Part A: The Tax Formula, Tax Collection Mechanisms

Ascertainment of Tax Liability

The Annual Accounting Requirement
 The system of accounting that is adopted by the Income Tax Assessment Act is predominantly periodic. As a result, in calculating the
amount of tax payable, a taxpayer must:
o Look at each accounting period
o Consider and then record each event within that period in isolation
 Section 4-10 indicates that a taxpayer’s liability to tax is computed by reference to a taxpayers taxable income for the income year. An
‘income year’ or ‘income period’ is the same as the financial year, which commences on 1 July of each year and ends on 30
June of the following year.
 There are however two exceptions to this rule:
1. In the case of companies the income year is the previous financial year
2. In limited circumstances companies can reconcile their tax liability by reference to a substituted accounting period which
ends on a date other than 30 June.

The Tax Formula

The ascertainment of tax liability is governed by the tax formula set out in sections 4-10 to 4-15 ITAA1997:
Tax payable/Refund Entitlement = [(Assessable income – Allowable deductions) x Tax rate ] – offsets - tax already paid
+ Medicare levy and surcharge + HELP debt

This formula is comprised of a 3 step process:

1. Taxable Income for the Year
2. Gross Tax Payable; and
3. Net Tax Payable or Refund Entitlement

The Taxing Process

Individual Tax Rates 2016/17
Resident Individual rates for 2016/17
Taxable income Tax on this income

0 – $18,200 Nil

$18,201 – $37,000 Nil + 19% of excess over $18,200

$37,001 – $87,000 $3,572 + 32.5% of excess over $37,000

$87,001 – $180,000 $19,822 + 37% of excess over $87,000

$180,001 and over $54,5232+ 47% of excess over $180,000

Taxpayer a resident for only part of year – reduced tax-free threshold

Example
 Lye Heng arrives in Australia on 20 October 2016 to take up permanent residence. From 1 February 2017 to 30 June 2017,
she earns $31,000.
 The reduced tax-free threshold is $13,464 + [$4,736 x 8/12] = $16,621.
 The first $16,621 of Lye Heng’s taxable income is tax free. The remaining $14,379 is taxed at 19%.

Foreign-Resident Individual rates for 2016/2017

Taxable income Tax on this income

0 – $87,000 32.5% on the entire amount

$87,001 - $180,000 $28,275 + 37% of excess over $87,000

$180,001 and over $62,685 + 47% of excess over $180,000

• Progressive Rates
• Marginal Rates
• The Temporary Budget Repair Levy
• Contrast the tax rates for residents and non-residents
• The Backpacker’s Tax

APPLICATION OF THE TAX FORUMLA

Illustrative Example – (FYE 30.06.2017):
 Claire, a single resident, earns $70,000 in wages in the current year and her employer withholds $15,000 in PAYG tax. She has $500
in deductions and is entitled to a medical expenses tax offset of $1,030.
 Required:
o Calculate Claire’s taxable income;
o Calculate Claire’s net tax liability or refund that she is entitled to.

HELP – Higher Education Loan Programme (previously HECS)

 Recovery of the HELP debt is through the PAYG withholding system
 The repayment schedule is based on a progressive scale:
 starting from a rate of 4% where HELP repayment income is between $54,870 and $61,119
 with the maximum repayment rate at 8%, where HELP repayment income is more than $101,900 (for 2016/17).
Tax Offsets (Rebates)
 Tax offsets provide income tax relief to taxpayers
 Offsets/rebates reduce the actual amount of tax payable -- more valuable than deductions of equal quantum
 $100 offset reduces tax payable by $100;
 $100 deduction reduces tax payable by $100 multiplied by taxpayer’s marginal tax rate, e.g. $100 x 30% = $30 tax reduction

Medicare Levy
Medicare Levy Act 1986
 Most individual resident taxpayers are liable to pay the Medicare levy which is based on their taxable income. The rates for 2016-
17 are as follows:
Taxable Income ($) Levy Payable

0 – 21,655 Nil

21,656 – 27,068 Nil + 10% on excess over $21,656

27,069 + 2% on entire taxable income

 Married Taxpayers – No Medicare levy is payable where the family income does not exceed $36,541. This threshold is increased
by $3,356 for each dependent child or student.
 Medicare Levy Surcharge of 1% is imposed on taxpayers whose income for surcharge purposes exceeds $90,000 pa and who do
not have private health insurance. For families, the threshold is $180,000 pa plus $1,500 for the second and every subsequent
dependant child.

Tax Collection Mechanisms

Tax File Number (TFN)
 Taxpayers have the option of providing a TFN to their employer, their bank or the company whose shares they own.
 Failure to provide a TFN is not an offence, but may result in tax being deducted at the highest marginal tax rate. Or in benefits being
denied.

Australian Business Number (ABN)

 The ABN is a unique identification number for all businesses dealing with government.
 Entities required to register for GST purposes must have an ABN and failure to quote an ABN when required to do so may result in
tax being withheld at the highest marginal rate.

Pay As You Go (PAYG)

 The PAYG is a system for reporting and withholding amounts and tax on business and investment income
 PAYG has two parts - the PAYG withholding system and the PAYG instalment system

PAYG Withholding PAYG Instalments

 Amounts are withheld in respect of particular payments or
transactions by
 the person who makes the payments
o Payments to employees;
o Payments under labour hire agreements.
 Investment Income
 Certain non-cash benefits are also caught
 These amounts are then paid (remitted) to the Commissioner
Businesses that register for GST generally pay their income tax in
quarterly payments at the same time as their GST when they lodge
their Business Activity Statement
Businesses may offset GST credits against income tax instalments
and other payments (eg, fringe benefits tax instalments) that are
made at the same time
 Non-GST payers also make quarterly PAYG instalments
unless they have a tax liability of <$8000, in which case they
can pay an annual instalment
The Small Business Entity (SBE) System
Div 328 ITAA 1997 (post 1 July 2007)
 The SBE system has been designed to benefit small businesses by:
o reducing tax liability;
o simplifying reporting requirements (for determining income and deductions, capital allowances and trading stock);
o reducing compliance costs by simplifying record keeping requirements.
 Eligibility criteria:
1. the taxpayer must carry on a business during the year, and
2. the taxpayer satisfies the < $2 million aggregate turnover test.

Business that opt for the SBE system can:

 Obtain an immediate deduction for certain advance payments under the 12 month pre-payment rule;
 Obtain an immediate write off for depreciable assets costing less than $20,000, and can access the simplified pooling
arrangements which provide accelerated depreciation deductions for other assets that are installed ready for use between 12 May
2015 and 30 June 2018; ***
 Adopt a simplified treatment for trading stock, by ignoring the difference between the opening and closing value of trading stock (up
to $5,000);
 Only have their assessments amended by the Commissioner within 2 years (rather than 4 years for most other businesses)
 Apply the reduced tax rates (from 1 July 2015) – see attachments to Lecture 3 PPT slides
 *** Note: From 1 July 2018, the $20,000 instant write-off threshold will revert to the former value of $1,000.

Self-Study Questions
ATSM 27th Edition
PAYG
PAYG Instalment: 246 – The solution to this question describes the mechanics of the PAYG system very clearly
PAYG Withholding: 259

Tax File Number

258 – The solution to this question provides a clear overview of the taxpayer’s obligations with respect to the TFN
system
Tasks
Reflection Tasks from the BUSL320 Assessment Guide, pages 26-27.

Download the 2014 Tax Pack from the unit’s iLearn page
 Part B: The Income Concept: Incidental Issues

Module 1: International tax issues:

Australia’s jurisdiction to tax
 Residence
 Source
 Treatment of Foreign Sourced Income of Residents
 Treatment of Australian-sourced Income of Non-residents

Module 2: Tax accounting for receipts:

 Choice of Method
 The Small Business Entity System

Australia’s Jurisdiction to Tax Income of Residents

Legislation
Sections 6-5(2) and 6-10(4) ITAA 97
Australian residents are taxed on:
 Ordinary income [sec 6-5 (2)] and;
 Statutory income [sec 6-10 (4)];
 Derived directly or indirectly;
 From all sources whether in or out of Australia
Look at the relevant sections of the legislation

– Issues & Definitions

 The context in which the residence of individuals comes up as a tax issue
 Sec. 6 (1) ITAA 36 – definition of “resident” individual:
o Four alternative tests:
1. The ‘common law’ test (i.e. you reside in Australia)
2. The ‘domicile’ test
3. The ‘183 day’ test
4. The Commonwealth ‘superannuation fund’ test

1. The “Common Law” Test

Relevant Considerations:
 Behaviour while present in Australia: Consistent with that of a resident?
 Intention or purpose of presence
 Family, business/employment ties
 Maintenance and location of assets
 Social and living arrangements
 Period of physical presence in Australia
 The weight to be given to each factor will vary with each case and no single factor is conclusive

2. The “Domicile” Test

 If a person is domiciled in Australia, then he/she remains a resident of Australia – even if they live overseas - UNLESS the ATO
is satisfied that the person has made the other country his/her permanent home.

CASES:
FCT v Applegate (1979) *Krever 329
FCT v Jenkins (1982) *Krever 330

 Taxation Ruling IT 2650: Residency – Permanent Place of Abode outside Australia

Relevant Considerations:
a) The intended length of the individual’s stay in the overseas country;
b) The duration and continuity of the individual’s presence in the overseas country;
c) Any intention either to return to Australia at some definite point in time or to travel to another country;
d) The abandonment of any residence in Australia; and
e) The durability of association that the individual has with a particular place in Australia.x
The weight to be given to each factor will vary with individual circumstances and no single factor is conclusive.

3. The “183-day” Test

 Physical presence in Australia on a continuous or intermittent basis for 183 days or more in a year of income.
EXCEPTION: if the ATO is satisfied that:
 the individual’s usual place of abode is outside Australia; and
 the individual does not intend to take up residence in Australia

4. “ Commonwealth Superannuation Fund” Test

 Members, spouses, & children under 16 years
The Tax Treatment of Working Holiday Maker’s – (WHM’s)
From 1 January 2017, a WHM’s residency status is no longer relevant, as all individuals who satisfy the definition of ‘working holiday maker’
in the Income Tax Rates Act 1986 will pay tax at the same rates on their ‘working holiday taxable income’ whether a resident or a
non-resident. In effect, a WHM who is a resident is not entitled to the tax-free thresholds.

Under the changes, the first $37,000 of ‘working holiday taxable income’ is taxed at 15% and then the balance is taxed at the standard rate
applicable to residents.

EXAMPLE: Sergio is a non-resident for income tax purposes. He is a WHM for the whole of the 2015-16 year, earning $75,000 in total.
Sergio pays tax at the rate of 15% for the first $37,000 and 32.5% on the remaining $38,000 (total tax of $17,900).

NOTE That: Entities that employ WHM’s are required to register with the Tax Office.

TASKS:
Read Woellner (27th edn.) 24-214 on “Temporary Residents” – and prepare your own short notes.
What are the differences between WHM’s and Temporary Residents?

Resident Companies
Section 6 (1) ITAA 1936 definition of “resident”:
An Australian resident company is one which is either:
1. Incorporated in Australia; or
2. a Foreign Registered Corporation, that
a) conducts business in Australia; and
b) Either has its
 central management and control in Australia; or
 voting control in Australia
Source of Income
Significance of ascertaining the source of income for tax purposes:
 Fundamental to the imposition of tax
 Are central to obtaining relief from double taxation.
 There are no specific statutory guidelines to establish the source of income
 The source of an item of income is factual, and is determined separately in each case.
While there are general rules for different types of income, consideration must always be given to the facts surrounding each case.

Role of Double Tax Agreements (DTAs)

DTAs may limit the ability of the ATO to assess tax on particular types of income – may allocate the taxing rights to a particular country

The following guidelines have emerged from the cases:

Income Type
Employment:
(Salary + Wages)
Professional Services:
(creative skills, specialized
knowledge)
Trading Income or Business
Profits
Dividends
Interest
Rental
Royalties received for
technical know-how and services
supplied outside the country
Royalties received in respect of
the right to use property
–(e.g. copyright, patents, designs,
mines of fields… etc)
Factors determining source Case
Where the services / duties were performed FCT v French (1957)
Krever 333
Where the contract is made FCT v Mitchum (1965)
Krever 334
Where the contract is made; or services are C of T (NSW) v Cam & Sons Ltd
performed in relation to the contract (1936)
Where the profits, out of which the dividend Esquire Nominees v FCT (1973)
is paid, are earned Krever 336
Where the obligation to pay the interest Spotless Services Ltd v FCT (1995)
arose (i.e. where the loan contract is made) Krever 357
Where the property is located -
Sourced in the country where the contract FCT v United Aircraft Corp (1943)
is made and the know-how is provided Krever 332
Sourced in the country where the property -
is located
Foreign Source Income of Residents
1. Under the Exemption System: - certain types of foreign sourced income are excluded from domestic tax
Examples:
 Foreign Sourced corporate income
 Section 23AF ITAA 36: income derived in respect of approved overseas projects (Woellner 24-210)
 Section 23AG ITAA 36: overseas employment income derived from services provided by Australian residents overseas
(limited to certain types of employment)

2. Foreign Income Tax Offset -- Div 770 ITAA97

(Post 1 July 2008)
(Woellner 24-380)
Australia fully taxes overseas income but provides an offset for any foreign taxes paid on that income

Conditions:
 Foreign tax must have been paid on the foreign income derived by the Australian resident
 Australian resident must gross up their foreign income to include the foreign tax paid, then apply the offset
 The offset can only be claimed for the income year in which the double taxed income is included in assessable income
 The amount of the tax offset is based on the amount of foreign income tax paid
 The offset is generally the lesser of:
 the amount of foreign tax paid; and
 the Australian tax payable on that income
Exception: if the foreign income tax does not exceed $1,000, an offset is available for the full amount of foreign tax paid.

Australia’s Jurisdiction to Tax Foreign Residents

 Generally the country of source has the primary taxing right with respect to income derived by foreign residents.
 Section 6-5(3) and 6-10(5) ITAA 97 -- Foreign residents are taxed in Australia only on their ordinary and statutory income that is derived
directly or indirectly from Australian sources.

Note – where there is a double tax agreement:

 Australia can only tax the business profits of a foreign resident corporations if those profits are earned by a permanent establishment
through which the foreign resident carries on business in Australia.
 The concept of a permanent establishment in the DTAs overrides the domestic source rules for determining the country which can tax
the business profits of foreign residents.
Woellner 24-570

Problem
 Countries are not under any obligation to collect tax on behalf of other countries
 To overcome this problem, a withholding tax mechanism (i.e. – the PAYG withholding) is employed to collect tax at a flat rate on
interest, dividends and royalties paid to non-residents (Woellner 24-600).
 The payer – (i.e. the Australian agent) - must withhold the tax from the gross receipts and remit it to the ATO.
 In the case of investment income, whilst the tax is withheld at a low rate (eg, for dividends, at a rate between 0% and 30%), this
satisfies the foreign resident taxpayer’s final tax liability
 For an overview of the W/T rates, see Woellner 24-605

Revision Questions
Students are advised to look at questions 9, 16, 17and 31 from ATSM (27th edn) which deal with residence and source issues.

Tax Accounting: Key Issues

Key Issues:
1. Quantification of Receipts: Receipts and outgoings tax accounting
2. Timing:
3. Common Themes
 Allocation of receipts and expenses to particular periods
 Choice of Method
 Statutory Accounting Regimes

Tax Accounting For Receipts: Derivation of Income

Choice of Method: Cash or Accruals?
The Most Appropriate Method
The starting point:
The correct method to be adopted is that which “…is calculated to give a substantially correct reflex of the taxpayer’s true income” .
Carden’s case 1938, *Krever 241

Professional Practice Income: Relevant Considerations

Circumstances of the Taxpayer:
1. One Person Practices – cash
 Carden (1938): doctor *Krever 241
 Firstenberg (1976): solicitor with one employee *Krever 242
 Dunn (1989): chartered accountant * Woellner 13-130
 2. Large Professional Practices – Accruals
 Henderson (1970) *Krever 243
 Barratt and Ors v FCT (1992) *Krever 242

Cash Basis Accounting Method

Income is recognised when cash, or something convertible into cash, is received.
The Type of Income Involved:
a) Salary and wages
b) Non-Cash Benefits: The money value is deemed to have been paid or given: sec 21 ITAA 1936.
c) Receipt of a cheque: when received not when banked
d) Investment income
e) Constructive Receipt: sec 6-5(4) and 6-10(3) ITAA97: A person is taken to have received an amount as income as soon as it is
applied or dealt with on the person’s behalf or as the person directs.

Accruals Basis Accounting Method

Income is recognised as it is earned and not when received.

 Usually, this occurs when services are provided, goods are sold or when rent is due
1. Accruals basis is in most cases the appropriate method to determine income derived from trading: (J Rowe & Sons 1971) *Krever 247
2. However accounts receivable (including those paid) are not always equal to the amount earned (or derived under accrual accounting)
-- Read Woellner 13-300.
3. Prepaid Income Subject to Potential Refund: Arthur Murray (1965) *Krever 245; Woellner 13-330
4. Work in Progress -- Read Woellner 13-380
Henderson v FCT (1970); Stapleton v FCT (1989

TR 98/1: Factors which indicate that the earnings method may be the appropriate basis for determining income
a) The taxpayer’s income producing activities involve the sale of trading stock;
b) The outgoings incurred by the taxpayer, in the day to day conduct of the business, have a direct relationship to income derived;
c) The taxpayer relies on circulating capital or consumables to produce income; or
d) Size of the business : the taxpayer relies on staff or equipment to produce income.
e) Credit policy and debt recovery
f) Books of account

Change In Accounting Method

Illustration:
Cash Basis and Accruals Basis Accounting Methods
 A is a dentist in sole practice. During the 2016/17 year of income he receives $50,000 fees, of which amount $10,000 represents
accounts rendered to patients before 30 June 2016. At 30 June 2017 a further $20,000 was outstanding in unpaid accounts rendered to
patients.
 What income has A derived during the 2016/17 year?
 If income returned on a cash basis: A has actually received $50,000 in cash and this is the amount of the income derived
 If income is returned on an accruals basis: A has earned $60,000 during the year and this is the amount of income derived. This
amount is calculated as follows:

 Amount received during the year 50,000

Less
Fees outstanding at 30.06.16 included in these receipts* (10,000)
Add
Fees earned during the year and outstanding at 30.06.17 20,000
60,000

 This amount was earned in 2015/16 year and would have been included in the income of that year

The Small Business Entity System

 Eligibility (See PPT Slides 17 – 18 of this Lecture pack)
 Effect:
o Use cash accounting
 Consequently business sales for which payment has not been received will not constitute income
 In addition, business expenses (s8-1; 25-5 and 25-10) will only be deductible when paid
o Simplified capital allowance system for depreciating assets
o Simplified trading stock treatment

Revision Questions
Students are advised to look at questions 1, 3, 4, 18 and 37, from ATSM (27th edn.) which deal with tax accounting issues.