Currency:This issue of Client Alert takes into account all developments up to and including 15 April 2010.
Tax Planning
Put simply, tax planning is the arrangement of a taxpayer’s affairs so as to comply with the tax law at the lowest possible cost. A common mistake is to believe that tax planning is optimised when every opportunity to reduce tax is taken. This is because some opportunities to reduce tax rely on strained interpretations of the law. Therefore, tax planning involves much more than taking the option that at first appears to result in lower tax costs. It involves objectively assessing and actively managing tax risk.
Common tax planning techniques are deferring the derivation of assessable income and bringing forward deductions. It is equally important that consideration be given to any pending changes to the tax legislation, especially when a proposed amendment will be backdated.
Deferring Assessable Income
The timing of when income is included in the assessable income of a taxpayer will depend on whether it is statutory income or ordinary income. Statutory income is included in assessable income at the time specified in the relevant provisions dealing with that income. Ordinary income is included in assessable income when it is derived unless a specific provision includes the amount in assessable income at some other time.
Consideration must be given to the nature of an income, ie revenue or capital, because of the difference in their tax treatment, which ultimately will have an impact on a taxpayer’s tax position.
When ordinary income of a business is derived and to be included in assessable income will depend on whether the business returns income on a cash basis or on an accruals basis.
If a business uses the cash basis, ordinary income is, generally, derived in the year in which it receives the income. Conversely, if the business is reporting income on an accrual basis, ordinary income is derived when a recoverable debt is created such that the taxpayer is not obliged to take any further steps before becoming entitled to payment.
Income received in advance of services being provided, generally, is not assessable until the services are provided (the Arthur Murray principle). This principle applies regardless of whether a taxpayer is reporting its income on an accrual basis or on a cash basis.
Ø STOP: For the Arthur Murray principle to apply, a taxpayer’s accounting records must classify the unearned income separately from income already earned. This may be done by a single journal entry at year-end or periodically during the year.
In relation to manufacturers, partly manufactured goods that are not ‘finished’ goods are treated as trading stock and it is necessary to determine the difference between the opening and closing value of the trading stock for the income year. (See Trading Stock on page 10.)
Ø TIP: Taxpayers who provide professional services may consider, in consultation with their clients, rendering accounts after 30 June to defer the income.
Income from property is essentially all income that is not personal exertion income and includes interest, rent, dividends, royalties and trust distributions. The time of when such income is derived for non-business taxpayers is as follows:
|
Category |
When income is derived |
|
Interest |
In the year of receipt |
|
Rental income |
In the year of receipt |
|
Dividends |
In the year of receipt |
|
Royalties |
In the year of receipt |
|
Trust distributions |
In the year the distribution is declared |
Ø STOP: Where the income has been applied or dealt with on behalf of a taxpayer, the taxpayer is taken to have received the income as soon as it is so applied or dealt with (principle of constructive receipt, albeit the taxpayer has not physically received the income): see s 6-5(4) of ITAA 1997.
A taxpayer is required to calculate the balancing adjustment amount resulting from the disposal of a depreciating asset. The balancing adjustment amount is calculated by comparing the termination value against the adjustable value. If the termination value is greater than the adjustable value, the difference is included as assessable income of the taxpayer. If the termination value is less than the adjustable value, the difference is a deduction available to the taxpayer.
If the disposal of an asset will result in assessable income, a taxpayer may want to consider postponing the disposal to the following income year. However, if it is not possible to delay the disposal, consideration may be given to whether a balancing adjusting rollover relief is available. If the disposal of an asset will result in a deduction, it may be beneficial to bring the disposal forward to the current year.
Balancing adjustment rollover relief
Balancing adjustment rollover relief effectively defers a balancing adjustment until the next balancing adjustment event occurs. Broadly, the rollover relief will apply automatically if the conditions listed in s 40-340(1) of ITAA 1997 are satisfied. If the automatic rollover relief applies, the transferor must give a notice containing sufficient information about the transferor’s holding of the asset for the transferee to work out how Div 40 applies to the transferee’s holding of the depreciating asset.
An optional rollover relief is available in a partnership scenario if the composition of the partnership changes or when assets are brought into or taken out of the partnership. To defer any balancing adjustments, the existing partners and the new partner can jointly elect for the rollover relief to apply.
Ø TIP: A small business entity can access the optional rollover relief.
Ø STOP: The optional rollover relief is not available unless the original holder retains an interest in the asset after the change.
Maximising Deductions
Deductions are divided into general deductions and specific deductions. General deductions are allowable under s 8-1 of ITAA 1997 whereas specific deductions are those provided for by sections of ITAA 1936 and ITAA 1997. If an item of expenditure would be a deduction under more than one section, it is deductible under the provision that is most appropriate.
In Taxation Ruling TR 97/7, the Commissioner states his view on the meaning of incurred for the purposes of s 8-1 of ITAA 1997. The following general rules assist in most cases in defining whether and when an outgoing has been incurred:
(a) a taxpayer need not actually have paid any money to have incurred an outgoing, provided the taxpayer is definitively committed in the year of income. There must be a presently existing liability to pay a pecuniary sum;
(b) a taxpayer may have a presently existing liability notwithstanding that the liability may be defeasible by others;
(c) a taxpayer may have a presently existing liability although the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation;
(d) whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise; and
(e) if a presently existing liability is absent, an outgoing is incurred when the money is paid.
The phrase ‘presently existing liability’ means that a taxpayer is definitively committed (or completely subjected) to the outgoing, ie the liability is more than impending, threatened or expected.
An outgoing is still incurred even if the amount cannot be quantified precisely, provided it is capable of approximate calculation based on probabilities.
If a taxpayer could have claimed a deduction for an outgoing that was incurred but not paid in the particular income year but failed to do so, the taxpayer cannot claim a deduction in the year in which the liability is discharged, as the outgoing has not occurred in that year. The taxpayer is required to seek an amendment of the assessment for the previous year, within the statutory limits.
Ø TIP: An outgoing may be incurred in one income year even if the liability is not discharged until a later year. Therefore, a taxpayer can claim a deduction for the outgoing.
Ø STOP: Small business entities which were Simplified Tax System (STS) taxpayers who are still using the mandatory cash accounting rules under the former STS can only deduct an outgoing under ss 8-1 (general deductions), 25-5 (tax-related expenses) and 25-10 (repairs) of ITAA 1997 when the outgoing is paid.
Managed investment schemes
Expenses incurred in a managed investment scheme (MIS) are generally deductible. In Hance v FCT 74 ATR 644; [2008] FCAFC 196, the Full Federal Court allowed two taxpayers’ deductions relating to their investment in an almond MIS. In that test case, the Full Court concluded that the relevant outgoings of the taxpayers would be incurred as operating expenses in carrying on each taxpayers’ business and that they were deductible pursuant to s 8-1 of ITAA 1997.
Following the failure of various schemes during the global financial crisis, the Tax Office issued three Taxation Determinations which deal with various scenarios and whether participants are still entitled to relevant deductions:
· TD 2010/7: A change of Responsible Entity of a registered agricultural MIS does not affect the tax outcomes for participants if the arrangement continues to be implemented in accordance with the relevant product ruling. In other words, the Commissioner continues to be bound by the ruling and a participant will continue to be able to rely on the ruling. However, where any change results in there being a material difference in the implementation of the scheme, the participant will not be able to rely on the product ruling for the scheme.
· TD 2010/8: The disposal or termination of an interest in a non-forestry MIS which arises as a result of circumstances outside the control of the taxpayer does not result in the denial of deductions previously allowed under s 8-1(1)(b) of ITAA 1997 in respect of contributions to the scheme.
· TD 2010/9: A payment received by an investor in a non-forestry MIS upon the winding-up of the scheme, that does not involve the disposal of an interest in the scheme to another person, is not necessarily ordinary or statutory income under ITAA 1997. However, the Taxation Determination says “whilst the proceeds received from a scheme that has been wound up may constitute assessable ordinary or statutory income, it will depend very much on what the payment is for actually for”. [Tax Office emphasis.]
Ø TIP: Each of the above Taxation Determinations contain an example illustrating the Commissioner’s view on the operation of the tax law. Taxpayers seeking to claim a deduction should ensure that the facts surrounding their circumstances are similar to the facts in the examples.
Bad debts
A debt that is written off as ‘bad’ in an income year is an allowable deduction under s 25-35 of ITAA 1997, provided:
· the amount owned was either previously brought to account as assessable income in the current or a former income year or lent in the ordinary course of a money-lending business of the taxpayer;
· there must be a bad debt in existence at the time of writing off;
· the debt must be bad; and
· the debt must be written off as bad during the income year in which the deduction is claimed.
Taxpayers should review their debtors prior to year-end and assess which debts may be written off as ‘bad’.
In Taxation Ruling TR 92/18, the Tax Office sets out the list of circumstances in which a debt may be considered to have become bad. These circumstances may include the death or the disappearance of a debtor leaving little or no assets of which the debt may be satisfied, or a corporate debtor going into liquidation or receivership with insufficient funds to pay the debt.
Before a debt can be written off as ‘bad’, a taxpayer must have taken appropriate steps in an attempt to recover the debt. The Tax Office, in TR 92/18, lists the steps to be taken to establish that a debt is bad. These include attempting to contact a debtor, issuing reminder notices and taking more formal measures.
It is important to note that while the factors listed in TR 92/18 are indicative of the circumstances in which a debt is considered bad, ultimately the question of whether the debt is bad is one of fact and will depend on all the facts and circumstances surrounding the debt.
Ø TIP: Notwithstanding that a bad debt is not deductible under s 25-35, it may be deductible under s 8-1.
Ø TIP: A bad debt does not need to be written off in the account books of a taxpayer. In the case of a company, the requirements of s 25-35 will still be satisfied in the following circumstances:
? a Board meeting authorises the writing off of a debt and there is a physical record of the written particulars of the debt and Board’s decision before year-end but the writing off of the debt in the taxpayer's books of account occurs subsequent to year-end; and
? a written recommendation by the financial controller to write off a debt, which is agreed to in writing by the managing director prior to year-end followed by a physical writing-off in the books of accounts subsequent to year-end.
Ø TIP: A bad debt deduction is also available for a partial write-off of a debt, provided the requirements of s 25-35 are satisfied. One debt may, over a period, be subject to several partial write-offs.
Additional requirements for companies
A company must pass either the continuity of ownership test (the primary test to be applied) or the same business test in addition to satisfying the requirements of s 25-35.
Companies that have undergone a change in underlying ownership due to a sale of the business during the year will need to pass the ‘same business test’ to claim a deduction for bad debts.
Ø STOP: A company cannot claim a deduction for a debt incurred and written off as bad on the last day of an income year.
Ø STOP: Consideration must be given to the specific anti-avoidance provisions contained in Subdiv 175-C.
Ø STOP: A deduction is denied where a company was purchased through an asset sale because the requirements of s 25-35 have not been met, albeit the same business test has been satisfied: see Easons Ltd v C of T (NSW) (1932) 2 ATD 211.
Additional requirements for trusts
Special rules apply to deny trusts a deduction for bad debts unless certain strict tests are passed. The applicable tests will depend on the nature of the trust. (See Trust losses on page 16.)
Footballers and management fees
In Spriggs v FCT; Riddell v FCT 239 CLR 1; [2009] HCA 22, the High Court unanimously held that two professional footballers were entitled to a deduction under s 8-1 of ITAA 1997 for management fees, even though the fees were paid for the negotiation of new playing contracts. In doing so, the High Court dismissed the Commissioner’s argument that it was necessary to separate their playing activities from their off-field business (promotional) activities and find that the fees were non-deductible capital costs incurred as employees in procuring new employment contracts.
Instead, the High Court held that the fees were deductible as the players were obtaining and performing employment contracts as part of the business they carried on as professional sportsmen. Furthermore, it noted that the definition of ‘business’ in s 955-1 of ITAA 1997 did not preclude an employment contract being carried out as part of a business. In addition, it held that the fees were not of a capital nature as the ‘advantage sought’ was the obtaining of playing contracts which were of a revenue nature in circumstances where a professional footballer enters into a number of playing contracts, with different clubs, in the course of their business.
Students on Youth Allowance and self-education expenses
In Anstis v FCT 180 FCR 288; [2009] FCAFC 154, a full-time student in receipt of Youth Allowance was allowed a deduction for various self-education expenses (eg a student administration fee, books and depreciation on a computer) as they were considered to be incurred in deriving the Youth Allowance, which was assessable income. The Full Federal Court rejected the notion that the purpose of the expenditure (to obtain a degree so that the taxpayer could become a teacher rather than to obtain Youth Allowance) was relevant to determining whether the expenditure was deductible under the first limb of s 8-1 of ITAA 1997.
The Commissioner has sought special leave to appeal to the High Court against the decision. The Tax Office said that, until the matter is resolved, it will continue to apply the view set out in Taxation Ruling TR 98/9. That is, education expenses are not deductible against various Commonwealth educational assistance schemes.
Carried forward losses
The deductibility of tax losses carried forward from previous income years will depend on the entity claiming the losses.
The entitlement of corporate tax entities to deductions in respect of prior year losses is subject to certain restrictions. An entity needs to satisfy the continuity of ownership test before deducting the prior year losses. If the continuity of ownership test is failed, the entity may still deduct the loss if it satisfies the same business test.
Ø TIP: A corporate tax entity can choose the amount of prior years losses it wishes to deduct in an income year. That is, the entity can choose to ‘ignore’ the carried forward tax losses and pay tax for the income year to generate franking credits for its distributions.
The method for deducting earlier tax losses incurred by other taxpayers is governed by s 36-15 of ITAA 1997. If a taxpayer derives net exempt income for an income year, the carried forward loss will need to be firstly offset against net exempt income before being available for deduction against assessable income.
Ø TIP: Carried forward losses do not need to be offset against non-assessable non-exempt income derived by a taxpayer. It is net exempt income that is offset against any carried forward tax losses and not exempt income. Net exempt income is defined in s 36-20 of ITAA 1997 and exempt income is defined in s 6-20 of ITAA 1997.
Ø TIP: Try to avoid deriving exempt income in an income year if there are carried forward losses.
Depreciation (Capital allowances)
A deduction may be available on the disposal of a depreciating asset if a taxpayer stops using and expects never to use it again. Therefore, asset registers may need to be reviewed for any assets that fit this category.
The effective life of an asset can be recalculated at any time after the end of the first income year for which depreciation is claimed by a taxpayer, if it is no longer accurate because of changed circumstances relating to the nature of use of the asset. Therefore, consideration may be given to the use of an asset to determine whether its effective life can be recalculated, which may result in an increased or decreased rate of depreciation
Non-business taxpayers are entitled to an immediate deduction for assets costing $300 or less, provided:
· the asset is used predominantly to produce assessable income that is not income from carrying on a business;
· the asset is not part of a set of assets that the taxpayer started to hold in the income year if the total cost of the set of assets exceeds $300; and
· the total cost of the asset and any other identical, or substantially identical, asset that the taxpayer starts to hold in that income year does not exceed $300.
Ø TIP: If two or more taxpayers jointly own a depreciating asset, a taxpayer is still eligible to claim an outright deduction, provided his or her interest does not exceed $300 (even if the asset costs more than $300).
A small business entity (see Small Business Entities on page 19) that chooses to apply the capital allowance rules contained in Div 328 of ITAA 1997 is eligible for an outright deduction for the taxable purpose proportion of the adjustable value of a depreciating asset in the income year it first starts to use the asset or installs it for a taxable purpose if:
· it starts to hold the asset when it is a small business entity, and
· the asset is a ‘low cost asset’, ie its cost is less than $1,000.
The entity is also entitled to an immediate deduction for any addition to a low cost asset, provided the cost of the addition is less than $1,000. If an asset costs more than $1,000, the entity is required to pool the asset into either a general pool or a long-life pool depending on the effective life of the asset. (See Pooling.)
For business taxpayers that are not small business entities, all capital items must be written off over their effective life under Div 40 of ITAA 1997, regardless of the cost (including low-value items). However, the Tax Office has adopted an administrative practice allowing an outright deduction for low-cost capital assets in certain cases.
Broadly, an expenditure of $100 or less (inclusive of GST) incurred by a taxpayer to acquire a capital asset in the ordinary course of carrying on a business will be assumed to be revenue in nature and therefore deductible in the year of the expenditure. It is important to note that because the threshold includes GST, for a business registered for GST, the threshold is effectively $90.91.
This administrative practice does not apply to expenditure incurred by a taxpayer on:
· establishing a business or business venture;
· building up a significant store or stockpile of assets;
· assets held under a lease, hire purchase or similar arrangement;
· assets acquired for lease or hired to, or that will otherwise be used by, another entity;
· assets included in an asset register maintained in a manner consistent with reporting requirements under generally accepted Australian accounting standards;
· any asset that forms part of a collection of assets that is dealt with commercially as a collection;
· trading stock or spare parts; and
· items that are part of another composite asset, ie items that are not functional on their own.
Certain depreciating assets can be pooled, with the result that the decline in value is calculated for the pool instead of the individual assets.
For a small business entity, two pools are available:
· a general pool for assets with an effective life of less than 25 years; and
· a long-life pool for assets with an effective life of more than 25 years.
If the cost of the asset is less than $1,000, the small business entity is entitled to an outright deduction.
For other taxpayers, there is the option of pooling ‘low-cost’ and ‘low-value’ assets to a low-value pool. A ‘low-cost’ asset is a depreciating asset that costs less than $1,000. A ‘low-value’ asset is a depreciating asset that has been depreciated using the diminishing value method, has an opening adjusted value of less than $1,000 in an income year, and is not a ‘low-cost’ asset. If a taxpayer sets up a low-value pool, all low-cost assets have to be allocated to the pool. However, low-value assets do not need to be allocated to the pool.
|
Category of taxpayer |
Assets allocated to pool during year are depreciated at: |
Assets allocated to pool in a previous income year are depreciated at: |
|
Small business entity — General pool |
15% |
30% |
|
Small business entity — Long-life pool |
2.5% |
5% |
|
Other taxpayers — Low-value pool |
18.75% |
37.5% |
Ø TIP: If two or more taxpayers jointly own a depreciating asset, a taxpayer can set up a low-value pool to take advantage of the accelerated rate of depreciating, provided his or her interest is less than $1,000, even though the asset costs more than $1,000.
Small business and general business tax break
Small businesses and general businesses may be eligible for a one-off bonus deduction for new investment in tangible depreciating assets made between 13 December 2008 and 31 December 2009 (inclusive). Key details of the bonus deduction include:
· The deduction is limited to new tangible, depreciating assets for which a deduction is available under Subdiv 40-B of ITAA 1997 and new investment in existing assets. An asset is new if it has never been used or installed ready for use by anyone, anywhere. Second-hand assets are not eligible for the deduction.
· New investment in relation to an asset (usually the asset’s GST-exclusive cost) needs to exceed a certain threshold before it can qualify for the deduction. The new investment threshold is $1,000 for small business entities and $10,000 for all other taxpayers.
· Generally, the new investment threshold needs to be met for each individual asset. However, multiple investments — or recognised new investment amounts — in the same, individual asset may be amalgamated in meeting the new investment threshold.
· The asset must be used principally in Australia for the principal purpose of carrying on a business. The deduction will not be apportioned for any non-taxable use of the asset.
· Assets that a taxpayer held, or entered into a contract to hold, on or before 12 December 2008 will not qualify. However, additional investment in such assets undertaken from 13 December 2008 may be eligible for the deduction.
· The deduction is worked out using a rate of either 50%, 30% or 10%, depending on the entity, when the taxpayer committed to investing in the asset, and when the asset is first used or installed ready for use. The deduction can be claimed in the income year that the asset is first used or installed ready for use. The following table summarises the different rates relating to key dates for different entities:
|
Business entity |
Investment commitment time (inclusive) |
Date of first use or installed ready for use (inclusive) |
Rate |
|
Small business |
13 December 2008 to 31 December 2009 |
By 31 December 2010 |
50% |
|
Other business |
13 December 2008 to 30 June 2009 |
By 30 June 2010 |
30% |
|
1 July 2009 to 31 December 2009 |
By 31 December 2010 |
10% | |
|
13 December 2008 to 30 June 2009 |
1 July 2010 to 31 December 2010 |
10% |
Other key points to keep in mind:
· Option to acquire a new asset — If a taxpayer enters into a contract prior to 13 December 2008 which includes an option to acquire an eligible asset at a later point in time and the option is exercised on or prior to 31 December 2009, the taxpayer may still be eligible to claim the tax deduction. The investment commitment time is deemed to have occurred when an option is exercised rather than on the date of an original contract.
· Jointly held assets — If an asset is jointly held, a taxpayer will be able to recognise all other business interests in the asset for the purpose of meeting the threshold that applies to that taxpayer individually but will only be able to claim the tax deduction on its interest in the asset.
· Self-constructed assets — A taxpayer who self-constructs an eligible asset may still qualify for the tax deduction. In determining whether the taxpayer qualifies for the deduction, the taxpayer must demonstrate a clear intention or commitment to proceed with the construction, which is analogous to a case where a taxpayer enters into a binding contract.
· Batches and sets of assets — A taxpayer is permitted to aggregate its investment in assets that are identical, or substantially identical, and in assets that form a set for the purposes of meeting the investment threshold. The taxpayer still needs to consider each asset individually. The assets forming a batch or a set will need to satisfy the basic requirements to qualify for the tax deduction. A batch or set of assets does not need to be acquired in the same transaction or in the same income year.
· Carried over for threshold purposes — Notwithstanding that a taxpayer has claimed an amount relating to the tax deduction for a new qualifying asset or new expenditure on a qualifying asset, the amount can still be used towards meeting the investment threshold for subsequent years. That is, the amount can be carried over for the purposes of meeting the investment threshold but it cannot be claimed again.
Ø TIP: If a taxpayer is in a tax loss position, the bonus deduction will form part of that loss and carry forward to the following income year.
Ø TIP: If an entity is classified as a small business entity based on its actual aggregated turnover (ie less than $2m at the end of the income year), the investment threshold of $1,000 will apply to all investments.
Ø TIP: Where an eligible asset is used for private and business purposes, a taxpayer does not need to apportion the cost of the asset between the different usages, provided the asset was required principally for a business use. Further, the bonus depreciation will not be clawed back in future years even if its usage changes.
Ø STOP: Where an eligible asset is held by a partnership, it is the partnership rather than the partners that is eligible to claim the bonus deduction.
Donations
A taxpayer may make a written election to spread a deduction for a donation over a period of up to five years if:
· the donation was a gift of money of $2 or more;
· the donation was property valued by the Tax Office at more than $5,000;
· the donation was made under the Cultural Gifts Program; or
· the donation was a heritage gift.
Ø TIP: A taxpayer must specify in the written election the percentage (if any) to be deducted each year. If a taxpayer anticipates an increase in assessable income in a future year, a taxpayer may consider allocating a greater percentage to that year.
Ø TIP: As a general proposition, try to avoid making donations in a year of losses. This is because a deduction for a donation cannot add to or create a tax loss for a taxpayer.
Ø TIP: Charitable donations of $2 or more are deductible, as long as receipts are retained. However, documentary evidence is not required where the gift does not exceed $10. An example would be a ‘bucket donation’ of less than $10 to a deductible gift recipient (DGR).
FBT and salary sacrificing donations
Donations to a deductible gift recipient (DGR) made under a salary sacrifice arrangement no longer result in an employer incurring an FBT liability from the 2008/09 FBT year. The legislative amendments which brought this into effect are contained in Tax Laws Amendment (2009 Measures No 4) Act 2009. It should be noted that employers who make donations under salary sacrifice arrangements are not entitled to claim an income tax deduction for the donations in their own tax return.
Ø STOP: Donations to an overseas disaster appeal (eg Haiti earthquake in January 2010) are tax deductible if the organisation operating the appeal is endorsed as a DGR and is an overseas aid fund.
Legal expenses
It is impossible to formulate an all-encompassing ‘rule’ as to the deductibility of legal expenses because each expense must be considered on its own merits.
Non-commercial losses
An individual taxpayer should consider whether a loss from his or her business activity (whether carried on alone or in partnership) will be deferred under the non-commercial loss rules, which are contained in Div 35 of ITAA 1997. This is because the individual’s overall tax position will be impacted when the loss is deferred.
In essence, an individual may only offset a loss arising from a business activity against other income derived in the same income year if the business activity satisfies at least one of the four commerciality tests – the assessable income, profits, real property, and other assets tests. If the individual does not satisfy at least one of the tests, the loss is carried forward and applied in a future income year against assessable income from the particular activity.
The Commissioner has the discretion to override the provisions of Div 35. Further, an exemption is available for individuals who carry on a primary production or professional arts business and whose assessable income for the year from other sources (eg salary and wages) does not exceed $40,000.
Ø TIP: The $40,000 threshold excludes net capital gains derived by a taxpayer.
High-income earners
From 1 July 2009, losses incurred by individuals with an adjusted taxable income of $250,000 or more from non-commercial business activities will be quarantined even if they satisfy the four commerciality tests. The effect of this is that they will not be able to offset excess deductions from non-commercial business activities against their salary, wage or other income.
The ‘adjusted taxable income’ is the sum of an individual’s:
· taxable income;
· reportable fringe benefits;
· reportable superannuation contributions; and
· total net investment losses.
Any excess deductions from a non-commercial business activity that are subject to Div 35 are to be disregarded in working out the adjusted taxable income of the individual.
While an individual with an adjusted taxable income of $250,000 or more is precluded from accessing the four commerciality tests, they will be able to apply to the Commissioner to exercise his discretion to not apply the non-commercial loss rules where they can satisfy the Commissioner, based on an objective expectation, that the business activity will produce assessable income greater than available deductions within a commercially viable period for the industry concerned.
Two provisions in the Income Tax (Transitional Provisions) Act 1997 ensure that:
· the non-commercial loss rules will not apply to a business activity that has greater available deductions than assessable income in a given income year only because of the Div 41 Business Tax Break (the Small Business and General Tax Break); and
· any discretion that has been applied by the Commissioner before the commencement of these amendments, including about any managed investment scheme, will continue in effect.
Prepayments
One of the simplest methods to accelerate deductions is the prepayment of deductible expenses.
The prepayment rules do not apply to ‘excluded expenditure’, ie a taxpayer is able to claim an outright deduction. Excluded expenditure is defined as:
· expenditure that is less than $1,000;
· expenditure that is required to be made under a court order or by law (eg car registration fees and audit fees); and
· expenditure that is for salary or wages.
Ø TIP: If a taxpayer is entitled to an input tax credit in respect of an expenditure, the $1,000 is the GST-exclusive amount. If the taxpayer is not entitled to an input tax credit, the $1,000 is the GST-inclusive amount.
Small business entities and non-business individuals
Small business entities and non-business individuals are able to access the 12-month prepayment rule. If the prepaid expenditure is not excluded expenditure, it is deductible outright in the income year it is incurred, subject to two provisos: the eligible service period does not exceed 12 months, and ends in the expenditure year or the income year immediately following. If the prepayment has an eligible service period of greater than 12 months, the expenditure will be apportioned over the relevant period (on a daily basis) up to a maximum of ten years. The eligible service period is the period over which the relevant services are to be provided.
If the eligible service period covers only one income year, the expenditure will be deductible in that particular year. If the eligible service period covers more than one income year, the expenditure is apportioned (on a daily basis) over those years up to a maximum of 10 years in accordance with the formula:
|
Expenditure |
X |
No of days of eligible service period in the year of income |
|
Total number of days of eligible service period |
Speculators and losses from shares
Generally, speculators are denied a revenue deduction for any losses arising for the disposal of shares unless a speculator is carrying on a business in relation to the shares. By way of example, in AATA Case 6297 (1990) 21 ATR 3747, the Tribunal concluded that a taxpayer’s share activities did not amount to carrying on a business and that, as a result, the taxpayer was not entitled to a deduction for losses arising from the disposal of his shares.
Furthermore, in ATO ID 2002/951 the Commissioner ruled that a speculator was not entitled to a revenue deduction for losses under s 25-40 of ITAA 1997 on the sale of post-CGT shares. Interestingly, the Commissioner did not discuss the deductibility of the losses under s 8-1 of ITAA 1997, nor whether the losses were capital in nature.
Trading stock
The tax treatment of trading stock, which is contained in Div 70 of ITAA 1997, impacts on year-end tax planning. This is because a taxpayer is required to either include in or deduct from its assessable income for an income year the difference between the opening and closing value of the trading stock.
Valuation of trading stock
A taxpayer can elect to use the cost, market selling value or replacement value to value each item of trading stock-on-hand. However, this does not apply to obsolete stock or certain taxpayers.
There is no requirement to adopt permanently any one of the three methods of value.
Ø TIP: There is no compulsion to use the same method to value all closing stock. A taxpayer can use different methods for different items of trading stock to maximise its deductions or minimise its assessable income.
If a small business entity elects to apply the trading stock concession under Div 328, it is permitted to ignore the difference between the opening and closing value of trading stock if the difference between the opening value of stock on hand and a reasonable estimate of stock on hand at the end of that year does not exceed $5,000. The effect of electing this concession is that the value of the entity’s stock on hand at the beginning of the income year is the same as the value taken into account at the end of the previous income year.
However, a taxpayer could choose to account for changes in the value of trading stock even if the reasonably estimated difference between opening and closing values was less than $5,000.
Ø TIP: Accounting for the difference between the opening and closing stock is a good tax planning method to avoid a large adjustment in the calculation of taxable income in a future year when the benefit of Div 328 is not available or to claim a deduction in the current year for a reduction in the value of trading stock.
It is a requirement to value each item of trading stock at the end of an income year at its cost, market value or replacement value. There is no requirement to permanently adopt any one of the three methods of valuation. Further, there is no compulsion for a taxpayer to use the same method across all items of trading stock.
Ø STOP: Manufacturers who elect to value stock on hand at year end at cost price, and wholesale and retail industries must use the absorption cost method to value their trading stock: see Rulings IT 2350 and TR 2006/8.
A deduction may be available for obsolete stock. Therefore, a taxpayer should review its closing stock to identify whether any obsolete stock exists. In Taxation Ruling TR 93/23, the Tax Office states that obsolete stock is either:
· going out of use, going out of date, becoming unfashionable or becoming outmoded (ie becoming obsolete); or
· out of use, out of date, unfashionable or outmoded (obsolete stock).
When valuing obsolete stock, a taxpayer does not need to use any of the prescribed methods (ie cost, market value or replacement value). Rather, provided adequate documentation is maintained, the Tax Office will accept any fair and reasonable value which is calculated taking into account the appropriate factors: see s 70-50 of ITAA 1997.
Repairs and maintenance
A deduction is available for repairs to premises, part of premises or a depreciating asset (including plant) held or used by a taxpayer solely for the purpose of producing assessable income: see s 25-10(1) of ITAA 1997. If the relevant premises or assets are held or used only partly for income-producing purposes, expenditure on repairs is only deductible to the extent that it is reasonable in the circumstances: see s 25-10(2).
A common issue that arises is the distinction between restoration of an item to its former condition (deductible) and improvement of the item (capital and thus not deductible). It is important to realise the mere fact that different materials from those replaced are used will not of itself cause the work to be classified as an improvement, particularly in circumstances where the previous materials are no longer in current use. If the change is merely incidental to the operation of the repair, the deduction, generally, will be allowed.
Initial repairs, the replacement of the entire item, and improvements are not deductible, but may qualify for a periodic write-off under the capital allowance provisions. In addition, the expenditure may form part of the cost base of an asset for capital gains tax purposes.
Ø TIP: The Tax Office has stated that if a taxpayer replaces something identifiable as a separate item of capital equipment, the taxpayer has not carried out a repair. Therefore, the taxpayer is required to depreciate the item over its effective life.
Ø TIP: Taxpayers should seek an itemised invoice to separate the costs of work where the work includes both repairs and improvements.
Superannuation contributions
Deductions for employer contributions
Employers are entitled to a tax deduction for contributions made to a complying superannuation fund or a retirement savings account (RSA) for the purpose of providing superannuation benefits for their employees. The contributions are only deductible for the year in which they are made: see s 290-60(3) of ITAA 1997. To maximise the deductions available, employers should ensure that the contributions are paid to their employees’ superannuation funds or RSAs before 30 June.
Ø TIP: A mere accrual of a superannuation liability or a book entry is not sufficient to qualify for a deduction.
Ø TIP: For employees turning 75, the contribution must be made by an employer within 28 days after the end of the month in which an employee turns 75 to obtain a deduction.
Superannuation guarantee charge
The superannuation guarantee charge (SGC) is imposed if an employer does not make sufficient quarterly superannuation contributions for each employee by the relevant quarter due date. The SGC is also imposed where the employer pays the contributions after the due date, albeit there is no shortfall for the quarter.
Employers who have made a contribution for an employee after the due date for a quarter and have an outstanding SGC for the employee for that quarter may elect (using the approved form) to use the late payment offset to reduce part of their SGC liability.
Since 24 June 2008, employers can elect to use the late payment offset to reduce their SGC liability for a year (rather than a quarter) which becomes payable after that date. From 26 March 2009, an employer will be eligible to use the offset to reduce its SGC liability where:
· the employer has made a contribution for a quarter into an employee’s fund after the due date for the quarter;
· the contribution in respect of the employee is made before the employer’s original assessment for the SGC for the quarter (original SG assessment date);
· the employer has given election (in the approved form) to the Commissioner to use the offset in respect of the employee to reduce their SGC liability for the quarter; and
· the election is made within four years after the original SG assessment date for the quarter.
Ø TIP: The SGC and late payment offset are not deductible to an employer. Therefore, the employer still has a strong incentive to continue making its superannuation guarantee quarterly payments on time.
Ø TIP: The SGC is the only tax that the Commissioner wants employers to avoid paying.
Personal superannuation deductions
The self-employed and other eligible persons are entitled to a deduction for personal superannuation contributions if less than 10% of a taxpayer’s total assessable income and reportable fringe benefits for an income year is attributable to activities that result in the taxpayer being treated as an ‘employee’ for superannuation guarantee purposes.
The contribution is only deductible for the year in which it is made. Further, the contribution is deductible in full, subject to the restriction that the maximum amount that is deductible is the amount stated in the notice of intention to claim a deduction, which is given to the trustee of a superannuation fund. However, excess contributions tax may apply for contributions above the contributions cap.
Ø TIP: A deduction for personal superannuation contributions should only be made towards the end of the income year when it is certain a taxpayer will satisfy the 10% rule (and other eligibility conditions) and not breach the taxpayer’s concessional contributions limit of $25,000 (or $50,000 for those aged between 50 and 74).
Ø TIP: A taxpayer who realised a significant capital gain during the year should evaluate his or her eligibility to claim a deduction for personal superannuation contributions. If the taxpayer is eligible, he or she should consider contributing an amount of the capital gain to superannuation which may reduce the tax payable on the capital gain derived.
Capital Gains Tax
A taxpayer may consider crystallising any unrealised capital gains and losses in order to improve his or her overall tax position for an income year. For example, if the taxpayer is anticipating a significant capital gain in an income year, consideration may be given to reducing the gain by crystallising a capital loss in the same income year. However, consideration must be given to the Commissioner’s view on ‘wash sales’ contained in Taxation Ruling TR 2008/1, particularly if a taxpayer reacquires the assets being disposed or identical assets, or somehow retains dominion or control over the original assets.
Small business CGT concessions
Broadly, the small business CGT provisions contained in Div 152 of ITAA 1997 provide a range of concessions for a capital gain made on a CGT asset that has been used in a business if certain conditions are met. These concessions are:
1. the 15-year asset exemption: a capital gain may be disregarded if the relevant CGT asset has been continuously owned by the taxpayer for at least 15 years. If the taxpayer is an individual, he or she must be at least 55 years of age and the CGT event must happen in connection with the taxpayer’s retirement, or he or she is permanently incapacitated at that time. If the taxpayer is a company or trust, a person who was a significant individual just before the CGT event must satisfy the requirements;
2. the 50% reduction: a capital gain resulting from a CGT event happening to an ‘active asset’ of a small business may be reduced by 50%;
3. the retirement exemption: a taxpayer can choose to disregard all or part of a capital gain up to a lifetime maximum of $500,000; and
4. the asset rollover: a taxpayer can disregard all or part of a capital gain if a replacement asset, which is an active asset, is acquired.
Ø TIP: The concessions do not apply to deny capital losses that a taxpayer has for an income year. That is, the taxpayer is still able to utilise any capital losses against any other capital gains for the income year.
Ø TIP: A taxpayer can choose not to claim the 50% reduction on a gain. If the taxpayer is a company or trust which cannot pass on the full benefits of the 50% reduction to shareholders or unit holders, by not choosing this option, the taxpayer will be able to pass on the full benefits of the retirement exemption.
Ø TIP: Partial use of an asset in the course of carrying on a business will suffice for the active asset test.
Ø TIP: A small business entity wanting to access the small business CGT concessions is exempted from the maximum net asset value test.
Ø STOP: Unless specifically excluded, all assets, including depreciating assets, are taken into account in the maximum net asset value test.
Ø STOP: Consideration should be given to the integrity measures contained in the CGT regime: see ss 115-40 and 115-45, Div 149 and CGT event K6.
Ø STOP: The Tax Laws Amendment (2009 Measures No 2) Act 2010 amends ITAA 1997 to increase access to the small business GST concessions. Generally, the amendments contained in the Act apply from the 2007/08 income year.
Rollover relief is available to provide taxpayers with the option to defer the consequences of a CGT event. Apart from disregarding any capital gains or capital losses that would otherwise arise from a CGT event, a rollover usually places the transferee under the rearrangement in the same CGT position as the transferor was before the event occurred. Some of the rollover reliefs will apply automatically while some will require taxpayers to elect the use of the reliefs, which is indicated by the way their tax returns are prepared.
Two types of rollovers are available: the replacement asset rollover and the same asset rollover. A replacement asset rollover allows the deferral of a capital gain or loss until a later CGT event happens to the replacement asset. A same asset rollover allows the deferral of a capital gain or loss arising from the disposal of the asset until the later disposal of the asset by the successor entity.
The table below sets out the common rollover reliefs that may be considered for tax planning purposes:
|
Type of rollover |
Brief description |
Election required |
|
Rollover from individual to company |
Individual disposes assets to a resident company |
Yes |
|
Rollover from trust to company |
Trustee of a trust disposes assets to a resident company |
Yes |
|
Rollover from partnership to company |
Partnership disposes assets to a wholly owned resident company |
Yes |
|
Assets compulsorily acquired, lost or destroyed |
Disposal of an asset from being compulsorily acquired, lost or destroyed |
Yes |
|
Fixed trust to company |
Fixed trust disposes all of its assets to a resident company |
Yes |
|
Marriage breakdown |
Taxpayer disposes assets to his or her spouse pursuant to an order of a court under the Family Law Act 1975 |
No |
|
Small business replacement asset rollover |
Taxpayer who is eligible for the small business CGT concessions acquires a replacement asset or improves an existing asset |
Yes |
Companies
The tax treatment of companies will depend on their classification, that is, a private company or a public company. For example, only a private company is subject to the operation of Div 7A of ITAA 1936. Companies are subject to a flat rate of tax (currently 30%) on the entirety of their taxable income. This rate applies whether the company is public, private, resident or non-resident.
It is a requirement that every entity that is (or has ever been) a corporate tax entity has a franking account. The franking account is recorded on a ‘tax paid’ basis and operates on a rolling balance basis.
All distributions are frankable unless specifically deemed unfrankable. Unfrankable distributions include:
· deemed dividends under Div 7A; and
· deemed dividends in relation to excessive payments made by a private company to its shareholders, directors and associates.
The benchmark rule requires all frankable distributions made by an entity during its franking period to be franked to the same extent (the ‘benchmark franking percentage’).
It should be noted that a corporate tax entity would incur an over-franking tax if the franking percentage for a distribution exceeds the benchmark percentage, or a franking debit (for under-franking) if the franking percentage is less than the benchmark rate. (Certain concessions to this rule may apply to public companies.)
If the benchmark percentage varies by more than 20% from the last frankable distribution in the last franking period, an entity must notify the Commissioner in writing.
The franking period of a corporate tax entity will depend on whether is it a public company or a private company. The franking period of a private company is the same as its income year. Generally, a public company has a six-month franking period.
Entities that make frankable distributions must provide their shareholders with a distribution statement. (Note that the information that must be disclosed on the statement is prescribed in s 202-80 of ITAA 1997.) For entities that are private companies, the distribution statement must be given to their shareholders within four months after the end of the income year in which the distribution was made, or such further time as the Commissioner allows. If this statement is not received, the shareholder will not be able to claim a franking credit tax offset.
Ø TIP: As a private company has four months after the end of an income to provide its shareholders the distribution statements, in effect, the company can retrospectively frank a distribution.
Ø STOP: It is an offence under the Taxation Administration Act 1953 if a corporate tax entity fails to give a distribution statement or makes a misleading statement in connection with a distribution.
A company’s franking account should be reviewed to ensure that the company is not liable for franking deficit tax. If the company is liable for franking deficit tax, it must be paid within a month of the end of the franking period. Franking deficit tax is not a penalty but an early payment of income tax that is offset against future tax obligations.
Concession for private companies
A private company generating profit in its first income year is prevented from making a franked distribution to its shareholders because of insufficient franking credits. However, a concession, which allows the company to make a franked distribution to its shareholders, exists if the following conditions are satisfied:
1. it is liable to pay income tax for the income year that is sufficient to generate franking credits equal to at least 90% of the deficit in its franking account at the end of that income year; and
2. it is the company’s first income year.
Private company and Div 7A
The broad thrust of Div 7A of ITAA 1936 is to deem certain loans, payments and debt forgivenesses by private companies to their shareholders and associates to be assessable unfranked dividends to the extent that there are realised or unrealised profits of the company.
To minimise any adverse Div 7A consequences, taxpayers must consider the following:
· repay private company loans by the earlier of the actual lodgment date or the due date for lodgment of the company’s return for that year;
· ensure a loan agreement is in place by the earlier of the actual lodgment date or the due date for lodgment of the company’s return for that year;
· ensure minimum repayments are made on loans from prior years;
· a deemed dividend can only arise to the extent of a company’s distributable surplus, so this issue needs to be considered along with planning opportunities;
· payments under a guarantee can trigger a deemed dividend and must be considered carefully;
· the payment of an actual franked dividend by a company to offset a loan which has been deemed to be a dividend can have adverse implications and should be carefully considered;
· the exemptions available should be considered and used if possible; and
· a deemed dividend can also apply if property is provided, so companies should consider requiring shareholders to pay market value.
If a private company beneficiary of a trust has an unpaid present entitlement to an amount of th
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