that company, debts of the company must be satisfied from the assets of that company,
and the company has perpetual succession until wound up.
The principle of perpetual succession is that the company continues to exist despite the death,
insolvency or insanity of any member or director, any change in membership or any transfer
of shares. The company will continue as a separate entity from its members until it is wound
up/liquidated.
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Veil of incorporation
A company is a legal entity separate from the natural persons connected with it—for example,
as members or directors. Because a company has a separate legal personality from the
people who own or run it (the members/directors), people can examine a company and not
know who or what owns or runs it.
The fact that members are ‘hidden’ in this way is sometimes referred to as the ‘veil of
incorporation’. The members are ‘veiled’ from view.
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Company for taxation purposes

As with the general definition of company, and its distinct features such as a separate legal
personality and the veil of incorporation, a company is also treated as distinct and separate from
its members for taxation purposes.
But the definition of a company under taxation law is broader than that under the Corporations
Act, and this is important.
A company for taxation purposes is defined in s. 995-1(1) of ITAA97 to mean ‘a body corporate
or any unincorporated association or body of persons, but does not include a partnership or
a non-entity joint venture.’ For taxation purposes, a company may also be a club, association
or society.
ITAA97, s. 4-1 states that ‘income tax is payable by each individual and company’.
A company must therefore lodge an annual tax return.
Public or private companies

A company’s classification for income tax purposes does not depend upon its status for company
law purposes. They are not always the same, and this distinction is important.
A private company under company law can be a public company for tax purposes and vice versa.
Further, a company’s status for tax purposes is determined separately each year, so a company
may be public one year and private the next year.
A company is a public company for taxation purposes if (s.103A of ITAA36):

• shares were listed on a stock exchange in Australia or elsewhere on the last day of the tax
year, or it was at all times during the tax year a cooperative company as defined in s. 117
of ITAA36, and in each case at no time during the tax year did 20 or fewer persons share in
75 per cent or more of the company’s capital, voting and dividend rights
• it is a company that has at all times since its date of incorporation been a non-profit company
• it is a mutual life assurance company
• it is a friendly society dispensary
• it is a subsidiary (s. 103A(4)–(4E) of ITAA36) of a public company, or
• it is a statutory body or a government body established for public purposes where there was
a controlling interest on the last day of the tax year.
A company may still qualify as a public company even if any of these tests do not apply. If the
Commissioner is of the opinion that, having regard to the market value of the share capital, MODULE 8
the spread of share ownership and control and other relevant matters, it is reasonable to treat the
company as a public company for taxation purposes, then the Commissioner will do so.
Conversely, the Commissioner has a discretionary power to treat as a private company a company
that has technically satisfied the tests for public company status, but in the circumstances the
Commissioner still regards it as a private company.
A private company is defined as one that is not a public company (s. 995-1 of ITAA97).
Why is this distinction important?

The distinction between a public and a private company is very important for taxation purposes.
The following areas of the tax legislation apply to private companies:
• Excessive payments made by private companies to their shareholders, directors or associated
persons may be treated as deemed dividends and disallowed as a deduction to the company
(s. 109 of ITAA36).
• Payments or loans made by a private company to a shareholder or associate, or the
forgiveness of a debt owed by a shareholder or associate by a private company, may be
treated as an assessable unfranked dividend in certain circumstances (Division 7A of ITAA36).
• The COT (discussed in Module 3) applied to a public company is not as strict as the test that
applies to private companies (s. 165-165(7) of ITAA97).
• Benchmark franking rules (discussed later in this module under ‘The benchmark rule’) differ
for private companies.
• Timing rules for issuing distribution statements to shareholders are more lenient for
private companies.
Residency status of company

Module 2 has already covered the residency test for a company. As a reminder:
If the taxpayer is a company, then the basic test of residence is formulated in s. 6(1) of ITAA36.
There are two tests of taxation purposes that establish if the company is a tax resident of Australia:
• it is incorporated in Australia, or
• although not incorporated in Australia it carries on business in Australia and has either:
– its central management and control in Australia, or
– its voting power controlled by shareholders who are residents of Australia (ITAA36, s. 6(1)).

Residency determines both liability to tax and entitlement to franking credit offsets.
A resident company is taxed on its total ordinary and statutory income from Australian and
non-Australian sources (ss. 6-5(2) and 6-10(4) of ITAA97).
A resident company is entitled to claim tax offset for franking credits on dividend income
received from other resident companies as the imputation system (discussed later in this module)
applies to dividends paid by Australian resident companies.
A non-resident company is generally only taxed on its Australian source ordinary and statutory
income. Note that it may also be taxed on ordinary and statutory income that is not sourced in
MODULE 8
Australia but is included in assessable income on some other basis.
A non-resident company does not qualify for a franking credit tax offset and the unfranked
portion of a dividend received from an Australian company is subject to withholding tax at a flat
rate of 30 per cent (usually reduced to 15% for countries where Australia has a double taxation
agreement in place) (as discussed in Module 2).
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Calculating taxable income

Company tax rate
From the 2018–19 income year, companies that are base rate entities must apply a lower
27.5 per cent company tax rate. A base rate entity is a company that:
• has an aggregated turnover less than the turnover threshold—which is $50 million for the
2018–19 income year
• no more than 80 per cent of its assessable income is to be ‘base rate entity passive income’
(BREPI).
BREPI is defined as including the following (Income Tax Rates Act 1986 (Cwlth), s. 23AB):
• corporate distributions (which includes dividends) and other non-share dividends. However,
non-portfolio dividends (where the recipient company has a voting interest amounting to
at least 10 per cent of the voting power in the company paying the dividend) are excluded
from BREPI
• franking credits attached to dividends that are considered passive income
• interest income (except if earned by financial institution or other similar organisation)
• a gain on a qualifying security within the meaning of Division 16E of ITAA36
• royalty income
• rental income
• net capital gains.
The company tax rate for base rate entities will progressively reduce from 27.5 per cent in
2018–19 to 25 per cent by 2021–22.
All other companies—that do not meet the rules for a base rate entity—are still taxed at the
30 per cent company tax rate.
In summary, the tax rates for 2018–19 are as follows:
Company† tax rates % rate
Base rate entity 27.5%
All other companies 30%
†
This includes corporate limited partnerships, strata title bodies corporate, trustees of corporate unit
trusts and public trading trusts.
Companies pay a flat rate of tax without a tax-free threshold, unlike the situation applicable to
individuals where a progressive rate scale applies. MODULE 8
Companies are not liable for the Medicare levy.

Calculating a company’s taxable income

A company is liable to pay tax on its taxable income. It is a taxation entity in its own right.
As taxable income is assessable income less deductions. The principles discussed in Modules 2
to 5 are applied when determining a company’s taxable income, noting any special rules that
apply to companies, such as the following:
• the need to satisfy the continuity of ownership or same business test when claiming a
deduction for bad debts or losses. Section 165-10 of ITAA97 provides that to claim a
deduction for a tax/capital loss, a company must satisfy either the COT or the same business
test (SBT). Similar provisions apply for the treatment of bad debts. This is discussed in detail
in the Module 3 section ‘Deducting tax losses for corporate entities’.
• debt/equity rules that may have specific application to companies
• tax concessions available for R&D (research and development) are generally restricted
to companies
• CGT implications of certain transactions are modified for companies.
In practice, the determination of a company’s taxable income often involves preparing

a statement to reconcile the accounting profit/loss in the financial statements to taxable
income, taking into account a number of adjustments. Practitioners refer to this statement as a
‘tax reconciliation’. This reconciliation involves adding back or subtracting items, as appropriate,
where the accounting and tax treatment of a transaction differ.
After determining taxable income, the company tax rate is applied to taxable income
to calculate the gross tax payable. Any tax offsets are then deducted from gross tax payable
to determine the net tax payable.
Figure 8.7 presents the process of calculating taxable income and gross tax payable for a
company. Note that the company rate used is for non-base rate entities, so in 2018–19 it is
30 per cent.
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STUDY GUIDE | 371
Figure 8.7: Reconciliation of accounting income to arrive at taxable income

The accounts prepared for accounting purposes would be the
Starting point – net profit/loss starting point for preparing the tax return.
as per accounts Adjustments would be made for items that need to be treated
differently for tax purposes.
Add or subtract
Differences between accounting Difference between accounting gains and income tax gains
income and income for tax (i.e. profit/loss on sale of depreciating assets, capital gains/losses),
purposes items assessable for income tax but not included in net profit/loss.
Add
Where depreciation charge in the accounts is different to what
Depreciation as per accounts is allowed for income tax due to different methods or
depreciation rates.
Add
Items expensed for accounting purposes but not deductible for
Items not allowed as tax income tax. Accounting provisions for items such as holiday pay,
deductions doubtful debts, capital items, entertainment, goodwill amortised,
interest not deductible, etc.
Subtract
Any exempt income Income included in the accounts which is specifically exempted
from tax, such as pre-CGT gains.
Subtract
Depreciation allowable Depreciation method and rates allowed for income tax.
Subtract
Special deductions and other

items to the extent not already Prior year losses, deduction for blackhole expenditure and
deducted in accounts R&D expenditure.
Equals
Taxable income Assessable income less allowable deductions.
Equals
Taxable income @ 30% (2018–19 tax year) = gross tax.
Tax assessed Less rebates/tax offset, foreign tax credits, franking deficit
tax offset.
Equals
Gross tax less rebates/tax offset.
Tax payable Less PAYG instalments, credit for tax withhold where ABN not MODULE 8
quoted, tax withheld from investments.

Gross-up and franking credit tax offset

Corporate tax entities that receive a franked distribution directly are required to include the
franking credit attached to the distribution in their assessable income.
In the gross-up and credit approach, corporate entities are entitled to a tax offset equal to
the amount of the franking credit included in their assessable income. This is to ensure that
corporate profits are not subject to company tax more than once.
The franking credit tax offset is limited to the tax payable.
Any unused tax offset is not refundable (ss. 67-25 (IC) and 67-25 (ID) of ITAA97). However,
certain income tax-exempt charities, deductible gift recipients, complying superannuation funds,
ADFs, PSTs and life insurance companies are entitled to a refund of excess franking credits.
Resident companies in receipt of overseas interest or dividend income must also gross up the
amount received for any withholding tax deducted by a foreign country. A company can then
claim a foreign tax credit against tax payable (s. 770-10).
Example 8.6: Franking credit tax offset

During the current tax year, Minus Minutes Pty Ltd (Minus) receives a franked distribution of $900
that has $350 of franking credits attached. Minus is not a base rate entity so the corporate tax rate
is 30 per cent. Minus includes the franked distribution of $900 plus the franking credit of $350 in its
assessable income and is entitled to a $350 tax offset against its income tax payable.
Assuming Minus has no other taxable income, its tax payable is calculated as follows:
$
Dividend 900
Franking credit 350
Primary tax @ 30% 375
Less: Tax offset for franking credit 350
Tax payable 25
Note: If the tax payable was less than the franking credit tax offset, the corporate entity would not be
entitled to a refund of the excess. Companies are not entitled to a refund of excess franking credits.
The excess franking credit can, however, be converted to a tax loss, which can be carried forward for
future use.
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Example 8.7: Calculating taxable income and tax payable

XYZ Pty Ltd (XYZ), a private company resident in Australia that is a non-base rate entity, is a manufacturer
of electrical goods. The following information relates to the company’s operations for the year ended
30 June 2019.
$
Profit from trading 229 200
Dividend from a portfolio investment in an unrelated company resident in
Singapore, after deducting 15% withholding tax 3 400
Dividend from an unrelated resident private company—dividend franked to 50% 7 000
Dividend from an Australian public company—a fully franked dividend 3 500
Profit on disposal of plant (see note (a)) 1 000
Net profit before tax 244 100
The profit from trading of $229 200 had been arrived at after deducting the following items:
$
Depreciation on depreciating assets 112 000
Provision for doubtful debts 1 200
Repairs and maintenance 15 000
You are advised that:

a. The machine disposed of on 1 July 2018 originally cost $8000 in 2015 and for income tax purposes
its adjusted value was $4800 at 30 June 2019. The profit on disposal of the machine had been
calculated in the books for accounting purposes as follows:
$
Selling price 4 630
Depreciated value, 30 June 2019 for book purposes 3 630
1 000
b. During the year the following additions to depreciating assets were made:
i. Second-hand manufacturing machine was purchased at a cost of $23 400 and installed on
1 April 2019.
ii. New manufacturing machine was purchased and installed on 1 July 2018, at a cost of $80 000;
and on 31 August 2018, at a cost of $50 000.
c. Repairs and maintenance include expenditure of $6000 incurred on reconditioning and repairing
the second-hand machine prior to its installation.
d. Income tax adjusted values of fixed assets at 30 June 2018 were: manufacturing machinery,
$214 000; and motor vehicles, $80 000. The cost of the manufacturing machinery was $500 000.
e. Franking credit of $1500 was allocated to the distribution from an unrelated resident private company.
f. The franking credit of $1500 was allocated to the distribution from Australian public company.
g. XYZ does not apply the small business entity tax depreciation rules.
h. The old manufacturing machinery is depreciated at 12 per cent per annum prime cost and the
motor vehicles are depreciated at 25 per cent diminishing value. The effective life depreciation
rate for the new manufacturing machine is five years and the effective life of the second-hand
manufacturing machine is four years. The taxpayer depreciates the new manufacturing machine MODULE 8
using the diminishing value method and depreciates the second-hand machine using the prime
cost method.
i. XYZ does not qualify as a small business entity for tax purposes.
The calculation of taxable income is as follows.
XYZ Pty Ltd: Calculation of taxable income for the year ended 30 June 2019
Statement reconciling net profit before tax as per statement of profit or loss and taxable income for
the year ended 30 June 2019.
$ $
Net profit before tax for accounting purposes 244 100
Add: Items expensed from profit but not deductible
for tax purposes or requiring adjustment
Depreciation as per books 112 000
Provision for doubtful debts 1 200
Repairs and maintenance 6 000 119 200
363 300
Add: Item assessable but not included in net profit
Withholding tax to gross up dividend from Singapore 6001
Franking credits attached to frankable distributions
($1500 + $1500)2 3 000 3 600
366 900
Deduct: Item included in net profit but not assessable
Accounting profit on disposal of plant 1 000
365 900
Less: Allowable deductions
Depreciation (as per Schedule A) 129 530
Balancing adjustment on disposal of machine
(as per Schedule B) 170 129 700
Schedule A: Calculation of depreciation allowable for tax
Written-down value (WDV)

30 June
Cost 2019 Depreciation rate Tax allowance
Item $ $ $ $
Second-hand 29 400 29 400 × 91 / 365 × 25% 1 832
manufacturing
machine ($23 400 and
$6000 repairs prior
to installation)
New manufacturing 80 000 80 000 × 365 / 365 × 200% / 5 32 000

machine 50 000 50 000 × 304 / 365 × 200% / 5 16 658
Existing manufacturing 492 0003 209 2004 492 000 × 365 / 365 × 12% 59 040
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machinery used
during the year less
machine disposed of
Motor vehicles 80 000 80 000 × 365 / 365 × 25% 20 000

129 530
Schedule B: Sale of plant

$
Adjusted value (tax depreciated value 30 June 2019) 4 800
Termination value (sales proceeds) 4 630
Balancing adjustment on disposal of machine (s. 40-285) 170
1
Withholding tax on Singapore dividend: $3400 / (1 – 15%) = $4000 grossed-up, less $3400 =
$600 withholding tax.
2
Franking credits: Dividend from unrelated private company $7000 × 1 / (70 / 30) × 50% = $1500.
Dividend from Australian public company $3500 × 30 / 70 × 100% = $1500.
³ Cost: $500 000 less $8000 adjustment for machine disposed = $492 000.
4
WDV: $214 000 less $4800 adjustment for machine disposed = $209 200.
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➤ Question 8.3
Now that we have determined the taxable income of XYZ in Example 8.7, use this information
to calculate its tax payable.
Tax administration
Companies must complete an annual tax return that discloses certain details relating to taxable
income. Companies self-assess their tax liability, which is subject to potential audit to verify its
correctness. The Commissioner is deemed to have made an assessment of the company return
on the date the return is lodged, irrespective of whether the return is lodged on time (s. 166A(2)).
A notice of assessment is also deemed to have been served on the date the return is lodged.
Companies are generally liable to pay tax under the PAYG system in either quarterly instalments
or, under certain circumstances, an annual lump sum (see Module 11).
Dividend imputation system

A dividend is an amount payable from the company to shareholders from distributable profits
or other allowable monies as declared under legislation.
Introducing the dividend imputation system

This was briefly introduced in the ‘Gross-up and franking credit tax offset’ section of this module;
we will look at it in more detail here. MODULE 8
Prior to the introduction of the dividend imputation system in 1987, the payment of a dividend by
a resident company to a resident individual shareholder involved double taxation. The company
profits from which the dividends were paid were taxed to the company and the dividend
distributed was taxed again in the hands of the individual shareholder.
The dividend imputation system removes the double taxation issue by giving shareholders a tax
offset for the tax paid by the company on the income from which the dividend was paid.
The dividend imputation rules apply to corporate tax entities. They apply to dividends,
which are defined as frankable distributions.
Corporate tax entities are (s. 960-115 of ITAA97):

• companies—(a body corporate or any other unincorporated association or body of persons
other than a partnership)
• corporate limited partnerships (Division 5A of Part III of ITAA36)
• corporate unit trusts (Division 6B of Part III of ITAA36)
• public trading trusts (Division 6C of Part III of ITAA36).
A distribution is defined in the context of the type of corporate tax entity that is making the
distribution (ITAA97, s. 960-120):
• company—for a company, a distribution is a dividend or something taken to be so under
the Act
• corporate limited partnership—either a distribution made by the partnership, in money
or property, to a partner or something that is deemed to be a dividend by the partnership
under the Act
• corporate unit trust—unit trust dividend as defined in s. 102D(1) of ITAA36
• public trading trust—unit trust dividend as defined in s. 102M of ITAA36.
A frankable distribution will include:

• general definition of dividends under s. 6(1) of ITAA97
• bonus shares that are taken to be dividends under s. 6BA(5) of ITAA97
• amounts taken to be dividends under the off-market share buy-back provisions
of s. 159GZZZP of ITAA97
• liquidator’s distributions that are deemed to be dividends under s. 47(1) of ITAA97
• non-share dividends that are distributions in respect of non-share equity interests in
the company (ss. 974-120, 974-115 of ITAA97).
Distribution statements
An entity that makes a frankable distribution must provide the recipient with a distribution
statement that contains certain information about the entity and the distribution.
Franking credit qualified person requirements

To be entitled to a tax offset for franking credits in relation to a particular dividend, a taxpayer
must be a qualified person in relation to the dividend.
The requirements for a qualified person are summarised in Table 8.4.

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STUDY GUIDE | 377
Table 8.4: Qualified person in relation to the dividend
Rule Explanation
Holding period rule Requires taxpayers to hold shares at risk for at least 45 days (or 90 days for
preference shares) excluding the day of acquisition and disposal.
As long as the taxpayer holds the shares for a continuous 45-day period
during the qualifying period, which includes the period both before and
after shares go ex-dividend, they are deemed to be a qualified person and
eligible for the franking credit tax offset.
The holding period rule only needs to be satisfied once for each purchase
of shares (ss. 207-145 and 207-150 of ITAA97).
Note that where a beneficiary of a discretionary trust has received franked

dividends through the trust, to rely on this rule, the trust must have made a
family trust election.
Related payments rule This rule must be satisfied if the taxpayer is under an obligation to make,
or is likely to make, a ‘related payment’.
A related payment is a payment that passes on the benefit of the franked

dividend to someone else.
If this applies, the taxpayer needs to hold the shares at risk for a period of
45 days (90 days for preference shares) to receive the tax offset.
This rule must be satisfied for each dividend payment (ss. 207-145 and
207-150 of ITAA97).
Small shareholder The taxpayer is a natural person (i.e. not a company) whose tax offset for
exemption: less than franking credits amounts to less than $5000 for the year.
$5000 a year
Note: If the small shareholder exemption applies, the individual does not
have to satisfy the holding period rule or the related payments rule and the
shareholder will still be treated as a qualified person (ss. 207-145 and 207-150
of ITAA97).
Franking credit ceiling A particular kind of taxpayer, such as a superannuation entity, who elects
to have a franking credit ceiling applied, calculated in accordance with a
prescribed formula as an alternative to the holding period rule.

MODULE 8
Maximum franking credit

The amount of franking credit allocated to a distribution will be the lesser of:
• the amount that is stated on the distribution statement, which must be provided to the
recipient, or
• the maximum franking credit that may be allocated to the distribution.
The maximum franking credit that may be allocated to a distribution is the maximum amount
of income tax that the corporate tax entity could have paid on its distributed profits.
This means that, in practice, a corporate tax entity must not give its members credit for more
tax than it has paid.
Formula to learn
The maximum franking credit is calculated using the following formula (s. 202-60(2) of ITAA97):
1
Amount of the frankable distribution ×
Applicable gross-up rate†
†
Where rate = (100% – Standard applicable corporate tax rate) / Standard applicable corporate
tax rate
Note that for this formula, the corporate tax rate is 30 per cent for non-base rate entities in the
2018–19 tax year, and 27.5 per cent for base rate entities. Note also that for the purposes of this
formula, in deciding whether the 30 per cent or 27.5 per cent rate applies, the turnover for the
current tax year is assumed to be the same as it was for the previous tax year. For instance, if in
the 2017–18 tax year the aggregated turnover of a company was $60 million (exceeding the base
rate entity threshold of $50 million), then in utilising the above-mentioned formula, the relevant
tax rate is 30 per cent, even if the turnover for the 2018–19 tax year is expected to be under the
$50 million threshold.
Example 8.8: Maximum franking credit

Gateway Pty Ltd (Gateway) has after-tax profits of $7000 available for distribution. It does not meet
the requirement for a base rate entity, so the company tax rate is 30 per cent.
Gateway decides to pay $3500 of this after-tax profit (i.e. a frankable distribution) to its shareholders.
The maximum franking credit that Gateway can attach to this distribution is calculated as follows:
1
$3500 × = $1500
(70 / 30)
Franking percentage
The franking percentage is a measure of the extent to which a frankable distribution has
been franked.
It is a percentage of the frankable distribution, rather than the whole of the distribution.
In the circumstances where a distribution contains both a frankable and unfrankable element,
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the franking percentage may be 100 per cent even where only part of the total distribution
is frankable.
The franking percentage is the lesser of 100 per cent or the amount calculated using the
following formula (s. 203-35(1) of ITAA97):
Formula to learn
Franking credit allocated to the frankable distribution
× 100%
Maximum franking credit for the (frankable) distribution
STUDY GUIDE | 379
The franking percentage in respect of the first frankable distribution made in the franking period
will establish the benchmark franking percentage—see the next section, ‘The benchmark rule’.
All frankable distributions made within a franking period must be franked in accordance with this
benchmark franking percentage.
If the entity fails to comply with the requirement that it should not frank a distribution in excess
of the maximum franking credit that may be allocated, then:
• the entity’s franking account (discussed in the ‘Franking account’ section later in this module)
is debited to the full extent of the franking credit allocation
• the recipient of the franked distribution will only include in assessable income the franked
distribution and the amount of franking credit up to the maximum that should have been
allocated on the distribution
• the tax offset to which the recipient is entitled will not exceed the maximum franking credit
that could be allocated on the distribution (ATO 2018a).
The benchmark rule

A company is not obliged to attach franking credits to its dividends. However, it does not
cost the company anything to do so and the credits will benefit eligible resident shareholders.
It is therefore possible for a company to allocate more credits than the balance available in the
franking account, but doing so may result in franking deficit tax and possible penalties—see the
‘Franking account’ section of this module.
Alternatively, a company might only partially frank dividends due to the limited availability of
franking credits. For example, when a company generates income overseas or has utilised carry-
forward tax losses, there may be insufficient credits available to pay a fully franked dividend.
A distribution may also consist of an unfrankable amount, such as a deemed dividend under
Division 7A of ITAA36.
The flexibility of a company to frank (i.e. allocate franking credits to) a frankable distribution to
whatever extent it wants is subject to the benchmark rule. In this respect, a company will be
able to select the level of franking having regard to the existing and expected franking account
surplus and the rate at which earlier distributions were franked.
The benchmark rule provides that all frankable distributions made by a corporate tax entity
during the franking period must be franked to the same extent—at the benchmark franking
percentage. This ensures that franking credits representing tax paid on behalf of all members
of an entity are not allocated (e.g. streamed to resident shareholders, to avoid the wastage
of credits distributed to non-residents who are unable to use the credits) to only some of the
MODULE 8
members (ITAA97, s. 203-15).
Arrangements that try to go against this fundamental principle constitute dividend streaming.
The anti-streaming rules are very briefly introduced later in this module.
There are two key components of the benchmark rule:

1. determining the franking period
2. determining the benchmark franking percentage for that period.
Once the benchmark franking percentage is established, the entity must apply this percentage
to all frankable distributions for the period, or face penalties (ITAA97. s. 203-50).
This is why the first frankable distribution in the franking period becomes important, as it
establishes the benchmark franking percentage for future distributions in the franking period.
Determining the franking period

If a corporate tax entity is a private company during a tax year, its franking period will be the
same as its tax year. For example, take a resident Australian private company for tax purposes.
It has only one franking period in its tax year (from 1 July to 30 June) and it is the same as its
tax year.
A corporate tax entity that is not a private company (i.e. a public company) has two franking
periods (July to December and January to June).
Determining the benchmark franking percentage

The benchmark franking percentage for a franking period will be the franking percentage allocated
to the first frankable distribution made by the entity within that period. If no frankable distributions
are made in the franking period, the entity does not have a benchmark franking percentage for
the franking period (Explanatory Memorandum, New Business Tax System (Imputation) Bill 2002,
para. 2.60).
Anti-streaming rules
Streaming means selectively directing the flow of franked distributions to those members who
can most benefit from franking credits.
The anti-streaming integrity rules (found in Division 204 of ITAA97) are intended to ensure
that franking credits are not:
• streamed, or disproportionately allocated to certain members
• used to benefit members who do not have a sufficient economic interest in the entity.
There are four specific anti-streaming rules:

1. Streaming using linked distributions (s. 204-15 of ITAA97).
2. Streaming using tax exempt bonus shares (s. 204-25 of ITAA97).
3. Streaming distributions to provide franking credits benefits to members who benefit more
from franking credits than other members (Subdivision 204-D of ITAA97).
4. Disclosure rule to help the Commissioner identify cases where the anti-streaming rules
might apply. It applies where an entity’s benchmark franking percentage differs significantly
between franking periods (s. 204-75 of ITAA97).
If the elements of streaming are present, the streaming entity will incur an additional franking
debit in respect of each distribution made or other benefit received by a member, and/or
there will be no imputation benefit to arise in respect of any streamed distributions paid to
MODULE 8
a member.
The disclosure rule

The disclosure rule is the last of the four specific rules that apply where an entity’s benchmark
franking percentage differs significantly between franking periods. The disclosure rule is the main
rule used in the anti-streaming measures, and the only one that will be examinable.
Significant variations between benchmark franking rates can indicate the presence of franking
credit streaming.
Because of this, entities are required to disclose any significant variation between successive
benchmark franking rates.
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Formula to learn
The benchmark franking percentage for the current franking period will vary significantly from the
benchmark percentage for the last relevant franking period if it has increased or decreased by an amount
greater than the range worked out under the following formula (s. 204-70(1)(b) of ITAA97):
Number of franking periods starting immediately

after the last relevant franking period† and ending × 20 percentage points
at the end of the current franking period
†
The last relevant franking period is the last franking period in which a frankable distribution was made.
Example 8.9: The disclosure rule

Colaborator Pty Ltd (Colaborator) has a benchmark percentage of 30 per cent in the current franking
period and a benchmark of 0 per cent in the immediately preceding franking period. Colaborator’s
benchmark franking percentage has increased by 30 per cent, which is greater than a 20 percentage
point increase (1 period × 20 percentage points).
As Colaborator’s benchmark franking percentage for the current period has varied significantly,
it has a disclosure requirement for the current franking period. Colaborator will be required to lodge
a franking account tax return.
Franking account
The franking account rules apply to all corporate tax entities.
A franking account is an account that a resident corporate tax entity maintains to keep track
of the franking credits that it can pass on to members.
The franking account does not form part of a company’s financial statements but is simply a
record of the Australian income tax that has already been paid by the company on its profits.
The franking account is credited with franking credits and debited with franking debits.
Franking credits will arise upon payment of income tax and PAYG instalments, and receipts of
franked distributions [either directly or indirectly]. Franking debits will arise upon payment of
franked distributions, and refunds of income tax.
…
Franking credits for payment of PAYG instalments and corporate income tax, and franking debits
MODULE 8
for refunds of corporate income tax, arise only for resident entities (Explanatory Memorandum,
New Business Tax System (Imputation) Bill, paras 4.2, 4.4).
Franking deficit tax

Franking deficit tax (FDT) will be imposed if a franking account is in deficit at the end of the
tax year (i.e. if the sum of the franking debits in the franking account exceeds the sum of
the franking credits). The opening balance in a franking account will either be a credit or zero
amount. Payment of franking deficit tax in respect of the prior year prevents any debit balance
from being carried forward.
FDT is not a penalty, but a payment that is required to be made to make good the amount
imputed to shareholders that exceeds the amount of tax actually paid. The tax paid to the ATO
represents a tax offset that can generally be deducted from the company’s income tax
liability at the end of the relevant income year. Where, however, the amount of the franking
deficit exceeds 10 per cent of all franking credits posted to the company’s franking account
during the tax year, then only 70 per cent of the FDT paid will result in a reduction of the
company’s tax liability (meaning in essence 30% of it will be a penalty).
Franking account tax return

A company must complete a franking account tax return in certain situations. The more important
of these are as follows:
• The company has a liability to pay FDT.
• The company has to pay a penalty due to franking a distribution greater than the rate set by
the benchmark rule.
• The company has triggered the disclosure obligation due to a significant variation in its
benchmark franking percentages.
Superannuation fund taxation

Superannuation is taxed at three points:
• Entry: Contributions made by the member.
• Earnings: Investment earnings while in the fund.
• Exit: On withdrawal via superannuation benefits, namely the pensions or income streams
paid out in what is now known as the retirement phase.
Entry: Contributions
There are two types of contributions that a superannuation fund member will make into a
superannuation fund. As discussed in Module 6, these are concessional contributions and
non-concessional contributions.
1. Concessional contributions received by complying superannuation funds on behalf of an

individual fund member are taxed at 15 per cent in the fund.
2. Non-concessional contributions received by complying superannuation funds on behalf
of an individual fund member are not taxed in the fund.
Concessional contributions are those made before tax is paid, such as employee
MODULE 8
Superannuation Guarantee (SG) contributions made by the employer, which are currently
legislated to be 9.5 per cent of pre-tax income (ss. 291-25 and 295-160 of ITAA97).
Another example of concessional contributions are before-tax contributions made through a

salary-sacrifice arrangement. Tax-deductible contributions are also available to taxpayers who
wish to make a direct contribution, as long as they notify the trustee of the superannuation fund
that they intend their contribution to be deductible (ss. 290-150 and 290-170 of ITAA97).
Non-concessional contributions are those paid from after-tax monies, so after tax has already
been paid at some point on the money being invested (s. 292-90 of ITAA97). A taxpayer might,
due to using up their concessional contributions cap (discussed below), choose to not claim
a deduction and so have the contribution regarded as non-concessional.
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This means that investing monies into superannuation is a tax-effective vehicle for all those
taxpayers who are subject to a tax rate higher than 15 per cent. This is deliberate, as government
policy is to increase the attractiveness of superannuation as an investment vehicle so that
individuals are encouraged to contribute to their retirement.
To encourage saving for retirement, but to balance this with ensuring that superannuation is not
used as a tax avoidance strategy, the government has set upper limits on the amount of money
an individual can contribute (concessional or non-concessional) to their superannuation fund
in each tax year.
These are called contributions caps, and they are applicable to concessional and non-
concessional contributions.
• For the 2018–19 tax year, the concessional contributions cap is $25 000 per year for all
individuals regardless of their age (s. 291-20 of ITAA97).
• For the 2018–19 tax year, the non-concessional contributions cap is $100 000 per year (s. 292-85
of ITAA97). In addition, those members with an overall accumulated superannuation balance
of over $1.6 million will no longer be able to make non-concessional contributions. Note that
taxpayers who at any time during the tax year are under 65 can utilise the three-year ‘bring
forward’ rule. This entitles them to make up to three years’ worth of non-concessional
contributions ($300 000) in one year, though this reduces how much can be contributed in
the following two years (s. 292-85 of ITAA97). For instance, if an eligible taxpayer makes a
non-concessional contribution of $210 000 in one year, they may only make non-concessional
contributions totalling $90 000 in the following two years.
• Individuals with superannuation balances of $500 000 or less will be eligible to ‘catch up’ their
contributions by rolling over any unused contributions caps for up to five years. This five-year
catch-up provision commenced 1 July 2018, meaning that unused concessional contributions
for the 2018–19 tax year can be carried over to the 2019–20 tax year (s. 291-20(3)–(7) of ITAA97).
We will look at Example 8.10 from the ATO on the application of the catch-up rules when it
comes to contributions caps.
Example 8.10: Catch-up concessional contributions

During the 2018–19 to 2021–22 financial years, Sam has minimal superannuation contributions as Sam
is working part-time while completing studies. Sam’s superannuation balance is continuing to grow
with earnings and a small amount of superannuation contributions but in 2020–21 Sam’s account
balance reduces due to negative returns in that year. Sam has unused cap amounts for each of the
2018–19 to 2021–22 financial years.
Sam’s concessional superannuation contributions cap MODULE 8
2018–19 2019–20 2020–21 2021–22
General contributions cap $25 000 $25 000 $25 000 $25 000
Cumulative available unused cap $0 $22 000 $0 $69 000
Maximum cap available $25 000 $47 000 $25 000 $94 000
Superannuation balance 30 June $480 000 $490 000 $505 000 $490 000
prior year
Concessional contributions $3 000 $3 000 nil nil
Available unused cap for relevant $22 000 $22 000 $25 000 $25 000
financial year
Sam would be entitled to use the unused concessional cap amounts in 2019–20 and 2021–22 financial
years as Sam’s total superannuation balance at the end of 30 June in the year immediately preceding
was less than $500 000.
Sam would not be able to use their unused concessional cap contributions in the 2020–21 financial
year as Sam’s total superannuation balance at the end of 30 June of the previous year was $505 000.
In the 2021–22 financial year Sam returns to work. For that year Sam has a maximum concessional
cap amount available of $94 000 ($69 000 plus $25 000) for the 2021–22 financial year and is eligible
to contribute this amount as their total superannuation balance at the end of 30 June 2021 was now
less than $500 000.
Source: Adapted from ATO 2019, ‘Concessional contributions cap’, accessed March 2019,
Those taxpayers who exceed the annual contributions caps are charged an excess contributions
tax.
There is also additional tax paid by individual taxpayers (known as the Division 293 tax) whose
overall taxable income plus their concessionally taxed superannuation contributions exceed a
threshold in every income year. This threshold is $250 000 (2018–19 income year), and for those
individuals earning over $250 000, their concessional superannuation contributions are levied an
additional 15 per cent tax, so they effectively pay 30 per cent tax on these contributions.
On the other end of the scale, low-income earners have their 15 per cent contributions tax paid
on SG contributions effectively rebated to them through the low income superannuation tax
offset (LISTO). This refund is paid directly to the superannuation fund by the government. This is
available for those earning less than $37 000.
Low-income earners can also participate in the co-contribution scheme, where the government
matches 50 cents for every $1 of non-concessional contributions made by the fund member.
The government’s maximum contribution under this scheme is $500 a year. The scheme is means-
tested, with those earning $37 697 and below for the 2018–19 year being able to benefit from a
maximum $500 government co-contribution. Every dollar of income above this amount reduces
this maximum entitlement to the co-contribution, with those earning $52 697 or more not having
any entitlement under this scheme.
Table 8.5 looks at the taxation status of contributions to superannuation funds.
Table 8.5: The taxation status of contributions to superannuation funds

MODULE 8
Concessional contribution Non-concessional contribution

Tax rate 15% in the fund Not taxed in the fund
Status Paid from pre-tax, or tax-deductible Paid from monies where tax has
monies been paid at some point
Types of contribution SG After-tax contributions where

the taxpayer has not notified the
Salary sacrifice superannuation trustee in writing
that they intend to claim a tax
Contributions made by the member deduction on the contribution
where they have notified the
superannuation trustee in writing Spousal contributions
that they intend to claim a tax
deduction Subject to non-concessional
contributions caps
Subject to contributions caps
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Concessional contribution Non-concessional contribution
Other issues LISTO effectively rebating 15% for Eligible for the government
income earners below $37 000. contribution:
Division 293 tax on income earners If income under $52 697 for the
over $250 000 doubling tax to 30% 2018–19 year, then government will
match a contribution of up to $500
Excess contributions tax paid on to the member’s superannuation
contributions over the cap fund on a sliding scale
Excess contributions tax paid on

contributions over the cap
Example 8.11: Concessional contributions

Katie earned an annual salary of $100 000. The relevant workplace agreement that applied to her stated
that she was entitled to 15 per cent superannuation contributions from her employer. During the 2018–19
year, her employer contributed not only the $15 000 that he had to under the workplace agreement,
but also another $7000 that Katie agreed to have salary sacrificed from her wages. In the same year,
Katie made a $6000 contribution into her superannuation account, and she notified the trustee that
she would claim a tax deduction on this. She also made another $8000 contribution into her account
where she gave no such notice. Katie had made no other direct contributions to her superannuation
account in recent years.
Katie’s concessional contributions would include the $15 000 compulsory contribution made by her
employer, the salary sacrificed amount of $7000 and the $6000 contribution that she would claim a tax
deduction on. As the total of these is $28 000, the $25 000 concessional contributions cap is exceeded
by $3000. As a result, if the money stays in the superannuation fund, Katie will pay excess contributions
tax on this $3000. The $8000 contribution that she did not intend deducting is a non-concessional
contribution, and this does not breach the $100 000 non-concessional contributions cap.
Earnings
Superannuation funds are taxed on their earnings during the accumulation (while the monies are
accumulating in the fund) phase at a rate of 15 per cent (s. 295-545 of ITAA97; s. 26 of Income
Tax Rates Act 1986 (Cwlth)). Note that contributions made by members are considered earnings
for taxation purposes, so the 15 per cent tax levied on the contributions discussed in the section
‘Entry: Contributions’ is the same tax applied. Members will not be taxed any more than
MODULE 8
15 per cent (unless they are subject to the Division 293 tax for high-income earners).
Capital gains from the sale of fund assets are treated as earnings and are subject to the
15 per cent earnings tax. If the asset sold has been held for longer than 12 months, the fund
is only liable to pay taxation on two-thirds of the capital gain realised (Division 115 of ITAA97).
Non-arm’s length income (if there is any) received by the superannuation fund will be subject
to 45 per cent tax for the 2018–19 year (s. 295-550 of ITAA97). Although the definition of non-
arm’s length income is complex (and its details are beyond the scope of this course), it is aimed
at situations where the superannuation fund earns non-arm’s length income, such as the sole
member of a superannuation fund renting for her own business an office owned by the fund,
and paying the fund rent equivalent to twice the market value.
Any earnings that are derived from assets that finance a pension/income stream (see the next
section for a discussion on the retirement phase), and any capital gains from the disposal of these
pension assets, are classed as tax exempt. No tax is payable on these earnings. This exemption
no longer applies to transition to retirement income streams, where earnings on these assets are
now taxable.
Exit: Retirement phase

For an individual’s superannuation benefits accessed on or after the age of 60, the benefit will be
tax-free for the majority of Australians (s. 301-10 of ITAA97).
This applies to most resident Australians over the age of 60, with the exception of members of
untaxed schemes (old-style public sector funds, where some tax will need to be paid). Some
individuals receiving defined benefit schemes (also a historical superannuation scheme structure)
will also be subject to some tax.
But, for most, the benefit is tax-free. This applies to whether the benefit is taken as a lump sum or
as an ongoing income stream (pension). This applies to all people aged 60 and over.
Since 1 July 2017, there is now a lifetime transfer balance cap on the amount of accumulated
superannuation a member can transfer into this tax-free retirement phase to commence an
income stream. That cap is currently $1.6 million (Subdivision 294-B of ITAA97).
➤ Question 8.4
Bermuda Triangle Trust carries on an importing business focusing on beach-inspired, high-end
domestic furniture. For the year ended 30 June 2019, its trust position was:
Trust income (the same as taxable income)
$
Net trading profit 200 000
Net rental income 38 000
238 000
The trustee of the Bermuda Triangle Trust resolves to distribute trust income as follows for the
income tax year ending 30 June 2019:
Barry Bermuda 25%
Bermuda Family Trust 50%
Clare Caribbean 25%
(a) What is the entitlement to taxable income for Clare Caribbean?
MODULE 8
On 1 July 2019 the Bermuda Triangle Trust was dissolved and a new company, Bermuda Triangle
Importers Pty Ltd (Bermuda Triangle Importers), was formed. It is a private company and
its shareholders/directors are Barry Bermuda, his wife Beryl and their business partner,
Clare Caribbean.
Bermuda Triangle Importers is a resident private company for tax purposes. It is an SBE.
STUDY GUIDE | 387
It has the following net taxable income for the 2018–19 income tax year.
$
Net trading income $900 000
Dividend from a resident public company with a franking credit attached
of $30 344 $80 000
Dividend from a resident private company with a franking credit attached
of $2275 $10 000
Bermuda Triangle Importers wishes to distribute $80 000 of realised profits to its shareholders.
The frankable part of the distribution is $55 000, and the remaining $25 000 is unfrankable.
(b) Calculate the net tax payable for Bermuda Triangle Importers for the 2018–19 income tax year.
$ $
MODULE 8
(c) Determine the maximum franking credit that Bermuda Triangle Importers can allocate to this
frankable distribution.
➤ Question 8.5
Lara earns an annual salary of $100 000 and is a member of the ABC Super Fund. In the 2018–19
tax year she had the following contributions made to her account:
• mandatory employer contributions of $9500
• amount paid by her employer, due to a salary sacrifice arrangement, of $6000
• her own contributions of $12 000. She notified her superannuation fund in writing that she
intended claiming a tax deduction of $5000 of this contribution.
What is the tax payable on the superannuation contributions to Lara’s account?
➤ Question 8.6
Craig’s superannuation account balance in the CJP Superannuation Fund (which was in its
accumulations phase) had the following investment earnings during the 2018–19 tax year:
• dividends of $7000 with franking credits of $3000
• interest of $2000
• capital gains on shares owned for at least 12 months of $15 000.
What is the tax payable on Craig’s superannuation account’s earnings?
MODULE 8
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Summary and review

This module has covered many of the important concepts regarding how income tax law applies
to trusts, companies and superannuation funds.
First, the taxation of trusts was covered. This opened with a discussion of some of the important
core trust concepts, including the different types of trusts, and the different parties involved in
a trust structure.
This was then followed with a discussion of the relevant provisions of Division 6 of ITAA36,
which contains the main provisions regarding the taxation of trusts. A specific application of
this was described, by discussing how the legislation affects deceased estates.
The taxation of trusts was then covered in more detail by describing how to calculate the net
income of a trust. Sometimes, the net income of a trust (for tax purposes) is different from
the income of the trust estate, and so the module went on to discuss how to deal with such a
discrepancy. The taxation treatment of the capital gains made by a trust was also covered in
this part. This was followed by an overview of the trust streaming rules and carry-forward loss
provisions, as well as a description of the rules and advantages of family trusts.
Finally, the discussion of trusts covered some of the relevant administration and withholding
tax issues.
The discussion of companies similarly commenced with an overview of the core concepts,
including covering what is regarded as a company for taxation purposes. This was then followed
with a description regarding how companies are taxed, including a discussion regarding which
companies are subject to a 30 per cent tax rate (non-base rate entities) and which ones are
eligible for a 27.5 per cent rate (base rate entities).
The rest of the company taxation discussion focused on the imputation system, which is a
regime that effectively gives resident shareholders receiving dividends a credit for the company
tax that was paid by the distributing company. Some of the specifics of the imputation system
were covered in this part, including the circumstances in which shareholders are entitled to
franking credits, and the maximum number of franking credits that companies can distribute
upon making dividend distributions. The benchmark rule, which seeks consistency in franking
percentages across a franking period, was also discussed, as were some of the other aspects
of the franking system.
The final section of the module examined the tax laws relating to superannuation funds.
This started off with a discussion of superannuation contributions, including a description MODULE 8
of the difference between concessional and non-concessional contributions, as well as their
taxation treatment.
After superannuation funds receive contributions, they then invest them and typically earn a
return on these investments. The module described how such investment earnings are taxed.
Lastly, a superannuation member, usually upon retirement, will seek to access their funds, and the
module discussed the important principle that in most instances, withdrawals made by those of
at least 60 years of age will be tax-free.
MODULE 8
Suggested answers
Suggested answers
Question 8.1
Each beneficiary will include in their personal tax return:
$
Share of trust income 4 000
Franking credit offset 900
Foreign income tax offset 150
Question 8.2
Applying the proportionate approach, the beneficiaries would each be subject to tax on $1100
(50 per cent of the net income of the trust of $2200), but would only actually receive $1050
(50 per cent of the trust income of $2100). They would also each be able to benefit from utilising
$150 of franking credits (each one gets half of the $300 of the franking credits).
MODULE 8
Question 8.3
The primary tax payable is determined by multiplying taxable income by 30 per cent, the current
company tax rate for non-base rate entities.
In the case of XYZ Pty Ltd, the primary tax payable is as follows:
$236 200 × 0.30 = $70 860
This amount is reduced by any tax offset for imputation credits (i.e. $3000), foreign tax credits or
other credits (withholding tax $600) to give a net tax payable figure of $67 260.

Question 8.4
(a) Clare is entitled to 25 per cent of the taxable trust income (s. 95, ITAA36). Her entitlement
to taxable income is 25 per cent of $238 000 which is $59 500.
(b) Net tax payable by Bermuda Triangle Importers Pty Ltd
$ $
Net trading income 900 000
Public company dividend 80 000
Grossed up for franking credit 30 344
Private company dividend 10 000
Grossed up for franking credit 2 275
Taxable income 1 022 619
Primary tax payable @ 27.5% of $1 022 619 281 220

(It would be a base rate entity due to being an SBE, so having turnover that is under
the threshold of $50 million, and its BREPI not exceeding 20 per cent of its income.)
Less: Franking credit offset
Public company dividend franking credit 30 344
Private company dividend franking credit 2 275 32 619
Net tax payable 248 601
(c) The maximum franking credit is calculated using the following formula: Bermuda Triangle
Importers is a base rate entity so the company tax rate is 27.5 per cent. The franking credit
can only be allocated to the frankable distribution of $55 000.
– Under s. 202-60(2) Amount of the frankable distribution × 1 / Applicable gross-up rate
– Where the applicable gross-up rate means the corporate tax gross-up rate of the entity
making the distribution for the income year in which the distribution is made (s. 203 50(2)).
– Therefore the calculation is $55 000 × 1 / (72.5 / 27.5)
= $55 000 × 1 / 2.6363
= $55 000 × 0.3793
= $20 862
Question 8.5
MODULE 8
The following amounts would be concessional contributions:

• mandatory employer contribution of $9500
• employer contribution due to salary sacrifice of $6000
• her own contribution of $5000 on which she intends to claim a tax deduction on.
The total of these is $20 500, which will be subject to tax in the hands of the superannuation fund
at 15 per cent, which comes to $3075. This tax, although payable by the superannuation fund,
will be paid out of the balance of Lara’s superannuation fund, meaning she will bear the economic
burden of the tax. Note that the total of $20 500 is less than the concessional cap threshold
of $25 000.
The $7000 of the $12 000 of personal contributions that Lara did not intend to claim a tax
deduction on is a non-concessional contribution, and so will not be subject to tax upon
depositing into the superannuation account.

Question 8.6
The following amounts would be assessable income from earnings:
• dividends of $7000
• franking credits of $3000
• interest of $2000
• capital gain of $10 000 ($15 000 subject to a one-third discount).
The total of this is $22 000, which would be taxed at the rate of 15 per cent, giving a figure of
$3300. This would then be reduced by the franking credits of $3000, meaning that the tax liability
would be $300. Although the liability for this would fall on the superannuation fund, it would be
taken out of Craig’s superannuation balance.
MODULE 8
MODULE 8
REFERENCES | 395
References
References
ATO 2016a, ‘Specific entitlement’, accessed March 2019, https://www.ato.gov.au/general/trusts/

in-detail/distributions/streaming-trust-capital-gains-and-franked-distributions/?page=3#specific_
entitlement.
ATO 2016b, ‘Streaming trust capital gains and franked distributions’, accessed December 2018,
https://www.ato.gov.au/general/trusts/in-detail/distributions/streaming-trust-capital-gains-and-
franked-distributions/.
ATO 2016c, ‘Streaming under the trust deed’, accessed March 2019, https://www.ato.
gov.au/general/trusts/in-detail/distributions/streaming-trust-capital-gains-and-franked-
distributions/?page=2.
ATO 2016d, ‘TFN report’, accessed March 2019, https://www.ato.gov.au/Forms/TFN-report/.
ATO 2017, ‘Family trusts: Concessions’, accessed March 2019, https://www.ato.gov.au/general/

trusts/in-detail/family-trusts---concessions/?page=1.
ATO 2018a, ‘Allocating franking credits’, accessed March 2019, https://www.ato.gov.au/Business/

Imputation/Paying-dividends-and-other-distributions/Allocating-franking-credits/.
MODULE 8
ATO 2018b, ‘Trust loss provisions’, accessed March 2019, https://www.ato.gov.au/general/trusts/
in-detail/losses/trust-loss-provisions/.
ATO 2019a, ‘Trust income’, accessed December 2018, https://www.ato.gov.au/general/trusts/

trust-income/.
ATO 2019b, ‘Trusts’, accessed March 2019, https://www.ato.gov.au/General/Trusts/.
CCH 1996, CCH Macquarie Dictionary of Law, rev. edn, CCH Australia by arrangement with
Macquarie Library, North Ryde.
Hayton, D. J. 1979, Underhill’s Law of Trusts and Trustees, 13th edn, Butterworths, London.
MODULE 8
AUSTRALIA TAXATION
Module 9
FBT FUNDAMENTALS
398 | FBT FUNDAMENTALS
Contents
Preview 399
Introduction
Objectives
Teaching materials
Fringe benefits tax core concepts 401
Essential features
Essential features of fringe benefits tax
Definition of a fringe benefit
Types of fringe benefits
Calculating fringe benefits tax 403
The gross-up formula
Steps in determining fringe benefits tax payable
Fringe benefits tax-exempt employers
Specific fringe benefits 410
Summary table of specific fringe benefits
Examples
Exempt fringe benefits and employees 418
Exempt fringe benefits
Salary packaging 420
What is salary sacrificing?
Does fringe benefits tax apply to salary sacrificing?
Salary sacrificing superannuation
Administration 422
Lodging returns and making payment
Penalties for non-compliance
Fringe benefits tax record keeping
Reportable fringe benefits 423
References 431
MODULE 9
STUDY GUIDE | 399
Module 9:
FBT fundamentals
Study guide
Preview
Introduction
The most common forms of employee remuneration are salary and wages. Other forms of
remuneration can include bonuses and cash allowances. However, an employer can also
provide employees with non-cash benefits that are private in nature. These are known as fringe
benefits. A fringe benefit may be the provision of a fully maintained company car that can
be used personally, or payment of certain private expenses, such as the employee’s personal
mobile telephone bill, private health insurance or gym membership. Where an employer
provides non-cash benefits to employees that are private in nature, then fringe benefits tax
(FBT) may apply.
This module examines FBT in detail, and includes an explanation of the most common fringe
benefits and how they are applied.
The module content is summarised in Figure 9.1. MODULE 9

Figure 9.1: Module summary—fringe benefits tax
Fringe benefits tax (FBT)
Exempt fringe
Specific fringe Salary Calculating
Definitions benefits
benefits packaging FBT
and employees
Gross-up
Legislation rates Reportable
fringe benefits
Seven step
process
Administration
and reporting
Objectives
• calculate the taxable value of fringe benefits, using the appropriate FBT rules;
• identify exempt fringe benefits and their related concessions;
• analyse the benefit of salary packaging arrangements in a given situation; and
• calculate reportable fringe benefit amounts.
Teaching materials
• Legislation:
– Fringe Benefits Tax Assessment Act 1986 (Cwlth) (FBTAA)
• Glossary:
Definitions/
terms/
MODULE 9
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Fringe benefits tax core concepts

Essential features
FBT is defined as a tax payable by employers on the value of fringe (or non-cash) benefits
provided to their employees or their associates in respect of employment. It is governed by
the Fringe Benefits Tax Assessment Act 1986 (Cwlth) (FBTAA).
FBT applies to the following individuals and entities:

• employees who are residents of Australia unless their income is exempt from tax
• non-resident employees who derive Australian-source income subject to tax in Australia
• nearly all employers—individuals, partnerships, companies, trusts
• most tax-exempt bodies.
The only employers fully exempt from FBT are those that have diplomatic or consulate immunity,
certain international organisations that have immunity from Australian tax, and religious institutions
for ministers undertaking pastoral care. Public benevolent institutions (PBIs) and some other
charitable and not-for-profit employers are also considered ‘exempt’, as detailed in the section
‘Fringe benefits tax–exempt employers’ in this module. However, these latter ‘exempt’ employers
are subject to certain caps and rebates and in some instances are still liable for FBT.
Essential features of fringe benefits tax

The essential features of the operation of FBT are presented in Table 9.1.
Table 9.1: Essential features of fringe benefits tax
Feature Commentary
FBT is paid by the employer, not the employee. It is paid on a self-assessment basis.
FBT Liability This is based on a flat 47% of the fringe benefits

taxable amount in the 2018–19 FBT year—this is
also known as the grossed-up amount.
As a result of paying FBT, the employer is able to This income deduction is claimed under s. 8-1 of
claim an income tax deduction. ITAA97 not only for the cost of the fringe benefit
provided to the employee, but also for the actual
amount of FBT paid.
FBT year runs at a different time to the income FBT year runs from 1 April to 31 March.
tax year.
Annual FBT return is required to be lodged by Lodgment date if by the employer is 21 May.
the employer/their registered tax agent.
Lodgment date if the FBT return is lodged
electronically by a registered tax agent is 25 June.
MODULE 9
Quarterly instalments of FBT are required in Where the amount of FBT payable is more than
some circumstances. $3000, the employer is required to pay quarterly
FBT instalments.

Definition of a fringe benefit

Fringe benefits are non-cash benefits that are private in nature and provided to employees.
Three conditions need to be met for a non-cash benefit to be defined as a fringe benefit:
• a benefit is provided during the tax year by an employer, associate or third-party arranger
• the benefit is provided to an employee or associate
• the benefit is provided in respect of employment (s. 136(1) of FBTAA).
A benefit is any right, privilege, service or facility. It does not include:

• salary or wages within the meaning of income
• exempt benefits
• superannuation fund contributions
• employment termination payments (ETPs), early retirement payments
and redundancy payments
• dividends assessable under ITAA36
• acquisition of shares under an employee share scheme (ESS).
Types of fringe benefits

Table 9.2 shows the 13 types of fringe benefits and where they can be found in FBTAA.
Table 9.2: Types of fringe benefits
Category of fringe benefit FBTAA Part III division
1. Car fringe benefits 2
2. Debt waiver fringe benefits 3
3. Loan fringe benefits 4
4. Expense payment fringe benefits 5
5. Housing fringe benefits 6
6. Living-away-from-home allowance fringe benefits 7
7. Board fringe benefits 9
8. Meal entertainment fringe benefits 9A
9. Tax exempt body entertainment fringe benefits 10
10. Car parking fringe benefits 10A
11. Property fringe benefits 11
12. Residual fringe benefits 12
13. Miscellaneous exempt benefits 13
Source: Based on Fringe Benefits Tax Assessment Act 1986 (Cwlth), Federal Register of Legislation,
MODULE 9
Income tax legislation

Where a taxpayer derives income by way of the provision of a fringe benefit within the meaning
of FBTAA, the income is non-assessable, non-exempt (NANE) income. This allows employees to
reduce their assessable income via salary sacrificing—giving up some salary in return for fringe
benefits. Salary sacrificing is discussed in more detail in the section ‘Salary packaging’.
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When these benefits come under FBTAA, they are taxed under the FBT regime.
Where a fringe benefit is provided to an employee whose employment income is exempt from
tax, the benefit is also exempt from FBT. It is important that any salary sacrifice agreement
does not involve redirection of income that would otherwise be assessable income.
Non-deductible expenses
Under income tax legislation, employers are denied a deduction for specific expenditure.
However, where the expenditure is incurred in providing a fringe benefit, a deduction may be
allowed in the following circumstances:
• entertainment
• club fees
• leisure facilities
• travel expenses of accompanying relative
• Higher Education Contribution Scheme (HECS) and Higher Education Loan Program
(HELP) payments
• Student Financial Supplement Scheme payments.
Goods and services tax

Goods and services tax (GST) does not apply where a fringe benefit is provided to an employee.
When the employee makes a contribution towards the benefit to the employer, the employer
is subject to GST on the contribution.
If the employee incurs expenditure that is not reimbursed by the employer, then the taxable
value (discussed later) is reduced.
Employers are not subject to GST when employees make contributions directly to a third party.

Where a payment is non-deductible under the personal services income (PSI) rules (covered in
Module 6), the taxable value of any fringe benefit is reduced by that amount.
Calculating fringe benefits tax

In the 2018–19 FBT tax year, FBT is payable at 47 per cent by the employer on the fringe benefit’s
‘taxable amount’ (i.e. the grossed-up ‘taxable value’) of fringe benefits.
The FBT rate is equivalent to the top marginal tax rate for individuals (of 45%) plus the 2 per cent
Medicare levy.
The fringe benefits taxable value is established from a series of specific valuation rules.
MODULE 9
As stated earlier, there are 13 categories of fringe benefits (including residual fringe benefits
and miscellaneous fringe benefits) and each has its own specific rules for calculating the fringe
benefits taxable value. Miscellaneous exempt benefits are found in Division 13 of FBTAA, and are
those benefits that are specifically exempt from the provisions of the Act.
The gross-up formula

Once the fringe benefits taxable value has been determined, the next step is to calculate the
fringe benefits taxable amount. This is also known as the grossed-up amount.
The fringe benefits taxable amount is calculated by multiplying the fringe benefits taxable value
by a gross-up factor.
There are two gross-up factors that can be used. These are referred to as Type 1 or Type 2 benefits.
An employer’s aggregate fringe benefits taxable amount is the sum of the total of the Type 1 and
Type 2 aggregate fringe benefits amounts.
Type 1: Higher gross-up rate

This rate is used where the provider of the fringe benefit is entitled to GST credit in respect of the
provision of a benefit. Put simply, it applies where GST was included in the cost of the item and
the employer has a GST input tax credit entitlement (see Module 10 on GST for more on input
tax credits).
FBT rate FBT rate Type 1 gross-up rate
Ending 31 March 2019 47% 2.0802
Type 2: Lower gross-up rate

This rate is used if the benefit provider is not entitled to claim GST credits.
FBT rate FBT rate Type 2 gross-up rate
Ending 31 March 2019 47% 1.8868
The fringe benefit taxable value can be reduced via employee contributions or by applying the
otherwise deductible rule. These terms are defined as follows.
Employee contribution: Where an employee makes an after-tax contribution to a benefit

subject to FBT, then the taxable value of the benefit is reduced by the amount of the employee
contribution, after applying other reductions.
Otherwise deductible rule: Taxable value of a fringe benefit may be reduced when the
‘otherwise deductible rule’ applies. This will be the case where the employee would have been
able to gain a deduction for the cost of the benefit if the employee had incurred the expenditure
(such as the benefit being used for employment-related purposes). Consequently, only the
private component of the benefit is subject to FBT.
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Employee declaration—if the otherwise deductible rule is involved

Employers must obtain an employee declaration, except where:
• the employee’s expense (other than an expense incurred in respect of a car they own or lease)
is incurred exclusively in the course of performing employment-related duties (for example,
protective clothing or tools of trade)
• there is a requirement to keep a travel diary
• the requirement to keep a travel diary is waived because the employee is a member of an
international aircrew
• the provision of the fringe benefit is covered by a recurring fringe benefit declaration (ATO 2019a).
Recurring fringe benefit declaration

The requirement to obtain an employee declaration is waived if the provision of the fringe
benefit is covered by a recurring fringe benefit declaration.
A fringe benefit is covered by a recurring fringe benefit declaration if:

• it is provided no later than five years after the day the declaration was made
• the deductible proportion of the benefit is not significantly less than the deductible
proportion of the benefit for which the declaration was first provided (a difference of more
than 10 percentage points is regarded as being significant)
• it is ‘identical’ to the fringe benefit for which the declaration was first made.
A recurring fringe benefit declaration is automatically revoked by a later declaration made for
an identical benefit. This means that the earlier declaration applies to the first benefit and to any
identical benefits provided before the later declaration was made. The later declaration applies
to the benefit for which it was provided and to any identical benefits provided subsequently.
For example: an employer regularly reimburses an employee for the cost of home telephone
expenses. This is an expense payment fringe benefit. The employee gives the employer a
recurring fringe benefit declaration that specifies that the deductible proportion of the expenses
is 80 per cent. The declaration will cover all further reimbursements in relation to telephone
costs over the next five years if the employment-related use of the telephone is not less than
70 per cent. If the employment-related use of the telephone drops to less than 70 per cent,
another declaration is required.
Example 9.1: Dimitra and the otherwise deductible rule

Dimitra is employed by XYZ Pty Ltd (XYZ). On 15 October 2018, Dimitra’s employer paid for her to
attend an all-day tax update conference run by CPA Australia. The amount paid was $985.
As Dimitra is employed as an accountant with XYZ, she would be able to claim a deduction under
s. 8-1of ITAA97 for her conference costs. Consequently, the operation of the ‘otherwise deductible
rule’ would reduce the fringe benefits taxable value of the benefit to $nil.
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Example 9.2: Dimitra and the otherwise deductible

rule continued
Because Dimitra travelled to perform some of her duties, XYZ paid for her annual airport lounge
membership of $665.
Since this benefit is an exempt fringe benefit under s. 58Y of FBTAA, there is no need to apply the
otherwise deductible rule. Exempt benefits are excluded from the definition of a fringe benefit, and are
discussed further in the section ‘Exempt fringe benefits and employees’ later in this module.
➤ Question 9.1
(a) On 1 March 2019 Shaun Field has a telephone bill of $220 (this includes $20 GST) paid by his
employer, Trucks Are Us Ltd. Trucks Are Us is able to claim the 10 per cent input tax credit.
What gross-up factor should it use?
(b) What would the gross-up factor be if Trucks Are Us was not able to claim the credit?
Steps in determining fringe benefits tax payable

Table 9.3 presents the steps required for determining total FBT payable.
Table 9.3: Determining total fringe benefits tax
Step 1 Calculate the taxable value of each fringe benefit provided to each employee. The rules for
calculating the taxable value of a fringe benefit vary according to the type of benefit.
Step 2 Calculate the total taxable value of all the fringe benefits provided for which a GST credit
can be claimed.
Step 3 Calculate the grossed-up taxable value of these benefits by multiplying the total taxable value
of all the fringe benefits for which a GST credit can be claimed (from step 2) by the Type 1
gross-up rate.
Step 4 Calculate the total taxable value of all those benefits for which a GST credit cannot be claimed
(e.g. supplies made that were either GST-free or input taxed).
Step 5 Calculate the grossed-up taxable value by multiplying the total taxable value of all fringe
benefits for which a GST credit cannot be claimed (from step 4) by the Type 2 gross-up rate.
Step 6 Add the grossed-up amounts from steps 3 and 5. This is the total fringe benefits taxable
amount.
Step 7 Multiply the total fringe benefits taxable amount (from step 6) by the FBT rate. This is the total
FBT amount payable.
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Source: Adapted from ATO 2019, ‘Calculating your FBT’, accessed April 2019,
https://www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/Calculating-your-FBT/.
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➤ Question 9.2
On 1 December 2018, Joe White had his telephone bill of $440 (which included $40 GST) paid by
his employer, Borox Ltd (Borox). The fringe benefits taxable value was $440. Borox is registered
for GST. As the telephone bill included GST and the employer is registered for GST, Borox was
able to claim the $40 input tax credit in its next business activity statement (BAS).
(a) Calculate the grossed-up amount.
(b) If Borox was not able to claim the input tax credit (either because the telephone provider
was not registered for GST or Borox was not registered for GST), what would be the relevant
gross-up rate?
(c) Calculate the grossed-up amount if the situation in (b) applies.
(d) What is the final amount of FBT payable based on the fact that Borox could claim the input
tax credit?
Fringe benefits tax-exempt employers

An FBT-exempt employer is one that is exempt from paying FBT on certain fringe benefits.
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Exempt entities are typically either wholly or partially exempt from income tax. They are:
• endorsed PBIs, which are non-profit institutions organised for the direct relief of poverty,
sickness, suffering, distress, misfortune, destitution or helplessness
• public and non-profit hospitals
• endorsed health promotion charities, which are non-profit charitable institutions whose
principal activities involve the promotion and prevention or control of diseases in
human beings
• public ambulance services.
Exempt employers are subject to a limit (or cap) on the amount of exempt fringe benefits that
can be provided to each employee. Where the cap is exceeded for a particular employee,
the employer is required to lodge an FBT return and pay the FBT owing in relation to the
excess amount.
This ‘cap’ is based on the grossed-up amount of fringe benefits provided to each employee,
not the fringe benefits taxable value.
Table 9.4 presents the cap for public and non-profit hospitals and for other FBT-exempt
employers for the FBT year ended 31 March 2019.
Table 9.4: Fringe benefits tax treatment for certain employers
Employer FBT concession for the year ending 31 March 2019
Public benevolent institution FBT exemption capped at $30 000 per employee
(other than public hospitals) and
health promotion charities Salary packaged meal entertainment and entertainment facility
leasing expense benefits capped at $5000 per employee
Public hospitals, non-profit hospitals FBT exemption capped at $17 000 per employee
and public ambulance services
Salary packaged meal entertainment and entertainment facility
Rebatable employers—certain FBT rebate of 47% capped at $30 000 per employee
registered charities, non-government
and non-profit organisations Salary packaged meal entertainment and entertainment facility
Source: ATO 2019, ‘Fringe benefits tax—rates and thresholds’, accessed December 2018,
https://www.ato.gov.au/Rates/FBT/.
Fringe benefits tax rebate for rebatable employers

The cost of paying FBT is generally deductible to most employers under s. 8-1 of ITAA97, as it
is an outgoing incurred in gaining or producing assessable income or carrying on a business.
Tax-exempt employers are, however, not entitled to a deduction for the payment of FBT because
it is an outgoing incurred in gaining or producing their exempt income and therefore falls within
the third negative limb of s. 8-1of ITAA97.
A special FBT rebate exists under s. 65J of FBTAA to compensate certain not-for-profit employers
who cannot benefit from a tax deduction relating to FBT because they are exempt from paying
tax. The rebate is provided to ‘rebatable employers’, which are defined as employers that are
exempt from income tax under the provisions set out in the table in s. 65J(1) of FBTAA.
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Calculation of rebate of fringe benefits tax

The amount of the rebate is calculated using the formula:
Rebatable days in year

FBT rate (0.47) × (Gross tax – Aggregate non-rebatable amount)
Total days in year
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Aggregate non-rebatable amount

• The aggregate non-rebatable amount is the total grossed-up taxable value of the fringe
benefits provided to an individual employee that exceeds $30 000.
• An employer is entitled to a rebate of 47 per cent of the FBT payable on the grossed-up
taxable value of benefits provided to each employee that does not exceed $30 000.
• The FBT rebate cannot be applied to the total aggregate non-rebatable amount.
• For the year ending 31 March 2019, the provision of salary packaged meal entertainment and
entertainment facility leasing expense benefits form part of the aggregate non-rebatable
amount where the grossed-up taxable value of such benefits exceeds $5000.
Examples of FBT rebatable employers include:

• religious institutions
• educational institutions including private not-for-profit schools and private not-for-profit
universities
• scientific, charitable or public institutions (other than an institution of the Commonwealth
or of a state or territory)
• a trade union
• a non-profit, non-government school
• a non-profit society or club established for the encouragement of music, science or sport.
Example 9.3: Rebate of fringe benefits tax for a non-

profit employer
A public charity provides the following benefits for the year ending 31 March 2019 to its employees:
• pay for Mark and Sam’s children’s school fees (an expense payment fringe benefit) and school
fees for eight other employees.
• provide Mark and Sam with cars for private use (a car fringe benefit)
• allow Mark and Sam to purchase restaurant meals on a credit card that is paid by the employer
at the end of the month, under a salary packaging arrangement.
The car fringe benefits are Type 1 benefits because they are GST taxable supplies.
Mark’s car fringe benefit calculated using the statutory formula method equals $14 000.
Sam’s car fringe benefit calculated using the statutory formula method equals $15 000.
Type 1 aggregate amount = $29 000 × 2.0802 = $60 326.
The school fees are Type 2 benefits because they are GST-free supplies.
10 × expense payment fringe benefits $6000 school fees equals $60 000.
Type 2 aggregate amount equals $60 000 × 1.8868 = $113 208.
The use of the meal credit card is a Type 2 benefit because it is an input-taxed financial supply.
Mark’s meal entertainment fringe benefit: credit card totals $5500.
Sam’s meal entertainment fringe benefit: credit card totals $2295.
Type 2 aggregate amount = $7795 × 1.8868 = $14 708.
The Type 2 aggregate amount is therefore $113 208 + 14 708 = $127 916.
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Thus in total:
• the fringe benefits taxable amount is $188 242 ($60 326 + $113 208 + $14 708)
• gross FBT payable is $88 474 ($188 242 × 47%).
Sam and Mark each have an individual grossed-up non-rebatable amount greater than $30 000.
Mark has an amount of $50 821 ($14 000 × 2.0802 + $6000 × 1.8868 + $5500 × 1.8868).
Sam has an amount of $42 524 ($15 000 × 2.0802 + $6000 × 1.8868).
(Sam’s amount does not include the salary packaged entertainment as the value $4330 ($2295 × 1.8868)
does not exceed the separate grossed-up cap of $5000.)
The calculation of the aggregate non-rebatable amount is as follows:
[($50 821 – $30 000 – $5000) + ($42 524 – $30 000)] × 47% = $13 322
The calculation of the FBT rebate amount is as follows:
47% × ($88 474 – $13 322) = $35 321
Specific fringe benefits

Summary table of specific fringe benefits
The following pages contain a comprehensive summary table (Table 9.5) of the specific
fringe benefits.
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Table 9.5: Specific fringe benefits
FBTAA
Benefit reference Definition What gives rise to a benefit? Methods for calculation
Car fringe Division 2 Section 136(1): To give rise to a car fringe benefit, 1. Statutory formula method
benefits (ss. 7–13) motor vehicle, the car must be ‘held’ by the employer.
of FBTAA being a ‘motor  Number of days 
car, station A car is ‘held’ by the employer if   Amount
 during that year of tax 
wagon, panel van, it is owned outright or leased by   (if any)
Base value on which the car fringe benefits
utility truck or the employer.  0.2 × ×  − of the
 of the car were provided by the provider 
other road vehicle recipient’s
 Number of days 
designed to carry In order to give rise to a fringe benefit,   payment
 in that year of tax 
a load of less the car must either be actually used by  
than one tonne the employee for private purposes or
Statutory rate: 20%
or fewer than made available for private use.
• Base value: Cost of vehicle plus accessories (market value for leased
nine passengers’.
vehicle). Cost excludes any depreciation.
Motorcycles
• Cost: Determined at earliest holding period by employee/associate.
are specifically
Where car is held for 4 years, cost reduced to 2/3 of original cost.
excluded from
the definition.
2. Operating cost (logbook) method
[Operating costs × (100% – business use %)] – employee contribution
Definitions:
• Operating costs: including fuel, registration, repairs, maintenance,
interest, insurance lease payments and depreciation
• Business use percentage: Employer is required to keep a logbook
to support business km estimate. If no records maintained, then the
business use percentage is deemed to be nil.
• Equals (business km travelled / total km travelled) × 100%
The employer is permitted to choose a different method each FBT year.
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FBTAA
Car parking Division A car parking fringe benefit may arise Five methods for valuing the car parking benefit:
benefits 10A of if an employer provides car parking 1. Commercial parking station method (s. 39C)—taxable value is the lowest fee
FBTAA to an employee and all the following charged for ‘all day parking’ on that day by any commercial parking station
conditions are satisfied: within a 1 km radius of the employer’s business premises. Reduced by any
• the car is parked at premises contribution to the cost of the car park by the employee.
that are owned or leased by, or 2. Market value method (s. 39D)—independent valuation to establish the cost
otherwise under the control of, the the employee could reasonably be expected to pay for the car park under
provider (usually the employer) an arm’s-length transaction. Reduced by any contribution to the cost of the
• the car is parked for a total of more car park by the employee.
than four hours between 7.00am 3. Average cost method (s. 39DA)—calculated by reference to an average of
and 7.00pm on any day the lowest fees charged by a commercial operation within a 1 km radius of
• the car is owned by, leased to, the employer on the first and last day of the FBT year on which a benefit was
or otherwise under the control of, provided. Reduced by any contribution to the cost of the car park by the
an employee, or is provided by employee.
the employer 4. Statutory formula—spaces method (s. 39FA)—calculated by multiplying
• the parking is provided in respect the daily rate amount (value of the benefit provided as determined under
of the employee’s employment either the ‘average cost method’, ‘commercial parking station method’
• the car is parked at or near the or ‘market value method’, assuming no recipient’s contribution) by the
employee’s primary place of statutory number of car parking benefits. Assume there are 228 available car
employment on that day parking days from each car parking space during the course of the FBT year.
• the car is used by the employee Formula: Reduced by any recipient’s contribution.
to travel between home and work
(or work and home) at least once Number of days in the period relating to the car space
Daily rate amount × × 228
on that day 366
Note that 366 days is always used as the denominator.

FBTAA
• there is a commercial parking 5. 12-week register method (s. 39GA)—employer is required to keep a register
station that charges a fee for all-day for 12 weeks indicating the total car parking benefit provided and the total
parking within a 1 km radius of value of the car parking fringe benefits provided.
the premises on which the car is
parked, and: Number of days of car
– the commercial parking 52 parking benefits
Total value of car parking benefits (register) × ×
station fee for all-day parking 12 366
is more than the car parking
threshold
– at the beginning of the FBT
year, the commercial parking
station fee for all-day parking
was more than the car parking
threshold (ATO 2017a).
Debt waiver Section 15 Debt waiver fringe benefit arises where Value of a debt waiver fringe benefit is the amount of the debt waived.
of FBTAA an employer forgives or otherwise
waives a debt owing by an employee. FBT is payable on the grossed-up value of the benefit.
Debts are an input-taxed supply; the gross-up factor to be used on all loan fringe
benefits is the Type 2 gross-up factor.
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FBTAA
Loan Section 18 A loan includes: Loan may be made by an employer or Taxable value of a benefit is the amount by which the statutory interest rate
of FBTAA • an advance associate, to an employee or associate, (the ‘benchmark interest rate’) exceeds the interest rate actually accrued on
of money and the loan fringe benefit will be taken the loan.
• provision to exist in any year where an obligation
of credit to repay any part of the loan remains. FBT is payable on the grossed-up value of the benefit.
• payment of
an amount Loans are an input-taxed supply; the gross-up factor to be used on all loan fringe
on behalf benefits is the Type 2 gross-up factor.
of a person,
which creates
an obligation
for it to be
repaid.
Expense Section 20 Examples include An expense payment fringe benefit The fringe benefits taxable value is the GST-inclusive amount of the expenditure,
payment of FBTAA 5 payment of: arises where the employee has incurred which is paid or reimbursed to the employee by the employer.
• gym a liability and either:
membership 1. the employer directly pays the Can be reduced by an after-tax employee contribution and/or the otherwise
fees expense to a third party on behalf deductible rule.
• golf club of the employee, or
subscriptions 2. the employer reimburses the
• education employee for the expense incurred
fees and paid for by the employee.
• private health
insurance
premiums
• personal
holidays, and
• home
telephone
and electricity
bills.
FBTAA
Meals Division 9A Section 32-10 of Meals and entertainment normally Can choose one of two methods to calculate meals entertainment fringe benefits:
and enter- of FBTAA ITAA97 defines liable for FBT as expense payment, 1. 50/50 split—assumes 50% of all meal entertainment provided by the
tainment entertainment property or residual benefits. employer is attributed to employees, and 50% to non-employees, such as
as ‘the provision customers, clients and suppliers.
of food, drink FBT is now liable on meal entertainment 2. 12-week register method—keep a register for 12 weeks indicating the total
or recreation benefits and entertainment facility meal entertainment provided and the fringe benefits provided by way of
plus associated leasing expense benefits. (Some meal entertainment to employees (s. 37C).
travel and concessions for not-for-profits.)
accommodation’. Total value of meal entertainment fringe benefits
× 100
Total value of meal entertainment
Property— Sections 40 Property is An in-house property fringe benefit Taxable value of an in-house property fringe benefit is calculated under rules
in-house or and 136(1) defined in is a benefit where the employer or an contained in s. 42 of FBTAA outlined as follows:
external of FBTAA s. 136(1) as associate provided the benefit and it • Where property is provided to the recipient under a salary-packaging
both tangible was property that was normally sold as arrangement the taxable value is the notional value of the property at time
and intangible part of the provider’s business (s. 136(1)). of provision reduced by the recipient’s contribution (s.42(1)(aa) of FBTAA).
property, and • Where s. 42(1)(aa) does not apply and the benefit is an airline transport
includes: benefit, the taxable value is 75% of the ‘stand-by airline travel value’ reduced
• goods (e.g. by any recipient’s contribution (s. 42(1)(ab) of FBTAA).
computer and
furniture) Where neither s. 42(1)(aa) or s. 42(1)(ab) apply, the taxable value is as follows:
• real property • If the property was manufactured, produced, processed or treated by the
(e.g. land and provider and sold by the provider to manufacturers, wholesalers or retailers,
buildings) the taxable value is the lowest price at which the property was sold under an
• rights to arm’s-length transaction; reduced by any recipient’s contribution.
property • If the property was manufactured, produced, processed or treated by the
(e.g. shares, provider and sold by the provider to the public (not to manufacturers,
bonds wholesalers or retailers) the taxable value is 75% of the lowest price at which
and other the property was sold to the public; reduced by any recipient’s contribution.
securities).
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FBTAA
An external property fringe benefit is • If the property was not manufactured, produced, processed or treated by
one that is not considered to be an in- the provider, but was acquired by the provider, the taxable value is the lesser
house benefit. of (a) the provider’s arm’s-length acquisition price of the property and (b) the
notional value of the property at the time it was provided; reduced by any
recipient’s contribution.
• In any other case, the taxable value is 75% of the notional value of the
property at the time it was provided; reduced by any recipient’s contribution.
Reduction amount
Section 52 of FBTAA provides that the first $1000 of the aggregate of any
‘in-house fringe benefits’ (not provided under a salary-packaging arrangement)
provided to an employee in a particular year of tax is not subject to FBT.
External property benefit—employer’s purchase price of the goods less the

amount paid by the employee (s. 43).
Residual Division 12 Benefit that does The fringe benefits taxable value of External residual benefit—amount by which the arm’s-length amount paid by
benefits of FBTAA not fall within a residual fringe benefit depends on the employer for the benefit exceeds the price paid by the employee.
any of the other whether it is:
categories of • an in-house residual benefit, or In-house residual benefit—taxable value of an in-house residual benefit is usually
benefit within • an external residual fringe benefit. 75% of the lowest price that is charged to the public for the same benefit less
FBTAA and any amount paid by the employee for the benefit.
includes any
right, privilege, In-house residual fringe benefits—the first $1000 of the aggregate taxable value
service or of ‘in-house’ residual fringe benefits provided by an employer to each employee
facility provided per FBT year is exempt (s. 62 of FBTAA).
in respect of
employment. Can be reduced by an after-tax employee contribution and/or the otherwise
deductible rule.
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Examples
The following examples and Question 9.3 are based on calculating the taxable value of the
specific fringe benefits presented in the summary table.
Example 9.4: Car parking benefits

After keeping a register for 12 weeks, an employer elects that 20 car parking benefits be valued at
$10 each (or $600 for the 12 weeks based on $10 per day × 5 days per week × 12 weeks). The car
parking spaces were available for the entire FBT year.
Under the 12-week register method, the taxable value is calculated as follows:
52 366 days
20 spaces × $600 per space × × = $52 000
12 366 days
Example 9.5: Expense benefits

On 18 April 2018, Ninja’s employer, Karate Ltd, paid her entire telephone bill of $550, including $50 of
GST. Ninja provides a declaration confirming that 40 per cent of the calls (i.e. $220) were work-related.
Ninja would have been entitled to a GST-inclusive tax deduction of $220 had she incurred the expense.
To calculate the FBT payable in the 2018–19 FBT year, note that the private component of the telephone
bill (being $330) will be subject to FBT. In other words:
Expense payment benefit: $

Payment of telephone bill 550
Less: Otherwise deductible component ($550 × 40%) (220)
Fringe benefits taxable value 330
Being a Type 1 benefit, the relevant gross-up rate is 2.0802. The fringe benefits taxable amount is
$686.47 (i.e. $330 × 2.0802). The FBT payable is $322.64 (i.e. $686.47 × 47%).
Example 9.6: In-house property benefits

A manufacturer sells a television to the public for $3200. It cost the manufacturer $1600 to make the
television. Assuming no other fringe benefits are provided to the employee, the taxable value of
the property fringe benefit (television) in the following scenarios is:
1. If the manufacturer sells the television to an employee for $1400, then the taxable value of the
fringe benefit is calculated as follows:
– 75% of normal price to the public ($3200) equals $2400
– Less general exemption for employee ($1000)
– Less amount paid by employee ($1400)
Taxable value of fringe benefit (0)
2. If the manufacturer sells the television to an employee for $800 then the taxable value of the fringe
benefit is calculated as follows:
– 75% of normal price to the public ($3200) equals $2400
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– Less general exemption for employee ($1000)

– Less amount paid by employee ($800)
Taxable value of fringe benefit ($600)
➤ Question 9.3
Assume that a new car is purchased by an employer on 1 April 2018 for $22 000 (inclusive of
$2000 GST) from a registered GST car dealer.
For the entire 2018–19 FBT year, the car is made available for the private use of an employee,
who travels a total of 28 000 kilometres (both business and private) during the period 1 April 2018
to 31 March 2019. The employee makes an after-tax cash contribution of $550 (GST inclusive) to the
employer towards the cost of the car and provides the employer with the necessary declaration.
What is the fringe benefit taxable value using the statutory formula method?
Exempt fringe benefits and employees

Exempt fringe benefits
Division 12, s. 47 of FBTAA contains a number of benefits that are ‘exempt residual benefits’.
Division 13 contains a number of miscellaneous exempt benefits and Division 14 contains
a number of concessions resulting in the reduction of taxable value of miscellaneous
fringe benefits.
Some of the main exemptions and concessions are:

• Free public transport to current employees where the employer carries on the business of
providing transport to members of the public (s. 47(1)). This exemption is not available if
provided as part of a salary sacrifice arrangement.
• Recreational facilities (unless it includes a facility for accommodation or a facility for food/
drinks) (s. 47(2)).
• Child-care facilities for the benefit of employees’ children on the employer’s business
premises. However, the facility must be for the purpose of minding, caring for or educating
children under six years of age (s. 47(2)).
• Use of property on the employer’s premises, if the benefit consists of the employee, on a
working day, using property located on the employer’s business premises that is principally
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used in connection with the employer’s business. This would cover use of the telephone,
work room and tea facilities (s. 47(3)).
• Accommodation away from home, if an employee receives a benefit of a residential lease
because they are required to live away from their usual residence to perform work duties.
The benefit will be exempt if the employee provides the employer with a declaration setting
out their usual place of residence and the place where they are temporarily residing (s. 47(5)).
• Relocation expenses—certain costs incurred in moving an employee from one location to
another for employment purposes (ss. 58B, 58C, 58E, 58F).
• Remote area worker travel—if provided with accommodation on/near the worksite, and with
transport between place of work and accommodation where an employee resides in a
remote area on a days on/days off basis (s. 47(7)).
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• Remote area holiday travel—under FBTAA, a 50 per cent discount applies to remote area
holiday travel. However, a constraint is that the value of the discount is not to exceed
50 per cent of the usual cost of travel to the capital city of the state in which the remote
area is located (ss. 60A, 61).
• Benefits that are of small value, are infrequently provided, and are difficult to record and
value. An example of this would be an occasional gift, such as a birthday present.
• A minor benefit is an exempt benefit under s. 58P where:
– the notional taxable value of the minor benefit is less than $300 (Taxation Ruling (TR)
2007/12 clarifies the requirement under the legislation to consider more factors than
simply applying a less than $300 threshold; it discusses the term ‘infrequent and irregular’,
which is one of several criteria that must be considered before any conclusion can be
reached that a particular benefit is an exempt benefit), and
– it would be concluded that it would be unreasonable, having regard to the specified
criteria in para. 58P(1)(f), to treat the minor benefit as a fringe benefit.
• Costs incurred in the sale or purchase of houses on relocation of an employee (s. 58C).
• Meals provided at home to other than live-in domestic employees (s. 58V).
• Accommodation and meals provided for live-in help employed to care for elderly (60 years
and over) or disadvantaged people (s. 58U).
• Newspapers and periodicals used for business purposes (s. 58H).
• Worksite medical facilities (s. 58K).
• Employees posted overseas. There is a 50 per cent reduction in the taxable value of holiday
travel (limited to an equivalent economy class airfare to the employee’s home) (s. 61A).
• Housing assistance in remote areas (within Australia). Under s. 60 the value of certain benefits
is reduced by 50 per cent. Examples are:
– interest on a housing loan
– sale of a house below value
– rent reimbursement (s. 60(2A))
– residential fuel (s. 59). Where an employer pays for gas and/or electricity for an employee
in a remote area, the value of the benefit is reduced by 50 per cent (s. 59).
• The following ‘eligible work related items’ are exempt under s. 58X:
– portable electronic devices (e.g. a laptop computer, smart phone, tablet)
– protective clothing
– briefcases
– computer software
– tools of trade.
• The s. 58X exemption only applies where the items just discussed are used primarily for work
purposes, and is limited to one item of each type per employee per FBT year (unless it is a
replacement item).
• Also, s. 58Y provides an exemption for:
– employee subscriptions to professional and trade journals
– corporate credit cards
– airport lounge benefits (e.g. Qantas Club).
Taxi travel provided to employees for direct travel between work and home (s. 58Z(1)) and to
employees who are sick or injured (s. 58Z(2)) is exempt. An exemption is provided for single taxi
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trips that begin or end at the employee’s place of work irrespective of when the trip commenced
or the departure point or destination.
From 1 April 2016, the exemption for portable electronic devices was extended to small business
entities (SBEs) that provide employees with more than one work-related portable electronic
device in an FBT year—‘even if the devices have substantially identical functions’ (ATO 2017c).
The employer must be an SBE for at least one income year that starts or ends in the relevant
FBT year. The definition of SBE was discussed in Module 4.
Salary packaging
What is salary sacrificing?
Salary sacrificing is an arrangement where an employee agrees to forgo some of their future
salary or wages in exchange for selected fringe benefits of a similar value.
The purpose of a salary sacrificing arrangement is to enable the employee to have certain
benefits paid from their pre-tax salary, rather than from post-tax dollars. This can then improve
the after-tax take-home financial position for the employee.
For the salary sacrifice arrangement to be valid, the salary sacrifice must be entered into before
the employee has performed the employment services.
The most typical items that employees choose to sacrifice are:

• car fringe benefits—these are the most commonly salary packaging arrangements.
Example 9.7 examines the advantages of using salary sacrificing for car fringe benefits
through a novated leasing arrangement. A novated lease is the arrangement made between
an employer, a vehicle finance company and the employee so that the costs of the vehicle
are paid for by the employee using pre-tax dollars. As Example 9.7 shows, the advantages
of novated leasing are greater for those on higher salaries, and the GST input tax credits
are also passed on to the employee
• car parking
• personal holidays
• payment of private expenses, such as private school fees, gym membership or home
electricity bills
• superannuation (these are not subject to FBT if made to a complying superannuation fund).
Example 9.7: Operation of salary sacrificing

Megan is an employee of Unfold Tech Pty Ltd. She is on a gross salary of $120 000 per annum. Megan
enters into a novated lease salary sacrificing arrangement with her employer to salary package a car.
The car is purchased on 1 April 2018 and costs $63 000 (including GST), which is financed via a five-
year lease. The monthly lease payments are $1500 per month (or $18 000 per year). Assume that the
running costs of the car each year total $8000 (including GST). Hence, the total costs of the car for the
first year are $26 000 (being $18 000 + $8000). Assume that the company elects to use the statutory
formula method in valuing the car fringe benefit.
Under the salary sacrifice agreement, Megan not only pays the lease payments and the running costs
of the car, but also any FBT associated with the provision of the car. These costs are ‘passed on’ by
the company to Megan and subsequently deducted from her pre-tax gross salary. However, under her
salary sacrifice agreement with the company, Megan also receives any GST input tax credits associated
with the transaction, which results in an addition to her salary. In other words, the employer ‘passes on’
any GST input tax credits it receives under the arrangement to Megan.
The following table summarises Megan’s after-tax position if the car were not packaged (i.e. Megan
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paid for the car out of her after-tax dollars), as well as her after-tax position assuming the car is salary
packaged. It can be seen that Megan is $3799 better off if she salary packages the car (see detailed
calculations following).
In calculating the FBT liability (using the statutory formula method), it is assumed that Megan
has maintained adequate private health insurance and has no other assessable items of income,
allowable deductions or tax offsets.
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Annual salary Car not packaged Car packaged
Annual gross salary $120 000 $120 000
Less: Motor vehicle costs ($18 000 + $8 000) — ($26 000)
Less: FBT payable (see Note 1) — ($12 319)
Add: GST input tax credits (see Note 2) — $2364
Remaining cash salary $120 000 $84 045
Less: Income tax payable (see Note 3) ($31 897) ($18 862)
Less: 2% Medicare levy ($2400) ($1681)
Net income (after-tax cash in hand) $85 703 $63 502
Less: After-tax lease payments and running costs ($26 000) —
Cash in hand $59 703 $63 502
Total benefit as a result of salary packaging $3 799
Note 1: The FBTV = $63 000 × 20% = $12 600

FBT payable of $12 318.94 = $12 600 × 2.0802 × 47%
Note 2: $2364 GST input tax credits (being $26 000 running costs / 11)
Note 3: Tax payable of $31 897 = tax on $120 000 on ‘remaining cash salary’ at resident tax rates,
being $20 797 + (($120 000 − $90 000) × 37%)
Tax payable of $18 862 = tax on $84 045 on ‘remaining cash salary’ at resident tax rates,
being $3572 + (($84 045 − $37 000) × 32.5%)
Does fringe benefits tax apply to salary sacrificing?

Yes, FBT applies to salary sacrifice arrangements (except for exempt benefits and
superannuation, which is discussed in the next section). And the employer is still liable to pay
FBT on the benefit. The normal rules relating to fringe benefits apply, so, for example, the rules
around car fringe benefits are the same.
When the employer is liable for (and pays) the FBT owing, then the employer passes their
paid FBT onto the employee as a reduction from the employee’s pre-tax salary. Consequently,
the employer should be in the same net after-tax position as they would have been if a cash
(pre-benefit) salary had been paid.
Salary sacrificing superannuation

Voluntary superannuation contributions can be made through a salary sacrificing arrangement
whereby an employer agrees to pay a portion of the employee’s pre-tax salary as an additional
concessional contribution into the employee’s superannuation account. (Refer to Module 6
for further discussion.)
Salary sacrificed superannuation contributions are classified as employer superannuation

contributions, rather than employee contributions. Because of this, the employer can reduce the
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amount of legislated Superannuation Guarantee payments they pay, unless there is an agreement
stating that the salary sacrificed contributions will be over and above the Superannuation
Guarantee amount.
As discussed in Module 8, superannuation contributions through a salary sacrifice agreement

are taxed in the superannuation fund at a maximum rate of 15 per cent.
The sacrificed component of the employee’s total salary package is not counted as assessable
income for tax purposes. This means that it is not subject to Pay-As-You-Go (PAYG)
withholding tax.
Importantly, if salary sacrificed superannuation contributions are made to a complying

superannuation fund, the sacrificed amount is not considered a fringe benefit.
Administration
Lodging returns and making payment
The FBT year starts on 1 April and ends on 31 March of the following year. The FBT is based on a
system of self-assessment and the employer must submit an annual return by 21 May. If the FBT
return is lodged electronically by a registered tax agent, it can be submitted by 25 June.
For quarterly payers (i.e. those required to pay GST on a quarterly basis or who are not required
to pay GST), the instalments of FBT are due on 28 July, 28 October, 28 February and 28 April.
Any balance is due to be paid by 21 May when the FBT return is lodged.
Where employers are required to pay GST on a monthly basis, the due dates are 21 July,
21 October, 21 January, 21 April and any balance on or before 21 May.
Quarterly instalments are paid via the BAS or instalment activity statement (IAS), discussed in
Module 11. Employers do not have to make quarterly instalments of FBT if the FBT liability
in the previous FBT year was less than $3000.
Penalties for non-compliance

If a taxpayer does not lodge an FBT return by the required date, the Australian Taxation Office
(ATO) will make an assessment of the amount payable. Penalties may be imposed where
employers fail to lodge a return or where they provide false or misleading information.
The penalty tax is based on the uniform penalty provisions covered in Module 11.The penalty
may be an amount of double the excess of the tax payable over the amount that has been
paid by the employer.
Fringe benefits tax record keeping

An employer should keep all records to explain any fringe benefits provided for five years.
They must be in written English. If the taxpayer does not keep written records (e.g. on an
electronic spreadsheet or through a mobile application), they must be in a form that can be
converted into written English.
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Where an associate of the business provides a fringe benefit to an employee of the business,
the associate is required to provide copies of the records to the business with the relevant
employee within 21 days of the end of the FBT year.
Both the business and the associate are required to keep the records for five years from the
date of the relevant transaction.
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Examples of FBT records include:

• employee declarations
• invoices
• receipts
• bills of sales
• lease documents
• travel diaries
• logbooks
• odometer records.
If the fringe benefits taxable value of any benefit provided has been reduced, then the employer
must obtain statutory evidentiary documents that prove this. Statutory evidentiary documents
must also be retained for five years. Failure to retain correct records for five years may result
in penalties.
Reportable fringe benefits

An employee’s reportable fringe benefits total for a year of income is the sum of each of the
employee’s reportable fringe benefits amounts for the year of income (s. 135M of FBTAA).
Reportable fringe benefits are defined as follows: if the value of certain fringe benefits provided
exceeds $2000 in an FBT year (1 April to 31 March), the grossed-up taxable value of those
benefits must be reported on the employee’s payment summary for the corresponding income
year (1 July to 30 June). The gross-up rate used is always the Type 2 rate, which is the lower of
the two rates or the 1 / (1 – FBT rate) (s. 135P(2)).
All reportable fringe benefits must be allocated to the relevant employee. They must also include
any fringe benefits provided to associates of the employee.
The amount reported on their payment summary or income statement in myGov is not included in
an employee’s assessable income; nor does it affect the amount of standard Medicare levy payable.
However, it is included in income tests for some government benefits and obligations.
Where employees share a benefit, you must allocate their respective shares individually (ATO 2019b).
The reportable fringe benefits amount of an employee is used for:

• calculating [any] liability to the Medicare levy surcharge
• determining [any] entitlement to the private health insurance rebate
• determining [any liability] for Division 293 tax for superannuation contributions
• determining … eligibility for the government co-contribution for [any] personal superannuation
co-contributions … made
• determining … eligibility for the low-income super tax offset for concessional … super
contributions [an employee or employer] pays into [an employee’s] super fund
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• determining whether [a business loss can be offset] against other income (non-commercial losses)
• working out if [an employee is] entitled to reduce [any] employee share scheme discount
• working out the amount [an employee] must repay against [any] Higher Education Loan
Program (HELP), Student Financial Supplement Scheme (SFSS), Student Start-up Loan (SSL),
ABSTUDY Student Start-up Loan (ABSTUDY SSL) or Trade Support Loan (TSL) debt
• determining [any] entitlement to a tax offset for

– contributions … made to [an employee’s] spouse’s super
– invalid and invalid carer
– zone or overseas forces
– net medical expenses for disability aids, attendant care or aged care
– [private health insurance]
– seniors and pensioners
• determining eligibility for family assistance payments (Family Tax Benefit Part A and Part B,
Child Care Benefit for approved care (prior to 2 July 2018), Child Care Subsidy (from 2 July
2018), Parental Leave Pay, and Dad and Partner Pay)
• working out [any employee] child support obligations (ATO 2018).
Special rules apply for working out the employee’s reportable fringe benefits amount if the
benefits provided in respect of the employee’s employment include exempt benefits under
Division 13 of FBTAA. Exempt benefits include those provided by exempt employers such as
public benevolent institutions, certain hospitals, public ambulance services, health promotion
charities and bodies providing care for sick, elderly or disadvantaged persons (s. 135M and
s. 135Q). There are also specifically exempt benefits under Division 13—for example,
newspapers used specifically for business purposes (s. 58H).
Excluded fringe benefits are those fringe benefits that do not have to be allocated to
employees or reported on individual payment summaries, but are still subject to the FBT
provisions. The following list provides an overview of the main excluded benefits as provided
for under s. 5E(3) of FBTAA:
• car parking fringe benefits
• remote area housing assistance, home ownership schemes and repurchase schemes
• if living in a remote area, costs of occasional travel to a major Australian population centre
• benefits to ensure individual security and personal safety because of occupation
• emergency or other essential health care received as an Australian citizen or permanent
resident while working outside Australia and where a Medicare benefit cannot be claimed
• certain benefits provided to a defence force member or a police officer
• car benefits coming from the private use of pooled or shared cars (ATO 2019a).
Individual fringe benefits amount is defined as the total value of all benefits provided to
a particular employee in an FBT year.
Changes have been made to how reportable fringe benefits amounts (RFBA) are treated for family
assistance and youth income support payments. The change means that the Department of Human
Services (DHS) will use 100% of the RFBA reported by a person on their income tax return, instead
of adjusting the amount to 51%. However, the DHS will continue to adjust the RFBA to 51% if it is
provided by certain non-profit organisations (ATO 2017b).
From 1 July 2017, changes to the treatment of fringe benefits under the income tests take effect
for the following tax offsets:
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• net medical expenses

• dependent (invalid and invalid carer)
• zone and overseas forces
• seniors and pensioners
• low income superannuation (ATO 2018).
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Example 9.8: Reportable fringe benefits

Anna’s employer provides her with two individual fringe benefits during the 2018–19 FBT year (consisting
of an entertainment fringe benefit and an expense payment fringe benefit) with a fringe benefits taxable
value totalling $2780. As the total taxable value exceeds $2000, the reportable fringe benefits amount
needs to be shown on Anna’s 2019 Pay-As-You-Go (PAYG) Payment Summary.
The reportable fringe benefits amount to be included on Anna’s 2019 PAYG Payment Summary is
$5245 (i.e. $2780 × 1.8868). This amount is required to be included in Anna’s individual tax return even
though she does not pay tax on this amount.
➤ Question 9.4
Tony is employed by Patti Smith, a sole trader, and is provided with a car as part of his remuneration
package. Tony has to return the car to the office when he is on leave and when he is away for
work (unless he is using the car). Tony had access to the car for his private use for the entire
FBT year except for 35 days leave and 27 days on interstate travel, when the car was returned
to the office. Tony maintains a logbook for the car.
The following details have been extracted from Patti’s records for the 2018–19 FBT year:
Odometer reading 31.03.18 21 467 km
Odometer reading 31.03.19 47 328 km
Business km travelled during the year 16 856 km
Costs (all amounts inclusive of GST unless otherwise stated)
Fully maintained lease $600 per month
Insurance and registration $1200
Petrol $3364
Market value of car when lease commenced $25 000 (GST exclusive)
Patti is registered for GST and was able to claim GST on all costs incurred.
These questions are examining the application of FBT. Do not calculate any depreciation.
(a) State what type of fringe benefit is being provided in this scenario.
(b) State what gross-up rate Patti will use to calculate the FBT payable, and explain why.
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(c) Use the operating cost method to calculate the FBT payable by Patti on the provision of
this vehicle.
(d) Use the statutory formula method to calculate the FBT payable by Patti on the provision of
this vehicle.
(e) Determine the total amount of FBT payable by Patti. Is this payable on an annual or a quarterly
basis?
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Summary and review

This module examined the principles of FBT, starting with an explanation of the essential
features. FBT is a tax payable by employers on the value of certain non-cash benefits that are
private in nature and that have been provided to their employees, or to associates of employees,
in respect of their employment. FBT is assessed under FBTAA. In general, employers are required
to pay FBT in four instalments even though FBT is assessed on an annual basis. However, if an
employer’s FBT liability in the previous year was less than $3000, the employer need only pay on
an annual basis.
The module then went on to discuss how FBT is calculated. The FBT year runs from 1 April until
31 March and the system is based on self-assessment by employers. The FBT rate is 47 per cent
and is equivalent to the top marginal tax rate of 45 per cent plus the Medicare levy of 2 per cent.
FBT is imposed on the fringe benefits ‘taxable amount’, which is the employer’s aggregate
fringe benefits amount for the year, grossed up. This amount is calculated by using two gross-
up methods: Type 1 (with a gross-up of 2.0802) for benefits for which the employer is entitled
to GST input tax credit; and Type 2 (with a gross-up of 1.8868) for benefits for which there is no
entitlement to GST input tax credits.
For income tax purposes, the amount of the FBT payable is generally tax deductible to the
employer, as is the value of the benefit provided.
The next sections of the module explained the specific fringe benefits, exempt fringe benefits
and salary packaging. There are 13 types of fringe benefits covered by the FBT legislation,
which interacts with the income tax legislation, GST and PSI rules. An FBT-exempt employer
is one that is exempt from paying FBT on certain fringe benefits and is typically either wholly
or partially exempt from paying income tax. Such employers are also subject to a cap on the
amount of exempt fringe benefits that can be provided to each employee.
There are a number of benefits that are excluded fringe benefits and are not included in
the reporting requirements and there are also a number of miscellaneous exempt benefits
contained in the legislation that are not subject to FBT. Division 12 of FBTAA contains a number
of benefits that are exempt residual benefits; Division 13 contains a number of benefits that are
miscellaneous exempt benefits; and Division 14 contains a number of concessions resulting in
the reduction of taxable value of miscellaneous fringe benefits.
Salary packaging is the structuring of an employee’s total remuneration so that it provides the
most value to the employee in relation to its cost to the employer. The purpose of a salary
sacrificing arrangement is so that an employee can have certain benefits paid from their pre-tax
salary by their employer, rather than from their own post-tax dollars. However, FBT applies to
salary sacrifice arrangements (except exempt benefits and superannuation), and where the
employer is liable for (and pays) the FBT owing, the employer passes their paid FBT onto the
employee as a reduction from the employee’s pre-tax salary.
After a review of administrative requirements, the module concluded with discussion of an

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employee’s reportable fringe benefits. Where the individual fringe benefits amount for an
employee exceeds $2000 for the FBT year ending 31 March, that amount, after being grossed-
up, is the reportable fringe benefits amount to be included by the employer on the employee’s
payment summary for that income year ending 30 June. The factor used for the gross-up is the
Type 2 benefit gross-up irrespective of whether GST has been included in the benefit.
MODULE 9
Suggested answers
Suggested answers
Question 9.1
(a) Type 1 gross-up factor of 2.0802
(b) Type 2 gross-up factor of 1.8868
Question 9.2
(a) In this case, the relevant FBT gross-up rate is 2.0802 (Type 1). The grossed-up amount
is calculated as $915.29 (i.e. $440 × 2.0802).
(b) In this case, the relevant FBT gross-up rate is 1.8868.
(c) Therefore, the grossed-up amount is calculated as $830.19 (i.e. $440 × 1.8868).
(d) The FBT payable by Borox is $430.19 (i.e. $915.29 × 47%).
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Question 9.3
The fringe benefits taxable value of the car fringe benefit using the statutory formula method
is calculated as follows:
 365 days 
Fringe benefits taxable value =  20% × $22 000 ×  − $550 = $3850
 365 days 
If the employer is able to claim an input tax credit for the GST paid to acquire the car, the gross-
up factor is 2.0802 (Type 1). FBT is payable on the grossed-up taxable amount of $8008.77
(i.e. $3850 × 2.0802).
Assuming there are no other fringe benefits, the FBT payable by the employer is $3764.00
(i.e. $8008.77 × 47%).
Question 9.4
(a) This is a Type 1 fringe benefit—a car fringe benefit (s. 7 of FBTAA).
(b) Patti uses the Type 1 gross-up rate of 2.0802 (based on the 2018–19 FBT gross-up rate)
as this is a GST inclusive and Patti is entitled to a GST input tax credit.
(c) Operating cost method (s. 10 of FBTAA):

Costs incurred by Patti in the provision of the car = $7200 + $1200 + $3364 = $11 764
Business use percentage = 16 856 / (47 328 – 21 467) = 16 856 / 25 861 km = 65.2%
Taxable value = $11 764 × (1 – 0.652) = $4093.87
Gross-up rate = 2.0802 (GST claimable)
Grossed-up value = $4093.87 × 2.0802 = $8516.07
FBT payable = $8516.07 × 47% = $4002.55
(d) Statutory formula method (s. 9 of FBTAA):

$27 500 (base value of car including GST) × 20% × (365 – 62) available for use /
365 (days calculation) = $4565.75
FBT payable = $4565.75 × 2.0802 × 47% = $4463.90
(e) Patti can choose which method to apply (operating cost or statutory formula) to the car fringe
benefit for the entire FBT year. She would choose the lesser amount, so $4002.55 under the
operating cost method.
Patti will be required to pay this amount on a quarterly basis as it is over $3000. This is
decided based on the FBT liability of the previous year—so if Patti was liable to a similar
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amount in the last tax year, then she would be on a quarterly instalment plan, in line with her
BAS payments. If this is the first year she has to make payment for a fringe benefit of $3000
or more, then she will be required to pay quarterly the following year.

REFERENCES | 431
References
References
ATO 2017a, ‘Car parking fringe benefits’, accessed March 2019, https://www.ato.gov.au/General/
Fringe-benefits-tax-(FBT)/Types-of-fringe-benefits/Car-parking-fringe-benefits/.
ATO 2017b, ‘Agenda items’, accessed May 2019, https://www.ato.gov.au/General/Consultation/

In-detail/Stakeholder-relationship-groups-minutes/FBT-States-and-Territories-Industry-
Partnership/FBT-States-and-Territories-Industry-Partnership-minutes-28-February-2017/?page=2.
ATO 2017c, ‘Work-related portable electronic device exemption’, accessed March 2019,
https://www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/In-detail/Getting-started/FBT-for-
small-business/?page=22.
ATO 2018, ‘Reportable fringe benefits: Facts for employees’, accessed March 2019, https://www.
ato.gov.au/General/Fringe-benefits-tax-(fbt)/In-detail/Employees/Reportable-fringe-benefits---
facts-for-employees/.
ATO 2019a, ‘Fringe benefits tax: A guide for employers’, ATO Legal Database, accessed March
2019, https://www.ato.gov.au/law/view/document?DocNum=0210000055&PiT=99991231235958&
FullDocument=true.
ATO 2019b, ‘Reportable fringe benefits’, accessed May 2019, https://www.ato.gov.au/General/

Fringe-benefits-tax-(FBT)/Reporting,-lodging-and-paying-FBT/Reportable-fringe-benefits/.
MODULE 9
MODULE 9
AUSTRALIA TAXATION
Module 10
GST FUNDAMENTALS
434 | GST FUNDAMENTALS
Contents
Preview 435
Introduction
Objectives
Teaching materials
GST core concepts 437
What is GST?
Major principles
Determining supply 437
What is taxable supply?
Partly taxable supply and composite supply
Special cases for supply
GST-free supply
Input taxed supply
Taxable importations
Input tax credits 447
Amount of input tax credits
Creditable acquisition
Creditable importations
Special input tax credit rules
Calculating GST 449
GST attributions rules
Tax periods
Accounting for GST
Special attribution rules
Calculating the net amount
Adjustments
Administration 453
Tax invoices
Registration
Withholding GST on purchase of new residential property
GST grouping provisions
Anti-avoidance provisions
References 463
MODULE 10
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Module 10:
GST fundamentals
Study guide
Preview
Introduction
The goods and services tax (GST) is a flat 10 per cent broad-based indirect tax on the private
consumption of most goods and services in Australia. It is also applied to importations into
Australia. GST collection and administration are through the Australian Taxation Office (ATO).
GST is levied on each step of the production chain. However, GST-registered suppliers can also
claim input tax credits. GST is therefore collected through each step of the supply process but is
generally only borne by the final consumer.
Where goods and services include GST, the amount of GST included is 1/11 of the price.
Registered entities in the production chain charge GST on goods and services that are a taxable
supply. Eligible suppliers of goods or services are entitled to claim an input tax credit for any GST
paid. At the conclusion of the process, the net amount of GST—that is, GST liability minus GST
paid—is remitted by the registered entity to the ATO via a business activity statement (BAS).

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Figure 10.1: Module summary—goods and services tax
Creditable
acquisitions
Definitions Core concepts Goods and services tax Input tax credits
(GST)
Creditable
importations
Administration Supply Calculating GST

Cash based
Tax invoices Types of supply Attributions
Accruals
Registration Consideration Tax period
GST grouping Enterprise Net amount
Anti-avoidance Taxable Adjustments

provisions importations
Objectives
• apply the general principles underlying the GST legislation to a given situation;
• determine the amount of input tax credit that an entity is entitled to;
• calculate GST net payable or refundable; and
• identify administrative requirements of the GST legislation.
Teaching materials
• Legislation:
– Taxation Administration Act 1953 (Cwlth)
• Glossary:
Definitions/
terms/

candidates/your-experience/skills-list (note that the employability skills are not examinable)
MODULE 10
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GST core concepts

What is GST?
GST is a flat 10 per cent broad-based indirect tax on the private consumption of most goods
and services in Australia. It is also applied to importations into Australia.
GST commenced in Australia on 1 July 2000, and the governing legislation is the GST Act.
GST collection and administration are through the ATO.
GST replaced several indirect taxes, including wholesale sales tax and a wide range of indirect
state taxes.
Major principles
With GST, the tax is charged on each step of the production chain. GST-registered suppliers can
also claim input tax credits. GST is therefore collected through each step of the supply process
but is generally only economically borne by the final consumer.
The major principles of GST are as follows:

• The term price is used to denote the dollar amount of the supply including GST (the amount
of GST included is 1/11 of the price). The term value is used to denote the dollar amount of
the supply excluding GST.
• Registered entities in the production chain charge GST on goods and services that are a
taxable supply. This is discussed in the section ‘Determining supply’.
• Eligible suppliers of goods or services are entitled to claim a credit for any GST paid; this
credit is known as an ‘input tax credit’. These are discussed in the section ‘Input tax credits’.
• The ‘net amount’ of GST (i.e. GST liability minus GST paid) is remitted by the registered
entity to the ATO each month or quarter on a BAS form. This is discussed in the sections
‘Calculating GST’ and ‘Administration’.
Determining supply
What is taxable supply?
Taxable supply is the most common transaction. For each stage of the supply chain, from
manufacture through to sale, the seller is liable to return 10 per cent on the pre GST sale value
of an item to the ATO. In turn, the seller is eligible for a credit for any GST included in their costs
related to the supply.
GST is charged at 10 per cent on the value of a taxable supply. For example, if a price received
for a skirt is $110, the value of the taxable supply is $100 ($110 × 10 / 11), and GST is $10.
Formula to learn
The value of the taxable supply is 10/11 of the price received for a supply by:
Value of taxable supply = Price × 10 / 11

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Price is defined in s. 9-75(1) of the GST Act:

• It includes consideration payable (an amount of money) and the GST-inclusive market value
of any consideration not expressed as an amount of money.
• Market value can be difficult to calculate and it is important to obtain appropriate valuations
if consideration is not in monetary terms.
GST is levied on goods and services that are defined as a taxable supply. A taxable supply arises if:
1. there is a supply, and
2. the supply is made for consideration, and
3. the supply is made in the course or furtherance of an enterprise, and
4. the supply is connected with the indirect tax zone, and
5. the supplier is registered or required to be registered for GST (see the ‘Registration’ section).
All five elements of a taxable supply must be present before GST arises. Note that a supply is
not a taxable supply if it is a GST-free or input taxed supply. These terms are discussed later in
the module.
What is supply?
Supply is defined under s. 9-10 of the GST Act as ‘any form of supply whatsoever’. It is deemed
to include any transaction that is a supply in the ordinary meaning of the word.
Specific examples of supply under s. 9-10 of the GST Act include:

• supply of goods
• supply of services
• provision of advice or information
• grant, assignment or surrender of real property
• creation, grant, transfer, assignment or surrender of any right
• financial supply
• entry into or release from, an obligation to do anything, to refrain from an act, or to tolerate
an act or situation.
A supply does not include the supply of money, including digital currency such as Bitcoin.
Example 10.1: Staged collection of GST—taxable supply

The accompanying figure shows how the GST from a taxable supply is collected at each stage of the
supply chain, but the final 10 per cent tax of $600 is borne entirely by the consumer. In the first stage,
the supplier of electronic components sells $3000 worth of goods to the computer manufacturer.
However, with the imposition of a GST, the supplier is required to include the GST in the sale price
or part of the profit margin will be lost. This is a result of the supplier having to remit 1/11 of the sale
price to the ATO regardless of whether the GST is actually collected from the purchaser. This results
in a sale price of $3300, being the original $3000 plus 10 per cent GST. The $300 GST collected is paid
to the ATO at the end of the tax period. Ignoring other GST and price implications, the supplier of
the electronic components still receives the same net amount ($3000), as was the case prior to GST.
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Computer
Electronic Computer
manufacturer
component retailer
Buys components Consumer
supplier Buys computer
for $3300. Buys computer
Sells components for $5500.
Sells computer for $6600.
for $3000 plus Sells for $6000
for $5000 plus
GST of $300. plus GST $600.
GST of $500.
Credit $300 Credit $500
GST $300 Net GST $200 Net GST $100 Total GST
($500 – $300) ($600 – $500) $600
Australian Taxation Office
The computer manufacturer now pays $3300 (including GST of $300) for the components used in the
manufacture of a computer that previously sold for $5000 (ignore any previous sales tax that may have
been applicable). Adding the 10 per cent GST increases the computer manufacturer’s selling price
for the computer to $5500 ($500 GST). The computer manufacturer has therefore paid $300 GST on
the components (inputs) necessary to produce the computer and collected $500 GST on the sale of
the completed computer. As the manufacturer is not the end consumer, they are entitled to a credit
for the $300 GST paid on inputs and are liable to return to the ATO the net amount of $200 being the
difference between the GST paid and the GST collected ($200 = $500 – $300).
As a result, the computer manufacturer’s economic position is not altered by GST, realising a profit
of $2000 ($5500 – $3300 – $200), the same as would have been the case if there were no GST: ($5000
– $3000 = $2000).
Similar to all other stages in the supply process, the computer retailer is also unaffected by GST
except that the net amount (difference between the GST paid on inputs and the GST collected on
sales) of GST must be remitted to the ATO. Without GST, the retailer would realise a profit of $1000
after selling the item for $6000 ($6000 – $5000). However, with GST, the profit margin will still be $1000
as the computer will be sold for $6600 ($6000 + 10%) and costs will be $5500 plus $100 GST ($1000 =
$6600 – $5500 – $100). The $100 GST liability is calculated as the difference between the GST paid on
inputs and the GST collected on the sale ($600 – $500).
Finally, the private consumer of the computer pays an additional 10 per cent ($600) because of GST,
and is not entitled to any credit for the GST paid. Through this staged process it can be seen that
the cost of GST falls on the final consumer, but it is collected in stages through the supply process.
The bottom box in the figure shows how the total tax of $600 is collected by the ATO.
What is consideration?
Consideration is defined under s. 9-15 of the GST Act as follows:
(1) Consideration includes:
(a) any payment, or any act or forbearance, in connection with a supply of anything, and
(b) any payment, or any act or forbearance, in response to or for the inducement of a supply
of anything.
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(2) It does not matter whether the payment, act or forbearance was voluntary, or whether it was
by the recipient of the supply (GST Act, s. 9-15).
Supplies to an associate for no consideration are deemed to have consideration of market value
if the associate is not registered for GST or does not use the goods or services wholly for a
creditable purpose (GST Act, ss. 72-5, 72-10).
Example 10.2: Consideration

Paul Evans provides specialist plumbing camera and crawler services. During a job, he needs some
electrical work done to complete his contract, so he asks his friend Doug (an electrician) to help.
Paul and Doug agree that Doug will not be paid for the work but that Paul will perform specialist
plumbing investigation for Doug in the future if required.
It could be argued in this case that Doug has made a supply of his electrician services for consideration,
with the consideration being the right to call in specialist plumbing work from Paul in the future.
➤ Question 10.1
A retailer donates goods to a local school fair so that the goods can be auctioned to raise money
for the school. The retailer does not request any advertising for the donation.
Does a taxable supply exist?
What is enterprise?
Enterprise is defined under s. 9-20 of the GST Act as an activity, or a series of activities:
• in the form of a business
• in the form of an adventure or concern in the nature of trade
• on a regular or continuous basis in granting interests in property
• by the trustee of a fund to which tax-deductible gifts can be made (ITAA97, Subdivisions 30-A
and 30-B)
• by the trustee of a complying superannuation fund
• by charities
• by religious institutions, or
• by the Commonwealth, states and territories of Australia.
Excluded from the meaning of enterprise are activities done:

• by an employee
• in connection with earning withholding payments
• as a hobby
• by an individual or partnership without reasonable expectation of profit, or
• as a member of a local governing body established under a state or territory law.
This definition results in the concept of enterprise being very broad. It includes not just activities
of a business, trade or profession, but also certain activities of gift-deductible funds, charitable
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institutions, religious institutions and government entities. Key elements in this definition are that
an enterprise is an activity ‘in the form of a business’ or ‘in the form of an adventure in the nature
of trade’.
Business is the same definition as in ITAA97 and discussed throughout this Study guide.
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Example 10.3: Defining an enterprise—non-taxable supply

A GST-registered second-hand bookshop owner sold some of her personal books (in her house) that
she no longer needed. These books had only been used for personal purposes and were not part of
her second-hand book shop.
The private sale of the personal books would not constitute a taxable supply because it is not associated
with the second-hand bookshop business, and it would not normally be seen as an enterprise in itself.
Example 10.4: Defining an enterprise—taxable supply

Personal tips received by a waiter would not normally be a taxable supply because the waiter receives
the amounts personally and the waiter is not conducting an enterprise. However, fixed surcharges paid
on all bills would be subject to GST (increasing the restaurant’s GST liability), as they are connected
with the restaurant’s enterprise, even though they may be distributed as bonuses or tips to employees.
What are supplies connected with the indirect tax zone?

Section 9-25 of the GST Act defines when supplies are, or are not, connected with the indirect
tax zone. The indirect tax zone covers Australia and includes offshore installations such as oil rigs,
but excludes the Australian external territories of Norfolk, Christmas and Cocos (Keeling) Islands.
Supplies of goods are connected with the indirect tax zone if the goods are:
• delivered in the indirect tax zone to the recipient
• made available in the indirect tax zone to the recipient
• removed from the indirect tax zone
• low-value goods delivered into the indirect tax zone by an offshore supplier, or
• being brought into the indirect tax zone, and the supplier is either:
– importing the goods into the indirect tax zone, or
– installing or assembling the goods in the indirect tax zone.
Supplies of real property are connected if the real property is located in the indirect tax zone.
Supplies of anything else (e.g. services) are connected if the supply is ‘done’ in the indirect tax
zone, or the supplier makes the supply through an enterprise that the supplier carries on in the
indirect tax zone.
For goods imported into the indirect tax zone, but installed or assembled in the indirect tax zone,
the part of the supply that involves the installation or assembly in the indirect tax zone is treated
as a separate supply. This will probably be connected with the indirect tax zone as it is a supply
of services ‘done’ here. The rest of the supply is treated separately, and it is connected with the
indirect tax zone if the supplier is the importer.
Offshore suppliers of digital products/intangible supplies to Australian consumers

From the tax period starting 1 July 2017, GST is now extended to the cross-border supply of
services and intangible products, such as digital products, to Australian consumers (GST Act,
s. 9-25(5)(d); GSTR 2017/1).
This now means the supply of these products has a connection with the indirect tax zone if
provided to a consumer who is a resident of the indirect tax zone. This means the products
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are subject to GST even though the supplier is overseas. This is aimed at capturing GST from
suppliers of streaming services and downloaded products such as music, movies, e-books
and apps.
The meaning of ‘Australian consumer’ is defined in s. 9-25(7) of the GST Act as an entity that is
an Australian resident and the entity is not registered for GST, or if the entity is registered for
GST, the entity does not acquire the thing supplied partly or solely for the purpose of carrying
on its enterprise.
Partly taxable supply and composite supply

A partly taxable supply is where the total value of the supply is apportioned between the
taxable supply and the non-taxable supply.
GST is calculated on the value of the taxable supply only.
If the supply is not able to be naturally apportioned, it will be treated as one supply that is either
all taxable or all not taxable.
A composite supply is one that is not naturally able to be broken up and may consist of a
dominant part and a lesser part (or ancillary). It will be determined to be either all taxable or
all non-taxable, dependent on the dominant part of the supply.
Special cases for supply

There are special rules for certain goods and services under the GST Act where taxable supply
is, or is not, defined. If there is a taxable supply, then no GST is charged in certain circumstances.
Table 10.1 summarises these special cases.
Table 10.1: Special cases of taxable supply
Good or service GST yes/no
Vouchers (Division 100) NO GST charged on supply of a voucher that entitles the holder to
access goods or services to a certain value
YES GST due when the goods or services are redeemed
YES GST due if the voucher is for the supply of specified goods
or services
Security deposits (s. 99-5) NO GST unless they are forfeited or the deposit is applied to an
actual supply
YES GST for the period when it was forfeited and the supply took place
Customer loyalty programs NO GST for the accrual and supply of goods or services for the
(not specific legislation— redemption of points
GST Ruling GSTR 2012/1)
YES GST if the redemption of points does not fully cover the cost of
the supply and additional consideration is provided—a part taxable
supply has occurred
Fines, penalties and taxes YES, potentially subject to GST

(ss. 81-5 and 81-10 and GST
Determination GSTD 2005/6) NO GST when the Treasurer announces exclusions from GST
(e.g. income tax, FBT, local government rates, licence fees,
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registration fees)
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Good or service GST yes/no
Court orders and out-of- YES GST supplies related to a court settlement of a dispute, the subject
court settlements (ss. 9-10(2) of which could be an earlier supply or transaction or one arising from
(g) and 9-15(2A) and GST the settlement
Determination GSTD 2003/1)
NO GST where damages are ordered for compensation for property
damage, negligence causing loss of profits, wrongful use of trade name,
breach of copyright, personal injury
NO GST on payment of either pre- or post-judgment interest
GST-free supply
GST-free supplies are free of GST. This means that the final supplier is not liable to pay GST
to the ATO on their supply, but they are entitled to claim an input taxed credit for the GST
component of their costs. As a result, the GST system in this case has not increased the cost
to the end consumer.
A supply is defined as GST-free if it is deemed to be so under Division 38 of the GST Act or

provisions of other Acts. If a supply is GST-free, a credit can still be claimed for GST paid on the
inputs used to produce the GST-free supply. It means that no GST is collected on the supply of
GST-free goods and services. It is the supply, not the supplier, which is GST-free.
There are specific GST-free items:

• most basic fresh food (this excludes processed food and food that is prepared for consumption
such as restaurant meals)
• health (from 1 January 2019 – this includes feminine hygiene products)
• education
• childcare
• exports
• religious services
• non-commercial activities of, and second-hand goods supplied by, charitable institutions
• water and sewerage
• supply of a going concern
• transport
• precious metal
• supplies through inward duty-free shops
• grants of freehold and similar interests by government
• farming land
• cars for use by disabled people
• international mail (ATO 2018b).
For further detail, see: https://www.ato.gov.au/Business/GST/When-to-charge-GST-(and-when-not-to)/

GST-free-sales/#MainGSTfreeproductsandservices.
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Example 10.5: Staged collection of GST—GST-free supply

The following figure shows that a supplier of GST-free goods and services (in this case private education)
is not required to charge GST on its supply, but is permitted to claim a credit for GST paid.
Computer
Electronic Private
manufacturer
component school
Buys components GST-free
supplier Buys computer
for $3300. education
Sells components for $5500 less
Sells computer supply
for $3000 plus credit $500
for $5000 plus
GST of $300. = $5000.
GST of $500.
Credit $300 Credit $500
GST $300 Net GST $200 –$500 Total GST

($500 – $300) (Credit $500) nil
The effect of this figure is that no GST is ultimately paid on the supply to the consumer (private school),
but this is still achieved through a staged collection process. The first two sales in this example are the
same as in Example 10.1, as these businesses are making a normal taxable supply that is not GST-free.
This means that the GST is first collected on the supply of components to the manufacturer. The GST
is then charged on the sale of the computer to the private school. However, as the school used the
computer in making a GST-free supply of education, a full credit of the GST paid can be claimed by
the school, refunding all previous tax collected.
Input taxed supply

Input taxed supply applies mostly to financial services and residential property. In this case,
the final supplier bears the economic cost of GST as they are not liable to pay GST to the
ATO on the final supply, but are also not entitled to claim a credit for the GST component of
their costs.
Input taxed supplies are not subject to GST and no input tax credit can be claimed for anything
acquired or imported to produce these supplies (see the ‘Input tax credits’ section for more
information on input tax credits).
Enterprises making input taxed supplies are not able to reclaim the GST cost on inputs used
in producing the supply. In the case of these supplies, the added cost of the GST paid would
normally be passed on in the pricing of the supply, if that was lawful and commercially viable.
If that cannot occur, then the entity effectively becomes the consumer and pays GST.
Input taxed supply items are:

• financial supplies, for example loans, share trades and life insurance. The term also includes
the supply of bank accounts and superannuation interests by Australian and foreign
financial institutions
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• supply of residential rent (the lease of new and commercial residential premises are not
input taxed)
• supply of residential premises (new and commercial residential premises are not input taxed).
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Example 10.6: Staged collection of the GST—input

taxed supply
Where goods and services are input taxed, the supplier is not liable for GST on the supply and therefore
cannot add 10 per cent to the value of the supply. The accompanying figure shows how GST is collected
at each stage of an input taxed supply.
Computer
Electronic
manufacturer Input taxed
component Bank
Buys components
supplier Buys computer financial
for $3300.
Sells components for $5500 service
Sells computer
for $3000 plus (no credit). supply.
for $5000 plus
GST of $300.
GST of $500.
Credit $300
GST $300 Net GST $200 Total GST

($500 – $300) $500
The supplier is not entitled to any credit for the GST paid on inputs, so that in this example the bank
is treated as the final consumer paying the $500 GST. Businesses supplying input taxed goods and
services therefore need to consider this additional cost when determining their pricing policy.
Taxable importations
The GST liability of taxable importations falls to the importer, not the international supplier.
The importer is liable for GST regardless of whether they are registered for GST or not. The
taxable importations provisions are needed because the international supplier is not likely to
be liable for Australian GST.
A taxable importation arises under s. 13-5 of the GST Act where:

• goods are imported, and
• the goods are entered for home consumption.
However, where the importer is registered for GST and uses the imported goods for a creditable
purpose (see later in this module), they will also be entitled to an input tax credit equal to the
GST paid on the imports, effectively refunding the tax paid on the import. To avoid the need
to first pay and then claim back the GST, the GST liability for an eligible importer (purchaser)
is deferred until the next tax period when the input tax credit will also be claimed, resulting in
a nil effect on tax for the importer.
From 1 October 2016, the supply of intangibles (not goods or real property) that are used for
a creditable purpose by a registered entity in the indirect tax zone, are not subject to GST.
This simplifies the importation of items such as software and technical information.
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Importers that are not registered for GST are still liable for GST on imports, but are not entitled
to an equivalent input tax credit.
GST is levied as 10 per cent of the value of the taxable importation, which is the sum of:
• custom value of the goods
• transportation and insurance costs to the extent they are not included in the custom value
• customs duty payable on importation
• wine tax payable.
Changes introduced from 1 July 2017 on GST on digital products and intangibles means that
GST will be levied on a sale of a digital product if:
• the sale is connected with the indirect tax zone
• the entity is registered or required to register for GST
• the sale is made for payment and as part of conducting the business (or it is part of the
business because the business is an electronic distribution platform operator)
• the imported service or digital product is sold to an Australian consumer, and
• the supply is not GST-free or input taxed.
Low-value goods
Until 1 July 2018, importations with a customs value of up to $1000 were not liable for GST.
Effective from 1 July 2018, this exemption has been removed and replaced with a new system
that imposes GST on the foreign supplier at the point of sale. It operates as follows:
• There must be a supply of goods by a foreign supplier to a consumer located in the indirect
tax zone.
• The goods are of ‘low value’—that is, up to $1000 (GST Act, s. 84-79). Where multiple low-
value goods are purchased in one order, GST will still be applied under the low-value goods
rules even if the total order amount is over $1000.
• Supplier meets the GST entity registration requirements. The registration requirements for
low-value goods are discussed in more detail shortly.
The entity supplying the goods must register in Australia if both of the following conditions apply
(ATO 2018a):
• they are running an enterprise, and
• the GST turnover from sales connected with the indirect tax zone, and made in the course
of the enterprise, meets or exceeds the registration turnover threshold of $75 000 or
$150 000, if a non-profit body (see the section on ‘Registration’). A simplified registration
process is also available where GST is reported and paid quarterly regardless of turnover.
A sale is treated as being made by an enterprise, instead of a vendor if the enterprise is an

electronic distribution platform operator or re-deliverer and responsible for GST on a sale.
These sales will be counted towards that enterprise’s GST turnover, instead of the vendor’s
GST turnover.
This means that if the value of the sales of low-value goods imported into Australia by consumers
(plus any other sales made by the enterprise that are connected with the indirect tax zone)
is $75 000 or more in a 12-month period, then the enterprise must register for GST.
Sales that are not connected with the indirect tax zone are not counted towards GST.
This includes sales that GST does not apply to under the low-value goods requirements
because the purchaser is not a consumer or because the goods are not low-value goods.
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Input tax credits

Amount of input tax credits
As seen in the first section, ‘GST core concepts’, the actual GST is ultimately borne by the
consumer but is collected at each stage of supply. To prevent the tax from accumulating, an input
tax credit is given to registered entities at each stage of the supply chain. See the examples
provided in Examples 10.1, 10.5 and 10.6, which show how this system operates.
In practice, this means that the supplier of taxable goods and services receives a refund of the
GST paid on the inputs used in their supply process. GST is therefore payable only on the value
added to the product at each stage of production.
The general rule under s. 7-1(2) of the GST Act is that an input tax credit can be claimed for the
GST component of creditable acquisitions and creditable importations.
Creditable acquisition
A registered GST entity is entitled to claim an input tax credit for a creditable acquisition,
which arises under s. 11-5 if:
• the entity acquires anything solely or partly for a creditable purpose
• the thing supplied is a taxable supply
• the entity provides, or is liable to provide, consideration for the supply, and
• the entity is registered or required to be registered.
All four components listed are needed in order for the entity to claim an input tax credit.
Section 11-25 of the GST Act states that the amount of input tax credit for a creditable
acquisition is the amount of the GST payable for the acquisition. This is normally 1/11 of the price
paid to acquire the good or service.
For a partly creditable acquisition (acquisition not used wholly for a taxable or GST-free supply,
or where only part of the consideration is to be provided for the acquisition), the input tax credit
is the amount determined using the following formula.
Formula to learn
For a partly creditable acquisition (s. 11-30 of the GST Act):
Full input tax credit × Extent of creditable purpose (%) × Extent of consideration (%)
The concept of acquisition mirrors the definition of supply so that whenever there is a supply,
there will also be an acquisition. This symmetry between acquisition and supply is important so
that all taxable supplies potentially give rise to a creditable acquisition.
Section 11-15 of the GST Act states that a thing is acquired for a creditable purpose to the
extent it is acquired in carrying on an enterprise for the purposes of making a taxable supply or
a GST-free supply (e.g. the acquisition of a desk for use solely in an entity’s business). However,
something is not acquired for a creditable purpose where the acquisition relates to making input
taxed supplies (or the acquisition is of a private or domestic nature).
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The acquisition is not creditable if is not deductible under certain listed provisions of Division 8
of ITAA97 and s. 51AK of ITAA36. These include:
• ITAA97, s. 26-5 (penalties)
• ITAA97, s. 26-30 (relative’s travel expenses)
• ITAA97, s. 26-40 (maintaining your family)
• ITAA97, s. 26-45 (recreational club expenses)
• ITAA97, s. 26-50 (leisure facilities or boats)
• ITAA97, Division 32 (entertainment expenses)
• ITAA97, Division 34 (non-compulsory uniforms)
• ITAA36, s. 51AK (non-deductible non-cash business benefits).
➤ Question 10.2
Hattie is a milliner and specialises in racing day hats. She is registered for GST. During the current
tax period, Hattie gives her sister, Evie (a cobbler, who is also registered for GST), a new sewing
machine. Hattie did not charge Evie for the sewing machine, and as such, did not provide her
sister with a tax invoice. The market value of the sewing machine was $3300 (GST-inclusive).
Assume that Evie uses the sewing machine 60 per cent for business purposes.
What is the effect of the transactions for both Hattie and Evie?
Creditable importations
We know from the section ‘Amount of input tax credits’ that an input tax credit can be claimed
for the GST component of both creditable acquisitions and creditable importations. Creditable
importations are dealt with separately (Division 15 of the GST Act) from creditable acquisitions.
The requirements for a creditable importation under s. 15-5 of the GST Act are that:
• goods are imported solely or partly for a creditable purpose (same meaning as for
creditable importations)
• the importation is a taxable importation, and
• the importer is registered or required to be registered.
Special input tax credit rules

The first three input tax credit sections dealt with the basic input tax credit rules. The GST Act
also provides for some special cases where an input tax credit is available even where the general
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requirements have not been fulfilled. These are summarised in Table 10.2.
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Table 10.2: Special cases for input tax credits
Area Input tax credit available—yes or no

Company pre-establishment costs for newly YES—the newly formed company can claim the
formed companies input tax credits, not the entity that incurred
the cost
Reimbursements of expenses paid by employees YES

or agents
Second-hand goods where no GST liability arose YES—they must be for resale or exchange
from the supply
Real property margin scheme NO—an input tax credit is denied even though
general requirements are met
Supplies from the Commonwealth or a state YES—special rule necessary as the Commonwealth
government is not liable to charge for GST
Financial services (normally exempt from GST) SOMETIMES—an input tax credit of 75% available
for services commonly outsourced
Calculating GST
GST attributions rules
The amount of GST that has to be paid by the GST-registered entity to the ATO, or the refund
due to them, is based on the netting off of the GST liabilities and the input tax credits for the
relevant tax period in the BAS.
Therefore, it is first necessary to determine the tax period that GST liabilities and input tax credits
are attributed to. These are the GST attributions rules and are discussed in more detail in the
section ‘Accounting for the GST’.
Tax periods
There are two main tax periods for the calculation and reporting of the GST—monthly or
quarterly. In limited circumstances GST can be reported annually.
An entity must use a monthly tax period if the entity:

• has a GST turnover of $20 million or more
• is only carrying on an enterprise for less than three months, or
• has a history of failing to comply with tax obligations.
An entity that uses a monthly tax period may change to quarterly tax periods if their annual
turnover falls below the threshold, and the one-month tax period has been used for at least
12 months. There is some flexibility where an entity’s accounting period does not accord with
either the monthly or three-month tax periods.
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GST and business activity statement concessions for small business entities
An eligible small business entity (SBE) with an aggregated turnover of $10 million or less is
able to access GST and BAS concessions. They can elect to account for GST on a cash basis
(see the next section) and pay GST instalments as calculated by the ATO instead of submitting
a quarterly BAS.
This is where an estimation of GST instalments is paid each quarter (determined by the ATO),
but there is only the requirement to lodge an annual return. Under this method, the quarterly
payments are estimated and adjustments are made from the annual return when the actual net
amount is determined. Taxpayers that have elected to be subject to GST, even though they are
below the turnover threshold, may report and pay GST annually.
Accounting for GST

Division 29 of the GST Act outlines attribution rules that are to be applied over the year so that
the GST transactions can be attributed to the specific tax periods. GST entities can account for
GST using one of two accounting methods—cash basis or accruals.
An entity may elect to use the cash basis if it meets at least one of the following conditions:
• the entity is an SBE with an aggregated turnover of $10 million or less
• the entity does not carry on a business and has a turnover of $2 million or less
• the cash basis is used for income tax purposes, or
• the Commissioner makes a determination that the cash basis may be elected.
If an entity meets any one of these conditions, it has a choice as to whether to adopt the cash or
accruals basis of accounting for GST. If an entity does not meet any of these conditions, it must
use the accruals basis of accounting.
An entity that is a charitable, gift-deductible entity or government school may also elect to use
the cash basis of accounting for GST.
Cash-basis attribution rules

Under the cash basis, the taxpayer can only include actual cash payments received and made
during that period.
Payment of the GST component may have to be apportioned where the ownership of goods
does not pass until the final payment is made.
Example 10.7: Cash-basis attribution

Hildergard supplies equipment for dog shows and she is registered for GST using the cash basis of
accounting. Rob has an enterprise that runs commercial dog shows all around Australia. He is also
registered, and uses the cash basis of accounting. Rob purchases a new loudhailer from Hildergard
for use in his dog shows, which is a taxable supply by Hildergard. The acquisition of the loudhailer
by Rob is also a creditable acquisition. The timing of events affecting this sale is set out in the
accompanying figure.
Rob attributes the input tax credit to tax period three because under the cash basis the input tax
credit is allowed in the tax period in which the supply is paid for (assuming that Rob has received a
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tax invoice during or before this period—the need for a tax invoice is discussed later in this module).
Hildergard attributes the GST on the taxable supply to tax period three because under the cash basis
the GST liability arises in the tax period that the payment is received.
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received received made

loudhailer tax invoice payment
Tax periods
Rob
Hildergard 1 2 3 4
delivered issued received

loudhailer tax invoice payment
Source: Adapted from Explanatory Memorandum, A New Tax System (Goods and Services Tax) Bill 1998,
para. 4.34, Federal Register of Legislation, accessed March 2019, https://www.legislation.gov.au/Details/
C2004B00300/Explanatory%20Memorandum/Text.
Accruals basis attribution rules

All entities that are not eligible to use the cash basis must account for the GST using the accruals
basis. Under this method, the taxpayer attributes the entire GST payable, or the full input tax
credit, to the tax period in which the invoice was issued or any payment was made (whichever
is earlier).
Timing is important under the accruals basis, as the issue of an early invoice or the acceptance
of a deposit can bring forward the period in which the supplier is liable for GST. Timing is
considered in Example 10.8.
Example 10.8: Accruals basis attribution rules

received received made
fasteners invoice payment
Handmade
Clothing
Tax period 1 2 3
XYZ P/L
delivered issued received

fasteners invoice payment
Handmade Clothing received the tax invoice in tax period two. It became liable to provide consideration
for the taxable supply when it received the invoice. Handmade Clothing may attribute the input tax
credit to period two when it receives the tax invoice (see the ‘Tax invoices’ section). XYZ issued the
invoice in tax period two and became entitled to receive consideration for the supply once it issued
the invoice, and therefore attributes all of the GST on the taxable supply to tax period two.
Source: Adapted from Explanatory Memorandum, A New Tax System (Goods and Services Tax) Bill 1998,
para. 4.40, Federal Register of Legislation, accessed March 2019, https://www.legislation.gov.au/Details/
C2004B00300/Explanatory%20Memorandum/Text.
Special attribution rules

Variations on the general attribution rules arise in certain circumstances, and these are outlined
in the GST Act. The chief special attribution rules are as follows:
• Variations arise as specified by legislation (e.g. supplies and acquisitions made on a periodic
basis such as leasing are deemed to constitute separate supplies in each period).
• Adjustments (see the section on ‘Adjustments’) are normally attributable to the tax period
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in which the taxpayer becomes aware of them.

• The timing of the credit on the acquisition of second-hand goods depends on the price paid
for the goods by the second-hand dealer.
• The Commissioner has discretion to make written determinations to vary the attribution rules
for particular taxpayers.
• Simplified GST accounting methods aimed at reducing the compliance cost of apportioning
sales between taxable supplies and GST-free supplies are available for small food retailers
who are an SBE.
• For hire purchase agreements entered into from 1 July 2012, any input tax credit can be
claimed in full at the start of the agreement.
• SBEs and non-business taxpayers operating an enterprise with turnover of ≤ $10 million can
claim a full input tax credit for partly creditable acquisitions and make one annual increasing
adjustment to compensate for partial non-business use.
Calculating the net amount

Determining the net amount is the basis of a GST and is the amount to be paid or refunded
by the ATO.
Formula to learn
GST – Input tax credits = Net amount
Where the net amount is greater than zero, the taxpayer pays the amount to the ATO.
Where the net amount is less than zero, the ATO pays the amount to the taxpayer.
The net amount can be increased or decreased for the tax period if adjustments are required.
Adjustments
As stated in the previous section, the net amount of GST payable is increased or decreased for
the relevant tax period if there are adjustments required. Adjustments will arise as a result of:
• adjustment events (Division 19)—see the next section for more information
• bad debts (Divisions 21 and 136)
• settlement of insurance claims (Division 78)
• changes in creditable purpose (Division 129)
• goods applied solely for private use (Division 130)
• supplies acquired without full input tax credit (Division 132)
• supplies of a going concern (Division 135)
• newly registered entities (Division 137)
• cessation of registration (Division 138)
• deceased estates (Division 139).
Adjustment events
An adjustment event is any event that changes a GST supply or acquisition resulting in a change
to the GST liability or entitlement to input tax credits (GST Act, s. 19-10). For example, if goods
are returned to a supplier, it will be necessary to adjust the GST as the previously reported supply
of these goods must now be reversed.
An adjustment may either be:

• an increasing adjustment, which increases the net amount of GST liability either through an
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increased GST liability or a reduced input tax credit, or

• a decreasing adjustment, which results from a reduced GST liability or an increased input
tax credit.
STUDY GUIDE | 453
Example 10.9: Adjustment event

Computer Health Pty Ltd carried out a service of several laptops for Graphic Arts for $550 (including
$50 GST) for the labour and parts. The account was paid by Graphic Arts in the same tax period and
they claimed an input tax credit of $50.
Six months after the account was paid, Computer Health’s accountant noticed that some of the parts
included on Graphic Arts’ account were incorrectly charged, so he paid them a refund of $110.
As a result, Computer Health has paid too much GST and must make a decreasing adjustment of
$10 ($110 × 1/11), while Graphic Arts has claimed too much input tax credit and needs to make an
increasing adjustment of $10.
➤ Question 10.3
Mr Williams runs an electrical goods store that is registered for GST, and he accounts for GST on
a quarterly basis. Twelve months ago, he purchased a large-screen television for stock costing
$4400 (GST-inclusive), and subsequently claimed an input tax credit on the purchase of $400.
Unfortunately, there has been little demand for such expensive televisions, so Mr Williams took
the television home for his private use.
What is the effect on the net amount of GST of these events?
Administration
Tax invoices
Tax invoices must be issued under the GST system. Note the following definitions.
An invoice is a notification of an obligation to pay, which generally triggers the liability for the
GST on the making of a supply (s. 29-5) unless the supplier accounts on a cash basis (s. 195-1;
GST Ruling GSTR 2000/34).
A tax invoice is a document that substantiates a creditable acquisition. It must contain the
information specified in the legislation. This is required for an input tax credit to be claimed.
Tax invoices have an important place in the administration of the GST system. It is generally
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not possible to claim an input tax credit without a tax invoice. Tax invoices are also important in
determining which tax period an acquisition is attributable to. The sections ‘Accounting for GST’
and ‘Special attribution rules’ examine the attribution rules.
If requested, a supplier must issue a tax invoice within 28 days for all supplies with a value ≥ $75
not including GST or $82.50 including GST.
A tax invoice for a sale under $1000 must include:

• identity of the supplier
• ABN of supplier
• date of issue
• brief description of item
• GST-inclusive price of supply
• extent to which each item supplied is a taxable supply
• amount of GST payable in relation to each item.
Where the price of the supply is $1000 or more (including GST), the tax invoice must also include
the buyer’s identity or ABN.
Registration
Section 23-5 of the GST Act states the requirements for registration. An entity is required to
register for the GST if:
• it carries on an enterprise, and
• its GST turnover meets the registration turnover threshold.
Section 184-1 of the GST Act defines an entity as any one of the following:
(a) an individual;
(b) a body corporate;
(c) a corporation sole [e.g. a church];
(d) a body politic [e.g. a government body];
(e) a partnership;
(f) any other unincorporated association or body of persons;
(g) a trust;
(h) a superannuation fund (GST Act, s. 184-1).
The registration turnover threshold is $75 000 per annum or $150 000 per annum for non-profit
bodies. An entity must register for GST if its:
• current GST turnover is equal to or exceeds the threshold, and the Commissioner of Taxation
is not satisfied that projected GST turnover is below the threshold, or
• projected GST turnover is equal to or exceeds the threshold (s. 188-10).
In practice, this means that the projected GST turnover must be below the turnover threshold
to avoid compulsory registration.
Formula to learn
Current GST turnover (current month and the previous 11 months)
Total value (excluding GST) of all supplies for the current month and 11 previous months,
excluding input taxed supplies, supplies for which no consideration was received
and supplies not connected with an enterprise
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STUDY GUIDE | 455
Formula to learn
Projected GST turnover (current month and next 11 months)
Total value (excluding GST) of all supplies that you have made, or are likely to make, for the current
month and the next 11 months, excluding input taxed supplies, supplies for which no consideration
was received, and supplies not connected with an enterprise
Note that s. 188-25 excludes from the determination of the projected GST turnover, the transfer
of capital assets and supplies made in relation to ceasing or reducing the scale of an enterprise.
However, the GST Act does not provide the same exclusions for current GST turnover. In this
case, the inclusion of capital sales in the current GST turnover is of no consequence; as explained
previously, s. 188-10 makes the current annual turnover irrelevant where the projected GST
turnover is below the registration threshold.
The rules relating to GST registration are presented in Figure 10.2.
Figure 10.2: An overview of the requirements for registration
Are you Do you

No No You
carrying intend to
cannot be
on an carry on an
registered
enterprise? enterprise?
Yes Yes
Is the entity a
Does the entity’s current or No taxi driver or
projected GST turnover meet
other special
the registration threshold? No
entity†?
No
Yes
Yes
The entity The entity
must may elect
register to register
†
Special registration rules apply to taxi drivers and certain other entities. These rules are not examinable.

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Example 10.10: Registration requirements

Matthew has operated a small gardening and landscaping business for several years, but has not
registered for GST as his annual GST turnover has always been below $75 000. Matthew is planning
to sell his equipment and look for full-time paid employment.
At present, Matthew’s current GST turnover is about $60 000, but he is concerned that the sale of the
assets will put him over the $75 000 limit.
Applying s. 188-25 of the GST Act, the sale of the capital assets is not included in the projected
GST turnover and therefore will not put Matthew over the threshold in the current period. In the
following period, when Matthew sells his business assets, his current GST turnover will exceed $75 000,
but his projected GST turnover will be very low because he will have ceased doing business. As the
projected GST turnover at that time will be less than $75 000, he still does not exceed the registration
turnover threshold.
This is an area where your critical analysis and professional judgment as a qualified accountant
will be important.
Withholding GST on purchase of new residential property

From 1 July 2018, the purchaser of new residential property or potential residential land
(newly subdivided land suitable for residential homes), will be required to withhold GST from
the purchase price (1/11 of the purchase price) and remit it to the ATO. Penalties apply for non-
compliance. There are also transitional rules for contracts entered into before 1 July 2018.
However, withholding is not required where the purchaser of land is registered for GST and
acquires it for a creditable purpose.
Where the full 1/11 is withheld, the seller will only be paid the GST-exclusive amount and will no
longer be liable for GST.
Sellers of all residential property must now notify the purchaser whether the sale is subject to the
withholding rules. An exception will be if the seller is not registered or required to register for GST.
GST grouping provisions

Many businesses are a series of entities operating as one group. These may take the form of
parent and subsidiary companies, or similar arrangements involving combinations of trusts,
companies, individuals, non-profit organisations, partnerships and joint venture arrangements.
Under general GST rules, transactions between members of the group would constitute separate
taxable supplies and creditable acquisitions.
GST group and GST joint ventures

Division 48 of the GST Act allows the group to be treated as one GST entity to avoid separate
transactions arising.
Two or more companies (similar rules operate for trusts, joint ventures, partnerships and
individuals) are treated as a GST group where the companies meet the requirements set out
in that provision. The primary test of whether separate entities can be treated as one GST group
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is whether the entities satisfy the membership requirements described in the Act.
STUDY GUIDE | 457
Central to this test is whether the company is part of a 90 per cent owned group (which is
satisfied where there are two companies and either one has a 90% or greater stake in the other).
Where there are three or more companies, one would need to have a 90 per cent or greater
stake in each of the other companies. Under s. 190-5 of the GST Act, a company has at least a
90 per cent stake in another company if it has, either directly or indirectly, at least 90 per cent of
the voting power, and has the right to receive at least 90 per cent of the dividends and capital
distributions of that company.
In addition to the membership requirements, for entities to be treated as one GST group:
• each of the entities must agree in writing to the formation of the group
• one entity must be nominated as the representative member, and that entity notifies the
Commissioner of the formation of the group
• that entity must be an Australian resident
• each entity must be registered for the GST
• each entity must have the same tax period and use the same accounting basis
• the entities must not be a member of another GST group, and
• the entities must not have a branch registered under Division 54 of the GST Act.
Similar grouping provisions are available for joint ventures (GST Act, Division 51), partnerships,
individuals and trusts (GST Act, s. 48-10(1)(a)(ii)).
Branches
In contrast to the formation of GST groups, Division 54 allows a branch of a registered entity
to be treated as a separate GST entity.
Under s. 54-40 of the GST Act, a branch treated as a separate entity is required to remit all GST
liabilities, including transactions with the parent entity, claim input tax credits and make its own
adjustments as if it were a GST entity. A GST branch may be registered if:
• the parent carries on or intends to carry on an enterprise through the branch
• the branch is separately identifiable by location or the nature of its activities
• the parent entity is registered, and
• the branch maintains independent accounts.
However, a branch cannot be registered if the parent entity is part of a GST group.
Amalgamations
Division 90 of the GST Act contains rules aimed at reducing the GST accounting and compliance
costs in relation to company amalgamations. These rules remove GST liability for transactions
between the original entities and the amalgamated entity during the process of amalgamation.
These provisions also remove the entitlement to input tax credits for these transactions.
Anti-avoidance provisions
Division 165 of the GST Act contains the anti-avoidance provision, which is used to deter
avoidance schemes used to obtain GST benefits.
It allows the Commissioner to make any offending scheme ineffective by cancelling the benefit
of the scheme and compensating an entity disadvantaged by the scheme.
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Schemes such as these may also incur penalties under the Taxation Administration Act 1953
(Cwlth) if the scheme aims to reduce GST payable, increase GST refunds, or alter the timing of
payment of the GST or refunds.
For the anti-avoidance provisions to apply, there must be a scheme entered into (or carried
out or commenced) on or after 2 December 1998, and the scheme has the sole or dominant
purpose, or principal effect, of obtaining a GST benefit (GST Act, s. 165-5).
Note the following definitions.
A scheme is any arrangement, agreement, understanding, promise or undertaking, whether

express or implied, legally enforceable or otherwise (s. 165-10(2)).
The dominant purpose of the scheme must be to obtain a GST benefit. The GST Act establishes
factors that will give rise to a dominant purpose and matters for the court to consider when
determining dominant purpose.
For GST purposes, a GST benefit will arise under s. 165-10 of the GST Act if the amount of GST:
• paid is smaller than could reasonably be expected
• refund received is bigger than could reasonably be expected
• payable is paid later than could reasonably be expected
• refund is received earlier than could reasonably be expected.
This is an important area for demonstrating your embracing of ethics and good governance
as a professional accountant.
➤ Question 10.4
Electrical Supplies and Services (ESS) Pty Ltd operates an electrical supplies retail store selling
directly to the electrician market. The following transactions were extracted from the records of
ESS for the month of June 2019.
ESS is registered for GST and holds valid tax invoices for all transactions as required.
ESS accounts for GST on an accruals basis.
$
Sales of electrical supplies 25 000
Payment of quarterly water bill for premises 1 500
Reimbursement of parking ticket incurred by employee while travelling on business 264
Purchases of fuel (tax invoice supplied) 3 300
Wages to staff 6 500
Purchase of new computer and point of sale register (100% business use) 3 000
Party for electrician clients and supplies 1 100
(a) Determine which amounts are claimable as input tax credits.
(b) Determine the overall amount that would be payable to or refundable from the ATO in
respect of GST for the month of June 2019.
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STUDY GUIDE | 459
(c) In December 2018, ESS sends a tax invoice for electrical items for $15 150. The tax invoice
contains the following details:
(i) ESS Pty Ltd—name, business address and ABN
(ii) Date of supply of the electrical items and what they were
(iii) Price of each separate electrical item inclusive of GST, and a short description
(iv) Amount of overall GST owing and the extent they are a taxable supply
Determine whether this is a valid GST invoice.
(d) The invoice for $15 150 was issued in February 2019, but is underpaid in the same month
by $3000 due to a dispute over the quality of the goods supplied. ESS accepts this in June
2019 and writes off the balance of the debt. When should any adjustment be claimed and
for how much?
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Summary and review

This module covered the fundamentals of GST, starting with a summary of the core concepts.
GST is a flat 10 per cent broad-based indirect tax on the consumption of most goods and
services in Australia (the indirect tax zone). It is also applied to importations into Australia.
It also discussed the important area of determining what is a taxable supply. GST is levied on
taxable supplies in each step of the production chain. GST-registered suppliers can also claim
an input tax credit for the GST paid on the inputs used in making taxable supplies and GST-free
supplies. GST is therefore collected through each step of the supply process but is generally only
borne by the final consumer.
Registered entities that make a taxable supply are liable to GST, and remit to the ATO the net
amount (GST liability – input tax credits) for the GST period. Entities that make GST-free supplies
are not liable for GST but can still claim input tax credits on GST paid on the inputs used in
making the GST-free supply. Entities that make input tax supplies are effectively end consumers.
They are not liable for GST and they are not entitled to any input tax credits.
A taxable supply arises if there is a supply, for consideration, by an enterprise, that is connected
with the indirect tax zone and the entity is registered or required to register for GST. There are
some special cases such as vouchers, customer loyalty programs, penalties and government
charges.
Taxable importations are also liable for GST, but in this case the purchaser rather than the seller
is liable. Special rules apply to supply by foreign entities of intangibles to Australian consumers
and the supply by foreign entities of goods with a value of up to $1000.
The module then went on to examine input tax credits. An input tax credit is available for
creditable acquisitions and creditable importations. This will arise when the entity purchasing
the goods or services is registered for GST and uses these goods or services in making taxable
supplies, GST-free supplies or acquiring taxable importations.
The last sections of this module discussed calculating GST and administrative arrangements.
A tax invoice must be issued if required and GST is mostly reported either on a monthly or
quarterly basis. The method of accounting for GST (cash or accruals) determines which period
the liability and input tax credit are attributed to. SBEs can opt for a simplified reporting system
of paying quarterly instalments and reporting annually. Adjustments (increasing or decreasing)
are required where the use of inputs changes, or the supply is altered at a later date. To simplify
the reporting process, group entities can be treated as one entity if they meet the requirements
of the grouping provisions.
Anti-avoidance provisions are included in the legislation to penalise taxpayers that undertake
a scheme with a dominant purpose of artificially reducing their GST liability or increasing input
tax credits.
MODULE 10
Suggested answers
Suggested answers
Question 10.1
In this case there is clearly a supply of goods, but for a taxable supply to exist there must also
be consideration. As no payment is made and the school is not an associate, there will not be a
taxable supply unless the school has given an inducement such as providing free advertising.
Question 10.2
Hattie has made a supply for no consideration, but the supply is to an associate and therefore
its value is deemed to be the market value under s. 72-10 of the GST Act if the associate is not
registered for GST or does not use the goods or services wholly for a creditable purpose.
However, in this case, her sister Evie is registered for GST but only uses the goods 60 per cent for
a creditable purpose, and therefore s. 72-10 of the GST Act deems the supply to have a market
value of $3300 and GST of $300 (1/11 of $3300). Hence, Hattie is required to remit GST of $300 to
the ATO in her next BAS.
Evie has made a partly creditable acquisition because there is a taxable supply, but as no tax
invoice has been received, the input tax credit cannot be claimed until a tax invoice is provided,
which is not possible as there was no consideration paid (see the section on ‘Administration’).

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Question 10.3
In the quarter that Mr Williams purchased the television for $4400, he has paid GST of $400
($4400 × 1/11) and as a result can claim an input tax credit of $400. In this quarter the effect on the
net amount will be a decrease of $400.
In the tax period that the television was taken from stock and used wholly for private purposes,
Mr Williams is required to make an increasing adjustment. The increasing adjustment is the full
value ($400) of the input tax credit previously claimed. This is because the item is no longer used
for a creditable purpose and therefore he is no longer entitled to the previous credit claimed.
In this quarter the effect on the net amount will be an increase of $400.
Question 10.4
(a) The purchase of fuel ($3300), and the new computer/register ($3000) are creditable supplies
and subject to an input tax credit (GST Act, s. 11-5). The water bill, the parking ticket, the
wages (excluded from the definition of ‘enterprise’ in s. 9-20(2) of the GST Act), and the
promotional party are not creditable supplies. The total amount claimable as an input tax
credit is therefore $6300 / 11 = $572.73.
(b) GST payable on electrical supplies that are taxable supplies (GST Act, s. 9-5) would be
$25 000 / 11 = $2272.73. Input tax credits are fuel $300 and the computer/point of sale
terminal $272.73 = $572.73. Therefore, the net GST would be $1700 payable.
(c) No, this is not a valid GST invoice. For amounts over $1000 (including GST), the tax invoice
must also include the identity of the buyer of the electrical items and it must also detail the
amount of GST payable for each separate item (GST Act, s. 29-70).
(d) The debt is written off in June 2019 and the amount is a decreasing adjustment of $3000 / 11
= $272.73 (GST Act, s. 21-5). ESS Pty Ltd should issue a credit note for that amount when the
debt is written off, in June 2019.

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REFERENCES | 463
References
References
ATO 2018, ‘Australian GST registration for non-residents’, accessed March 2019, https://www.ato.
gov.au/Business/International-tax-for-business/In-detail/Doing-business-in-Australia/Australian-
GST-registration-for-non-residents/.
ATO 2018b, ‘GST-free sales’, accessed April 2019, https://www.ato.gov.au/Business/GST/When-

to-charge-GST-(and-when-not-to)/GST-free-sales/#MainGSTfreeproductsandservices.
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MODULE 10
AUSTRALIA TAXATION
Module 11
ADMINISTRATION OF THE TAX SYSTEM
466 | ADMINISTRATION OF THE TAX SYSTEM
Contents
Preview 467
Introduction
Objectives
Teaching materials
Income tax self-assessment 469
Income tax self-assessment
Requirements to lodge tax returns
Lodging of tax returns and assessments 470
Tax returns
Assessments
Amended assessments
Tax audits 472
Why tax audits are needed
The audit process
Australian Taxation Office information gathering powers
Objections, reviews and appeals 475
Objections
Reviews
Appeals
Tax reporting and payment obligations 480
Payment dates
Pay-As-You-Go withholding system
Pay-As-You-Go instalment system
Business activity statement
Instalment activity statement
Running balance account
Australian Taxation Office guidance documents and rulings 485
The rulings system
Law companion guidelines
Law administration practice statements
Australian Taxation Office interpretative decisions
Penalties and interest charges 488
Administrative civil penalties
Criminal penalties
General interest charge and shortfall interest charge
Identifying Part IVA 494
Part IVA of the Income Tax Assessment Act 1936 (Cwlth)
Purpose of the adviser
Discharge of duty to the client
Promoter penalty regime 496
What is the regime?
Operation of the scheme
Penalties
Exclusions and exceptions
References 503
MODULE 11
STUDY GUIDE | 467
Module 11:
Administration of the
tax system
Study guide
Preview
Introduction
The taxation system is administrated by the federal government through its delegated authority,
the Australian Taxation Office (ATO). The ATO is headed by the Commissioner of Taxation and
decisions are made by the ATO acting in the authority of the appointed Commissioner. The ATO
is in charge of administering the income tax self-assessment system with which all taxpayers must
comply. The ATO has powers to conduct audits under the self-assessment system.
The ATO publishes taxation guidance through a variety of publications, including public and
private rulings, law companion guidelines, practice statements and interpretative decisions.
These are introduced in this module. This module also examines the lodgment of returns
and assessments, fines and penalties for non-compliance, the application of the Part IVA
anti-avoidance laws and the operation of the promoter penalty regime.
Also discussed is the formal objections, review and appeals process, to which taxpayers may
apply if they do not agree with the Commissioner’s treatment of a certain tax issue.

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Figure 11.1: Module summary—taxation administration
Lodge returns
Self-assessment Penalties and
system interest charges
Issue
assessments ATO Guidance
and Rulings
ATO conducts Taxation Part IVA

audits administration obligations
Promoter
penalty regime
Objections Tax payment

and reporting
obligations
Reviews
Appeals
Objectives
• apply the income tax legislation associated with the lodgment, assessment and amendment
of income tax returns in a given situation;
• identify the tax reporting and payment obligations of withholding and instalment taxes;
• examine the purposes of various ATO guidance documents;
• analyse situations where a taxpayer may be subject to tax penalties and/or interest
charges; and
• explain how the general anti-avoidance provisions of Part IVA operate.
Teaching materials
• Legislation:
– Administrative Appeals Tribunal Act 1975 (Cwlth)
– Crimes Act 1914 (Cwlth)
– Criminal Code Act 1995 (Cwlth)
– Higher Education Support Act 2003 (Cwlth)
– Fringe Benefits Tax Assessment Act 1986 (Cwlth) (FBTAA)
– Superannuation Industry Supervision Act 1993 (Cwlth) (SIS Act)
– Trade Support Loans Act 2014 (Cwlth)
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STUDY GUIDE | 469
• Glossary:
Definitions/
terms/

Liability to pay income tax arises upon the assessment of a taxpayer.
Assessment is defined in s. 6(1) of ITAA36 as the ascertainment of the amount of taxable income
and of the tax payable on that taxable income. The process of assessment is completed by the
serving of a notice on the taxpayer.
Australian income tax operates on a system of self-assessment. This means that the onus is
on the taxpayer to complete the tax return and to report all assessable income and allowable
deductions. The taxpayer has the responsibility to understand taxation law and apply it correctly
in preparing and lodging their tax returns and other documents. There is a large emphasis on
post-assessment checking for compliance. Compliance is reviewed through taxation audits,
discussed in the ‘Tax audits’ section of this module.
Under the partial self-assessment system, which applies to most taxpayers, the ATO generally
accepts the statements made in a tax return at face value and issues a tax assessment based on
the taxpayer’s return. The return is not generally subject to close technical scrutiny by the ATO
prior to the assessment being issued.
For a full self-assessment, the relevant taxpayer (companies and superannuation funds come
under the full self-assessment guidelines) lodging a return creates an automatic deemed
assessment based on the information in the return. Assessments are discussed in more detail
in the ‘Assessments’ section of this module.
Requirements to lodge tax returns

Each income tax year, a legislative instrument is made that sets out which entities are required
to lodge returns under ITAA36, ITAA97, TAA, the SIS Act, the Higher Education Support Act and
the Trade Support Loans Act. It is published on the Federal Register of Legislation: http://www.
legislation.gov.au.
Most individuals, sole traders, partnerships, trusts, superannuation funds and companies are
required to lodge income tax returns. All these taxpayers have the option of using a registered
tax agent to lodge their return. The tax agent must be registered with the Tax Practitioners Board
(TPB) (discussed in Module 1). The separate requirements are as follows.
MODULE 11
• Individuals (excluding sole traders): Resident taxpayers (full or part year) earning over the
tax-free threshold ($18 200 in the 2018–19 tax year, or threshold apportioned for part-year
residents) are generally required to lodge an income tax return. There are exceptions for those
resident taxpayers with special circumstances, which means they may not have to complete
a return. These exceptions include those receiving a type of Australian Government taxable
allowance or payment with income under a certain amount (and where other conditions
are met), and special rules also apply for minors and beneficiaries of a trust (among others).
The ATO provides a comprehensive tool for individuals that determines whether they need to
lodge a tax return.
There is an online tool available via the ATO website aimed at individuals, which determines if the
individual taxpayer needs to lodge a tax return. Access it here: https://www.ato.gov.au/Calculators-
and-tools/Host/?anchor=DINTL&anchor=DINTL/questions#DINTL/questions.
• Sole traders: They are required to lodge tax returns even if the income derived is below the
tax-free threshold or they are in a tax-loss situation.
• Partnerships: The partnership is required to lodge a partnership tax return and is required to
report the partnership’s net income (as discussed in Module 7). Each individual partner must
also report their share of the partnership’s net income or loss, as well as any other individual
assessable income (such as salary, wages, rent and dividends).
• Trusts: Trustees are required to lodge a trust tax return. Each beneficiary of the trust is also
generally required to lodge an individual tax return, where they must declare any income
they receive from the trust, as well as any other individual assessable income (such as salary,
wages, rent and dividends).
• Superannuation funds: All superannuation funds, including self-managed superannuation
funds (SMSFs), are required to lodge a separate superannuation fund trust return.
• Companies: Companies are required to lodge a company income tax return. ‘The company
reports its taxable income, tax offsets and credits, Pay-As-You-Go (PAYG) instalments
and the amount of tax it is liable to pay on that income or the amount that is refundable’
(ATO 2018) on the company tax return. Certain large companies are also required to
complete a ‘Reportable tax position schedule’, which identifies contentious or disputable
positions they have taken on significant tax arrangements. Company income is separate
to individual income.
Lodging of tax returns and assessments

Tax returns
As presented in the previous section of this module, there are separate requirements for
individuals and entities regarding the lodgment of tax returns.
A registered tax agent has the authority to lodge income tax returns on behalf of individuals
and entities based on the tax agent’s lodgment program (see later in this section). They also
have the authority to undertake communications on the taxpayer’s behalf in relation to income
tax returns.
A registered BAS agent has the authority to lodge business activity statements (BASs) and
instalment activity statements (IASs); see later in the module for a description of those
documents. They have the authority to undertake communications on the taxpayer’s behalf
in relation to the BAS and the IAS.
A tax return must be in the approved form and contain the prescribed information. The return
must be signed by the taxpayer (and the registered tax agent, where they have prepared it)
and contain a declaration that the return is true and correct.
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Tax returns are due to be lodged by specified lodgment dates. For most individual taxpayers,
the due date for lodgment is usually 31 October following the end of the tax year.
However, the ATO has the power to extend the time for lodgment of a return, and the
Commissioner of Taxation uses this power to create ‘lodgment programs’ for tax agents.
Where a taxpayer’s return is prepared and lodged by a registered tax agent, an extension
of time to lodge is usually available in accordance with the tax agent’s lodgment program.
The ‘Tax reporting and payment obligations’ section examines lodgment dates in more detail.
Further and special tax returns

In addition to ‘normal’ annual tax returns, the Commissioner of Taxation also has power under
s. 162 of ITAA36 to require a ‘further’ return—for example, where the Commissioner is not
satisfied with the original return lodged by the taxpayer, or the taxpayer has not lodged a return.
The Commissioner of Taxation may also, under s. 163, require a ‘special’ return where the normal
lodgment time would not be appropriate or effective—for example, because the taxpayer
proposes to leave Australia before the normal lodgment date.
Assessments
For taxpayers not subject to the full self-assessment system, the ATO provides a notice of
assessment of the taxation payable after the income return has been lodged.
A tax assessment issued by the ATO is deemed prima facie to be correct when challenged
under the statutory objections, reviews and appeals process as contained in Part IVC of the TAA.
Accordingly, it is the responsibility of the taxpayer to challenge the tax assessment. They can
undergo a statutory review and appeal process through Part IVC of the TAA. When relying on
the statutory right to a review or appeal under Part IVC, the taxpayer must not only show that
the assessment is excessive but also demonstrate the correct amount. This process is discussed
further in the section on ‘Objections, reviews and appeals’ later in the module.
Where some taxpayers might be tempted to avoid assessment simply by not lodging a tax
return, in these cases the Commissioner of Taxation has the power under s. 167 of ITAA36 to
issue a ‘default’ assessment (it may be issued as an original or amended assessment), based
upon the amount of tax the Commissioner believes is payable.
Amended assessments
The ATO recognises that not every assessment issued by them will be correct, so there needs to
be a method of correcting, that is amending, an issued assessment. Similarly, a taxpayer is also
able to request the ATO to amend their return—known as self-amendment—in the same time
frames as for amended assessments in general.
The time frames for amending an assessment, which apply to both the ATO and the taxpayer,
are as follows:
• two-year time limit: applies to most individuals and small business entities (SBEs), and is
two years from the day the ATO served (or is deemed to have served) the original notice of
assessment on the taxpayer (ITAA36, s. 170(1), Items 1–3)
• four-year time limit: applies to other taxpayers, namely larger entities, individuals with
complex affairs or higher-risk taxpayers, and is four years from the day the ATO served
(or is deemed to have served) the original notice of assessment on the taxpayer (ITAA36,
s. 170(1), Item 4).
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In very limited circumstances, the ATO has unlimited time to amend an assessment. This applies
if they suspect there has been tax avoidance or tax evasion. The amendment gives effect to a
decision on review or appeal, or if the amendment relates to a specific provision that allows for
an unlimited time frame.
Section 170(3) of ITAA36 permits the Commissioner of Taxation to re-amend an assessment for
a second or subsequent time in prescribed circumstances. The ATO may repeat this process—
but only for some items—within two or four years of the later assessment.
The Commissioner can amend an assessment after the expiry of the normal time limit where,
before the expiry of the time limit:
• the taxpayer requested an amendment (s. 170(5)), or
• the taxpayer had applied for a Private Ruling (s. 170(6)). Rulings are discussed later in
this module.
The Commissioner can also, under s. 170(7), obtain an extension to amend where the ATO has
begun but not completed an examination of the taxpayer’s affairs before expiry of the time limit,
and either:
1. the Federal Court in its discretion grants an extension, or
2. the taxpayer consents in writing to an extension.
Example 11.1: Amendment of assessment—time limits

The ATO served a notice of income tax assessment for the 2015–16 tax year on Reece Morris on
20 November 2016. Reece is an individual taxpayer who works as an employee in a retail store and
has very simple tax affairs. In his tax returns there is only a salary, a small amount of interest income
from a bank account and a few deductions.
The ATO has been conducting a tax audit of Reece for some time, but has not yet completed it. The ATO
intends to issue an amended assessment for the 2015–16 year to Reece.
As Reece is an individual with simple tax affairs, the time limit for amendment under s. 170(1) Table item 1
is two years. As more than two years have passed since the 20 November 2016 assessment of Reece,
the ATO could use the s. 170(7) extension procedure to apply to the Federal Court, or ask Reece for
an extension. If an extension cannot be obtained under s. 170(7), the ATO can only issue an amended
assessment against Reece if it can establish, for example, that Reece entered into a scheme for the
dominant purpose of obtaining a tax benefit (s. 170(1), Table item 1(e)), or there has been fraud or
evasion (Table item 5).
Tax audits
Why tax audits are needed
Most taxpayers in Australia endeavour to comply with their tax obligations (‘voluntary
compliance’), and the ATO over recent years has introduced a number of initiatives to help
taxpayers ‘do the right thing’—for example, education programs, simplified tax returns and
‘pre-filling’ of returns by the ATO.
Nevertheless, there are some taxpayers who attempt to avoid paying the correct amount of
tax—for example, by failing to declare all income they derive or incorrectly claiming deductions
or tax offsets.
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To prevent this, the Commissioner of Taxation needs some method of checking a taxpayer’s
affairs, to confirm that they are paying the correct amount of tax. One of the chief ways of doing
this is to conduct taxation audits.
The ATO does not have the resources—or the political will of the people and governments—
to audit every Australian taxpayer to ensure they are correctly adhering to the self-assessment
taxation regime.
The audit process

The ATO needs to be able to obtain timely and accurate information about taxpayers and their
transactions in order to identity who to target.
To do this, the ATO uses ‘data-matching’ technology. This means it compares items that
taxpayers have declared or claimed in their returns with information from other sources such as
banks (interest income), companies (dividends), land title offices (land purchases), the Family
Assistance Office (spouse rebates and other tax concessions), AUSTRAC fund transfers, and other
government and non-government organisations. Data matching also identifies persons who
should have lodged a return but have not done so. The use of data matching is improving
rapidly, and each year more taxpayers are being detected where their assessable income does
not match the sources of their income.
See: https://www.ato.gov.au/datamatching.
Enhanced third-party reporting, prefilling and data matching have improved audit activity.
For example in 2017, the ATO investigated taxpayers in the sharing economy, such as those
working as Uber drivers, letting rooms on Airbnb and offering services through Airtasker. As the
transactions in the sharing economy are made electronically, they are easy to trace.
The ATO can also mine social media sites, such as Instagram, for disparities between assessable
income declared and images of a more expensive lifestyle. For example, a person may be
identified as having $25 000 assessable income in the last tax year, but their Instagram shows
images of extended European holidays or the purchase of expensive sports cars.
Where the ATO suspects that a taxpayer has not declared all assessable income in a particular
tax year in their tax return, or is not entitled to all the deductions they have claimed, the ATO may
initiate a risk review. This is important given voluntary disclosures at this stage can often give rise
to significant penalty reductions. This is when they will serve the taxpayer with an initial ‘please
explain’ letter.
If matters cannot be resolved on review, the ATO may decide to conduct an audit. This may be
either an internal audit, or an audit in the field, with officers attending the taxpayer’s premises
to seek information and examine documents.
Where an audit reveals inaccuracies in the taxpayer’s return (or the fact that they should have
lodged a return), the ATO will issue an amended assessment.
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Australian Taxation Office information gathering powers

Often when the ATO is undertaking an audit, it will ask the taxpayer for information informally in
the first instance. The taxpayer generally has a reasonable time to respond to the initial ‘please
explain’ notice.
Failure to respond can result in the ATO using its formal powers to gather information.
Under s. 353-10 of Schedule 1 of the TAA, a person (whether the taxpayer or not) is required to:
• provide specified information
• attend before one or more taxation officers to give evidence on relevant matters
• produce specified books, documents and other papers in their custody or control
• attend, give evidence and produce documents, and
• give the ATO information about rights or interests in property.
Section 353-15 of Schedule 1 of the TAA is the power of the ATO to make access visits in order
to gather information. These are the ‘access powers’ and they will generally only be used if the
ATO cannot obtain the documents or information required from the taxpayer. Under these access
powers, the ATO can enter and remain on any land, premises or place, and they can have full and
free access to books, documents, goods or other property. Access rights can only be exercised
for the purposes of the taxation laws administrated by the ATO.
The ATO publishes detailed guidance on its information gathering and access powers, which can
be found at: https://www.ato.gov.au/about-ato/commitments-and-reporting/in-detail/privacy-
and-information-gathering/information-management/access,-accountability-and-reporting/.
Limitations in ATO power

While the ATO’s powers are very wide, they do have important limitations. The two main
limitations are the legislated legal professional privilege and the administrative-only
accountants’ concession.
The ATO cannot obtain access to documents or communications that are protected by
legal professional privilege. This privilege applies to protect from disclosure confidential
communications (or a relevant part of a communication) between a taxpayer and their legal
adviser, which were created for the dominant purpose of giving or receiving legal advice or
for use in current or anticipated litigation. See FC of T v. Citibank Ltd [1989] ATC 4268; JMA
Accounting Pty Ltd & Entrepreneur Services Pty Ltd v. Carmody [2004] ATC 4736; AWB Ltd v.
Cole [2006] 152 FCR 382).
While legal professional privilege only applies to communications with a lawyer, most tax advice
these days is given by accountants, and there is accordingly a strong argument for extending similar
protection to such advice. Accordingly, the ATO has for some years provided an ‘accountants’
concession’, under which the ATO will seek access to ‘source documents’ such as contracts and
other documents that record a transaction, but will only seek access to ‘restricted source’ and
‘non-source’ documents in ‘exceptional circumstances’.
‘Restricted source’ documents are those prepared by an external accountant at the time of
planning or implementing a transaction for the sole purpose of advising on that transaction.
‘Non-source’ documents cover advice provided after the completion of a transaction, or papers
prepared as part of an audit or due diligence report.
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Example 11.2: ATO information gathering powers

Mark Evans, ATO tax auditor, was not able to find all the information and documents he wanted during
his access visit to BTC Enterprises (BTC). Accordingly, the ATO decided to issue a notice to BTC under
s. 353-10 of TAA 53, requiring BTC to:
• provide specified information about the tax planning scheme that they have been promoting
• produce all documents relating to the scheme for the period 1 July 2015 to 1 July 2018
• attend before the ATO and others to be examined on oath about aspects of the scheme.
Subsequently BTC refuses to provide the information, arguing that it will require time and trouble
to assemble it; refuses to produce the documents requested on the basis that they are all protected
by legal professional privilege; and attends examination, but refuses to answer any questions on the
basis that the answers might be incriminating.
The fact that compliance with the notice may require some effort is not a valid reason for refusing
to comply. While legal professional privilege is a valid defence to a notice, a vexatious claim for
privilege where it is clearly not available amounts to obstruction, so BTC would need to be sure
that the privilege was arguably available.
Objections, reviews and appeals

Objections
Some tax assessments issued by the ATO will contain errors, or apply interpretations of the law or
facts with which the taxpayer disagrees. Procedural fairness therefore requires that the taxpayer
must have some way to challenge or dispute an assessment. A taxpayer may object to a tax
assessment, determination, notice or decision.
A taxpayer who is unhappy or dissatisfied with an income tax assessment can lodge a written
objection against that assessment within prescribed time limits and on the approved form,
stating fully and in detail the grounds on which the taxpayer relies. The taxpayer may lodge their
objection within two years (or within four year for more complex matters). This time limit begins
from when the notice of assessment is served, unless there is an agreed extension. (See s. 14ZU
and 14ZW of the TAA regarding how and when taxation objections are to be made.)
An unusual feature of self-assessment is that a taxpayer may choose to prepare their return on
the basis of an ATO ruling or interpretation (even though they disagree with that interpretation)
in order to avoid the risk of imposition of penalties. However, the taxpayer may then object
against an assessment based on their own return, in effect arguing that the ATO interpretation
is wrong and their interpretation—even though not reflected in their return—is right.
Where a taxpayer wishes to object against an amended assessment, the objection must be
lodged by the later of:
• the normal two- or four-year limit applying to the original assessment, or
• 60 days after the notice of amended assessment has been served.
Any objection to an amended assessment is limited to the particular issues that were amended
by the later assessment (s. 14ZV). The taxpayer has the right to withdraw their objection up to the
time the Commissioner of Taxation decides to accept or reject the objection. Once the objection
is withdrawn, the Commissioner can no longer make an ‘objection decision’ in relation to it.
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Unless the objection is withdrawn, the Commissioner of Taxation must make an objection
decision on whether to allow or disallow the objection. Where the Commissioner has not
made a decision on their objection within the prescribed time (most often 60 days after the
objection was lodged with the Commissioner), the taxpayer can give the Commissioner a
notice requiring the Commissioner to make a decision on the objection.
If the Commissioner of Taxation fails to make a decision within a further 60 days, the
Commissioner is deemed to have disallowed the objection, and the taxpayer can then
seek review of this decision. Reviews and appeals will be discussed shortly.
Table 11.1 shows the type of decisions and time limits for each area of tax law to lodge an
objection. This table is adapted from the ATO.
Table 11.1: Types of decisions and time limits for lodging an objection
Fringe benefits tax (FBT)
You can object to How long you have
Assessments Four years from the date the assessment was given to you.
Amended assessments Until the later of:

• 60 days from the date the amended assessment was given to you
• four years from the date the original assessment (that was amended)
was given to you.
Private rulings Until the later of:

• 60 days from the date the ruling was given to you
• four years from the last day for lodging the relevant return.
You cannot object to a private ruling if you have an assessment for the
period concerned—object to the assessment instead.
Goods and services tax (GST)
Assessments Four years and one day from the date the assessment was given to you.
For assessments relating to tax periods that started before 1 July 2012,
you have until the later of:
• 60 days from the date the assessment was given to you
• four years from either the:
– end of the relevant tax period
– date of importation (for imported goods).

• four years after the assessment that has been amended was given
to you.
For amended assessments relating to tax periods that started before

1 July 2012, you have until the later of:
• four years from either the
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Private rulings Until the time you lodge a BAS that takes into account the matter to
which the ruling relates.
For private rulings relating to tax periods that started before 1 July 2012,
you have until the later of:
• 60 days from the date the ruling was given to you
• four years from either the
Reviewable GST decisions 60 days from the date the decision was given to you.
Failures to make an 60 days—starting 30 days after the date you gave notice requesting
assessment an assessment.
Decisions to retain refunds Your objection period starts 75 days (plus any time you take to provide
additional information the ATO asks for) after you lodge your activity
statement. It ends when you receive an amended assessment (or equivalent
for refunds relating to tax periods that started before 1 July 2012).
Income tax
Assessments Two or four years from the date the assessment was given to you:
• two years for most individuals and small businesses
• four years for all other taxpayers.†

• 60 days from the date the amended assessment, was given to you
• two or four years from the date the assessment that has been
amended was given to you
– two years for most individuals and small businesses
– four years for all other taxpayers.†
Private rulings Until the later of:

• 60 days from the date the private ruling was given to you
• two or four years from the last day for lodging the relevant return
– two years for most individuals and small businesses
– four years for all other taxpayers.†
Decisions to retain refunds Your objection period starts 90 days (plus any time you take to provide
additional information we ask for) after you lodge your income tax return.
It ends when you receive an amended assessment.
Penalties and interest
Shortfall penalty Until the later of:

• 60 days from the date the penalty assessment notice was given to you
• the last day for lodging an objection to the assessment to which the
penalty relates.
Penalty for failing to provide Until the later of:

a document • 60 days from the date the penalty assessment notice was given to you
• the last day for lodging an objection to the assessment to which the
penalty relates.
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Decisions not to remit 60 days from the date the decision was given to you.
shortfall interest charge (SIC),
but you cannot object to our
decision not to remit SIC if
the interest is 20% or less of
the shortfall amount.
For example, if your shortfall

is $2000, 20% is $400. If the
SIC you were left to pay after
the ATO had made a decision
on remission was $400 or less
you could not object to it.
Other administrative
penalties, but you cannot
object to a decision not to
remit (waive) a penalty if
the amount you are faced
with paying is less than $340
(two penalty units).
Superannuation
Excess contributions tax Four years from the date the assessment was given to you.
assessments
Excess transfer balance cap Four years from the date the assessment was given to you.
tax assessment
Excess transfer balance 60 days from the date the determination was given to you.
determination
Termination payments 60 days from the date the assessment was given to you.
surcharge assessments
Superannuation guarantee 60 days from the date the assessment was given to you (note—an
charge employee does not have a right to object to a superannuation
guarantee assessment).
Administrative penalties 60 days from the date you were notified of the decision.
Superannuation: Reviewable decisions
You can ask for a review of How long you have
A notice about a complying 21 days from the date that you first received notice of decision.
fund status
A notice of disqualification 21 days from the date that you first received notice of the decision.
of an individual from being
a trustee
All other reviewable decisions 21 days from the date that you first received notice of the decision.
made by the Commissioner
as regulator under the
Superannuation Industry
(Supervision) Act 1993 (Cwlth)
†
‘All other taxpayers’ refers to companies, superannuation funds and individuals that are not eligible for
the two-year period. Income tax assessments include tax offsets and rebates.
Source: Adapted from ATO 2018, ‘Decisions you can object to and time limits’, accessed March 2019,
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https://www.ato.gov.au/general/dispute-or-object-to-an-ato-decision/object-to-an-ato-decision/
decisions-you-can-object-to-and-time-limits/.
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Example 11.3: Objection to amended assessment

A notice of assessment for the 2017–18 tax year is received by Joe Canon (who carries on a business
but is not an SBE taxpayer) on 11 October 2018. As a result of an audit, the Commissioner of Taxation
served a notice of an amended assessment on 8 September 2019. Joe would need to lodge an objection
to the amended assessment by the later of 7 November 2019 (60 days after the service of the notice of
the amended assessment) or 11 October 2022 (four years after the service of the original assessment).
Reviews
Where a taxpayer is dissatisfied with the Commissioner of Taxation’s objection decision, they can
choose in almost all cases to seek review of that decision by either applying to the Administrative
Appeals Tribunal (AAT) or appealing to the Federal Court. (TAA, s. 14ZZ) (see also the definition
of ‘reviewable objection decision’ in TAA, s. 14ZQ). Additionally, individuals, small businesses
or not-for-profits with a tax or superannuation dispute can use the ATO’s in-house facilitation
service. This form of alternative dispute resolution (ADR) is commonly used for less complex
disputes and can be used at any stage from the audit up to and including the litigation stage.
The majority of reviews and appeals are settled by the parties through ADR through the in-house
facilitation service and the AAT, or ADR via the Federal Court. Litigation via the Federal Court
is the last step, and comparatively few tax matters end in litigation.
Process of review
Taxpayers can seek a review of an objection decision through an AAT and then with litigation
through the Federal Court of Australia. In most cases, the taxpayer must lodge an objection and
be dissatisfied with the outcome before an external review can be applied for.
The taxpayer may be able to access a test case litigation program where the ATO will reimburse
some or all of the legal costs if they decide the case has important implications for the
administration of the revenue system.
Procedure of review
Both the AAT and Federal Court use ADR processes to help resolve tax disputes that come
before them. Such ADR processes can occur at any time, including after a position paper has
been issued following an audit, to even the early stages of litigation.
Where the dispute cannot be settled, it will proceed to the AAT or Federal Court for a court-
based hearing and adjudication. When a taxpayer takes a review to the AAT or the Federal Court
for litigation, they will need to supply evidence. The onus is on the taxpayer to prove that the
decision should not have been made, or should have been made differently. They should also
show what the correct assessment should be. The onus is on the taxpayer of proving the case
of the civil law balance of probabilities (TAA, s. 14ZZK(b)(i), 14ZZO(b)(i); Brookdale Investments
Pty Ltd v. FC of T [2013] ATC 10-310). Basically, this means that the Commissioner of Taxation
does not have to prove that the assessment is correct or not excessive. If the arguments of the
Commissioner and taxpayer are evenly balanced, the taxpayer will lose (FC of T v. Dalco [1990]
168 CLR 614; Healey v. FC of T (No. 2) [2012] ATC 20-365; Gashi v. FC of T [2013] ATC 20-377).
Appeals
A taxpayer can appeal a review decision of the AAT to the Federal Court, but only ‘on a question
of law’ (s. 44(1) of the Administrative Appeals Tribunal Act). This means that the Federal Court is
limited to determining whether or not the AAT decided the disputed question of law correctly—it
does not re-hear the entire case (Bell v. Commissioner of Taxation [2013] FCAFC 32; FC of T v. Trail
Bros Steel & Plastics Pty Ltd [2010] ATC 20-196, 11, 213–4; Politis v. FC of T [1988] ATC 5029, 5032).
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If the taxpayer is dissatisfied with the Federal Court judge’s decision, they can appeal to the
Full Federal Court. If still dissatisfied, they can seek special leave to appeal to the High Court—
however, special leave is not often granted.
Example 11.4: Analysis of the review and appeals process

Peter has been involved in a dispute with the ATO, involving substantial amounts of what Peter believes
are non-assessable amounts, but which the ATO regards as the proceeds of a tax avoidance scheme.
The ATO has rejected Peter’s objection against its assessment, and Peter is trying to decide whether
to take the case to the AAT or Federal Court.
The issue in dispute raises some interesting and difficult legal issues and has not previously been taken
to court. There is a considerable amount of potential tax and penalties at risk.
If the result of the case depends on how a discretion should be exercised by the Commissioner of
Taxation, the AAT will be able to re-exercise the discretion, whereas the Federal Court can only override
the exercise of a discretion by the Commissioner where it involves an error of law.
AAT members are very experienced in tax matters, but so are members of the Tax Division of the
Federal Court.
It will usually be much more expensive to go to the Federal Court than the AAT, so unless there are
substantial amounts at issue, the AAT may be preferable.
In Peter’s circumstances, if there are complex legal issues involved and Peter can afford it, many advisers
would suggest going to the Federal Court, with the availability of appeal to the Full Court and the
possibility that on a complex and important legal question arising for the first time, the High Court
might grant special leave if it were necessary to appeal beyond the Federal Court.
Tax reporting and payment obligations

Payment dates
The annual dates for when taxation is due vary depending on the entity:
• Individuals or trustees who lodge income tax returns on or before the lodgment date: the
payment of any outstanding tax is due 21 days after the notice of assessment. If a tax return is
late or not lodged at all, the default payment date is 21 days after the due date for lodgment
of the return.
• Self-assessment entities (such as companies and superannuation funds): the payment of any
outstanding amounts is due on the first day of the sixth month after the end of the tax year.
As most of these taxpayers apply the standard tax year ending on 30 June, the payment date
is generally 1 December.
These dates represent the final date for any outstanding tax amounts. Generally, taxpayers will
have already made some payments of tax (directly or indirectly) during the tax year by way of the
PAYG withholding and/or instalment systems.
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Pay-As-You-Go withholding system

The PAYG withholding system is the process of deducting tax from payments made to others
(such as employees) and remitting that tax directly to the ATO. For example, an employer is an
entity who has a responsibility to withhold tax on behalf of the employee and remit that tax to
the ATO.
The rules governing when a withheld amount should be paid to the Commissioner of Taxation
largely depend upon the status of the ‘withholder’ as being large, medium or small. Large
withholders are those where the amounts withheld during the financial year, ending at least
two months before the current month, exceed $1 million. Depending on the day of the week,
large withholders will remit the tax within a week. For medium withholders where the withholding
is greater than $25 000, payment of tax will be due by the 21st or 28th day after the end of the
month in which the amount was withheld. For small withholders where the amount withheld is
less than $25 000, the payment of the tax will be due by the 21st or 28th day after the end of the
quarter in which the amount was withheld (TAA, Schedule 1, ss. 16-75, 16-85).
From 1 July 2019, where an entity fails to comply with the PAYG requirements when paying
employees and contractors, a deduction for the payment will be denied (s. 26-105).
Common types of payments from which entities are required to withhold tax and the amount
that should be withheld are set out in Table 11.2.
Table 11.2: Withholding rates for 2018–19
Type of payment Withheld amount

Payments of salary or wages to an employee Amount calculated via the withholding schedules
or remuneration to a director (as above) (based on progressive rates)
Where no TFN supplied, 47%† for residents or 45%

for non-residents
Payments to a resident arising from an investment 47%† (for dividends, withholding only applies
where no tax file number (TFN) or Australian to unfranked portion unless streamed through
Business Number (ABN) has been provided certain trusts)
Dividends paid to non-residents For unfranked dividends, 30%, but may be reduced
under a double tax agreement
Interest paid to non-residents 10%
Royalty paid to non-residents 30%, but may be reduced under a double taxation
agreement
Business transaction payments where recipient does 47%†

not quote an ABN
†
The rate of 47 per cent represents the top marginal tax rate of 45 per cent plus the 2 per cent
Medicare levy.
accessed April 2019, https://www.legislation.gov.au/Details/C2018C00364; ATO 2018, ‘Withholding rate’,
accessed April 2019, https://www.ato.gov.au/Business/PAYG-withholding/In-detail/Investment-income-
and-royalties-paid-to-foreign-residents/?page=5.
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Payees (such as employees) who have had amounts withheld under the PAYG withholding rules
are entitled to tax credits for the amounts withheld, which are claimed through their annual tax
returns. Payees are advised of the total amount withheld (with some exceptions) in a year via a
payment summary, a document that must be issued to them by the payer within 14 days after the
end of the financial year.
Pay-As-You-Go instalment system

The PAYG instalment system is the paying of instalments on expected tax liabilities for business
and/or investment income.
The aim of the PAYG instalment system is to spread larger tax obligations over time through the
progressive collection of income tax in a financial year. The system applies to entities such as
companies, superannuation funds and individuals that have business and/or investment income.
A taxpayer is only liable to make PAYG instalments if they have been issued an instalment rate
by the Commissioner of Taxation.
Despite some exceptions, instalments are generally paid quarterly, or monthly for large
taxpayers. Taxpayers (all entities, including individuals, trusts, companies and superannuation
funds) with ordinary income of over $20 million must pay their PAYG instalments monthly.
Some taxpayers may be eligible to pay their PAYG instalment through one annual payment.
Taxpayers will be eligible for annual payments if:
• their most recent notional tax assessment was less than $8000
• if they are registered for GST and report and pay GST annually
• if they are a partner in a partnership that is registered for GST, and reports and pays
GST annually
• in the case of a company, the company is not part of an instalment group, head company
of a consolidated group, or a participant in a GST joint venture (ATO 2017a).
The instalments paid by the taxpayer result in a credit against their actual tax liability at the time
of annual assessment.
Calculating the PAYG instalments

There are two main ways of calculating PAYG instalments: the GDP-adjusted notional tax method
(TAA, Schedule 1, s. 45-112) and the instalment rate method (TAA, Schedule 1, s. 45-110).
For the GDP-adjusted notional tax method, the Commissioner of Taxation provides a taxpayer
with their GDP-adjusted notional tax, which is based on the tax liability from the last lodged tax
return, and multiplied by a GDP adjustment factor that is based on the gross domestic product
(GDP) activity of the previous two calendar years and that is supposed to reflect expected
changes in the Australian economy (TAA, Schedule 1, s. 45-405). Those who may be eligible
for this method include individuals, small companies and superannuation funds. The taxpayer
may vary their GDP-adjusted notional tax instalment by calculating their estimate of their
benchmark tax. They must advise why a variation is being sought—for instance, changes in
trading conditions. If the PAYG instalment amount is varied down and the taxpayer pays
less than 85 per cent of their actual tax liability, then the general interest charge (GIC) might
be levied.
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Both the taxpayer and Commissioner contribute to the instalment rate method. The
Commissioner of Taxation issues the taxpayer with an instalment rate. The taxpayer can vary
this rate if they consider it is not appropriate (TAA, Schedule 1, s. 45-205). The taxpayer calculates
their instalment income, which is ordinary income derived over the quarter (or month for monthly
payers). Instalment income generally excludes statutory income such as capital gains.
The instalment income is then multiplied by the instalment rate (TAA, Schedule 1, ss. 45-110,
45-114).
The taxpayer is obliged to inform the Commissioner of their instalment income in the approved
form—even if it is nil (TAA, Schedule 1, s. 45-20). As with the GDP-adjusted notional tax method,
a taxpayer can vary the instalment rate provided by the Commissioner. However, if doing so
results in a rate (varied rate) that is less than 85 per cent of the benchmark instalment rate,
GIC may be payable. The benchmark instalment rate is the rate calculated in reference to
benchmark tax. Benchmark tax is tax payable on taxable income less net capital gains.
Example 11.5: Calculating Pay-As-You-Go instalments

Grace is eligible to pay her PAYG instalments on the basis of the GDP-adjusted notional tax method.
Before the first quarterly payment was due, she was notified by the Commissioner of Taxation that
her annual GDP-adjusted notional tax was $100 000, so for the first quarter of the income tax year she
paid 25 per cent of that amount ($25 000).
By the next quarter, Grace had lodged a further tax return, and the Commissioner of Taxation notified
her that her annual GDP-adjusted notional tax was now $120 000. The second quarter payment due
was then calculated under s. 45-400 of Schedule 1 of TAA to be (50% × $120 000) – $25 000 (already
paid) = $35 000.
➤ Question 11.1
Vivienne is eligible to pay her PAYG instalments on the basis of the instalment amount method.
When the first quarterly payment became due, she was notified by the Commissioner of Taxation
that her annual instalment amount was $200 000, and so for the first quarter of the income tax
year she paid 25 per cent of that amount ($50 000).
By the next quarter, Vivienne had lodged a further tax return, and the Commissioner notified
that her annual ‘GDP-adjusted notional tax’ was now $220 000.
What is Vivienne’s second quarter payment?
Table 11.3 compares the main features of the PAYG withholding system and the PAYG
instalment system.
MODULE 11
Table 11.3: PAYG withholding versus PAYG instalment system
PAYG withholding system PAYG instalment system

Deduction of tax from payments made to others and Paying instalments on expected tax liabilities for
remitting that tax to the Commissioner of Taxation investment and business income
Applies to individual taxpayers, both residents and Applies to companies, superannuation funds and
non-residents individuals with business or investment income
Withheld from payments made to the taxpayer Generally paid quarterly, or monthly for large
taxpayers with ordinary income of over $20 million.
Some taxpayers, with a notional tax assessment
of less than $8000 and who are registered for GST
and pay GST on an annual basis, may be able to
make annual payments
Amount to be withheld from payments Two methods of calculation:

• Instalment amount method
TAA (Schedule 1, s. 15-10) contains a summary of (tax liability of last return × GDP adjustment
withholding payments, and the relevant sections factor)
of TAA indicate how much to withhold • Instalment rate method
(taxpayer given an instalment rate that they
Example—interest paid to non-residents: can then vary. Based on ordinary income over
10% is withheld the quarter)
Business activity statement

Entities registered for GST must complete a BAS for each reportable tax period. Types of tax
reported on are:
• GST
• PAYG withholding
• PAYG instalments
• FBT instalments
• wine equalisation tax
• luxury car tax.
Instalment activity statement

An entity that is not registered for GST will be issued an IAS instead of a BAS. Individuals and
trustees with investment income are also issued with an IAS. Types of tax covered in the IAS
and the BAS are:
• PAYG instalments
• PAYG withholding
• FBT.
The effect of both a BAS and IAS is that taxpayer credits and obligations are offset and the
taxpayer pays one lump sum for all types of tax listed previously.
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Running balance account

The running balance account (RBA) consolidates the reporting of a taxpayer’s liabilities and
payments. Debit entries arise when assessments are raised or interest charges imposed,
while credits occur when instalments are paid.
Difficulties can arise due to the fact that this is a consolidated account and the Commissioner
of Taxation has a discretion to apply a refund from one activity statement amount—say, GST—
against a different tax debt before the latter is due and payable. The taxpayer may apply to the
ATO for a refund and/or request that future refundable amounts are only applied against debts
due and payable.
Australian Taxation Office guidance documents

and rulings
Tax law can raise very difficult issues, but under self-assessment a taxpayer may be liable for
substantial penalties if they do not report their income and deductions correctly. To help
taxpayers navigate through the tax legislation and practice, the ATO publishes a range of
‘advice’ in the form of guidance documents setting out the ATO’s views on key issues.
This guidance is set out in a variety of publications, including public and private rulings,
law companion guidelines, practice statements and interpretative decisions.
The rulings system

There are several different categories of rulings issued by the Commissioner of Taxation to
provide taxpayers with guidance regarding how the ATO interprets the tax legislation.
The Commissioner of Taxation can issue rulings about the application of tax legislation to
a specified fact situation, and accordingly the ATO can rule not only on actual tax liability,
but also on matters such as collection and payment of tax, administrative or procedural
matters, and ultimate conclusions of fact such as whether an activity is a hobby or a business
(TAA, Schedule 1, s. 357-55).
Rulings are the statement of the ATO’s opinion on how the law applies to a particular situation—
they are not the law (strictly speaking), though they will bind the ATO in specified circumstances.
Acting in accordance with a ruling will protect the taxpayer against liability for tax, interest
and penalties.
A ruling binds only the Commissioner of Taxation. The taxpayer is not required to follow a ruling,
though if they do not do so and the ruling is found to be correct, the taxpayer may be liable to
penalties (TAA, Schedule 1, ss. 357-60, 357-65).
Crucially, a ruling will only apply and bind the Commissioner of Taxation where the taxpayer’s
facts fall within the scope of the ruling. If the taxpayer’s arrangement is materially different
to the situation covered by the ruling, the ruling (and its protection) will not apply to the
taxpayer’s arrangement.
MODULE 11
Public rulings
A public ruling is issued by the ATO to provide guidance on issues the ATO regards as being
of general importance, and sets out the ATO’s opinion on how a particular provision of an Act
applies to taxpayers or a class of taxpayers in relation to an arrangement outlined in the ruling.
To be a (binding) public ruling, it must state that it (or a specified part of the document) is a
public ruling and be published by the Commissioner of Taxation (TAA, Schedule 1, s. 358-5).
A public ruling will apply automatically to anyone who is acting in accordance with its terms.
Unlike a private ruling, the taxpayer does not have to ‘apply’ for the protection of a public ruling.
Public rulings include, among others:

• taxation rulings
• GST rulings
• tax determinations
• product rulings—these are rulings that apply to all taxpayers who participate in a particular
‘product’ such as a primary production scheme
• class rulings—these are rulings applying to all members of a particular class (such as
employees, shareholders or the like) who engage in a particular arrangement, and
• product grants and benefits rulings (e.g. for agriculture, mining and forestry operations).
A public ruling applies from the time it is published—or such earlier or later time as is specified
in the ruling—and ceases to apply when it is withdrawn, or else at the time specified in the ruling.
A public ruling is withdrawn from the time specified by the Commissioner of Taxation in a notice
published in the Government Notices Gazette (TAA, s. 358-20).
Taxation determinations
A taxation determination is a type of public ruling that covers a very specific point of tax law.
Taxation determinations have exactly the same status as taxation rulings, but they only deal with
a single issue, whereas a taxation ruling may look at a number of tax issues that are evident in
an arrangement or transaction.
Private rulings
A taxpayer may be contemplating a transaction not covered by a public ruling, or may wish to
challenge the interpretation applied in a public ruling. In such cases, the taxpayer can apply for
a private ruling.
A private ruling is ‘personal’ to the person whose tax affairs are ruled on (the ‘rulee’) and no-one
other than the rulee can rely on it, even if their facts are very similar or even identical. However,
a private income tax ruling given to the trustee of a trust also applies to the beneficiaries of the
trust and any replacement trustee (TAA, Schedule 1, s. 359-30).
In addition, a private ruling only applies to the particular scheme (set of facts) described in the
ruling. Thus, if the taxpayer changes the arrangement in any significant way, the ruling will not
apply to the changed arrangement (CTC Resources NL v. FC of T [1994] ATC 4072). A new private
ruling will have to be applied for.
For the guidance of other taxpayers, summaries of each private ruling issued are posted on the
ATO website, but all names and other identifying features are removed. It is important to note
that these rulings are not updated when legislation changes and so the advice they contain can
be out of date.
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See private ruling requirements: https://www.ato.gov.au/general/ato-advice-and-guidance/in-detail/

private-rulings/reference-guide-for-private-rulings/?page=1#Section_A__Taxpayer_details.
Oral rulings
Oral rulings by the Commissioner of Taxation can only be given to individuals over the telephone.
An oral ruling is an expression of the ATO’s opinion of how a provision of the law applies to an
individual in relation to their specific circumstances (TAA, Schedule 1, s. 360-5).
The ruling is given orally and the taxpayer is provided with a registration identifier only. There is
no written record of the ruling. As with other rulings, an oral ruling will be binding on the
Commissioner of Taxation where it applies to the rulee and the rulee acts in accordance with
it (s. 357-60).
Law companion guidelines

A law companion guideline is a form of public ruling. Its purpose is to provide the view of the
ATO on how recently enacted law applies. It is usually developed at the same time as the drafting
of the legislation Bill.
For example, there have been a large range of superannuation law companion guidelines
developed in line with superannuation changes enacted in 2017.
The ATO normally releases a law companion guideline in draft form for comment when the Bill
is introduced into parliament. It is finalised after the Bill receives royal assent. It provides early
certainty in the application of the new law, before it can be tested through the rulings system.
A law companion guideline is usually finalised as a public ruling when the law is enacted. As they
are prepared so early on in the existence of the law, a law companion guideline is not informed
by experience of the new law operating in practice. While they offer the same protection in
relation to underpaid tax, penalties or interest as a normal public ruling, this only applies if the
taxpayer relies on it in good faith.
Law administration practice statements

The ATO produces law administration practice statements, to provide direction and assistance
to ATO staff on approaches to take when performing duties involving the laws they administer.
Practice statements are published on the ATO’s legal database.
Practice statements are not law and are not public rulings. They are not intended to provide
interpretative advice, but technical issues may be discussed in the practice statements in the
course of providing directions to ATO staff.
Australian Taxation Office interpretative decisions

According to the ATO (2017b):
An ATO interpretative decision (ATO ID) is an edited version of a decision we have made on
an interpretative matter and gives an indication of how we might apply a provision of the law.
We produce ATO IDs to help us apply the law consistently and accurately. They set out the
precedential ATO view that we must apply in resolving interpretative issues. ATO IDs don’t
provide advice to taxpayers and they are not rulings (ATO 2017b).
MODULE 11
Penalties and interest charges

The ATO will accept most taxpayers’ returns at face value, subject to some basic cross-checking.
This is the basis of the self-assessment system.
Because of this, there needs to be a system of penalties in place for taxpayers who fail to
correctly report an amount of income or over-claim tax deductions and benefits, whether
through mistake, carelessness or intentional evasion. The penalty system is split into two—
actual administrative and criminal penalties—and a system of interest charges on unpaid or
late taxation.
Accordingly, Part 4-25 of Schedule 1 of the TAA imposes administrative and criminal penalties,
and penalty interest on taxpayers who do not properly meet their tax obligations. Other penalties
are imposed by the Crimes Act 1914 (Cwlth) and related legislation.
Administrative civil penalties

Administrative penalties relating to statements (such as tax returns) are specified as a base
penalty amount that can be varied according to the behaviour of the taxpayer during the
process of sorting out the issue with the ATO.
A taxpayer will be liable to a penalty if they applied the tax legislation in a manner that is not
‘reasonably arguable’ and there is a significant tax shortfall (ss. 284-75(2), 284-90(1); see items
4–6 of the ‘Base penalty amount’ table in s. 284-90(1)). The threshold amount is the greater
of $10 000 and 1 per cent of the tax liability based on the tax return for an individual, or $20 000
and 2 per cent for the tax return of a partnership or trust.
In simple terms, a position will be ‘reasonably arguable’ if, when the relevant authorities are
applied to the facts, it would be concluded that the taxpayer’s argument is ‘about as likely to
be correct as incorrect’—that is, the arguments for and against the taxpayer’s interpretation are
finely balanced (s. 284-15; Walstern Pty Ltd v. FC of T [2003] ATC 5076).
Tables 11.4 and 11.5 present a summary of these penalties relating to the behaviour of the
taxpayer.
Table 11.4: Summary of penalties relating to statements—behaviour of the taxpayer
Base penalty if no Base penalty as

shortfall (penalty a percentage
Behaviour of taxpayer units—see Table 11.5) of shortfall
No reasonable care 20 25%
Recklessness 40 50%
Intentional disregard 60 75%
No reasonably arguable position† with a significant shortfall 25%
Failure to make a statement 75%
†
‘A position is reasonably arguable if it would be concluded in the circumstances, 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, Schedule 1, s. 284-15(1)).
Source: Based on ATO 2018, ‘Statements and positions that are not reasonably arguable’, accessed
March 2019, https://www.ato.gov.au/General/Interest-and-penalties/Penalties/Statements-and-positions-
that-are-not-reasonably-arguable/.
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Table 11.5: Summary of penalties relating to statements—infringement date

and penalty amount
When infringement occurred Penalty unit amount
Up to 27 December 2012 $110
28 December 2012 – 30 July 2015 $170
31 July 2015 – 30 June 2017 $180
On or after 1 July 2017 $210
Source: ATO 2018, ‘Penalties’, accessed March 2019,

https://www.ato.gov.au/general/interest-and-penalties/penalties/.
Where more than one item applies, the item with the greater base penalty amount is used.
As seen in Table 11.4, failure to take reasonable care results in a penalty of 25 per cent of the
amount owed. Recklessness incurs a penalty of 50 per cent of the amount owed and intentional
disregard attracts a penalty of 75 per cent. Where the taxpayer has ‘aggravated’ the situation
(e.g. by trying to obstruct the Commissioner’s investigation), the base penalty is increased by
20 per cent (e.g. from 25 to 30 per cent) (TAA, s. 284-220(1), Schedule 1, Division 284). Conversely,
if the taxpayer takes steps to assist the Commissioner of Taxation by voluntarily disclosing a tax
shortfall, the base penalty will be reduced by 20 per cent or 80 per cent, depending on when the
disclosure is made (s. 284-225(1)–(5)) and will be reduced to nil where the amount is below $1000
(s. 284-225(3)(b)).
As of 1 July 2017, one penalty unit is $210. There is a sliding scale dependent on when the
infringement the penalty is being applied on actually occurred.
A taxpayer will not be liable for a statement penalty where they (or their agent):
• took ‘reasonable care’ in making the statement (TAA, s. 284-75(5), Schedule 1, Division 284).
‘Reasonable care’ basically requires that the taxpayer and agent take the care that ‘a reasonably
prudent person with the taxpayer’s knowledge, education, experience and skill would take’
(JG & JA Williamson Holdings Pty Ltd v. FC of T [2007] ATC 2206; Practice Statement PS LA
2012/4, paras 69–73; Aurora Developments Pty Ltd v. FC of T (No. 2) [2011] ATC 20-280)
• created a ‘safe harbour’ by providing their registered tax or BAS agent with ‘all relevant
taxation information’, and the false or misleading nature of the statement by the agent did
not result from either intentional disregard or recklessness as to the operation of a taxation
law (TAA, s. 284-75(6))
• followed advice received from the ATO or a general ATO administrative practice in making
the statement (PS LA 2012/4, paras 104–9).
On or after 1 July 2018, eligible individuals and entities with a turnover of less than $10 million
will be able to receive penalty relief after an audit for inadvertent errors in tax returns and activity
statements that have resulted from a failure to take reasonable care or taking a position that is
not reasonably arguable. Penalty relief is available once every three years, provided there has not
been any infringement during a three-year period.
Penalties relating to schemes

Division 284 of TAA penalties will apply where a taxpayer would have obtained a tax benefit from
a taxation ‘scheme’ but for the application of Part IVA of ITAA36 (see the next section of this
module) or other general anti-avoidance provisions. These penalties also cover situations where
a transfer pricing adjustment has arisen.
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Example 11.6: Applying administrative penalties

Susie Brown was involved in complex international share-trading arrangements over the period
2012–14, which yielded substantial profits. Susie did not declare these profits in her tax return for any
of those years.
The ATO discovered these transactions in December 2018, and requested details from Susie on certain
aspects of these transactions, including the amount of the profits. Susie did not answer these queries
or provide any information, despite several reminders.
The ATO subsequently assessed Susie on these profits. It imposed a base penalty of 75 per cent of
the total tax-related liability under s. 284-75(3) due to failure to provide a document necessary for
the Commissioner of Taxation to work out that tax liability. The ATO increased this base penalty by
20 per cent (to a total of 90 per cent of the tax-related liability).
Susie would be liable for the 90 per cent penalty, as the failure to respond to the ATO requests for
information ‘was a step taken to prevent or obstruct the Commissioner of Taxation from finding
out about the shortfall amount’ (Leighton (As Trustee of the Leighton Family Trust) v. FC of T [2010]
ATC 20-215). The taxpayer may also be liable for failing to lodge a return or other documents on time
under s. 286 80(2) of the TAA, Schedule 1 (discussed in the next section of this module).
The ATO has the ability to increase or decrease the base penalty by 20 per cent for aggravating
or mitigating behaviour. Here, the fact that Susie did not answer the queries despite several
reminders means the increase by 20 per cent is expected. If the taxpayer is dissatisfied with a
TAA Division 284 penalty imposed on them, they can lodge an objection.
Penalties for failing to lodge documents on time

There are administrative penalties for failing to lodge documents on time.
For small entities, the penalty is imposed at the rate of one penalty unit ($210) for each 28-day
period or part of a period of 28 days that a statement (e.g. a BAS) remains unlodged, with a
maximum penalty of five penalty units.
The penalty increases according to the size of the taxpayer.
The basic penalty is doubled (i.e. $420 per 28-day period) for medium-sized PAYG withholders,
entities with an assessable income between $1 million and $20 million in the current year,
or entities with a current annual turnover for GST purposes of between $1 million and $20 million.
The basic penalty is multiplied by five (i.e. $1050 per 28-day period) for large PAYG withholders,
and entities with current annual assessable income or current annual turnover for GST purposes
of $20 million or more (s. 286-80).
The safe harbour defence may be applied by entities for failure to lodge documents (s. 286-75(1A)).
Penalties for failing to withhold or remit PAYG withholding amounts

Failure to withhold an amount under the PAYG withholding system or to pay it to the
Commissioner of Taxation as required carries a penalty of 10 penalty units ($2100). In addition,
the taxpayer may be required to pay the Commissioner the amount that should have
been withheld.
Alternatively, the taxpayer may be required to pay a penalty equal to the amount that should
have been withheld (s. 16-30).
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Miscellaneous administrative penalties

Penalties for failing to meet other tax obligations are imposed in multiples of $210 penalty units.
Relevant penalties include, among others:
• not keeping or retaining records as required: 20 penalty units (s. 288-25), so $4200
• preventing a tax officer from gaining access to premises or records when permitted:
20 penalty units (s. 288-35), so $4200.
Criminal penalties
Taxpayers and their agents may also face criminal prosecution for tax offences, either under the
TAA or the Crimes Act and related legislation (e.g. the Criminal Code Act).
Natural persons (individuals, sole traders, partners, trust beneficiaries and individual trustees)
may be punishable by penalty units and/or imprisonment for certain offences, while maximum
penalties for a company are five times higher. In each case, a taxpayer is only liable to the extent
they are capable of complying with the requirement (Ganke v. DFC of T (No. 1) [1975] ATC 4097;
Griffin & Elliott v. Marsh [1994] ATC 4354; Ambrose v. Edmunds-Wilson [1988] ATC 4173).
In recent years, a number of taxpayers and advisers have been found guilty of offences under
the general criminal law provisions and sentenced to jail for significant periods.
General interest charge and shortfall interest charge

As introduced earlier, there are interest charges levied on outstanding tax payments and late
payments for taxation. These are the GIC and the SIC.
Why are the general interest charge and shortfall interest charge charged?
Interest is charged on taxpayers to compensate the ATO for the time value of money, to address
inequities between taxpayers who pay their taxes on time and those who do not, and to punish
taxpayers who may be careless about the conduct of their tax affairs.
GIC and SIC interest is calculated on a daily compounding basis.
A deduction may be claimed for GIC or SIC in the year in which the notice of assessment
(which includes the GIC/SIC) is issued (ITAA97, s. 25-5(1)).
Operation of the general interest charge

The GIC is a uniform interest charge with the rate being updated quarterly, and interest
compounding daily (TAA, Part IIA, ss. 8AAA–8AAH). The GIC applies where:
• an amount of tax, charge, levy or penalty remains unpaid (such as a PAYG instalment)
• there is an underpayment of tax (which might occur if an amended assessment is ignored)
• an instalment of tax is underestimated (this generally occurs when an ‘instalment rate’
is varied down)
• returns are lodged late (such as a BAS), or
• there is a failure to remit certain amounts (e.g. PAYG withholding).
The GIC compounding rate covers most taxes including income tax, FBT, GST and PAYG.
As shown in Table 11.6, the GIC is updated quarterly, with rates for the next quarter generally
announced two weeks before the start of that quarter.
MODULE 11
Table 11.6: General interest charge rates
Quarter GIC annual rate GIC daily rate
April – June 2018 8.77% 0.02402740%
January – March 2018 8.72% 0.02389041%
October – December 2017 8.70% 0.02383562%
July – September 2017 8.73% 0.02391781%
Quarter GIC annual rate GIC daily rate

April – June 2019 8.96% 0.02454794%
January – March 2019 8.94% 0.02449315%
July – September 2018 8.96% 0.02454794%
Source: ATO 2019, ‘General interest charge (GIC) rates’, accessed December 2018,
https://www.ato.gov.au/rates/general-interest-charge-(gic)-rates/?=top_10_rates.
➤ Question 11.2
Joseph’s quarterly BAS is lodged late with $15 000 owing. It was due to be lodged on
28 February 2019 (day that tax is due). It is not lodged and the tax is not paid until 17 March
2019. GIC is due for 17 days (28 February to 17 March 2019) at the daily GIC compounding rate
of 0.02454794 per cent.
Added to the GIC is a penalty for failing to lodge on time, which is imposed for each 28-day
period (or part thereof) that a statement is overdue. Assume that Joseph is an SBE. How much
is his penalty, and what is the GIC charge?
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Operation of the shortfall interest charge

The SIC rate is four percentage points lower than the GIC rate. It is applied in the case of
amended assessments where the amount of tax payable is increased compared with the original
assessment. The SIC replaces the GIC for the period between the due date for payment of the
original (understated) assessment and the day before the amended assessment is issued.
As shown in Table 11.7, the SIC rate is updated quarterly with rates for the next quarter generally
announced two weeks before the start of that quarter. The applicable SIC rate is the rate in the
quarter where the taxpayer is notified of the amended assessment.
Table 11.7: Shortfall interest charge rates
Quarter SIC annual rate SIC daily rate

April – June 2018 4.77% 0.01306849%
January – March 2018 4.72% 0.01293151%
July – September 2017 4.73% 0.01295890%
Quarter SIC annual rate SIC daily rate

April – June 2019 4.96% 0.01358904%
January – March 2019 4.94% 0.01353425%
July – September 2018 4.96% 0.01358904%
Source: ATO 2019, ‘Shortfall interest charge (SIC) rates’, accessed March 2019,
https://www.ato.gov.au/rates/shortfall-interest-charge-(sic)-rates/.
➤ Question 11.3
Ava incorrectly claims $700 for clothing, related to her office job in her 2016–17 tax return. The due
date for the payment of her assessment was 21 January 2018. Following an ATO audit carried
out in 2018, her claim of $700 for clothing is disallowed. Her top marginal rate is 32.5 per cent
(plus the Medicare levy of 2 per cent). An amended assessment is issued, increasing her tax liability
by $241.50 (34.5% × $700) and the amendment is notified to her on 20 July 2018.
Determine for which period and at what rate the SIC will apply.
MODULE 11
Identifying Part IVA

A general discussion on the differences between tax planning, tax avoidance and tax evasion
was provided in the section ‘Distinguishing between terms’ in Module 1.
General anti-avoidance provisions are found in the following taxation legislation:

• income tax—Part IVA of ITAA36
• GST—Division 165 of the GST Act
• FBT—s. 67 of FBTAA.
Part IVA of the Income Tax Assessment Act 1936 (Cwlth)

The anti-avoidance provisions of Part IVA of ITAA36 will apply where it appears that a taxpayer
has entered into a scheme with the sole or dominant purpose of obtaining a tax benefit.
Penalties apply for those found to have entered into a scheme proven to fall under the anti-
avoidance provisions of ITAA36 (TAA, Schedule 1, ss. 284-140–284-160).
The requirements for the application of Part IVA are as follows:

• There is a ‘scheme’ (s 177A).
• It would be concluded, having regard to the eight matters listed in s. 177D(2) of the Act,
and reproduced here, that one or more persons who entered into or carried out the scheme,
or any part thereof, did so for a dominant purpose of enabling the taxpayer to obtain
a tax benefit.
• The Commissioner of Taxation makes a determination that the whole or part of the tax
benefit is cancelled (s. 177F).
Scheme is defined in s. 177A of ITAA36 and is expressed in very broad terms. The term is used
in a neutral and not a moral sense, and refers to:
(a) any agreement, arrangement, understanding, promise or undertaking, whether express
or implied and whether or not enforceable, or intended to be enforceable, by legal
proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct (ITAA36, s. 177A).
Section 177C(1) provides that a tax benefit is obtained in a number of different ways, including:
(a) an amount not being included in the assessable income of the taxpayer in a year of income
where that amount would have been included, or might reasonably be expected to have been
included … if the scheme had not been entered into or carried out; or
(b) a deduction being allowable to the taxpayer in … a year of income where the whole or a part
of that deduction would not have been allowable, or might reasonably be expected not to
have been allowable … if the scheme had not been entered into or carried out …; or
(ba) a capital loss being incurred by the taxpayer (ITAA36, s. 177C(1)).
To determine whether a tax benefit has arisen under s. 177C, the actual tax position must be
compared with what would have arisen, or might reasonably be expected to have arisen, if the
scheme had not been entered into. This involves a comparison with an alternative postulate
(i.e. a theoretical alternative situation or counterfactual).
In FC of T v. Futuris Corporation Ltd [2012] FCFCA 32, the Full Federal Court dismissed the
Commissioner’s appeal, accepting the view that the taxpayer might have pursued transactions
different from the counterfactual offered by the Commissioner had it not used the beneficial
transactions that it did.
See FC of T v. Futuris Corporation Ltd [2012] FCFCA 32: https://www.ato.gov.au/law/view/

document?DocID=JUD/2012ATC20-306/00001&PiT=99991231235958.
MODULE 11
STUDY GUIDE | 495
The purpose test is an objective one based on the facts of the case. In this respect, s. 177D(2)
provides that regard should be had to:
• the manner in which the scheme was entered into or carried out
• the form and substance of the scheme
• the time and duration of the scheme
• the result that would be achieved by the scheme
• the change in the financial position of the relevant taxpayer that resulted, or may reasonably
be expected to result from the scheme
• the change in the financial position of any person connected with the taxpayer
• any other consequences for the taxpayer or other person connected with the taxpayer, and
• the nature of any connection between the relevant taxpayer and other person connected
with the taxpayer.
Consideration of the dominant purpose of the scheme is critical. In FC of T v. Spotless Services

& Anor [1996] 186 CLR 104, the High Court upheld the Commissioner’s assessment on the basis
of Part IVA. A rational commercial purpose for the arrangement entered into was to increase
the after-tax returns for the taxpayer by investing in the Cook Islands rather than in Australia.
However, the commercial purpose was consistent with a dominant purpose of obtaining a tax
benefit. The investment at a much lower interest rate was only sensible if Australian tax could
be avoided and this suggested that the dominant purpose of the arrangement was to obtain a
tax benefit.
See FC of T v. Spotless Services & Anor [1996] 186 CLR 104: https://www.ato.gov.au/law/view/docum
ent?DocID=JUD/96ATC5201/00001&PiT=99991231235958.
When Part IVA is contravened

If a scheme is found to be in breach of Part IVA, then the Commissioner of Taxation can cancel
the tax benefit arising under the scheme by including the amount as assessable income,
or denying a deduction.
The taxpayer may be subject to scheme penalties of 50 per cent of the tax avoided. This may be
reduced to 25 per cent of the tax avoided if the taxpayer has a contrary position that is able to
be reasonably argued (see TAA, Schedule 1, s. 284-160).
Other key cases on Part IVA

Some other key cases on Part IVA include FC of T v. Peabody [1994] 181 CLR 359; FC of T v.
Consolidated Press Holdings Ltd (No. 1) [2001] ATC 4343; Eastern Nitrogen Ltd v. FC of T [2001]
ATC 4164; FC of T v. Metal Manufactures Ltd [2001] ATC 4152; FC of T v. Hart [2004] 50 ATC 4599;
and FC of T v. Mochkin [2003] ATC 4272.
These issues are discussed in more detail in the subject Australia Taxation – Advanced.
Purpose of the adviser

The case, FC of T v. Consolidated Press Holdings Ltd (No. 1) [2001] ATC 4343, deals with a
financing structure put into place by Australian Consolidated Press (ACP) to effect a takeover of
an overseas company. The High Court found that, regardless of the overall commercial purpose
of a wider scheme, it is permissible to identify within the wider scheme a tax avoidance scheme
in respect of s. 177D (the purpose). In this case, but for a step in the wider scheme of interposing
an entity, interest deductions would not have been available.
MODULE 11
The ACP taxpayer group retained the services of a firm of accountants as a tax adviser.
ACP argued that it was unaware of the implications of a complex transaction and merely relied
upon their adviser. The High Court was prepared to accept attribution of the purpose of a
professional adviser to a person who entered into the scheme.
Discharge of duty to the client

The taxpayer is not only subject to penalties for entering into the scheme (TAA, ss. 284-140–
284-160), but may also suffer costs and reputation damage. The tax adviser is also at risk of
becoming personally liable under contract law and tort of negligence. There may be sanctions
through the tax practitioners regime (discussed in Module 1) for registered tax agents negligently
causing a taxpayer to be liable to pay a fine, penalty or a GIC.
Under laws of negligence, a duty of care arises from the relationship of professional and
client, where the latter may be expected to rely on advice. This is a positive duty to give
advice regardless of whether it is specifically requested. Given the uncertainty associated with
application of Part IVA, a mere disclaimer is inadequate within any advice and the client should
be assisted in making a decision regarding the risk of a prospective scheme.
Frequently, a client is unaware that Part IVA could apply to a scheme having a commercial
purpose, so it is important to stress that the purpose test is an objective one that does not
usually try to uncover any subjective intention. This reassurance will make it easier to raise the
issue of further investigation of the facts, perhaps involving consultation with other specialists.
The possibility of applying for a private ruling to achieve certainty should be considered,
being careful to specifically ask whether the Commissioner of Taxation may apply Part IVA to
the arrangement.

What is the regime?
The promoter penalty regime is in place in order to deter the promotion of tax avoidance
and tax evasion schemes (TAA, Schedule 1, Division 290).
Before the introduction of the promoter penalty regime, there were no civil or administrative
penalties available for the promotion of these schemes. This meant that promoters could
obtain substantial profits from the sales of these schemes, while investors could be subject to
penalties under the existing Part IVA and other tax avoidance provisions. By introducing this law,
the government has now addressed the imbalance of the taxpayer bearing the risk while the
scheme promoters avoided any penalty.
The ATO has provided clarity, stating that these laws are not intended to obstruct advisers or tax
practitioners and intermediaries from giving typical advice to their clients.
Operation of the scheme

Section 290-50 of Schedule 1 of the TAA states the following:
Promoter of tax exploitation scheme
(1) An entity must not engage in conduct that results in that or another entity being a promoter
of a tax exploitation scheme.
MODULE 11
STUDY GUIDE | 497
Implementing scheme otherwise than in accordance with ruling

(2) An entity must not engage in conduct that results in a scheme that has been promoted on the
basis of conformity with a product ruling being implemented in a way that is materially different
from that described in the product ruling.
Note: A scheme will not have been implemented in a way that is materially different from that
described in a product ruling if the tax outcome for participants in the scheme is the same as that
described in the ruling (TAA, Schedule 1, s. 290-50).
Section 290-60 of Schedule 1 of the TAA defines a promoter as follows:

(1) An entity is a promoter of a tax exploitation scheme if:
(a) the entity markets the scheme or otherwise encourages the growth of the scheme or
interest in it; and
(b) the entity or an associate of the entity receives (directly or indirectly) consideration in
respect of that marketing or encouragement; and
(c) having regard to all relevant matters, it is reasonable to conclude that the entity has had a
substantial role in respect of that marketing or encouragement.
(2) However, an entity is not a promoter of a tax exploitation scheme merely because the entity
provides advice about the scheme.
(3) An employee is not to be taken to have had a substantial role in respect of that marketing or
encouragement merely because the employee distributes information or material prepared by
another entity (TAA, Schedule 1, s. 290-60).
Section 290-65 of Schedule 1 of the TAA defines a tax exploitation scheme as follows:
(1) A scheme is a tax exploitation scheme if, at the time of the conduct mentioned in subsection
290-50(1):
(a) one of these conditions is satisfied:
(i) if the scheme has been implemented—it is reasonable to conclude that an entity
that (alone or with others) entered into or carried out the scheme did so with the sole
or dominant purpose of that entity or another entity getting a scheme benefit from
the scheme;
(ii) if the scheme has not been implemented—it is reasonable to conclude that, if an
entity (alone or with others) had entered into or carried out the scheme, it would have
done so with the sole or dominant purpose of that entity or another entity getting a
scheme benefit from the scheme; and
(b) one of these conditions is satisfied:
(i) if the scheme has been implemented—it is not reasonably arguable that the scheme
benefit is available at law;
(ii) if the scheme has not been implemented—it is not reasonably arguable that the
scheme benefit would be available at law if the scheme were implemented.
Note: The condition in para. (b) would not be satisfied if the implementation of the scheme for all
participants were in accordance with binding advice given by or on behalf of the Commissioner of
Taxation (for example, if that implementation were in accordance with a public ruling under this Act,
or all participants had private rulings under this Act and that implementation were in accordance
with those rulings).
(2) In deciding whether it is reasonably arguable that a scheme benefit would be available at law,
take into account any thing that the Commissioner can do under a taxation law.
Example: The Commissioner may cancel a tax benefit obtained by a taxpayer in connection with
a scheme under s. 177F of the ITAA36 (TAA, Schedule 1, s. 290-65).
MODULE 11
Penalties
If an entity is found to be a promoter of a tax exploitation scheme, the Federal Court can
impose civil penalties. This penalty will be the greater of:
• 5000 penalty units ($1.05 million) for an individual
• 25 000 penalty units ($5.25 million) for a body corporate, or
• twice the consideration received or receivable, directly or indirectly, by the entity or its
associates in respect of the scheme (ATO 2016).
Depending on the type or seriousness of the conduct, the ATO could also consider:
• voluntary self-correction for less significant non-compliance with these laws
• applicants for rulings (including product rulings) providing additional promises or
guarantees to mitigate taxation risks (including material differences in implementation
of the relevant arrangement)
• offers of voluntary undertakings
• issuing of warnings to lower risk entities or ‘cease and desist’ letters to higher-risk entities
(ATO 2016).
Exclusions and exceptions

People who advise on tax planning arrangements, even those who advise favourably on a scheme
later found to be a tax exploitation scheme, are not at risk of civil penalty to the extent that they
have merely provided independent, objective advice to clients (ATO 2016).
However, this ‘advice exclusion’ is limited to balanced and impartial advice. When a tax agent has
marketed or encouraged an arrangement, even by presenting an overly positive view, then the
ATO may regard this as a more ‘entrepreneurial activity’. Promoter penalties may apply if it is
reasonable to expect that a client may use this advice to promote a scheme themselves. In this
respect, the tax agent should be alert to the possibility of unwittingly assisting the promotion
of a scheme.
Employees or other entities that have only minor involvement in a tax avoidance scheme
are excluded.
If the conduct is found to have occurred by mistake or accident, the adviser is exempted.
Similarly, an event that occurs outside an entity’s control is excluded. A four-year time limit for
prosecution under the penalty regime may apply (ATO 2016).
➤ Question 11.4
Susan Johnson has always had simple tax compliance obligations. On 18 October 2018, Susan
received her income tax notice of assessment for the 2017–18 income tax year. Susan objects
to her notice of assessment. She objects to the refusal of a deduction of expenses for ongoing
maintenance on her investment property, which she rents out through the sharing economy
vehicle, Airbnb, for nine months of the year. The ATO has rejected her claim of $8450 worth
of expenses. The Commissioner of Taxation also indicated that Susan failed to take reasonable
care when making her deductions as they were clearly for capital works and consequently the
Commissioner applied a base penalty unit amount.
MODULE 11
STUDY GUIDE | 499
(a) Is Susan liable for a base penalty amount for acting without reasonable care in relation to
this matter?
Susan lodges a written objection to her original notice of assessment on 24 January 2019, which
includes an objection to the application of the penalty for recklessness.
(b) What is the final date that Susan can lodge her objection against the notice of assessment?
(c) How long does the Commissioner of Taxation have to make an objection decision about
Susan’s case?
The Commissioner of Taxation makes their decision and upholds their refusal of Susan’s claim
for the deductions and the application of the penalty. Susan is determined to seek a review of
the objection decision.
(d) Describe the review process as it relates to Susan’s case.
Susan is not successful in the review decision, and the disallowing of her deductions still stands.
(e) Is Susan able to appeal the review decision?
MODULE 11
Summary and review

Module 11 focused on the administration of the tax system and the interaction between
taxpayers and the tax authority. In particular, the module covered the process by which taxpayers
are to operate under the self-assessment system that applies in Australia.
The module began with an overview of the self-assessment environment and the requirement
of taxpayers to lodge a tax return, in most cases regardless of the type of entity. Upon lodging
a tax return, an individual taxpayer is issued with a notice of assessment, whereas a deemed
assessment arises in the case of companies. An assessment can be amended by the ATO or
requested to be amended by the taxpayer, known as ‘self-amendment’. These amendments
must be done within particular time frames.
As a method of ascertaining the correctness of these assessments, the Commissioner of Taxation

conducts audits after employing data-matching technology and exercising various information
gathering powers. If a taxpayer is dissatisfied with the assessment, the taxpayer can challenge
or dispute it by lodging an objection. There are specific time limits that apply when lodging
objections to various decisions concerning income tax, GST, FBT, superannuation, penalties and
interest, as illustrated in Table 11.1.
Where a taxpayer is still dissatisfied with an objection decision, they can generally seek a review
by either applying to the AAT or the Federal Court.
The next section of the module discussed the tax reporting and payment obligations of taxpayers.
This includes the operation of the PAYG withholding and instalment systems and the lodgment of
BASs and IASs, and maintaining a running balance account. To further assist taxpayer compliance,
the ATO issues a number of guidance documents and rulings in addition to law companion
guidelines, practice statements and ATO interpretative decisions.
However, for those taxpayers who fail to comply with the law and meet their tax obligations,
the tax system imposes penalty and interest charges. These can take the form of administrative
civil penalties for failure to lodge and failure to withhold, or criminal prosecution and penalties
for more serious offences. Along with the tax owing, there is also the GIC and the SIC that
may apply.
The final section of the module referred to the general anti-avoidance rule found in Part IVA
of ITAA36. In particular, the concept of scheme, tax benefit and having a dominant purpose of
obtaining a tax benefit are all critical elements. The operation of the promoter penalty regime
and the penalties that apply in this case are discussed along with the relevant exclusions
and exceptions.
MODULE 11
Suggested answers
Suggested answers
Question 11.1
The second quarter payment due was then calculated under TAA, Schedule 1, s. 45-400, to be
(50% × $220 000) – $50 000 (already paid) = $60 000.
Question 11.2
For an SBE, the penalty for late submission of documents (in this case the October–December
BAS) is one penalty unit ($210) for every 28 days or part thereof. Joseph is 17 days late
(28 February–17 March 2019), which is less than 28 days and consequently it would only be
one penalty unit. The GIC is due for 17 days at the daily GIC compounding rate of 0.02454794
per cent levied on the overdue tax amount of $15,000.
The amount of Joseph’s total debt is made up of the outstanding tax and the GIC:
$15 000 × (1.0002454794)17 = $15 062.72
The GIC is $62.72.
Question 11.3
The SIC at the daily compounding rate of 0.01358904% per cent (for the July–September 2018
period) would apply as this is when the taxpayer was notified of the amended assessment.

MODULE 11
Question 11.4
(a) A base penalty unit amount will only apply where there is no shortfall. There would be a
shortfall in this situation (see Table 11.4).
(b) 18 October 2020—this is two years, which is the time frame that applies to individual taxpayers
with simple affairs in relation to income tax decisions, on an original assessment.
(c) The Commissioner of Taxation generally has 60 days from the date that the objection was
lodged with the Commissioner.
(d) Susan’s first step is to use the ATO’s in-house facilitation service, which is an ADR service used
for less complex disputes, such as Susan’s. If facilitation does not work, or if she does not wish
to use the service, then Susan can seek review of the decision by applying to the AAT.
(e) Susan can appeal a review decision to the AAT or the Federal Court—but only on a question
of law to the Federal Court. If Susan has a question of law on which to appeal—such as a
misunderstanding of the effect of a prior legal case in the area of income versus capital
property deductions—then she would be able to do so (s. 44(1) of the Administrative Appeals
Tribunal Act). If she is still dissatisfied with the Federal Court judge’s decision, she can appeal
to the Full Federal Court. If still dissatisfied, she can seek special leave to appeal to the
High Court, but this is not often granted.

MODULE 11
REFERENCES | 503
References
References
ATO 2016, ‘Promoter penalty law’, accessed March 2019, https://www.ato.gov.au/general/tax-

planning/promoter-penalty-law/.
ATO 2017a, ‘Annual instalments’, accessed March 2019, https://www.ato.gov.au/general/payg-

instalments/how-often-you-lodge-and-pay/annual-instalments/.
ATO 2017b, ‘ATO interpretative decisions’, accessed March 2019, https://www.ato.gov.au/

General/ATO-advice-and-guidance/ATO-guidance-products/ATO-interpretative-decisions/.
ATO 2018, ‘Income tax return’, accessed March 2019, https://www.ato.gov.au/Business/Reports-

and-returns/Income-tax-return/.
MODULE 11
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CPA PROGRAM

Previously published as Introductory Taxation by BPP Learning Media Ltd

Edited and designed by DeakinCo.

ISBN 978 0 6482918 4 8

CPA Program team

Module 1: Legal, ethical and regulatory fundamentals 23

Module 2: Principles of assessable income 67

Module 3: Principles of general and specific deductions 107

Module 4: Capital allowances 143

Module 5: CGT fundamentals 175

Module 6: Taxation of individuals 231

Module 7: Taxation of SBEs and partnerships 301

Module 8: Taxation of trusts, companies and

Module 9: FBT fundamentals 397

Module 10: GST fundamentals 433

Module 11: Administration of the tax system 465

Before you begin

On completion of this subject, you should be able to:

Some of the resources you may find on My Online Learning include:

Table 1: Module weightings and study time

1. Legal, ethical and regulatory fundamentals 6 6 Week 1

2. Principles of assessable income 10 10 Weeks 1, 2

3. Principles of general and specific deductions 8 8 Weeks 2, 3

4. Capital allowances 7 7 Week 3

5. CGT fundamentals 15 15 Weeks 4, 5

6. Taxation of individuals 15 15 Weeks 5, 6

7. Taxation of SBEs and partnerships 6 6 Week 7

8. Taxation of trusts, companies and 9 9 Weeks 7, 8

9. FBT fundamentals 7 7 Week 8

10. GST fundamentals 8 8 Week 9

11. Administration of the tax system 9 9 Weeks 9, 10

Australia Taxation Study map

Study guide—Subject outline

• Study and exam information

• Frequently asked questions

administration queries Week 1

Study time proportion: 6%

Ask the Expert forum Study guide

Study time proportion: 10% Knowledge checks

M11 Ask the Expert forum

Weeks 9, 10 Study time proportion: 9%

• Study companion and exam

Detailed study session planning

Before you begin

— Study guide—Subject outline 15 mins

— Video: Insights for a great semester of study 6 mins

— Study and exam information 5 mins

— Study companion and exam mark allocations 30 mins

— Ask the Expert forum: Frequently asked questions and —

1 Study guide—Tax law environment 1.5 hrs

2 Study guide—Ethical principles and behaviour and 3.5 hrs

3 Study guide—Tax practitioner obligations, Tax Practitioners 3.5 hrs

— Knowledge checks 30 mins

— Ask the Expert forum: Module 1—Legal, ethical and —

1 Study guide—Defining and determining income 2 hrs

2 Study guide—Tax implications of residency and 3 hrs

3 Study guide—Derivation and Determining derivation 3 hrs

4 Study guide—International taxation core concepts 3 hrs

5 Study guide—Trading stock core concepts 2 hrs

— Knowledge checks 30 mins

— Ask the Expert forum: Module 2—Principles of —

Total 13.5 hrs

1 Study guide—General deductions 3 hrs