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CLAW 3201 Australian Taxation System What is tax??

A tax is compulsory, no goods or services in return, liability imposed according to general criteria, does not have to go into consolidated revenue. (a) income tax imposed by the Income Tax Act 1986, as assessed under this Act (b) income tax imposed as such by any other Act, as assessed under this Act There are two primary tax acts in Australia, the Income Tax Assessment Act 1936 which supplements the Income Tax Assessment Act 1997. The Income Tax Assessment Act 1997 was enacted in an attempt to rewrite the ITAA 1936 in simpler form. In order to put into effect the reforms from the review of business tax, the rewrite was abandoned. Who taxes? The government of the day decides whom to tax. Under the constitution, the federal government was given the power to levy income tax under s 51(ii). Who to tax? Income Tax Assessment Tax Act 1997, s6-5 (1) Your assessable income includes income according to ordinary concepts, which is called ordinary income (2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly and indirectly from all sources, whether in or out of Australia during the income year. (3) If you are a foreign resident, your assessable income includes: a. The ordinary income you derived directly or indirectly from all Australian sources during the income year b. Other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australian source (4) In your working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf as you direct. Income Tax Assessment Tax Act 1997, s6-10 (1) Your assessable income also includes some amounts that are not ordinary income (2) Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income (3) If an amount would be statutory income apart from the fact that you have not received it, it becomes statutory income as soon as it is applied or dealt with in any way on your behalf as you direct. (4) If you are an Australian resident, your assessable income includes your statutory income from all sources, whether in or out of Australia (5) If you are a foreign resident, your assessable income includes:

a. Your statutory income from all Australian sources; and b. Other statutory income that a provision includes in your assessable income on some basis other than having an Australian source How much to tax? Income Tax Assessment Act 1997, s4-10 (1) You must pay income tax for each financial year. (2) Your income tax is worked out by reference to your taxable income for the income year. The inome year is the same as the financial year, exept in these cases: a. For a company, the income year is the previous financial year; b. If you have an accounting period that is not the same as the financial year, each such accounting period or, for a company, each previous accounting period is an income year. (3) Work out your income tax for the financial year as follows: Income Tax = (taxable income*Rate) Tax offsets Income Tax Assessment Act 1997, s4-15 (1) Work out your taxable income for the income year like this: Taxable Income = Assessable income Deductions When to tax? Income Tax Assessment Act 1997 s3-5 (1) Income ax is payable for each year by each individual and company, and by some other entities. What makes a good tax system? (1) Equality the subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state. (2) Certainty The tax that each individual was bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment and the quantity to be paid should be clear and plain to the contributor, and to every other person. Uncertainty can cause insolence and corruption. (3) Convenience of Payment Every tax should levied at the time or in the manner in which it was most likely to be convenient for the contributor to pay it. (4) Economy of Collection Every tax should be so contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state. Tax should not be more burdensome to the people than they are beneficial to the government (1) Equity Person in the same situation should be treated equally and those in different situations be treated differently, with those more favorably placed being able to pay more.

(2) Simplicity A tax is simple if for each dollar raised by it the cost of the official administration is small and if the compliance costs, the costs in money and effort of all kinds to the taxpayer are also small. (3) Efficiency Efficiency requires that the resources available to the public use be as nearly as possible equal to the resources withdrawn from the private sector. The cost of administering and complying with the tax law is a dead weight cost to the community and should be minimized. These were determined to be the dominant tests of merit for the tax system as a whole, while other features, such as flexibility may also be desirable. Prevention of tax avoidance and international competitiveness are also desirable. There are three sources of Tax Law. ITAA 1936 and ITAA 1997; Common Law Cases from the federal court in the High Courts of Australia; After 1 July 1992, Rulings where they are more favourable to the tax payer than the general law. There are other tax legislation that supplement these in: Fringe benefits tax assessment act 1986 A new tax system act (GST) 1999 Income tax rates act 1986 Taxation administration act 1953 International tax agreements act 1953

Residence and Source Resident is defined in ITAA 1936 s6, as (a) a person, other than a company, who resides in Australia and includes a person: i. whose domicile is in Australia, unless the Commissioner is satisfied that the persons permanent place of abode is outside Australia; ii. who has actually been in Australia, continuously or intermittently, during more than one-half of the year of income, unless the Commissioner is statisfied that the persons usual place of abode is outside Australia and the person does not intend to take up residence in Australia; or iii. who is A. a member of the superannuation scheme established by deed under the superannuation act 1990; or B. an eligible employee for the purposes of the superannuation act 1976; or C. the spouse, or a child under 16, of a person covered by sub-subparagraph (b) a company which is incorporated in Australia, or which, not being incorporated in Australia, 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. Residents are assessable on their derived worldwide ordinary income (ITAA s65 (4)) and statutory income (ITAA s6-10 (3)).

Individual Residence
Foreign Resident is defined in ITAA 1997 s995-1 as: A person who is not a resident of Australia for the purposes of the Income Tax Assessment Act 1936. Foreign residents are assessable only on their Australian sourced income under ITAA 1997 s6-5 (3) and ITAA 1997 s6-10 (5). Australian Resident is defined in ITAA 1997 s995-1 as: A person who is a resident of Australia for the purposes of the ITAA 1936. Resident is defined in ITAA 1936 in s6(1) as is written above. Residence comes with two issues; The issues of either gaining or losing residence. The tests for indicidual residence may be summarized as follows: reside test domicile test 183 day test commonwealth superannuation fund test Reside Test Reside test is very broad and most difficult to apply. It means literally person who resides in Australia according to the everyday meaning of the term resides. Levene v IRC [1928] AC 217 The taxpayer was held to be a resident of England: Even though the tax payer was out of United Kingdoms for more than half the year (7 months per year), the tax payer was still deemed to be a resident, because he did not set up a new fixed place of living. Once the taxpayer took a lease on a flat in Monte Carlo, thereby setting up a new place of residence, he was no longer deemed to be a resident of England. IRC v Lysaght [1928] AC 217 The taxpayer was held to be a resident even though he was physically present in England for only about a week each month. Gregory v FCT [1937] 57 CLR 774 A person may reside in more than one country at the same time. The tax payer had business interest in Darwin as well as a lease. He also had a place of abode in Broome. It was held that even though he was a resident of Broome, his giving as much or more attention to his business in Darwin, as well as the social and living arrangements he made in Darwin. TR 98/17 covers persons entering Australia for work, study and holidays. It illustrates the ATOs position on the application of the reside test. Need to consider: intention or purpose of presence, family and business/employment ties, maintenance and location of assets, social and living arrangements.

Domicile Test A person is a resident of Australia If domiciled in Australia, unless it can be established that the permanent place of abode is outside Australia. The concept of domicile comprises physical residence and an intention to remain permanently or indefinitely in the place of residence. Domicile of origin is the domicile acquired at birth. If domicile is then changed, it is known as a domicile of choice. Factors to consider when determining domicile are: the length of absence from Australia Whether a dwelling was maintained in Australia while the taxpayer was absent Whether the taxpayer took out long-term accommodation outside Australia The location of the taxpayers economic interests The location of the taxpayers social connections FCT v Applegate (1979) 9 ATR 899 The taxpayer was not held to be a resident, and to not hold a permanent place of abode for the year ended June 1972. The taxpayer went to Vila in 8 November 1971, retaining no assets in Australia, giving up tenancy of his Sydney flat. His family accompanied him. He took up a lease for 12 months in Vila with an option to renew for another 12 months. Jenkins v FCT (1982) 12 ATR 745 Court regarded the period of three years as significant and held that the taxpayer had a permanent place of abode outside of Australia. This has basis of 183 day rule, and since the taxpayer was outside of Australia for more than 183 days, it was held that the tax payer, for that year, had a permanent place of abode outside of Australia. Ruling IT 2650 Ruling IT 2650 deals with the interpretation of permanent place of abode outside Australia. As a rule of thumb under IT 2650, if a taxpayer is overseas for two or more years, they are said to have a permanent place of abode outside Australia. The criteria for losing resident status is: the intended and actual length of the individuals stay in the overseas country any intention either to return to Australia at some definite point in time or to travel to another country the establishment of a home outside Australia the abandonment of any residence or place of abode the individual may have had in Australia the duration and continuity of the individuals presence in overseas country the durability of association that the individual has with a particular place in Australia. The weight to be given to each factor will vary with individual circumstances of each case and no single factor is conclusive.

183 days test A person will be a resident of Australia if he or she has actually been in Australia, continuously or intermittently, during more than one half of the year of income, unless the Commissioner is satisfied that their usual place of abode is outside Australia and that they do not intend to take up residence in Australia. Under s6-(1) of the ITAA 1936, the taxpayer needs to have presence in Australia of more than half the year, so exactly half the year does not qualify. Under the 183 tests, the taxpayer will be considered to be a resident for the whole year. Commonwealth Superannuation Fund Test This test has a limited scope and applies to members of Commonwealth superannuation funds and their families. It does not apply to retirees, as they are former members. Temporary Individual Resident Temporary individual residents is a separate category of resident with individualized tax treatment. A temporary resident is defined as an individual who holds a temporary visa granted under the Migration Act 1958: s995-1 of ITAA 1997. Exception: an individual would not be a temporary resident if either: (a) the individual or his/her spouse is an Austraian resident within the meaning of the Social Security Act 1991 (b) before becoming a temporary resident, the individual has been an Australian resident for income tax purposes ITAA 1997 s768-910 A temporary resident is taxed as a non-resident, except for employment related income. The individual would be taxed only on ordinary income and statutory income sourced in Australia, unless the income is related to his employment.

Company Residence
Company residence is pursuant to s 6(1) of the ITAA 1936, which states that a company is a resident of Australia if: it is incorporated in Australia if it is not incorporated in Australia, it carries on business in Australia and either: o has its central management and control in Australia; or o its voting power is controlled by shareholders who are residents of Australia Incorporation Test This refers to incorporation under the relevant company law of Australia. Whether or not this test is satisfied is a question of fact under the Corporations Act 2001. Under the Corporations Act 2001, the issue of a certificate of incorporation is conclusive evidence of the fact of incorporation, irrespective of any incorporation defects in registering the company. Central Management and Control Test Central management and control test looks to see where the real control of the company is located. This refers to decisions on board company policy, financing policy and business strategies made at directors meetings. In practice, central management and control, is taken to be located where the directors meetings take place. Advent of technology, with cyber communications, the relevance of the place of where directors meetings are held may need to be reconsidered. Malayan Shipping Co Ltd v FCT (1946) 71 CLR 156 It was held that the company was a resident of Australia and the source of income was also in Australia. The company argued that they were not carrying on business in Australia, however since the preparation and execution of the documents occurred in Australia this was overruled. Further Mr Sleigh, who was the managing director, managing agent and majority shareholder, was also residing in Australia. TR 2004/15 This states that for a company to be a resident the two requirements are that the company must be carrying on business in Australia, therefore, trading activities must take place in Australia and central management and control must be in Australia Voting power and carrying on business test The third test applies where a company, not incorporated in Australia, has its voting power controlled by shareholders who are residents of Australia and carries on business in Australia. Control of voting power in general means at least greater than 50 per cent control of voting shares.

Carrying on business requires that some business activities must be conducted in Australia. Preferably, the core activities of the company must have some connection with Australia as opposed to some minor connection. Dual Residency Company A company may have dual residency on the basis that it may be incorporated in one jurisdiction but have its central management and control in another jurisdiction. There must be a division of central management and control before a company can be found to have residence in two places. North Australian Pastoral Co Ltd v FCT (1946) 71 CLR 623 It was held that the company had dual residence in both Queensland and Northern territories as central management and control was exercised in both jurisdictions. Koitaki Para Rubber Estates Ltd v FCT It was found that the company was exclusively a resident of Australia. Even though an officer in Papua under power of attorney managed the company, the board of directors resided in Sydney and always met there. Because of dual residencies, Australia has double tax treaties with over 40 countires. This overrides domestic law according to the International Tax Agreements Act 1953 s4(1) Residence concluded Residence is a test of fact and a matter of degree. It is a question of balance.

Source

Source is defined by [p6szzNon residents in general are assessable only on ordinary and statutory income which is derived from an Australian source, unless the income tax law stipulates otherwise. Legislation for the source is mainly found in ITAA 1936: S 25(2): Interest on a loan secured by the mortgage if any property in Australia in general is deemed to be derived from a source in Australia. S 6C: Royalties derived by a non-resident that are paid by a resident are generally deemed to have an Australian source Source of Personal Exertion Source is a question of fact and the courts look to a number of factors to determine this. The weight given to each factor varies according to he type of income: For income from personal exertion, major factors include: (1) the place where the contract is entered into (2) where the performance occurs (3) where the payment is made Nathan v FCT (1918) 25 CLR The legislature in using the word source meant, not a legal concept , but something which a practical man would regard as a real source of income. Legal concepts must, of course, enter into the question when we have to consider to whom a given source belongs. CT (NSW) v Cam & Sons Ltd (1936) 36 SR (NSW) 544 Some of the mens income was derived in New South Wales and some was derived outside New South Wales according to the working time spent in and out of the jurisdiction. The men were employed in NSW at dockside, and were paid in NSW when their ships returned, but bulk of the services were done outside NSW water. FCT v French (1957) 98 CLR 398 It was held that Frenchs source of income was outside of Australia. He was a resident of Australia and got contracted and paid in Australia, however, the work was carried out in New Zealand. FCT v Mitchum (1965) 113 CLR 401 Mitchums income was said to not be from an Australian source as the most important factor was the actor, rather than the place of service. This is saying that French does not say income from personal services is always sourced from where it is performed. FCT v Efstathakis (1979) 9 ATR 867 Opposite of above, it was held that the taxpayers income was sourced in Australia. Even though she was employed by a Greek company and got sent by

the Greek Ministry, the place of performance was the most important factor in this case, as it was a relatively simple task. Source of Business Income The source of business income is more difficult to determine. FCT v United Aircraft Corp (1943) 68 CLR 525 It was held that the income did not have an Australian source. The taxpayer was an American resident company, which entered into an agreement to license an Australian company to use its plans to manufacture certain aircraft engines. The rulings of United Aircraft Corp was overturned by the enactment of s 6C of the ITAA 1936 and the expanded definition of royalty in s 6(1) of the ITAA 1936 Cliffs International Inc v FCT (1985) 16 ATR 601 It was held that the commission on the overseas sales agreements did not have an Australian source, while the royalties payments did have an Australian source by virtue of s 6C of the ITAA 1936. The royalties were for iron ore produced and sold by the joint venture in Australia, while the sales were negotiated and concluded with overseas clients. Sources of Dividends The source of dividends cannot always be determined by the location of the share register. Instead the source in general is the location where the funds enabling the payments of the dividend arise. Esquire Nominees Ltd v FCT (1973) 4 ATR 75 It was held that the source of the dividends was Norfolk Island since this is where the taxpayer made its decision to invest and this was the location of the fund from which the dividend was paid. Even though there was a long chain, the court would not trace through the chain of companies. Source of Interest Section 25(2) of the ITAA 1936 provides that where a loan is secured by a mortgage on property in Australia, the interest is deemed to have derived from an Australian source. Spotless Services Ltd v FCT (1993) 25 ATR 344 It was held that the source of the loan was outside of Australia. The high court held that there was a case of tax avoidance, however in terms of source of interest, the source was outside of Australia since the taxpayers solicitor had flown to the Cook Islands, the contact of loan had been negotiated there and the money made available there.

Income

Income From Labour ITAA 1997 s6-5(2) says that an Auustralian residents assessable income includes the ordinary income you derived directly or indirectly from all sources. ITAA 1997 s6-5 (3) states that if you are not an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all Australian sources ITAA 1997 s6-10 says that assessable income includes some amounts that are not ordinary incomes. These are called statutory incomes such as: return to work payments accrued leave transfer payments bounties and subsidies profits from a profit-making undertaking or plan royalties insurance or indemnity for loss of assessable income interest on overpayments and early payments of tax. Income on ordinary concepts The general principle here is a gain from a persons labour, in employment or for personal services, is income under ordinary concepts. Generally for income: 1. Payment is linked to the provision of employment or services 2. The payment is often recurrent 3. Services are provided for the purpose of obtaining a gain Scott v DCT (NSW) It was held that the extra money received by the taxpayer was an unsolicited gift and therefore not income. The money was not given for the service. Must be income according to the ordinary concepts and usages of mankind. Sufficient Nexus The payment has to be sufficiently connected to the employment or services. Even if its third party, as in Dixon. Dixon v FCT (1952) 86 CLR 540 It was held that the extra remunerations, that the company paid the taxpayer for enlisting in the army, was indeed income. One of the reasons is because the payments were periodical and were added onto the original income. The payments were incidental to the taxpayers employment as a soldier. This also holds that gifts from third parties can be considered income. Eisner v Macomber 252 US 182 (1920) It was held that the increase in wealth due to a pro rate stock dividend was not income. The shareholder received no other cash or property, and retained the same portion of the corporation. This brought about the idea of the fruit and the tree.

Hayes v FCT (1956) It was held that the shares received was not income, rather a gift. Facts show that the taxpayer was fully remunerated for his services. The employer did very with the floats, and gave gifts to others as well, not just employees. This shows that the motive of the donor was to give a gift, rather than income. Saved outgoing can be income International Nickel Australia Ltd v FCT (1977) 137 CLR 347 The company made an exchange gain which was held to be assessable income. The purchase price was fixed in sterling, however after a year with the devaluation of sterling, the taxpayer paid a lesser amount in Australian dollars. This was deemed to be a trading profit. Warner Music Australia Pty Ltd v FCT (1996) 34 ATR 171 It was held that the refund of an amount previously deducted should not necessarily be included in assessable income. Smith v FCT (1987) 19 ATR 274 It was held that the payments for further study were assessable. Since there were no other connections, the payment was definitely a result of the employment relationship. Constable v FCT (1952) 86 CLR 402 It was held that the money taken out of the superannuation was not assessable under s 26(e) of the ITAA 1936. This is because the money was capital, and it didnt amount to allowing, giving or granting him the benefit FCT v Holmes It was held that the reward gotten for the successful salvage was income because the payment was for the provision of a service. Even though the service was outside of employment, it is still assessable income under s26 (e) of the ITAA 1936 Payne v FCT (1996) 32 ATR 516 It was held that the frequent flyer points were not ordinary income since its not able to convert it to cash. It was held that there was not sufficient nexus, the third party wasnt aware of the relationship. Brent v FCT (1971) 125 CLR 418 It was held that there was no sale of an asset as the taxpayer was not an original owner of the copyright. Since it was not property it was deemed to have ben a provision of services for reward and therefore the payment was accordingly income. FCT v Cooke and Sherden (1980) 10 ATR 696 It was held that the prizes were not income on general principles since the taxpayer did not provide a service and the benefits were not convertible to cash. If these benefits had been convertible to cash they would have been income on ordinary concepts.

Tennant v Smith (1892) AC 150 It was held that paying for the mans accommodation was not income, as it was not convertible to cash. It was held that it was not assessable. Higgs v Olivier (1951) Ch 899 It was held that the payment for not act in anything else was capital amount. The service for acting in the film was fully performed. Perhaps if agreement was made while he was still acting for the film, it would have been considered income. Dickenson v FCT (1958) 90 CLR 460 It was held that the payments made were capital. The restrictive covenant in this case involved substantial sterilization of rights to trade. FCT v Woite (1982) 13 ATR 579 It was held that the payment for signing an agreement to not play football for any other team was a non-assessable capital receipt. Reuter v FCT (1993) 24 ATR 527 It was held that the payment was assessable income as a reward for services.

Income from Business There are a number of factors in determining whether a business is being carried on: System and organization Profit motive Size and scale of activity Frequency of transactions Nature of property Supplementary work done on the property Circumstances responsible for the realization Ferguson v FCT (1979) 9 ATR 873 It was held that the taxpayer was carrying on business and the expenditures were deductible. The taxpayer carried on activities such as reading periodicals, maintaining a card system. Today under Div 35 of the ITAA 1997 his losses would be quarantined to the farming business due to its small scale. FCT v Walker It was held that the taxpayer was carrying on a business. Similar to above, the taxpayer did a series of things to prove that he was carrying on business. Watson v DCT (2010) 75 ATR 225 It was held that the taxpayer could not deduct the losses against the insurance payments since the payments were not from the business Evans v FCT (1989) 20 ATR 922 It was held that the taxpayers gambling was not business rather a hobby since it was lacking organization and no attempt was made at maximizing profit. FCT v Stone All the extra amounts were held to be income. This is because the income was part of the business she was carrying on, even if unsolicited Californian Copper Syndicate v Harris (1904) 5 TC 159 The profit from selling the mines were held to be assessable income. The court decided that the taxpayer intended at the time of acquisition to resell the mine at a profit rather than work the mine. The court looked available capital to work the mine. Western Goldmines (NL) v DCT (1938) 59 CLR 729 It was held that the profit from selling the mines was not held as assessable income because they had intention to and did work the mines. Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188 It was held that the proceeds from the sale of land were not assessable income. This is because the company used the land for mining for a long period.

FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355 It was held that the income from the sale of land was income. This is because when the new owners came in their intention was to sell the property. FCT v Myer Emporium Ltd (1987) 163 CLR 199 The high court held that the funds from selling the right to receive interest income was assessable income even though it was outside the scope of the business. The right to receive income from a property was a revenue asset and its sale price accordingly is income. FCT v Cooling The payment for allowing the other company becoming a tenant was held to be assessable income. Westfields Ltd v FCT (1991) It was held that the profit made from the selling the property was not assessable income. This is because the taxpayers intentions was to run a shopping mall when it bought the property, which it went on doing as a tenant of the person who they sold it to. FCT v Montgomery It was held that the lease incentive is assessable income. Evans Medical Supplies Ltd v Moriarty (1958) It was held that the confidential information was capital. The purchaser agreed to keep it confidential. Rolls-Royce Ltd v Jeffrey As opposed to Evans Medical Supplies, the payments received from the selling of the intangible assets was held to be income. GP International Pipecoaters Pty ltd v FCT (1988) It was held that the price used to build the plant was income. The plant had no further use after the services performed, otherwise may have been able to be consider as capital. Statham v FCT It was held that the receipts were on capital account, since the trustees were not carrying on a business of subdivision. Subdivision was done by the council. Moana Sand Pty Ltd v FCT It was held that the payment received for the resumption of land by the government was assessable income, since the taxpayer had intention of selling for profit. It doesnt Shields v DCT It was held that the losses were part of the business. This is because of his extensive commercial knowledge and his strategy.

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