3106AFE Revenue Law Trimester 1, 2017 Seminar 9 Troy and Jenny (both Australian residents) have a takeaway coffee outlet in Brisbane city. They are carrying on the GST-registered business together in a partnership using the accruals basis to account for income tax and the non-cash basis for GST. Under the partnership agreement, Troy receives an annual salary of $70,000 as he is actively running the business and Jenny receives interest on capital contribution of $10,000, as she contributed $200,000 of capital when the partnership commenced. The balance of the net income is to be equally shared between the two partners. Troy had made a loan to the partnership and in 2016/17 he received interest income of $1,000 in relation to this loan. During the 2017 income year, the partnership had received $491,500 in cash, and had one outstanding invoice for coffee beans from CBC Bank Ltd for $500 as at 30 June 2017. On 3 March 2017 income year the two partners disposed of office premises that they had acquired under a contract dated 1 July 2016 (with a 60% interest for Troy and 40% interest for Jenny) - the sale of the premises gave rise to a capital gain of $80,000. The partners were going to convert the premises into a caf, but the location was found to be unsuitable. Receipts and expenses for the partnership during the 2016/17 income year are as follows: Receipts: Sales - coffee $ 462,000 (including GST) Sales - coffee beans $ 30,000 Expenditure (inclusive of GST where applicable): Coffee supplies (coffee beans, milk, & sugar) $ 124,500 Supplies (disposable coffee cups, etc.) $ 30,800 (including GST) Bank charges $ 1,100 Bribe to health official $ 5,000 Electricity $ 16,500 (including GST) Rental expenses $ 44,000 (including GST) Telephone expenses $ Salaries - staff $ 85,900 Salary Troy $70,000 Drawings - Troy $ 20,800 Drawings - Jenny $ 20,800 6,050 (including GST) The partners advise you that they hold valid tax invoices for all their acquisitions (that is, for all of the above expenditure). 1 3106AFE Revenue Law Trimester 1, 2017 Required: 1) In relation to the above facts, DISCUSS and CALCULATE the 'NET INCOME' of the partnership for the income year ending 30 June 2017. Please ensure you include in your answer whether the assessable income and the allowable deductions should include or exclude GST (where applicable), and why. 2) Calculate the partnership's NET AMOUNT OF GST PAYABLE OR (REFUNDABLE) to / (from) the ATO for the income year ending 30 June 2017. 3) Calculate each partner's SHARE OF THE NET INCOME of the partnership as well as their TAXABLE INCOME. 4) Calculate TROY'S INCOME TAX PAYABLE for the income year ending 30 June 2017, assuming that he has no private health insurance, no dependants and no other income. You are also advised that Troy has net capital losses carried forward of $8,000, plus net capital losses carried forward from collectables of $900. Notes: (i) For all the above questions, make sure you support your answer with appropriate legislative references. (ii) Assume that the partnership is not a small business entity (ignore the small business CGT concessions in Div 152). SOLUTIONS: In relation to the above facts, DISCUSS and CALCULATE the 'NET INCOME' of the partnership for the 2016/17 income year. (1) As per s 90 of the ITAA36, the 'net income' is The actual assessable income of a partner will include: The assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions expect deductions allowable under section 290-150 ITAA97 ( partners' super contributions) or Division 36 (revenue losses from prior income years) Coffee sales $462,000(42,000) Coffee beans $30,000 Sales $492,000 Less: allowable deductions: Coffee supplies $124,500 Supplies (cups ) $30,800 2 3106AFE Revenue Law Trimester 1, 2017 Bank charges $1,100 Electricity $16,500 (1500) Rental expenses $44,000 (4,000) Telephone expenses $6,050 (550) Salaries : Staff $85,900 $183,15 Things that not included are: Troy salaries $70,000 Drawing Troy $20,800 Drawing Jenny $20,800 Bribe to Health official $5,000 Superannuation Troy $10,000 Superannuation Jenny $12,000 Once the net income is calculated of partnership, shared between individuals. However, it is calculated at partnership level. Partnership treated as an entity for GST purposes. (partnership does lodge tax return) The partnership is registered for GST and would be making: taxable supplies in relation to the sale of pre-made coffee, electricity, rental and telephone____________ and GST free supplies in relation to the __s38-4____________. Any GST charged/collected on the sale of coffee is ______________ assessable income: s ______________ITAA97, so this income would be assessed on the GST ______________ amount. The business expenses that include GST would be ____________________________for the partnership (as they are acquisitions made in relation to their GST registered enterprise which is making taxable supplies or GST-free supplies). Therefore, where GST is included in the price, the partnership is able to claim an _________________________for the GST paid and accordingly, any allowable deductions should be ________________________: s ____________ITAA97 3 3106AFE Revenue Law Trimester 1, 2017 4 3106AFE Revenue Law Trimester 1, 2017 Section 90: Net Income = Assessable Income less deductions (except....) Assessable income: Amount GST s 90 amount Sale of coffee $462,000 $ 42,000 $ 420,000 Sale of coffee beans $30,000 $ 30,000 S 9-5(a-d) GST Free under s 38-4 $ Nil assume $0 Capital gain Law and Reasons $80,000 Total Assessable Income $0 Note 1 Not included as income under s90 ITAA36 $450,000 Note 1. Net Capital Gain Capital Gains are / are not included in the \"net income\" of the partnership. Partners are/ are not assessed on their proportional share of the capital gain: (section ____________ITAA 1997), as each individual partner will/ will not have their own CGT event in respect to the sale of the premises. 5 3106AFE Revenue Law Trimester 1, 2017 Allowable deductions Amount s 90 amount GST Law and Reasons Purchases Coffee supplies Supplies (cups, etc.) $124,500 $ Nil $30,800 $2,800 $124,500 $28,000 Bank charges $1,100 $ 1,100 $ 1,100 Bribe to health official $5,000 assume $0 $ Electricity Rental expenses Telephone expense Staff salaries $16,500 $1,500 $44,000 $4,000 $6,050 $550 $85,900 $ $15,000 $40,000 $ 5,500 $85,900 Div 38-4GST S 8-1(1)(b) S9-5ITAA 97 S 11-20GST S 9-5 S 27-5 S 8-1(1)(b) 97Ac Div 40 S11-15(2) GST S 29-10 S26-53 ITAA97 S 11-10GST S 9-5 S 27-5 S27-20 S8-1(1)(b) 97ACT S 11-20GST S 9-5 S 27-5 S27-20 S8-1(1) S11-20 GST S27-5 S27-20 S8-1(1)(b) S9-20(2) GST S801(1)(b) 6 3106AFE Revenue Law Trimester 1, 2017 Troy's salary Interest capital account Jenny $70,000 $ $ $10,000 $ $ $1,000 $ $ $20,800 $ $ $20,800 $ $ Div 36 S90(36 ACT) Rye v Rye Ellis v Ellis As above on - Interest on loan from Troy Drawings - Troy Drawings - Jenny Total Allowable Deductions $ Net Income = Assessable Income less Deductions $ 150,000 (2) = $450,000 less $300,000 . Calculate the partnership's net amount of GST payable or (refundable) to / (from) the ATO for the income year ended 30 June 2017 Amount Law - GST Act Taxable supplies (note items) Coffee sales $ 42,000 S9-5(a-d) GST, S17-5, ITAA97 Less Input tax credits (note items) Coffee cups supplies $2,800 S11-20GST S9-5 7 3106AFE Revenue Law Trimester 1, 2017 Electricity $1,500 Rental expenses $4,000 Telephone expenses $550 GST OWING TO THE ATO $33,150 S27-5 S8-1(1)(b) 8 3106AFE Revenue Law Trimester 1, 2017 (3) Calculate each partner's SHARE of net income and their TAXABLE INCOME Share of net income: Troy's and Jenny's individual interest in the net income of the partnership is as follows (as per section _92 ITAA36__________): Troy (50%) Jenny (50%) TOTAL Partners' Salary $ 70,000 $0 $70,000 distribution $40,000 $40,000 $80,000 TOTAL $110,000 $ 40,000 $150,000 In addition to their share of partnership income in their Taxable Income, Troy and Jenny will have each potentially a net capital gain in respect of the sale of office premises. Initial Capital gain for partners (s 106-5): Troy (60%) Jenny (40%) $48,000__________ $32,000____________ $80,0000 Are either Troy or Jenny entitled to the 50% discount or indexation method for the sale of the office premises? Why or why not? Jenny and Troy are nor entitled to use indexation method as they acquired the asset after 21 sept 1999 and did not hold property for 12 months or more than that. Which capital losses is Troy able to use to reduce his capital gain? TROY Office premises Current year capital gains $48,000 less current year capital losses less carried forward capital losses ($8,000 ) 9 3106AFE Revenue Law Trimester 1, 2017 $40,000 Apply 50% discount N/A Net capital gain $ 40,000 Note: Troy has net losses from collectables ($900) which should be __________________________ JENNY Office premises Current year capital gains $32,000 less current year capital losses - less carried forward capital losses - Apply 50% discount _NA__________ Net capital gain $ 32,000 Troy Jenny Assessable income Partnership distribution $ 110,000 $ 40,000 $ 40,000 $ 32,000 s92 Net capital gain s102-5 (other?) Total assessable income $ $ $ 150,000 $_72,000_______ Total allowable deductions $ 10,000 $ _12,000_______ TAXABLE INCOME $ 140,000 $ 60,000 Less Allowable deductions (4) Calculate the tax payable by Troy for the 30 June 2017 income year, assuming that he has no private health insurance, no dependants and no other income. Taxable Income $140,000 BITL $ {140,00080,000)* 0.37} + 39,747 Reasons (including sections) 10 3106AFE Revenue Law Trimester 1, 2017 Less non-refundable offsets LITO S158N ITAA 36 $ 0 Net Tax Payable $39,747 Plus Temporary budget repair levy S4-11 $0 Medicare levy (TI x 2%) $ 2,800 Medicare Levy Surcharge ROW 3 -OVER 26,668 S 8B MEDICARE LEVY ACT ISP ___ (TI + RFBA) x _1.25__% $1,750 Tier __2 RATE (1.25%) as 105,000 < 140,000< 140,000 Less Refundable Offsets &/or tax credits $ Tax Payable $39,747 11 3106AFE Revenue Law Trimester 1, 2017 Individuals and Partnerships John Minas Last week - Key points Goods and Services Tax There are, in effect, six elements to a taxable supply in s 9-5: 1. Must be a supply: s 9-10 2. Supply must be for consideration: s 9-15 3. Supplier must be registered for GST: s 23-5 4. Supply must be made in connection with an enterprise carried on by the supplier: s 9-20 5. Supply must be connected with Australia: s 9-25 6. Supply must not be GST-free or input taxed: s 9-30 2 Last week - Key points Goods and Services Tax There are in effect five elements to a creditable acquisition in s 11-5: 1. There must be an acquisition: s 11-10 2. You must be registered or required to be registered: 5 s 23- 3. Must be solely or partly for a creditable purpose: s 11-15 4. Must have been a taxable supply to you: see s 9-5 5. Must have provided or be liable to provide consideration: s 915 Plus must have a valid TAX INVOICE: s 29-10(3) 3 Last Week Fringe Benefits Tax 1. Policy reasons for FBT 2. FBT - general concepts 3. Steps for calculating FBT payable 4. Is there a fringe benefit? 5. Exempt fringe benefits 6. Summary of benefits types 7. Car benefits 8. Expense payment benefits 9. Recipient's contribution 10. Otherwise deductible rule 11. Calculating FBT payable 12. Reporting of FBT on PAYG Payment Summaries 4 11. Calculating FBT 1. 'Gross-up' the taxable value: The gross-up factor will depend on whether the benefit is 'Type 1' or 'Type 2' Type 1 benefits are those benefits where the employer was entitled to claim a GST input tax credit in providing the benefit. Add together Type 1 benefits' taxable values and gross up by 2.1463 5 11. Calculating FBT 1. 'Gross-up' the taxable value (cont'd): Type 2 benefits are those benefits where the employer was NOT entitled or able to claim a GST input tax credit in providing the benefit. Add together Type 2 benefits' taxable values and gross up by 1.9608 2. Multiply the resulting amount by the FBT rate. From 1 April 2015 the rate is 49% (this is the rate in the 2016/17 FBT year) 6 12. Reporting of FBT on PAYG Payment Summary Starting from the income tax year ended 30 June 2000, employees may have the taxable value of fringe benefits received during the year noted on their PAYG Payment Summary. The employees do not have to pay tax on those fringe benefits, but the value of the fringe benefits is included in a number of income tests relating to the following government benefits and obligations: 7 Medicare levy surcharge Higher Education Contribution Scheme (HECS) repayments; child support obligations; and entitlement to certain income tested government benefits 12. Reporting of FBT on PAYG PS To determine whether an individual employee has reportable fringe benefits, the employer must: Step 1: add-up the taxable value (the amount before gross-up) of all the benefits received by the employee in the FBT year: s 135N Note: there are some exceptions (none of which are relevant to this course, although some will be for the advanced tax course) see your Study Guide chapter. 8 12. Reporting of FBT on PAYG PS Step 2: If: Step 1 > $2,000 then employee has reportable fringe benefits: s135P(1) go to step 3 Step 1 < $2,000 then employee does NOT have reportable fringe benefits so nothing has to appear on the employee's PAYG Payment Summary Step 3: Get total amount in Step 1 and multiply by 1.9608: s 135P(2) [note that this factor is the Type 2 gross up amount] Step 4: Include Step 3 amount on employee's PAYG payment summary 9 OUTLINE: 1. 2. 3. 4. 5. Different entity types Taxation of individuals Taxation of sole traders Taxation of minors Taxation of partnerships 10 This week Why is the taxation of individuals & partnerships important? Individuals are the most common type of taxpayer in Australia. Some anti-avoidance provisions exist for income of minors. There are some inconsistencies between the concept of partnership for common law compared to tax law. 11 1. Different Entity Types The entity type can greatly affect the imposition of tax. The main business entities are: sole traders partnerships companies, and trusts. Different structures will be suitable in different situations, and each has its own advantages and disadvantages (which will be considered in the advanced tax course). Apart from business entities, individuals are also a type of tax entity, and in fact, the taxation of individuals contributes the most to the Revenue. 12 1. Different Entity Types Who must pay income tax? Income tax is payable by each individual and company, and by some other entities: s 4-1 The list of entities that must pay income tax is in s 9-1 and includes: individuals, companies (next lecture), trustees of superannuation funds (advanced tax course), and trustees liable under ss 98, 99, 99A and 102 (next lecture). 13 1. Different Entity Types How is income tax calculated? Income tax is worked out in reference to taxable income (s 4-10(3)): Income tax = (taxable income x rate) - tax offsets Method Statement Step 1. Work out your taxable income for the income year (refer to s 4-15) Step 2. Work out your basic income tax liability on your taxable income by (a) income tax rate or rates applicable to you; and (b) any special provisions that apply to working out that liability Step 3. Work out your tax offsets for the income year. Tax offsets reduces the amount of income tax you have to pay. (see s13-1 for list of offsets) Step 4. Subtract the tax offsets from your basic income tax liability. 14 2. Taxation of Individuals Steps: 1. CALCULATE TAXABLE INCOME (TI) where TI = AI - D 2. APPLY RELEVANT TAX RATE TO TAXABLE INCOME to get the BASIC INCOME TAX LIABILITY (BITL) 3. DEDUCT any available NON-REFUNDABLE OFFSETS to get 'NET TAX PAYABLE' 4. If applicable, calculate the TEMPORARY BUDGET REPAIR LEVY, MEDICARE LEVY and MEDICARE LEVY SURCHARGE and add to 'NET TAX PAYABLE' 5. DEDUCT any available REFUNDABLE OFFSETS and/or TAX CREDITS from the PREVIOUS TOTAL 6. Positive remainder is TAX PAYABLE, negative remainder is a REFUND 15 2. Taxation of Individuals 1. CALCULATE TAXABLE INCOME (TI) where TI = AI - D An individual's assessable income could include such receipts as: Salary and wages, tips and allowances Rental or interest income Dividends received from companies Share of partnership profit Trust distributions The deductions that an individual may be entitled to could include: Car expenses Work related expenses Share of partnership loss Cost of managing tax affairs 16 2. Taxation of Individuals 2. APPLY RELEVANT TAX RATE TO TAXABLE INCOME to get the BASIC INCOME TAX LIABILITY (BITL) Resident rates 2016/17 income year Taxable income Tax on this income $0 - $18,200 Nil $18,201 - $37,000 $37,001 - $87,000 19c for each $1 over $18,200 $3,572 plus 32.5c for each $1 over $37,000 $87,001 - $180,000 $19,822 plus 37c for each $1 over $80,000 Over $180,000 $54,232 plus 45c for each $1 over $180,000 17 2. Taxation of Individuals Example - using the progressive rates table BITL for a taxable income of $85,000 for a resident individual in 2016/17? Locate correct table (Resident 2017) Locate correct row - T.I of $85,000 is in the 3rd row as it falls within the $80,001 - $180,000 range Follow instructions for that row $3,572 plus 32.5c for each $1 over $37,000 $85,000 minus $37,000 = $48,000. So multiply $48,000 by 0.325 which equals $15,600 Add $15,600 to the $3,572 to get a total of $19,172 - this is the BITL. Abbreviate as: BITL = [($85,000 - $37,000) x 0.325] + $3,572 = $19,172 18 Average rate of tax is 22.6% 2. Taxation of Individuals 3. DEDUCT any available NON-REFUNDABLE OFFSETS to get 'NET TAX PAYABLE' From the BITL deduct any non-refundable tax offsets that the taxpayer is entitled to claim. Note: We deduct non-refundable offsets at this point because: General rule: the sum of the tax offsets available to a taxpayer cannot exceed the amount of income tax otherwise payable by the taxpayer: s160AD ITAA36 These tax offsets cannot be applied against a taxpayer's liability to Medicare levy, HECS or superannuation contributions Excess tax offsets are lost and cannot be carried forward 19 Offset reduces by 1.5 cents for every dollar TI is over the threshold income level. 2. Taxation of Individuals Low Income Tax Offset - s 159N ITAA36 From 1 July 2012 Maximum offset Threshold income level Upper threshold $445 $37,000 $66,667 Reduction rate 1.5% Effective taxfree threshold $20,542 20 2. Taxation of Individuals Examples of calculating the LITO (2017 income year) If T.I is $37,000 or less, then the (resident) taxpayer would be entitled to the maximum offset of $445 (any excess offset is not refundable) If the T.I is $66,667 or more, then the taxpayer would not be entitled to the low income offset. If the T.I is in between the thresholds, then calculate the entitlement: 21 If the T.I is $50,000 then deduct $37,000 from this and multiply the sum by 0.015, and then deduct this from $445 (max. offset): Low income tax offset = $445 - [($50,000 - $37,000) x 0.015] = $445 - $195 = $250 2. Taxation of Individuals Temporary measure for the 2014/15, 2015/16 and 2016/17 income years 4(a) If applicable, CALCULATE the TEMPORARY BUDGET REPAIR LEVY and ADD TO 'NET TAX PAYABLE' Section 4-11 of the Income Tax (Transitional Provisions) Act 1997 provides that certain taxpayers must pay an additional income tax levy of 2% if: a) They are an individual (applies to both resident and foreign residents) b) Their taxable income for the income year exceeds $180,000; and c) The income year is a 'temporary budget repair levy year' (that is, the 2014/15, 2015/16 and 2016/17 income years). The temporary budget repair levy is only imposed on the part of the individual's taxable income that exceeds $180,000 22 2. Taxation of Individuals 4(b) If applicable, CALCULATE MEDICARE LEVY and ADD TO 'NET TAX PAYABLE' Medicare Levy thresholds - 2016/17 year Taxable Income Medicare Levy payable $0 - $21,335 Nil $21,335 - $26,668 Nil + 10% of the excess over $21,335 Over $26,668 2% of taxable income 23 2. Taxation of Individuals 4(c) If applicable, CALCULATE MEDICARE LEVY SURCHARGE and ADD TO 'NET TAX PAYABLE' An additional Medicare levy surcharge can apply if the INDIVIDUAL'S 'income for surcharge purposes' is greater than $90,000 and the individual does not have private hospital health insurance with an excess of $500 or less: s 8B Medicare Levy Act 1986 The surcharge can apply for FAMILIES when the combined 'income for surcharge purposes' is $180,000 or more (plus $1,500 for each dependant over the first one): s 8C Medicare Levy Act 1986 Example: family with 3 dependents: $180,000 + (3 - 1) x $1,500 = $183,000 24 2. Taxation of Individuals MEDICARE LEVY SURCHARGE (MLS) (continued) From 1 July 2009 the income test for determining whether a taxpayer is liable for the Medicare levy surcharge is the taxpayer's 'income for surcharge purposes'. This is the sum of the taxpayer's: taxable income, exempt foreign employment income, reportable fringe benefits (RFBA), reportable superannuation contributions (RESC), and total net investment loss (including both net financial investment losses and net rental property losses) less any taxed component of a superannuation lump sum received, other than a death benefit, which does not exceed the taxpayer's low rate cap. 25 Before 1 July 2012 the MLS rate was 1% 2. Taxation of Individuals MLS rate now depends on level of income for surcharge purposes MEDICARE LEVY SURCHARGE (MLS) continued From 1 July 2012, the MLS (and the private health insurance offset) is income tested against three income tier thresholds - 2017 below: No MLS Tier 1 Tier 2 Tier 3 Singles $90,000 or less $90,001 - $105,000 $105,001 - $140,000 $140,001 or more Families $180,000 or less $180,001 - $210,000 $210,001 - $280,000 $280,001 or more Medicare levy surcharge Rate 0.0% 1.0% 1.25% MLS rate applies to total of Taxable income, RFBA & the amount on which Family trust distribution tax has been paid . 1.5% 26 2. Taxation of Individuals MEDICARE LEVY SURCHARGE (MLS) continued Is the taxpayer's income for surcharge purposes1 > MLS threshold?2 Does the taxpayer have Yes No adequate private health insurance (hospital cover)? No Yes Taxpayer will be liable for MLS. MLS = rate% x (TI + RFBA + amount on which FTDT has been paid ) Taxpayer is NOT liable for MLS 1 Income for surcharge purposes A taxpayer's MLS threshold depends on whether they are an individual (single) taxpayer, or whether they are a family (including de facto couples) or have children 2 27 2. Taxation of Individuals MEDICARE LEVY SURCHARGE (MLS) EXAMPLE: Samantha is single, with no dependents. For the 2017 income year her taxable income is $89,000. She does not have any private health insurance. When completing her 2017 income tax return she also discloses that she has: Reportable fringe benefits of $21,000 Net investment losses of $7,000 Calculate Samantha's Medicare Levy Surcharge (if any) for the 2017 income year 28 2. Taxation of Individuals MEDICARE LEVY SURCHARGE (MLS) EXAMPLE: (continued) Samantha's 'income for surcharge purposes' is: Taxable income $89,000 + RFBA $21,000 + Net investment losses $ 7,000 $117,000 As her ISP of $117,000 > $90,000 and she does not have private health insurance she will be liable for the MLS. Tier 2 rate (1.25%) as $105,000 < ISP $140,000 MLS = [$89,000 (taxable income) + $21,000 (RFBA)] x 1.25% = $1,375 29 2. Taxation of Individuals 5. DEDUCT any available REFUNDABLE OFFSETS and/or TAX CREDITS from the PREVIOUS TOTAL Example of tax credits PAYG CREDITS - that is, tax already deducted throughout the year by the employer (Pay As You Go). Example of a refundable offset Franking Credit (Imputation Credit) s 207-20(2) discussed next week as part of the \"Companies\" lecture 30 2. Taxation of Individuals 6. Positive remainder (after Step 5) is the amount of TAX PAYABLE Negative remainder is a REFUND NB: There is NO need to write out the actual steps (as given above) Just get straight into your calculation, but make sure you cite appropriate legislative references, show calculations, and provide an explanation as to why something is or is not applicable. EXAMPLE Jack is a 24 year old single male resident of Australia for tax purposes. He earns $43,600 salary and $200 interest, and has tax deductible workrelated expenses of $300. He does not have any private health insurance. He has $6,270 in PAYG credits (deducted from his salary by his employer). CALCULATE his income tax payable / (refundable) for the 2017 year. 31 2. Taxation of Individuals Salary Interest less Work related expenses Taxable income BITL [($43,500 - $37,000)*0.325] + $3,572 Less non-refundable offsets: Low income tax offset $445 - [($43,500 - $37,000) x 0.015] Net Tax Payable Plus Medicare levy ($43,500 x 0.02) Plus Medicare levy surcharge (if applicable) Less refundable offsets & tax credits PAYG credit Tax payable / (refundable) 32 $43,600 200 $43,800 300 $43,500 $ 5,684.50 s 6-5 s 6-5 ($ 347.50) s 159N s 8-1 (as $37,000 $26,120) N/A as ISP $90,000 3. Taxation of Sole Traders A sole trader is an individual trading in his or her own name, with the business form neither having a separate legal entity nor perpetual succession. Sole traders are taxed in the same way as individuals Use the progressive tax rates table for individuals, plus add Medicare Levy & Medicare Levy Surcharge (if applicable). Their business income would go in the Supplementary section of the Individual tax return, as it forms part of their assessable income. 33 4. Taxation of Minors A minor is a person under the age of 18 years. Families have used children in attempts to split income, thereby lower the overall taxation burden - hence special rules in Div 6AA A minor who is a prescribed person under Div 6AA has their income divided into earned income and unearned income. EARNED INCOME: Is the minor's personal exertion income A minor is taxed at normal rates for earned income Must fall under the category of 'excepted assessable income' as per s102AE(2) ITAA36 such as employment or business income. 34 4. Taxation of Minors UNEARNED INCOME: Is all the assessable income which is NOT 'excepted income' For example, passive income such as interest, dividends, trust distributions, or capital gains However, passive income that is the result of the investment of earned income such as salary and wages is NOT considered unearned income Unearned income is referred to as Eligible Taxable Income (ETI) in that it is 'eligible' to be subject to the special provisions in the ITAA. The tax-free threshold is $416 (compared to the normal $18,200) and the highest marginal rates plus the TBRL apply to unearned amounts over $416. Note from 1 July 2011 the LITO is NOT available to offset a minor's unearned income (but is available to offset their earned income) 35 4. Taxation of Minors UNEARNED INCOME - Taxation: If the eligible taxable income (ETI) is $416 or less, the amount is tax free. However, if the minor is in receipt of earned income, the whole taxable income amount is taxed in the normal way. If the ETI is more than $416, but less than $1,446: the excess over $416 is taxed at 68% OR the difference between tax on the whole of the taxable income and tax on so much of the taxable income that does not qualify as eligible taxable income. Whichever is greater If the ETI is $1,446 or more: then the entire amount is taxed at 47% - no tax free threshold at all. 36 4. Taxation of Minors EXAMPLE Nathan, a minor, has a taxable income of $23,000 for 2016 of which $1,200 is ETI. The tax payable on the $1,200 is the greater of: a) 68% ($1,200 - $416) = $533.12, or b) tax on $23,000 [i.e. ($23,000 - $18,200) x 0.19 = $912] less tax on ($23,000- $1,200) [i.e. ($21,800 - $18,200) x 0.19 = $684] = $228. As (a) > (b), tax payable on the $1,200 of ETI is $533.12. The total tax payable by Nathan would be $533.12 (tax on ETI) plus $684 (tax on taxable income other than ETI) equals $1,217.12 Nathan would be liable for the ML, but would be entitled 37 to the LITO in relation to his earned income. 5. Taxation of Partnerships Definition of a general partnership from partnership law: 'the relationship that exists between persons carrying on business in common with a view to profit'. A 'partnership' itself is not a separate legal entity. For example, you cannot sue a partnership, as a partnership is not a 'legal person.' You must sue the individual partners, as the partners are jointly and severally liable. 38 5. Taxation of Partnerships Definition of a 'partnership' in s 995-1 ITAA97: 'partnership means an association of persons carrying on business as partners or in receipt of *ordinary income or *statutory income jointly, but does not include a company.' The definition of 'partnership' in ITAA extends the notion of 'partnership' beyond the general law. If a taxpayer is in receipt of assessable income jointly with another person, even though the taxpayer is not carrying on a business, a partnership exists for taxation purposes. 39 5. Taxation of Partnerships With taxation, a partnership is treated somewhat like a separate person, in that the partnership files a partnership tax return showing the net income or loss of the partnership. However, the partnership itself pays no tax on the income disclosed in the partnership income tax return: s 91 ITAA36 Instead, the net income or loss is split up between the individual partners. The individual partners include their share of the income or loss in their own individual tax returns and pay tax accordingly. 40 5. Taxation of Partnerships DIFFERENT TAX TREATMENT General partnership - partner's individual interest is determined according to the partnership agreement Can share income and losses in whatever proportion they so choose. Tax (only) partnership - partner's individual interest in the net income, partnership loss and non-assessable income is determined according to the interests of the partners in the property producing the income. 41 5. Taxation of Partnerships FCT v McDonald 87 ATC 4541 The taxpayer and his spouse purchased rental properties as joint tenants (that is, equal ownership). They entered into an agreement to share the net rental income: Taxpayer: 25% Spouse : 75% Under the agreement the taxpayer was get all of the losses. The rental properties generated net rental losses and the taxpayer sought to claim a tax deduction for 100% of the losses. The Federal Court agreed with the Commissioner that the taxpayer and his spouse were not carrying on a business was a tax law only partnership. Hence the income and losses had to be equally shared in accordance with the ownership interest. 42 5. Taxation of Partnerships TAXATION LAW TREATMENT OF PARTNERSHIPS 1. Calculate the 'net income' of the partnership in accordance with s 90 ITAA36, which in relation to a partnership means: The assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions except deductions allowable under section 290-150 ITAA97 (partners' super contributions) or Division 36 (revenue losses from prior income years). Net Income can actually be a loss when deductions > assessable income. 43 5. Taxation of Partnerships 1. Calculate the 'net income' of the partnership in accordance with s 90 ITAA36 (continued) Net income does NOT include capital gains as: CGT assets are treated as being owned directly by the individual partners rather than the general partnership itself. Each individual partner will have their own cost base and acquisition date of part of their interest (direct fractional interest) in the partnership's CGT assets. On a disposal of a CGT asset, each individual partner must do their own CGT calculation in respect of the CGT asset: s 106-5(1). 44 5. Taxation of Partnerships 1. Calculate the 'net income' of the partnership in accordance with s 90 ITAA36 (continued) Allowable deductions from the Net income do NOT include: Notional partner salary - this is just a greater share of the profits. Interest paid to partner - depends whether in the capacity of lender or not. Drawings made by the partners during the year. 45 5. Taxation of Partnerships Often, the partners will want to give a partner performing work a 'salary': But a partnership is not a separate legal entity separate from the partners, so a person cannot enter into a contract with his or herself: Rye v Rye [1962] 2 WLR 36. Thus a partnership cannot enter into an employment contract to employ a partner, since the partner would be effectively employing themselves: Ellis v Joseph Ellis & Co [1905] 1 KB 324 So partners' salaries are not a salary in the PAYG sense - in a legal sense it is an early distribution of profits; early because the partner gets the profits before the end of the financial year when the partnership net income or loss is determined. 46 5. Taxation of Partnerships 2. Allocate the net income of the partnership to the individual partners. The actual assessable income of a partner will include: So much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident; and So much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was not a resident and is also attributable to sources in Australia 47 5. Taxation of Partnerships 3. Each partner then includes their share of 'partnership net income' in their assessable income as per s 92 ITAA36. This share of partnership net income is added to their other assessable income, and is part of their taxable income. So for partners who are individuals, normal individual tax rates will be payable on their share of the partnership's net income. 48 Next lecture Taxation of Companies Private vs public companies Taxation of companies Imputation system Taxation of Trusts Introduction to trusts Flow through taxation Taxation of trusts and beneficiaries 49