Taxation – historical briefing

 1. Historical briefing
Milestones in Australia’s taxation history
• first income tax: South Australia (1884)
• Cth income taxation (1915 - a war tax)
• dual state/cth tax until WW2 when states were
squeezed out by the cth government
 attempt to standardize the legislation led to the 1936 Act
(ITAA36) - 60yrs the source of our tax law;
 still operates in conjunction with ITAA97

Taxation – historical briefing

 Historical curiosity
• Why did Australia not adopt the English legislation for
their Income Tax Acts?
• The UK model imposes tax on business profits - a net
concept (subject to statutory modifications).
Aust model only very rarely assesses profit.
Generally it assesses gross income (less deductions).

 • Most important implication of not adopting UK model is

limited application of UK case law (except in relation to
common tax issues such the meaning of income, source
and residency issues etc).

Taxation – constitutional issues

 Constitutional basis
• Cth power to tax derives from s55 of the
Australian Constitution
 power ‘to make laws with respect to taxation’;
 Provides that ‘laws imposing taxation shall deal
with one subject of taxation only’
 more than 40 pieces of legislation dealing with
matters of income taxation.
 no constitutional barrier to state income tax

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 2. Sources of law
 2. Sources of tax law
i) Statutory law
ii) Case law
iii) Australian Tax Office [ATO] rulings
 Statutory law: subject to Constitution,
parliament can make or unmake laws with
respect to taxation
 primary source of law in the sense that
law arising from other sources is overruled
by statute law.

2. Sources of law
 • Case law; makes sense of statute law
– ie, it interprets the law.
 It also makes law in the sense that it fills
‘statutory vacuums’
~ Consider the leading words of ITAA97 s6-5(2)
[the principal assessing provision]
 ‘If you are an Australian resident, your assessable
income includes the ordinary income you derive
directly or indirectly from all sources .....’

2. Sources of law
 Only assessable income is defined in the Act.
~ Other words - most importantly ordinary income
derive their meanings as the courts decide cases
brought before them.

 • These ‘statutory vacuums’ mean that, although

statute law is the primary source of law, a good
deal of the study of tax is devoted to case law in
the search for a meaning of terms.

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 2. Sources of law
 • ATO Rulings:

~ Since 1992 the ATO is a formal source of

law through legally binding Taxation
Rulings.
 [IT; TD; TR – see www.ato.gov.au]

Legal method
 Our aim is:
1st to distill the principles (by examining the leading cases)
2nd to apply the principles to given fact situations

 Our method is:

1st to identify the issue
[eg: is the receipt income, capital, a mere gift, a windfall gain etc?]

2nd to examine the authorities

[eg: what principles govern receipts of this type?]

3rd to apply the principle to the facts of the present case

eg: can the facts of this case (or question) be distinguished

3. Tax Reform Process

 3. The tax reform process
• 1936 Act was in danger of collapse
• 1993: Tax Law Improvement Project [TLIP] was set up - to
restructure, rewrite and renumber tax laws

 ITAA97, but process incomplete

 So, remains of ITAA36 operates concurrently with new ITAA97

[TLIP has been overtaken by the reform process

 A New Tax System [ANTS]
• ANTS: Goods & Services tax; ABN linking into a new PAYG system;
Simplified Tax system [STS] for small businesses; SBE;
Ralph Report; Henry Review; Carbon Tax; Mining Tax etc.

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 4. Demystifying the Acts
 4. Demystifying the Acts
From ITAA36 to ITAA97
 i) Organisation

In general, ITAA97 covers:

income & deductions, depreciation, trading stock and capital gains

 ITAA36 still covers

partnerships, companies (in part) and trusts, together with some
administrative matters

 [ITAA36 covers dividends but the imputation provisions are in ITAA97.]

 Separate legislation covers fringe benefits, tax administration (such as
appeals).

Demystifying the Acts

 ii) Organisation of the 1997 Act

~ ITAA97 is designed to be read as one might read a book;

• Ch 1: Core provisions and checklists [assessable income and
deductions]  s1 to 13; central provisions are s6 and s8
• Ch 2: General provisions [trading stock, depn, CGT]
• Ch 3: Specialist provisions [eg: Superannuation]: in due course it will
cover anti-avoidance rules and taxation of particular entities such as
Partnerships and Trusts
• Ch 4: Dictionary of terms; Administration, etc. [note s995-1]

 [Note: The Taxation Administration Act contains collection & recovery

provisions, penalties and administration.]
 An attempt is made to represent as a pyramid this proposed structure
in s2 of ITAA97.

Rates of tax
 Tax rates - Income Tax (Rates) Act;
[2012/13] (Resident individuals)
Tax Income Tax MRT
0 - 18,200 nil
18,200 - 37,000 19% income > 18,200
37,001- 80,000 3,572 + 32.5% income > 37,000
80,001 - 180,000 17,547 + 37% income > 80,000
180,000 + 54,547 + 45% income >180,000

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 Rates of tax
 EG: TI: 85,000: 18,200 - tax free threshold
18,800 x 19% = 3,572
43,000 x 32.5% = 13,975
5,000 x 37% = 1,850
85,000 19,397
 [plus 1.5% medicare]*

 OR: Tax on 80,000 = 17,547

+ 5,000 x 37% = 1,850 = 19,397
 • Average rate of tax: 19,400/85,000 = 23.8%
 • Marginal rate of tax = 37%
 Companies: 30% flat rate; Trusts: various

Medicare levy
 Medicare Levy
*Medicare levy: applies @ 1.5% on taxable income
to resident individuals (and some trustees)
- does not apply on income below [2011/12]
$19,404 [$22,829]; $30,451 (pensioners)
- Medicare surcharge applies to individuals with
[2012/13] income > $84,000 who do not have
private medical coverage.
 A flood levy applied in 2011/12.

Tax offsets
 Offsets - rebates/credits: [franked dividends]
 low income offset: $445 [2012/13] for TI <
$37,000; reduces by 1.5c/$1 for income >
$37,000.
 So, in effect, ‘tax free threshold’ is $20,542.
[That is, tax 18,200 = nil; tax on 2,342 x 19% = $445 - offset = nil]
 Note: a tax offset reduces your tax; a tax
deduction reduces your taxable income
 See non-residents rates
~ no ‘tax free threshold’
~ threshold pro rata for part year residents

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 5. Tax Equation
 5. The Tax Equation; s4-15

 Assessable income
minus Deductions
= Taxable income x Tax Rate
+ levies - offsets

5. Tax Equation
 INCOME
Ordinary & Statutory
~ source, residence; exempt income

 DEDUCTIONS
General & Specific
~ nexus with assessable income

Tax system
 So, a snapshot of the two Acts operating
concurrently can be presented as follows
 s4-1 of ITAA97 imposes tax ;
[but remaining machinery provisions from ITAA36]
 s161 requires tax return
 s166 assessment
 s174 assessment served
 s175A appeal

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 Collection of tax
 Collection of Tax [overview]

 From July 2000:

A New Tax System (Pay As You Go) Act, 1999 [PAYG]
Designed to collect all income tax as well as Medicare or HECS

 Tax Administration Act, 1953 [TAA] under two headings:

• TAA Schedule 1, Part 2-5: withholding tax system

 objective ‘the efficient collection of’ income tax

Payers must give a payment summary that, for an employee,

replaces the familiar ‘group certificate’.

Collection of tax
 • TAA Schedule 1, Part 2-10: tax instalment system
– replaces the former provisional tax and the company instalment
systems]
– monthly or quarterly reporting of instalment income via the
Business Activity Statement
[BAS – GST taxpayers or
Instalment Activity Statement [IAS non-GST].

 Features a ‘running balance account’ [RBA]; withholding or

instalment amounts remitted to the Commissioner and
credited against the taxpayer’s tax debts.
Excess credits are refunded and any deficit is payable.

6. Language & Definitions

 6. Language & definitions
Tax language derived its meaning from two places:
~ definitions: ITAA36 s6(1)
ITAA97 s995-1 [defined terms marked *]
~ defined terms = technical terms

 If a word is not defined it takes on its normal or ordinary

meaning
~ normal/ordinary use?
 found in dictionaries or commercial parlance
 ultimately decided by the courts

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 6. Definitions & Language
 Sometimes, technical terms build on normal usage:
eg ITAA97 s70-10:
trading stock includes anything produced, manufactured
or acquired that is held for ... sale...
 Sometimes definitions are definitive:
eg ITAA36 s6(1):
taxpayer means a person deriving income or deriving
profits or gains of a capital nature.
 Sometimes both apply:
eg ITAA36 s6(1):
resident means (a) a person who resides in Australia
and includes a person (i) [of Australian domicile]…

7. Structure of the Act

 7. Structure of the ITAA (1997)
~ may be regarded as a series of parallel
provisions:
 s6-5 assesses what is described as
‘ordinary income’ [or ‘judicial income’];
 s6-10 covers ‘statutory income’ (series of
provisions bring specific items into s6-10:-
- eg: s102-5 makes a net capital gain
part of assessable income.)

7. Structure of the Act

 Note: an amount that is both statutory and
ordinary income is assessable only once: s6-25
 under the more specific provision [generally]

 ordinary or judicial income

 income deriving from the courts
 statutory income
 income deriving from specific sections

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 Non-assessable & Exempt income
 Non-assessable & exempt income
• an amount that is neither ordinary nor statutory
income is not assessable;
- eg, mutual receipts; a mere gift
 Do not describe such amounts as ‘exempt’
income. These are simply not income.
 Exempt income is a technical term.
• exempt income is an amount excluded from
assessable income even though otherwise it is
either ordinary or statutory income.

7. Structure - deductions
 Similarly, deductions are divided into two groups
~ general deductions  ITAA97 s8-1
~ specific deductions  ITAA97 s8-5
(including:-
ITAA97 Div 25: allowing & qualifying
ITAA97 Div 26: specific denying
ITAA97 Div 40: depreciation
ITAA97 Div 70: trading stock

7. Structure of the Acts

 Preventing overlap

 In regard to income provisions, (generally)

the specific provision applies: double
taxation is precluded by s6-25 ITAA97
 In regard to deductions, by virtue of s8-10
ITAA97, the ‘appropriate’ section applies so
no double deductions allowed.

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 Income - exercise
 ITAA36 s6(1):
income from personal exertion means income consisting of
earnings, salaries, wages, commissions, fees, bonuses, pensions
….received in the capacity of employee or in relation to any
services rendered, the proceeds of any business carried on by the
taxpayer alone or as a partner…but does not include
interest, unless the taxpayer’s principal business consists of the
lending of money…..
rents, dividends
income from property means all income not being income from
personal exertion.

Income - exercise
 Exercise
~ refer to definitions of ‘income from personal
exertion’ & ‘income from property’ [see above]
i) Could you define ‘income from property’?
[‘all income not being income from personal exertion’]

ii) What would you include in the category?

iii) If ‘income’ was to be defined, what would

you include/exclude?

Income - exercise
 Consider the following cases [ See p9 -10 Lecture Guide]
FCT v Rowe (1997) 97 ATC 4317
~ Are recoveries of formerly deductible amounts ipso facto
income?
Held: The High Court (unanimously) - no such general principle.
~ Was Rowe’s receipt income? Majority [4/3] said No.

 FCT v Cooling 90 ATC 4472

~ Was a ‘lease incentive’ ordinary income?
Held: The Full Federal Court: amount was assessable income.

[Ten years later the issue was reconsidered in Montgomery’s case and
the High Court held 4/3 that the receipt was income.]

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 Ordinary income concepts
 “the ordinary concepts and usages of
mankind.” Scott v C of T (NSW) (1935)
 Economists’ view:
- income is a gain: (W1- W0) + C1
- if wealth does not change: Y = C.
- if consumption is nil: Y = ∆W
~ problems arise in taxing ‘gains’, especially
unrealised gains. [Other taxes required?]

Ordinary income concepts

 Accountants’ view:
~ income = profit [Revenue - Exps].
‘Ordinary income’ is not the same as profit;
- ‘profit’ is generally a net concept;
Act’s focus is income [minus deductions]

 Understanding why ‘income’ is not the same as

‘profit’, when profit can be income and what
important differences there may be between the
two concepts can be gleaned only by an
examination of court decisions.

Ordinary income concepts

 So,
* do not confuse credits in a P&L A/c with
‘income’ or assessable income
* deductions not the same as P&L debits
* neither ‘income’ nor ‘taxable income’ is
the same thing as profit
* ‘income’ is ‘what comes in’!

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 Ordinary income concepts
 Ordinary concepts and usages
- Ordinary concepts might begin with dictionary
definitions and commercial practices.
- Generally income’s seen as:

• as remuneration for employment or provision of

personal services;
• as a reward from carrying on a business;
• as a return on investments.

Ordinary income exercise

 Consider the following late C19th UK case:
- Tennant v Smith

Facts: Mr Tennant was a bank officer who occupied rent free premises
owned by a bank where he lived and from which he transacted after-
hours business. He could not sublet the house and was obliged to quit
the premises on ceasing employment. The relevant English Tax Act
imposed tax on ‘salaries, fees, wages, perquisites or profits’ arising
from office and the Surveyor of Taxes included in Mr Tennant’s income
a sum of £50 representing the annual value of the rent free
accommodation.

 i) Would that benefit be ordinary income?

 ii) Would (or should) the position be any different in the C21st? [Refer:
FCT v Cooke & Sherden (1980)]

Ordinary income exercise

 Held: The amount was not liable to tax. Lord
Watson said:
‘I do not think [the rent free accommodation]
comes within the category of profits ... ,
because that word in its ordinary acceptation,
appears to me to denote something acquired
which the acquirer becomes possessed of and
can dispose of to his advantage - in other words,
money - or what can be turned to pecuniary
account.

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 Ordinary income exercise
 Lord Macnaughten said:

‘Income tax is a tax on income in the proper sense of the word. It

is a tax on what ‘comes in’ - on actual receipts....No doubt if [the
taxpayer] had to find lodgings for himself he might have to pay
for them. His income goes further because he is relieved from
that expense. But a person is chargeable for income tax ... not on
what saves his pocket, but on what goes into his pocket.’

  in other words, an amount not convertible into money is

not ordinary income  judicial income

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